QS Study

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:

  1. 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.
  2. 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.
  3. 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.
  4. 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.