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Ratios Analysis

Important to :
• Describe Balance Sheet , P&L ,
Budgetary Variances
•Analysis and Decision making
•Basis for Inter firm and Intra firm
comparisons
Balance Sheet , P&L a/c

Financial Statements :
• Reports what has actually
happened to earnings during a
specified period and presents a
summary of financial position of
the company.
Statement of Retained
Earnings

Reconciles Income earned during


the year and any dividends
distributed with the changes in
Retained earnings between the
start and end of the financial year.
Ratio

Ratio is a quotient of two numbers


and the relation expressed
between two accounting figures.
Ratio - Advantages

•Easy Comparison
•Meaningful analysis of non financial
information
•Provides valuable insights into
company’s financial position
•Pinpoints strengths and weaknesses
•Competitive advantage /
disadvantage.
Ratio - Types

•LIQUIDITY
•LEVERAGE
•ASSET MANAGEMENT
•PROFITABILITY
•OPERATING
•MARKET BASED.
LIQUIDITY RATIOS

• Indicate Short Term position of the Organization.


• Indicates the efficiency with which the Working
Capital is being used.
• Used by Short Term Creditors and Commercial
Banks
LIQUIDITY RATIOS
Current Ratio = Current Assets / Current Liabilities
Current Assets :
1. Cash in Bank / Hand
2. Marketable securities
3. Sundry Debtors
4. Bills Receivable
5. Debtors
6. Inventories
7. Prepaid Expenses
8. Short Term loans and advances.
Current Liabilities :
1. Sundry Creditors
2. Bills Payables
3. Outstanding Expenses
4. Bank Overdraft
5. Cash credit
LIQUIDITY RATIOS
Current Ratio = Current Assets / Current Liabilities
• Indicates the backing available to Current liabilities in the
form of Current Assets.
• A Higher Current Ratio indicates there are sufficient
assets available with the organization which can be
converted into cash without any reduction in the value , in
a short span of time.
• A Current ratio of 2:1 is a standard and ideal ratio.
• Care should be taken that Inventories do not include Non
Moving or Dead Inventories and Non recoverable debts.
• A higher current ratio may also indicate unnecessary high
investments in current assets in the form of inventories or
receivables or both.
LIQUIDITY RATIOS
Liquid Ratio (Acid Test or Quick) = Liquid Assets /
Liquid Liabilities
Liquid Assets :
1. Cash in Bank / Hand
2. Marketable securities
3. Sundry Debtors
4. Bills Receivable
5. Debtors
Liquid Liabilities :
1. Sundry Creditors
2. Bills Payables
3. Outstanding Expenses
LIQUIDITY RATIOS
Liquid Ratio (Acid Test or Quick) = Liquid Assets /
Liquid Liabilities
1. Indicates the backing available to Liquid liabilities in the
form of Liquid Assets.
2. A Higher Current Ratio indicates there are sufficient
assets available with the organization which can be
converted into cash without any reduction in the value ,
almost immediately.
3. A Liquid ratio of 2:1 is a standard and ideal ratio.
4. The Inclusion of Receivables can be challenged.
TURNOVER RATIOS

• Indicate the efficiency of the organization to use the


various kinds of assets by converting them in the
form of Sales.
TURNOVER RATIOS
1. FIXED ASSETS TURNOVER RATIO = NET SALES / FIXED ASSETS
1. Net Sales includes Sales net of returns – Cash + Credit
2. Fixed Assets include Net Fixed Assets. i.e FA less Depreciation
3. A High FA Turnover ratio indicates the capability of the Organization to achieve
maximum sales with the minimum investment in FA.
4. Higher the FA Turnover, Better is the situation.

• CURRENT ASSETS TURNOVER RATIO = NET SALES / CURRT ASSTS


1. A high CA Turnover ratio indicates the capability of the organization to achieve
maximum sales with the minimum investment in CA.
2. It indicates that the CA are turned over in the form of sales more number of
times.
3. Higher the CA Turnover, Better is the situation.
TURNOVER RATIOS
3. WORKING CAPITAL TURNOVER RATIO = NET SALES / WKG CAP
1. Net Sales includes Sales net of returns – Cash + Credit
2. Working Capital denotes CA – CL.
3. A high WC Turnover ratio indicates the capability of the organization to achieve
maximum sales with the minimum investment in WC.
4. It indicates that the WC are turned over in the form of sales more number of
times.
5. Higher the WC Turnover, Better is the situation.
4. STOCK TURNOVER RATIO = COGS / AVG INVENTORY or
NET SALES / AVG INVENTORY or COGS / CLOSING INVENTORY or
COGS / AVG INVENTORY
1. The best out of the above is COGS / AVG INVENTORY
2. A High Stock Turnover ratio indicates that Maximum Sales Turnover is achieved
with the Minimum Investment in Inventories.
3. A Higher ratio is desirable but it has to be viewed from various angles ….The
company may have a very tight delivery schedule and may lose customers if its
not able to service the requests.
4. A Low Inventory Turnover indicates investment in Non Moving Inventories.
TURNOVER RATIOS
5. DEBTORS TURNOVER RATIO = NET CREDIT SALES / CLOSING
SUNDRY DEBTORS
1. Indicates the speed at which the Debtors are converted into Cash.
2. Supported by Calculation of Daily Sales as well as Average Collection period
3. DAILY SALES = NET CREDIT SALES / NO. OF DAYS.
4. AVERAGE COLLECTION PERIOD = CLOSING DEBTORS / DAILY SALES
5. Bills Receivables should also be included in the Debtors .
6. If Average Collection period is more than the normal credit period, it indicates
an over investment in debtors.
6. CAPITAL TURNOVER RATIO = NET SALES / CAPITAL EMPLOYED
1. Capital Employed indicates the Long Term Funds supplied by Creditors and
Owners of the company.
2. C E = FA + Investments + CA – CL
3. CE = Share Capital + Reserves & Surplus + Long Term Liabilities
4. This ratio indicates the efficiency with which the Capital Employed is being
utilized.
5. A High Capital Turnover ratio indicates the capability of the organization to
achieve maximum sales with minimum amount of capital employed.
6. Higher the Capital Turnover, Better is the situation.
SOLVENCY RATIOS

• Indicate the long term financial prospects of the


company.
• The Share holders , Debenture holders and other
lenders of Long Term finance / Term loans will be
more interested in these ratios.
SOLVENCY RATIOS
1. DEBT EQUITY RATIO = share holders funds / total assets OR
SHAREHOLDERS FUNDS / EXTERNAL LIABILITIES
1. Shareholders funds consists of Share Capital + Reserves & Surplus
2. Preference Shareholders may be treated as part of Debt or Equity depending on
the Redemption period. If the redemption is OVER 12 years , the same is treated
as Equity , else, Debt.
3. The D/E ratio indicates the stake of stake holders or owners vis-à-vis that of the
creditors.
4. A High D/E indicates that the financial stake of Creditors is higher than that of the
Owners.
5. A Very High D/E is a Risky proposition from the point of view of Owners.
6. A very low D/E indicates that there is under utilization of the Borrowing Capacity
of the firm.
7. To Borrow the funds from outside is the best way to increase the earnings to the
Owners. : Because : expectations of returns of the creditors are less and this is
a Tax deductible expenditure…
SOLVENCY RATIOS
2. PROPRIETORY RATIO = OWNERS FUNDS / TOTAL ASSETS or
OWNERS FUNDS / FIXED ASSETS or CURRENT ASSETS
• Owners funds = Equity funds
• Indicates the extent to which the Owners funds are sunk into various Assets
• If OF > FA , it indicates that OF are used for CA also.
• Similarly, OF > CA, it indicates the extent to which OF are locked up towards CA.
• In some cases, a higher proportion of CA to OF , as compared to proportion of
FA to OF may indicate good health of the Business.
3. FIXED ASSETS / CAPITAL EMPLOYED RATIO = FA / CE * 100
1. C E = FA + Investments + CA – CL
2. CE = Share Capital + Reserves & Surplus + Long Term Liabilities
3. Indicates the extent to which LT funds are sunk into FA.
4. LT funds must finance FA as well as part of CA for efficient operations.
SOLVENCY RATIOS
4. INTEREST COVERAGE RATIO = PBIT / INTEREST
1. Interest = Interest paid on LT borrowings.
2. Indicates the protection available to the lenders of LT Capital in the form of funds
available to pay Interest charges
3. A High Ratio is generally desirable but it indicates under utilization of borrowing
capacity of the organization.

5. DEBT SERVICE COVERAGE RATIO = (NP + DEP + INT ON LT LOANS) /


(INTEREST ON LT LOANS + INSTALMTS OF LT LOANS)

1. Indication about the capability of the organization to meet the obligations of LT


Borrowings
2. Bankers / FI’s will like to consider this ratio before extending finance to
companies.
3. Lower DSCR Indicates insufficient capacity to meet the obligations of long term
borrowings
4. Higher DSCR it is likely that the period of term loan may be reduced from
whatever is requested by the borrowing organization.
PROFITABILITY RATIOS

• Intention is to ascertain the profitability of the


organization
PROFITABILITY RATIOS
1. GROSS PROFIT RATIO = GROSS PROFITS / NET SALES *100
1. GP = SALES – COGS
2. HIGHER GP INDICATES LOWER MANUFACTURING COSTS
3. HIGH GP IS ALSO RESULTANT OF INCREASED PRICES
4. COST-PRICE-VOLUME IMPACT CAN BE ASCERTAINED
2. NET PROFIT RATIO = NET PROFITS / NET SALES *100
1. NP = SALES – COGS – ALL EXPENSES
2. HIGHER NP INDICATES EFFICIENCY IN MANAGING COSTS
3. RETURN ON ASSETS = NET PROFITS / ASSETS *100
1. NP = PFT AFTER TAX
2. ROA MEASURES PROFITABILITY OF THE INVESTMENTS IN A FIRM.
4. RETURN ON CAPITAL EMPLOYED (ROCE) = (NET PROFIT AFTER TAX
+ INTEREST) / CAPITAL EMPLOYED *100
1. C E = FA + Investments + CA – CL
2. CE = Share Capital + Reserves & Surplus + Long Term Liabilities
3. HIGHER ROCE INDICATES BETTER AND PROFITABLE USE OF LONG
TERM FUNDS OF OWNERS AND CREDITORS.
PROFITABILITY RATIOS
5. RETURN ON SHAREHOLDERS FUNDS = NET PROFIT AFTER TAXES /
SHAREHOLDERS FUNDS *100
1. MOST IMPORTANT RATIO INDICATING WHETHER THE FIRM HAS EARNED
SUFFICIENT FOR THE SHAREHOLDERS OR NOT.
2. HIGHER THE RATIO, BETTER THE SITUATION.
OTHER RATIOS
1. CAPITAL GEARING RATIO = FIXED INCOME BEARING SECURIETIES /
EQUITY CAPITAL
1. FIXED INCOME BEARING SECURITIES INCLUDE PREFERENCE SHARES ,
DEBENTURES, LONG TERM LOANS.
2. A HIGH CG RATIO INDICATES THAT IN THE CAPITAL STRUCTURE, FIXED
INCOME BEARING SECURITIES ARE HIGHER.
3. A COMPANY EMPLOYS A HIGH CG TO INCREASE THE EARNINGS OF THE
EQ SHARE HOLDERS.
4. IF THE INCOME OF A COMPANY IS UNSTABLE, A HIGH CG MAY BECOME
FATAL AS A MAJOR PORTION WILL BE USED YO MEET OBLIGATIONS OF
FIXED INCOME BEARING SECURITIES.
OTHER RATIOS
2. EARNINGS PER SHARE = (NET PFT (AT) – PREF DIV) / (NO. OF EQ SHARES
OUTSTANDING)
• WIDELY USED TO MEASURE THE PROFIT AVAILABLE TO EQUITY SHARE HOLDERS.
• EPS IS CALCULATED ON CURRENT PROFITS. IT WOULD BE BETTER TO
CALCULATE ON RETAINED PROFITS.
• HOWEVER EPS DOES NOT DENOTE HOW MUCH OF EARNINGS ARE PAID TO THE
OWNERS BY WAY OF DIVIDEND AND HOW MUCH OF THE EARNINGS ARE
RETAINED IN THE BUSINESS.
3. PRICE EARNINGS RATIO = MARKET PRICE PER SHARE / EPS
• P/E RATIO INDICATES THE PRICE CURRENTLY BEING PAID IN THE MARKET FOR
EACH RUPEE OF EPS.
• IT MEASURES EXPECTATIONS OF INVESTORS.
• HIGH P/E INDICATES POSSIBILITY OF INCREASE IN EPS.
• IMPORTANT FOR INVESTORS.
4. DIVIDEND PAYOUT RATIO = DIVIDEND PER SHARE / EPS * 100
1. IT MEASURES RELATIONSHIPS BETWEEN THE EARNINGS BELONGING TO THE
EQUITY SHAREHOLDERS AND THE AMOUNT FINALLY PAID TO THEM BY WAY OF
DIVIDENDS.

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