Importance of Ratio Analysis
It helps in evaluating the firms performance:
With the help of ratio analysis conclusion can be drawn regarding several aspects such as financial health, profitability and operational efficiency of the undertaking. Ratio points out the operating efficiency of the firm i.e. whether the management has utilized the firm’s assets correctly, to increase the investor’s wealth. It ensures a fair return to its owners and secures optimum utilization of firms assets
It helps in inter-firm comparison:
Ratio analysis helps in inter-firm comparison by providing necessary data. An interfirm comparison indicates relative position.It provides the relevant data for the comparison of the performance of different departments. If comparison shows a variance, the possible reasons of variations may be identified and if results are negative, the action may be intiated immediately to bring them in line.
It simplifies financial statement:
The information given in the basic financial statements serves no useful Purpose unless it s interrupted and analyzed in some comparable terms. The ratio analysis is one of the tools in the hands of those who want to know something more from the financial statements in the simplified manner.
It helps in determining the financial position of the concern:
Ratio analysis facilitates the management to know whether the firms financial position is improving or deteriorating or is constant over the years by setting a trend with the help of ratios The analysis with the help of ratio analysis can know the direction of the trend of strategic ratio may help the management in the task of planning, forecasting and controlling.
It is helpful in budgeting and forecasting:
Accounting ratios provide a reliable data, which can be compared, studied And analyzed.These ratios provide sound footing for future prospectus. The ratios can also serve as a basis for preparing budgeting future line of action.
With help of ratio analysis conclusions can be drawn regarding the Liquidity position of a firm. The liquidity positon of a firm would be satisfactory if it is able to meet its current obligation when they become due. The ability to met short term liabilities is reflected in the liquidity ratio of a firm.
Long term solvency:
Ratio analysis is equally for assessing the long term financial ability of the Firm. The long term solvency s measured by the leverage or capital structure and profitability ratio which shows the earning power and operating efficiency, Solvency ratio shows relationship between total liability and total assets.
Yet another dimension of usefulness or ratio analysis, relevant from the View point of management is that it throws light on the degree efficiency in the various activity ratios measures this kind of operational efficiency.
Help in investment decisions
It helps in investment decisions in the case of investors and lending decisions in the case of bankers etc.