Ratio Analysis Pros and Cons

How does Ratio Analysis work?

The ratio analysis is a quantitative analysis of the financial statements of an organization. A company’s liquidity, turnover, solvency, and profitability can be assessed from multiple perspectives.

Ratio analysis, in other words, is a method for analyzing and comparing financial data by computing meaningful financial statement value percentages instead of comparing line items directly.

In addition to its merits, ratio analysis also has its detriments. There are a few points below that highlight those points.

There are several advantages to Ratio Analysis:

• Performs trend analysis to assist with forecasting and planning.
• Analyzes past trends in order to estimate the firm’s budget.
• By assessing an organization’s efficiency, we can determine how effective it is.
• A business performance report provides significant information about the performance of the company to users of accounting information.
• A comparison of two or more firms can be made with it.
• As well as determining the firm’s liquidity, it helps to determine its long-term solvency.

As a result of Ratio Analysis, there are the following disadvantages:

• It seems that financial statements are complicated.
• As several organizations worked in different enterprises with different market structures, regulations, etc., it might be difficult to compare two organizations from different industries.
• Views and hypotheses affect financial accounting data. In such circumstances, ratio analysis is less useful because accounting criteria provide different accounting methods, decreasing comparability.
• Ratio analysis tells us how prior data is associated with current and future data, while users are more concerned about the current and future data.

This is an explanation of Ratio Analysis’ Advantages and Disadvantages for class 12 Commerce students. Follow Nemani Classes to learn more.

Also see:

• Achieving Gains
• An assessment of the solvency ratio
• An analysis of profitability ratios
• The new profit sharing ratio