AMP 415 Module 3 DQ 1

The Ratio analysis forms an essential part of the financial analysis which is a vital part of business planning. The key benefits of ratio analysis include:

Determines profitability

Ratio analysis assists managers to work out the production of the company by figuring the profitability ratios. Also, the management can evaluate their revenues to check if their productivity. Thus, probability ratios are helpful to the company in appraising its performance based on current earning.

Helpful in evaluating solvency

By computing the solvency ratio, the companies are able to keep an eye on the correlation between the assets and the liabilities. If, in any case, the liabilities exceed the assets, the company is able to know its financial position. This is helpful in case they wish to set up a plan for loan repayment.

Better financial analysis

Ratio analysis is also helpful to recluses, in addition to shareholders, debenture holders, and creditors. Besides, bankers are also able to know the profitability of the company to find out whether they are able to pay the dividend and interests under a specific period.

Performance analysis

Ratio analysis is also helpful in analyzing the performance of a company. Through financial analysis, companies can review their performance in the past years. This is also helpful in identifying their weaknesses and improving on them.

Forecasting

At present, many companies use ratio analysis to reveal the trends in production. This provides them an opportunity for estimation of future trends and thus the foundation for budget planning so as to determine the course of action for the growth and development of the business.

reference:

http://smallbusiness.chron.com/advantages-financial-ratios-3973.html

Despite usefulness, financial ratio analysis has some disadvantages. Some key demerits of financial ratio analysis are:

Different companies operate in different industries each having different environmental conditions such as regulation, market structure, etc. Such factors are so significant that a comparison of two companies from different industries might be misleading.

Financial accounting information is affected by estimates and assumptions. Accounting standards allow different accounting policies, which impairs comparability and hence ratio analysis is less useful in such situations.

Ratio analysis explains relationships between past information while users are more concerned about current and future information.

Reference:

http://www.investopedia.com/exam-guide/cfa-level-1/financial-ratios/uses-limitations-ratios.asp