RATIOS ANALYSIS A tool used by individuals to conduct a quantitative analysis of information in a company’s financial statements. Ratios are calculated from current year numbers and are then compared to previous years, other companies, the industry, or even the economy to judge the performance of the company. (Source: Investopedia)
ADVANTAGES OF RATIO ANALYSIS • It simplifies financial statements • It helps in comparing companies of different size with each other • It helps in trend analysis which involves comparing a single company over a period • It highlights important information in a simple to use form quickly. A user can judge a company by just looking at a few numbers instead of reading the whole financial statements
LIMITATIONS OF RATIO ANALYSIS • One ratio result is not very helpful. Comparisons need to be made. • May be difficult to compare firms in different industries. • Trend analysis need to take into account changing circumstances over time which could have affected theratio results. • Ratios are only concerned with accounting items to which a numerical value can be given. There are qualitative factors to consider.
TYPES OF RATIOS • Liquidity Ratios • Profitability Ratios • Efficiency / Activity Ratios • Gearing / Solvency Ratios • Investors/ Shareholders Ratios
TIPS ON RATIO ANALYSIS • Once you have calculated your ratios, do not restate the figures seen if doing an evaluation but instead look at the differences. • Once a comparison is made, make inferences about the reason why the ratios are as they are. • Ensure that you remember basic financial statements • These are NOT ALL ratios, they are only the ones on the syllabus. A ratio is any form of comparison between figures and therefore you can be asked to calculate anything. Eg Wages to Sales Ratio.