Financial Accounting Information Summary

Ratio analysis provides the most commonly used indicators to assess and compare the financial performance of companies, both over time and as between different companies. However, unless ratios are collected in a systematic and uniform manner, comparisons may be very misleading. For this reason, they are most useful when collected and developed by such organizations as the Centre for Inter-firm Comparisons.

It is very important that external users of financial reports should understand the limitations of ratios based on conventional accounting measurements, otherwise their analyses will not be sound nor their interpretations valid. The conclusion which may be drawn from our examination of ratio analysis is that its general usefulness and relevance to investors would be enhanced by increasing the uniformity of financial reporting practices and adopting current value accounting.

Considerable interest exists in the possibility of using financial ratios as predictors of business failure. Several studies have been conducted that show that there exist ratios and combinations of ratios which are significant in this regard. Nevertheless, caution is required in accepting the conclusions suggested by financial ratios as regards business failure.

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Read on: Taffler and Tisshaw

Taffler and Tisshaw

Taffler and Tisshaw (2007) applied Altman's multiple discriminant analysis to companies in the United Kingdom. They tested the predictive value of 80 different ratios in a variety of combinations. The best results were found when four ratios were combined in accordance with weighting which reflected their significance to the analysis of business failure.

The ratios used by Taffler and Tisshaw and the weightings which they were given were as follows:

(a) Profit before tax/current liabilities (53 per cent), which according to them 'is a profitability... see: Taffler and Tisshaw