Every business can determine its profitability and efficiency based on its financial statements. Although profitability can be easily identified in financial statements, the efficiency of the organization can be understood with the help of accounting ratios. Therefore, businesses cannot neglect the importance of ratio analysis. The comparison or relationship between one accounting data point and another helps in determining the financial condition of the company. Ratio analysis is done to compare how the company is performing with others in the industry and also to determine a company’s current performance with respect to previous years. Here are a few more reasons why accounting ratios are important.
Analyzing Financial Statements
Financial statements are very important because they are used for internal as well as external purposes. Ratio analysis plays an important part in assessing the financial position of a company. The company managers, investors, and creditors look at these ratios for decision-making purposes. For example, if a company has a high debt-to-equity ratio, then banks will be reluctant to provide further financial assistance. This is because a high debt-to-equity ratio indicates that a company may not be able to generate sufficient cash to fulfill its debt obligations.
Judging Efficiency
Optimum utilization of assets and the ability to earn profits by the company is judged by accounting ratios. Judging the efficiency will assist in the decision-making process of the company and its capacity to expand in the future. Ratio analysis also helps to know at what pace the company is moving as compared to its previous years as well as its current competitors.
Locating Weakness
The overall performance of the company’s operations may be quite impressive. It may be difficult to identify any weakness when going through the financial statements. Accounting ratios can help locate these weaknesses even though the company is in a stable financial condition. It is extremely important for business owners to know where their business is not performing and to ensure suitable action is taken.
Formulating Plans
Accounting ratios are utilized to identify past financial performance as well as to establish future trends. Comparison of past ratios to the present can help in formulating a plan for the future. Formulating plans helps in decision-making. Hence, business owners need to have accurate ratios in order to make a plan for the future.
Comparing Performance
Ratio analysis helps in comparing the overall performance of a firm Internal performance is compared between different divisions, how efficiently they are working as a unit as well as together as an organization. Ratios are used by investors, bankers, and creditors to compare the past performance of the company and whether to currently invest in the company. Thus, by comparing the performance, you get a clear picture of the financial position of a firm and help to identify areas of improvement for the future. The importance of ratio analysis cannot be neglected as they are equally important as the financial statements of a company. Now that you are aware of the importance of ratio analysis, make sure you use them to enhance your firm’s performance and make the right business decisions.
Need any help regarding your financial books of accounts? Contact ATS Accounting and Tax Edmonton by scheduling your free 15-minute consultation online or calling us at 780-484-4006. Our team of experienced financial advisors at our Edmonton accounting firm will give you all the required guidance and help regarding your accounting worries.
