Ratios are used in business because they are measureable and can be used in the decision-making process.
It allows companies to compare their performance with competitors.
It can judge how profitable a firm is and how liquid (ability to pay off debtors) it is.
It also allows firms to compare their own yearly performance.
It can be used by banks as a measure to grant or deny loans.
There are some problems however:
Ratios are historic, so info may be out of date.
External factors are not taken into consideration. For example, there could be a worldwide recession, or an event in the firm's life that has a serious affect on it. Perhaps a natural disaster like Hurricane Katrina or the burning down of a warehouse (though hopefully insurance would come into it!).
Other factors have to be taken into account, like the ability of the workers
However it has to be with similar competitors (you have to compare like with like, ie Tesco judging performance with a local grocer is pretty silly!)
Remember the different Ratios?
GROSS PROFIT PERCENTAGE
NET PROFIT PERCENTAGE
RETURN ON CAPITAL EMPLOYED
WORKING CAPITAL RATIO (CURRENT RATIO)
ACID TEST RATIO
RATE OF STOCK TURNOVER
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