Essay About Ratio Analysis And Financial Data

Ratio Analysis
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A preponderance of evidence suggests that since the late 1800s, ratio analysis has been
widely used in the analysis and valuation of published financial data. During much of this time,
security analysis firms (e.g., Dun & Bradstreet) have published, and presumably have profited from
publishing, listings of annual financial ratio values for various firms and industries. The literature
on financial statement analysis, as well as accounting and finance textbooks, emphasizes the use of
ratio analysis. Additionally, auditors are now required under SAS No. 56, Analytical Procedures,
to use analytical procedures in the planning and final review stages of a financial statement audit.
Ratio analysis is an analytical procedure that can assist the auditor in evaluating the reasonableness
of financial statement amounts. The demand for financial ratio data provides some supportive
evidence of the utility of this information.
Ratios derived from financial statements are used extensively by both practitioners and
researchers (Gibson, 1982; Whittington, 1980). Whittington (1980) identified two principal uses
of financial ratios: “the traditional, normative use of the measurement of a firms ratio compared
with a standard (usually an industry norm), and the positive use in estimating empirical
relationships, usually for purposes of prediction.” This positive use of financial ratios has typically
been of two types: (1) by accountants and analysts in evaluating firm performance and forecasting
future financial variables for the firm, and (2) by researchers in statistical models for mainly
predictive purposes, such as bankruptcy prediction (Altman, 1968; Ohlson, 1980), credit rating
(Pinches & Mingo, 1973), security analysis (Reilly, 1986), audit evaluation (Altman & McGough,
1974), assessment of risk (Beaver, 1966), identification of the characteristics of takeover targets
(Rege, 1984; Belkaoui, 1978), and the assessment of the incremental information content of
earnings- and nonearnings-based financial ratios (Hopwood & Schaefer, 1988).