How to do Ratio analysis

Ratio analysis is one of the widely used techniques to understand the financial position any organization. Ratio analysis helps in understanding the numerical relationship between the items of the financial statement of a company. This strategy helps in interpreting the financial statements with the help of accounting ratios derived from the balance sheet, profit & loss statement and the cash flow statement. Ratios indicate the financial performance of an organisation by summarising the bulk financial data in the financial statements of an organisation to facilitate the management in making qualitative judgments regarding the organisation’s financial performance.

This article has been written with the objective of helping the students in understanding the ratio analysis concept and the way they can use it to analyze the financial position of any organization. There are different types of rations that help in getting different information about the organization. The main categories of rations are as follow;

  • Liquidity ratio
  • Financial leverage ratio
  • Profitability ratio
  • Asset turnover ratio
  • Dividend policy ratio

The liquidity ratios are the most important ratios of all it helps in evaluating the liquidity position of an organisation. It helps in analyzing the capacity of the management in repaying their short-term liabilities by retaining an adequate working capital. This helps in evaluating whether organization is in a position to continue its operational activities smoothly or not.

The financial leverage ratio helps in analyzing the long term position of the company; it helps in evaluating the position of the company in terms of repaying its long term debts. There are three main types of ratios that are included in this, which are debt ratio, debt to equity ratio and interest coverage ratio.

The profitability ratio helps in understanding the financial position of the company and also helps in comparing it with the industry performance. This ratio includes the gross profit margin ratio, the return on asset and return on equity ratio.

The effectiveness of the usage of the assets in the organization can be evaluated with the help of asset turnover ratio. It also helps in analyzing that how effectively the assets are being used in the organization.

Another important ratio is the dividend policy ratio that is very helpful for the investors in understanding the future growth of the company. With the help of above analysis the student can understand the requirement and choose the appropriate ratio and apply.