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Finance > Corporate Finance > Ratio Analysis

Ratio Analysis

Not all corporates can raise capital from the market. Capital market is an information driven arena. The availability of market capital to an existing corporate depends solely on its perceived performance. The market watchers have, at their disposal, various tools to make this value judgement. Ratio analysis is one such oft used (or abused) tool. The trends in management, financial viability and other factors relevant from the point of view of the market can be studied from the various financial ratios such as:

Leverage Indicators (debt-equity ratio)
Cost ratios
Current ratios
Retained earning ratios
Dividend ratios etc.

The indicators of profitability of companies are:

Profits to sales ratios
Profits (EBDIT) to total capital employed ratio,
Operating profit to sales ratios and
Profit to tangible Net worth ratio.

Other ratios and percentages:

Profit allocation ratios
Profitability ratios
Capital formation growth rates
Ratios on sources and uses of funds
Activity ratios

Ratio analysis is a useful tool of for both micro and macro financial appraisal. Like all other analytical tools, its usefulness depends on the user and the purpose. There are no standard ratios applicable to all purposes and situations. Certain ratios are more useful at micro level and others at macro level. Broadly, ratios represent a relation between two variables chosen and the type of relation set out has to be seen for a particular purpose. Any number of such ratios can be designed depending upon the purpose of the analysis. In isolation, ratios can be used only for time-series analysis of the company' performance. In such an analysis, continuing inefficiencies built into the system of a corporate escape observation. Very important factors in ratio analysis, therefore, are benchmarking and cross-sectional analysis. With the availability of commercial databases in the market these tools can also be used to accurately analyse the performance of a corporate.

Ratio analysis, therefore, should be applied, not in isolation but with reference to a group of companies within an industry to ascertain its financial viability, and other relevant factors. This same tool can also be used at the time of taking investment decisions.

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