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Ratios

Ratios

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Published by shani27
Ratio formulas & interpretation.
Ratio formulas & interpretation.

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Published by: shani27 on Jun 25, 2010
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RATIO ANALYSISMeaning and definition of ratio analysis:
Ratio analysis is a widely used tool of financial analysis. It is definedas the systematic use of ratio to interpret the financial statements so that thestrength and weaknesses of a firm as well as its historical performance andcurrent financial condition can be determined. The term ratio refers to thenumerical or quantitative relationship between two variables.
Significance or Importance of ratio analysis:
It helps in evaluating the firms performance
:With the help of ratio analysis conclusion can be drawnregarding several aspects such as financial health, profitability andoperational efficiency of the undertaking. Ratio points out theoperating efficiency of the firm i.e. whether the management hasutilized the firm’s assets correctly, to increase the investor’s wealth. Itensures a fair return to its owners and secures optimum utilization of firms assets
It helps in inter-firm comparison:
Ratio analysis helps in inter-firm comparison by providingnecessary data. An interfirm comparison indicates relative position.It provides the relevant data for the comparison of the performance of different departments. If comparison shows a variance, the possiblereasons of variations may be identified and if results are negative, theaction may be intiated immediately to bring them in line.
It simplifies financial statement:
The information given in the basic financial statements servesno useful Purpose unless it s interrupted and analyzed in somecomparable terms. The ratio analysis is one of the tools in the hands of those who want to know something more from the financialstatements in the simplified manner.
It helps in determining the financial position of the concern:
 
Ratio analysis facilitates the management to knowwhether the firms financial position is improving or deteriorating or isconstant over the years by setting a trend with the help of ratios Theanalysis with the help of ratio analysis can know the direction of thetrend of strategic ratio may help the management in the task of  planning, forecasting and controlling.
It is helpful in budgeting and forecasting:
Accounting ratios provide a reliable data, which can becompared, studied And analyzed.These ratios provide sound footingfor future prospectus. The ratios can also serve as a basis for preparing budgeting future line of action.
Liquidity position:
With help of ratio analysis conclusions can be drawn regardingthe Liquidity position of a firm. The liquidity positon of a firm would be satisfactory if it is able to meet its current obligation when they become due. The ability to met short term liabilities is reflected in theliquidity ratio of a firm.
Long term solvency:
Ratio analysis is equally for assessing the long term financialability of the Firm. The long term solvency s measured by theleverage or capital structure and profitability ratio which shows theearning power and operating efficiency, Solvency ratio showsrelationship between total liability and total assets.
Operating efficieny:
Yet another dimension of usefulness or ratio analysis, relevantfrom the View point of management is that it throws light on thedegree efficiency in the various activity ratios measures this kind of operational efficiency.
 
Classification of ratios:
Different ratios are used for different purpose these ratios can be grouped into various classes according to the financial activity.Ratios are classified into four broad categories.1.Liquidity Ratio2.Leverage Ratio3.Profitability Ratio4.Activity Ratio
1.Liquidity Ratio:
Liquidity ratio measures the firms ability to meet itscurrentobligations i.e. ability to pay its obligations and when they becomedue. Commonly used ratios are:
Current ratio: 
Current ratio is the ratio, which express relationship between currentasset and current liabilities. Current asset are those which can be convertedinto cash within a short period of time, normally not exceeding one year.The current liabilities which are short- term maturing to be met. Current ratioCurrent Asset =
Current liabilities
Acid test ratio:
The acid test ratio is a measure of liquidity esigned to overcome the

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