A ratio expresses the numerical relationship between two numbers. In the words of Kennedy and McMullen, “the relationship of one item to another expressed in simple mathematical form is known as a ratio”. Thus, the ratio is a measuring device to judge the growth, development and present condition of concern. It plays an important role in measuring the comparative significance of the income and position statement. Accounting ratios are expressed in the form of time, proportion, percentage, or per one rupee. Ratio analysis is not only a technique to point out the relationship between two figures but also points out the devices to measure the fundamental strengths or weaknesses of a concern.
The main purpose of ratio analysis is to measure past performance and project future trends. It is also used for inter-firm and intra-firm comparison as a measure of comparative productivity. The significance of the various components of financial statements can be judged only by ratio analysis. The financial analyst x-rays the financial conditions of concern by the use of various ratios and if the conditions are not found to be favorable, suitable steps can be taken to overcome the limitations.
The main objectives of ratio analysis are:
- To simplify the comparative picture of financial statements.
- To assist the management in decision making.
- To gauge the profitability, solvency, and efficiency of an enterprise, and
- To ascertain the rate and direction of change and future potentiality.