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What Are the Benefits of Ratio Analysis?

K.C. Bruning
K.C. Bruning

One of the primary benefits of ratio analysis is that it can enable a quick assessment of the value of a company. While the method lacks full detail, it is an efficient way to simplify complex financial statements. Long-term ratio analysis can also give an investor useful information about trends, company history, and other performance characteristics in the market.

Another one of the important benefits of ratio analysis is that it quickly provides the tools necessary to forecast the future of the company. It is like a quick snapshot that can be used to create a solid, if roughly sketched, picture of a company's status. In addition to helping investors, this information can be used to help executives and other leaders strategize.

Businesswoman talking on a mobile phone
Businesswoman talking on a mobile phone

There are also some financial benefits of ratio analysis. Overall, ratios can give a quick view of the financial stability of a company and the way it manages change. Financial institutions can use ratios in order to determine if granting a loan to a particular company will be worth the risk. Companies can also use ratios when deciding whether or not it is advisable to take on a loan.

The ability to compare competing companies and departments within companies is another one of the benefits of ratio analysis. It is a way to forecast the future of companies in order to determine how to approach ventures such as making investments, the planning of improvements, and making marketing decisions. Ratios can also help a company to determine how it measures up against competitors and other kinds of similarly sized businesses.

Ratio analysis can be a method of finding the value of a company quickly, but it is not a thorough review. For this reason, it is primarily reviewed as an early step in the process of fully analyzing a company. Ratio analysis can also help to pinpoint problems or certain areas of the company’s finances that warrant more exploration.

While ratio analysis can provide several benefits to an analyst, its effectiveness depends upon the state of the financial statements it is based upon. If the records are inaccurate or otherwise misleading, the ratios will be of little use. For this reason, ratio analysis is best looked upon as one of many tools for analyzing a company. In some cases, it may also work well as a way to quickly eliminate less desirable companies when making decisions such as for investment or lending.

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