RATIO ANALYSIS INTRODUCTION:Ratio Analysis is the process of establishing a significant relationship between the items of financial statements to provide

a meaningful understanding of the performance and financial position of the firm. Using the term Ratio in relation of financial statements analysis, it may properly mean An Accounting Ratio or Financial Ratio, defined as the mathematical relationship between two accounting figures, having mutual cause and effect relationship to produce a meaningful and useful ratio. Ratio is a simple mathematical expression between two items in a more meaningful way which help us to draw conclusions.

MEANING OF RATIO:A ratio is a simple arithmetical expression of the relation of one number to another. It may be defined as the indicated quotient of two mathematical expressions. According to Accountants Handbook by Wixon, Kell and Bedford, a ratio is an expression of the quantitative relationship between two numbers.

IMPORTANCE OF RATIO ANALYSIS: The importance of ratio analysis lies in the fact that it presents facts on a comparative basis and enables the drawing of inferences regarding the performance of a firm Ratio Analysis in relevant in assessing the performance of a firm in respect of the following points. LIQUIDITY POSITION: With the help of ratio analysis conclusions can be drawn regarding the liquidity position of the firm. The liquidity ratios are particularly useful in credit analysis by banks and other suppliers of short-term loans. OPERATING EFFICIENCY It is relevant from the view point of management, and it throws light on the degree of efficiency in management and utilization of assets.

OVER ALL PROFITABILITY : In this, the management in constantly concerned about the overall profitability of the enterprise. They are concerned about the ability of the firm to meet its short term as well as long term obligations to creditors to ensure reasonable returns to its owners and secure optimum utilization of firms assets.

SIGNIFICANCE OF RATIO ANALYSIS: Ratios are significant in both the vertical and horizontal analysis. In vertical analysis, ratios help the analyst to form a judgment whether the performance of the firm at a given point of time is in good position or not use of ratios in horizontal analysis indicates whether the financial condition of the firm is improving or deteriorating and whether cost profitability of efficiency is showing an upward trend or downward trend.

NATURE OF RATIO ANALYSIS:Ratio analysis is a technique of analysis and interpretation of financial statements. It is the process of establishing and interpreting various ratios for helping in making certain decisions. Ratios provide clues to the financial position of the concern. These are the pointers or indicators of financial strength, soundness, position or weakness of an enterprise. One can draw conclusions about the exact financial positions of a concern with the help of ratios. Calculation of mere ratios does not serve any purpose, unless several appropriate ratios are analyzed and interpreted. The following are the four steps involved in the ratio analysis. Selection of relevant data from the financial statements depending upon the objective of the analysis Calculation of appropriate ratios from the above data Comparison of the calculated ratios with the ratios of the same firm in the past, or the ratios developed from the projected financial statement or the ratios of some other firms or the comparison with ratios of the industry to which the firm belongs

OBJECTIVES OF RATIO ANALYSIS:

UTILITY OF RATIO ANALYSIS: The ratio analysis is the most powerful tool of the financial analysis. Many diverse groups of people are interested in analyzing the financial information to indicate the operating and financial efficiency, and growth of the firm. These people use ratios to determine those

financial characteristics of the firm in which they are interested with the help of ratios, one can determine: The ability of the firm to meet its current obligations The extent to which the firm has used its long-term solvency by borrowing funds The efficiency with which the firm is utilizing its assets in generating sales revenue and The overall operating efficiency and performance of the firm

NEED AND SIGNIFICANCE OF RATIO ANALYSIS:The ratio analysis is one of the most important and powerful tools of financial analysis, to determine a particular financial characteristic of the firm. It is used as a device to analyze and interpret the financial health of an enterprise. It is with help of ratios that the financial statements can be analyzed more clearly and decisions made from such analysis. The use of ratios is not confined to financial managers only but there are different parties interested in to ratio analysis for knowing the financial position of a firm for different purposes. The supplier of good on credit, banks, financial institutions, investors, shareholders and management all make use of ratio analysis as a tool in evaluating the financial position and performance of a firm for granting credit, providing loans or making investments in the firm and can point out whether the condition is strong, good, questionable or poor. The conclusions can also be drawn as to whether the performance of the firm is improving or deteriorating.

(A) Managerial Uses of Ratio Analysis

1) Helps in decision-making: Financial statements are prepared primarily for decision-making. But

the information provided in financial statements is not an end in itself and no meaningful conclusion can be drawn from these statements alone. Ratio Analysis helps in making decisions from the information provided in these statements

2) Helps in financial forecasting and planning: Ratio analysis is of much help in financial forecasting and planning. Planning is looking ahead and the ratios calculated for a number of years work as a guide for the future. Meaningful conclusions can be drawn for future from these ratios.

3) Helps in communicating: The financial strength and weakness of a firm are communicated in a

more easy and understandable manner by the use of ratios. The information contained in the financial statements is conveyed in a meaningful manner to which it is meant. Thus, ratios help in communicating and enhance the value of the financial statements.

4) Helps in co-ordination: Ratios even help in co-ordination which is of utmost importance in

effective business management. Better communication of efficiency and weakness of an enterprise results in better co-ordination in the enterprise.

5) Helps in Control: Ratio analysis even helps in making effective control of the business.

Standards ratios can be based upon proforma financial statements and variances or deviations, if any, can be found by comparing the actual with the standards so as to take a corrective action at the right time. The weakness or otherwise, if any, come to the knowledge of the management which helps in effective control of the business.
6) Other Uses: There are so many other uses of the ratio analysis as it is an essential part of the

budgetary control and standard costing. Ratios are immense importance in the interpretation of financial statements as they bring the strength or weakness of the firm.

(B) Utility of Shareholders / Investors:

An investor in the company will like to assess the financial position of the concern where he is going to invest. His first interest will be the security of his investment and then a return in the form of dividend or interest. Long term solvency ratios will help in accessing financial position of the concern. Probability ratios, on the other hand, will be useful to determine profitability position. Ratio analysis will be useful to the investor in making up his mind whether present financial position of the concern warrants further investments or not.
(C) Utility to Creditors:

The creditors or suppliers extend short-term credit to the concern. They are interested to know whether financial position of the concern warrants their payments at a specified time or not. The concern pays shot-term creditors out of its current assets. If the current assets are quite sufficient to meet the current liabilities then the creditor will not hesitate in extending credit facilities. Current and acid-test ratio will give an idea about the current financial position of the concern.
(D) Utility to Employees:

The employees are also interested in the financial position of the concern especially profitability. Their wage increases and amount of fringe benefits are related to the volume of profits earned by the concern. The employees make use of information available in financial statements. Various profitability ratios relating to gross profit, operating profit, net profit etc., enable employees to put forward their viewpoint for the increase of wages and other benefits.
(E) Utility to Government:

Government is interested to know the overall strength of the industry. Various financial statements published by industrial units are used to calculate ratios for determining short-term, long-term and overall financial position of the concerns. Profitability indexes can also be prepared with the help of ratios. Government may base its future policies on the basis of industrial information available from various units. The ratios may be used as indicators of overall financial strength of public and private sectors.

LIMITATIONS OF RATIO ANALYSIS: The ratio analysis is one of the most powerful tools of financial management. Though ratios are simple to calculate and easy to understand, they suffer from some serious limitations:
1) Limited use of a Single Ratio: A single ratio does not convey much of a sense. To make better

interpretation a number of ratios have to be calculated which is likely to confuse the analyst than help him in making any meaningful conclusion.
2) Lack of Adequate Standards: There are no well accepted standards or rules of thumb for all

ratios which can be accepted as norms. It renders interpretation of the ratios difficult.
3) Inherent Limitations of Accounting: Like financial statements, ratios also suffer from the

inherent weakness of accounting records such as their historical nature. Ratios of the past are not necessarily true indicators of the future.
4) Change of Accounting Procedure: Changes in accounting procedure by a firm often makes ratio analysis misleading where the change in valuation of methods of inventories, which make the stock turnover ratio to be lucrative and an unfavorable gross profit ratio. 5) Window Dressing: Financial Statements can easily be window dressed to present a better

picture of its financial and profitability position to outsiders. Hence, one has to be very careful in making a decision from ratios calculated from such financial statements. But it may be very difficult for an outsider to know about the window dressing made by a firm.
6) Personal Bias: Ratios are only means of financial analysis and not an end in itself. Ratios have

to be interpreted and different people may interpret the same ratio in different ways.
7) Uncomparable: Not only industries differ in their nature but also the firms of the similar

business widely differ in their size and accounting procedures, etc. It makes comparison of ratios difficult and misleading. Moreover, comparisons are made difficult due to differences in definitions of various financial terms used in the ratio analysis.
8) Absolute figures Distortive: Ratios devoid of absolute figures may prove distortive as ratio analysis is primarily a quantitative analysis and not a qualitative analysis.

9) Price Level Changes: While making ratio analysis, no consideration is made to the changes in

price levels and this makes the interpretation of ratios invalid.

become useless if separated from the statements from which they are computed.
It is difficult to decide on the proper basis of comparison. The comparison is rendered difficult because of differences in situations of two companies or of one company over years. The price level changes make the interpretations of ratios invalid. The differences in the definitions of items in the balance sheet and the profit and loss statement make the interpretation of ratios difficult. The ratios calculated at a point of time are less informative and defective as they suffer from short-term changes.