Ratio Analysis

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Recommended: Chapter 4 analysis of financial statements

Ratio Analysis Ratio analysis is a process of determining and presenting the relationship of items and groups of items in the financial statements so as to provide information to the financial statements in a concise form. In the words of Myres, “ Ratio analysis is largely a study of relationship among the various financial factors in a business as disclosed by a single set of statements and a study of the trend of these factors as shown in a series of statements.” Advantages of ratio analysis It facilitates the comprehension of financial statements and evaluation of several aspects such as financial health, profitability and operational efficiency of the undertaking. It provides the inter-firm comparison to measure efficiency and helps the management to take remedial measures. It is also helpful in forewarning corporate sickness and helps the management to take corrective action. Trend analysis with the use of ratios helps in planning and forecasting. It helps in investment decisions in the case of investors and lending decisions in the case of bankers and financial institutions. Disadvantages of ratio analysis Ratios are an attempt to make an analysis of the past financial statements; so they are historical documents. Now days keeping in view the complexities of the business, it is important to have an idea of the probable happenings in future. Changes in price levels make comparison for various years difficult. For example, the ratio of sales to total assets in 1999 would be much higher than in 1980 due to rising prices. Types of Ratio 1.ROCE 2.Gross Profit 3.Operating Ratio 4.Price Earning 5.Dividend Ratio 6.Fixed Asset Ratio 7.Stock Turnover Ratio 8.Creditor Turnover 9.Debtor Turnover 10.Liquidity Ratio 11.Quick Ratio ... ... middle of paper ... ...olders equity+ long-term debts Example: Ordinary share capital for the year = $ 500000 8% preference share capital for the year =200000 Profit for the year = 300000 Long term debts for the year =400000 Debt/equity ratio= 400000 *100=28.75% 1000000+400000 Explanation: This is the most important ratio and is usually used by the log term financiers. It represents the composition of long-term investment in capital assets by the outsiders and the owners. As per prudential regulations 60:40 is the required debt/equity ratio. This proportion reveals that in the total capital expenditure the financiers & 40% by the owners have contributed 60%. This proportion gives a reasonable security to the lenders. References Advance Accounts Volume 1 by M.C.Chukla Frank wood’s Business Accounting 7th Edition Financial Accounting by PBP

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