## Top 11 Advantages of Ratio Analysis

Ratios are useful tools used for expressing the relationship between data that can be used for internal comparisons and also be used for comparisons across firms. They are used for answering questions that are needed to be answered rather than answering questions directly. Specifically, ratio analysis is advantageous and can be used for the following –

### #1 – Ratio Analysis Helps in Analyzing Financial Statements

For eg:

The first advantage of is that it provides a broad overview of the company’s health, financial stability, valuation. It helps bankers, investors, as well as management in decision making. This is one of the vital methods of financial statement analysis and can be modified as per user’s needs. Ratios give minute details of each segment of the company

### #2 – Ratio Analysis Helps in Judging the Efficiency

The second advantage of Ratio Analysis is that Profitability, help assess the company’s overall performance. It helps investors in determining how the company’s operations are going on and how well the management is making decisions. It also helps determine if the company is over or underleveraged. Ratio analysis helps in determining if the assets are well utilized, and the profits are growing at a strong pace. Ratios also help identify if the profits are used wisely. Ratios like and help in understanding how much profit is passed to investors

It basically helps to evaluate a firm’s flexibility .ie. if the firm has the ability to grow and meet its obligations when unexpected events occur

### #3 – Ratio Analysis Helps in Determining Weakness

Even though the overall performance may look good, often there can be situations where management’s attention is required. Another advantage of Ratio Analysis is that Ratios like interest coverage, debt service ratio analysis help in getting a detailed understanding. Management can then focus on these areas

### #4 – Ratio Analysis Help in Projecting Future Earnings and Cash Flow

Ratios are calculated by using historical figures and are forecasted based on the growth rate of these figures. Ratio analysis can be used in preparing that provide estimates of financial statement items for one or more future periods. Ratio analysis and forecasting help management in formulating plans and investors to see how the company is growing.

### #5 – Comparing Performance to Peers

It is one of the most important advantages of ratio analysis that facilitates comparisons between two companies. It is impossible to compare two companies just by looking at the income statement or Balance Sheet. Investors often wish to understand where the company stands in the sector it operates.  It also helps in understanding if the company is overvalued or undervalued among its peers

Apart from comparing itself to peers, it also helps in comparing different divisions in the same company. Most often, management use ratios when they have to decide which division they want to invest in or which division they want to shut down

### #6 – Trend Analysis

The other advantage of Ratio analysis is that it helps in understanding the trends over the years. The analyst can easily determine by looking at the numbers whether the company is going up, down, or stable. The comparison can be made easily and helps in determining if the ratio is above or below the benchmark in the industry.

### #7 – Ratios Give Meaning to Absolute Figures

As we discussed earlier, it is difficult to understand a company solely based on the numbers provided in the financial statements. Ratios give meaning to numbers and simplify complex accounting statements. For example, if we say that the company has a PE ratio of 1.2x, it will not make much sense if we don’t know what the ratio was like in the last year or what it is now for its peers. Similarly, if we say that the company has revenues of two billion, we cannot interpret if it is good compared to the assets and if the company is selling a maximum of its services or products on credit. , account receivable days, help in understanding this.

### #8 – Analysis of Past Results

Another advantage of Ratio analysis is that it helps in understanding the different relationships and interlinks in the past data and help scrutinize the results.

### #9 – Determining Short-Term Liquidity

help in determining the short-term liquidity position of the company. These ratios help in understanding whether the firm is able to meet its short-term obligations. Long-term solvency can also be determined using profitability and .

### #10 – Communication

When the management discloses their results, it is always announced in terms of ratios. They focus on ratios like EV/EBITDA, EPS, PE. This is well communicated to the investors. When management talks about a number, it is considered to be well summarized and simplified. Ratios have the power to speak

### #11 – Ratio Analysis Helps Analysts do a Better Job

Analysts mainly conduct hardcore number-crunching of the company’s data. Ratios provide an early warning in situations where the company’s performance is going down. Analysts use ratio analysis to evaluate how efficiently the firm is managing its inventory.

For example, the inventory turnover ratio measures how quickly a firm is selling its inventory. Inventory turnover that is too low may be an indication of slow-selling or even obsolete products. Carrying too much inventory is costly, as the firm incurs storage costs, insurance, and inventory taxes. The excessive inventory also ties up cash that might be used more effectively somewhere else. Most of the successful companies have very strong ratios; any fault or weakness in any of the.areas may lead to a strong sell-off. Ratios are also specific to industries. Ratios important for banks may not necessarily be important to manufacture companies; the analyst performs their analysis considering these factors.

As described above, ratios have multiple uses and can be used by everyone starting from management, customers, investors as well as creditors.

This article has been a guide to Ratio Analysis Advantages. Here we discuss the Top 11 advantages and applications of Financial Statement Analysis that can be used by everyone starting from management, customers, investors as well as creditors.