You may remember the term “ratio” from the math lessons on the quantitative relation between two variables. However, ratio analysis goes beyond simple calculations and is a powerful tool in business, finance, and accounting.
This article will cover top examples of ratio analysis and how it can benefit a business.
🤔 What Is a Ratio Analysis in Business?
Ratios are benchmarks created by relating one piece of corporate information with another. Companies use ratio analysis to understand how well their businesses operate compared to their previous performance or other firms in the industry.
Financial Ratio Analysis
Ratio analysis is used to gain insight into a company’s liquidity, efficiency, and profitability. It analyses the business’s financial reports, for example, the balance sheet and income statement.
Financial ratio analysis is conducted to:
- Evaluate the financial health of a company;
- Compare data to see how a company is performing over time;
- Estimate the company’s future performance;
- Measure economic indicators across companies in the industry;
- Attract new investors.
There are six types of financial ratio analysis based on the data they provide:
- Liquidity ratio analysis measures a business’s ability to pay its short-term debts.
- Solvency ratio analysis compares a business’s debt levels with its assets and earnings.
- Profitability ratio analysis indicates how well a company can generate profits.
- Efficiency ratio analysis measures how efficiently a firm uses its assets and recourses.
- Coverage ratio analysis predicts a business’s ability to meet its financial obligations.
- Market prospect ratio analysis forecasts the business’s earnings from specific investments and future performance.
HR Ratio Analysis
One of the critical functions of the HR department is forecasting, which would be impossible without ratio analysis. Ratio analysis is the first step in HR forecasting. It determines the required number of employees based on production processes or sales. Ratio analysis improves the accuracy of hiring procedures by specifying the number of employees the company will need in the near future, associated timelines, and costs.
HR forecasting employs various ratio analysis formulas to forecast different aspects of hiring. Consider these subtypes of HR ratio analysis:
- Revenue-related ratio analysis. This type of analysis forecasts how many additional employees the company will need to hire according to sales projections.
- Time-related ratio analysis. It assists the HR department in developing the hiring timeline and creating work schedules.
- Employee-related ratio analysis. It estimates how many employees the company should hire to replace those leaving the business.
🚫 Limitations of Ratio Analysis
Despite being a helpful forecasting tool, ratio analysis has some limitations. Consider the key ones:
- Ratio analysis can only be based on a company’s historical information and past results.
- It should be updated whenever changes in accounting policies and procedures occur.
- Ratio analysis should be adjusted to inflation to make the numbers across different periods comparable.
- This analysis may result in misleading conclusions in case of any changes in operational structures.
- Ratio analysis is based on financial statements that can easily be manipulated.
📝 HR & Financial Ratio Analysis Examples
For your inspiration, we’ve collected examples of ratio analysis of four business giants: Amazon, Walmart, Apple, and McDonald’s.
By calculating the key ratios mentioned in the table, you can gain insight into these companies’ financial performance.