Question

Explain the role of ratio analysis in analyzing and interpreting a firm's financial statement with suitable examples. Consider an appropriate example in your analysis.

simple & not too long answer

Answer 1

SOLUTION:-

Ratio analysis is very important in analyzing and interpretation of firm's financial statement. From a financial statement we get to know about a firm's Debts, equity, assets, liability. By using them we calculate different ratios of the firm, for example current ratio, quick ratio, debt equity ratio, return on investment etc.

A firm financial performance can be identified by analyzing these ratios. We can understand better with examples.

Current ratio:- Current ratio is Current assets/current liability. This explains about compans working capital ability to meet day to day business requirements.

Quick Ratio:- Quick ratio is (Current assets - Iventory)/Current liability. This explains the quick cash available with the firm to meet immidiate cash requirements. Its ability to pay any immidiate debt.

Debt equity Ratio:- Debt equity ratio is Long term debts/Equity. Thisexplains firm's capital structure. How firm has balanced its capital financing. It give basis for decision making regarding future funding from debt or equity, calculating firm's cost of capital.

Return on investment:- It means the Net income per $ earned on per $ of sales. This ratioenables investor to decide whether to invest in firm's equity or not. This ratio helps to decide the actual market value of firm depend upon its current return on investment and predictions of future returns on investments.

There are many other ratios too which help in interpreation and analysing a firm financial statement in different ways. Analysing these ratios help in better decision making. Therefore ratio analysis plays a very important role in interpretation of firm's financial statements.

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