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What is Ratio Analysis?
Ratio analysis is one of the tool or technique used for analysis of financial statements. Financial executives need certain yardstick to evaluate the financial position and performance of the business. Ratio analysis is considered a significant yardstick in this direction. The financial statements can be analyses with the help of ratio analysis and quality decisions are also taken by top management from such analysis.
What does Ratio mean?
Ratio means an expression of simple arithmetical relationship of one number to another. In other words, the relationship between two figures can be established on the basis of some logical methods, which is called ratio.
Meaning of Ratio Analysis
Ratio analysis is the process of establishing and interpreting various ratios for helping in making certain decisions. The mere calculation of a ratio does not bring any usage to the management. Some more appropriate ratios should be calculated for analysis and interpretation. The ratios may be used as a symptom like blood pressure, the pulse rate or the body temperature.
Ways of expressing ratios
A ratio may be expressed in any one of the following ways.
1. In proportion: The amounts of two items are being expressed in a common denominator. For example current ratio may be expressed as 2.5:1. It means that the value of current assets is Rs.250 and the value of current liabilities is Rs.100.
2. In Rate or Times or Days or Coefficient: In this form, a quotient is considered as unit of expression, which is obtained by dividing one item by another item. For example: Stock turnover ratio is 5 times. It ls the expression of relationship between closing stock or average stock with sales or cost of goods sold. In this case, the sales value is 5 times value of closing stock. Likewise, average collection period is 50 days. It is the expression of number of days required to collect the amount from the sundry debtors.
3. In Percentages: In this form, a quotient becomes the percentage form of expression, which is obtained by dividing one item by another and multiplied by one hundred. For example: Net Profit ratio is 20%. It is expressing the relationship between the amounts of net profit and the amounts of sales. It means that every sale of Rs.100 yields Rs.20/- as net profit to the business concern.