MSG Team's other articles

11648 Different Types of Accounts in a Business

The entity concept separates the concerns of the owners from the business. An extension of the same concept is the concept of accounts which splits up the business’s affairs further. The account concept becomes clearer once the double entry system of accounting is explained. That is done at a later stage in the tutorial. Transactions […]

9101 Elasticity of Taxes

In the previous article, we have studied the concepts of the tax base and tax rate individually. Now, it is time to see how the two react. We already know the basics to some extent. We know that the tax base and the tax rate move in opposite directions. Hence, ideally, if we increase the […]

11242 Series B Funding

In the previous articles, we have already learned about the seed funding stage as well as the series A funding stage. We know that entrepreneurs raise seed funding in order to be able to build the prototype of the product. After the prototype is in place, they raise Series A funding to build the actual […]

9800 The Impact of Technology on Pension Funds

Technology is the elephant in the room as far as pension funds are concerned. There is no meeting or conference where pension funds are discussed but the manner in which technology impacts these pension funds is not discussed. There are many experts who believe that technology is the future and hence pension funds must prioritize […]

10730 The Problem with Having Bitcoin Futures

Bitcoin futures have been introduced on the Chicago Mercantile Exchange (CME) and Chicago Board Options Exchange (CBOE) from December 10, 2017. Although it is being claimed that these future contracts will be used for hedging and mitigating risks, the reality is that they are being used for speculative purposes. Bitcoin has become a highly speculative […]

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