Ratios as a tool of financial analysis provide symptoms with the help of
which any analyst is in a position to diagnose the financial health of the unit.
Financial analysis may be compared with biopsy conducted by the doctor on the
patient in order to diagnose the causes of illness so that treatment may be
prescribed to the patient to help him recover. As, already hinted different
groups of persons are interested in the affairs of any business entity,
therefore, significance of ratio analysis for various groups is different and
may be discussed as follows:
Usefulness to the Management:
1. Decision Making:
Mass of information contained in the financial statements may be
unintelligible a confusing. Ratios help in highlighting the areas deserving
attention and corrective action facilitating decision making.
2. Financial Forecasting and Planning:
Planning and forecasting can be done only by knowing the past and the
present. Ratio help the management in understanding the past and the present of
the unit. These also provide useful idea about the existing strength and
weaknesses of the unit. This knowledge is vital for the management to plan and
forecast the future of the unit.
Ratios have the capability of communicating the desired information to the
relevant persons in a manner easily understood by them to enable them to take
stock of the existing situation:
4. Co-ordination is Facilitated:
Being precise, brief and pointing to the specific areas the ratios are likely
to attract immediate grasping and attention of all concerned and is likely to
result in improved coordination from all quarters of management.
5. Control is more Effective:
System of planning and forecasting establishes budgets, develops forecast
statements and lays down standards. Ratios provide actual basis. Actual can be
compared with the standards. Variances to be computed an analyzed by reasons and
individuals. So it is great help in administering an effective system of
Usefulness to the Owners/Shareholders:
Existing as well as prospective owners or shareholders are fundamentally
interested in the (a) long-term solvency and (b) profitability of the unit.
Ratio analysis can help them by analyzing and interpreting both the aspects of
Usefulness to the Creditors
Creditors may broadly be classified into short-term and long term. Short-term
creditors are trade creditors, bills payables, creditors for expenses etc., they
are interested in analyzing the liquidity of the unit. Long-term creditors are
financial institutions, debenture holders, mortgage creditors etc., they are
interested in analyzing the capacity of the unit to repay periodical interest
and repayment of loans on schedule. Ratio analysis provides, both type of
creditors, answers to their questions.
Usefulness to Employees:
Employees are interested in fair wages: adequate fringe benefits and bonus
linked with productivity/profitability. Ratio analysis provides them adequate
information regarding efficiency and profitability of the unit. This knowledge
helps them to bargain with the management regarding their demands for improved
wages, bonus etc.
Usefulness to the Government:
Govt. is interested in the financial information of the units both at macro
as well as micro levels. Individual unit's information regarding production,
sales and profit is required for excise duty, sales tax and income tax purposes.
Group information for the industry is required for formulating national policies
and planning. In the absence of dependable information, Govt. plans and policies
may not achieve desired results.