Purpose, Important & Users of financial ratio

Purpose & Importance of Financial Ratio:

1. Ratios help in analyzing the performance trends over a long period of time.
2. They also help a business to compare the financial results to those of competitors.
3. Ratios assist the management in decision-making.
4. They also point out the problem and weak areas along with the strength areas.
5. Ratios to help to develop relationships between different financial statement items.
6. Ratios have the advantage of controlling for differences in size. For example, two businesses may be quite different in size but can be compared in terms of profitability, liquidity, etc., by the use of ratios.

 

Users of Financial Ratios:

Financial ratio analysis is aimed to measure the financial performance of a company and to define the financial position of a company through relevant indicators/ratios. There are many groups and individuals who want to know about their business performance.

Financial ratios users are:

Bankers and Money Lenders:

They Use profitability, liquidity, and investment ratio because they want to know the ability of the borrowing business in regularly scheduled interest payments and repayments of a principal loan amount.
Investors:

they Use profitability and investment ratio because they are more interested in the profitability performance of the business and safety & security of their investment and growth potential of their investment.

Management:

They use almost all ratios because management is interested in all aspects of the organization i.e., both financial performance and financial condition of the business.

Employees:

They use profitability, liquidity, and activity ratio because employees will be worried about job security, bonus, and continuation of business and wage rate negotiating.

Suppliers:

They use liquidity ratio because suppliers are more interested in knowing the ability of the business to relax its short-term duties as and when they are due.

Customers:

They use liquidity ratio because customers will search for comfort that the business can stay alive in the short term and continue to supply.
Government: They Use the profitability ratio because the government may use profit as a basis for taxation, grants, and subsidies.