Advantages of Ratio Analysis

The advantages derived by an enterprise by the use of accounting ratios are:

1) Useful in analysis of financial statements:

Bankers, investors, creditors, etc analysis balance sheets and profit and loss accounts by means of ratios.

2) Useful in simplifying accounting figures:

Accounting ratio simplifies summarizes and systematizes a long array of accounting figures to make them understandable. In the words of Biramn and Dribin,

“ Financial ratios are useful because they summarize briefly the results of detailed and complicated computation”

3) Useful in judging the operating efficiency of business:

Accounting Ratio are also useful for diagnosis of the financial health of the enterprise. This is done by evaluating liquidity, solvency, profitability etc. Such a evaluation enables management to access financial requirements and the capabilities of various business units.

4) Useful for forecasting:

Helpful in business planning, forecasting. What should be the course of action in the immediate future is decided on the basis of trend ratios, i.e., ratio calculated for number of years.

5) Useful in locating the weak spots:

Locating the weak spots in the business even though the overall performance may quite good. Management cab then pay attention to the weakness and take remedial action. For example if the firm finds that the increase in distribution expense is more than proportionate to the results achieved, these can be examined in detail and depth to remove any wastage that may be there.

6) Useful in Inter-firm and Intra-firm comparison:

A firm would like to compare its performance with that of other firms and of industry in general. The comparison is called inter-firm comparison. If the performance of different units belonging to the same firm is to be compared, it is called intra-firm comparison. Such comparison is almost impossible without accounting ratios. Even the progress of a firm from year to year cannot be measured without the help of financial ratios. The accounting language simplified through ratios are the best tool to compare the firms and divisions of the firm.

 

 

 

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