Advantages of Ratio Analysis:
Ratio is an expression of one number in relation to another. Ratio analysis is the procedure of formative and interpreting the mathematical relationship between figures of financial statements. A ratio is a mathematical relationship between two items expressed in a quantitative form. The objectives of using ratios are to test the profitability, financial position (liquidity and solvency) and the operating efficiency of a concern.
Ratio analysis is an important technique in financial analysis. It is a means for judging the financial soundness of the concern. The advantages of accounting ratios are as follows:
- It is a useful device for analyzing the financial statements. This helps the banks, insurance companies and other financial institutions in lending and making investment decisions.
- It simplifies, summarizes the accounting figures to make it understandable. They highlight the inter-relationship which exists between various segments of the business as expressed by accounting statements.
- It helps in financial forecasting. This trend helps in setting up future plans and forecasting. For example, expenses as a percentage of sales can be easily forecasted on the basis of sales and expenses of the past years.
- It facilitates interfirm and intrafirm comparisons. The best way of inter-firm comparison is to compare the relevant ratios of the organization with the average ratios of the industry.
Ratio analysis is useful in finding the strength and weakness of a business concern. After identifying the weakness, the ratios are also helpful in determining the causes of the weakness.