What is Ratio Analysis

Meaning of Financial Statements

What is Ratio Analysis

The term financial statements refers to two basic statements which an accountant prepares at the end of an accounting period for a business enterprise. These are:

1. Balance Sheet (or Statement of Financial Position) which reflects the assets, liabilities and capital as on a certain date, and
2. Profit and Loss Account (or Income Statement) which shows the results of operations i.e. profit or loss during a certain period.

Ratio Analysis of Financial Statements

Ratio analysis of financial statements means to determine the significance and meaning of the data presented in financial statements. Such an analysis makes use of various analytical tools and techniques to the data of financial statements so as to derive from them certain relationships that are significant and useful for decision making.


  

In the terms of John N. Myers, "Financial statement evaluation is largely research of the relationships one of the various financial aspects in a business like disclosed by an individual set of statements and research of the trends of these aspects as shown in a series of statements."

Thus, financial statement analysis converts the mass of data into useful information which is always in scarce supply. It pinpoints the strengths and weaknesses of a business undertaking by use of various techniques such as ratio analysis, comparative statements etc. Such analysed information is used by management, bankers, creditors, investors and others to form opinion about the operating performance and financial position of the business. Thus financial statement analysis helps in evaluating a business performance according to some specific objectives.

Quick Ratio Analysis

Ratio analysis is a very powerful and most commonly used tool of analysis and interpretation of financial statements. It concentrates on the inter-relationship among the figures appearing in the financial statements. Ratio analysis helps to analyse the past performance of a company and to make future projections.

It enables various interested events such as shareholders, management, government, potential investors creditors, along with other analysts to create an evaluation of the different aspects of companys efficiency from their own viewpoint and interest. For instance, shareholders and management might be interested in the companys success while debenture holders and creditors may be fascinated in the solvency of the organization.

Meaning of Ratio

A ratio is simply one number expressed in terms of another number. In other words, a ratio expresses mathematical relationship between one number and another. For example, the ratio of 200 to 100 is expressed as 2:1 or as 2. Thus a ratio is calculated by dividing one figure into another.