What is the primary purpose of ratio analysis in a business?

The primary purpose of ratio analysis is to assess relationships between elements in financial statements. This analytical tool allows businesses to evaluate their financial health by examining the relationships among various numbers reported in financial statements, such as the income statement and balance sheet. By using ratios, analysts can gain insights into profitability, liquidity, efficiency, and solvency, which are crucial for decision-making and strategic planning.

This approach helps stakeholders, including management and investors, understand how different metrics relate to one another—for example, how sales generate profits or how assets relate to liabilities. It goes beyond individual financial figures, providing a more comprehensive view of the company's financial performance and stability.

While monitoring daily cash flow, forecasting future sales trends, and calculating employee productivity are important aspects of managing a business, they do not encompass the broad analytical overview and relational insights provided by ratio analysis. The strength of ratio analysis lies in its ability to connect various financial components to provide a clearer picture of a company's overall economic condition.