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benefits and drawbacks of ratio analysis?!

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    i cant find any of my notes on this...help!
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    Benefits - It gives a frank financial account into the current state of the business, regarding stock turnover and the ability to meet short and long term debts. Managers, Shareholders, Creditors etc all take an interest in Ratio Analysis, for example - Managers can use the information to see if the company's liquidity is struggling and they may have to take out short term finance such as an overdraft to over come this.

    Drawbacks - Includes that it purely only covers the financial aspects of how a business is performing, managers should take into account the current state of the market - Is it in a period of recession? This may reflect depressing ratios - depressing ratios may also mean that the company is growing and investing heavily into marketing or research and development which means it will have very small amounts of working capital. It should also be used as part of a trend of data for example - Gearing over a number of years, is it decreasing or increasing - and why and what is the result of this?

    Hope that helps
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    Just to add to the above......

    Benefits
    1. Can see the efficiency of the business e.g. stock turnover shows how the stock is being managed
    2. Can see the profitability of the biz

    3. Can compare the performance with previous years and see whether there is an improvement or reduction in performance

    4. Can compare with rivals or industry standards to see comparative performance.

    Disadvantages
    1. It involves figures as at a given date.......therefore balance sheets prepared on different dates may produce different results. Moreover, it is not feasible to compare with rivals as they may have different accounting policies and different balance sheet dates

    2. If the accounts are prepared inaccurately, it could lead to wrong ratios and the managers will take wrong decisions, thereby increasing losses.

    3. Doesn't show the non - financial aspect of the biz e.g. customer and labour satisfaction, quality of the product, market share, etc.
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    Benefits
    Stakeholders including managers, employees and the government may be interested in analysing the accounts of the business.
    ~ Indicate long term and short term financial stability of the organisation
    ~ Indicates areas of strength, which can be built upon to improve future performance or encourage potential investment in the business

    Limitations
    Does not provide information on key aspects of businesses operating environment
    ~ Morale and motivation of the workforce
    ~ Legal environment - affected by changes in gov legislation e.g. Interest rates
    ~ Future plans for the managment of the business

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Updated: June 21, 2007
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