Importance of Ratio Analysis
The importance of Ratio analysis lies in the fact that it presents facts on a comparative basis and enables the drawing of inference regarding the performance of a firm. Ratio analysis is relevant in assessing the performance of a firm in respect of the following aspects:
1. Liquidity Portion:
The liquidity portion of a firm would be satisfactory if it is able to meet it’s current obligations when they become due. A firm can be said to have the ability to meet it’s short maturing debt usually within a year as well as the principal. This ability is reflected in the liquidity ratios of a firm.
2. Long term Solvency
Ratio – analysis is equally useful for assessing the long term financial viability of a firm. The long term solvency is measured by the leverage or capital structure and profitability ratio which focus on earning power and operating efficiency. Ratio analysis reveals the strength and weakness of a firm.
3. Operating efficiency
Ratio Analysis throws light on the degree of efficiency in the management and utilization of its assets. It would be recalled that the various activity ratios measures this kind of operational efficiency.
4. Overall profitability
The management is constantly concerned about the over all profitability of the enterprises they are concerned about the ability of the firm to meet its short term as well as long term obligation to its creditors to ensure a reasonable return to its owners and secure optimum utilization of the assets of the firm.
5. Inter firm comparison
An inter firm comparison would demonstrate the relative portion vis-à-vis it’s competitors. If the results are at variance either with the industry average or with those of the competitors the firm can seal to identify the probable reasons and in the light take remedial measures.
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