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Ratio Analysis And Commonly Asked Questions

Financial statements cannot be intelligently analyzed without ratio analysis. 

Append below are some commonly asked questions of Ratio analysis:- 

Question No 1: Why is Ratio Analysis so important? 

It is important as it is able to: 

• Assist in analyzing the performance of the company and comparing the performance with that of other similar companies
• Highlight the relative strengths and weaknesses of a company – whether it is profitable, financially sound or in a state of decline
• Help in determining whether the company has earn sufficiently on the funds invested and its debt servicing ability
• Enable the forecasting of future performance.
  

 

Question No 2 : What is Ratio Analysis?

Ratio analysis involves methods of calculating and interpreting financial ratios to assess a firm’s financial condition and performance.

Question No 3: Who is then interested in Ratio analysis?

Since it’s able to assess a firm’s financial condition and performance, hence it is of  interest to shareholders, creditors, and the firm’s own Management.

Question No 4: How many types of Ratio comparison?

There can be broadly classified into three (3) types:

1. Trend or Time-Series Analysis

To evaluate a firm’s performance over time 

2. Cross-Sectional Analysis

To  compare one firm’s financial performance to the industry’s average performance. Cross-sectional analysis is used to compare different firms at the same point in time. 

3. Combined Analysis

Combined analysis simply uses a combination of both time series analysis and cross-sectional analysis 

Question No 4: Are there any limitation or  cautions in using Ratio Analysis?

1. Ratios must be considered together;
   

2. Financial statements that are being compared should be dated at the same point in time;
   

3. Use audited financial statements when possible;

4    Merely numbers & data hard to get

5    Be wary of inflation distortions, historical cost, different

      accounting policies, management manipulation & different

      definitions; 

6. It is difficult to define categorically what a good or bad ratio value should be.
   

Question No 5. Basically how many types of Financial Ratio Classifications?

Can be broadly classified into:

• Liquidity
• Asset Management
• Profitability
• Financial leverage management
• Market based
• Dividend policy
• Bankruptcy – Altman Z
  

 

Question No. 6: Any tips/advice on how to interpret & analysis

The user has to identify changes and trends to help explain some fundamental questions and raised supplementary questions

Take for example:

Turnover – Is it increasing ? If yes.

Is there a corresponding increase in profits?

Is there an additional investment in fixed assets?

How is the additional investment financed?

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March 21, 2007   Posted in: Ratio Analysis

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