Ratio Analysis Essay Example | Topics and Well Written Essays - 2750 words

Ratio Analysis - Essay ExampleFinancial statement depth psychology consists of the occupation of analytical tools and techniques to the data in pecuniary statements in order to derive from them measurements and relationships that are significant and useful for decision making (ICFAI Center for Management enquiry ICMR, 2004). The process of financial analysis can be described in various ways, depending on the objectives to be obtained. Financial analysis can be utilize as a preliminary screening tool of prospective financial conditions and results. It may be used as a forecasting tool of future financial conditions and results. It may be used as a process of evaluation and diagnosis of managerial, operating, or other problem areas. Above all, financial analysis reduces reliance on intuition, guesses and thus narrows the areas of uncertainty that is present in all decision making processes. Financial analysis does not lessen the need for judgment but rather establishes a sound and systematic basis for its rational application.In the analysis of financial statements, the analyst has a variety of tools available from which he can choose those best suited to his specific purpose. The following are the important tools of analysis.Ratios are well known and the most widely used tools of financial analysis. ... The analysis of ratios can disclose relationships as well as bases of comparison that reveal conditions and trends that cannot be detected by going through the individual components of the ratio. The utility of ratios is ultimately dependant on their intelligent and skillful interpretation.Ratios are used by different people for various purposes. As ratio analysis primarily helps in valuing the firm in quantitative terms, two groups of people are interested in the valuation of the firm and they are creditors and shareholders. Creditors are again divided up into short-term creditors and long-term creditors. Short-term creditors hold obligations that will so on mature and they are concerned with the firms ability to present its bills promptly. In the short run, the amount of unruffled assets determines the ability clear off legitimate liabilities. These persons are interested in liquidity. Long-term creditors hold bonds or mortgages against the firm and are interested in current payments of interest and eventual repayment of principal. The firm must be sufficiently liquid in the short-term and have adequate profits for the long-term. These persons examine some(prenominal) the liquidity and profitability of the firm. In addition to liquidity and profitability, the owners of the firm i.e. the shareholders are concerned about the policies of the firm that affect the market price of the firms stock. Without liquidity, the firm cannot pay cash dividends. Without profits, the firm would not be able to declare dividends. With poor policies, the common stock would trade at low prices in the market. Keeping in view the above discussions rega rding the category of users, financial ratios fall into three groups as followsLiquidity