The most useful type of financial statement analysis is Ratio Analysis. According to Sanford I.

Weill, a former chief executive, and chairman of Citigroup “Details create the big picture.” In
financial statement analysis “Details” can be deciphered through Ratio Analysis.
Unlike Vertical and Horizontal Analysis which covers limited uses such as the bottom-line
approach and trend analysis. Ratio Analysis covers very wide analytical techniques; as it is a
quantitative analysis of data enclosed in a company’s financial statements. You cannot see it at
first glance; however, it is hidden behind the line items of the financial statements. It is used to
assess multiple perspectives of a company’s working and financial performance such are
generally broken into the following broad categories; liquidity, leverage, activity, and profitability.
 Profitability Ratios: These ratios offer insight into how profitable a company is. Some
important profitability ratios include gross profit ratio, return on equity, break-even point,
return on equity, and return on net assets.

 Liquidity Ratios: Liquidity ratios offer insight into how liquid a company is, which is important
in measuring a company’s ability to stay in business. Some important liquidity ratios include
cash coverage ratio, current ratio, and liquidity index.

 Leverage Ratios: Leverage ratios offer insight into how much a company is dependent on
debt to maintain its operations. Some important leverage ratios include debt-to-equity ratio,
debt service coverage ratio, and fixed charge coverage.

 Activity Ratios: Activity ratios offer insight into how well a company is utilizing resources.
Some important activity ratios include accounts payable turnover rate, accounts receivable
turnover rate, inventory turnover rate, and working capital turnover rate.

To put it in other words, Ratio analysis is the method of analyzing and comparing financial data
by computing meaningful financial statement value percentages rather than comparing line
items from each financial statement. It enables management and decision-makers to formulate
strategies and policies for effectiveness and efficiency in the Company’s operation.

Advantages of Ratio Analysis are as follows:

 Helps in forecasting and planning by performing trend analysis.

 Helps in estimating a budget for the firm by analyzing previous trends.
 It helps in determining how efficiently a firm or an organization is operating.
 It provides significant information to users of accounting information regarding the
performance of the business.
 It helps in the comparison of two or more firms.
 It helps in determining both the liquidity and long-term solvency of the firm.

Once you have calculated a ratio for the current period, you can compare it against previous
periods to understand how the company is performing over time. It’s also possible to compare
the ratio against industry standards to understand if the company in question is under- or over-
performing.