RATIO ANALYSIS

Ratio-analysis means the process of

computing, determining and presenting the
relationship of related items and groups of
items of the financial statements.

They provide in a summarized and concise
form of fairly good idea about the financial
position of a unit.
RATIO ANALYSIS
WHY RATIO ANALYSIS?
Ratios are used for carrying out the following :
Technical Appraisal (for overall performance)
Commercial Appraisal (by the creditors)
Financial Appraisal (by banks, stock holders)
Economic Appraisal (for M&A)
Management Appraisal (for improving
efficiency)
RATIO ANALYSIS
Its a tool which enables the analyst to arrive at
the following factors :
Liquidity position
Profitability
Solvency
Financial Stability
Quality of the Management
Safety & Security of the loans & advances to be
or already been provided
CLASSIFICATION OF RATIOS
Balance Sheet
Ratio
P&L Ratio or
Income/Revenue
Statement Ratio
Balance Sheet
and Profit & Loss
Ratio
Financial Ratio Operating Ratio Composite Ratio
Current Ratio
Quick Asset Ratio
Proprietary Ratio
Debt Equity Ratio
Gross Profit Ratio
Operating Ratio
Expense Ratio
Net profit Ratio
Stock Turnover Ratio
Fixed Asset
Turnover Ratio,
Return on Total
Resources Ratio,
Return on Own
Funds Ratio,
Earning per Share
Ratio, Debtors
Turnover Ratio,

FORMAT OF BALANCE SHEET FOR RATIO ANALYSIS
LIABILITIES ASSETS
NET WORTH/EQUITY/OWNED FUNDS
Share Capital/Partners Capital/Paid up
Capital/ Owners Funds
Reserves and Surpluses
FIXED ASSETS : LAND & BUILDING, PLANT
& MACHINERIES
Original Value Less Depreciation

LONG TERM LIABILITIES/BORROWED
FUNDS : Term Loans (Banks & Institutions)
Debentures/Bonds, Unsecured Loans, Fixed
Deposits, Other Long Term Liabilities

NON CURRENT ASSETS
Investments in quoted shares & securities
Long Term Security Deposits
Other Misc. assets which are not current or
fixed in nature
CURRENT LIABILTIES
Bank Working Capital Limits such as
CC/OD/Bills/Export Credit
Sundry /Trade Creditors/Creditors/Bills
Payable, Short duration loans or deposits
Expenses payable & provisions against various
items
CURRENT ASSETS : Cash & Bank Balance,
Marketable/quoted Govt. or other securities,
Book Debts/Sundry Debtors, Bills Receivables,
Stocks & inventory Advance Payment of Taxes,
Prepaid expenses, Loans and Advances
recoverable within 12 months
INTANGIBLE ASSETS
Patent, Goodwill


Current Ratio : It is the relationship between the
current assets and current liabilities of a concern.
Current Ratio = Current Assets/Current Liabilities
If the Current Assets and Current Liabilities of a concern
are Rs.4,00,000 and Rs.2,00,000 respectively, then the
Current Ratio will be : Rs.4,00,000/Rs.2,00,000 = 2 : 1

Net Working Capital : it is the difference of Current
Assets and Current Liabilities.
NWC = Current Assets Current Liabilities
Current Assets : Raw Material, Stores, Spares, Work-in Progress. Finished
Goods, Debtors, Bills Receivables, Cash.

Current Liabilities : Sundry Creditors, Installments of Term Loan, payable within
one year and other liabilities payable within one year.

Current Ratio measures short term liquidity of the concern and its ability to
meet its short term obligations within a time span of a year.

It shows the liquidity position of the enterprise and its ability to meet current
obligations in time.

Higher ratio may be good from the point of view of creditors. In the long run
very high current ratio may affect profitability ( e.g. high inventory carrying cost)

Shows the liquidity at a particular point of time. The position can change
immediately after that date. So trend of the current ratio over the years to be
analyzed.

3. ACID TEST or QUICK RATIO : It is the ratio between Quick Current
Assets and Current Liabilities. The should be at least equal to 1.

Quick Current Assets : Cash/Bank Balances + Receivables upto 6 months +
Quickly realizable securities such as Govt. Securities or quickly marketable/quoted
shares and Bank Fixed Deposits

Acid Test or Quick Ratio = Quick Current Assets/Current Liabilities


Example :
Cash 50,000
Debtors 1,00,000
Inventories 1,50,000 Current Liabilities 1,00,000
Total Current Assets 3,00,000

Current Ratio = > 3,00,000/1,00,000 = 3 : 1
Quick Ratio = > 1,50,000/1,00,000 = 1.5 : 1

4. DEBT EQUITY RATIO or LEVERAGE RATIO
: It is the relationship between borrowers fund (Debt) and Owners
Capital (Equity).

Long Term Outside Liabilities / Tangible Net Worth

Liabilities of Long Term Nature

Total of Capital and Reserves & Surplus Less Intangible Assets

For instance, if the Firm is having the following :

Capital = Rs. 200 Lacs
Free Reserves & Surplus = Rs. 300 Lacs
Long Term Loans/Liabilities = Rs. 800 Lacs

Debt Equity Ratio will be => 800/500 i.e. 1.6 : 1





5. PROPRIETARY RATIO : This ratio indicates the extent to which
Tangible Assets are financed by Owners Fund.
Proprietary Ratio = (Tangible Net Worth/Total Tangible
Assets) x 100
The ratio will be 100% when there is no Borrowing for purchasing
of Assets.

6. GROSS PROFIT RATIO : By comparing Gross Profit percentage to
Net Sales we can arrive at the Gross Profit Ratio which indicates the
manufacturing efficiency as well as the pricing policy of the concern.

Gross Profit Ratio = (Gross Profit / Net Sales ) x 100

Alternatively , since Gross Profit is equal to Sales minus Cost of
Goods Sold, it can also be interpreted as below :

Gross Profit Ratio = [ (Sales Cost of goods sold)/ Net Sales]
x 100
A higher Gross Profit Ratio indicates efficiency in production of the unit.
7. OPERATING PROFIT RATIO :

It is expressed as => (Operating Profit / Net Sales ) x 100

Higher the ratio indicates operational efficiency


8. NET PROFIT RATIO :

It is expressed as => ( Net Profit / Net Sales ) x 100

It measures overall profitability.



9. STOCK/INVENTORY TURNOVER RATIO :



(Average Inventory/Sales) x 365 for days
(Average Inventory/Sales) x 52 for weeks
(Average Inventory/Sales) x 12 for months


Average Inventory or Stocks = (Opening Stock + Closing Stock)
-----------------------------------------
2

. This ratio indicates the number of times the inventory is
rotated during the relevant accounting period







10. DEBTORS TURNOVER RATIO : This is also called Debtors
Velocity or Average Collection Period or Period of Credit given .

(Average Debtors/Sales ) x 365 for days
(52 for weeks & 12 for months)

11. TOTAL ASSET TRUNOVER RATIO:Net Sales/Tangible Total Assets

12. FIXED ASSET TURNOVER RATIO : Net Sales /Fixed Assets

13. CURRENT ASSET TURNOVER RATIO : Net Sales / Current Assets













14. RETRUN ON ASSETS : Net Profit after Taxes/Total Assets


15. RETRUN ON CAPITAL EMPLOYED :

( Net Profit before Interest & Tax / Average Capital Employed) x 100

Average Capital Employed is the average of the equity share
capital and long term funds provided by the owners and the
creditors of the firm at the beginning and end of the accounting
period.














Composite Ratio

16. RETRUN ON EQUITY CAPITAL (ROE) :
Net Profit after Taxes / Tangible Net Worth

17.EARNING PER SHARE : EPS indicates the quantum of net profit
of the year that would be ranking for dividend for each share of
the company being held by the equity share holders.

Net profit after Taxes and Preference Dividend/ No. of Equity
Shares

18. PRICE EARNING RATIO : PE Ratio indicates the number of times
the Earning Per Share is covered by its market price.

Market Price Per Equity Share/Earning Per Share















20. DEBT SERVICE COVERAGE RATIO : This ratio is one of the most
important one which indicates the ability of an enterprise to
meet its liabilities by way of payment of installments of Term
Loans and Interest thereon from out of the cash accruals and
forms the basis for fixation of the repayment schedule in
respect of the Term Loans raised for a project.

EBITD (earning before interest tax and deprciation)
---------------------------------------------------------------------------------
Annual interest on Long Term Loans & Liabilities + Annual
Installments payable on Long Term Loans & Liabilities



























LIABILITES ASSETS
Capital 180 Net Fixed Assets 400
Reserves 20 Inventories 150
Term Loan 300 Cash 50
Bank C/C 200 Receivables 150
Trade Creditors 50 Goodwill 50
Provisions 50
800 800
EXERCISE 1
a. What is the Net Worth : Capital + Reserve = 200
b. Tangible Net Worth is : Net Worth - Goodwill = 150
c. Outside Liabilities : TL + CC + Creditors + Provisions = 600
d. Net Working Capital : C A - C L = 350 - 250 = 50
e. Current Ratio : C A / C L = 350 / 300 = 1.17 : 1
f. Quick Ratio : Quick Assets / C L = 200/300 = 0.66 : 1

EXERCISE 2
LIABILITIES 2005-06 2006-07 2005-06 2006-07
Capital 300 350 Net Fixed
Assets
730 750
Reserves 140 160
Security Electricity
30 30
Bank Term Loan 320 280 Investments 110 110
Bank CC (Hyp) 490 580 Raw Materials 150 170
Unsec. Long T L 150 170 S I P 20 30
Creditors (RM) 120 70 Finished Goods 140 170
Bills Payable 40 80 Cash 30 20
Expenses
Payable
20 30 Receivables 310 240
Provisions 20 40 Loans/Advance
s
30 190
Goodwill 50 50
Total 1600 1760 1600 1760
1. Tangible Net Worth for 1
st
Year : ( 300 + 140) - 50 = 390
2. Current Ratio for 2
nd
Year : (170 + 30 +170+20+ 240 + 190 ) / (580+70+80+70)
820 /800 = 1.02
3. Debt Equity Ratio for 1
st
Year : 320+150 / 390 = 1.21
Exercise 3.

LIABIITIES ASSETS
Equity Capital 200 Net Fixed Assets 800
Preference Capital 100 Inventory 300
Term Loan 600 Receivables 150
Bank CC (Hyp) 400 Investment In Govt.
Secu.
50
Sundry Creditors 100 Preliminary Expenses 100
Total 1400 1400
1. Debt Equity Ratio will be : 600 / (200+100) = 2 : 1
2. Tangible Net Worth : Only equity Capital i.e. = 200

3. Total Outside Liabilities / Total Tangible Net Worth : (600+400+100) / 200
= 11 : 2
4. Current Ratio will be : (300 + 150 + 50 ) / (400 + 100 ) = 1 : 1
LIABILITIES ASSETS
Capital + Reserves 355 Net Fixed Assets 265
P & L Credit Balance 7 Cash 1
Loan From S F C 100 Receivables 125
Bank Overdraft 38 Stocks 128
Creditors 26 Prepaid Expenses 1
Provision of Tax 9 Intangible Assets 30
Proposed Dividend 15
550 550
Q. What is the Current Ratio ? Ans : (1+125 +128+1) / (38+26+9+15)
: 255/88 = 2.89 : 1

Q What is the Quick Ratio ? Ans : (125+1)/ 88 = 1.43 : 11

Q. What is the Debt Equity Ratio ? Ans : LTL / Tangible NW
= 100 / ( 362 30)
= 100 / 332 = 0.30 : 1


Exercise 4.
LIABILITIES ASSETS
Capital + Reserves 355 Net Fixed Assets 265
P & L Credit Balance 7 Cash 1
Loan From S F C 100 Receivables 125
Bank Overdraft 38 Stocks 128
Creditors 26 Prepaid Expenses 1
Provision of Tax 9 Intangible Assets 30
Proposed Dividend 15
550 550
Q . What is the Proprietary Ratio ? Ans : (T NW / Tangible Assets) x 100
[ (362 - 30 ) / (550 30)] x 100
(332 / 520) x 100 = 64%
Q . What is the Net Working Capital ?
Ans : C. A - C L. = 255 - 88 = 167
Q . If Net Sales is Rs.15 Lac, then What would be the Stock Turnover
Ratio in Times ? Ans : Net Sales / Average Inventories/Stock
1500 / 128 = 12 times approximately
Exercise 4. contd
LIABILITIES ASSETS
Capital + Reserves 355 Net Fixed Assets 265
P & L Credit Balance 7 Cash 1
Loan From S F C 100 Receivables 125
Bank Overdraft 38 Stocks 128
Creditors 26 Prepaid Expenses 1
Provision of Tax 9 Intangible Assets 30
Proposed Dividend 15
550 550
Q. What is the Debtors Velocity Ratio ? If the sales are Rs. 15 Lac.

Ans : ( Average Debtors / Net Sales) x 12 = (125 / 1500) x 12
= 1 month
Q. What is the Creditors Velocity Ratio if Purchases are Rs.10.5 Lac ?
Ans : (Average Creditors / Purchases ) x 12 = (26 / 1050) x 12 = 0.3 months
Exercise 4. contd
EXERCISE 12. A firm sold its stocks in CASH, in order to meet its liquidity
needs. Which of the following Ratio would be affected by this?

1. Debt Equity Ratio
2. Current Ratio
3. Debt Service Coverage Ratio
4. Quick Ratio
EXERCISE 13. A company is found to be carrying a high DEBT EQUITY
Ratio. To improve this, a bank may suggest the company to :

1. Raise long term interest free loans from friends and relatives
2. Raise long term loans from Institutions
3. Increase the Equity by way of Bonus Issue
4. Issue Rights share to existing share holders.
EXERCISE 14. Which of the following is a fictitious Asset?

1. Goodwill
2. Preliminary Expenses
3. Pre-operative expenses
4. Book Debts which have become doubtful of recovery