Example of Ratio Analysis Use

Ratios are useful to indicate various symptoms. Usually those symptoms require more detailed analysis. For example, ratio analysis may reveal an increase in sales volume relative to inventory and receivables. But inventories could have increased less rapidly than sales due to reduced cost of goods, inability to replace inventory items, change in inventory policy or a change in inventory valuation. Receivables could have increased less rapidly than sales because of a more efficient collection policy, a larger proportion of cash sales or a change in policy with regard to the extension of credit. Sales volume could have increased due to plant expansion, an aggressive sales campaign, price increase, price decrease or extension of sales territories. Ratio changes lead managers to ask pointed questions.