RATIO ANALYSIS
Meaning of Ratio
A ratio is a simple arithmetical
expression of the relationship of one number to another. It may be defined as
the indicated quotient of two mathematical expressions.
Definition
According to Accountant's Handbook by
Wixon, Kell and Bedford, a ratio "is an expression of the quantitative
relationship between two numbers".
Uses and Significance of
Ratio Analysis
The ratio analysis is one of the
most powerful tools of financial analysis. It is used as a device to analyse
and interpret the financial health of enterprise. Ratios have wide applications
and are of immense use today.
Managerial Uses of
Ratio Analysis
a) Helps in
decision-making: Financial statements are prepared primarily for
decision-making.
b) Helps in
financial forecasting and planning: Ratio Analysis is of much help in
financial forecasting and planning
c) Helps in
communicating: The financial strength and weakness of a firm are
communicated in a more easy and understandable manner by the use of ratios.
d) Helps in
co-ordination: Ratios even help in co-ordination which is of utmost
importance in effective business management.
e) Helps in Control:
Ratio analysis even helps in making effective control of the business
Limitations of Ratio Analysis
1. Limited Use of a
Single Ratio:
A
single ratio, usually, does not convey much sense. To make a better
interpretation,
A number of ratios have to be calculated, which is likely to
confuse the analyst rather than help make a meaningful conclusion.
2. Lack of adequate standards:
There
are no well-accepted standards or rules of thumb for all ratios that can be
accepted as norms. It renders interpretation of the ratios difficult.
3. Inherent Limitations
of Accounting:
Like
financial statements, ratios also suffer from the inherent weakness of
accounting records, such as their historical nature.
4. Change of Accounting
Procedure:
Change
in accounting procedure by a firm often makes ratio analysis misleading.
5. Window Dressing:
Financial
statements can easily be window-dressed to present a better picture of their
financial and profitability position to outsiders.
6. Personal Bias:
Ratios
are only a means of financial analysis and not an end in themselves. Ratios have to
be interpreted,d and different people may interpret the same ratio in different
ways.
7. Uncomparable:
Not
only do industries differ in their nature, but also the firms of the same business
widely differ in their size and accounting procedures, etc. It makes comparison
of ratios difficult and misleading.
8. Absolute Figures
Distortive:
Ratios
devoid of absolute figures may prove distortive
as ratio analysis is primarily a quantitative analysis and not a qualitative
analysis.
9. Price Level Changes:
While
making ratio analysis, no consideration is made of the changes in price levels, and this makes the interpretation of ratios invalid.
10. Ratios no
Substitutes:
Ratio
analysis is merely a tool of financial statements. Hence, ratios become useless
if separated from the statements from which they are computed.
11. Clues not
Conclusions:
Ratios
provide only clues to analysts and not final conclusions. These ratios have to
be interpreted by these experts, and there are no standard rules for
interpretation.
References
1. Anthony,
R. N., Govindarajan, V., & others – Management Accounting
2. Khan, M. Y., & Jain,
P. K. – Management Accounting
3. Management Accounting – S.
N. Maheswari
- La Rosa, Nic – Analysing
Financial Performance Using Integrated Ratio Analysis
- Axel, Tracy – Ratio Analysis
Fundamentals: How 17 Financial Ratios Can Allow You to Analyse Any
Business on the Planet
- Steffy, Wilbert; Zearley, Thomas; Strunk, Jack – Financial
Ratio Analysis: An Effective Management Tool
Journals for Management Accounting
These peer-reviewed journals are excellent sources for scholarly articles on management accounting topics:
· Journal of Management Accounting Research (JMAR) – Focuses specifically on management accounting theory and practice. American Accounting Association
· Management Accounting Research – Premier international journal dedicated to rigorous and relevant management accounting studies. (Publisher: Elsevier; highly credible)
· Contemporary Accounting Research – Publishes accounting research with managerial accounting topics included. Wikipedia
· Accounting, Auditing & Accountability Journal – Covers accounting topics with frequent studies on management accounting, control systems and corporate decision-making. Wikipedia
· British Accounting Review – Includes research on management accounting and organizational accounting practice. Wikipedia
