Q.

2 (A): Discuss the importance of ratio analysis for inter-firm and intra-firm
comparisons including circumstances responsible for its limitations .If any
Answer: Ratio analysis implies the systematic use of ratios to interpret the financial
statements so that the strength and weaknesses of a firm as well as its historical
performance and current financial position can be determined. With the help of ratio
analysis conclusion can be drawn regarding several aspects such as financial health,
profitability and operational efficiency of the undertaking. Ratio analysis is very useful in
making inter-firm comparison as it helps to draw a comparison between the entities
within the same industry or otherwise following the same accounting procedure. It
provides the relevant financial information for the comparative firms with a view to
improving the in productivity & profitability. Ratio analysis helps in intra-firm
comparison by providing necessary data. An inter-firm comparison indicates relative
position. It provides the relevant data for the comparison of the performance of different
departments. If comparison shows a variance, the possible reasons of variations may be
identified and if results are negative, the action may be initiated immediately to bring
them in line. However, in spite of being such a useful tool, it is not free from its
limitations. A single ratio is of a limited use and it is essential to have a comparative
study. The base used for ratio analysis viz: financial statements have their own
limitations. Also, they consider only the quantitative aspects of business transactions
where as there are various others non-quantitative aspects such as quality of work force
which considerably affect profitability and productivity. Also, ratio analysis as a tool is
also limited by changes in accounting procedures/policies.
Q. 2(B): Why do you understand by the term 'pay-out ratio'? What factors are
taken into consideration while determining pay-out ratio? Should a company follow
a fixed pay-out ratio policy? Discuss fully
Answer: Pay-out Ratio means the amount of earnings paid out in
dividendsto shareholders. Investors can use the payout ratio to determine whatcompanies
are doing with their earnings. It can be calculated as: A very low payout ratio indicates
that a company is primarily focused on retaining its earnings rather than paying out
dividends. The pay-out ratio also indicates how well earnings support the dividend
payment. The lower the ratio, the more secure the dividend because smaller dividends are
easier to payout than larger dividends. The major factor to be considered in determining
the payout ratio is the dividend policy of the company. Young, fast-growing companies
are typically focused on reinvesting earnings in order to grow the business. As such, they
generally sport low (or even zero) dividend payout ratios. At the same time, larger, moreestablished companies can usually afford to return a larger percentage of earnings to
stockholders. Also, another factor to be considered is the type of industry in which the
company is operating. For example, the banking sector usually pays out a large amount of

its profits. Certain other sectors like real estate investment trusts are required by law to
distribute ascertain percentage of their earnings. Funds requirement of the company and
its available liquidity is another factor which is considered while determining the pay-out.
Some companies prefer to follow a fixed pay-out ratio policy irrespective of the earnings
made. This is a welcome policy from the point of view of the investors. But, the company
should take into account various important factors such as its need for future investment
and growth, cash requirements and debt obligations.