Question

First, explain what is meant by the term “Financial Analysis.”

Then, explain how financial ratios are used in Financial Analysis.

Answer 1

Financial analysis is the process of analysing the financial information contained in the financial statements. Analysis of the financial statements helps in ascertaining the financial strenght and performance of the entity. Financial analysis is used to analyze whether the entity is solvent, profitable and stable.

Financial ratios help a lot in financing analysis. It is a quantitative analysis of the financial information. It provides a certain number which can tell if the business is in good condition.

For example: Debt to equity ratio tells the ratio between Debts of an entity and the shareholder's equity. A ratio of less than 1 tells us that shareholder's equity if sufficient enough to cover it's debts. While a ratio of more than one says that debt is more than equity, thus, whole of the entity's debts is not covered by the the shareholder's equity.