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Ratio analysis - A summary

Ratio analysis has been covered on an individual basis in the previous units. Use the table of contents on the left and look at the pages for individual ratios if you are not sure about any of them.

This page simply gives an overall summary of the use and limitations of ratio analysis. In the questions section of the module there is a case study where you can practise all the knowledge gained in this unit so far. The case study is called Stortford Yachts and it also has the answers for you to see how you got on.

summary pad.pngRatios are a powerful tool in the interpretation of the accounts and can discover issues and problems not immediately evident from the accounts and financial information provided in the annual report. The can provide the basis for inter-firm comparisons allowing managers to benchmark the performance and efficiency of the firm against its competitors. Trends can then be examined and analysed. Stakeholders may use ratios to support their decision making. Employees, for example may use profit ratios to support pay claims and creditors can use liquidity ratios to evaluate whether debts will be repaid.

Further limitations:

  • However other types of analysis exist, which are not based solely on financial performance.
  • Ratios are based on data published in public financial accounts. Only financial data is used, so non-financial factors are not included. It cannot be concluded that all the data needed is published, so it is hard to draw solid conclusions from the ratios alone.
  • Analysis is only of real use if there are a series of accounts available.
  • Access to the equivalent information for other firms in the same industry is needed so inter-firm comparisons can be made.
  • Ratios are always looking at historical data, and so the situation the firm is facing may have changed significantly between publication of the accounts and analysis of them.