Abstract ABSTRACT: Financial report ratio analysis is frequently taught in introductory financial accounting courses. Beginning students often have unrealistically high expectations concerning the usefulness of such ratio analysis. After learning the basics of the Efficient Markets Hypothesis, many students over-react and dismiss ratio analysis as useless. This paper provides a more balanced appraisal of ratio analysis by discussing three areas in which ratio analysis may be useful: (1) analysis of business transactions in markets that may not be efficient, (2) contractual limits based on accounting ratios, and (3) performance prediction and risk evaluation in an efficient market. By discussing these potential contributions of ratio analysis in class, the instructor can help students place ratio analysis in proper perspective and can also help integrate the accounting/finance curriculum.
James M. Patton (1982) studied this question.