Understanding a company’s financial health is very important for banking professionals. Ratio analysis is one of the easiest ways to do this. It converts complicated financial statements into simple numbers that tell us how well a company is doing. For JAIIB 2026 aspirants, knowing ratio analysis is important because it helps in checking a company’s liquidity, profitability, efficiency, and financial stability.
In this blog, we have provided all the details about the Meaning of accounting ratios, classification of ratios, uses of accounting ratios, limitations of accounting ratios, calculation and Interpretation of various ratios, different users and their use of ratios.
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What is ratio analysis and why is it important?
Ratio analysis is the process of comparing numbers from financial statements to understand a company’s performance.
- It simplifies financial data and shows the relationship between different financial figures.
- It helps management, investors, and banks make smart decisions.
- It shows trends over time, like whether profits are increasing or debts are under control.
Example: If a company has current assets of ₹10 lakh and current liabilities of ₹5 lakh, the current ratio is 2. This tells us the company can pay its short-term debts twice over.
What are accounting ratios and how are they classified?
Accounting ratios are numbers that show the relationship between two financial figures. They help to quickly understand the financial position and performance of a business.
| Type of Ratio | Purpose | Examples |
| Liquidity Ratios | Show if a company can pay short-term debts | Current Ratio, Quick Ratio |
| Solvency / Leverage Ratios | Show long-term financial stability | Debt-Equity Ratio, Interest Coverage Ratio |
| Profitability Ratios | Show how much profit a company earns | Gross Profit Margin, Net Profit Margin, ROCE, ROE |
| Activity / Efficiency Ratios | Show how efficiently a company uses assets | Inventory Turnover, Receivables Turnover, Asset Turnover |
| Market / Investment Ratios | Show company’s value for investors | EPS, P/E Ratio, Dividend Yield |
How are accounting ratios used?
Ratios are not just numbers; they tell a story about the company’s finances.
- Decision Making: Helps management and investors take smart decisions.
- Performance Check: Shows whether the company is improving or facing problems.
- Planning: Helps plan future investments or borrowings.
- Comparison: Helps compare with competitors or industry standards.
- Trend Analysis: Shows financial performance over time.
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What are the limitations of ratio analysis?
Even though ratios are very useful, they have some limitations:
| Limitation | Simple Explanation |
| Historical Data | Ratios use past financial statements, so may not show current or future health |
| Accounting Methods | Different ways of calculating (like depreciation) can affect ratios |
| Ignores Qualitative Factors | Does not show company reputation, management skill, or market conditions |
| Manipulation | Companies may adjust numbers to look better temporarily |
| Snapshot Only | Ratios give a picture at one point in time, not the whole story |
| Industry Differences | Ratios can differ between industries, so comparisons may be misleading |
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How to calculate and interpret important ratios?
To calculate financial ratios, first gather the necessary figures from a company’s balance sheet, profit and loss account, or cash flow statement. Next, apply the appropriate formula for the ratio you want to analyze, such as liquidity, profitability, or efficiency ratios. After calculating, compare the results with previous years’ performance or industry averages to see how the company is performing relative to its peers. Finally, interpret the numbers to understand what they indicate about the company’s financial health, stability, and operational efficiency.
| Ratio | Formula | What It Tells You (Simple) |
| Current Ratio | Current Assets ÷ Current Liabilities | Shows if short-term debts can be paid. >1 is safe. |
| Quick Ratio | (Current Assets – Inventory) ÷ Current Liabilities | Can pay short-term debts immediately, without relying on inventory. |
| Debt-Equity Ratio | Total Debt ÷ Equity | Shows financial risk. Lower is safer. |
| Interest Coverage Ratio | EBIT ÷ Interest | Shows ability to pay interest. Higher is better. |
| Gross Profit Margin | (Gross Profit ÷ Sales) × 100 | Shows profit from sales before expenses. Higher is better. |
| Net Profit Margin | (Net Profit ÷ Sales) × 100 | Shows overall profit after all expenses. |
| ROCE (Return on Capital Employed) | EBIT ÷ Capital Employed | Measures efficiency of using capital to earn profit. |
| ROE (Return on Equity) | Net Profit ÷ Shareholders’ Equity | Shows return for shareholders. Higher is better. |
| Inventory Turnover | COGS ÷ Average Inventory | How fast inventory is sold. Higher = efficient. |
| Receivables Turnover | Credit Sales ÷ Average Receivables | Shows how quickly money is collected from customers. |
| Asset Turnover | Sales ÷ Total Assets | How efficiently assets generate sales. |
| EPS (Earnings per Share) | Net Profit ÷ Number of Shares | Profit earned per share. |
| P/E Ratio | Market Price ÷ EPS | Shows market expectations for the company. |
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Who uses ratio analysis and how?
Different people use ratios for different purposes:
| User | How They Use It |
| Management | To check performance, plan, and take decisions |
| Investors / Shareholders | To see profitability, dividend potential, and company growth |
| Banks / Creditors | To check repayment capacity and financial risk |
| Employees / Unions | To know financial stability for salary and profit-sharing |
| Government / Regulators | To monitor compliance, taxation, and financial health |
| Suppliers / Customers | To assess reliability and stability of the company |
FAQs
Ratio analysis is the study of financial statements using numerical relationships to assess a company’s performance.
It helps banks and professionals evaluate liquidity, profitability, and financial stability before making decisions.
Accounting ratios are numbers that show relationships between two or more financial figures from accounts.
Ratios are classified into liquidity, solvency, profitability, activity/efficiency, and market/investment ratios.
Current ratio measures a company’s ability to pay short-term debts using its current assets.
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