What does ratio analysis primarily involve?

Ratio analysis primarily involves evaluating financial statements through various metrics, which is essential for assessing a company's performance and financial health. By using ratios, financial analysts can derive insights into aspects such as profitability, liquidity, solvency, and efficiency. These metrics normalize financial data, allowing for meaningful comparisons across time periods or against industry standards.

This method provides a clear picture of how different elements of financial statements relate to one another, illuminating trends and identifying areas for improvement. The importance of ratio analysis lies in its ability to consolidate complex financial information into comprehensible and actionable insights, aiding stakeholders in making informed decisions.

Comparing historical and budgeted financial data, while valuable for performance assessment, does not encapsulate the broader purpose and method of ratio analysis. Similarly, although assessing management effectiveness may involve analyzing various metrics, it is not the primary focus of ratio analysis itself. Predicting customer demand based on sales data is outside the scope of ratio analysis, as it pertains more to market analysis than financial evaluation.