Question

When making “meaning” of ratios: what are the three things a smart analyst must do?

Answer 1

Ratio analysis is a tool used to determine the financial health and operational efficiency of a company.The investor can use ratio analysis for various types of assesment such as Assesment of Liquidity,Assesment of Long Term Solvency,Assesment of profitability,Assesment of operating efficiency.

When Analysing different types of ratios,A financial analyst must keep in his mind these three things -

1.It is important to keep in mind that financial ratios are time sensitive;they can only present a picture of the business at the time the underlying figures were prepared.Ratios can be misleading at the times.

2.Financial Analyst should keep in mind that a ratio in isolation is meaningless, Financial ratios must be compared with some standard to arrive at any logical conclusion.

3.Financial ratios can only to be used as a guide not the ultimate measure of the performance of the company.It is based only quantitative factor not the qualitative factor so a high level of reliance cannot be placed on these figures.