Introduction to Financial Ratio

Financial statements can be off-putting. Most people find them over-whelming and often startling, simple because they don’t recognize them. As a consequence, they usually look at the net income and, if it has increased, look no further in the firm belief that all is well.

It is in the analysis of the financial statements that ratios come into their own. They help:

• To analyze the performance of the company and compare it with that of other similar companies;
• To determine the relative weakness and strengths of a company – whether it is profitable, financially sound and whether its condition is improving or deteriorating;
• To fulfill the needs of the stakeholders;

Financial ratios really put financial figures into perspective. Financial ratios summarize the figures in a form that is easily understood, interpreted and used. Ratios express relationship between one figure and another.

It is important when interpreting financial ratios, to be aware of the factors that affect the company such as its management policy, the industry, general business conditions and the state of the economy. Otherwise conclusion arrived at can be incorrect.

• Ratios give strong pointers to areas where one should concentrate. They do not necessarily give answers. Ratios are only starting points and whether the ratio is good or bad depends on the company.
• Ratios, in short, are simple, but their usefulness is wholly dependent on their logical and intelligent interpretation.