Relevance of Ratios in Business Finance

Business Finance

TABLE OF CONTENTS
Relevance of ratios.................................................................................................................3
Limitations of financial ratios................................................................................................4
REFERENCES...........................................................................................................................6

The financial ratios are very useful in determining and evaluating the performance of
the business organization. Based on the analysis, various business decisions are being taken
and strategies are being formulated in respect to investment, expansion, setting long term
goals and forth.
Relevance of ratios
Some of the most useful and important financial ratios are stated below.
Gross profit margin, is the important indicator of the performance and financial health of
the organization. It states about the amount of gross profit each dollar/ pound is generating. It
is then either compared with the industry average or with the past year ratios of the company
in order to determining the change in it and its impact over the business (Aktas, Croci and
Petmezas, 2015). The higher ratio means that the company is able to generate enough profits
on sales or is effective in exercising control over the overhead cost. The investors mainly
invest in the company having higher gross profit ratio.
Net profit margin, highlights the amount of income the company makes with respect to its
sales achieved. The high net profit ratio indicates that the organization s very effective in
making profits by converting its sales into profit. While calculating this ratio, all the cost is
involved for determining the final gain of the organization (Weetman, 2010). It measures
how successful the business is in making profit on its sales. It includes all the factors that
influence the profit earning capacity of the business and how effective the management is in
controlling it. It tells about how the company is performing against its competitors.
ROCE, this financial ratio measures both the company’s efficiency and profitability as well.
Return on capital employed (ROCE) is a measure which recognizes the viability where the
organization utilizes its capital and suggests the long term productivity in regard to profits
and is determined by dividing income before interest and tax (EBIT) to capital utilized
(employed), capital utilized is the total resources (assets) of the organization less all the
liabilities. It is extremely helpful from the points of view of investors on the grounds that
from this ratio they get the chance to decide whether this organization would be good enough
to put resources into.
Current ratio is used for evaluating the short-term financial position of the business entity in
terms of liquidity. A high current ratio means that the firm is fluid and can pay its present
commitments in time as and when they become due (Watson and Head, 2010). Then again, a