Benefits of Ratio Analysis
Ratio analysis forms an integral part of financial analysis which is an essential part of business planning. In other words, ratio analysis is the backbone of SWOT, being the primary tool in business planning. Since SWOT is dependent on ratio analysis, determining a company’s financial position is of utmost importance in order to ensure equitable distribution of resources.
1. Determines profitability
Ratio analysis can help managers to workout the productivity of the company by computing the profitability ratios. The management can calculate their revenues to identify if they are productive or not. This way, probability ratios will help the company to appraise its performance based on current earnings.
2. To calculate the solvency
By calculating the solvency ratio, companies can monitor the correlation between the assets and liabilities. In cases liabilities are on the higher side than the assets, the company can know its financial position. This will help them in case they want to set up a plan to repay their loans.
3. Better financial analysis
Ratio analysis is also beneficial to outsiders, as well as debenture-holders, shareholders and creditors. Bankers can know the profitability of the business to determine whether they can pay dividend and interests under the stipulated period.
4. Performance analysis
Ratio analysis also aid in performance analysis. With the use of financial analysis companies can study their performance of the previous year. This can help them to identify their weak points and improve on them.
Today, most companies use ratio analysis to show the trend in production. This gives them an opportunity to estimate future trends. With the use of preceding year’ ratios, company can make estimates for the future. This gives companies the foundation for budget planning in order to determine the course of action for success and growth in business.
Since accounting ratios must be drawn from bookkeeping records, wrong misinterpretation of data can indicate a false financial position.