What is a Ratio?

 It is an arithmetical expression of relationship between two interdependent or

related items
 When a ratio is calculated on the basis of accounting information, it is called an
Accounting Ratio

 Accounting Ratios can be expressed in any of the following forms:

• Pure: It is expressed as a quotient.
For example: Current Ratio is expressed as (say) 2 or can be expressed as (say) 2:1

• Percentage: It is expressed in percentage.

For example: Net Profit Ratio is expressed as (say) 25%

• Times: It i s expressed in number of times.

For example: Interest Coverage Ratio is expressed as (say) 2 times.

• Fraction: It is expressed in fraction.

For example: Ratio of fixed assets to share capital is (say) 3/4 (i.e. 0.75)
 What is Ratio Analysis?
 It is a process of determining and interpreting relationships between the items of
financial statements to provide a meaningful understanding of the performance and
financial position of an enterprise.
OBJECTIVE OF RATIO ANALYSIS
1. To simplify the accounting information.
2. To determine liquidity (Short-term solvency and Long-term solvency) of the business.
3. To assess the operating efficiency of the business.
4. To analyze the profitability of the business.
5. To help in comparative analysis i .e. inter-firm and intra-firm comparisons.

ADVANTAGES OF RATIO ANALYSIS

Besides meeting the objectives,
• The trend of ratios are analyzed and used for forecasting and planning.
• Helps locating the weak areas even though the overall performance may be good.
The management can take remedial action.
 What is Ratio Analysis?
DISADVANTAGES OF RATIO ANALYSIS
• The reliability of ratio and its analysis is dependent upon the correctness of the
financial statements.
• Ignores qualitative factors, which may be important in decision-making.
• There is no single standard ratio against which the ratio can be compared
• Ratios may not be comparable if different firms follow different accounting policies
and procedures.
For example, one firm may follow Straight Line Method of Depreciation while
another may follow Diminishing Balance Method.
• Change in value is an important factor when analyzing businesses, but these are
ignored as accounts are recorded at costs.
• Ratios may be affected by window dressing
• Different people may interpret the same ratio in different ways.