Meanings of Ratio:
According to J. Batty, "The term accounting ratios is used to describe
significant relationships which exist between figures shown in a balance sheet,
in a profit and loss account, in a budgetary control system or in any other part
of the accounting organization"
In simple words, "Ratio" is the numerical relationship between two variables
which are connected with each other in some way or the other. Ratios may be
expressed in any one of the following manners
As a number the relationship between 500 and 100 may be expressed as 5(500
divided by 100).
As a fraction the above may alternatively be expressed as former being 5
times of the latter or latter being 1/5th of
the former.
As a percentage the relationship between 100 and 500 may be expressed as 20%
of the latter (100/500 x 100) = 20%.
As a proportion the relationship between 100 and 500 may be expressed as 1 :
5. Ratio analysis facilitates the presentation of information of financial
statements in simplified, concise and summarized form.
Nature of Ratio Analysis:
Ratios, by themselves, are not an end but only one of the means of
understanding the financial health of a business entity. Ratio analysis is not
capable of providing precise answers to all the problems faced by any business
unit. Ratio analysis is basically a technique of:
- Establishing meaningful relationship between significant variables of
financial
statements and
- Interpreting the relationships to form judgment regarding the financial
affairs of the unit.
Usefulness of Ratio Analysis:
Usefulness of ratio analysis depends upon identifying:
- Objective of analysis
- Selection of relevant data
- Deciding appropriate ratios to be calculated
- Comparing the calculated ratios with norms or standards or forecasts; and
- Interpretation of the ratios
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