Ratio Analysis

What is ratio analysis?

Accounting theory of ratio analysis for the board exam.

What do you understand by the term of ratio analysis?

What is mean by ratio analysis?

MEANING OF RATIO ANALYSIS

Ratio is the relationship between two accounting figures of financial statement.

The financial statements are income statement (trading, profit and loss account) and balance sheet.

Income statement shows the operating result of the company.

Balance sheet shows the financial position at the end of accounting year.

Ratio analysis is a process of determining and presenting the quantitative relationship between two accounting figures to evaluate the strengths and weakness of a business.

Ratio is calculated from the financial statement by outsider parties like creditors, investors, financial institutes and management of the company.

Give any two limitation of ratio analysis.

LIMITATION OF RATIO ANALYSIS

Although ratio is most important tools to analysis two different numbers yet it has some limitation.

These limitations are as follow:

Incorrect data of financial statement may mislead to analysis.

Past events may not effective in future; therefore past analysis may not for future.

The ratio analysis ignores quality, it takes only quantity.

It does not adjust price level change.

Sometime company shows arithmetical window dressing data to attract investors, it mislead true analysis.

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Write about gross profit margin and net profit margin.

GROSS PROFIT MARGIN

Gross profit margin is also called gross profit ratio.

The gross profit should be adequate to cover operating expenses, to provide fixed charge, to pay dividend and make proper reserve.

As more as this ratio, business is also better. GPR = (Gross profit ÷ Net sales) x 100

NET PROFIT MARGIN

Net profit margin is also called net profit margin.

It measures overall profit during an accounting period after deducting all operating expenses.

These operating expenses are administrative expenses, selling expenses and distribution expenses etc.

As more as this ratio, business is also better. NPR = (Net profit ÷ Net sales) x 100

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