Ratio Analysis "evaluating Past Performances and Predicting Future"

“In spite of its limitations ratio analysis is widely used as a means of evaluating the past performance and predicting the future successes or failures of business organisations.”

Ratio analysis isn't just picking different numbers from the balance sheet, income statement, and cash flow statement and comparing them. Ratios compare facts against previous years, the industry, other companies, or even the economy in general. Ratios look at the relationships between values and relate them to find out how a company has performed in the times of yore and might perform in the future. The echelon and chronological trends of these ratios can be used to make inferences about a company's financial condition, its operations as well as the attractiveness as an investment. Financial ratios are calculated from one or more pieces of information from a company's financial statements. They investigate thoroughly the financial condition of a business and can assist in making a decision about whether a company has the financial backup to support the console and achieve success or not.

Financial ratios are a suitable system of evaluating or assessing the current financial health and its related performance of a company relative to similar companies in the same industry. Users of financial ratios use the traditional balance sheet and income statement to determine the liquidity, leverage, asset activity, profitability and performance of companies. It should be provided that both companies are similar to each other and the basis of calculation of ratios is the same because inter-firm comparisons provide a more meaning, objective and controlled way of evaluation. Now these inter-firm comparisons can be used as identifying the strengths and weaknesses of company related to a particular industrial sector. These comparisons can be analysed by either internal management or external users such as stakeholders, investors and creditors. There are several sources of getting inter-firm comparisons both internally and externally.

1) Either they gather data from external published accounts

2) Those companies that confidentially and strictly survey for inter-firms comparisons.

The users of ratio analysis are not only the top management but all levels of management are concerned with Financial Ratios. It depends on the firm whether and which ratios will it use, the factors depend on the size of the firm and the nature of the firm. But nevertheless a management always requires an analysis of the past data of the firm and its performance in order to maximize profits and prevent loss. Since management has to make decision on a daily basis thus it is not satisfied with annual or quarterly analysis. It requires and up to date and meaningful financial information in order to make decisions on a daily basis. Since financial information is required and used at all levels, the management can decide what information is relevant for each level and hence filter the unnecessary flow of financial information. The questions arising by the management are: Is the company in the growing sector of the economy? What are its trends in terms of profitability, liquidity and investment? How does the board perceive the past performance of the company and how do they intend to change their strategy for the future? The profitability of a company is a major concern for the management as well as the stakeholders. The share holder’s major concern lies in the profitability of their company as well as the profit that they will earn upon investment in that company. The integrity of the financial information provided by the companies is also a vital concern of most external observers. In order to address the problem, certain laws have been created by governments and international organizations to prevent from “Window dressing” of a company’s performance.

Financial ratios can also be used to assess the risk factor involved for an investor and to predict the bankruptcy of a company. The liquidity and non-bank credit ratio are used for assessing the companies going through a hard time. The non bank ratio is used by a firm where the firm cannot afford to get more credit from banks. This ratio is assumed to be of greater risk as if the firm cannot pay back the loan to the bank, it will probably charge a higher interest. Interest payments are subject to the primary earnings of a firm (as regarded by some financial analysts), so the interest must be calculated as the percentage of sales of that firm or alternatively the total costs as the percentage of the previous year’s earnings. The analysis that an investor gets from these ratios affect the decision making of their investment into any firm associated.

Now let us talk about the hierarchical usage of ratios in the firms. The production manager in