Meaning and definition of Ratio Analysis
Ratio analysis is a tool brought into play by individuals to carry out an evaluative analysis of information in the financial statements of a company. These ratios are calculated from current year figures and then compared to past years, other companies, the industry, and also the company to assess the performance of the company. Besides, ratio analysis is used predominantly by proponents of financial analysis.
As stated by Investopedia, there are numerous ratios that can be estimated from the financial statements pertaining to a business company’s activity, performance, liquidity, and financing. Some of the most common ratios include the debt-equity ratio, price-earnings ratio, asset turnover, earnings per share, and working capital.
Benefits of Ratio Analysis
The ratio analysis forms an essential part of the financial analysis which is a vital part of business planning. The key benefits of ratio analysis include:
- Determines profitability
Ratio analysis assists managers to work out the production of the company by figuring the profitability ratios. Also, the management can evaluate their revenues to check if their productivity. Thus, probability ratios are helpful to the company in appraising its performance based on current earning.
- Helpful in evaluating solvency
By computing the solvency ratio, the companies are able to keep an eye on the correlation between the assets and the liabilities. If, in any case, the liabilities exceed the assets, the company is able to know its financial position. This is helpful in case they wish to set up a plan for loan repayment.
- Better financial analysis
Ratio analysis is also helpful to recluses, in addition to shareholders, debenture holders, and creditors. Besides, bankers are also able to know the profitability of the company to find out whether they are able to pay the dividend and interests under a specific period.
- Performance analysis
Ratio analysis is also helpful in analyzing the performance of a company. Through financial analysis, companies can review their performance in the past years. This is also helpful in identifying their weaknesses and improving on them.
At present, many companies use ratio analysis to reveal the trends in production. This provides them an opportunity for estimation of future trends and thus the foundation for budget planning so as to determine the course of action for the growth and development of the business.