Financial statements such as the balance sheet and the profit and loss account show a business’ absolute financial performance or absolute financial strength. Absolute financial information provides useful information about a business but in some situations these absolute numbers are not very meaningful when interpreted in isolation.

In order to improve interpretation of financial performance and financial strength of a business accountants and analysts can use financial ratios to analyse financial information so that they get a better and deeper understanding of a business.

Absolute numbers are useful but on their own they may not reveal much about a business. For example knowing that a company has made a profit of £1 million or that it made sales of £5 million may not be helpful in understanding how well a business has done or how the business is doing relative to competition. What ratios do is express these numbers in relative terms such as gross profit margin, net profit margin or turnover ratios. Ratios simplify analysis and allow comparisons to be made between two or more companies.

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