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Financial statements are used to report the status of the firm at one point in time as wellas the results of its operations of the previous year. However, the real use comes in theeffective analysis to predict the future income and dividends along with the risksassociated with these variables. (Melicher 2008)There is an assortment of analytical methods - trend analysis, common size analysis,ratio analysis, segmental analysis and cash flow analysis (Alexander 2007), and out ofthe various methods in use, financial ratios are the corner stone of financial statementanalyses (Horngren 2004) as they capture the critical dimensions of the economicperformance of the firm (Horngren 2004).Financial ratios are the most widely used among other measures of financialperformance of a firm. Ratio analysis can be considered a means to determine a firmsstrengths and weaknesses (Melicher 2008) and are increasingly being used as a tool bymanagement to guide, measure and subsequently reward the employees; Hewittassociates, a compensation consulting firm reports that 60% of the 1941 large firmshave profit sharing programs (Horngren 2004).

Besides the obvious uses, ratios have also been used in forecasting potential corporate

bankruptcies, classifying a potential customers credit rating; and lately there is researchinto models to identify potential takeovers and also to value shares. This is madepossible because of progress in application of statistical techniques to ratios. This hasresulted in improvement of the quality of a general picture of a company through timelineanalysis and line-of-business analysis (Pendelbury 2004).

In trend analysis, a base year is chosen as a benchmark and the various elements areshown as an index of this benchmark. Literature suggests a minimum of 5 year timeframe (Alexander 2007) to check how the various items in a balance sheet have changesover time. In a common size analysis the financial statements items are compared withthe peer group, and to remove the size effect, the balance sheet items are expressed interms of percentage of revenue and the balance sheet items in terms of percentage of

assets (Alexander 2007).

Financial ratios are employed widely by all parties interested in an enterprise: theowners, management, personnel, customers, suppliers, competitors, regulatory agencies,and academics, each with their own objectives on application (Salmi 1994). All userswill no doubt be interested in the future prospects and different users would have variedrequirements based on the decisions required to be taken (Pendelbury 2004).Potential shareholders would examine the financial statements as an excellent source ofinformation about a company (Melicher 2008) before they decide to invest in acompanys shares. Subsequently they will continually assess their investments andsome of the results may be translated into buy, hold, or sell decisions. There are ratios specifically made for investors which focus on the returns to be obtained in the formof dividends or capital appreciation (Alexander 2007). Practitioners (analysts) use financialratios to forecast the future prospects of a firm,whereas the researchers aim to exploit the ratios for creation of better models (Salmi1994).

Practitioners (analysts) use financial ratios to forecast the future prospects of a firm,whereas the researchers aim to exploit the ratios for creation of better models (Salmi1994).

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