Question

Write a response to the following in a minimum of 500 words:

Financial statement analysis focuses primarily on isolating information that is useful for making a particular decision. Through ratio analysis, users of financial data can analyze various relationships between items reported.

Describe the 3 main categories of ratios and provide a specific example of a ratio that is used in each category. For each of the 3 ratios you selected, describe how it is used in managerial decision-making.

Answer 1

Ratio analysis is a quantitative tool that enables the management analyse the the liquidity, operational effectiveness and efficiency of an organisation.

The three main categories of ratios along with examples and how they are used in decsion making are as follows

1. Liquidity ratios

• Examples= Current Ratio, Quick Ratio, Working capital ratios
• Usefulness in decision making- They measure a company's ability to pay off its short-term debts as they become due, using the company's current or quick assets.

2. Solvency Ratio

• Examples- Debt equity ratio, Interest coverage ratio
• Usefulness in decision making- These compare a company's debt levels with its assets, equity, and earnings, to evaluate the likelihood of a company to survive in the long run, by paying off its long-term debt as well as the interest on its debt.

3. Profitability Ratios

• Examples- Gross Profit Ratio, Net profit Ratio
• Usefulness in decision making- These ratios help the managers analyse how well the company is able to generate profits