Ratio Analysis Fundamentals

Ratio analysis

Rich analysis is a Quantitative method by which a company's Insights in terms of profitability, operational efficiency and liquidity could be gained by analysing its financial statements like income statement, balance sheets and other books of account. It is a fundamental way to carry out equity analysis. It makes a comparison of the line-item detail which is collected from the company’s financial statements thereby revealing its profitability, operational efficiency, liquidity and solvency. By the help of ratio analysis, one could make out how are companies performing over a certain period of time, thereby comparing two or more companies within the same sector. The ratios derived from the financial statements when paired with other Factors, provides a bigger picture of the financial condition of the company.

It is with the help of an issue analysis that investors and analysts evaluate the financial situation of a company, thereby deciding whether to invest in a particular company so that they could derive profit. Investors often use this method to understand the economic standing of a company in comparison to the industry standard of similar companies. Evaluation of the stocks offer company is a must, there by measuring the historical numbers of the company itself with its present position.  Financial ratios of a company could be divided into certain categories, like liquidity ratios, profitability ratios, Solvency ratios and efficiency ratios.

• Liquidity ratios

A company’s ability to payback its short term debts with the help of the current assets of the company Is determined with the help of liquidity ratio. Liquidity ratio is calculated to understand if a company is capable of paying off its debt, which is done by measuring the liquid assets as well as the current liabilities of the company. There are certain common types of liquidity ratios like current ratio that determines the current asset and liabilities of the company, quick ratio, cash ratio, networking capital ratio, operating cash flow ratio and cash coverage ratio.

• Solvency ratios

The solvency ratios help to evaluate the level of debts of the company by comparing it with its equity, assets, and earnings. For the long run, it helps in determining whether a company is capable of staying afloat in the market, especially after paying off its long-term debts and the interests on such debts. examples of solvency ratio include interest coverage ratios, debt assets ratios and debt equity ratios.

• Profitability ratios

The profitability ratio helps to determine how a company would be able to generate profits from its business operations. It is often used by accountants in order to evaluate a company’s earnings in respect to its expenditure. Some of the common type of profitability ratios are return on assets, earnings per share, profit margin and return on equity.

• Efficiency ratios

It is with the help of the efficiency ratios that one could evaluate how a company is capable of generating sales and increase profit making by using its assets and liabilities. It is also known as activity ratios for it help system in the activity of the business operations and determine whether it is shaping in a positive way for the benefit of the company. some of the common efficiency ratios are inventory turnover, turnover issue and days' sales in inventory.

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Importance of Ratio Analysis

Ratio analysis is extremely important for a company, especially for the investors of a company in order to evaluate and analyse its financial condition at the moment, there by studying its liquidity, profitability, efficiency, solvency risk, correct utilisation of funds and operational effectiveness. It is with the help of ratio analysis that investors make a decision whether to make an investment on a given company and whether such investments shall be profitable for them depending on the ratio analysis report and Trend Analysis Assignment Help of its financial position and trend position. In addition to that, ratio analysis is significant for the following reasons

• Analysis of the financial statements of a company
• Analysis of the operational efficiency of the company
• Helps in comparing the performance of other businesses similar to it in the market
• Helps to understand the company’s profitability
• Helps to identify the potential risks that the business may encounter
• Useful to identify beneficial planning and future forecasting of the company.

Examples of ratios used in financial analysis

Financial ratios of a company could be divided into certain categories, like liquidity ratios, profitability ratios, Solvency ratios and efficiency ratios.  

The solvency ratios help to evaluate the level of debts of the company by comparing it with its equity, assets and earnings. For the long run, it helps in determining whether a company is capable of staying afloat in the market, especially after paying off its long term debts and the interests on such debts. A company’s ability to payback its short term debts with the help of the current assets of the company Is determined with the help of liquidity ratio. Liquidity ratio is calculated to understand if a company is capable of paying off its debt, which is done by measuring the liquid assets as well as the current liabilities of the company. The profitability ratio helps to determine how a company would be able to generate profits from its business operations. It is often used by accountants in order to evaluate a company’s earnings in respect to its expenditure. Another important step is Business Plan Assignment Help for Business Plan, is the defined process of how the desired objectives of business profits can be achieved.

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Purpose and limitation of ratio analysis

The primary purpose of ratio analysis is to evaluate and determine the financial condition of a company by reading through the factors that could influence such financial position. It is with the help of ratio analysis that investors make a decision whether to invest in a particular company based on other issue analysis report of the same company.

The concept of ratio analysis, a competitive approach to evaluate the current financial health of the company is an historic model which is not updated or current. The process of ratio analysis is done by evaluating the internal factors of the company like profitability, business operations, efficiency, risks and solvency, however it does not consider the external factors common to most companies in a given market like recession. It also overlooks the aspects of human element that are constantly impacting the different situations of a company. in terms of drawing a comparison of the target company, it could only be compared with other companies similar to its business operating in the same market