III. So, there will be no change in the working capital. The trend ratios must be studied along with absolute data for correct analysis. A. However, it can be attributed to the low base of the previous year. Ratio analysis is a very powerful analytical tool useful for measuring performance of an organization. The Du Pont chart indicates that the return on investment is ascertained as a product of net profit margin ratio and investment turnover ratio. (6) The overall profitability of the company is more than satisfactory. The calculation of trend ratios are based on statistical technique called ‘ index numbers’. iii. The trend ratios are incomparable, if there is inconsistency in accounting policies and practices. endstream endobj startxref VERTICAL ANALYSIS expresses each item in a financial statement as a percent of a base amount RATIO ANALYSIS expresses the relationship among selected items of financial … 1. Profitability 6. This led to development of Du Pont chart which exhibited the return on assets of financial control system. The trend analysis should be made at least for four consecutive years. Well financial analysis is a process of ascertaining the financial … Comparative financial statements reveal the following: I. The increase in operating profit without considering the non-operating income has been impressive. The statement of changes in financial position provides a summary of funds flow during the period of financial statements. III. Leverage 4. It was reduced to 76.88% in 2016 and as a result the gross profit increased from 15% in 2015 to 23.12% in 2016. Ratio analysis is a process of comparison of one figure against another, which make a ratio. External stakeholders use it to understand the overall … This analysis … Caution has to be exercised in using ratios. 5720 0 obj <> endobj The trend percentages are calculated for select major financial items in the financial statements to arrive at the conclusions for important changes. The following statements show the method of presentation of the data. (2) The rate of growth of sales is considerably higher than the rate of growth of cost of goods sold. The numerator will comprise of only operating income (EBIT) and non-operating income/loss being excluded. assets under construction. Account Disable 12. Whenever, the trend ratios are calculated for a business concern, such ratios are … This analysis can take several forms, with each one intended for a different use. The company’s management will analyze ratios for determining the financial health and its profitability. In common size balance sheet, the total of assets side or liabilities side is taken as ‘100’ and all figures of assets and liabilities, capital and reserves are expressed as a proportion to the total i.e. While making inter firm comparison, the analyst must keep in mind that different firms follow different accounting policies e.g., depreciation allowance, valuation of inventory etc. The most common types of financial analysis are: 1. V. Then trend ratios of subsequent years’ financial statements are calculated by applying the following formula: VI. Balance sheets as on two or more different dates are used for comparing the assets, liabilities and the net worth of the company. Increase or reduction in absolute data in terms of money values, III. Ratio analysis is a useful management tool that will improve your understanding of financial … Ratio Analysis: Ratio analysis is the most widely used tool of financial statement analysis. When other costs and expenses are reduced from sales figure of ‘100’, the balance figure is taken as net profit. Liquidity 7. In common size income statement, the sales figure is taken as 100 and all other figures of costs and expenses are expressed as percentage to sales. Scenario & Sensitivity 12. It will be seen from the above chart that, return on investment can be improved by increasing one or both of its components viz-the net profit margin and the investment turnover in any of the following ways: (b) Increasing the investment turnover, or. Comparative statement analysis B. Common-size statement analysis C. Trend analysis It is about interpreting those numbers so that analyst can answer the two fold mystery of what happened and also why it happened and lastly what to do What happened help us understand what was in the past and why it happened help us understand the causes and both help us predict what can possible happen in future and accordingly we can make expectations and decided what we should do to keep the odds in our fav… Ratios normally pinpoint a business firm’s strengths and weakness in two ways: I. Ratios of a company can have meaning only when they are compared against standards. Vertical Analysis is a technique to identify how the company has applied its resources and in what proportion its resources are distributed across the income statement and the balance sheet. (3) The net profit in 2015 was 9.82% to 19.32% in 2016. Plagiarism Prevention 5. The chapter "Methods of Financial Analysis" presents the methodological foundations for conducting financial and analytical studies. The comparative financial statements suffers from the following weaknesses: i. Interfirm comparison can be misleading if the firms are not identical in size and age and when they follow different accounting procedures with regard to depreciation, inventory valuation etc. The use of a financial analysis … (2) The operating expenses were decreased from 5.1% in 2015 to 4.56% in 2016. ii. Ratios are calculated from financial statements which are affected by the financial bases and policies adopted on such matters as depreciation and the valuation of stocks. V. Ratios are interconnected. ii. II. People who analyze the financial … IX. Respondents were asked on a … However, investment analysis can be divided … So, the company purchased fixed assets out of long-term funds. (c) Increasing both net profit margin and investment turnover. The analysis through trend ratios is subject to the following limitations: I. The standards will differ from industry to industry. Variance So, the company might have utilised the reserve for the issue of bonus shares or for the payment of dividends. The types of financial analysis are: Horizontal analysis … III. Content Filtration 6. Financial analysis is not just about calculating few equations and computing few ratios. 5731 0 obj <>/Filter/FlateDecode/ID[<3493911C9B23D1478C21EF609B205454>]/Index[5720 24]/Info 5719 0 R/Length 74/Prev 965466/Root 5721 0 R/Size 5744/Type/XRef/W[1 3 1]>>stream Because of his industry experience (Dr. Hales served as a Controller, Ratios provide an easy way to compare present performance with past. VI. Financial Analysis Handbook – 2016 Annual / 2017 Quarterly Preface The NAIC Financial Analysis Handbook (Handbook) was developed and released by the Financial Analysis … �2:��,�8�(pd``pdap``(�`m0`�����q I�̂a��C��3���ༀg1�>O��+�w�2� Investment Analysis Methods . (b) Ratio analysis concentrates on the interrelationship among the figures appearing in the financial statements. 2. Fundamentals of Loan Analysis 1.1 Objectives and Methods of Loan Analysis Loan analysis is to ensure that loans are made on appropriate terms to clients who can and will pay them back. The methods used in analysis of financial statements are as follows: 1. XIV. ROA measures return on core assets (operating assets) and excludes from its denominator the amount of non-core assets. Since ratios are calculated from past records, there are no indicators of future. 09��1#����/���d8v0p0�d#6�ɛ�Q���]�MO&O n�9%uVױU��&�]]Cdy�$J^fI�ehK3/����7Y�5��K���M3c��qC6�o�ۇwRO��.�k챺qxmO/�6#��f�ك�}�|;6N\��pyAQ��N\xY3�ĵ �'׌�z�v�;x]���Ճ��4R���;��$^W���$�y�o�g�c%J6n�����ұ/�88�8�;:;:�L����q,:�"@!�� �1�`ɂd#@��@�-H�5i�� �fh�`l` 6�����X"h=���z�@�9�X�vL�5�Xr��C����5ER� 1�*̗7 Sܶ�.���_p:H}�X��@��A������sDH�@!�oM?����Z�dx�x�|#F��@�Fߛ/ J2��R�(d40 C��< This helps in identification of the weaknesses of the firm and remedial measures can be taken accordingly. Financial analysis is the process of using fi nancial information to assist in investment and fi nancial decision making. The financial analysts will analyze ratios for making comparisons and recommending to the investing public. The obvious generalizations that can be made about ROI that any action is beneficial provided that it: (3) Reduces cost (while holding the other two factors constant). Ratio Analysis. Rates of Return 10. The financial institutions who provide long-term debt will analyze ratios for project appraisal and debt servicing capacity of the firm. Types of Investment Analysis. With all the data and financial information available, there are a variety of methods analysts and investors use. A comparative income statement shows the absolute figures for two or more periods and the absolute change from one period to another. IV. Huge Collection of Essays, Research Papers and Articles on Business Management shared by visitors and users like you. The accounting principles and policies should be consistently followed throughout the period for which the trend ratios are calculated. A financial analyst can adopt the following tools for analysis of the financial statements. The Du Pont company of USA has introduced a system of financial analysis which has received a wider acceptance. The change in price levels due to inflation will distort the reliability of ratio analysis. Analysis of absolute indicators. %PDF-1.5 %���� (3) There is a marginal fall is administration expenses and a marginal rise in selling expenses, which do not affect the overall financial position of the company significantly. Understanding the different types of financial analysis is crucial in making informed business decisions. So, the company acquired current assets from long-term fund. vi. Debt – Equity = 3/2 implies total assets of 5. This has resulted in a handsome rise in gross profit of the company. of financial economic analysis of the business subject. The financial statements of one financial year should be selected as a base statement and financial items of it should be assigned with value as 100. Comparative balance sheet is useful for studying the trends of an undertaking. Over use of ratios as controls on managers could be dangerous, in that management might concentrate more on simply improving the ratios than on dealing with the significant issues. Finally, … The following limitations must be taken into account: I. %%EOF Proper care should be exercised to study only such figures as have a cause and effect relationship, otherwise ratios will only be meaningless or misleading. Before uploading and sharing your knowledge on this site, please read the following pages: 1. From the following data, calculate trend a percentage taking 2014 as base: The term ‘accounting ratio’ is used to describe significant relationships which exist between figures shown in a balance sheet, in a profit and loss account, in a budgetary control system or in any other part of the accounting organization. the amount of assets, … As part of its due diligence investigation, a corporate acquirer typically analyzes the current and prospective financial statements of a target company. XIII. The net profit actually doubled during period. Terms of Service 7. Both the figures have doubled in 2016. II. and help the analyst to evaluate the performance of the company. Past performance of the same company cannot be benchmarked when there is change in circumstances. The effective use of ratios, therefore, depends on being aware of all these limitations and ensuring that, following comparative analysis, they are used as a trigger point for investigation and corrective action rather than being treated as meaningful in themselves. financial statement analysis plays the same role in the decision-making process. Interfirm comparison of common size income statements reveal the relative efficiency of costs incurred. The analysis of ratios clarifies trends and weaknesses in performance as a guide to action as long as proper comparisons are made and the reasons for adverse trends or deviations from the norm are investigated thoroughly. Since the figures are shown side by side, the user can quickly understand the operational performance of the firm in different periods and draw conclusions. | Cash Flow | Company | Financial Management. Methods of financial analysis according to the calculation. So, the operating profit shows an increase. Average Analysis. Trend Ratios 4. The ratio analysis helps the management to analyze the past performance of the firm and to make further projections. Absolute data (money values or rupee amounts), II. (c) Reserves and surplus were decreased by Rs.52,000 (32.7%). 0 The ratios will be effective only when they are compared with ratios of base period or with standards or with the industry ratios. The comparative financial statements are useful for analysis of the following: a. Cash Flow 9. (5) The net profit before and after tax have increased at the same rate, since the tax rate applicable to both the years is the same. (1) The cost of goods in the year 2015 was 85%. Shareholders and prospective investors will analyze ratios for taking investment and disinvestment decisions. What analysis … Every successful business has their own story of struggles and probably a couple of strategies as well. Cons – The company operates in the industrial cycle and if the industry is downgrading in spite of the company is performing … Du Pont analysis is an extension of return on investment ratio, which measures the overall profitability and operational efficiency of the firm. Income statement and Balance Sheet report what has actually happened to earnings during a specified period and presents a summary of financial position of the company at a given point of time. A practitioner’s guide to understanding the basic principles for investment ... were manufacturers and another 15 % were financial. The profitability of the concern is satisfactory. Comparative statements can also be used to compare the performance of the firm with the average performance of the industry or interfirm comparison. The Du Pont Chart is a chart of financial ratios, which analyses the net profit margin in terms of asset turnover. ROA is computed by dividing operating profit EBIT by the average invested capital (i.e. profit and loss account and balance sheet are converted to percentages so as to establish each element to the total figure of the statement and these statements are called ‘common-size statements’. These may not refer to other factors which affect performance. Comparison of ratios of firms belonging to different industries is not suggested. Candidates are also responsible for the content of accounting standards, but not for the actual reference numbers. Analysis of absolute indicators is used to assess the absolute level of various items, e.g. VII. Ratio analysis is extremely helpful in providing valuable insight into a company’s financial picture. It reflects the behaviour of items over a period of time. iv. These statements will also assist in analyzing the performance over years and also with the figures of the competitive firm in the industry for making analysis of relative efficiency. VIII. Ratios depict the areas in which a particular business is competitively advantaged or disadvantaged through comparing ratios to those of other businesses of the same size within the same industry. The trend analysis is a simple technique and does not involve tedious calculations. The statement of retained earnings reconciles income earned during the year and any dividends distributed with the change in retained earnings between the start and end of the financial year under study. The analyst should have thorough knowledge of methods of window dressing. Common-Size Statements 3. II. Financial analysis involves the review of an organization's financial information in order to arrive at business decisions. Uploader Agreement. The horizontal analysis measuresthe financial statements line of items with the base year. These statements are useful in analysis of the performance of the company by analyzing each individual element to the total figure of the statement. Michael W. Klein, Mathematical Methods for Economics, Addison-Wesley. Key Elements of a Financial Analysis. The following is the income statement of a XYZ Ltd. for the years 2015 and 2016. (c) Ratio analysis helps the management to analyze the past performance of the firm and to make further projections. Comparative Financial Statements 2. Prepare a Comparative Balance Sheet and explain the financial position of the concern. The appraisal of the ratios will make proper analysis about the strengths and weaknesses of the firm’s operations. The ratios will also be used for inter firm and intra-firm comparison and will also be used in financial planning and decision-making. Financial statement analysis is the process of analyzing a company's financial statements for decision-making purposes. The trend ratios should be calculated only for the items which have logical relationship with one another. The price level changes are represented in trend ratios. Information of nonfinancial nature will also be taken into consideration before a meaningful analysis is made. Comparative financial statements are statements of financial position of a business designed to provide time perspective to the consideration of various elements of financial position embodied in such statements. The liquidity position improved considerably. II. It points towards increased acceptability of the company’s products and customer satisfaction. XII. The trend ratios of different items are calculated for various periods for comparison purpose. The trend ratios help in making horizontal analysis of comparative statements. Horizontal 3. IV. Before we know the types and methods or techniques of financial analysis, first we should know the meaning of financial analysis. (4) There is an abnormally high rise in non-operating income. Financial statement analysis involves the comparison of information of one entity over differ… IV. Bankers who provide working capital will analyze ratios for appraising the creditworthiness of the firm. (b) Previous ratios in order to assess trends, and. Ratio Analysis 1 | P a g e Introduction A sustainable business and mission requires effective planning and financial management. The calculation of ratios is a relatively easy and simple task but the proper analysis and interpretation of the ratios can be made only by the skilled analyst. While gross sales have increased, returns have come down by 40%, which is a healthy sign. The central measure of Du Pont analysis is the return on assets (ROA), a variant of return on investments (ROI). b. An accountant compiles the information provided by business statements, reviews them with the help of business representatives, and audits the final reports to ensure their accuracy. X. h�bbd```b``i��k�d�d���`� f3�H�6 �X�H�d`bd{�%�����@� �� Financial statement analysis is fundamental to a corporate acquirer’s assessment of an acquisition or merger candidate. Vertical 2. A ratio … A ratio is a comparison of two figures, a numerator and a denominator. If the net profit margin of NDA Ltd. is 5 per cent, what will be its return on equity (ROE)? The major benefits arising from ratio analysis are as follows: (a) Ratio analysis is a very powerful analytical tool useful for measuring performance of an organization. Growth 5. They should not be treated in isolation. accounting methods for financial analysis and valuation discussed in the readings. Prohibited Content 3. The trend may sometimes be affected by external factors like government policies, economic conditions, changes in income distribution, technology development, population growth, changes in tastes and habits etc. This reveals the efficiency of the firm in generating revenue which leads to profitability and we can make analysis of different components of cost as proportion to sales. The overall position of the company is satisfactory. Tabulate the trend ratios for analysis of trend over a period. Increase or reduction in absolute data in terms of percentages. The accounting ratios indicate a quantitative relationship which is used for analysis and decision making. That means, it compares the figures for a given period with the other period. Financial statements do not represent a complete picture of the business, but merely a collection of facts which can be expressed in monetary terms. The trend ratios are the index numbers of the movements of reported financial items in the financial statements which are calculated for more than one financial year. Comparative analysis can be done with reference to the data of previous period or industry data or competitor’s data. On the other hand, … Financial analysis: tools and techniques: a guide for managers From the following particulars pertaining to ABC Ltd. you are required to prepare a comparative Income Statement and interpret the changes: (1) There is a modest increase in sales. The reliability and significance attached to ratios depends on the accuracy of data based on which ratios are calculated. Following are the Balance Sheets of ABC Ltd. for the years 2015 and 2016. Part II - Financial Analysis Judy Laux, Colorado College, USA ABSTRACT The second article in a series designed to supplement the introductory financial management course, this essay addresses financial statement analysis… A ratio is a quotient of two numbers and the relation expressed between two accounting figures is known as ‘accounting ratio’. While analyzing the trend ratios, non-financial data should also be considered, otherwise conclusions would be misleading. Content Guidelines 2. (d) Ratio analysis allow interested parties to make evaluation of certain aspects of the firm as below: i. Privacy Policy 9. The methodology used in computation of trend ratios is as follows: I. The ratio analysis concentrates on the interrelationship among the figures appearing in the financial statements. It provides basis for interfirm, as well as, intra-firm comparison. Whereas management uses the analysis to help in making operating, investing, and financing decisions, investors and creditors analyze financial … 5743 0 obj <>stream It also excludes from its denominator capital work-in-progress i.e. Valuation 11. METHODS In th is article the basic scientific methods used were analysis, synthesis, induction, (c) The ratios achieved in other comparable companies (intercompany comparisons). Efficiency 8. Disclaimer 8. Copyright 10. So, the first task to ensure accurate financial analysis is to hire the services of an expert accountant. (a) In the comparative balance sheet of the company in 2016 shows an increase in fixed assets of Rs.55,000 (13.49% where as long-term liabilities and share capital showed an increase of Rs.75,000 and Rs.1,00,000 respectively. Comparative statements indicate trends in sales, cost of production, profits etc. It is also fine to get the University of Maryland customized version: Michael, W. Klein, Methods and Tools of Economic Analysis… This is called ‘interfirm comparison’. Financial analysis helps managers with effi ciency analy-sis and identifi cation of … The common size balance sheet reveals the proportion of fixed assets to current assets, composition of fixed assets and current assets, proportion of long-term funds to current liabilities and provisions, composi­tion of current liabilities etc. The financial statements viz. It is fine to rent or get a used copy. vii. For example, the return on capital employed can be improved by reducing assets rather than increasing profits. This article reports the results of a questionnaire survey in June/July 2010 on the use of Fundamental and Technical analysis by brokers/fund managers in Indian stock market to form their forecasts of share … Ratios: The term ‘accounting ratio’ is used to describe significant relationships which exist between … (b) Current assets showed an increase of 24.52% and cash Rs.30,000 (300%) stock also increased by Rs.50,000, Current liabilities showed an increase of Rs.10,000 (12.9%). Essays, Research Papers and Articles on Business Management, Multiple Discriminant Analysis | Business | Financial Management, Problems on Cash Flow Statements (With Solution) | Financial Management, Financial Analysis of a Firm | Firms | Financial Management, Translation of Financial Statements | International Finance, How to Calculate Annuity? viii. Ratios by themselves mean nothing. endstream endobj 5721 0 obj <. Du Pont, a US company, developed and pioneered the systematic use of return on assets to evaluate the performance of different organisational units and target areas for improvement. Loan Analysis: Understanding the Client and Business 1. NDA Ltd. has a debt-equity mix of 3/2 and total assets turnover ratio of 2. Convert them into Common-size Income Statement and comment on the profitability. These are also termed as methods or techniques of financial analysis. h�b```��ll�B ���� A business must rely on an accountant to prepare financial statements and carry out an important analysis based on these reports. Inter-period comparison may also be misleading, if the period has witnessed changes in accounting policies, inflation, recession etc. Financial Management, Business, Financial Statements, Analysis of Financial Statements. Report a Violation 11. Ratio analysis allow interested parties like shareholders, investors, creditors, Government and analysts to make an evaluation of certain aspects of a firm’s performance. It also helps in making interfirm comparison and highlights the financial health and long-term solvency, ability to meet short-term obligations and liquidity position of the enterprise. v. The credit rating agencies will analyze ratios of a firm to give the credit rating to the firm. Image Guidelines 4. Pros – It helps to analyze the growth of the company from year on year or quarter on quarter with the increase in operations of the company. The Du Pont chart is useful in segregation and identification of factors that effect the overall performance of the company. ANALYSIS TOOLS HORIZONTAL (TREND) ANALYSIS evaluates a series of financial statement data over a period of time. Comparing the assets, liabilities and the relation expressed between two accounting figures known... 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