.FINANCIAL RATIO ANALYSIS
Introduction
The
financial statement contains a wealth of information and it provides valuable
insight into a firm’s financial performance and position. The balance sheet and
income statement provides an overview financial background which is not
sufficient information to creditors and investor to make their investment
decision exactly; they need detailed and careful investigation about the
financial condition of firm. The comprehensive assessment of financial
statement exhibits company’s strength and weakness. For this purpose ratio
analysis is far the most widely used tool. Different ratios are used for
different purposes which are calculated from the accounting data contained in
the financial statement.
Ratio
analysis is indispensable part of interpretation of results revealed by the
financial statements. It provides users with crucial financial information and
points out the areas which require investigation. Ratio analysis is a technique
which involves regrouping of data by application of arithmetical relationships,
though its interpretation is a complex matter. It requires a fine understanding
of the way and the rules used for preparing financial statements.
Meaning of ratio
As ratio
represent a relationship between figures or it comparison of the numerator with
denominator. The term ratio refers to the numerical or quantitative relationship
between two figures.
A financial ratio is defined as relationship
between two variables taken from a financial statement of a concern. It is a
mathematical yardstick that measures the relationship between two financial
figures. It involves breakdown for the examined financial report into
components parts which are then evaluated in relation to each other and to
exogenous standards. Ratio analysis is an instrument for diagnosis for the
financial health of an enterprise.
OBJECTIVES OF RATIO ANALYSIS
1. To know the areas of the business which need
more attention
2.
To know about the potential areas which
can be improved with the effort in the desired direction
3.
To provide a deeper analysis of the
profitability, liquidity, solvency and efficiency levels in the business
4.
To provide information for making
cross-sectional analysis by comparing the performance with the best industry
standards; and
5.
To provide information derived from
financial statements useful for making projections and estimates for the
future.
STEPS IN RATIO ANALYSIS
Set the Objectives of Ratio
Analysis
The first steps of ratio analysis is set objectives and purpose
clearly, the reason to examine financial
statement is provide some valuable information about companies strength and
weakness so for the management can take right decision according to the
situation.
Collection of Relevant
Data
The financial analyst should collect the relevant data which are
already available in the various functional areas such as sales transaction
details from sales department, financial planning, fund collection, fund
deployment and fund management details from finance department and material and
manufacturing expenses details from production department etc. Data are recorded in the monetary value
should be collected.
Select Appropriate
Information
The important task of the financial analyst is to collect and select
the information relevant to the decision under consideration from the
statements and calculates appropriate ratios.
Analysis of Information
or Ratios Calculation
The main and core step in the ratio analysis is analysis of information
or calculation of ratios. The financial statements and collected relevant
information can be analyzed by using of various financial ratios, such as
solvency ratios, profitability ratio and turnover ratio.
Compare Calculated
Ratios
Through the analysis steps each ratio can be provide some result, it is
the role of financial analyst to compare the calculated ratios with the ratios
of the same firm relating to past, other similar business concern ratio or with
the industry ratios. This step facilitates in assessing success or failure of
the firm.
Interpretation and
Reporting
This step involves interpretation, drawing of inferences and
report-writing. Conclusions are drawn after comparison in the shape of report
or recommended course of action.
Review and Decision making
Finally, the entire analysis part may be
reviewed to check whether the analysis reached or matched with objectives, and
based on interpretation report the present alternatives with comparative merits
the situation business decision can be taken.
