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Management Science-II Prof. R.

Madumathi

MODULE 2

Business Analysis

Types Of Business Analysis


• Comparative Statements

• Ratio Analysis

• Break Even Analysis

Comparative Statements

Comparative statements present the accounts of two or more consecutive

years side by side, such that an absolute comparison of the financial statement

position of a business enterprise can be made. The comparative statements also

indicate the percentage change over the previous year. This indicates the

upward or downward trend of specific accounts in the balance sheet.

Indian Institute of Technology Madras


Management Science-II Prof. R.Madumathi

Comparative Statement

Particulars Amount Amount %change


ASSETS 60,000 68,000 13.3%
Land and Buildings 15,000 12,000 - 20%
Plant and Machinery 25,000 35,000 40%
Stock 5,000 6,000 -20%
Debtors 12,000 14,000 16.7%
Cash and Bank balance 3,000 1,000 -66.7%
LIABILITIES 20,000 25,000 25%
Creditors 2,000 6,000 200%
Term Loan 8,000 12,000 50%
Debentures 10,000 7,000 30%
CAPITAL 40,000 43,000 7.5%
Share capital 20,000 25,000 25%
Preference capital 15,000 15,000 0%
Reserves 5,000 3,000 -40%

Ratio Analysis

The relationship between two relevant accounting information is termed as


a ratio. Ratios are hence relative measures and help in business enterprise
evaluation across years, enterprises, and industries.

Types Of Ratios
• Profitability Ratios
• Liquidity Ratios
• Turnover Ratios
• Leverage Ratios
• Market Measure Ratios

Indian Institute of Technology Madras


Management Science-II Prof. R.Madumathi

Profitability Ratios
Net Profit Ratio
Higher the net profit ratio better the operational performance of the
company. An increase in the net profit ratio is always viewed positively.

Return on Investment

An improvement in the return on investment is viewed favorable by the


company. When the ratio is higher than the industry standard / expected ratio,
the company’s profitability position will be considered good.

Indian Institute of Technology Madras


Management Science-II Prof. R.Madumathi

Indian Institute of Technology Madras


Management Science-II Prof. R.Madumathi

Liquidity Ratios

Current Ratio
The current ratio indicates the solvency position of a company.

The higher the current ratio the safer the solvency poison of the company. This

confirms the ability of the company to meet its current obligation through its

current assets. Caution should be exercised in deriving the implication of a very

high ratio. Very high ratio then industry standards or expected figure would

indicate that the company could shift funds locked up in current assets to earning

assets (long term). So that future returns could be high.

Acid – test ratio / Quick Ratio


The immediate debt paying ability is indicated by the quick ratio.

A quick ratio position of 1.0 would be an adequate position for the company, here

also very high ratios do not indicate profit positions, through they might indicate

safe liquidity position for the company.

Indian Institute of Technology Madras


Management Science-II Prof. R.Madumathi

Indian Institute of Technology Madras


Management Science-II Prof. R.Madumathi

Indian Institute of Technology Madras


Management Science-II Prof. R.Madumathi

Turnover Ratios
Inventory Turnover Ratio
The relationship between cost of goods sold and inventory

level held by the company is measured by this ratio. This ratio is best utilized by

comparing it with industry standards or expectations. A very low ratio to this

standard indicates that huge inventory positions are held by the company that

needs to be managed properly. A very high ratio might indicate that ‘out-of-stock’

situation could be faced by the company.

Debtors Turnover Ratio


The collection process of the credit transaction is reflected

by this ratio. An increase in the debtors turnover ratio indicates that the collection

process has improve. On the other hand if the ratio has declined from that of the

previous accounting duration, their indicates that the collection process has to be

strengthened by the company.

Creditors Turnover Ratio


The payment process of the credit transactions is indicated by this ratio. The

larger the payment duration than the collection duration the company has an

advantage in its overall credit policy.

Asset Turnover Ratio


The higher the asset turnover ratio, the better is the asset utilization position of

the company. This indicates that the company is able to generate more revenue

for a investment in fixed assets.

Indian Institute of Technology Madras


Management Science-II Prof. R.Madumathi

Indian Institute of Technology Madras


Management Science-II Prof. R.Madumathi

Indian Institute of Technology Madras


Management Science-II Prof. R.Madumathi

Indian Institute of Technology Madras


Management Science-II Prof. R.Madumathi

Indian Institute of Technology Madras


Management Science-II Prof. R.Madumathi

Leverage Ratio
Debt Equity Ratio

The extent of external borrowing by the company is given


by the debt-equity ratio. This ratio indicates the margin of safety for the debt
holders in a company. Lower the ratio higher the margin of safety for the debt
holders.

Indian Institute of Technology Madras


Management Science-II Prof. R.Madumathi

Market Measure Ratios

Book value per share


The book value per share is the intrinsic value of the
company. This is the historical value for the investor of a company. Higher book
values then the marketed price indicates that the company is under priced by the
market.

Dividend Per Share


Dividend Per Share payment given to the shareholders of
the company. High dividend payments usually reduce the market price of a
company.

P/E Ratio
Price Earning multiplier compares the earnings of the company to the market
price. A low P/E ratio indicates under pricing by the market.

Dividend yield
Dividend yield is a profitability measure. Higher the dividend yield higher the cash
return to the investor. This indicates immediate cash return to the shareholder
from investment in the company.

Market Measure Ratios

• Book Value Per Share:


Book value / Number of Outstanding Shares

• Earnings Per Share:


Net Earnings / Number of Outstanding Shares

• Dividend Per Share:


Dividend Declared/ Number of Outstanding
Shares

• Dividend Yield:
Dividend Per Share / Market Price

• P/E Multiplier:
Earnings Per Share / Market Price

Indian Institute of Technology Madras


Management Science-II Prof. R.Madumathi

Example – Income Statement

'2001 '2000 '1999


Sales 7825.4 7423.8 7291.5
Excise 446.8 467.7 408.7
Net Sales 7378.6 6956.1 6882.8
Expenditure 6547 6107.7 6090.5
Op. Profit (PBDIT) 831.6 848.4 792.3
Interest 493 429.1 282.4
Gross Profit (PBDT) 338.6 419.3 509.9
Depreciation 313.1 293.2 268.1
PBT 25.5 126.1 241.8
Other Income (OI) 312.6 255.2 279.8
PBT + OI 338.1 381.3 521.6
Tax 39.7 22.9 5.5
Reported Net Profit 4.3 4.9 6.8
Net Extraordinary
43.5 36.2 16.4
Items
Net Profit (PAT) 315.1 341.5 470.8
Equity 248.6 248.6 248.5
No of Share
248600 248600 248500
Outstanding ('000)

Indian Institute of Technology Madras


Management Science-II Prof. R.Madumathi

Example – Balance Sheet

'2001 '2000 '1999


Liabilities
Equity 248.6 248.6 248.5
Preference Capital 0 0 0
Reserves and Surplus 3750.8 3615.6 3457.7
Net Worth 3999.4 3864.2 3706.2
Debt 4263.4 3973.7 3358.8
Total Liabilities 8262.8 7837.9 7065
Assets
Net Fixed Assets 4538.8 4346.9 4060.6
Capital Working in Progress 132.2 241.9 494.2
Investments 813.5 774.2 489.4
Net Working Capital 2734.8 2438.9 2004.4
Miscellaneous Expenses not
43.5 36.2 16.4
written off
Total Assets 8262.8 7838.1 7065

Indian Institute of Technology Madras


Management Science-II Prof. R.Madumathi

Example – Ratio Analysis

'2001 '2000 '1999


Operating Profit Margin (OPM
11.3 % 12.2% 11.5 %
%)
Net Profit Margin (NPM %) 4.3 % 4.9 % 6.8 %
Sales Growth (%) 73.4 % 97.5 % --
Operating Profit Growth (%) 80.7 % 118.3 % --
Net Profit Growth 117 % 124 % --
Balance Sheet Ratios
Debt/ Equity (D/E) 1.1 1.1 1.1
Interest/Debt 1261.6 1069.1 1069.4
RONW (%) 7.9 % 8.8 % 12.7 %
Depreciation / Fixed Assets (%) 0.1 % 0.1 % 0.1 %
Fixed Assets / Sales 0.6 0.6 0.6
Sales/Fixed asset + working
2736.5 2440.6 2006.2
capital
Share Statistics
EPS (Rs) Rs 12.7 Rs 13.7 Rs 19
Cash EPS (Rs) Rs 25.3 Rs 25.5 Rs 29.7
Book Value 160.9 155.4 149.1

Break Even Analysis


A business is said to break even which its total sales are equal to its total costs. It

is a point of no profit or no loss. Hence, contribution can be defined as sales less

variable cost. Using this definition, break even point may be said to be that point

at which contribution is equal to fixed cost.

Indian Institute of Technology Madras


Management Science-II Prof. R.Madumathi

Break Even Formula

Indian Institute of Technology Madras


Management Science-II Prof. R.Madumathi

Example

Particulars Amount (Rs.)

Sales (80,000 units @ Rs.50) 4000000

Less: Variable costs (80,000 units @ Rs.30) 2400000

Contribution margin 1600000

Less: Fixed expenses 900000

Operating income 700000

Break Even Point


45000
= 900000/(50-30) Units

Break Even Point


2250000
= 900000/(50-30)* 50 Value

Indian Institute of Technology Madras