Financial Ratio Definition

In finance Ratio analysis is carried out to judge the liquidity of the organization. It helps the analysts to find if a company is capable enough to pay its liabilities. Moreover it also helps to show the operating efficiency and internal return of an organization. Keep in mind that the ratio is good or bad only if it is compared to the industry in which the organization is operating in.

Some of the important ratios are: * Current Ratio * Asset Test Ratio * Return on Asset * Return on Investment * Inventory turnover ratio * Operating Cycle
Ratio analysis is an important and age-old technique of financial analysis. The following are some of the advantages of ratio analysis:

Simplifies financial statements: It simplifies the comprehension of financial statements. Ratios tell the whole story of changes in the financial condition of the business
Facilitates inter-firm comparison: It provides data for inter-firm comparison. Ratios highlight the factors associated with
Limitations of financial Statement Analysis are given below:
Limitations of Financial Statement Analysis
1. There will be no doubt in this statement that ratios are a useful analysis tool, there are certain limitations, which are very important for an analyst to understand before applying this tool, in order to make his analysis more meaningful and significant.
2. FSA (Financial Statement Analysis) is generally an outdated (because of Historical Cost Basis) post-mortem of what has already happened. It is simply a common starting point for comparison. Always use Constant Rupee / Dollar analysis to account for inflation or increase.
3. FSA is limited by the fact that financial statements are "window dressed" by creative accountants. Window dressing refers to the understatement or overstatement of financial facts.

4. Different companies use different accounting standards for Inventory, Depreciation, etc. Therefore comparing their financial ratios can be misleading