# Chapter 6

Financial Statements Analysis

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6-1

FINANCIAL STATEMENTS ANALYSIS

Ratio Analysis

Common Size Statements Importance and Limitations of Ratio Analysis
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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 strengths and weaknesses of a firm as well as its historical performance and current financial condition can be determined.

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6-3

Basis of Comparison
1) Trend Analysis involves comparison of a firm over a period of time, that is, present ratios are compared with past ratios for the same firm. It indicates the direction of change in the performance – improvement, deterioration or constancy – over the years. 2) Interfirm Comparison involves comparing the ratios of a firm with those of others in the same lines of business or for the industry as a whole. It reflects the firm’s performance in relation to its competitors. 3) Comparison with standards or industry average.
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Types of Ratios
Liquidity Ratios Capital Structure Ratios

Profitability Ratios

Efficiency ratios

Integrated Analysis Ratios

Growth Ratios
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80.00.000 Rs 30.000 Particulars Current assets Current liabilities NWC Company A Rs 1.000 60. Management Accounting .000 1.000 Company B Rs 2.00.00.20.000 25.00. Table 1: Net Working Capital Particulars Company A Company B Total current assets Total current liabilities NWC Table 2: Change in Net Working Capital Rs 1.000 20.000 6-6 © Tata McGraw-Hill Publishing Company Limited.000 1.000 10.000 1.Net Working Capital Net working capital is a measure of liquidity calculated by subtracting current liabilities from current assets.000 75.

Management Accounting 6-7 .Liquidity Ratios Liquidity ratios measure the ability of a firm to meet its short-term obligations © Tata McGraw-Hill Publishing Company Limited.

80.000 Rs 1.000 = 3:2 (1.000 3:1 6-8 Particulars Current Assets Current Liabilities Current Ratio Firm A Rs 1.Current Ratio Current Ratio is a measure of liquidity calculated dividing the current assets by the current liabilities Current Ratio = Current Assets Current Liabilities Firm B Rs 30.20.000 Rs 10.5:1) © Tata McGraw-Hill Publishing Company Limited. Management Accounting .

Acid-Test Ratio The quick or acid test ratio takes into consideration the differences in the liquidity of the components of current assets Quick Assets Current Liabilities Acid-test Ratio = Quick Assets = Current assets – Stock – Pre-paid expenses © Tata McGraw-Hill Publishing Company Limited. Management Accounting 6-9 .

000 2:1 0.000 8. Management Accounting 6 .000 16.000 2.Example 1: Acid-Test Ratio Cash Debtors Inventory Total current assets Total current liabilities (1) Current Ratio (2) Acid-test Ratio Rs 2.5 : 1 © Tata McGraw-Hill Publishing Company Limited.10 .000 12.

Supplementary Ratios for Liquidity Inventory Turnover Ratio Debtors Turnover Ratio Creditors Turnover Ratio © Tata McGraw-Hill Publishing Company Limited.11 . Management Accounting 6 .

Cost of goods sold Inventory turnover ratio = Average inventory The cost of goods sold means sales minus gross profit. © Tata McGraw-Hill Publishing Company Limited. A low ratio would signify that inventory does not sell fast and stays on the shelf or in the warehouse for a long time. A high ratio is good from the viewpoint of liquidity and vice versa. Management Accounting 6 . The average inventory refers to the simple average of the opening and closing inventory.12 .Inventory Turnover Ratio The ratio indicates how fast inventory is sold.

The stock at the beginning and the end of the year was Rs 35.Example 2: Inventory Turnover Ratio A firm has sold goods worth Rs 3.00.000) ÷ 2 6 (times = per year) 12 months Inventory = = 2 months holding period Inventory turnover ratio.000 with a gross profit margin of 20 per cent.13 .000 respectively. Management Accounting 6 .000 and Rs 45. What is the inventory turnover ratio? Inventory turnover ratio = (Rs 3.00.000 + Rs 45.000) (Rs 35. (6) © Tata McGraw-Hill Publishing Company Limited.000 – Rs 60.

from customers. Average debtors is the simple average of debtors (including bills receivable) at the beginning and at the end of year.Debtors Turnover Ratio The ratio measures how rapidly receivables are collected. Management Accounting 6 .14 . A high ratio is indicative of shorter time-lag between credit sales and cash collection. A low ratio shows that debts are not being collected rapidly. © Tata McGraw-Hill Publishing Company Limited. Debtors turnover ratio = Net credit sales Average debtors Net credit sales consist of gross credit sales minus returns. if any.

Determine the debtors turnover ratio.500) ÷ 2 = 12 Months Debtors turnover ratio.500 + Rs 32.40.000 (Rs 27. The outstanding amount of debtors at the beginning and at the end of the year respectively was Rs 27. Debtors turnover ratio = Rs 2.Example 3: Debtors Turnover Ratio A firm has made credit sales of Rs 2.000 during the year.500 and Rs 32. Management Accounting 6 .5 Months © Tata McGraw-Hill Publishing Company Limited. (8) 8 (times = per year) Debtors collection period = 1.15 .40.500.

16 . Management Accounting 6 .Creditors Turnover Ratio A low turnover ratio reflects liberal credit terms granted by suppliers. The creditors turnover ratio is an important tool of analysis as a firm can reduce its requirement of current assets by relying on supplier’s credit. © Tata McGraw-Hill Publishing Company Limited. while a high ratio shows that accounts are to be settled rapidly. Average creditors = Average of creditors (including bills payable) outstanding at the beginning and at the end of the year.Returns to suppliers. Creditors turnover ratio = Net credit purchases Average creditors Net credit purchases = Gross credit purchases .

000) (Rs 42. The amount payable to the creditors at the beginning and at the end of the year is Rs 42.Example 4: Creditors Turnover Ratio The firm in previous Examples has made credit purchases of Rs 1.500 and Rs 47. Creditors turnover ratio Creditor’s payment period = (Rs 1.500 Rs 47.500 respectively. Management Accounting 6 . Find out the creditors turnover ratio. (4) = 3 months © Tata McGraw-Hill Publishing Company Limited.80.500) ÷ 2 = 4 (times per year) = 12 months Creditors turnover ratio.17 .000.80.

18 .5 months – 3 months 0. collections from debtors and payment to creditors. Management Accounting 6 . The combined effect of the three turnover ratios is summarised below: Inventory holding period Add: Debtor’s collection period Less: Creditor’s payment period 2 months + 1. © Tata McGraw-Hill Publishing Company Limited. the shorter is the cash cycle.The summing up of the three turnover ratios (known as a cash cycle) has a bearing on the liquidity of a firm.5 months As a rule. The cash cycle captures the interrelationship of sales. the better are the liquidity ratios as measured above and vice versa.

Defensiveinterval ratio Liquid assets = Projected daily cash requirement Projected daily cash requirement = Projected cash operating expenditure Number of days in a year (365) © Tata McGraw-Hill Publishing Company Limited. Management Accounting 6 .DEFENSIVE INTERVAL RATIO Defensive interval ratio is the ratio between quick assets and projected daily cash requirement.19 .

Management Accounting .500 365 Rs 40. Projected daily cash requirement = Defensive-interval ratio = Rs 1.Example 5: Defensive Interval Ratio The projected cash operating expenditure of a firm from the next year is Rs 1.000 Rs 500 = Rs 500 = 80 days 6 .500.000.82. It has liquid current assets amounting to Rs 40.20 © Tata McGraw-Hill Publishing Company Limited.82. Determine the defensive-interval ratio.

21 . Management Accounting 6 . Cash-flow from operations ratio Cash-flow from operations Current liabilities = © Tata McGraw-Hill Publishing Company Limited.Cash-flow From Operations Ratio Cash-flow from operation ratio measures liquidity of a firm by comparing actual cash flows from operations (in lieu of current and potential cash inflows from current assets such as inventory and debtors) with current liability.

and (ii) Regular payment of the interest .Leverage Capital Structure Ratio There are two aspects of the long-term solvency of a firm: (i) Ability to repay the principal when due.22 . there are two different types of leverage ratios. Capital structure or leverage ratios throw light on the long-term solvency of a firm. Management Accounting 6 . Accordingly. First type: These ratios are computed from the balance sheet Second type: These ratios are computed from the Income Statement (a) Debt-equity ratio (b) Debt-assets ratio (c) Equity-assets ratio (a) Interest coverage ratio (b) Dividend coverage ratio © Tata McGraw-Hill Publishing Company Limited.

It is danger signal for the lenders and creditors. the creditors would lose heavily. the owners are putting up relatively less money of their own. To the creditors. Debt-equity ratio measures the ratio of long-term debt + Other Current Total Debt Debt-equitytotal de3bt to shareholders equity Liabilities = Total external term or ratio = Shareholders’ equity Obligations If the D/E ratio is high. Debt-equity ratio Debt-equity ratio measures the ratio of long-term or total debt to shareholders equity.I. Management Accounting Long-term Debt + Short 6 .23 . If the project should fail financially. a relatively high stake of the owners implies sufficient safety margin and substantial protection against shrinkage in assets. A low D/E ratio has just the opposite implications. © Tata McGraw-Hill Publishing Company Limited.

The disadvantage of low debt-equity ratio is that the shareholders of the firm are deprived of the benefits of trading on equity or leverage. its operational flexibility is not jeopardised and it will be able to raise additional funds. © Tata McGraw-Hill Publishing Company Limited.24 .For the company also. the servicing of debt is less burdensome and consequently its credit standing is not adversely affected. Management Accounting 6 .

25 © Tata McGraw-Hill Publishing Company Limited.000 800 200 300 30 270 94.000 — 300 — 300 105 195 19.5 6 .000 200 800 300 120 180 63 117 58. Trading on Equity Particular (a) Total assets Financing pattern: Equity capital 15% Debt (b)Operating profit (EBIT) Less: Interest Earnings before taxes Less: Taxes (0.5 (Amount in Rs thousand) B 1.000 600 400 300 60 240 84 156 26 D 1. Management Accounting .9 C 1.5 21.35) Earnings after taxes Return on equity (per cent) A 1.000 1.Trading on Equity Trading on equity (leverage) is the use of borrowed funds in expectation of higher return to equity-holders.5 175.

26 . Debt to Total Capital The relationship between creditors’ funds and owner’s capital can also be expressed using Debt to total capital ratio. Debt to total capital ratio = Total debt Permanent capital Permanent Capital = Shareholders’ equity Long-term debt. Management Accounting 6 . + © Tata McGraw-Hill Publishing Company Limited.II.

Total debt Total assets Proprietary ratio = Capital Gearing Ratio Proprietary funds X 100 Total assets Capital gearing ratio is used to know the relationship between equity funds (net worth) and fixed income bearing funds (Preference shares.III. Debt to total assets ratio Debt to total assets ratio = Proprietary Ratio Proprietary ratio indicates the extent to which assets are financed by owners funds. debentures and other borrowed funds.27 . Management Accounting 6 . © Tata McGraw-Hill Publishing Company Limited.

EBIT (Earning before interest and taxes) Interest Dividend coverage ratio = EAT (Earning after taxes) Preference dividend 6 . Interest coverage ratio = Dividend Coverage Ratio Dividend Coverage Ratio measures the firm’s ability to pay dividend on preference share which carry a stated rate of return. Management Accounting .Coverage Ratio Interest Coverage Ratio Interest Coverage Ratio measures the firm’s ability to make contractual interest payments.28 © Tata McGraw-Hill Publishing Company Limited.

it would be more appropriate to relate cash resources of a firm to its various fixed financial obligations. EBIT + Lease Payments + Depreciation + Non-cash expenses Lease payment + + Interest (Principal repayment) (1– t) + (Preference dividend) (1 .Total fixed charge coverage ratio Total fixed charge coverage ratio measures the firm’s ability to meet all fixed payment obligations. that is.29 Total cashflow = coverage ratio © Tata McGraw-Hill Publishing Company Limited. Accordingly.t) 6 . Management Accounting . EBIT + Lease Payment Total fixed charge = coverage ratio Interest + Lease payments + (Preference dividend + Instalment of Principal)/(1-t) Total Cashflow Coverage Ratio However. coverage ratios mentioned above. suffer from one major limitation. they relate the firm’s ability to meet its various financial obligations to its earnings.

Debt Service Coverage Ratio Debt-service coverage ratio (DSCR) is considered a more comprehensive and apt measure to compute debt service capacity of a business firm.30 . Management Accounting 6 . ∑ DSCR n = t=1 EATt + Interestt ∑ t=1 n + Depreciationt + OAt Instalmentt DEBT SERVICE CAPACITY Debt service capacity is the ability of a firm to make the contractual payments required on a scheduled basis over the life of the debt. © Tata McGraw-Hill Publishing Company Limited.

31 .20 18.70 18.00 The net profit has been arrived after charging depreciation of Rs 17.00 18.56 5.77 36.68 lakh every year.00 18.40 18.64 15.00 18.08 7. (Figures in Rs lakh) Year 1 2 3 4 5 6 7 8 Net profit for the year 21.41 Interest on term loan during the year 19.00 18. Management Accounting 6 .00 18.14 17.01 19. You are required to work out yearly debt service coverage ratio (DSCR) and the average DSCR.04 Nil Repayment of term loan in the year 10.60 10.33 16.12 12. © Tata McGraw-Hill Publishing Company Limited.61 18.00 18.Example 6: Debt-Service Coverage Ratio Agro Industries Ltd has submitted the following projections.67 34.

64 33. 6) 7 29.14 17.48 46.08 1.00 18.20 18.68 17.68 17.00 Average DSCR (DSCR ÷ 8) © Tata McGraw-Hill Publishing Company Limited.00 1.68 17.65 1.04 18.68 17.00 18.64 15.12 30.00 18.00 18.60 10.84 35.40 18. Management Accounting .78 1.01 19.68 17.09 Principal instalment Debt obligation (col.96 1.08 25.37 43.41 3 17. 7 (No. of times)] 8 1.71 1.62 1.97 2.64 41.68 17.70 18.32 DSCR [col.68 17. 5 ÷ col. 4 + col.77 36.Solution Table 3: Determination of Debt Service Coverage Ratio (Amount in lakh of rupees) Ye ar Net profit Depreciation Interest Cash available (col.05 34.33 16.83 6 .56 23.60 28.61 18.04 Nil 6 10.89 1 1 2 3 4 5 6 7 8 2 21.00 18.00 18.09 68.67 34.12 12. 2+3+4) 5 58.49 70.81 49.68 4 19.08 7.56 5.

33 © Tata McGraw-Hill Publishing Company Limited. Profitability Ratios Profitability Ratios Related to Sales (i) Profit Margin (ii) Expenses Ratio Related to Investments (i) Return on Investments (ii) Return on Shareholders’ Equity 6 . Management Accounting .Profitability Ratio Profitability ratios can be computed either from sales or investment.

34 . Gross profit margin = Gross Profit X 100 Sales © Tata McGraw-Hill Publishing Company Limited.Profit Margin Gross Profit Margin Gross profit margin measures the percentage of each sales rupee remaining after the firm has paid for its goods. Management Accounting 6 .

Net profit margin can be computed in three ways Earning before interest and taxes Net sales Earnings before taxes Net sales i. Operating Profit Ratio = ii. Net Profit Ratio = Earning after interest and taxes Net sales 6 .35 © Tata McGraw-Hill Publishing Company Limited.Net Profit Margin Net profit margin measures the percentage of each sales rupee remaining after all costs and expense including interest and taxes have been deducted. Pre-tax Profit Ratio = iii. Management Accounting .

00.000 = 50 per cent (2) Net profit margin = Rs 2.000 Rs 50. determine (i) Gross profit margin and (ii) Net profit margin.000 2.000 (1) Gross profit margin = Rs 1.Example 7: From the following information of a firm.000 = 25 per cent © Tata McGraw-Hill Publishing Company Limited. Management Accounting 6 .000 3.000 Rs 2.36 .00. 1. Other operating expenses 50.00.00. Sales Rs 2.00. Cost of goods sold 1.

Administrative expenses = Net sales iv. Management Accounting . Cost of goods sold = ii. Operating ratio = X 100 Net sales vi. Operating expenses = Cost of goods sold X 100 Net sales Administrative exp.37 © Tata McGraw-Hill Publishing Company Limited. Selling expenses ratio = Selling expenses Net sales X 100 X 100 X 100 Cost of goods sold + Operating expenses v. Financial expenses = Financial expenses Net sales X 100 6 . Net sales Administrative expenses iii.Expenses Ratio i. + Selling exp.

38 © Tata McGraw-Hill Publishing Company Limited. Management Accounting . i.Return on Investment Return on Investments measures the overall effectiveness of management in generating profits with its available assets. Return on Capital Employed (ROCE) ROCE = EAT + (Interest – Tax advantage on interest) Average total capital employed 6 . Return on Assets (ROA) ROA = EAT + (Interest – Tax advantage on interest) Average total assets ii.

39 . Return on total shareholders’ equity = Net profit after taxes X 100 Average total shareholders’ equity Return on ordinary shareholders’ equity (Net worth) = Net profit after taxes – Preference dividend X 100 Average ordinary shareholders’ equity © Tata McGraw-Hill Publishing Company Limited.Return on Shareholders’ Equity Return on shareholders equity measures the return on the owners (both preference and equity shareholders ) investment in the firm. Management Accounting 6 .

the speed with which inventory is sold © Tata McGraw-Hill Publishing Company Limited. Cost activity/liquidity of i. Inventory Turnover measures theof goods sold Inventory Turnover Ratio = Average inventory inventory of a firm. Inventory turnover measures the efficiency of various types of inventories. the speed with whichmaterial inventory Average raw inventory is sold i.40 . the speed with which inventory is sold Cost of raw materials of i.Efficiency Ratio Activity ratios measure the speed with which various accounts/assets are converted into sales or cash. Inventory Turnover measures the activity/liquidityused Raw materials turnover = inventory of a firm. Management Accounting 6 . Inventory Turnover measuresCost activity/liquidity of the of goods manufactured Work-in-progress turnover = Average work-in-progress inventory inventory of a firm.

Debtors turnover = measures the activity/liquidity of inventory of Inventory Turnover i. Average collection period = Months (days) in a year Debtors turnover i.Debtors Turnover Ratio Liquidity of a firm’s receivables can be examined in two ways. Credit sales i. a firm.41 . © Tata McGraw-Hill Publishing Company Limited. the speed with which inventory is credit sales Ageing Schedule enables analysis to identify slow paying debtors. the speed with whichdebtors + Average bills receivable (B/R) Average inventory is sold 2. Management Accounting 6 . Inventory =Months (days) in a year (x) (Average Debtors + Average (B/R) Alternatively Turnover measures the activity/liquidity of inventory of a Total sold firm.

Inventorycapital turnover = Costactivity/liquidity of inventory of Turnover measures the of goods sold v. a firm. Management Accounting 6 . Inventory Turnover measures the activity/liquidity of inventory of iii. the speed with which inventory total assets Average is sold ii. Working Net working capital a firm. the speed with which inventory is sold © Tata McGraw-Hill Publishing Company Limited.Assets Turnover Ratio Assets turnover indicates the efficiency with which firm uses all its assets to generate sales. Total assets turnover = Inventory Turnover measures the activity/liquidity of inventory of i.42 . Fixed assets turnover = Cost of goods sold Average fixed assets Cost of goods sold i. the speed with which inventory is sold employed Cost of goods sold iv. Cost of goods sold i. Current assets turnover = Average current assets i. Capital turnover = Average capital a firm.

3) Earnings per share (EPS) = Net profit available to equity shareholders’ (EAT – Dp)/Number of equity shares outstanding (N). © Tata McGraw-Hill Publishing Company Limited. Return on equity funds = (EAT – Preference dividend)/Average ordinary shareholders’ equity (net worth).43 . Book value per share = Ordinary shareholders’ equity/Number of equity shares outstanding. 8) 9) Price-earnings (P/E) ratio = Market price of a share/EPS.1) 2) Return on shareholders’ equity = EAT/Average total shareholders’ equity. Dividend payment/payout (D/P) ratio = DPS/EPS. 5) 6) 7) Earnings yield = EPS/Market price per share. Management Accounting 6 . 4) Dividends per share (DPS) = Dividend paid to ordinary shareholders/Number of ordinary shares outstanding (N). Dividend Yield = DPS/Market price per share.

44 . (1) Rate of return on assets (ROA) can be decomposed in to (i) Net profit margin (EAT/Sales) (ii) Assets turnover (Sales/Total assets) (2) Return on Equity (ROE) can be decomposed in to (i) (EAT/Sales) x (Sales/Assets) x (Assets/Equity) (ii) (EAT/EBT) x (EBT/EBIT) x (EBIT/Sales) x (Sales/Assets) x (Assets/Equity) © Tata McGraw-Hill Publishing Company Limited.Integrated Analysis Ratio Integrated ratios provide better insight about financial and economic analysis of a firm. Management Accounting 6 .

Rate of Return on Assets EAT as percentage of sales EAT Divided by Sales Sales Fixed assets Gross profit = Sales less cost of goods sold Minus Expenses: Selling Administrative Interest Assets turnover Divided by Plus Total Assets Current assets Alternatively Shareholder equity Plus Long-term borrowed funds Plus Current liabilities Minus Income-tax © Tata McGraw-Hill Publishing Company Limited.45 . Management Accounting 6 .

46 . Inventory Turnover measurestaxes x x Earning Power = a firm.Return on Assets Earning Power Earning power is the overall profitability of a firm. the speed with which inventory isTotal Assets Total assets Sales sold © Tata McGraw-Hill Publishing Company Limited. Net profit margin = Earning after taxes/Sales Asset turnover = Sales/Total assets Earning after the activity/liquidity of inventory of Sales EAT i. Management Accounting 6 . is computed by multiplying net profit margin and assets turnover. Earning power = Net profit margin × Assets turnover Where.

Total assets 4. whereas the sales of firm B aggregate Rs 40. Net profit 3.EXAMPLE: 8 Assume that there are two firms.00. that is.000. Rs 40.000. each having total assets amounting to Rs 4.000 1 10 10 6 . Profit margin (2 ÷ 1) (per cent) 5. A and B. Table 4: Return on Assets (ROA) of Firms A and B Particulars 1.000 40.000 40. Determine the ROA of firms A and B.000.47 © Tata McGraw-Hill Publishing Company Limited. Firm A has sales of Rs 4. Table 4 shows the ROA based on two components. ROA ratio (4 × 5) (per cent) Firm A Rs 4.00.000 4.00.000 4. Assets turnover (1 ÷ 3) (times) 6. Net sales 2.00.000.00.000 10 1 10 Firm B Rs 40. and average net profits after taxes of 10 per cent.00. Management Accounting . each.00.

48 © Tata McGraw-Hill Publishing Company Limited. Inventory Turnover measures the activity/liquidity of x = x Sales Earnings before taxes speed with which inventory is sold Sales inventory of a firm. the EBIT As a result of three sub-parts of net profit ratio. the ROE is composed of the following 5 components.Return on Equity (ROE) ROE is the product of the following three ratios: Net profit ratio (x) Assets turnover (x) Financial leverage/Equity multiplier Three-component model of ROE can be broadened further to consider the effect of interest and tax payments. Net Profit EBT EBIT EAT i. Management Accounting . EAT EBT x EBT EBIT x EBIT x Sales Sales Assets x Assets Equity 6 .

00.000 0.26.538 40.000 61.00.84 10 1.00. Table 5: ROE (Five-way Basis) of Firms A and B Particulars Net sales Less: Operating expenses Earnings before interest and taxes (EBIT) Less: Interest (8%) Earnings before taxes (EBT) Less: Taxes (35%) Earnings after taxes (EAT) Total assets Debt Equity EAT/EBT (times) EBT/EBIT (times) EBIT/Sales (per cent) Sales/Assets (times) Assets/Equity (times) ROE (per cent) Firm A Rs 4.4 1 2 20 Firm B Rs 40.462 (Firm B) for the facts contained in Example 8.50.000 1.79 19.00.A 5-way break-up of ROE enables the management of a firm to analyse the effect of interest payments and tax payments separately from operating profitability.6 16 6 .000 0.50. Management Accounting .65 0.000 39.65 0.26.462 (Firm A) and Rs 39.00.462 77.000 4.000 2.000 2.22.538 40.000 3.462 73. To illustrate further assume 8 per cent interest rate.000 4.538 21.000 2.00. 35 per cent tax rate and other operating expense of Rs 3. Table 5 shows the ROE (based on the 5 components) of Firms A and B.000 61.538 21.49 © Tata McGraw-Hill Publishing Company Limited.538 16.84 1.538 12.22.

These statements convert absolute sums into more easily understood percentages of some base amount. Nevertheless.Common Size Statements Preparation of common-size financial statements is an extension of ratio analysis. they are an important tool of financial analysis. It is sales in the case of income statement and totals of assets and liabilities in the case of the balance sheet.50 . Management Accounting 6 . They are as good or as bad as the data itself. Limitations Ratio analysis in view of its several limitations should be considered only as a tool for analysis rather than as an end in itself. © Tata McGraw-Hill Publishing Company Limited. The reliability and significance attached to ratios will largely hinge upon the quality of data on which they are based.