Business Studies: Ratio Analysis: Introduction

• Businesses record financial transactions as part of the finance and accounting function
• This financial information is presented in the form of financial statements also known as final accounts at the end of each year/trading period
• This information is used by various stakeholders of the business to make sense of the business’s performance and decisions
• Often the figures provided by the financial statements make little sense by themselves
• For example if a business made a profit of $1 000 000
•  Did the business perform well or not?
• Did it do better than X Ltd our competitor which made a loss of $10 000?
• Without context it would be difficult to pass judgement on these figures
• To help with decision making and understanding financial information has to be analysed
• A common technique is to use ratio analysis
• A ratio is when one number is given in relation to another usually by dividing the two numbers
• Ratios can be expressed as a fraction, decimal or percentage
• For example 1 in 4 employees are HIV positive in a given company is a ratio
• It could be expressed as:
  1. 1 in 4
  2. 1 as to 4
  3. 1:4
  4. \frac{1}{4}
  5. 0.25
  6. 25%
• Note that while it is possible to represent the ratio as 10:40 in business speak it is customary to present it as 1:something to wit the above would be 1:4
• This is true even if the other value would become a decimal for example 1 : 0.9
• The preferred way of presenting each ratio will be shown as we discuss each ratio
• Analysis  refers to a systematic examination and evaluation of data or information, by breaking it into its component parts to uncover their interrelationships
•  Ratio analysis is therefore a technique in finance where financial data is analysed and broken down in order to be compared to:
  1. Past performance of the organisation e.g. the business’s previous year’s results
  2. Against a competitor’s performance e.g. Econet compares its results against Telecel and Netone
  3. Against the industry average
• For results to be meaningful comparisons have to be between organisations in the same industry/line of business.
•  It would be unhelpful to compare the financial statements of a baker (Lobels) and Econet (Mobile network operator)
• There a lot of ratios but the following groups of ratios are of interest to ordinary level students:
  1. Profitability ratios
  2. Liquidity ratios
  3. Gearing ratios
• To learn more about each ratio just click on it
• In addition students are expected to be able to make a simple comment on the ratio e.g. is it an improvement or not
• When making these comment please take note of the dates on the presented financial statements and make sure you are calculating the ratio for the right year examiners frequently reverse dates in order to confuse students

To access more topics go to the O Level Business Notes