Top 6 Advantages of Ratio Analysis

The following points highlight the top six advantages of ratio analysis. The advantages are: 1. Useful in Financial Position Analysis 2. Useful in Simplifying Accounting Figures 3. Useful in Assessing the Operational Efficiency 4. Useful in Forecasting Purposes 5. Useful in Locating the Weak Spots of the Business 6. Useful in Comparison of Performance.

Advantages of Ratio Analysis:

  1. Useful in Financial Position Analysis
  2. Useful in Simplifying Accounting Figures
  3. Useful in Assessing the Operational Efficiency
  4. Useful in Forecasting Purposes
  5. Useful in Locating the Weak Spots of the Business
  6. Useful in Comparison of Performance

Ratio Analysis: Advantage # 1.

Useful in Financial Position Analysis:

Accounting ratios reveal the financial position of the concern. This helps the banks, insurance companies and other financial institutions in lending and making investment decisions.

Ratio Analysis: Advantages # 2.

Useful in Simplifying Accounting Figures:

Accounting ratios simplify, summarise and systematize the accounting figures in order to make them more understandable and in lucid form. They highlight the inter-relationship which exists between various segments of the business as expressed by accounting statements. Often the figures standing alone cannot help them convey any meaning and ratios help them to relate with other figures.

Ratio Analysis: Advantage # 3.

Useful in Assessing the Operational Efficiency:

Accounting ratios helps to have an idea of the working of a concern. The efficiency of the firm becomes evident when analysis is based on accounting ratio. They diagnose the financial health by evaluating liquidity, solvency, profitability etc. This helps the management to assess financial requirements and the capabilities of various business units.

Ratio Analysis: Advantage # 4.

Useful in Forecasting Purposes:

If accounting ratios are calculated for a number of years, then a trend is established. This trend helps in setting up future plans and forecasting. For example, expenses as a percentage of sales can be easily forecasted on the basis of sales and expenses of the past years.

Ratio Analysis: Advantage # 5.

Useful in Locating the Weak Spots of the Business:

Accounting ratios are of great assistance in locating the weak spots in the business even though the overall performance may be efficient. Weakness in financial structure due to incorrect policies in the past or present are revealed through accounting ratios.

For example, if a firm finds that increase in distribution expenses is more than proportionate to the results expected or achieved, it can take remedial steps to overcome this adverse situation.

Ratio Analysis: Advantage # 6.

Useful in Comparison of Performance:

Through accounting ratios comparison can be made between one departments of a firm with another of the same firm in order to evaluate the performance of various departments in the firm. Manager is naturally interested in such comparison in order to know the proper and smooth functioning of such departments. Ratios also help him to make any change in the organisation structure.

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