Financial Ratio Analysis

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Meaning of Financial Ratio and Financial Ratio Analysis

Financial ratios are routinely expressed measures to describe the significant relationship that exists between figures shown in income statements of companies normally spoken in the form of times, proportion, and percentage. The standard ratios a manager uses to evaluate a firm’s overall financial condition are financial ratios. Thus the ratio that is used to quantify the relationship between two or more financial data that are taken from different financial statements is known as financial ratios. Financial ratios provide information relating to the firm’s strength, weaknesses in various aspects of a firm’s performance. Financial ratios are important tools for financial statement analysis of a firm. The systematic use of financial ratios to analyze and interpret the financial statements so that the strength and weaknesses of a firm can be determined is known as financial ratio analysis.

The financial analyst uses financial ratios to compare the strengths and weaknesses of other companies to measure against the industry average or the past figures of the company.

Objective and Use of Financial Ratios

Ratio analysis is one of the most commonly used techniques in the analysis of financial statements and evaluation of managerial performance. The analysis points out the problems, if there are any in any areas of business and provides a basis to recommend corrective actions. Many parties often refer to financial ratios to keep track of their investment performance or for some other reasons for their interest. The stakeholders, who want to make sure that the business operation is being carried out properly and the results are within the expected range, examine financial statements using various ratios. Thus, ratio analysis is a technique that helps stakeholders for fulfilling their financial purpose.

Therefore, in general objectives of ratio analysis are; To examine

  • Liquidity position
  • Operating efficiency
  • Financial leverage
  • Earning power
  • The market value of the company  

Such various aspects of firms are examined by testing the following types of financial ratios.

Types of Financial Ratios

Financial ratios can be classified as below:

  • Liquidity ratios- examine the liquidity position of the company
  • Assets management ratios-examine operating efficiency
  • Debt management ratios-examine financial leverage
  • Profitability ratios-examine earning power
  • Market value ratios-examine market value

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