What is Ratio Analysis?

Ratio analysis is a quantitative analysis of data enclosed in an enterprise’s financial statements. It is used to assess multiple perspectives of an enterprise’s working and financial performance, such as its liquidity, turnover, solvency and profitability.

Ratio analysis is the method of analysing and comparing financial data by computing meaningful financial statement value percentages rather than comparing line items from each financial statement.

Ratio analysis has its own merits and demerits, too. The points mentioned below highlight those points.

The advantages of Ratio Analysis are as follows:

• Helps in forecasting and planning by performing trend analysis.
• It helps estimate the firm’s budget by analysing previous trends.
• It helps determine how efficiently a firm or an organisation operates.
• It provides significant information to users of accounting information regarding the performance of the business.
• It helps compare two or more firms.
• It helps determine both the liquidity and long-term solvency of the firm.

Disadvantages of Ratio Analysis are as follows:

• Financial statements are complicated.
• Several organisations work in various enterprises, each possessing different environmental positions such as market structure, regulation, etc.; such factors are important that a comparison of 2 organisations from varied industries might be ambiguous.
• Views and hypotheses influence financial accounting data. Accounting criteria provide different accounting methods, which reduces comparability and thus, ratio analysis is less helpful in such circumstances.
• Ratio analysis illustrates the associations between prior data, while users are more concerned about current and future data.

The concept mentioned above is elucidated in detail about the advantages and disadvantages of ratio analysis for class 12 commerce students. To know more, stay tuned to eduacademy