The Three Methods of Analysis

Financial ratio analysis is a valuable tool that allows one to assess the success, potential failure or future prospects of the company (Bazley 2012). The ratios are helpful in spotting useful trends that can indicate the warning signs of

To analysis financial statements there are various tools. Ratio analysis is one of them. In ratio analysis we establish relationship between two or more items of financial statements and derive some vital information about the business.

Ratios are highly important profit tools in financial analysis that help financial analysts implement plans that improve profitability, liquidity, financial structure, reordering, leverage, and interest coverage. Although ratios report mostly on past performances, they can be predictive too, and provide lead indications of potential problem areas. Financial ratios are important because they help investors make decisions to buy hold or sell securities.

Current Ratio “To calculate the current ratio, we divide current assets by current liabilities. More liquidity is better because it means that the firm has a greater ability, at least in the short term, to make payments” (Parrino, Kidwell, & Bates, 2012).

The horizontal analysis is a method used to analyze changes in the company’s financial health between years in values of dollars and percentages using data from the balance sheet and income statement. In the horizontal analysis a base year is set and then other years are compared to the base year. The horizontal

There is a essential use and limitations of financial ratio analysis, One must keep in mind the following issues when using financial ratios: One of the most important reasons for using financial ratio analysis is comparability and for this, a reference point is required. Usually, financial ratios are compared to historical ratios of the business itself, competitor’s financial ratios or the overall ratios of the industry in question. Performance may be adjudged as against organizational goals or forecasts. A number of ratios must be analyzed together to get a true and reliable picture of the financial performance of the business. Relying on each ratio

This paper examines financial ratio analysis by defining, the three groups of stakeholders that use financial ratios, the five different kinds of ratios used and their applications, the analytical tools used in analysis, and finally financial ratio analysis limitations and benefits.

Horizontal analysis is the “comparative study of a balance sheet or income statement for two or more accounting periods, to compute both total and relative variances for each line item” (www.businessdictionary.com)

Financial ratios are great indicators to find a firm’s performance and financial situation. Most of the ratios are able to be calculated through the use of financial statements provided by the firm itself. They show the relationship between two or more financial variables that can be used to analyze trends and to compare the firm’s financials with other companies to further come up with market values or discount rates, etc.

This ratio is used to assess a company’s financial performance by revealing the money left over from the revenues. Gross Profit Margin also serves as the source for paying additional expenses and future savings.

Financial ratios provide a quickly and relatively way of assessing financial situation of an organisation. Ratios could be very helpful when comparing the financial health of different business, and it describes the relationship between different items in financial statement (Elliott & Elliott, 2008). By calculating a relatively small number of ratios, it will build up a good picture of the position and the performance of an organisation. Ration analysis includes five main areas, which are including profitability, efficiency, liquidity, financial gearing and investment (Atrill & Mclaney, 2006).

Financial ratios can be used for a quick comparison to other companies in the industry and to the same company over time. They allow you to ignore the numbers and focus on their relationships.

The calculation of ratios is the calculation technique for analyzing a company’s financial performance that divides or standardize one accounting measure by another economically relevant measure. Financial ratios can be used as a tool to demonstrate financial statement users for making valid comparisons of firm operating performance, over time for the same firm and between comparable companies. External investors are mostly interested in gaining insights about a firm’s profitability, asset management, liquidity, and solvency.

Ratio analysis is generally used by the company to provide some information on how the company has performed during that year, so that the parties involved including shareholders, lenders, investors, government and other users could make some analysis before making any further decision towards that particular company. As mentioned by Gibson (1982a cited in British Accounting Review, 2002 pg. 290) where he believes that the use of ratio analysis is such an effective tool to evaluate the company’s finance, and to predict its future financial state. Ratios are simply divided in several categories; these are the profitability, liquidity, efficiency and gearing.

Seeing that financial ratios depend on the financial data of companies which are influenced by their accounting practices and procedures, information can be distorted and render the comparison of ratios less useable. Also ratios indicate on overall result for a period (financial year) but do not explain how this was achieved in detail and what factors favorable or unfavorable contributed to its