How ratio analysis provides a meaningful comparison of a company to Essay

How ratio analysis provides a meaningful comparison of a company to its industry, chief competitors, or to any other well run firm - Essay Example These techniques help to compare a company’s performance with its chief competitors in same industry as well as monitor the company’s progress over time. Accounting ratios is an important tool for financial statement analysis. A ratio is defined as relation between two numbers expressed as fraction or as percentage. When such relationships are derived from the financial statements, they are called accounting ratios (Kim & Ayoun, 2005, p.2). Accounting ratios have immense application in interpretation of financial statements by helping perform both intra-firm and inter-firm comparison. Intra-firm comparison helps to measure the performance of the company on Y-O-Y basis while inter-firm comparison helps to evaluate Company’s performance with its competitors. Ratios can be broadly classified into income statement ratios (derived from income statement), balance sheet ratios (derived from balance sheet) and composite ratios (one item from balance sheet and another from income statement). They help to evaluate the firm’s ability to honor its short term or current obligations. It is an indicator for the measure of working capital management. The firms’ short term obligations include carrying out day to day operations, payments to creditors for purchase of raw materials, payment of daily wages of laborers, outstanding expenses and bills payables, etc. These current liabilities are financed by current assets (Bragg, 2012, p.73). It is the ratio of total long-term debt to total asset. While a low ratio provides security to creditors a high ratio helps the management to trade on equity. Hence it is also called the leverage ratio (Drake, 2008, p.9). It is the ratio of long term debt to shareholders’ fund (Equity shares, retained earnings, preference shares, and fictitious assets). Form the investors’ point of view a