Financial ratios refer to the relationships established between the different aspects of the financial information of any given entity. Their use is however not just limited to organizations; they can also be applied to personal finances. In such regard as Tang & Peter (2015) advance, financial ratios such as the liquidity ratio will help individuals determine their abilities to pay up their financial obligations and hence inform the decision of whether or not to seek more debt. Other ratios such as the leverage will help one establish, as Weygandt, Kimmel & Kieso (2015) note, their ability to service long-term financial obligations such as mortgages. Overall, financial ratios are significant because they help individuals make decisions concerning the management of their finances.
Banking institutions are in the business of money; keeping it for others, lending it to some, and making profits in the process. For this reason, therefore, banking institutions need to have an understanding of the relationships that different aspects of an entity’s financial information give. This would go a long way in enabling the bank to determine which entities would be most likely to repay money advanced to them and which would be less likely to, and what amount of interest to charge on monies advanced to which entities. Weygandt, Kimmel & Kieso (2015) also allude to the fact that banking institutions may also use financial institutions to determine their abilities to meet their financial obligations. Financial ratios (considered together with other information) may help banking institutions determine the amount of interest to pay to each customer for deposits kept at such bank or the rates at which to lend money each customer.
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Investors need to understand the different financial ratios to have an idea of how the money they invest in an entity is performing. They also need to have a grasp of such information to understand exactly how much their money earns for them and whether the entities in which they have invested are viable, and could still stay sustainable going forward.Further, as Reid &Myddelton (2017) indicate, financial ratios could also help investors gauge the performance of the management of the entities in which they have invested.
References
Reid, W., & Myddelton, D. R. (2017). The Meaning of Company Accounts . Northridge, CA: Routledge.
Tang, N., & Peter, P. C. (2015). Financial Knowledge Acquisition among the Young: The Role of Financial Education, Financial Experience, and Parents' Financial Experience. Financial Services Review , 24 (2), 119.
Weygandt, J. J., Kimmel, P. D., & Kieso, D. E. (2015). Financial & Managerial Accounting . John Wiley & Sons.
