Ratio analysis helps you to assess whether your business is performing well against other companies in your industry and whether it has the ability to pay off any debts it may have incurred.
It involves calculating and interpreting a variety of financial ratios to assess the company’s financial health, efficiency, profitability, and other key aspects of its operations.
Ratio analysis can be used by investors, creditors, and management to make informed decisions about the company’s financial performance and to identify areas where improvements can be made.
Examples of financial ratios used in ratio analysis include liquidity ratios, profitability ratios, efficiency ratios, and solvency ratios.
Why do we need ratio analysis?
The purpose of ratio analysis is to help you compare the performance of one company with others in the same industry, and its performance over time.
For example, you might use ratio analysis to see how a particular stock is doing relative to its peers on the stock exchange.
You might also use it to show whether your business has improved since last year’s report.
Ratio analysis can show whether a company is growing or declining.
Ratio analysis and Financial statements
Financial statements are used to draw conclusions regarding whether an organization is financially healthy or not.
The balance sheet, income statement and cash flow statements are the three primary financial statements that show an organization’s performance over time.
Ratios can be calculated using these three documents in order to assess if there has been improvement (or deterioration) over time for any given metric such as profitability or asset turnover ratio.
Types of ratio analysis
- Profitability ratios are used to measure the company’s ability to generate profits.
- Liquidity ratios measure the amount of cash a company has on hand.
- Investment ratios measure how much money is being invested in assets and how it is being allocated across different asset classes.
- Debt ratio measures how much debt a company has compared to its total assets (debt/total assets). This ratio can help determine whether or not a business is financially stable enough to handle any unexpected expenses.
- Performance ratios are used by analysts who are interested in evaluating their companies’ financial performance over time, especially when comparing them with other businesses in the same industry.
Key Points
- Ratio analysis is a tool that can be used to make sense of financial statements
- It can be used in any industry and by anyone who wants to learn more about their company’s performance.
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