Ratio Analysis

Meaning and definition of ratio analysis:

Ratio analysis is a widely used tool of financial analysis. It is defined as the

systematic use of ratio to interpret the financial statements so that the strength and
weaknesses of a firm as well as its historical performance and current financial
condition can be determined. The term ratio refers to the numerical or quantitative
relationship between two variables.

Importance of ratio analysis:

 It helps in evaluating the firms performance:

With the help of ratio analysis conclusion can be drawn regarding several
aspects such as financial health, profitability and operational efficiency of
the undertaking. Ratio points out the operating efficiency of the firm i.e.
whether the management has utilized the firm’s assets correctly, to increase
the investor’s wealth. It ensures a fair return to its owners and secures
optimum utilization of firms assets

 It helps in inter-firm comparison:

Ratio analysis helps in inter-firm comparison by providing necessary

data. An interfirm comparison indicates relative position.It provides the
relevant data for the comparison of the performance of different
departments. If comparison shows a variance, the possible reasons of
variations may be identified and if results are negative, the action may be
intiated immediately to bring them in line.

 It is helpful in budgeting and forecasting:

Accounting ratios provide a reliable data, which can be compared,

studied And analyzed.These ratios provide sound footing for future
prospectus. The ratios can also serve as a basis for preparing budgeting
future line of action.
 Liquidity position:

With help of ratio analysis conclusions 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.
The ability to met short term liabilities is reflected in the liquidity ratio of a
firm.

 Long term solvency:

Ratio analysis is equally for assessing the long term financial ability
of the Firm. The long term solvency s measured by the leverage or capital
structure and profitability ratio which shows the earning power and
operating efficiency, Solvency ratio shows relationship between total
liability and total assets.

 Operating efficiency:

It throws light on the degree efficiency in the various activity ratios

measures this kind of operational efficiency.

Classification of ratios:

Different ratios are used for different purpose these ratios can be grouped into
various classes according to the financial activity. Ratios are classified into four
broad categories.

1. Liquidity Ratio

2. Leverage Ratio

3. Profitability Ratio

4. Activity Ratio
 1. Liquidity Ratio:

Liquidity ratio measures the firms ability to meet its current obligations i.e. ability
to pay its obligations and when they become due.
It is found by taking a relationship between Current Assets and Current Liablities.

2. Leverage or capital structure ratio:

Leverage or capital structure ratios are the ratios, which indicate the relative
interest of the owners and the creditors in an enterprise. These ratios indicate
the funds provided by the long-term creditors and owners.
3. Activity ratio:

Activity ratio are sometimes are called efficiency ratios. Activity ratios are
concerned with how efficiency the assets of the firm are managed.
These ratio express relatonship between level of sales and the investment in
various assets inventores, receivables, fixed assets etc.

4. Profitability ratio:

Profitability ratio are the best indicators of overall efficiency of the business
concern, because they compare return of value over and above the value put into
business with sales or service carried on by the firm with the help of assets
employed

COMPANY PROFILE

Infosys - Infosys was founded on 2 July 1981 in Pune by N. R. Narayana Murthy

and six others.It is the 2nd largest IT company in India.

TCS - Tata Consultancy Services was established in the year 1968 and is a pioneer
in the Indian IT industry. Tata Consultancy Services Limited (TCS) is a software
services and consulting company headquartered in Mumbai, India. TCS is the
largest provider of information technology and business process outsourcing
services in India.

• GROSS PROFIT - Gross Profit Ratio = Gross Profit x 100

 Net Sales

The gross profit margin ratio indicates how efficiently a business is using its
materials and labor in the production process. It shows the percentage of net sales
remaining after subtracting cost of goods sold. A high gross profit margin indicates
that a business can make a reasonable profit on sales, as long as it keeps overhead
costs in control.

GP RATIO COMPARISON OF INFOSYS AND TCS

35

30

25

20
TCS
15 Infosys

10

0
2004-05 2005-06 2006-07 2007-08 2008-09

Gp Ratio of TCS
 28.25
2004-05
2005-06 27.42

2006-07 26.49

2007-08 24.64

2008-09 25.01

GP Ratio OF INFOSYS
2004-05 30

2005-06 28.25

2006-07 28.57

2007-08 28.23

2008-09 30.66

TCS ANALYSIS - It can be seen that GP ratio of TCS is having a downward

trend. In 2007 there is a sharp fall due to Recession.

Infosys ANALYSIS - There is a fall in Gross Profit ratio in 2005 as there was a
decrease in onsite revenue. In 2008 there is a rise in Gross Profit due to 156 new
clients.