Financial Analysis

Introduction to Ratio Analysis

What ratios are for

Ratios interpret financial statements (income statement and SFP) to evaluate business performance, identify trends, and support decision-making. They are used by various stakeholder groups.

How ratios are expressed

Ratios can be expressed as whole numbers or to one or two decimal places. Where a question specifies the format, use it; otherwise any equivalent format is acceptable.

Skills required

1. Know the formula (AO1 — knowledge)
2. Apply the formula to financial statement data (AO2 — application)
3. Interpret the outcome and recommend improvements (AO3 — analysis and evaluation)

Basis for comparison

A ratio on its own means little — it needs a comparison:

• Prior year — has performance improved or deteriorated? Possible for established businesses only
• Competitor — is performance better or worse than a similar business in the same industry?
• Industry average — how does the business compare to the sector as a whole?
• Budgeted ratios — is the business meeting its own targets?

Interpretation language rules