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Meanings, Nature and Usefulness of Ratios Analysis:

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Meanings of Ratio:

According to J. Batty, "The term accounting ratios is used to describe significant relationships which exist between figures shown in a balance sheet, in a profit and loss account, in a budgetary control system or in any other part of the accounting organization"

In simple words, "Ratio" is the numerical relationship between two variables which are connected with each other in some way or the other. Ratios may be expressed in any one of the following manners

As a number the relationship between 500 and 100 may be expressed as 5(500 divided by 100).

As a fraction the above may alternatively be expressed as former being 5 times of the latter or latter being 1/5th of the former.

As a percentage the relationship between 100 and 500 may be expressed as 20% of the latter (100/500 x 100) = 20%.

As a proportion the relationship between 100 and 500 may be expressed as 1 : 5. Ratio analysis facilitates the presentation of information of financial statements in simplified, concise and summarized form.

Nature of Ratio Analysis:

Ratios, by themselves, are not an end but only one of the means of understanding the financial health of a business entity. Ratio analysis is not capable of providing precise answers to all the problems faced by any business unit. Ratio analysis is basically a technique of:

1. Establishing meaningful relationship between significant variables of financial
statements and
2. Interpreting the relationships to form judgment regarding the financial affairs of the unit.

Usefulness of Ratio Analysis:

Usefulness of ratio analysis depends upon identifying:

1. Objective of analysis
2. Selection of relevant data
3. Deciding appropriate ratios to be calculated
4. Comparing the calculated ratios with norms or standards or forecasts; and
5. Interpretation of the ratios
More study material from this to

More study material from this topic:

 Meanings, Nature and Usefulness of Ratios Analysis Interpretation of Ratios Important Factors for Understanding Ratios Analysis Significance and Usefulness Ratios Analysis Classification of Ratios Analysis of Short Term Financial Position or Test of Liquidity Current Ratio Quick/Acid Test/Liquid Ratio Absolute Liquid Ratio Inventory/Stock Turnover Ratio Debtors / Receivable Turnover Ratio Creditors / Payables Turnover Ratio Working Capital Turnover Ratio Profitability Ratios Gross Profit Ratio (GP Ratio) Operating Profit Ratio Net profit ratio (NP ratio) Earnings Per Share Ratio Operating ratio Expense ratio Solvency ratios - Test of Long Term Solvency Debt-equity Ratio Debt Service Ratio or Interest Coverage Ratio Fixed Assets Ratio Debts to Total Funds or Solvency Ratio Reserves to Capital Ratio Capital Gearing Ratio Proprietary Ratio Accounting Ratios Formulas Limitations of Ratios Analysis

A D V E R T I S E M E N T

 Financial Accounting Topics Introduction to Accounting ---------------------------------------------------------------------------- Transactions and Accounting Equation ---------------------------------------------------------------------------- Analysis of Business Transactions ---------------------------------------------------------------------------- Journal, Ledger and Trial Balance ---------------------------------------------------------------------------- Accounting for Bills of Exchange ---------------------------------------------------------------------------- Special Journals ---------------------------------------------------------------------------- Cash Book ---------------------------------------------------------------------------- Bank Reconciliation Statement ---------------------------------------------------------------------------- Final Accounts ---------------------------------------------------------------------------- Work Sheet ---------------------------------------------------------------------------- Capital and Revenue Items ---------------------------------------------------------------------------- Valuation of Inventories ---------------------------------------------------------------------------- Accounts of Non-profit Making Organizations ---------------------------------------------------------------------------- Statement of Cash Flows ---------------------------------------------------------------------------- Accounting Ratios Analysis ---------------------------------------------------------------------------- Depreciation, Provisions and Reserves ---------------------------------------------------------------------------- Accounting Dictionary ---------------------------------------------------------------------------- Financial Calculators

 Managerial Accounting Topics Financial Statements ---------------------------------------------------------------------------- Cost Volume Profit Relationship ---------------------------------------------------------------------------- Variable Costing System ---------------------------------------------------------------------------- Materials and Inventory Cost Control ---------------------------------------------------------------------------- Activity Based Costing System ---------------------------------------------------------------------------- Standard Costing and Variance Analysis ---------------------------------------------------------------------------- Balanced Scorecard ---------------------------------------------------------------------------- Capital Investment Analysis/Capital Budgeting