Ratio analysis The ratio analysis is one of the powerful tools of financial analysis. It is the process of establishing and interpreting various ratios. It is with the help of ratios that the financial statements can be analyzed more clearly ad decisions made from such analysis. Meaning of Ratio A ratio is a simple arithmetical expression of the relationship of one number to another. It may be defined as the indicated quotient of two mathematical expressions. According to Accountant's Handbook by Wixon, Kell and Bedford, a ratio is an expression of the quantitative relationship between two numbers. In simple language ratio is one number expressed in terms of another and can be worked out by dividing one number into the other. A ratio can be expressed in the form of a fraction, number of times, percentage or in proportion. Nature of Ratio analysis. Ratio analysis is a technique of analysis and interpretation of financial statements. It is the process of establishing and interpreting various ratios for helping in making certain decisions. It is not an end in itself and is only a means of better understanding of financial strengths and weakness of a firm. A ratio will be meaningful only when it is analysed and interpreted. The following are the four steps involved in ratio analysis. 1. Selection of relevant data from the financial statements depending upon the objective of the analysis. 2. Solution of appropriate ratios from the above data 3. Comparison of the calculated ratios with the ratios of the same firm in the past, or the ratios developed from projected financial statements or the ratios of some other firms or the comparison with ratios of the industry to which the firm belongs. 4. Interpretation of the ratios.
Ratio analysis will be meaningful only when the analyst will consider the following factors while interpreting ratios: 1. Accuracy of financial statements 2. Clear about the objective or Purpose of analysis 3. Selection of appropriate ratios that suits the need of the analyst 4. Use of appropriate standards while analyzing ratios 5. Calibre of the analyst 6. Analyst should understand that the ratios provide only a base