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debt-to-asset ratio may indicate that a company is overburdened with debt and may eventually

be facing default risk.

2. Make comparative judgments regarding company performance

Comparing financial ratios with that of major competitors is done to identify whether a

company is performing better or worse than the industry average. For example, comparing the

return on assets between companies helps an analyst or investor to determine which company

is making the most efficient use of its assets.

Interpretation - interpreting financial ratios is logical when you stop to think about what the

numbers tell you. When it comes to debt, a company is financially stronger when there is less

debt and more assets. Thus a ratio less than one is stronger than a ratio of 5. However, it may be

strategically advantageous to take on debt during growth periods as long as it is controlled.

A cash flow margin ratio calculates how well a company can translate sales into actual cash. It is

calculated by taking the operating cash flow and dividing it by net sales found on the income

statement. The higher the operating cash flow ratio or percentage, the better.

Applications of Ratio Analysis

 Ratio analysis will help validate or disprove the financing, investment and operating

decisions of the firm. They summarize the financial statement into comparative figures,

thus helping the management to compare and evaluate the financial position of the firm

and the results of their decisions.

 It simplifies complex accounting statements and financial data into simple ratios of

operating efficiency, financial efficiency, solvency, long-term positions etc.

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