Question

Explain the purpose of financial ratios and what issues should be considered when using them for comparing organizations? Explain the purpose and difference types of benchmarking.

Answer 1

The purpose of financial ratios is analysis the company’s financial strength and weakness.   Financial ratios are very important tool for the financial analysis and help us compare the different parameters of financial analysis with a single number. We can compare the number over the period for the same organization or also can compare different organizations within same industry. It helps the companies to improve profitability, liquidity, financial structure, etc. The calculation of financial ratios or based on past performances but it can give an idea about the future performance also by the trend analysis.

Benchmarking is comparison of the performance or ratios with some set standards. It is used to know that the stock is comparatively undervalued or overvalued. There are mainly four types of benchmarking

• Internal benchmarking: it is comparison of ratios over the period for the same organization.
• Competitive benchmarking: it compares with the different organizations within same industry
• Functional benchmarking: it is an analysis of similar or identical functions within the same or different industry.
• Generic benchmarking: It compares different unrelated business processes across the industry.