A literature review is an integral part of a ratio analysis project. It involves a comprehensive analysis of relevant literature on the subject to better understand the various concepts and methods used in ratio analysis.
The use of ratios to analyze financial statements dates back to the early 20th century and has since become a widely accepted tool for financial analysis. Ratios provide a means of comparing and evaluating different financial characteristics of a company, such as its liquidity, profitability, and solvency.
There are various types of ratios that can be used in a ratio analysis project. Some common ratios include liquidity ratios, which measure a company's ability to meet its short-term obligations; profitability ratios, which assess a company's ability to generate profits; and solvency ratios, which assess a company's ability to meet its long-term financial obligations.
There are several approaches to ratio analysis, including the traditional approach, which involves calculating ratios using historical financial data, and the DuPont analysis, which decomposes a company's return on equity into its constituent parts. Other popular approaches include the common size analysis and the trend analysis.
One of the key advantages of ratio analysis is that it allows for comparison between companies within the same industry or sector. This allows investors and analysts to identify industry trends and make informed decisions about the relative performance of different companies.
However, it is important to note that ratio analysis is not without its limitations. For example, ratios are based on historical data and may not accurately reflect a company's future financial performance. In addition, different companies may use different accounting methods, which can impact the accuracy of ratio analysis.
Despite these limitations, ratio analysis remains a valuable tool for financial analysis and is widely used by investors, analysts, and other stakeholders. A comprehensive literature review of ratio analysis can provide a thorough understanding of the various concepts and methods used in this field and can serve as a foundation for further research and analysis.