Accounting Ratios

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Financial information

The financial statements of a business provide important financial information for people outside the business (external users) who do not have access to the internal accounts.

For example, current and potential shareholders can see how much profit a business made, the value of its assets and the level of cash reserves.

Although these figures are useful, they do not mean a great deal by themselves.

To summarise and present financial information in a more understandable form, they need to be properly analysed using accounting ratios and then compared with either the previous year’s ratios or against averages for the industry.

The lack of detailed information available to the external user is a considerable disadvantage in undertaking ratio analysis.

There may simply be insufficient data to calculate all of the required ratios.

Comparisons with previous year’s ratios can be difficult especially if there have been changes in accounting policies or in the nature of the business.

Comparability between companies may be impaired due to different accounting policies and different environments in which the two companies are operating.

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