A financial ratio is a relationship of two values of financial statements. Ratios
basically are mathematical expressions, which are calculated to derive certain
conclusion. The ratio may be expressed as number of times, proportion or
percentage. There are number of ratios, but which to consider for a particular
type of analysis is left to the personal judgement of the analyst. As a matter of
fact, all the ratios are for different purposes and have different objectives.
Uses of Ratios.
- Ratios offer help in intra firm comparisons, industry comparison and also for inter-firm comparison.
- Financial position of the entity can be studied.
Limitations & problems of Ratio analysis:
- Ratios are based on financial statements, so contain almost all of the deficiencies of those accounts.
- Some ratios are open for manipulation and need to be interpreted with care.
- Inter-firm comparisons are faced with the problem that different organizations might use rather different accounting policies.
- Detailed knowledge of a company’s markets is seldom obtainable from the published accounts, but is extremely important for assessing future profitability.
- Ratios are useful when comparing similar organizations operating under similar conditions. Comparisons with different types of organizations can be misleading.
- There is a real danger that ratio analysis can lead to conclusions, which are over-simplified.
Types of Ratios.
Turnover Ratios:
- Debtors Turnover Ratio
- Creditors Turnover Ratio.
- Inventory Turnover Ratio.
Liquidity Ratios:
- Current Ratio
- Acid Test Ratio
Profitability
- Gross Profit Ratio
- Net Profit Ratio
- Material cost ratio
- Expenses Ratios
- Return on Capital
- Return on Proprietor’s Funds
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