Welcome to the Investors Trading Academy talking glossary of financial terms and events.
Our word of the day is “Ratio Analysis” Ratio analysis is the single most important
technique of financial analysis in which quantities are converted into ratios for meaningful comparisons,
with past ratios and ratios of other firms in the same or different industries. Ratio
analysis determines trends and exposes strengths or weaknesses of a firm.
A sustainable business and mission requires effective planning and financial management.
Ratio analysis is a useful management tool that will improve your understanding of financial
results and trends over time, and provide key indicators of organizational performance.
Managers will use ratio analysis to pinpoint strengths and weaknesses from which strategies
and initiatives can be formed. Funders may use ratio analysis to measure your results
against other organizations or make judgments concerning management effectiveness and mission
impact. Ratio Analysis is a form of Financial Statement
Analysis that is used to obtain a quick indication of a firm's financial performance in several
key areas. The ratios are categorized as Short-term Solvency Ratios, Debt Management Ratios, Asset
Management Ratios, Profitability Ratios, and Market Value Ratios.
Ratio Analysis as a tool possesses several important features. The data, which are provided
by financial statements, are readily available. The computation of ratios facilitates the
comparison of firms which differ in size. Ratios can be used to compare a firm's financial
performance with industry averages. In addition, ratios can be used in a form of trend analysis
to identify areas where performance has improved or deteriorated over time.
Because Ratio Analysis is based upon accounting information, its effectiveness is limited
by the distortions which arise in financial statements due to such things as Historical
Cost Accounting and inflation. Therefore, Ratio Analysis should only be used as a first
step in financial analysis, to obtain a quick indication of a firm's performance and to
identify areas which need to be investigated further.