Ratio Analysis: How it Helps Determine A Company’s Financial Health
Determining the financial health of your business depends on
several aspects. One of them is ratio analysis which draws a clear comparison
of line items in the financial statements of a business. Ratio analysis is a
powerful tool for financial analysis. The report indicates the health of the
business using the defined formula. The higher / lower ratio indicates good
/poor liquidity position of the business. This report is not just useful for
the stakeholders outside of a firm who do not have direct access to other
crucial financial statements like balance sheet, profit and loss statement,
etc, but also for internal management. Ratio analysis report permits the stakeholder
of an entity to make better sense of the accounts and better understanding of
the current fiscal scenario.
Objective of Ratio Analysis
While ratio analysis helps a business owner understand the
overall financial health of his company, it also becomes a vital tool for
financial management. With a clear understanding of the company’s finances, an
entrepreneur can easily take crucial business decisions which would impact his
company’s growth and profitability. Here are some of the most crucial objectives
of ratio analysis report:
Profitability measurement
Profit is always the ultimate motive behind running a business.
If a company is selling goods on a large scale, that does not necessarily mean
that it’s making profits. The crucial part is drawing a comparison of two
numbers with respect to each other and calculate the net profit. Ratio analysis
also helps a company in determining the use of its assets and how these assets
are incurring profits. To measure profitability, you must get adequate information
on Gross Profit Ratios, Net Profit Ratio, Expense ratio etc which measure the
profitability of a firm. The management can use such ratios to find out problem
areas and improve upon them.
Evaluation of Operational
Efficiency
Certain ratios highlight the degree of efficiency of a company
in the management of its assets and other resources. It is crucial that assets
and financial resources be allocated and used efficiently to avoid unnecessary
expenses and prevent cash blockages. Turnover Ratios will point out any
mismanagement of assets. A single ratio may sometimes give some information,
but to make a comprehensive analysis, a set of inter-related ratios are
required to be analysed and that’s exactly what ratio analysis does.
Ensure Suitable Liquidity
Every firm must ensure that some of its assets are liquid, in
case of emergencies when cash is required. Thus, the liquidity of a firm is
measured by ratios such as Current Ratio and Quick Ratio. These help a firm
maintain the required level of short-term solvency.
Determine Long-Term Solvency
There are some ratios that help determine the firm’s long-term
solvency. They help determine if there is a strain on the assets of a firm or
if the firm is highly in debt. The management will need to immediately address
and rectify the situation to avoid liquidation in the future.
Working Capital Ratios
Like the Liquidity ratios, it also analyses if the company can
pay off the current debts or liabilities using the current assets. This ratio
is crucial for the creditors to establish the liquidity of a company, and how
quickly a company converts its assets to bring in cash for resolving the debts.
With Tally.ERP’s Ratio Analysis report
you can get a clear picture between the principal groups and key figures in
detail instantly without any added efforts. From determining the efficiency
ratio to sundry debtors and sundry creditors to the inventory turnover, get
information about all the crucial aspects which impact the financial health of
a business in a single shot. Another important lever which regulates
regular cashflow in
your business, payment
performance of debtors is also detailed out in
ratio analysis. Both the receivable turnover in days and the customer’s actual
payment performance is displayed in the report which helps you take appropriate
decision to avoid blockage of cash. To get a better understanding of how ratio
analysis will help you get a clear picture of your company’s finances, take
a free
trial now.
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