Fredericton: What is Ratio Analysis?
What is ratio analysis?
Author: Ayaz Haider
Ratio analysis is the study of financial statements with respect to calculation and comparison of ratios. The resulting information can represent a company’s situation financially, operationally and prosperity of investment. This information is mainly intended to present in front of stake holders, banks and other financial institution for obtaining debts or investments.
Financial ratios are derived from company’s financial statements at any given period. An analyst can use it in preparing comparative analysis for example, take the value of GP (gross profit) and divide it with revenue then multiply with 100. It will give you a percentage that you can compare with past years to identify the trend line. Information that comes from ratio analysis is only effective if combined with a comparative study like previous example.
Financial ratio analysis is of different types according to the requirements at given scenario, following are some of them:
- Leverage analysis: It represents the amount of debt that is part of the capital.
- Liquidity analysis: It represents cash flow situation in short term.
- Operational analysis: It shows the efficiency of expenditures and asset management.
- Profitability analysis: It represents gross and net profit with respect to retained earning in capital.
- Solvency analysis: It shows the business’s ability of paying back its debt and use of cash flows.
As with any financial tool, ratio analysis has its pros and cons, they are:
- Useful to present company’s current performance in comparison to past years.
- It shows long and short term stability of company’s financials.
- Identifies key areas of strength and weakness.
- It is not suppose to be use in predicting future financial situation.
- It cannot show health of business operation and legal environment.
- It is not capable of analyzing morale and motivation of staff.
There are many online specialized firms providing ratio analysis services at affordable cot such as iSource Biz, it provides ratio analysis as well as many other financial services.
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