What is the main purpose of ratio analysis in business?

The main purpose of ratio analysis in business is to provide insight into financial performance through analysis. Ratio analysis allows stakeholders to evaluate various aspects of a company's financial health and operational efficiency by examining relationships between different figures found in financial statements. By using these ratios, businesses can assess profitability, liquidity, solvency, and efficiency, which are crucial in making informed decisions.

For example, profitability ratios measure how effectively a company generates profit relative to its sales, assets, or equity, allowing stakeholders to understand how well the company can manage its resources while generating earnings. Likewise, liquidity ratios help assess a company's ability to meet short-term obligations, which is vital for maintaining operational stability. This analytical approach helps in identifying strengths and weaknesses within a business, driving strategic planning and operational improvements.

While forecasting future market trends is important for long-term planning, it is not the primary purpose of ratio analysis. Additionally, communicating financial information to stakeholders can be a function of ratio analysis, but the analysis's primary focus is deeper insight into financial performance rather than merely relaying data. Setting employee salaries is generally based on a variety of factors other than ratio analysis, including industry standards, roles, and individual performance metrics.