MSG Team's other articles

12341 Anti-Money Laundering Activities at Commercial Banks

In the previous article, we have already seen how commercial banks inadvertently help anti-social elements in laundering money. We have also seen why commercial banks are preferred by anti-social elements when it comes to laundering money. We know that commercial banks have already put in place a lot of processes to stop this money laundering […]

10487 Objectives of Financial Modelling

Financial modeling enables key personnel to make better decisions. These models are used for various types of decision making. Hence, one model cannot be used for all types of decision making. As a result, several different types of models have to be created. Each of these models’ requires different inputs and provides different outputs. A […]

12098 Does Financial Innovation Benefit the Society?

We live in a world which idolizes innovation. We tend to idolize companies which have produced some products which can be considered to be innovative. The underlying belief in the capitalistic system is that innovation is beneficial. It is innovation which creates more value, and since the capitalistic system allows the creator of innovation to […]

11658 Types of Covenants

In the previous article, we had a closer look at the concept of covenants as well as indentures. However, we only covered the basics. Indentures and covenants are extremely important to the investors who deploy their money in fixed-income securities. It is for this reason that investors need to have a better understanding of the […]

10284 Market Indicators For Commodities Investing

All kinds of investing is driven by market sentiment. These sentiments in turn are driven by certain market indicators. Investors and traders are often glued to these indicators. The markets get particularly volatile when information pertaining to these market indicators is released. Every type of market has its own set of indicators. Some indicators overlap […]

Search with tags

  • No tags available.

Ratio analysis is one of the oldest methods of financial statements analysis. It was developed by banks and other lenders to help them chose amongst competing companies asking for their credit. Two sets of financial statements can be difficult to compare. The effect of time, of being in different industries and having different styles of conducting business can make it almost impossible to come up with a conclusion as to which company is a better investment. Ratio analysis helps creditors solve these issues. Here is how:

What are Financial Ratios ?

  • Shortcut: Financial ratios provide a sort of heuristic or thumb rule that investors can apply to understand the true financial position of a company. There are recommended values that specific ratios must fall within. Whereas in other cases, the values for comparison are derived from other companies or the same companies own previous records. However, instead of undertaking a complete tedious analysis, financial ratios helps investors shortlist companies that meet their criteria.

  • Sneak-Peek: Investors have limited data to make their decisions with. They do not know what the state of affairs of the company truly is. The financial statements provide the window for them to look at the internal operations of the company. Financial ratios make financial analysis simpler. They also help investors compare the relationships between various income statement and balance sheet items, providing them with a sneak peek of what truly is happening behind the scenes in the company.

  • Connecting the Dots: Over the years investors have realized that financial ratios have incredible power in revealing the true state of affairs of a company. Analyses like the DuPont Analysis have brought to the forefront the inter-relationship between ratios and how they help a company become more profitable.

Sources of Data

Here is where the investors get the data they require for ratio analysis:

  • Financial Statements: The financial data published by the company and its competitors is the prime source of information for ratio analysis.

  • Best Practices Reports: There are a wide range of consulting firms that collate and publish data about various companies. This data is used for operational benchmarking and can also be used for financial data analysis.

  • Market: The data generated by all the activity on the stock exchange is also important from ratio analysis point of view. There is a whole class of ratios where the stock price is compared with earnings, cash flow and such other metrics to check if it is fairly priced.


MSG Video - Introduction to Ratio Analysis


Article Written by

MSG Team

An insightful writer passionate about sharing expertise, trends, and tips, dedicated to inspiring and informing readers through engaging and thoughtful content.

Leave a reply

Your email address will not be published. Required fields are marked *

Related Articles

What are Common Size Statements ?

MSG Team

Cash Ratio – Meaning, Formula and Assumptions

MSG Team