An empirical study on the practical efficacy of ideal financial ratios

Ratio analysis is the simplest and the oldest of methods of analyses of a company's state of affairs for all the stakeholders. This method has been understood as a tool that will compare the actual ratio with an ideal ratio. People not only value a business based on its profitability using profitability ratios but also measure financial efficiency or leverage using solvency ratios. Creditors and bankers use certain standard ratios for assessing the credit rating of businesses. This makes even laymen value a business based on ratios such as price earnings ratio. This paper is an attempt to understand the efficacy of ratio analysis and the concept of ideal ratios. The attempt will help find how ideal ratios have been determined and if they sector sensitive. A capital structure decision is expected by common logic of fixed capital requirements and working capital requirements which is dependent on the nature of business. However, there is a general perception which is based on sound logic that leverage is adopted to take advantage of tax benefits. This paper will help in testing this hypothesis as well.