Ratio Analysis is a technique of analysis and interpretation of financial statements. It is the process of establishing and interpreting various ratios for helping in making certain decisions. However Ratio Analysis is not an end itself.It is only a means of better understanding of financial strengths and weakness of a firm.Just like a doctor examines his patient by recording his body temperature,blood pressure,etc before making his conclusion regarding the illness and before giving his treatment,a financial analyst analyses the financial statements with various tools of analysis before commenting upon the financial health or weakness of an enterprise. A ratio is known as a sympton like blood pressure,the pulse rate or the temperature of an individual.

The use of ratios is not confined to financial managers only. As discussed earlier,there are different parties interested in the ratio analysis for knowing the financial position of a firm for different purposes. The suppliers of goods on credits,banks,financial institutions,investors,shareholders and management all make use of ratio analysis  as a tool in evaluating the financial position and performance of a firm for granting credit,providing loans or making investments in the firm.With the use of ratio analysis one can measure the financial condition of a firm and can point out whether the condition is strong,food,questionable or poor.The conclusions can also be drawn as to whether the performance of the firm is improving or deteriorating. The steps involved in Ratios analsis are as follows :-

STEP 1  : Determination of Purpose – The prime step of ratio analysis is to determine the objective and purpose of which ratios are required to be determined,because of the fact that different rations are provided for different purposes.

STEP 2 : Setting up of Ratios :-   After indentification of objective,we are required to select the specific type of ratios that can better suit the purpose. The ratios required by the prospective investors cannot be identical with the ratios required by the lending institutions.

STEP 3 : Definition of Ratios – The next step is to define the ratios identified in a befitting manner. This is most important. The ingredients will depend upon the category of the users.

STEP 4 : Calculation of Components  — It is required to find out the value of each component from the profit and loss a/c.Balance Sheet and other information available.

STEP 5 : Determination  of Results –  Thereafter the values of the components are to be put in the defined formula to get the desired result.

STEP 6 : Interpretation  –   For proper interpretation of the results so calculated, the standards available and the industry averages are to taken into consideration then  the results so determined be compared with the standards and industry averages. This comparison will indicate the financial health of the Org.

The importance of Ratio Analysis may be detailed out as follows :-

1. TREND ANALYSIS :- The financial trend of any firm can be better compared and analyzed with the help of ratios. The trend analysis on the basis of accounting ratios helps suggest the corrective measures.

2.MEASURE OF EFFECIENCY :-   with the help of  Ratios, the position of a firm in the industry can easily ascertained by comparing the ratios determined with standards and industry averages available.The ratios will indicate whether the management is efficiently discharging the assigned responsibilities or not.

3. BUDGETARY CONTROL  :-  The ratios are the integral part of budgetary control. The ratios are useful to fix up targets and standards.The performance level is indicated by the ratios. So ratios are a tool of budgetary control.

4.SHORT TERM LIQUIDITY :-  Liquidity is the basic requirement of survival of any firm. Ratio Analysis can easily ascertain short-term liquidity, as liquidity ratios are the indicators of short-term solvency.

5. LONG TERM SOLVENCY :- The long-term solvency indicates the viability of a firm in the long run.The ratio analysis plays a vital role for effective Equity analysis,security analysis and so on in such a way that long term solvency can be predicated with much more accuracy.

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