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ABOUT RATIO ANALYSIS
Ratio Analysis is a quantitative review of knowledge which contains a company, or an organization’s financial reports. This type of analysis is based on line items in financial statements like the balance sheet, and income statement the ratios of one element or a combination of parts to another part or sequence are calculated. Ratio analysis is utilized to assess various features of a company’s functioning systems and financial representation such as its efficiency, profitability, liquidity, and solvency. The drift of these ratios over time is studied to examine whether they are developing or degenerating. Ratios are also correlated across different organizations in the same division to see how they accumulate, and to get an opinion of relative appraisals. Ratio analysis is mainly the foundation of Fundamental Analysis.
Ratio analysis can present an early warning of a possible improvement or decline in a company’s financial condition or performance. Investigators analyze and engage in extensive number-crunching of the business data in an enterprise’s periodically financial records for any such hints. Wealthy corporations have fixed ratios in all areas, and any signs of weakness in a zone may spark a notable sell-off in the stock. Certain ratios are approximately examined because of their pertinence to an individual sector like for example an inventory turnover ratio is required for the retail sector and DSOs which is formerly known as The Days Sales Outstanding for technology organizations.
As we have stated that Ratio Analysis is a form of Financial Statement Analysis this is used mainly to obtain a quick indication of a business entities financial performance in various areas. These ratios are categorized as short-term solvency ratios, asset management ratios, market value ratios and debt management ratios. The data, which are implemented by financial statements, are easily available. The calculation of ratios helps in comparing business entities which vary in size. Ratios can be used to analyze a firm’s financial enforcement with industry standards. Besides, ratios can be utilized in the form of course analysis to identify fields where performance has developed or deteriorated over time. Because Ratio Analysis is ignoble upon Accounting information, its effectiveness is defined by the perversions which result in financial reports due to such things as Historical Cost Accounting and increase. Hence, Ratio Analysis should only be practiced as the first step in the financial outline, to achieve a quick indication of a firm’s representation and to identify areas which need to be examined and reviewed further scrutiny.
IMPORTANCE OF RATIO ANALYSIS
Effective planning on financial management are the key roles in running any small or big time business entity successfully. The work of ratio analysis is a simple way to understand the financial statement and its analysis; this even helps in understanding the position of the business or that of an organization. In this study, we will also that lenders, as well as investors, mainly relies on this analytical system as this helps in making any type of lending or investing decisions. Below are some of the important pointers which will help us to understand that why ratio analysis is required in our daily lives as for why it’s required in businesses and other industrial sectors. They are as follows:-
- COMMON SIZE COMPARISON OF RATIOS
- Common size ratios are essential for making correlations of assets as well as of liabilities. These business or financial ratios concentrate on estimating each asset on the balance sheet as a portion of entire assets and each debt as a portion of total liabilities added owner’s equity. Determining and comparing common size ratios for similar reporting periods in two following years helps us to identify trends such as declining cash and growing accounts receivable steadiness. Financial planning intentions might then incorporate strengthening the company’s accounts receivable, and collection policy.
- CASH AND LIQUIDITY RATIOS
- Cash and liquidity ratios help circumscribe whether you can support in investing capital assets or long-term market growth. A working capital and current ratio both are helpful for evaluating whether a business has sufficient liquidity to pay for daily functioning and short-term debt investments. For example, a current ratio matches current liabilities to current assets. A ratio of 6 to 1 intimates a business entity whether it is sufficiently liquid or not. At this position, one can begin consolidating market or capital investments into a business strategy.
- VERSATILITY OF RATIO ANALYSIS
- Ratios are crucial quantitative analytical tools. One of the most significant functions lies in their potential to act as staggering indicators in distinguishing positive and negative economic market drifts. The message a trend analysis presents allows to us to make and achieve continuing financial systems, whenever required. Course improvements are required for short-term financial plans, and ratio analysis grants access us to distinguish the financial status of business against other businesses within an enterprise. The sheer quantities of available financial ratios deliver outstanding research work and help in choosing ratios most applicable to run a business successfully.
- TURNOVER RATIOS
- Turnover ratios and operating expenses are important for helping in assessing how efficiently an individual can run a business by employing assets and operating liabilities. An operating expense ratio corresponds to that of operating expenses such as inventory purchases and advertising. While a low ratio symbolizes that the business is operating expenses successfully, a high ratio indicates the need to course correct continuing financial plans. Turnover ratios typically require deeper investigation, with both unusually high and low ratios showing cause for attention. For instance, a high inventory turnover ratio shows a need to evaluate the inventory accounts, because the business could be missing sales due to regular stock-outs.
TYPES OF RATIO ANALYSIS AND A BRIEF DESCRIPTION ABOUT THEM
There are various financial ratios to examine different features of a business fiscal position, production and cash flows. Financial ratios computed and analyzed in critical situations depending on the user of the financial records. For instance, a shareholder is originally bothered about a business’s profitability and stability, and a debt-holder is concerned about its stability, liquidity, and profitability in the descending system of importance, as well as a creditor or supplier, is annoyed mainly regarding the industry’ liquidity, etc. Below are the following types of ratios and their brief descriptions, they are as follows:-
- CURRENT RATIO – The current ratio is also called as liquidity ratio that estimates a company’s capacity to pay short-term as well as long-term commitments. The current ratio measures the total current assets of a company relevant to that of an organization’s total current liabilities. The current ratio is designated as “current” because, contrarily some other liquidity ratios, it includes all current liabilities and assets. The current ratio is also comprehended as the working capital ratio. The formula for determining Current Ratio is ( CURRENT RATIO = CURRENT ASSETS/CURRENT LIABILITIES ).
- DEBT RATIO – A financial ratio which helps in measuring the extent of consumers or a company’s leverage. Debt Ratio is mainly defined as the total ratio of short-term and long-term debt towards that of total assets generally expressed as a percentage or in decimals. This can be interpreted as the proportion of company’s assets which are yet to financed by debt. Debt Ratio is also referred as Debt to assets ratio. The formula is ( Debt Ratio = Total Debt / Total Assets ).
- PRICE EARNING RATIO – This type of ratio is required for the valuation of a company and helps in measuring the current share price relevant to it’s per-sharing earnings. Price earning Ratios is also known as earning multiple or price multiple ratio. The formula is ( Price Earning Ratio = Market Value Per Share / Earnings Per Share ).
- INVENTORY TURNOVER RATIO – This type of ratio helps in showing that how many times the stock or inventory of a company is being replaced and sold over a period. The days present in the time can then be evaluated by the help of the Inventory Turnover formula which helps to retrieve the exact results and tells that how many days are required to sell the remaining inventories so that the company can bring in or develop new stock again. The formula is ( Inventory Turnover Ratio = Sales / Average Inventory ).
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