2.

(a)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 providing necessary 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.

(b)
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 = dividends 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, 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.