RATIO ANALYSIS: Meaning, Definition, Importance/Advantages and Limitations/Disadvantages

In this article we will discuss about RATIO ANALYSIS: Meaning, Definition, Importance/Advantages and Limitations/Disadvantages.


RATIO ANALYSIS: Meaning, Definition, Importance/Advantages and Limitations/Disadvantages.

Ratio analysis refers to an analytical process in which the financial statements are analyzed. Ratio analysis helps to compare between current performances with previous. It compares the company performance with its other competitors. It is widely used as a powerful tool of financial statement. It helps to examine company performance and to analyses position of company. It also helps to identify and monitor company issues.

Advantages/Importance of Ratio analysis

  1. Analysis of financial position: Ratio analysis is an analytical process which helps to analysis of financial position of business organization.
  2. Comparison of performance: It helps to compare between current performances with previous and helps to ascertain financial statements.
  3. Measurement of operating efficiency: It also helps organization to measure efficiency and helps to identify and monitor company issues.
  4. Inter-firm comparison: This process helps business organization to compare its performance with other organization. The best way of inter-firm comparison is to compare the relevant ratios of the organisation with the average ratios of the industry.

Disadvantages/Limitations of ratio analysis

  1. Historical information: Ratio analysis provides historical information and it is safe as proof but it doesn’t effect current  conditions.
  2. Lack of standard of comparison: There is a lack of standard comparison  and no fixed standardize ration laid down from current information.
  3. Ratio analysis explains relationships between past information while users are more concerned about current and future information.
  4. Window dressing: It means an arrangement which present financial statement in such a way which show better position then its actual position. It is a technique used by companies and financial managers to manipulate financial statements and reports to show more favorable results for a period.
  5. Quantitative analysis: In ratio analysis only quantitative ratios are taken but qualitative ratios are ignored in this process.

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