The Extensive Use of Financial Ratios by Both Practitioners and Essay

The Extensive Use of Financial Ratios by Both Practitioners and Researchers - Essay Example One of the major reasons for using financial ratios is to compare different firms in the same industry regardless of the size of the organizations. For instance, Return on Equity (ROE) can be calculated by using two variables; profitability or income of the organization and its equity therefore even if the size of the firms differs a lot but still these two firms can be compared to each other (Gowthorpe, 2006). As a result, financial ratios are helpful in controlling different factors while comparing different companies operating in the industry and allowing researchers a platform to compare firms which might have not been possible without these ratios. Similarly, besides controlling the size of the organization, financial ratios control other factors like technology and assuming that these factors are uniform within the same industry. ... he firm is ignored, as investors investing in a riskier firm would like to demand higher return on investment therefore the firm should earn higher returns in order to attract investors Therefore all this considerations or limitations of financial ratios have raised concerns on important issues that are ignored by the financial ratios but despite of this fact, financial analysts, researchers and practitioners have been continuously using financial ratios. ADVANTAGES AND APPLICATION OF USING FINANCIAL RATIOS There are several advantages and applications of using financial ratios which are as follows: ENABLES COMPARISON BETWEEN DIFFERENT FIRMS Financial ratios are helpful in allowing comparison between different firms and their performance and therefore management of the firm is able to take decisions considering its competitors in the industry and overall averages in the industry (Bodie, Kane, & Marcus, 2004) BENCHMARKING TECHNIQUE Because of financial ratios, companies are able to se t their performance targets and measures against the leading firms in the industry and as they aim high, they are able to improve their overall performances (Heaton, 2002). FINANCIAL RATIOS ENABLE ORGANIZATIONS TO EVALUATE FROM THEIR PAST PERFORMANCES Financial ratios allow organizations to compare their past performances against their current performance and in this way they are able to identify whether they are going in the right direction or not (Correia, Flynn, Uliana, & Wormald, 2007). FINANCIAL RATIOS ARE HELPFUL IN IDENTIFY DIFFERENT COSTS AND EXPENSES THAT CAN BE REDUCED With the help of financial ratios, management is able to identify different costs and expenses of the company that have increased over the last few years or costs and expenses in comparison to their competitors and