Advantages and Disadvantages of Ratio Analysis

What is Ratio Analysis?

Ratio analysis is a quantitative analysis of data enclosed in an enterprise’s financial statements. It is used to assess multiple perspectives of an enterprise’s working and financial performance such as its liquidity, turnover, solvency and profitability.

To put it in other words, Ratio analysis is the method of analysing and comparing financial data by computing meaningful financial statement value percentages rather than comparing line items from each financial statement.

Ratio analysis has its own merits and demerits too. Below mentioned points highlights those points.

Advantages of Ratio Analysis are as follows:

  • Helps in forecasting and planning by performing trend analysis.
  • Helps in estimating budget for the firm by analysing previous trends.
  • It helps in determining how efficiently a firm or an organisation is operating.
  • It provides significant information to users of accounting information regarding the performance of the business.
  • It helps in comparison of two or more firms.
  • It helps in determining both liquidity and long term solvency of the firm.

Disadvantages of Ratio Analysis are as follows:

  • Financial statements seem to be complicated.
  • Several organisations work in various enterprises each possessing different environmental positions such as market structure, regulation, etc., Such factors are important that a comparison of 2 organisations from varied industries might be ambiguous.
  • Financial accounting data is influenced by views and hypotheses. Accounting criteria provide different accounting methods, which reduces comparability and thus ratio analysis is less helpful in such circumstances.
  • Ratio analysis illustrates the associations between prior data while users are more concerned about current and future data.

The above mentioned is the concept, that is elucidated in detail about the Advantages and Disadvantages of Ratio Analysis for the class 12 Commerce students. To know more, stay tuned to BYJU’S.

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