What is the purpose of financial ratio analysis?

What is the purpose of financial ratio analysis?

• A. To project future revenues based on historical trends
• B. To evaluate financial performance and stability using financial statement data
• C. To compare market share with competitors
• D. To assess employee costs and benefits

Answer: (B)

The purpose of financial ratio analysis is to evaluate financial performance and stability using financial statement data. This analysis allows stakeholders, including management, investors, and creditors, to gain insights into a company's financial health, operational efficiency, and overall performance over a specific time frame. By calculating various ratios, such as liquidity ratios, profitability ratios, and solvency ratios, users can make informed decisions about investment opportunities, creditworthiness, and effectiveness in managing resources. These ratios provide a benchmark for comparing a company's performance against industry standards or previous periods, helping to highlight trends and areas needing improvement. The other choices, while related to aspects of business analysis, do not capture the comprehensive purpose of financial ratio analysis. Projecting future revenues based on historical trends is a separate analytical process that often uses forecasts and trends rather than ratios. Comparing market share with competitors involves strategic market analysis rather than strictly financial performance evaluation. Lastly, assessing employee costs and benefits focuses more on human resources management and does not utilize the financial ratios that measure overall company health.

The purpose of financial ratio analysis is to evaluate financial performance and stability using financial statement data. This analysis allows stakeholders, including management, investors, and creditors, to gain insights into a company's financial health, operational efficiency, and overall performance over a specific time frame.

By calculating various ratios, such as liquidity ratios, profitability ratios, and solvency ratios, users can make informed decisions about investment opportunities, creditworthiness, and effectiveness in managing resources. These ratios provide a benchmark for comparing a company's performance against industry standards or previous periods, helping to highlight trends and areas needing improvement.

The other choices, while related to aspects of business analysis, do not capture the comprehensive purpose of financial ratio analysis. Projecting future revenues based on historical trends is a separate analytical process that often uses forecasts and trends rather than ratios. Comparing market share with competitors involves strategic market analysis rather than strictly financial performance evaluation. Lastly, assessing employee costs and benefits focuses more on human resources management and does not utilize the financial ratios that measure overall company health.