A Ratio analysis is an important tool that is widely used in many business and accounting practices. It is the calculation and comparison of a lot of key indicators within a company’s financial statements. Its’ main strength is that it encourages a systematic approach to analyzing the performance of a company. Investment analysts, creditors, lenders, investors and manager’s are constantly evaluating historical data and forecast information of companies while using these ratio’s to analyze the financial situation of the company for their decision making purposes. There are many advantages of using these accounting ratios. Some of which are that they are important for analyzing financial statements, judging the efficiency of the company, they help in locating the company’s weakness’s, they help in formulating plans, and they are used to compare performances.
However, these ratios deal mostly with numbers that need to be interpreted carefully and don’t allow you to predict the future. On their own, they don’t show whether performance is good or bad, they require more information to make an informed decision. These ratios are based primarily on financial statements, which are the summaries of the company’s accounting records. Through the summarization some important information may be left out which could have relevance to the person analyzing them. This information can be anything from year end information which may not be a true reflection of the overall year’s results, inflation issues, changes in technology, seasonal factors, changes in accounting policies, future perspectives of a company, future actions by management. Ratio analysis is very useful, but analysts should be aware of issues that are not factored into these equations like future performance, financial practices of a particular company, customer service, seasonal influences, product quality, and employee morale.