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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



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