An efficiency of an individual can be assessed only by fixing the standard. If not so, the concerned individual has no option of knowing his level of efficiency. Anybody can improve maintain his efficiency on comparing with standard. Likewise, the financial position of the business concern can be identified only by fixing standards for various ratios and then reporting upon the condition. There is no hard and fast rule for fixing the standard regarding various ratios. Eventhough, the followings may be regarded as yardsticks for ratio analysis.
Yardsticks for ratio analysis
1. Industry Norms: A business concern may be compared with the financial ratios of other business concerns in the same industry. It is feasible. Besides, this type of comparison brings many more meaningful information to the business concern. In India, an analyst can note such norms in the Reserve Bank of India Bulletin, Directory of Bombay Stock Exchange and the like.
2. Similar Size Business Concern: The volume of sales turnover in terms of money value is the main criteria for identifying the size of business concern. If small size business unit is compared with medium size business unit, an analysis or the interested party does not get any fruitful conclusion. Hence, same size of business unit ratios are used as yardstick for ratio analysis.
3. Similar Type of Form of Business Organization:Type of form of business organization is sole trader, partnership firm, private limited company, public limited company and multinational corporation. If the ratio of partnership form of business organization is compared with private limited form of business organization, what is the use? Hence, one form of business organization ratio is considered as norms for similar type of form of business organization.
4. Historical Trends: An analyst can calculate ratios form any years of the same business concern. If so, there is a possibility of knowing the overall performance of the business concern over a period of time. It is a good sign if the business concern is maintaining or increasing its profits and bad sign if its liquidity is dropping.
5. Common Sense. An analyst can use common sense for meaningful ratio analysis. For example: 5% net profit can never be a norm now a days as it is low for rational investors, keeping in view the normal bank rate of interest. At the same time, 50% net profit is too high. Hence, the common sense is that 15% net profit is more reasonable as a norm.