Importance And Advantages Of Ratio Analysis

Ratio analysis is an important tool for analyzing the company's financial performance. The following
are the important advantages of the accounting ratios.
1. Analyzing Financial tatements Ratio analysis is an important techni!ue of financial statement
analysis. Accounting ratios are useful for understanding the financial position of the company. "ifferent
users such as investors# management. $an%ers and creditors use the ratio to analyze the financial
situation of the company for their decision ma%ing purpose.
&. 'udging (fficiency Accounting ratios are important for )udging the company's efficiency in terms of
its operations and management. They help )udge how well the company has $een a$le to utilize its
assets and earn profits.
*. +ocating ,ea%ness Accounting ratios can also $e used in locating wea%ness of the company's
operations even though its overall performance may $e !uite good. -anagement can then pay attention
to the wea%ness and ta%e remedial measures to overcome them.
.. Formulating /lans Although accounting ratios are used to analyze the company's past financial
performance# they can also $e used to esta$lish future trends of its financial performance. As a result#
they help formulate the company's future plans.
0. 1omparing /erformance It is essential for a company to %now how well it is performing over the
years and as compared to the other firms of the similar nature. 2esides# it is also important to %now
how well its different divisions are performing among themselves in different years. Ratio analysis
facilitates such comparison.
Advantages
1. It simplifies the financial statements.
&. It helps in comparing companies of different size with each other.
*. It helps in trend analysis which involves comparing a single company over a period.
.. It highlights important information in simple form !uic%ly. A user can )udge a company $y )ust
loo%ing at few num$ers instead of reading the whole financial statements.
+imitations
"espite usefulness# financial ratio analysis has some disadvantages. ome %ey demerits of financial
ratio analysis are3
1. "ifferent companies operate in different industries each having different environmental conditions
such as regulation# mar%et structure# etc. uch factors are so significant that a comparison of two
companies from different industries might $e misleading.
&. Financial accounting information is affected $y estimates and assumptions. Accounting standards
allow different accounting policies# which impairs compara$ility and hence ratio analysis is less useful
in such situations.
*. Ratio analysis e4plains relationships $etween past information while users are more concerned a$out
current and future information.
,ritten $y O$aidullah 'an
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