Question

Describe ratio analysis and how it helps investors weigh their potential options for investments. Give examples of what they might be looking for. Describe the purpose of horizontal analysis and how it is applied. What are the standards for comparison when performing financial analysis? Give an example of each.

Answer 1

Q Describe Ratio Analysis

Ans The ratio analysis involves comparison for a useful interpretation of of financial statements. A single ratio in itself does not indicate favourable or unfavourable position. it should be compared with that of some other firm in the same industry or with that of past ratios of the same Firm.

Question examples of what they might be looking for?

Q How it helps Investors weight their potential options for investment?

Ans financial statements prepared at the end of the year does not always tell about the real profitability and financial health of the business. There are certain for the investors to conclude weather these facts are indicating good or bad managerial performance. Ratio analysis is an important tool for analysing these financial statements. It provides investors an Eagle eye view about mute heaps of figures given in the financial statements. This figures provide information about liquidity, solvency and  profitability of a business enterprise. Some important advantages derived by the investors by use of these ratio analysis are as follows:-

1) Helpful in analysis of financial statements as it helps investor in acquiring knowledge about the financial position of of the business and after getting this knowledge they can take effective decisions about their relationships with the concern.

2) Simplification of accounting data:- it summarises accounting data and make it understandable

3) It is helpful in comparison of one firm and another firm in the same industry

4) Identification of weak spots:- ratio analysis is helpful in locating the weak spots of the business so that the investors can take better decisions regarding whether to invest in such business organisations or not.

5) Ratio analysis is helpful in forecasting investing decisions:- ratio analysis is helpful in preparing the investment plans for the future

Q) examples of what they might be looking for?

Example 1 profitability ratios

a) gross profit ratio tells investor about the margin of profit available on Revenue from operations and investor may compare gross profit of current year with that of earlier years and decide whether to invest or not.

b) net profit ratio helps investors in determining the overall efficiency of the business operations . An increase in the ratio of the previous year shows improvement in the overall efficiency and profitability of the business.

c) Return on capital employed which is also known as return on investment helps the investor in measuring how efficiently the capital employed in the business is being used. In other words, it is also a measure of the earning power of the net assets of the business.

Q) purpose of horizontal analysis and how it is applied

Ans) in such type of analysis financial statements for a number of years are reviewed and analysed. Figures for two or more years are contained in such type of analysis and these figures are placed side by side to facilitate comparison. Sach analysis indicates the increase or decrease in these items not only in absolute figures but also in percentage form. Thus, it involves making comparisons and establishing relationships among related items of an enterprise for a number of years. When data about sales, cost of production, profits etc. Are compared for two or more years of a firm, they indicate the areas of strength and weakness of the Enterprise. It also helps in knowing the trend of the business .since such type of analysis is based on the data from year to year rather then only one year, it is also called dynamic analysis.

It is also known as trend analysis. For calculating trend percentage any year is selected as the base year. Each item of the base year is assumed to be equal to hundred and on that basis the percentage of each item of each year is calculated. The 10th percentage is helpful in revealing the trend increase or decrease in various items.

Q) Standard for comparison when performing financial analysis along with examples of each?

Ans Standards for comparisons include

(1) intracompany—prior performance and relations between financial items for the company under analysis;

(2) competitor—one or more direct competitors of the company;

(3) industry—industry statistics;

and

(4) guidelines (rules of thumb)—general standards developed from past experiences and personal judgments.Identi