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Significance and Usefulness of Ratio Analysis:

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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.

3. Communication:

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 control.

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 their unit.

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.

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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