Financial Analysis: Ratio Analysis In The Financial Industry

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Ratio Analysis is a financial tool that is used to compare information that is provided by the people working in the financial sector of a company. The results that we obtain from ratio analysis tell us about the financial health, position, and cash flows of a company. They tell us everything there is to know about the cash that is flowing in and out of the company and also how well the company is doing financially. Ratio analysis is used not only by people working within the company but also by people outside of the company, such as a credit analyst, lender, stock analyst, etc etc. These people use ratio analysis and the financial statements of the company to find out how well the company is doing from a financial point of view. Ratio analysis…show more content…
Because of the difference between the data obtained from balance sheets and income statements, the results obtained by comparing them can be quite inaccurate because it is hard to predict whether the same results will be observed in the future. However, assumptions (or “pro forma” information) as to what the financial position of a company might be in the future can be made or used and that can be compared with the historical data to keep the results consistent.
• Inflation: Inflation is one of the biggest limitations when using ratio analysis. If you’re using a balance sheet that shows data from a period when inflation was low, then chances are that the results obtained from the analysis will be highly inaccurate. Because of the low inflation in the past, it may look like sales and profit have doubled in the current time period when inflation is high, when in reality they might not have changed at all. That’s why it is important to take inflation into account whenever we’re using ratio analysis as it can greatly distort our
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Without context, interpretation of the results can be misleading leading to inaccurate results and eventually bad decisions.
• Window Dressing: Window dressing is when a company is performing bad all year round and decides to carry out a transaction before issuing its financial statements at the end of the year to make it look like it has improved financially. Window dressing is considered an unethical practice in the business world yet a lot of companies use it to change their data so their annual reports don’t discourage anyone outside of the company that might be looking to invest in them.
• Aggregation: Because economic conditions tend to change very quickly and unpredictably, it is important for companies to continuously update the results throughout the whole of the economic cycle, instead of just a part of it. Doing so would tell them about the financial condition of the company in the changing economic conditions. If the company, for example, only analyses the ratios during a period of expansion, then it will become a very hard and tiring process to obtain results using the same data during a period of recession, as the values will have changed a lot. And changing economic cycles will also demand different

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