Ratios are the best tools for measuring liquidity, solvency, profitability and management efficiency of the firm. The importance of ratio analysis is discussed below:

1. It helps in analyzing the probable causal relationships among different items after analyzing the past results.

2. These ratios that are derived after analyzing the past results help the management to prepare budgets, to formulate policy, and to prepare a future plan of action.

3. It takes the time dimension into consideration through trend analysis. Trend Analysis using ratios helps in understanding the performance of the company over a period of time.

4. It is also called the surveyor of efficiency as it throws light upon the efficiency of the management and the degree of utilization of the assets by the business.

5. Ratio analysis helps in making inter-firm comparisons and also comparisons between the different divisions of the company.

6. The short-term liquidity position of the firm can be easily found by applying the liquidity ratios. Often, a firm may have the assets, short of short-term funds however short they may be. Liquidity ratios help in understanding the firm's short-term liquidity position.

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