Performance ratios - Why are these used?

Discussion in 'Economy' started by Robert_us, Aug 12, 2009.

  1. Robert_us

    Robert_us Rookie

    Jul 30, 2009
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    Financial ratios provide a quick and comparable view of the performance of a business - by using financial ratio analysis, a lot of seemingly complex and overwhelming accounting information and year-end reporting can be made easy to comprehend. It may not be easy to adjudge the performance of a company over a period of time, say over five years or compare the same with a competitor or industry peer by looking at the year-end reporting, at least for an average investor. However, the use of financial performance ratios makes this possible. Financial analysts at business channels and newspapers use these to recommend one stock over the other. Stakeholders and the Board keep a close watch on these in order to ensure that the management is doing its job properly.

    Use and Limitations of Financial Ratio Analysis

    However, one must keep in mind the following issues when using financial ratios:

    - One of the most important reasons for using financial ratio analysis is comparability and for this, a reference point is required. Usually, financial ratios are compared to historical ratios of the business itself, competitor’s financial ratios or the overall ratios of the industry in question. Performance may be adjudged as against organizational goals or forecasts.

    - A number of ratios must be analysed together to get a true and reliable picture of the financial performance of the business. Relying on each ratio individually may not be a good strategy.

    - Year-end values may not be truly representative of the actual performance of the business and hence, average values should be used when they are available.

    - The limitations of accounting methods also apply to financial ratio analysis. The selection and application of accounting standards may result in different ratio values.

    Financial ratio analysis, in fact, has a great use in management accounting which differs from financial accounting in being an on-going, performance management exercise.
  2. editec

    editec Mr. Forgot-it-All

    Jun 5, 2008
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    Very informative.

    If you're planning on continuing this lecture series (and why not? beats the usual childish bitchfesting we're used to) let me propose you begin listing proformance ratios.

    And while you'er listing them and explaining what they're telling us, you might want to note which ones can be manipulated by bad managment practices to mislead the investors, too?

    For example. one can change the numbers by firing workers.

    In the short run the books look bette because current costs are reduced. Profits in the long run, however might suffer.

    Hence one notes that thse numbers, while useful and very valuable, can be quite misleading.
    Last edited: Aug 12, 2009

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