In the past few blogs we looked at how an investor would look at the balance sheet and make his/her assessment about the company's health. In the next few blogs we will look at the aspect of ratio bases analysis of the balance sheet. In today’s blog we look at the need for such ration analysis.
These various ratios are called by the name of accounting ratios, and provide a relation between the various accounting figures. Given a balance sheet, using the actual values in it to assess to assess if the company would be inappropriate; the relative values of one with respect to another section would be a better mode to make a comparison. Making it a ratio enables comparison of the various figures.
The advantages of Ratio Analysis are;
- It assists the management in knowing the earning capacity of the business.
- Helps assess the solvency of the company
- Assists comparison across years
- Simplifies the accounting information
- Calculation of the operating efficiency
- Helps forecasting
This however has certain limitations:
- Given the difference in accounting policies that the firms use, it cannot be used to compare across firms.
- Unless the absolute numbers are known, it is hard to really understand the results.
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