Ratio analysis as a tool to review financial statements

Every organisation that exists in the world needs to evaluate its performance after a period of time. Most of the companies do this after the end of each financial year by making financial statements. To analyse the statement, you can use many techniques but the most helpful of them is ratio analysis.

Ratio analysis is seen as an important tool of accounting as it not only helps in quantification of the data but makes it easier to compare the figures. Ratio analysis is done by finding out the ratio of the data of an organisation for the financial year and comparing it with the ratio of the previous year. This helps a person in understanding how the business is growing and what are its chance of survival. There are few important types of ratios which should be carefully evaluated.

Current Ratio

Current ratio is calculated by dividing the current liabilities of the company by current assets. It is done to check the ability of a company to pay its obligations in the near future. Most of these obligations are short and are under one year. To evaluate this ratio, one only needs to take into consideration the current liabilities and these are then divided by the current assets. This gives an idea whether the current assets of the company are good enough to pay the liabilities.

Debt Ratio

Debt is considered as a negative word in the normal world but it is one of the most important elements of business. Debt helps a business to grow and almost all companies take some kind of debt from banks, investors and other agencies. It is however important to know if you are capable of paying your debt by the assets you have. In other words, it helps in determining the bankruptcy of the company. If the company has a good debt ratio, it only stand a chance to survive in the dynamic environment but it also attract more support and loans from the investors. Therefore, it is important to calculate the debt ratio after every year.

Profit Margin

No business can survive without ensuring the profits. The ultimate goal of an organisation is to maximize its profit. You can earn money by generating revenue from different sources but if you are not making enough profits, you are not doing something right. To calculate the profit margins, one divides the overall sale or net revenue by the total expenses. The more profit margin the company has on a product, the higher are its chances of succeeding.

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