To understand the information contained in financial statements with a view to know the strength or weaknesses of the firm and to make forecast about the future prospects of the firm and thereby enabling the financial analyst to take different decisions regarding the operations of the firm.
Fundamental Analysis has a very broad scope. One aspect looks at the general (qualitative) factors of a company. The other side considers tangible and measurable factors (quantitative). This means crunching and analyzing numbers from the financial statements. If used in conjunction with other methods, quantitative analysis can produce excellent results.
Ratio analysis isn't just comparing different numbers from the balance sheet, income statement, and cash flow statement. It's comparing the number against previous years, other companies, the industry, or even the economy in general. Ratios look at the relationships between individual values and relate them to how a company has performed in the past, and might perform in the future.
MEANING OF RATIO:
A ratio is one figure express in terms of another figure. It is a mathematical yardstick that measures the relationship two figures, which are related to each other and mutually interdependent. Ratio is express by dividing one figure by the other related figure. Thus a ratio is an expression relating one number to another. It is simply the quotient of two numbers. It can be expressed as a fraction or as a decimal or as a pure ratio or in absolute figures as “ so 1
many times”. As accounting ratio is an expression relating two figures or accounts or two sets of account heads or group contain in the financial statements.
MEANING OF RATIO ANALYSIS:
Ratio analysis is the method or process by which the relationship of items or group of items in the financial statement are computed, determined and presented. Ratio analysis is an attempt to derive quantitative measure or guides concerning the financial health and profitability of business enterprises. Ratio analysis can be used both in trend and static analysis. There are several ratios at the disposal of an annalist but their group of ratio he would prefer depends on the purpose and the objective of analysis. While a detailed explanation of ratio analysis is beyond the scope of this section, we will focus on a technique, which is easy to use. It can provide you with a valuable investment analysis tool. This technique is called cross-sectional analysis. Cross-sectional analysis compares financial ratios of several companies from the same industry. Ratio analysis can provide valuable information about a company's financial health. A financial ratio measures a company's performance in a specific area. For example, you could use a ratio of a company's debt to its equity to measure a company's leverage. By comparing the leverage ratios of two companies, you can determine which company uses greater debt in the conduct of its business. A company whose leverage ratio is higher than a competitor's has more debt per equity. You can use this information to make a judgment as to which company is a better investment risk. However, you must be careful not to place too much importance on one ratio. You obtain a better indication of the direction in which a company is moving when several ratios are taken as a group.
OBJECTIVE OF RATIOS
Ratio is work out to analyze the following aspects of business organizationA) Solvency1) Long term 2) Short term 3) Immediate B) Stability C) Profitability D) Operational efficiency E) Credit standing F) Structural analysis G) Effective utilization of resources H) Leverage or external financing
FORMS OF RATIO:
Since a ratio is a mathematical relationship between to or more variables / accounting figures, such relationship can be expressed in different ways as follows – A] As a pure ratio: For example the equity share capital of a company is Rs. 20,00,000 & the preference share capital is Rs. 5,00,000, the ratio of equity share capital to preference share capital is 20,00,000: 5,00,000 or simply 4:1. B] As a rate of times: In the above case the equity share capital may also be described as 4 times that of preference share capital. Similarly, the cash sales of a firm are
Rs. 12,00,000 & credit sales are Rs. 30,00,000. so the ratio of credit sales to cash sales can be described as 2.5 [30,00,000/12,00,000] or simply by saying that the credit sales are 2.5 times that of cash sales. C] As a percentage: In such a case, one item may be expressed as a percentage of some other item. For example, net sales of the firm are Rs.50,00,000 & the amount of the gross profit is Rs. 10,00,000, then the gross profit may be described as 20% of sales [ 10,00,000/50,00,000]
STEPS IN RATIO ANALYSIS
The ratio analysis requires two steps as follows: 1] Calculation of ratio 2] Comparing the ratio with some predetermined standards. The standard ratio may be the past ratio of the same firm or industry’s average ratio or a projected ratio or the ratio of the most successful firm in the industry. In interpreting the ratio of a particular firm, the analyst cannot reach any fruitful conclusion unless the calculated ratio is compared with some predetermined standard. The importance of a correct standard is oblivious as the conclusion is going to be based on the standard itself.
TYPES OF COMPARISONS
The ratio can be compared in three different ways – 1] Cross section analysis: One of the way of comparing the ratio or ratios of the firm is to compare them with the ratio or ratios of some other selected firm in the same industry at the same point of time. So it involves the comparison of two or more firm’s
financial ratio at the same point of time. The cross section analysis helps the analyst to find out as to how a particular firm has performed in relation to its competitors. The firms performance may be compared with the performance of the leader in the industry in order to uncover the major operational inefficiencies. The cross section analysis is easy to be undertaken as most of the data required for this may be available in financial statement of the firm. 2] Time series analysis: The analysis is called Time series analysis when the performance of a firm is evaluated over a period of time. By comparing the present performance of a firm with the performance of the same firm over the last few years, an assessment can be made about the trend in progress of the firm, about the direction of progress of the firm. Time series analysis helps to the firm to assess whether the firm is approaching the long-term goals or not. The Time series analysis looks for (1) important trends in financial performance (2) shift in trend over the years (3) significant deviation if any from the other set of data\ 3] Combined analysis: If the cross section & time analysis, both are combined together to study the behavior & pattern of ratio, then meaningful & comprehensive evaluation of the performance of the firm can definitely be made. A trend of ratio of a firm compared with the trend of the ratio of the standard firm can give good results. For example, the ratio of operating expenses to net sales for firm may be higher than the industry average however, over the years it has been declining for the firm, whereas the industry average has not shown any significant changes.
The combined analysis as depicted in the above diagram, which clearly shows that the ratio of the firm is above the industry average, but it is decreasing over the years & is approaching the industry average.
PRE-REQUISITIES TO RATIO ANALYSIS
In order to use the ratio analysis as device to make purposeful conclusions, there are certain pre-requisites, which must be taken care of. It may be noted that these prerequisites are not conditions for calculations for meaningful conclusions. The accounting figures are inactive in them & can be used for any ratio but meaningful & correct interpretation & conclusion can be arrived at only if the following points are well considered. 1) The dates of different financial statements from where data is taken must be same. 2) If possible, only audited financial statements should be considered, otherwise there must be sufficient evidence that the data is correct.
3) Accounting policies followed by different firms must be same in case of cross section analysis otherwise the results of the ratio analysis would be distorted. 4) One ratio may not throw light on any performance of the firm. Therefore, a group of ratios must be preferred. This will be conductive to counter checks. 5) Last but not least, the analyst must find out that the two figures being used to calculate a ratio must be related to each other, otherwise there is no purpose of calculating a ratio.
CLASSIFICATION OF RATIO
CLASSIFICATION OF RATIO
BASED ON FINANCIAL USER STATEMENT
BASED ON FUNCTION
1] BALANCE SHEET RATIO 2] REVENUE STATEMENT RATIO 3] COMPOSITE RATIO
1] LIQUIDITY RATIO 2] LEVERAGE RATIO 3] ACTIVITY RATIO 4] PROFITABILITY RATIO 5] COVERAGE RATIO
1] RATIOS FOR SHORT TERM CREDITORS 2] RATIO FOR SHAREHOLDER 3] RATIOS FOR MANAGEMENT 4] RATIO FOR LONG TERM CREDITORS
BASED ON FINANCIAL STATEMENT
Accounting ratios express the relationship between figures taken from financial statements. Figures may be taken from Balance Sheet , P& P A/C, or both. One-way of classification of ratios is based upon the sources from which are taken. 1] Balance sheet ratio: If the ratios are based on the figures of balance sheet, they are called Balance Sheet Ratios. E.g. ratio of current assets to current liabilities or ratio of debt to equity. While calculating these ratios, there is no need to refer to the Revenue statement. These ratios study the relationship between the assets & the liabilities, of the concern. These ratio help to judge the liquidity, solvency & capital structure of the concern. Balance sheet ratios are Current ratio, Liquid ratio, and Proprietory ratio, Capital gearing ratio, Debt equity ratio, and Stock working capital ratio. 2] Revenue ratio: Ratio based on the figures from the revenue statement is called revenue statement ratios. These ratio study the relationship between the profitability & the sales of the concern. Revenue ratios are Gross profit ratio, Operating ratio, Expense ratio, Net profit ratio, Net operating profit ratio, Stock turnover ratio. 3] Composite ratio: These ratios indicate the relationship between two items, of which one is found in the balance sheet & other in revenue statement. There are two types of composite ratiosa) Some composite ratios study the relationship between the profits & the investments of the concern. E.g. return on capital employed, return on proprietors fund, return on equity capital etc. b) Other composite ratios e.g. debtors turnover ratios, creditors turnover ratios, dividend payout ratios, & debt service ratios
BASED ON FUNCTION:
Accounting ratios can also be classified according to their functions in to liquidity ratios, leverage ratios, activity ratios, profitability ratios & turnover ratios. 1] Liquidity ratios: It shows the relationship between the current assets & current liabilities of the concern e.g. liquid ratios & current ratios. 2] Leverage ratios: It shows the relationship between proprietors funds & debts used in financing the assets of the concern e.g. capital gearing ratios, debt equity ratios, & Proprietory ratios. 3] Activity ratios: It shows relationship between the sales & the assets. It is also known as Turnover ratios & productivity ratios e.g. stock turnover ratios, debtors turnover ratios. 4] Profitability ratios: a) It shows the relationship between profits & sales e.g. operating ratios, gross profit ratios, operating net profit ratios, expenses ratios b) It shows the relationship between profit & investment e.g. return on investment, return on equity capital. 5] Coverage ratios: It shows the relationship between the profit on the one hand & the claims of the outsiders to be paid out of such profit e.g. dividend payout ratios & debt service ratios.
BASED ON USER:
1] Ratios for short-term creditors: Current ratios, liquid ratios, stock working capital ratios 2] Ratios for the shareholders: Return on proprietors fund, return on equity capital 3] Ratios for management: Return on capital employed, turnover ratios, operating ratios, expenses ratios 4] Ratios for long-term creditors: Debt equity ratios, return on capital employed, proprietor ratios.
LIQUIDITY RATIO: Liquidity refers to the ability of a firm to meet its short-term (usually up to 1 year) obligations. The ratios, which indicate the liquidity of a company, are Current ratio, Quick/Acid-Test ratio, and Cash ratio. These ratios are discussed below
Meaning: This ratio compares the current assests with the current liabilities. It is also known as ‘working capital ratio’ or ‘ solvency ratio’. It is expressed in the form of pure ratio. E.g. 2:1 Formula: Current assets Current ratio = Current liabilities
The current assests of a firm represents those assets which can be, in the ordinary course of business, converted into cash within a short period time, normally not exceeding one year. The current liabilities defined as liabilities which are short term maturing obligations to be met, as originally contemplated, with in a year. Current ratio (CR) is the ratio of total current assets (CA) to total current liabilities (CL). Current assets include cash and bank balances; inventory of raw materials, semi-finished and finished goods; marketable securities; debtors (net of provision for bad and doubtful debts); bills receivable; and prepaid expenses. Current liabilities consist of trade creditors, bills payable, bank credit, provision for taxation, dividends payable and outstanding expenses. This ratio measures the liquidity of the current assets and the ability of a company to meet its shortterm debt obligation. CR measures the ability of the company to meet its CL, i.e., CA gets converted into cash in the operating cycle of the firm and provides the funds needed to pay for CL. The higher the current ratio, the greater the short-term solvency. This compares assets, which will become liquid within approximately twelve months with liabilities, which will be due for payment in the same period and is intended to indicate whether there are sufficient short-term assets to meet the short- term liabilities. Recommended current ratio is 2: 1. Any ratio below indicates that the entity may face liquidity problem but also Ratio over 2: 1 as above indicates over trading, that is the entity is under utilizing its current assets.
Meaning: Liquid ratio is also known as acid test ratio or quick ratio. Liquid ratio compare the quick assets with the quick liabilities. It is expressed in the form of pure ratio. E.g. 1:1.
The term quick assets refer to current assets, which can be converted into, cash immediately or at a short notice without diminution of value. Formula: Quick assets Liquid ratio = Quick liabilities Quick Ratio (QR) is the ratio between quick current assets (QA) and CL. QA refers to those current assets that can be converted into cash immediately without any value strength. QA includes cash and bank balances, short-term marketable securities, and sundry debtors. Inventory and prepaid expenses are excluded since these cannot be turned into cash as and when required. QR indicates the extent to which a company can pay its current liabilities without relying on the sale of inventory. This is a fairly stringent measure of liquidity because it is based on those current assets, which are highly liquid. Inventories are excluded from the numerator of this ratio because they are deemed the least liquid component of current assets. Generally, a quick ratio of 1:1 is considered good. One drawback of the quick ratio is that it ignores the timing of receipts and payments.
Meaning: This is also called as super quick ratio. This ratio considers only the absolute liquidity available with the firm. Formula: Cash + Bank + Marketable securities Cash ratio = Total current liabilities
Since cash and bank balances and short term marketable securities are the most liquid assets of a firm, financial analysts look at the cash ratio. If the super liquid assets are too much in relation to the current liabilities then it may affect the profitability of the firm.
INVESTMENT / SHAREHOLDER
EARNING PER SAHRE:Meaning: Earnings per Share are calculated to find out overall profitability of the organization. An earnings per Share represents earning of the company whether or not dividends are declared. If there is only one class of shares, the earning per share are determined by dividing net profit by the number of equity shares. EPS measures the profits available to the equity shareholders on each share held.
Formula: NPAT Earning per share = Number of equity share The higher EPS will attract more investors to acquire shares in the company as it indicates that the business is more profitable enough to pay the dividends in time. But remember not all profit earned is going to be distributed as dividends the company also retains some profits for the business
DIVIDEND PER SHARE:Meaning:
DPS shows how much is paid as dividend to the shareholders on each share held. Formula: Dividend Paid to Ordinary Shareholders Dividend per Share = Number of Ordinary Shares
DIVIDEND PAYOUT RATIO:Meaning: Dividend Pay-out Ratio shows the relationship between the dividend paid to equity shareholders out of the profit available to the equity shareholders.
Formula: Dividend per share
Dividend Pay out ratio =
Earning per share
D/P ratio shows the percentage share of net profits after taxes and after preference dividend has been paid to the preference equity holders.
CAPITAL GEARING RATIO:Meaning: Gearing means the process of increasing the equity shareholders return through the use of debt. Equity shareholders earn more when the rate of the return on total capital is more than the rate of interest on debts. This is also known as leverage or trading on equity. The Capital-gearing ratio shows the relationship between two types of capital viz: - equity capital & preference capital & long term borrowings. It is expressed as a pure ratio.
Formula: Preference capital+ secured loan Capital gearing ratio = Equity capital & reserve & surplus Capital gearing ratio indicates the proportion of debt & equity in the financing of assets of a concern.
These ratios help measure the profitability of a firm. A firm, which generates a substantial amount of profits per rupee of sales, can comfortably meet its operating expenses and provide more returns to its shareholders. The relationship between profit and sales is measured by profitability ratios. There are two types of profitability ratios: Gross Profit Margin and Net Profit Margin.
GROSS PROFIT RATIO:Meaning: This ratio measures the relationship between gross profit and sales. It is defined as the excess of the net sales over cost of goods sold or excess of revenue over cost. This ratio shows the profit that remains after the manufacturing costs have been met. It measures the efficiency of production as well as pricing. This ratio helps to judge how efficient the concern is I managing its production, purchase, selling & inventory, how good its control is over the direct cost, how productive the concern , how much amount is left to meet other expenses & earn net profit. Formula: Gross profit Gross profit ratio = Net sales NET PROFIT RATIO:Meaning: Net Profit ratio indicates the relationship between the net profit & the sales it is usually expressed in the form of a percentage. Formula: NPAT Net profit ratio = Net sales This ratio shows the net earnings (to be distributed to both equity and preference shareholders) as a percentage of net sales. It measures the overall efficiency of production, administration, selling, financing, pricing and tax 18 * 100 * 100
management. Jointly considered, the gross and net profit margin ratios provide an understanding of the cost and profit structure of a firm. RETURN ON CAPITAL EMPLOYED:Meaning: The profitability of the firm can also be analyzed from the point of view of the total funds employed in the firm. The term fund employed or the capital employed refers to the total long-term source of funds. It means that the capital employed comprises of shareholder funds plus long-term debts. Alternatively it can also be defined as fixed assets plus net working capital. Capital employed refers to the long-term funds invested by the creditors and the owners of a firm. It is the sum of long-term liabilities and owner's equity. ROCE indicates the efficiency with which the long-term funds of a firm are utilized. Formula: NPAT Return on capital employed = Capital employed *100
These ratios determine how quickly certain current assets can be converted into cash. They are also called efficiency ratios or asset utilization ratios as they measure the efficiency of a firm in managing assets. These ratios are based on the relationship between the level of activity represented by sales or cost of goods sold and levels of investment in various assets. The important turnover ratios are debtors turnover ratio, average collection period, inventory/stock turnover ratio, fixed assets turnover ratio, and total assets turnover ratio. These are described below:
DEBTORS TURNOVER RATIO (DTO) Meaning: DTO is calculated by dividing the net credit sales by average debtors outstanding during the year. It measures the liquidity of a firm's debts. Net credit sales are the gross credit sales minus returns, if any, from customers. Average debtors are the average of debtors at the beginning and at the end of the year. This ratio shows how rapidly debts are collected. The higher the DTO, the better it is for the organization. Formula: Credit sales Debtors turnover ratio = Average debtors
INVENTORY OR STOCK TURNOVER RATIO (ITR) Meaning: ITR refers to the number of times the inventory is sold and replaced during the accounting period. Formula: COGS Stock Turnover Ratio = Average stock ITR reflects the efficiency of inventory management. The higher the ratio, the more efficient is the management of inventories, and vice versa. However, a high inventory turnover may also result from a low level of inventory, which may lead to frequent stock outs and loss of sales and customer goodwill. For calculating ITR, the average of inventories at the beginning and the end of the year is taken. In general, averages may be used when a flow figure (in this case, cost of goods sold) is related to a stock figure (inventories). FIXED ASSETS TURNOVER (FAT) The FAT ratio measures the net sales per rupee of investment in fixed assets. Formula: Net sales Fixed assets turnover = Net fixed assets This ratio measures the efficiency with which fixed assets are employed. A high ratio indicates a high degree of efficiency in asset utilization while a low ratio reflects an inefficient use of assets. However, this ratio should be used with caution because when the fixed assets of a firm are old and substantially depreciated, the fixed assets turnover ratio tends to be high (because the denominator of the ratio is very low).
PROPRIETORS RATIO: Meaning: Proprietary ratio is a test of financial & credit strength of the business. It relates shareholders fund to total assets. This ratio determines the long term or ultimate solvency of the company. In other words, Proprietary ratio determines as to what extent the owner’s interest & expectations are fulfilled from the total investment made in the business operation. Proprietary ratio compares the proprietor fund with total liabilities. It is usually expressed in the form of percentage. Total assets also know it as net worth. Formula: Proprietary fund Proprietary ratio = Total fund OR
Shareholders fund Proprietary ratio = Fixed assets + current liabilities STOCK WORKING CAPITAL RATIO: Meaning: This ratio shows the relationship between the closing stock & the working capital. It helps to judge the quantum of inventories in relation to the working capital of the business. The purpose of this ratio is to show the extent to which working capital is blocked in inventories. The ratio highlights the predominance of stocks in the current financial position of the company. It is expressed as a percentage. Formula: Stock Stock working capital ratio = Working Capital
Stock working capital ratio is a liquidity ratio. It indicates the composition & quality of the working capital. This ratio also helps to study the solvency of a concern. It is a qualitative test of solvency. It shows the extent of funds blocked in stock. If investment in stock is higher it means that the amount of liquid assets is lower. DEBT EQUITY RATIO: MEANING: This ratio compares the long-term debts with shareholders fund. The relationship between borrowed funds & owners capital is a popular measure of the long term financial solvency of a firm. This relationship is shown by debt equity ratio. Alternatively, this ratio indicates the relative proportion of debt & equity in financing the assets of the firm. It is usually expressed as a pure ratio. E.g. 2:1 Formula: Total long-term debt Debt equity ratio = Total shareholders fund Debt equity ratio is also called as leverage ratio. Leverage means the process of the increasing the equity shareholders return through the use of debt. Leverage is also known as ‘gearing’ or ‘trading on equity’. Debt equity ratio shows the margin of safety for long-term creditors & the balance between debt & equity. RETURN ON PROPRIETOR FUND: Meaning: Return on proprietors fund is also known as ‘return on proprietors equity’ or ‘return on shareholders investment’ or ‘ investment ratio’. This ratio indicates
the relationship between net profit earned & total proprietors funds. Return on proprietors fund is a profitability ratio, which the relationship between profit & investment by the proprietors in the concern. Its purpose is to measure the rate of return on the total fund made available by the owners. This ratio helps to judge how efficient the concern is in managing the owner’s fund at disposal. This ratio is of practical importance to prospective investors & shareholders. Formula: NPAT Return on proprietors fund = Proprietors fund * 100
CREDITORS TURNOVER RATIO: It is same as debtors turnover ratio. It shows the speed at which payments are made to the supplier for purchase made from them. It is a relation between net credit purchase and average creditors Net credit purchase Credit turnover ratio = Average creditors
Months in a year Average age of accounts payable = Credit turnover ratio
Both the ratios indicate promptness in payment of creditor purchases. Higher creditors turnover ratio or a lower credit period enjoyed signifies that the creditors are being paid promptly. It enhances credit worthiness of the company. A very low ratio indicates that the company is not taking full benefit of the credit period allowed by the creditors.
IMPORTANCE OF RATIO ANALYSIS:
As a tool of financial management, ratios are of crucial significance. The importance of ratio analysis lies in the fact that it presents facts on a comparative basis & enables the drawing of interference regarding the performance of a firm. Ratio analysis is relevant in assessing the performance of a firm in respect of the following aspects: 1] Liquidity position, 2] Long-term solvency, 3] Operating efficiency, 4] Overall profitability, 5] Inter firm comparison 6] Trend analysis. 1] LIQUIDITY POSITION: With the help of Ratio analysis conclusion can be drawn regarding the liquidity position of a firm. The liquidity position of a firm would be satisfactory if it is able to meet its current obligation when they become due. A firm can be said to have the ability to meet its short-term liabilities if it has sufficient liquid funds to pay the interest on its short maturing debt usually within a year as well as to repay the principal. This ability is reflected in the liquidity ratio of a firm. The liquidity ratio are particularly useful in credit analysis by bank & other suppliers of short term loans.
2] LONG TERM SOLVENCY: Ratio analysis is equally useful for assessing the long-term financial viability of a firm. This respect of the financial position of a borrower is of concern to the long-term creditors, security analyst & the present & potential owners of a business. The long-term solvency is measured by the leverage/ capital structure & profitability ratio Ratio analysis s that focus on earning power & operating efficiency.
Ratio analysis reveals the strength & weaknesses of a firm in this respect. The leverage ratios, for instance, will indicate whether a firm has a reasonable proportion of various sources of finance or if it is heavily loaded with debt in which case its solvency is exposed to serious strain. Similarly the various profitability ratios would reveal whether or not the firm is able to offer adequate return to its owners consistent with the risk involved. 3] OPERATING EFFICIENCY: Yet another dimension of the useful of the ratio analysis, relevant from the viewpoint of management, is that it throws light on the degree of efficiency in management & utilization of its assets. The various activity ratios measures this kind of operational efficiency. In fact, the solvency of a firm is, in the ultimate analysis, dependent upon the sales revenues generated by the use of its assets- total as well as its components. 4] OVERALL PROFITABILITY: Unlike the outsides parties, which are interested in one aspect of the financial position of a firm, the management is constantly concerned about overall profitability of the enterprise. That is, they are concerned about the ability of the firm to meets its short term as well as long term obligations to its creditors, to ensure a reasonable return to its owners & secure optimum utilization of the assets of the firm. This is possible if an integrated view is taken & all the ratios are considered together. 5] INTER – FIRM COMPARISON: Ratio analysis not only throws light on the financial position of firm but also serves as a stepping-stone to remedial measures. This is made possible due to inter firm comparison & comparison with the industry averages. A single figure of a particular ratio is meaningless unless it is related to some standard or norm. one of the popular techniques is to compare the ratios of a firm with
the industry average. It should be reasonably expected that the performance of a firm should be in broad conformity with that of the industry to which it belongs. An inter firm comparison would demonstrate the firms position vice-versa its competitors. If the results are at variance either with the industry average or with the those of the competitors, the firm can seek to identify the probable reasons & in light, take remedial measures. 6] TREND ANALYSIS: Finally, ratio analysis enables a firm to take the time dimension into account. In other words, whether the financial position of a firm is improving or deteriorating over the years. This is made possible by the use of trend analysis. The significance of the trend analysis of ratio lies in the fact that the analysts can know the direction of movement, that is, whether the movement is favorable or unfavorable. For example, the ratio may be low as compared to the norm but the trend may be upward. On the other hand, though the present level may be satisfactory but the trend may be a declining one.
ADVANTAGES OF RATIO ANALYSIS
Financial ratios are essentially concerned with the identification of significant accounting data relationships, which give the decision-maker insights into the financial performance of a company. The advantages of ratio analysis can be summarized as follows: Ratios facilitate conducting trend analysis, which is important for decision making and forecasting. Ratio analysis helps in the assessment of the liquidity, operating efficiency, profitability and solvency of a firm. Ratio analysis provides a basis for both intra-firm as well as inter-firm comparisons.
The comparison of actual ratios with base year ratios or standard ratios helps the management analyze the financial performance of the firm.
LIMITATIONS OF RATIO ANALYSIS
Ratio analysis has its limitations. These limitations are described below: 1] Information problems Ratios require quantitative information for analysis but it is not decisive about analytical output . The figures in a set of accounts are likely to be at least several months out of date, and so might not give a proper indication of the company’s current financial position. Where historical cost convention is used, asset valuations in the balance sheet could be misleading. Ratios based on this information will not be very useful for decision-making. 2] Comparison of performance over time When comparing performance over time, there is need to consider the changes in price. The movement in performance should be in line with the changes in price. When comparing performance over time, there is need to consider the changes in technology. The movement in performance should be in line with the changes in technology. Changes in accounting policy may affect the comparison of results between different accounting years as misleading.
3] Inter-firm comparison Companies may have different capital structures and to make comparison of performance when one is all equity financed and another is a geared company it may not be a good analysis. Selective application of government incentives to various companies may also distort intercompany comparison. comparing the performance of two enterprises may be misleading. Inter-firm comparison may not be useful unless the firms compared are of the same size and age, and employ similar production methods and accounting practices. Even within a company, comparisons can be distorted by changes in the price level. Ratios provide only quantitative information, not qualitative information. Ratios are calculated on the basis of past financial statements. They do not indicate future trends and they do not consider economic conditions.
PURPOSE OF RATIO ANLYSIS: 1] To identify aspects of a businesses performance to aid decision making 2] Quantitative process – may need to be supplemented by qualitative Factors to get a complete picture. 3] 5 main areas: Liquidity – the ability of the firm to pay its way Investment/shareholders – information to enable decisions to be made on the extent of the risk and the earning potential of a business investment Gearing – information on the relationship between the exposure of the business to loans as opposed to share capital
Profitability – how effective the firm is at generating profits given sales and or its capital assets Financial – the rate at which the company sells its stock and the efficiency with which it uses its assets
ROLE OF RATIO ANALYSIS:
It is true that the technique of ratio analysis is not a creative technique in the sense that it uses the same figure & information, which is already appearing in the financial statement. At the same time, it is true that what can be achieved by the technique of ratio analysis cannot be achieved by the mere preparation of financial statement. Ratio analysis helps to appraise the firm in terms of their profitability & efficiency of performance, either individually or in relation to those of other firms in the same industry. The process of this appraisal is not complete until the ratio so computed can be compared with something, as the ratio all by them do not mean anything. This comparison may be in the form of intra firm comparison, inter firm comparison or comparison with standard ratios. Thus proper comparison of ratios may reveal where a firm is placed as compared with earlier period or in comparison with the other firms in the same industry. Ratio analysis is one of the best possible techniques available to the management to impart the basic functions like planning & control. As the future is closely related to the immediate past, ratio calculated on the basis of historical financial statements may be of good assistance to predict the future. Ratio analysis also helps to locate & point out the various areas, which need the management attention in order to improve the situation. As the ratio analysis is concerned with all the aspect of a firms financial analysis i.e. liquidity, solvency, activity, profitability & overall performance, it enables the interested persons to know the financial & operational characteristics of an organisation & take the suitable decision.
EVALUATION OF APLAB LIMITED THROUGH RATIO
COMPANY PROFILE THE COMPANY – APLAB Limited is a professionally managed Public Limited company quoted on the Bombay Stock Exchange. Since its inception in 1962, APLAB has been serving the global market with wide range of electronic products meeting the international standards for safety and reliability such as UL, VDE etc. They specialize in Test and Measurement Equipment, Power Conversion and UPS Systems, Self-Service Terminals for Banking Sector and Fuel Dispensers for Petroleum Sector. APLAB enjoys worldwide recognition for the quality of its products, business integrity and innovative engineering skills.
ABOUT APLAB: Aplab started its operation in October 1962. It is a professionally managed 40 years old public limited company. It is quoted on BOMBAY STOCK EXCHANGE. It serves customer global customer par excellence. It specialized in Test & measurement instruments, power conversion, & UPS & fuel dispensers for petroleum sector. It enjoys worldwide recognition for the quality of its business integrity & innovative engineering skills. MISSION: To deliver high quality, carefully, engineered products, on time, with in budget, as per the customer specification in a manner profitable to both, our customers & so to us. VISION: To be a global player, recognized for quality & integrity. To be the TOP INDIAN COMPANY as conceived by our customers. To be “ THE BEST ” company to work for, as rated by our employees. GOAL: 32
Goal at Aplab is extract ordinary customer service as we provide our customer needs in the personal service industry. CORPORATE MISSION – 1] To achieve healthy and profitable growth of the company in the interest of our customers & the shareholders. 2] To encourage teamwork, reward innovation and maintain healthy interpersonal relations within the organization. 3] To expand knowledge and remain at the leading edge in technology to serve the global market. 4] To understand the customer’s needs and provide solutions than merely selling products. 5] To create intellectual capital by investing in hardware and embedded software development. VALUES & BELIEFS: Their values & beliefs required that they Treat employees with respect & give them an opportunity for input on how to continuously improve their service goals. Offer opportunities for growth, professional development & recognition. Provide most effective & corrective action, to resolve customer service issues, to ensure customer satisfaction. Foster an open door policy, which encourages interaction, discussion & ideas to improve work environment & increase productivity. “ Do it right the first time & every time” is their team commitment * our way of doing business, it ensures as growth & prosperity.
THE 21ST CENTURY SUCCESS – APLAB had planned to enter the 21st Century with a program for a fast and healthy growth in the global market based on company’s high technology foundation and the reputation of four decades for prompt customer service and as a reliable solution provider. After completing three years in the new era, we can say with pride that we have been delivering our promises to our customers and the shareholders. APLAB has entered the field of Professional Services starting with the Banking and the Petroleum Industry. Focus on developing embedded system software has been also enhanced. We believe that professional services sector is poised to grow at a very rapid pace. QUALITY IS OUR WORK CULTURE - ISO 9001:2000 Quality at APLAB is a part of our people’s attitude. Entire organization is committed to create an environment that encourages individual excellence and a personal commitment to quality. In APLAB, “Quality is everybody’s responsibility” and all strive to “do it right the first time”. It is therefore natural that APLAB Limited is certified for quality with ISO 9001:2000 registration. QUALITY POLICY: Aplab will deliver to its customer products & services that consistently meet or exceed their requirement. Aplab will achieve this by total commitment & involvement of every individual. Aplab will encourage its employees & suppliers to develop quality products prevent defects & make continual improvement in all processes. QUALITY OBJECTIVE:
Aplab is an ISO 9001:2000 certifies company. 100% customer satisfaction. On time delivery every time reduction is out going PPM to 10,000 [4 sigma]
RESEARCH AND DEVELOPMENT Developing innovative products with the latest technology is the core strength of APLAB. The Science & Technology Ministry of the Govt. of India accredits our R&D Laboratories. We have a large team of dedicated, highly qualified skilled engineers who excel in the latest state-of-the-art-technology. APLAB is recognized not only for manufacturing standard products but also in providing solutions and services as per the customer specifications. We spend more than 4% of the company revenue in Research & Development activities. Specific areas in which the company carries out R&D 1. Development of new product especially hi-tech intelligent product & electronic substitution. 3. Development of products to suit exports markets. 4. Customizing the products to the customer’s specifications & adaptation of imported technology. The company has achieved its position of leadership in the Indian instrumentation industry & continuous to maintain it through its strong grip of technology. Almost all the products manufactured by the company are import transaction control system. 2. Improvement in the existing products & production processes, import
substitution items, which are fully developed in house. It has resulted in considerable saving of foreign exchange. With the company, R&D is an ongoing process. The ministry of science & technology, Government of India, recognizes the company’s R&D. Through a continuous interaction with production& Quality Assurance Department takes up redesign of existing products. This is done to achieve state of the art in our design & to bring about improvement to get maximum performance / cost ratio. FUTURE PLAN OF ACTION Major R&D activity is concentrated around up gradation of product design & re-alignment of production processes to bring about improved quality at lower cost. This will greatly help the company in facing competition in local markets from foreign companies. EXPORT APLAB currently exports over 25% of its production to Western Europe, Canada & USA. Over 30 million U.S. Dollars worth of Power Systems and Test Instruments from APLAB are today operational in UK, Germany, France, Sweden, Belgium, Canada, and USA & Australia.
APLAB’S ORGANISATION CHART EXECUTIVE CHAIRMAN
MANAGING DIRECTOR DIRECTOR [TECHNICAL - PE] GENERAL MANAGER MAEKETING DIRECTOR REGIOAL HEAD: MUMBAI NEWDELHI SECUNDARABAD BANGLORE CHENNAI
G.M PROD. &
G.M. ELTRAC PROD.
G.M. DESIGN & DESIGN
OFFICERS STAFF WORKERS
PRODUCTS OF APLAB: a. TEST & MEASUREMENT INSTRUMENTS b. HIGH POWER AC SYSTEMS (UPS, Frequency Converter, Inverter, Isolation Transformer) c. HIGH POWER DC SYSTEMS (DC Power Supply, DC Uninterruptible Power Supply) d. ATM INSTACASH e. POWER SUPPLIES, AC-DC POWER SUPPLY, STABILIZER, DC/DC LINE CONVERTERS, SMPS, INVERTERS,
CONDITIONER, ISOLATION TRANSFORMER ATM INSTACASH The Banking Automation Division of APLAB was launched in 1993, when we introduced INSTACASHIndia’s first indigenously manufactured ATM INSTACASH demonstrated APLAB’s skills in design, hardware manufacturing and software integrations. 38
Our in house R&D group is constantly striving to scan the rapidly changing technology and offer suitable end to end solutions. We are into Self Service Delivery Systems, MICR Cheque Processing and Smart Card based solutions. The latest is IMAGEENABLED Cheque Processing solution- QUICKCLEAR.
BALANCE SHEET AS AT 31ST MARCH 2002 (RS.’000) AS AT 31ST 2002 AS AT 31ST 2002 SOURCES OF FUNDS SHAREHOLDERS FUND Share capital Reserves and surplus LOANS Secured Unsecured DEFFERED TAX LIABILITY (NET) TOTAL APPLICATION OF FUNDS FIXED ASSETS Gross block Less: depreciation Net block Capital work in progress INVESTMENT CURRENT ASSESTS, LOANS & ADVANCES Inventories Sundary debtors Cash & bank balances Loan & advances CURRENT LIABLITIES & PROVISIONS Current liabilities
5,00,00 16,29,69 21,29,69 12,13,48 3,67,99 15,81,47 1,06,85 38,18,01
15,90,33 10,32,96 5,57,37 54,36 6,11,73 1,22,32
19,09,77 18,49,35 3,31,32 5,80,36 46,70,80
Provisions NET CURRENT ASSESTS MISCELLANEOUS EXPENDITURE Total
57,57 15,93,66 30,77,14 6,84 3818,01
PROFIT & LOSS ACCOUNT FOR THE ENDED 31ST MARCH 2002 (RS.’000) AS AT 31-3- 2002 AS AT 31-3-2002 INCOME: Sales and operating earnings Other income Variation in stock EXPENCES: Materials consumed Purchase of trading goods Payments to & provision for employees Manufacturing expenses Excise duty Other expenses Interest & finance charges Depreciation Less: transferred to revaluation PROFIT BEFORE TAX PRIOR YEAR ADJUSTMENT (NET) PROVISION FOR TAXATION Current tax Deferred tax liability / (Assets) PROFIT AFTER TAX Balance brought forward from previous year Balance available for appropriation Appropriations: General reserve Surplus / (loss) carried to B/S Proposed dividend Tax on proposed dividend 40 48,19,19 80,50 1,31,07 50,30,76 18,97,28 8,61,75 9,95,04 2,21,37 65,05 5,76,71 2,60,22 1,05,37 1,15 1,04,22 49,81,64 49,12
24,42 4,02 20,68 1 20,69
20,69 Basic earning per share (rupee) 0.41 0.41
BALANCE SHEET AS AT 31ST MARCH 2003 (RS.’000) AS AT 31-3- 2003 AS AT 31-3- 2003 SOURCES OF FUNDS SHAREHOLDERS FUND Share capital Reserves and surplus LOANS Secured Unsecured DEFFERED TAX LIABILITY (NET) TOTAL APPLICATION OF FUNDS FIXED ASSETS Gross block Less: depreciation Net block Capital work in progress INVESTMENT CURRENT ASSESTS, LOANS & ADVANCES Inventories Sundary debtors Cash & bank balances Loan & advances CURRENT LIABLITIES & PROVISIONS Current liabilities Provisions
5,00,00 16,55,19 21,55,19 10,27,55 4,53,16 14,80,71 87,21 37,23,11
17,40,97 11,40,93 6,00,04 29,74 6,29,78 1,47,26
19,02,79 19,05,76 3,95,25 8,98,62 51,02,42
20,41,56 1,20,76 21,62,32 41
NET CURRENT ASSESTS MISCELLANEOUS EXPENDITURE TOTAL
29,40,10 5,97 37,23,11
PROFIT & LOSS ACCOUNT FOR THE ENDED 31ST MARCH 2003 (RS.’000) AS AT 31-3- 2003 AS AT 31-3- 2003 INCOME: Sales and operating earnings Other income Variation in stock EXPENCES: Materials consumed Purchase of trading goods Payments to & provision for Employees Manufacturing expenses Excise duty Other expenses Interest & finance charges Depreciation Less: transferred to revaluation PROFIT BEFORE TAX PRIOR YEAR ADJUSTMENT (NET) PROVISION FOR TAXATION Current tax Deferred tax liability / (Assets) PROFIT AFTER TAX Balance brought forward from previous year Balance available for appropriation Appropriations: General reserve Surplus / (loss) carried to B/S Proposed dividend Tax on proposed dividend Basic earning per share (rupee) 42 59,62,22 15,04 (59,27) 59,17,99 22,41,60 10,37,52 10,63,96 2,69,99 72,69 7,62,23 2,36,57 1,07,97 1,03 1,06,94 57,91,50 1,26,49
63,19 (19,64) 82,94 1 82,95
26,50 4 50,00 6,41 82,95 1.66
BALANCE SHEET AS AT 31ST MARCH 2004 (RS.’000) AS AT 31-3- 2004 AS AT 31-3- 2004 SOURCES OF FUNDS SHAREHOLDERS FUND Share capital Reserves and surplus LOANS Secured Unsecured DEFFERED TAX LIABILITY (NET) TOTAL APPLICATION OF FUNDS FIXED ASSETS Gross block Less: depreciation Net block Capital work in progress INVESTMENT CURRENT ASSESTS, LOANS & ADVANCES Inventories Sundary debtors Cash & bank balances Loan & advances CURRENT LIABLITIES & PROVISIONS Current liabilities Provisions NET CURRENT ASSESTS TOTAL
5,00,00 17,42,59 22,42,59 11,38,86 5,58,29 16,97.15 95,33 40,35,07
18,41,58 12,40,03 6,01,55 15,29 6,16,84 1,48,34
21,46,20 19,51,56 4,49,74 850,58 53,98,08
18,16,17 3,12,02 21,28,19 32,69,89 40,35,07
PROFIT & LOSS ACCOUNT FOR THE ENDED 31ST MARCH 2004 (RS.’000) AS AT 31-3- 2004 AS AT 31-3-2004 INCOME: Sales and operating earnings Other income Variation in stock EXPENCES: Materials consumed Purchase of trading goods Payments to & provision for employees Manufacturing expenses Excise duty Other expenses Interest & finance charges Depreciation Less: transferred to revaluation PROFIT BEFORE TAX PRIOR YEAR ADJUSTMENT (NET) PROVISION FOR TAXATION Current tax Deferred tax liability / (Assets) PROFIT AFTER TAX Balance brought forward from previous year Balance available for appropriation Appropriations: General reserve Surplus / (loss) carried to B/S Proposed dividend Tax on proposed divident Basic earning per share (rupee) 73,90,47 31,39 53,99 74,75,85 28,51,40 14,03,33 12,94,47 3,07,51 70,08 9,17,94 2,46,30 1,10,89 93 1,09,96 72,00,99 2,74,86 25,71 1,19,50 8,13 17294 4 1,72,98
88,30 7 75,00 9,61 1,72,98 3.46
BALANCE SHEET AS AT 31ST MARCH 2005 (RS.’000) AS AT 31-3- 2005 AS AT 31-3- 2005 SOURCES OF FUNDS SHAREHOLDERS FUND Share capital Reserves and surplus LOANS Secured Unsecured DEFFERED TAX LIABILITY (NET) TOTAL APPLICATION OF FUNDS FIXED ASSETS Gross block Less: depreciation Net block Capital work in progress INVESTMENT CURRENT ASSESTS, LOANS & ADVANCES Inventories Sundary debtors Cash & bank balances Loan & advances CURRENT LIABLITIES & PROVISIONS Current liabilities Provisions NET CURRENT ASSESTS TOTAL
5,00,00 19,14,91 24,14,91 17,23,12 5,36,89 22,60,01 92,02 47,66,94
21,64,89 13,43,05 8,21,84 8,21,84 2,32,91
19,32,88 23,06,67 6,04,64 10,04,02 58,48,21
16,55,15 4,80,87 21,36,02 37,12,19 47,66,19
PROFIT & LOSS ACCOUNT FOR THE ENDED 31ST MARCH 2005
(RS.’000) AS AT 31-3- 2005 AS AT 31-3 2005 INCOME: Sales and operating earnings Other income Variation in stock EXPENCES: Materials consumed Purchase of trading goods Payments to & provision for employees Manufacturing expenses Excise duty Other expenses Interest & finance charges Depreciation Less: transferred to revaluation PROFIT BEFORE TAX PRIOR YEAR ADJUSTMENT (NET) PROVISION FOR TAXATION Current tax Deferred tax liability / (Assets) PROFIT AFTER TAX Balance brought forward from previous year Balance available for appropriation Appropriations: General reserve Surplus / (loss) carried to B/S Proposed dividend Basic earning per share (rupee) 74,20,31 41,69 (38,45) 74,23,55 25,91,83 15,21,00 13,54,15 2,71,41 75,41 8,44,78 2,15,82 1,26,68 84 1,25,84 70,00,24 4,23,31
1,50,84 (3,31) 2,75,78 7 2,75,85
1,73,20 3 90,00 2,75,85 5.52
CALCULATIONS AND INTERPRETATION OF RATIO’S 1] CURRENT RATIO:
Formula: Current assets Current ratio = Current liabilities YEAR Current assets Current liabilities Current ratio COMMENTS: In Aplab company the current ratio is 2.72:1 in 2004-2005. it means that for one rupee of current liabilities, the current assets are 2.72 rupee are available to the them. In other words the current assets are 2.72 times the current liabilities. Almost 4 years current ratio is same but current ratio in 2004-2005 is bit higher, which makes company more sound. The consistency increase in the value of current assets will increase the ability of the company to meets its obligations & therefore from the point of view of creditors the company is less risky. The available working capital with the company is in increasing order. 2001-2002 - 30,77,14 2002-2003 - 29,46,07 2003-2004 - 32,69,89 2004-2005 - 36,92,19 The company has sufficient working capital to meets its urgency/ obligations. A company has a high percentage of its current assets in the form of working capital, cash that would be more liquid in the sense of being able to meet obligations as & when they become due. From this working capital, the company meets its day-to-day financial obligations. Thus, the current ratio throws light on the company’s ability to pay its current liabilities out of its current assets. The Aplab Company’s has a very good liquidity position of company. 2001-2002 46,70,80 15,93,66 2.93 2002-2003 51,08,39 21,62,32 2.36 2003-2004 53,98,08 21,28,19 2.53 2004 -2005 58,28,21 21,36,02 2.72
2] LIQUID RATIO:
Formula: Quick assets Liquid ratio = Quick liabilities YEAR Quick assets Quick liabilities Liquid ratio COMMENTS: The liquid or quick ratio indicates the liquid financial position of an enterprise. Almost in all 4 years the liquid ratio is same, which is better for the company to meet the urgency. The liquid ratio of the Aplab Company has increased from 1.12 to 1.36 in 2004-2005. Day to day solvency is more sound for company in 2004-2005 over the year 2003-2004. This indicates that the dependence on the short-term liabilities & creditors are less & the company is following a conservative working capital policy. Liquid ratio of Company is favorable because the quick assets of the company are more than the quick liabilities. The liquid ratio shows the company’s ability to meet its immediate obligations promptly. 2001-2002 21,80,67 15,93,66 1.36 2002-2003 23,01,01 21,62,32 1.06 2003-2004 24,01,30 21,28,19 1.12 2004 -2005 29,11,31 21,36,02 1.36
3] PROPRIETORY RATIO:
Formula: Proprietary fund Proprietary ratio = Total fund Shareholders fund Proprietary ratio = Fixed assets + current liabilities OR
YEAR Proprietary fund Total fund Proprietary ratio COMMENTS:
2001-2002 21,29,69 52,82,53 40
2002-2003 21,55,19 57,38,17 37.55
2003-2004 22,42,59 66,14,92 33.90
2004 -2005 24,14,91 66,70,05 36.20
The Proprietary ratio of the company is 36.20% in the year 2004-2005. It means that the for every one rupee of total assets contribution of 36 paise has come from owners fund & remaining balance 66 paise is contributed by the outside creditors. This shows that the contribution by outside to total assets is more than the owners fund. This Proprietary ratio of the Company shows a downward trend for the last 4 years. As the Proprietary ratio is not favorable the Company’s long-term solvency position is not sound.
4] STOCK WORKING CAPITAL RATIO:
Formula: Stock Stock working capital ratio = Working Capital YEAR Stock Working Capital Stock working capital ratio COMMENTS: This ratio shows that extend of funds blocked in stock. The amount of stock is increasing from the year 2001-2002 to 2003-2004. However in the year 2004-2005 it has declined to 52%. In the year 2004-2005 the sale is increased which affects decrease in stock that effected in increase in working capital in 2004-2005. It shows that the solvency position of the company is sound. 2001-2002 19,09,77 30,77,14 62.06 2002-2003 19,02,79 29,46,07 64.58 2003-2004 21,46,20 32,69,89 65.63 2004 -2005 19,32,88 37,12,19 52.06
5] CAPITAL GEARING RATIO:
Formula: Preference capital+ secured loan
Capital gearing ratio =
Equity capital & reserve & surplus
YEAR Secured loan Equity capital & reserves & surplus Capital gearing ratio COMMENTS:
2001-2002 12,13,48 21,29,69 56.97
2002-2003 10,27,56 21,55,19 47.67
2003-2004 11,38,86 22,42,59 50.78
2004 -2005 1,72,312 2,41,491 71
Gearing means the process of increasing the equity shareholders return through the use of debt. Capital gearing ratio is a leverage ratio, which indicates the proportion of debt & equity in the financing of assets of a company. For the last 3 years [i.e.2001-2002 TO 2003-2004] Capital gearing ratio is all most same which indicates, near about 50% of the fund covering the secured loan position. But in the year 2004-2005 the Capital-gearing ratio is 71%. It means that during the year 2004-2005 company has borrowed more secured loans for the company’s expansion.
6] DEBT EQUITY RATIO:
Formula: Total long term debt Debt equity ratio = Total shareholders fund YEAR Long term debt 2001-2002 15,81,47 2002-2003 14,80,70 21,55,19 2003-2004 16,97,15 22,42,59 2004 -2005 22,60,01 24,14,91
fund Debt Equity Ratio 0.74 COMMENTS:
The debt equity ratio is important tool of financial analysis to appraise the financial structure of the company. It expresses the relation between the external equities & internal equities. This ratio is very important from the point of view of creditors & owners. The rate of debt equity ratio is increased from 0.74 to 0.93 during the year 2001-2002 to 2004-2005. This shows that with the increase in debt, the shareholders fund also increased. This shows long-term capital structure. The lower ratio viewed as favorable from long term creditors point of view.
7] GROSS PROFIT RATIO:
Formula: Gross profit Gross profit ratio = Net sales * 100
YEAR Gross profit Net sales Gross profit Ratio
2001-2002 24,54,48 43,45,46 56.48
2002-2003 37,65,90 51,02,37 73.80
2003-2004 45,57,45 68,76,89 66.27
2004 -2005 42,37,52 68,09,78 62.22
Gross profit Ratio 80 60 40 20 0 20012002 20022003 20032004 2004 2005 Gross profit Ratio
COMMENTS: The gross profit is the profit made on sale of goods. It is the profit on turnover. In the year 2001-2002 the gross profit ratio is 56.48%. It has increased to 73.80% in the year 2002-2003 due to increase in sales without corresponding increase in cost of goods sold. However the gross profit ratio decreased to 66.27% in the year 2003-2004. It is further declined to 62.22% in the year 2004-2005, due to high cost of purchases & overheads. Although the gross profit ratio is declined during the year 2002-2003 to 2004-2005. The net sales and gross profit is continuously increasing from the year 2001-2002 to 2004-2005.
8] OPERATING RATIO:
Formula: COGS+ operating expenses
Operating ratio =
Net sales YEAR COGS + Operating expenses Net sales Operating ratio 2001-2002 18,90,98 + 2,21,37 + 5,76,71 43,45,46 61.88% 2002-2003 21,96,32 + 2,69,98 + 7,62,23 51,02,37 63.27%
2003-2004 28,33,02 + 3,07,51 + 9,17,94 68,76,89 59% 2004 -2005 2,57,226+ 27,141+ 84,478 6,80,978 54.16%
COMMENTS: The operating ratio shows the relationship between costs of activities & net sales. Operating ratio over a period of 4 years when compared that indicate the change in the operational efficiency of the company. The operating ratio of the company has decreased in all 4 year. This is due to increase in the cost of goods sold, which in 2001-2002 was 61.88%, in 2002-2003 was 63.27%, in 2003-2004 was 59% & in 2004-2005 it is 54.16%. though the cost has increased in 2002-2003 as compared to 2001-2002, it is reducing continuously over the next two years, indicate downward trend in cost but upward / positive trend in operational performance. 9] EXPENSE RATIO: The ratio of each item of expense or each group of expense to net sales is known as ‘Expense ratio’. The expense ratio brings out the relationship between various elements of operating cost & net sales. Expense ratio analyzes each individual item of expense or group of expense& expresses them as a percentage in relation to net sales. A] MANUFACTURING EXPENSES: Formula: Manufacturing expenses Manufacturing expense ratio = Net sales YEAR Manufacturing expenses Net sales Manufacturing expenses ratio 2001-2002 2,21,37 43,45,46 5% 2002-2003 2,69,98 51,02,37 5.29% 2003-2004 3,07,51 68,76,89 4.47% 2004 -2005 2,71,41 68,09,78 3.98% *100
COMMENTS: The manufacturing expense is shows the downward trend. During the year 2001–2002 to 2002-2003 the manufacturing expense increased because there is increase in the charges like labour, rent , power & electricity, repair to plant & machinery & miscellaneous works expenses. The manufacturing expense during the year 2001-2002 to 2004-2005 is decreased from 5% to 3.96%. This indicates that the company has control over the manufacturing expense. B] OTHER EXPENSES: Formula: Other expenses Other expense ratio = Net sales YEAR Other expenses Net sales Other expenses ratio 2001-2002 5,76,71 43,45,46 13.2% 2002-2003 7,62,23 51,02,37 14.93% 2003-2004 9,17,94 68,76,89 13.34% 2004 -2005 8,44,78 68,09,78 12.40% *100
COMMENTS: The other expense of company is increased during the 2001-2002 to 20032004, because increase in the charges of rent of office, equipment lease rental, printing & stationary, advertisement & publicity, transport outward & other charges. But during the year 2004-2005 the other expenses is decrease from 13.34% to 12.40%. Because decrease in equipment lease rental, advertisement & publicity, transport charges, commission & discount, sales tax & purchase tax . This indicates that the company also controlling the other expenses.
10) NET PROFIT RATIO
Formula: NPAT Net profit ratio = Net sales YEAR NPAT Net sales Net profit ratio 2001-2002 20,98 434546 0.48 2002-2003 82,94 51,02,37 1.6 2003-2004 1,72,94 68,76,89 2.5 2004 -2005 2,75,78 68,09,78 4.04 * 100
5 4 3 2 1 0 2001-2002 2002-2003 2003-2004 2004-2005
COMMENTS: The net profit ratio of the company is low in all year but the net profit is increasing order from this ratio of 4 year it has been observe that the from 2001-2002 to 2004-2005 the net profit is increased i.e. in 2003 it is increased by 1.12 in 2003-2004 by 0.9 & in 2004-2005 by 1.54. Profitability ratio of company shows considerable increase. Company’s sales have increased in all 4 years & at the same time company has been successful in controlling the expenses i.e. manufacturing & other expenses. It is a clear index of cost control, managerial efficiency & sales promotion.
11] STOCK TURNOVER RATIO:
Formula: COGS Stock Turnover Ratio = Average stock YEAR COGS Average stock Stock Turnover Ratio COMMENTS: Stock turnover ratio shows the relationship between the sales & stock it means how stock is being turned over into sales. The stock turnover ratio is 2001-2002 was 3.4 times which indicate that the stock is being turned into sales 3.4 times during the year. The inventory cycle makes 3.4 round during the year. It helps to work out the stock holding period, it means the stock turnover ratio is 3.4 times then the stock holding period is 3.5 months [12/3.4=3.5months]. This indicates that it takes 3.5 months for stock to be sold out after it is produced. For the last 4 years stock turnover ratio is lower than the standard but it is in increasing order. In the year 2001-2002 to 2004-2005 the stock turnover ratio has improved from 3.4 to 3.73 times, it means with lower inventory the company has achieved greater sales. Thus, the stock of the company is moving fast in the market. 2001-2002 18,90,98 5,49,90 3.4 2002-2003 21,96,32 5,97,58 3.6 2003-2004 28,33,02 6,73,11 4.20 2004 -2005 25,72,26 6,89,30 3.73
12] RETURN ON CAPITAL EMPLOYED:
Return on capital employed =
YEAR NPAT Capital employed Return on capital employed COMMENTS:
2001-2002 20,68 38,18,01 0.54
2002-2003 82,94 37,23,11 2.23
2003-2004 1,72,94 40,35,07 4.28
2004 -2005 2,75,78 47,66,93 5.79
The return on capital employed shows the relationship between profit & investment. Its purpose is to measure the overall profitability from the total funds made available by the owner & lenders. The return on capital employed of Rs.5 indicate that net return of Rs.5 is earned on a capital employed of Rs.100. this amount of Rs.5 is available to take care of interest, tax,& appropriation. The return on capital employed is show-increasing trend, i.e. from 0.54 to 5.79. All of sudden in 2001-2002 the return on capital employed increased from 0.54 to 5.79. This indicates a very high profitability on each rupee of investment & has a great scope to attract large amount of fresh fund.
13] EARNING PER SHARE:
Earning per share =
Number of equity share YEAR NPAT No.ofequity share Earning per share COMMENTS: Earning per share is calculated to find out overall profitability of the company. Earning per share represents the earning of the company whether or not dividends are declared. The Earning per share is 5.52 means shareholder gets Rs. 5.52 for each share of Rs. 10/-. In other words the shareholder earned Rs. 5.52 per share. 2001-2002 20,98,000 50,00,000 0.41 2002-2003 82,94,000 50,00,000 1.66 2003-2004 1,72,94,000 50,00,000 3.46 2004 -2005 2,75,78,000 50,00,000 5.52
The net profit after tax of the company is increasing in all years. Therefore the shareholders earning per share is increased continuously from 2001-2002 to 2004-2005 by 0.41 to 05.52. This shows it is continuous capital appreciation per unit share by 0.41 to 05.52.
The above diagram shows the Earning per share and Dividend per share is increasing rapidly. It is beneficial to the shareholders and prospective investor to invest the money in this company.
14] DIVIDEND PAYOUT RATIO:
Formula: Dividend per share
Dividend Pay out ratio =
Earning per share YEAR Dividend per share Earning per share Dividend payout ratio 2001-2002 0.41 2002-2003 1 1.66 60.24
2003-2004 1.50 3.46 43.35 2004 -2005 1.80 5.52 32.60
COMMENTS: In the year 2002-2003 and 2003-2004 the Dividend pay out ratio is 60.24 and 43.35 respectively. In the year 2002-2003 the company has declared the dividend 60.24 and the balance 39.76 is retained with them for the expansion. The company has not earned more profit in the year 2001-2002 hence the company has not declared dividend in the year 2001-2002. However the company has declared more dividends in the year 2002-2003 as the company has sufficient profit. In the year 2004 the company has declared 1.50 dividends per share hence the earning per share has doubled. From this one can say that the company is more conservative for expansion.
15] COST OF GOODS SOLD:
Formula: COGS Cost of goods sold Ratio = Net sales YEAR COGS Net sales Cost of goods sold ratio COMMENTS: This ratio shows the rate of consumption of raw material in the process of production. In the year 2001-2002 the cost of goods sold ratio is 43.51% so the gross profit is 56.49%. it indicates that in 2001-2002, the 43% of raw material is consumed in the process of production. During the last 4 years the rate of cost of goods sold ratio is continuously decreasing however the gross profit & sales is increased during the same period. 2001-2002 18,90,98 43,45,46 43.51 2002-2003 21,96,32 51,02,37 43.04 2003-2004 28,33,02 68,76,89 41.19 2004 -2005 25,72,26 68,09,78 37.77 * 100
16] CASH RATIO:
Formula: Cash + Bank + Marketable securities Cash ratio = Total current liabilities YEAR Cash + Bank + Marketable securities Total current liabilities Cash ratio COMMENTS: This ratio is called as super quick ratio or absolute liquidity ratio. In the year 2001-2002 the cash ratio is 0.20 & then it is decreased to 0.18 in the year 2002-2003. Then again it is increased to 0.21 in the year 2003-2004 & 0.28 in the year 2004-2005. This shows that the company has sufficient cash, bank balance, & marketable securities to meet any contingency. 2001-2002 3,31,32 15,93,66 0.20 2002-2003 3,95,25 21,62,32 0.18 2003-2004 4,49,74 21,28,19 0.21 2004 -2005 6,04,64 21,36,02 0.28
17] RETURN ON PROPRIETORS FUND:
Formula: NPAT Return on proprietors fund = Proprietors fund YEAR NPAT Proprietors fund Return on proprietors fund 2001-2002 20,68 21,29,69 0.97 2002-2003 82,94 21,55,19 3.84 2003-2004 1,72,94 22,42,59 7.71 2004 -2005 2,75,78 24,14,91 11.41 * 100
COMMENTS: Return on proprietors fund shows the relationship between profits & investments by proprietors in the company. In the year 2002-2003 the return on proprietors fund is 3.84% it means the net return of Rs. 3 approximately is earned on the each Rs. 100 of funds contributed by the owners. During the last 4 years the rate of return on proprietors fund is in increasing order. The return on proprietors fund during the year 2001-2002 to 2004-2005 is increased from 0.97% to 11.41%. It shows that the company has a very large returns available to take care of high dividends, large transfers to reserve etc. & has a great scope to attract large amount of fresh fund from owners.
18] RETURN ON EQUITY:
Formula: NPAT Return on equity share capital = No. of equity share YEAR NPAT No. of equity share Return on equity share capital COMMENTS: This ratio shows the relationship between profit & equity shareholders fund in the company. It is used by the present / prospective investor for deciding whether to purchase, keep or sell the equity shares. In the year 2002-2003 the return on proprietors fund is 16.5%, which means the net return of Rs. 16, is earned on the each Rs.100 of the funds contributed by the equity shareholders. The rate of return on equity share capital is increased from4.13% to 55% during the year 2001-2002 to 2004-2005. This shows that the company has a very large returns available to take care of high equity dividend, large transfers 61 2001-2002 20,68 50,000 4.13 2002-2003 82,94 50,000 16.5 2003-2004 1,72,94 50,000 34.58 2004 -2005 2,75,78 50,000 55 * 100
to reserve, & also company has a great scope to attract large amount to fresh funds by issue of equity share & also company has a very good price for equity shares in the BSE.
19] OPERATING PROFIT RATIO:
Formula: Operating profit Operating profit ratio = Net sales COMMENTS: Operating profit ratio shows the relationship between operating profit & the sales. The operating profit is equal to gross profit minus all operating expenses or sales less cost of goods sold and operating expenses. The operating profit ratio of 7.11% indicates that average operating margin of Rs.7 is earned on sale of Rs. 100. this amount of Rs. 7 is available for meeting non operating expenses. In the other words operating profit ratio 7.11% means that 7.11% of net sales remains as operating profit after meeting all operating expenses. During the last 4 years the operating profit ratio is increased from 7.11% to 9.38%. It indicates that the company has great efficiency in managing all its operations of production, purchase, inventory, selling and distribution and also has control over the direct and indirect costs. Thus, company has a large margin is available to meet non-operating expenses and earn net profit. *100
20] CREDITORS TURNOVER RATIO:
Formula: Net credit purchase Credit turnover ratio = Average creditors
Months in a year Average age of accounts payable = Credit turnover ratio YEAR Net credit purchase Average creditors Credit turnover ratio Average age of accounts payable COMMENTS: The creditors turnover ratio shows the relationship between the credit purchase and average trade creditors. It shows the speed with which the payments are made to the suppliers for the purchase made from them. The credit turnover ratio of 4, indicate that the creditors are being turned over 4times during the year. It indicates the number of rounds taken by the credit cycle of payables during the year. There is no standard ratio in absolute term. The creditors ratio for the year 2001-2002 and 2002-2003 as good as the same, but it is increased by 3.6 to 4 in 2003-2004.this means the company has settled the creditors dues very fastly than the previous year. DEBTORS TURNOVER RATIO: Formula: Credit sales Debtors turnover ratio = Average debtors Days in a year Debt collection period = Debtor’s turnover 2001-2002 21,21,43 5,88,42 3.6 times 3.3 months 2002-2003 22,71,80 7,91,21 3.6 times 3.3 months 2003-2004 29,08,61 6,96,86 4 times 3 months 2004 -2005 25,29,04 7,80,39 3 times 4 months
YEAR Credit sales Average debtors Debtors turnover ratio Debt collection period COMMENTS:
2001-2002 47,77,48 18,49,35 2.5 times 146 days
2002-2003 55,21,33 19,05,76 2.8 times 130 days
2003-2004 74,87,36 19,51,56 3.8 times 96 days
2004 -2005 68,09,78 23,06,67 2.9 times 125 days
Debtor’s turnover ratio is alternative known as “ Accounts Receivable Turnover Ratio”. This ratio measures the collectibility of debtors & other accounts receivable, it means the rate at which the trade debts are being collected. The Debtors turnover ratio of 2.5 indicates that the debtors are being turned over 2.5 times during the year. It means that the credit cycle of debtors makes 2.5 rounds during the year. It helps to workout the debt collection period i.e. 146 days [365/ 2.5 = 146]. This indicates that it take146 days on an average for the debtors to be settled. Debt collection period indicates the duration of the credit cycle of the debtors. The Debtors turnover ratio is almost same during the year 2001-2002 to 2004-2005, which indicates that the debts are being collected at a fast speed during the year. The operating cycle of the debtors is short. In other words the debts collection period is short which result into less chance of bad debts.
SUMMARY OF FINANCIAL POSITION OF APLAB LIMITED
After going through the various ratios, I would like to state that: • • • • • • • The short-term solvency of the company is quite satisfactory. Immediate solvency position of the company is also quite satisfactory. The company can meet its urgent obligations immediately. Credit policies are effective. Over all profitability position of the company is quite satisfactory. Stock turnover rate is satisfactory. Stock of the company is moving fast in the market. The company is paying promptly to the suppliers. The return on capital employed is satisfactory.
The management should take care of inventory management and speed up the movement of stock. Effective selling technique or product modification may be adopted to face the competitors and to improve the financial position of the company by taking appropriate decisions.
The focus of financial analysis is on key figures contained in the financial statements and the significant relationship that exits. The reliability and significance attach to the ratios will largely on hinge upon the quality of data on which they are best. They are as good for as bad as the data it self. Financial ratios are a useful by product of financial statement and provide standardized measures of firms financial position, profitability and riskiness. It is an important and powerful tool in the hands of financial analyst. By calculating one or other ratio or group of ratios he can analyze the performance of a firm from the different point of view. The ratio analysis can help in understanding the liquidity and short-term solvency of the firm, particularly for the trade creditors and banks. Long-term solvency position as measured by different debt ratios can help a debt investor or financial institutions to evaluate the degree of financial risk. The operational efficiency of the firm in utilizing its assets to generate profits can be assessed on the basis of different turnover ratios. The profitability of the firm can be analyzed with the help of profitability ratios. However the ratio analyses suffers from different limitations also. The ratios need not be taken for granted and accepted at face values. These ratios are numerous and there are wide spread variations in the same measure. Ratios generally do the work of diagnosing a problem only and failed to provide the solution to the problem.
REFERENCE BOOKS – FINANCIAL MANAGEMENT Theory, Concepts & problems R.P.RUSTAGI FINANCIAL MANAGEMENT Text and problems M.Y. KHAN AND P. K. JAIN MANAGEMENT ACCOUNTING AINAPURE FINANCIAL MANAGEMENT L.N. CHOPDE D.N. CHOUDHARI S.L. CHOPDE ANAUAL REPORTS OF APLAB LIMITED 2001-2002 2002-2003 2003-2004 2004-2005
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