Question

Financial Ratio have been the mainstay in financial analysis. They are one of the most used methods in financial investment. what do these ratios really mean and are they useful?

How should we use financial Ratios in the decision-making process?

Answer 1

The success and failure of business operation is reflected in the data of the business and proper analysis of the data available can only be done through financial ratios. Financial ratios helps in interpreting numbers of income statement and balance sheet in an effective way. A business consist of various stakeholders and every stakeholder have different expectations from the business, for example creditors would be interested in solvency position of the company, while investor would be looking for growth rate of company in terms of ROE and dividend growth etc. Therefore, financial ratios are very crucial from the perspective of stakeholders as well. The different ratios also helps in identifying the risks for business like financial risk and business risk, which is essential for overall growth as well as profitability in the longer run.

Financial ratios can play a vital role in the decision making process. It helps in evaluating the financial position of the company along with analyzing the internal and external risks for the business. For example, degree of operating leverage is a financial ratio which helps in assessing the business risk of a firm, while degree of financial leverage is a ratio which describes the financial risk that the company might be having. Ratio analysis is core part of any management decision making process. Overall, financial ratios makes it easy for management to take decision of business growth, sustainability, competition etc.