Advantages · Seeing the future and planning: Ratio analysiswill see the trends in the costs, sales and profits of businesses such as Funtimeand playtime. This is extremely useful as businesses can forecast trends thatmay happen in the future and businesses can plan their future activities whichmay be aims and objectives relative to their business. · Budgeting: A budget is a certain estimate offuture activities that is based upon past events occurred in the business andaccounting ratios can help the business understand their budgets.
For example, Funtimeand Playtime can prepare a sales budget due to the help of the analysis of pastsales. · The measurement of the efficiency when operating:Ratio analysis can show a business’s efficiency in terms of their managementand uses of its assets. As different ratios can indicate how businessesoperational efficiency is, the solvency of a firm can depend on the salesrevenue generated by utilizing its assets.
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· Communication: Communication is an important partof a business, as ratio analysis is an effective way of communicating as itsinforms positions of and progress made by the business which affects employees,owners and shareholders. · Controlling of the performance and cost: Ratioanalysis can be used to control performance for different departments in abusiness and controlling costs for different departments too. For example, asplaytime and Funtime are both businesses which distribute apparatus andequipment for children’s play areas they will both have different departmentsand the marketing department will both be pressured to rely on their budgetsand control it by the management team.
· Inter firm comparison: This is when businesseswill compare the performance of two or more firms which can reveal efficientand inefficient firms, thus it will enable the inefficient firms to adapt theirpractices and measures for improving their efficiency. This is extremely usefulfor playtime and Funtime as they are both competing in the same markets. · liquidity position: Ratio analysis will helpbusinesses to assess its liquidity position as these liquidity ratios can indicatethe ability of the business to payback credit by banks, creditors and suppliersof short term loans.
· long term solvency position: Ratio analysis isused to assess the businesses ability to pay long term debts, the better the solvencyposition it will indicate the businesses earning power and the functioningefficiency, the ratio analysis shows the strengths and weaknesses in abusiness. · overall profitability: The owners and managementof Funtime and playtime are constantly concerned with the overall profitabilityof their business as they want to know whether the business has the ability tomeet its long and short-term obligations to creditors and such. This willsecure the higher utilisation of the assets of the firm. · Understanding failure of a business: This iswhen a business fails to generate a profit and a regular basis, thus meaningthat the business is suffering severe liquidity crisis.
Ratio analysis canindicate the businesses expenses and liabilities which means the business canget on top of this beforehand which can prevent the occurrence of failure. · decision- making: Ratio analysis can help abusiness make a decision which will impact the business rightly, for example,whether the business should supply goods on credit to another firm or whetherbank loans will be made available. · Simpler financial statements: Ratio analysis canmake the business documents easier to grasp the relationship between differentitems and can help understanding the financial statements. Disadvantages · Limitations of financial statements: Thebusinesses financial statements are calculated by the ratio; the financialstatement has multiple limitations and can affect the quality of the ratioanalysis which may affect the business activities in the future. · Past occurrences: As we know, financialstatements provide past occurrences in a business and doesn’t reflect on thepresent conditions in the business, thus meaning it isn’t useful in predictingthe future of the business. · Different accounting policies: As there are manydifferent accounting polices such as, valuation of stock, depreciation andvaluation debt this makes the data and ratios of two businesses incomparable tosome extent.
· Quantitative analysis: Ratios are only usedquantitatively which means the qualitative aspects are completely disregardedwhich means for instance, a high current ratio may mean that the liquidityposition when current assets does include stock which consist of largely out ofdate items. · Fluctuations in price: Comparing prices can be difficultas fixed assets only show the statement at cost which means it doesn’t show thefluctuations in prices. · Ratios accounting for one variable: As ratiosare one variable, it means that they cannot give a suitable picture as theremay be external variable such as political, economy, government and availableresources problems which have to be understood by management. · Seasonal demand: Businesses must take measureswhen making account ratios for seasonal items. For example, for playtime and Funtimesales will be much higher in summer time than winter time which means thatsales will fluctuate due to it being a children’s play area business.