Ratio Analysis is one of the basic tools of financial analysis. And it is a fact that financial analysis itself plays an important role in the progress of business strategic planning. Being the basic tool of the strategic analysis, ratio analysis plays a vital role and it is not possible to complete the analysis of a company’s strengths, weaknesses, opportunities and threats, without an analysis of its financial position.
This tool is normally used to conduct a quantitative analysis of information in a company’s financial statements. Ratios are calculated by comparing the current year figures to previous years, other companies, the industry, or even the economy to judge the performance of the company. This is predominately used by proponents of fundamental analysis. If you don’t know how to evaluate the present performance of a company and its possible future performance, you should learn how to analyze ratios.
Types of Ratios used for Business Strategic Planning
Different types of ratios can be calculated from the financial statements pertaining to a company’s activity, performance liquidity and financing. When it comes to investing, ratio analysis is one of the most important element in the fundamental analysis process. Among the dozens of ratios available, the most relevant ratios are categorized into six major heads, which are-
• Liquidity Measurement Ratios: - Liquidity ratio is calculated by comparing a company’s most liquid assets. The greater the coverage of liquid assets to short-term liabilities, the better as it is a clear signal that a company can pay its debts that are coming due in the near future.
• Profitability Indicator Ratios:- This discusses the different measures of corporate profitability and financial performance.
• Debt Ratios:- These ratios give users a general idea of the company’s overall debt load.
• Operating Performance Ratios:- These ratios look at how well a company turns its assets into revenue as well as how efficiently a company converts its sales into cash.
• Cash Flow Indicator Ratios:- These ratios can give users another look at the financial health and performance of a company.
• Investment Valuation Ratios:- These ratios can be used by investors to estimate the attractiveness of a potential or existing investment and get an idea of its valuation.
Why Ratio Analysis is so important?
Ratio Analysis, being the basic tool of the strategic analysis, is extremely important for an organization to carry out its business planning. Some of the key reasons why it holds so much of importance are -
• This analysis gives users a good understanding of how well the company utilized its resources in generating profit and shareholder value.
• It attempts to measure a company’s ability to pay off its short-term debt obligations.
• Used to determine the overall level of financial risk a company and its shareholders face.
• It helps to enrich financial health and performance of a company.
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