Question

Despite its several drawbacks, why many analysts still use ratio analysis? Justify with logical arguments.

Answer 1

Despite LImitations Ratio analysis holds widde gamut of accenptance in the industry this is because of the following reasons

• Ratios trickle down data into a meaningful conclusion as it gives meaning to a number- With humongous data structure given in the financial statements it is vital to comprehend the data in a unbiased and rational manner.
• It facilitates analyses based on time and camong industry peer : For valuation among peers P/E, P/B,P/CF, P/S plays a crirtical roel
• It simplifies the accounting data so that the stakeholders can interpret the health of the business. DEbt to Euity ratio and ROE tells about how much business is generating per unit of capital contribution.
• It helps in explainig the blind spots of the business; eg through DuPont anaysis one can find out the weakness or the reason of the result cocnveyed by the number
• Helpfult to draw Trend analysis; To see what is happening on year on year bases CAGR of each top line and bottom line is essential
• It plays a key role in forecasting; Some ratios stand constant in a business whereas some are variable with the revenue for instance fixed cost as apercentage of sales remains constant but variable cost increases with revenue.