Business Policy and Strategy
Ratio analysis is the relationship drawn between different connected financial figures and expressed in mathematical terms. Financial ratio analysis is useful as it acts as a brief summary of the result of a complicated and detailed computation. In business computations, absolute figures are quite useful and important but one can rarely derive a meaning from them. The comparison of these related figures helps one draw meaning from them. For instance, when the figures of profits for two companies are shown, it becomes difficult to determine he efficiency of either unless other figures like sales and capital investments are shown along with them.
The analysis of and interpretation of various financial ratios gives better understanding to the performance, financial condition and the future profitability of a business entity. The importance of financial ratios can be described using the importance they have to different stakeholders of a business concern. These ratios are used by different stakeholders for different purposes of working out particular financial characteristics of the business in which they are interested. The ratios are used to determine the profitability of the business by calculating the different profitability ratios. The ratios are also used to work out the solvency of the business entity. With these solvency ratios, the relationship between the liabilities and assets is shown (Gibson, 2008).
The financial ratios help stakeholders like creditors, debenture holders, bankers and shareholders to analyze the financial statements and determine the company’s ability to satisfy their different interests. Financial ratios also help in the comparison of performance between two or more competing financial entities or between different periods of operation of the same business concern. The operating efficiency of a firm can also be determined using financial ratios. The short-term financial position of a business entity can be determined from financial ratios on the other hand, forecasting and predictions about business performance can be determined by use of financial ratios (Bull, 2007).
Gibson, C. H. (2008). Financial Reporting and Analysis. London, UK: Cengage Learning.
Bull, R. (2007). Financial ratios: how to use financial ratios to maximize value and success for your business. New York, NY: Elsevier.