Ratio Analysis: It is concerned with the calculation of relationships, which after proper identification

& interpretation may provide information about the operations and state of affairs of a business
enterprise. The analysis is used to provide indicators of past performance in terms of critical
success factors of a business. This assistance in decision-making reduces reliance on guesswork
and intuition and establishes a basis for sound judgments.
Types of Ratios
Liquidity
Measurement
Profitability
Indicators
Financial
Leverage/Gearing
Operating Performance Investment
Valuation
Current Ratio Profit Margin Analysis Equity Ratio Fixed Assets Turnover Price/Earnings Ratio
Quick Ratio Return on Assets Det Ratio !ales/ Revenue Price/Earnings to
"ro#t$ ratio
Return on Equity Det%Equity Ratio Average Collection Period Dividend &ield
Return on Ca'ital
E('loyed
Ca'itali)ation Ratio *nventory Turnover Dividend Payout
Ratio
*nterest Coverage Ratio Total assets Turnover
Liquidity Measurement Ratios
+iquidity refers to t$e aility of a fir( to (eet its s$ort%ter( financial oligations #$en and as t$ey fall
due, T$e (ain concern of liquidity ratio is to (easure t$e aility of t$e fir(s to (eet t$eir s$ort%ter(
(aturing oligations, T$e greater t$e coverage of liquid assets to s$ort%ter( liailities t$e etter as it is a
clear signal t$at a co('any can 'ay its dets t$at are co(ing due in t$e near future and still fund its
ongoing o'erations, -n t$e ot$er $and. a co('any #it$ a lo# coverage rate s$ould raise a red flag for
investors as it (ay e a sign t$at t$e co('any #ill $ave difficulty (eeting running its o'erations. as #ell as
(eeting its oligations,
Ratio Formula Meaning nalysis
!urrent Ratio !urrent ssets/!urrent
Liabilities
Current assets includes cas$.
(arketale securities. accounts
receivale and inventories,
Current liailities includes
accounts 'ayale. s$ort ter(
notes 'ayale. s$ort%ter( loans.
current (aturities of long ter(
det. accrued inco(e taxes and
ot$er accrued ex'enses
T$e nu(er of ti(es t$at t$e
s$ort ter( assets can cover t$e
s$ort ter( dets, *n ot$er #ords.
it indicates an aility to (eet t$e
s$ort ter( oligations as / #$en
t$ey fall due
0ig$er t$e ratio. t$e etter it is.
$o#ever ut too $ig$ ratio
reflects an in%efficient use of
resources / too lo# ratio leads
to insolvency, T$e ideal ratio is
considered to e 123,.
"uic# Ratio or
cid $est Ratio
%!as&'!as&
(quivalents')&ort $erm
Investments'ccounts
Receivables* / !urrent
Liabilities
*ndicates t$e aility to (eet
s$ort ter( 'ay(ents using t$e
(ost liquid assets, T$is ratio is
(ore conservative t$an t$e
current ratio ecause it excludes
inventory and ot$er current
T$e ideal ratio is 323, Anot$er
eneficial use is to co('are t$e
quick ratio #it$ t$e current ratio,
*f t$e current ratio is
significantly $ig$er. it is a clear
indication t$at t$e co('any4s
assets. #$ic$ are (ore difficult
to turn into cas$
current assets are de'endent on
inventory,
Profitability Indicators Ratios
Profitaility is t$e aility of a usiness to earn 'rofit over a 'eriod of ti(e,T$e 'rofitaility ratios s$o# t$e
co(ined effects of liquidity. asset (anage(ent 5activity6 and det (anage(ent 5gearing6 on o'erating
results, T$e overall (easure of success of a usiness is t$e 'rofitaility #$ic$ results fro( t$e effective use
of its resources,
Ratio Formula Meaning nalysis

Gross Profit
Margin
%Gross Profit/+et )ales*,-.. A co('any4s cost of goods sold
re'resents t$e ex'ense related to
laor. ra# (aterials and
(anufacturing over$ead
involved in its 'roduction
'rocess, T$is ex'ense is
deducted fro( t$e co('any4s net
sales/revenue. #$ic$ results in a
co('any4s gross 'rofit, T$e
gross 'rofit (argin is used to
analy)e $o# efficiently a
co('any is using its ra#
(aterials. laor and
(anufacturing%related fixed
assets to generate 'rofits,
0ig$er t$e ratio. t$e $ig$er is t$e
'rofit earned on sales
Operating Profit
Margin
%Operating Profit/+et
)ales*,-..
7y sutracting selling. general
and ad(inistrative ex'enses
fro( a co('any4s gross 'rofit
nu(er. #e get o'erating
inco(e, Manage(ent $as (uc$
(ore control over o'erating
ex'enses t$an its cost of sales
outlays, *t Measures t$e relative
i('act of o'erating ex'enses
+o#er t$e ratio. lo#er t$e
ex'ense related to t$e sales
+et Profit Margin %+et Profit/+et )ales*,-.. T$is ratio (easures t$e ulti(ate
'rofitaility
0ig$er t$e ratio. t$e (ore
'rofitale are t$e sales,
Return on ssets +et Income / verage $otal
ssets
5 Earnings 7efore *nterest /
Tax 8 9et *nco(e6
T$is ratio illustrates $o# #ell
(anage(ent is e('loying t$e
co('any4s total assets to (ake a
'rofit,
0ig$er t$e return. t$e (ore
efficient (anage(ent is in
utili)ing its asset ase
Return on (quity +et Income / verage
)&are&olders (quity,-..
*t (easures $o# (uc$ t$e
s$are$olders earned for t$eir
invest(ent in t$e co('any
0ig$er 'ercentage indicates t$e
(anage(ent is in utili)ing its
equity ase and t$e etter return
is to investors,

Return on !apital
(mployed
+et Income / !apital
(mployed
Ca'ital E('loyed 8 Avg, Det
+iailities : Avg, !$are$olders
Equity
T$is ratio co('le(ents
t$e return on equity ratio y
adding a co('any4s det
liailities. or funded det. to
equity to reflect a co('any4s
total ;ca'ital e('loyed;, T$is
(easure narro#s t$e focus to
gain a etter understanding of a
co('any4s aility to generate
returns fro( its availale ca'ital
ase,

*t is a (ore co('re$ensive
'rofitaility indicator ecause it
gauges (anage(ent4s aility to
generate earnings fro( a
co('any4s total 'ool of ca'ital,

Financial Leverage/Gearing Ratios
T$ese ratios indicate t$e degree to #$ic$ t$e activities of a fir( are su''orted y creditors< funds as
o''osed to o#ners as t$e relations$i' of o#ner<s equity to orro#ed funds is an i('ortant indicator of
financial strengt$, T$e det requires fixed interest 'ay(ents and re'ay(ent of t$e loan and legal action can
e taken if any a(ounts due are not 'aid at t$e a''ointed ti(e, A relatively $ig$ 'ro'ortion of funds
contriuted y t$e o#ners indicates a cus$ion 5sur'lus6 #$ic$ s$ields creditors against 'ossile losses fro(
default in 'ay(ent,
Financial leverage #ill e to t$e advantage of t$e ordinary s$are$olders as long as t$e rate of earnings on
ca'ital e('loyed is greater t$an t$e rate 'ayale on orro#ed funds,

Ratio Formula Meaning nalysis

(quity Ratio %Ordinary )&are&older/s
Interest / $otal assets*,-..
T$is ratio (easures t$e strengt$
of t$e financial structure of t$e
co('any
A $ig$ equity ratio reflects a
strong financial structure of t$e
co('any, A relatively lo#
equity ratio reflects a (ore
s'eculative situation ecause of
t$e effect of $ig$ leverage and
t$e greater 'ossiility of
financial difficulty arising fro(
excessive det urden,
0ebt Ratio $otal 0ebt / $otal ssets T$is co('ares a co('any4s
total det to its total assets.
#$ic$ is used to gain a general
idea as to t$e a(ount of
leverage eing used y a
co('any, T$is is t$e (easure of
financial strengt$ t$at reflects
t$e 'ro'ortion of ca'ital #$ic$
$as een funded y det.
including 'reference s$ares,
=it$ $ig$er det ratio 5lo#
equity ratio6. a very s(all
cus$ion $as develo'ed t$us not
giving creditors t$e security t$ey
require, T$e co('any #ould
t$erefore find it relatively
difficult to raise additional
financial su''ort fro( external
sources if it #is$ed to take t$at
route, T$e $ig$er t$e det ratio
t$e (ore difficult it eco(es for
t$e fir( to raise det,
0ebt 1 (quity $otal Liabilities / $otal (quity, T$is ratio (easures $o# (uc$ A lo#er ratio is al#ays safer.
Ratio su''liers. lenders. creditors and
oligors $ave co((itted to t$e
co('any versus #$at t$e
s$are$olders $ave co((itted,
T$is ratio indicates t$e extent to
#$ic$ det is covered y
s$are$olders< funds,
$o#ever too lo# ratio reflects an
in%efficient use of equity, Too
$ig$ ratio reflects eit$er t$ere is
a det to a great extent or t$e
equity ase is too s(all
!apitali2ation
Ratio
Long $erm 0ebt / %Long
$erm 0ebt ' )&are&older/s
(quity*
T$is ratio (easures t$e det
co('onent of a co('any4s
ca'ital structure. or
ca'itali)ation 5i,e,. t$e su( of
long%ter( det liailities and
s$are$olders4 equity6 to su''ort
a co('any4s o'erations and
gro#t$,

A lo# level of det and a
$ealt$y 'ro'ortion of equity in a
co('any4s ca'ital structure is an
indication of financial fitness,
A co('any too $ig$ly leveraged
5too (uc$ det6 (ay find its
freedo( of action restricted y
its creditors and/or $ave its
'rofitaility $urt y $ig$ interest
costs, T$is ratio is one of t$e
(ore (eaningful det ratios
ecause it focuses on t$e
relations$i' of det liailities as
a co('onent of a co('any4s
total ca'ital ase. #$ic$ is t$e
ca'ital raised y s$are$olders
and lenders,

Interest !overage
Ratio
(3I$ / Interest on Long $erm
0ebt
T$is ratio (easures t$e nu(er
of ti(es a co('any can (eet its
interest ex'ense
T$e lo#er t$e ratio. t$e (ore t$e
co('any is urdened y det
ex'ense, =$en a co('any4s
interest coverage ratio is only
3,> or lo#er. its aility to (eet
interest ex'enses (ay e
questionale,

Operating Performance Ratios4
T$ese ratios look at $o# #ell a co('any turns its assets into revenue as #ell as $o# efficiently a co('any
converts its sales into cas$. i,e $o# efficiently / effectively a co('any is using its resources to generate
sales and increase s$are$older value, T$e etter t$ese ratios. t$e etter it is for s$are$olders,

Ratios Formula Meaning nalysis

Fi5ed ssets
$urnover
)ales / +et Fi5ed ssets T$is ratio is a roug$ (easure of
t$e 'roductivity of a
co('any4s fixed assets #it$
0ig$ fixed assets turnovers are
'referred since t$ey indicate a
etter efficiency in fixed assets
res'ect to generating sales utili)ation,
verage !ollection
Period
% ccounts Receivable/nnual
!redit )ales *,678 days
T$e average collection 'eriod
(easures t$e quality of detors
since it indicates t$e s'eed of
t$eir collection,
T$e s$orter t$e average
collection 'eriod. t$e etter t$e
quality of detors. as a s$ort
collection 'eriod i('lies t$e
'ro('t 'ay(ent y detors, An
excessively long collection
'eriod i('lies a very lieral and
inefficient credit and collection
'erfor(ance, T$e delay in
collection of cas$ i('airs t$e
fir(<s liquidity, -n t$e ot$er
$and. too lo# a collection
'eriod is not necessarily
favorale. rat$er it (ay indicate
a very restrictive credit and
collection 'olicy #$ic$ (ay
curtail sales and $ence
adversely affect 'rofit,
Inventory $urnover )ales / verage Inventory *t (easures t$e stock in relation
to turnover in order to
deter(ine $o# often t$e stock
turns over in t$e usiness,
*t indicates t$e efficiency of t$e
fir( in selling its 'roduct,
0ig$ ratio indicates t$at t$ere is
a little c$ance of t$e fir(
$olding da(aged or osolete
stock,
$otal ssets
$urnover
)ales / $otal ssets T$is ratio indicates t$e
efficiency #it$ #$ic$ t$e fir(
uses all its assets to generate
sales,
0ig$er t$e fir(<s total asset
turnover. t$e (ore efficiently its
assets $ave een utilised,
Investment Valuation Ratios4
T$ese ratios can e used y investors to esti(ate t$e attractiveness of a 'otential or existing invest(ent and
get an idea of its valuation,
Ratio Formula Meaning nalysis

Price (arning Ratio
% P/( Ratio *
Mar#et Price per )&are /
(arnings Per )&are
T$is ratio (easures $o# (any
ti(es a stock is trading 5its
'rice6 'er eac$ ru'ee of EP!
A stock #it$ $ig$ P/E ratio
suggests t$at investors are
ex'ecting $ig$er earnings
gro#t$ in t$e future co('ared
to t$e overall (arket. as
investors are 'aying (ore for
today4s earnings in antici'ation
of future earnings gro#t$,
0ence. stocks #it$ t$is
c$aracteristic are considered to
e gro#t$ stocks, Conversely. a
stock #it$ a lo# P/E ratio
suggests t$at investors $ave
(ore (odest ex'ectations for its
future gro#t$ co('ared to t$e
(arket as a #$ole,

Price (arnings to
Gro9t& Ratio
% P/( Ratio * / (arnings Per
)&are
T$e 'rice/earnings to gro#t$
ratio. co((only referred to as
t$e PE" ratio. is oviously
closely related to t$e P/E ratio,
T$e PE" ratio is a refine(ent
of t$e P/E ratio and factors in a
stock4s esti(ated earnings
gro#t$ into its current
valuation, 7y co('aring a
stock4s P/E ratio #it$ its
'ro?ected. or
esti(ated. earnings 'er s$are
5EP!6 gro#t$. investors are
given insig$t into t$e degree of
over'ricing or under 'ricing of
a stock4s current valuation. as
indicated y t$e traditional P/E
ratio,

T$e general consensus is t$at if
t$e PE" ratio indicates a value
of 3. t$is (eans t$at t$e (arket
is correctly valuing 5t$e current
P/E ratio6 a stock in accordance
#it$ t$e stock4s current
esti(ated earnings 'er s$are
gro#t$, *f t$e PE" ratio is less
t$an 3. t$is (eans t$at EP!
gro#t$ is 'otentially ale to
sur'ass t$e (arket4s current
valuation, *n ot$er #ords. t$e
stock4s 'rice is eing
undervalued, -n t$e ot$er $and.
stocks #it$ $ig$ PE" ratios can
indicate ?ust t$e o''osite % t$at
t$e stock is currently
overvalued,

0ividend :ield
Ratio
% nnual 0ividend per )&are /
Mar#et Price per
)&are * ,-..
T$is ratio allo#s investors to
co('are t$e latest dividend t$ey
received #it$ t$e current (arket
value of t$e s$are as an indictor
of t$e return t$ey are earning on
t$eir s$ares
T$is enales an investor to
co('are ratios for different
co('anies and industries,
0ig$er t$e ratio. t$e $ig$er is
t$e return to t$e investor
0ividend Payout
Ratio
%0ividend per )&are /
(arnings per )&are * , -..
T$is ratio identifies t$e
'ercentage of earnings 5net
inco(e6 'er co((on s$are
allocated to 'aying
cas$ dividends to s$are$olders,
T$e dividend 'ayout ratio is an
indicator of $o# #ell earnings
su''ort t$e dividend 'ay(ent,