Ratio analysis is a useful tool for comparing the financial performance of companies. It allows analysis of a company's financial health, profitability, and operational efficiency over time and relative to peers. However, ratio analysis has limitations as it only considers quantitative factors and a single ratio provides limited insight. Ratios can also be impacted by changes in accounting policies. The payout ratio measures the percentage of earnings paid out as dividends. It is calculated as dividends per share divided by earnings per share. A company's dividend policy, industry, growth plans, cash needs, and debt obligations should all be considered when determining its payout ratio rather than following a fixed policy. Maintaining a stable payout can provide investors with certainty but

1. Question 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 their productivity & profitability.
Ratio analysis helps in intrafirm comparison by providingnecessary data. An interfirm 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 other 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.
Question 2b: 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 dividends to shareholders. Investors
can use the payout ratio to determine what companies are doing with their earnings. It can be
calculated as:
Payout Ratio = (Dividents per share) / (Earnings per share)
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,

2. larger, more-established 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 a certain 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.