In this article we will discuss about:- 1. Introduction to Ratio Analysis 2. Steps in Ratio Analysis 3. Nature.

Introduction to Ratio Analysis:

The company’s financial information is contained in Balance Sheet and Profit and Loss Account. The figures contained in these statements are absolute and sometimes unconnected with one another. An absolute figure does not convey much meaning. However, it is only in the light of other information that the significance of a figure is realised. For instance, Mr. X weighs 50Kg. Is he fat? We cannot give answer unless we know his age and height.

Similarly a company’s profitability cannot be known unless together with the amount of profit, the capital employed is also seen. The relationship of these two figures expressed mathematically is called a RATIO. The ratio refers to the numerical or quantitative relationship between two variables or items. A ratio is calculated by dividing one item of the relationship with the other.

The ratio analysis is one of the most useful and common method of analysing financial statements. As compared to other tools of financial analysis, the ratio analysis provides very useful conclusions about various aspects of the working of an enterprise. The need for ratio arises due to the fact that absolute figures are often misleading.

Absolute figures are certainly valuable but their value increases manifold if they are studied with another through ratio analysis. Ratios enable the mass of data to be summarised and simplified. Ratio analysis is an instrument for diagnosis of the financial health of an enterprise. Ratios, in fact, are full of meaning and communicate the relative importance of the various items ‘appearing in the Balance Sheet and Profit and Loss Account.

Steps in Ratio Analysis:

The first task of the financial analyst is to select the information relevant to the decision under consideration from the statements and calculates appropriate ratios.

The second step is to compare the calculated ratios with the ratios of the same firm relating to past or with the industry ratios. This step facilitates in assessing success or failure of the firm.

The third step involves interpretation, drawing of inferences and report-writing. Conclusions are drawn after comparison in the shape of report or recommended course of action.