You are on page 1of 23

An Introduction to Financial Ratio Analysis

Financial ratio analysis is a useful technique to measure, compare, and evaluate the financial condition and performance of a customer. Ratio analysis enables a credit manager to spot trends in a customer's financial performance, and to compare its performance and financial condition with the average performance of similar businesses in the same industry. Balance sheet ratios measure liquidity and solvency (a business's ability to pay its bills as they come due) and leverage (the extent to which the business is dependent on creditors).

Financial ratio analysis is used by credit professionals to answer these questions about customers:

Is the business profitable? Can the business pay its bills on time? How is the business financed? How does the company financial performance this year compare to last year? How does the customer's performance compare with its competitors? How does the customer's performance compare to the industry norms?

Financial ratio analysis is a useful tool for determining a customer's overall financial condition. Industry-wide financial ratios are published by a variety of sources, including Dun & Bradstreet. Financial ratios are useful for making quick comparisons. Banks and trade creditors use financial ratio analysis to help them decide whether a business is a good credit risk or not. Ratio analysis is a tool to help evaluate the overall financial condition of a customer's business. Ratios are useful for making comparisons between a customer and other businesses in an industry. A financial ratio is a simple mathematical comparison of two or more entries from a company's financial statements. Creditors use ratios to chart a company's progress, uncover trends and point to potential problem areas.
Liquidity Ratios

These ratios indicate the ease of turning assets into cash. Liquidity refers a company's ability to meet current obligations with cash or other assets that can be quickly converted to cash. Liquidity Ratios give an indication

of a company's short term financial or solvency. They include the Current Ratio, Quick Ratio, and Working Capital.

The Current Ratio formula is: Current assets divided by current liabilities. The current ratio is one of the best-known measures of financial liquidity. The current ratio is the standard measure of any business' financial health. It will tell you whether a customer is able to meet its current obligations by measuring if it has enough assets to cover its liabilities. The Quick Ratio formula is: (Current assets less inventories) divided by current liabilities. The quick ratio (also sometimes called the acid test ratio) measures a customer's liquidity. The quick ratio is more 'strenuous' than the current ratio because it attempts to answer the question of whether current liabilities could be paid without selling inventory.

Leverage Ratios

Leverage ratios measure the relative contribution of stockholders and creditors. Leverage ratio indicates the extent to which the business is reliant on debt financing (creditor money versus owner's equity). Leverage Ratios which show the extent that debt is used in a company's capital structure

The Debt to Equity ratio formula is: Total liabilities divided by total equity. This ratio indicates how much the company is leveraged (in debt) by comparing what is owed to what is owned. A high debt to equity ratio could indicate that the debtor company may be overleveraged [too reliant on debt as a source of funding] and should look for ways to reduce its debt. The Interest Coverage Ratio formula is: Earnings before Interest, Taxes, Depreciation and Amortization divided by Interest Expense. This ratio indicates what portion of debt interest is covered by a company's cash flow situation. Profitability Ratios Profitability refers to a company's ability to generate revenues in excess of the costs incurred in producing those revenues. The Gross Profit Margin formula is: Gross Profit divided by Total Sales. The gross profit margin ratio indicates how efficiently a business is using its materials and labor in the production process. The Return on Sales formula is: Net profit divided by sales. This ratio compares after tax profit to sales. It can help you determine if you are making an adequate return on sales.

The Return on Assets formula is: Net Income divided by Average Total Assets. The higher the percentage rate that a company has the better.

Efficiency Ratios

The Inventory Turnover Ratio formula is: Cost of goods sold divided by average inventory. In general, the higher the turnover ratio the better the company is performing and the less likely it is that your customer has a lot of obsolete and slow moving inventory that sooner or later will need to be disposed of at a loss. The Asset Turnover formula is: Net sales divided by average total assets. Asset turnover is an indicator of how efficiently a firm utilizes its assets to generate sales and profits. If the ratio is high, it implies that the firm is using its assets efficiently.

In modern fashion technology, the demand for perfection begins right at the birth of the raw material, permeates through every single process, till the highly discerning customer dons the finished garment. It is this demand for perfection that has spurred the growth of an organisation and its corporate philosophy. Those who can furnish clients with the best quality, competitive price, excellent customer services and prompt delivery can only survive in the market. Super Spinning Mills Limited takes immense pride in perceiving its role as the comprehensive architect of every single yarn that its produces. SARA ELGI is a multi-unit, multi-interest business group with a wide range of industrial activity, an organisation that has founded its evolution on value-based commercial practice. Super Spinning MillsLimited was established in 1962 with an initial capacity of 12,000 spindles. Over its four decades of chequered growth it has expanded to 1,66,526 spindles spread over 4 operational units. The company commenced operations with the manufacture of grey, gassed, mercerised and dyed cotton yarn. Today, the company has carved a niche for itself on the textile map of the country.

Group Companies

ELGI Electric & Industries Ltd. SARA ELGI Industries Ltd. ELGI Building Products Ltd. SARA Trading & Industrial Services Ltd. SARA Envirotech Ltd SARA ELGI Industrial Research & Development Ltd. SARA ELGI Insurance Advisory Services Pvt.Ltd. SARA ELGI Arteriors Ltd. Super Farm Products Ltd.

Related Companies

ELGI Equipments Ltd. Treads direct Ltd.

L.G.Balakrishnan & Bros. Ltd.

ELGI Ultra Industries Ltd. Precot Meridian Limited Each company in the Group specializes in a specific area, thus enabling us to better meet the diverse needs of the industry. Our companies are focused on meeting our customers individual needs. We exist to provide superior customer satisfaction developing solid, long-term relationships with our customers.

We believe that quality products are not only by promises but also by proven results. Development of new textile products is done through Innovation in defining production processes of higher quality and making available modern technologies and professionals with the highest level of competence.


Combed Cotton Yarn for Knitting and Weaving

The following advantages which have always been our ultimate goals:
o o o

High Efficiency The Most Competitive & Reasonable Price Products Quality Guarantee Prompt & Superior Service Punctual Delivery NE 20s to NE 120s Regular Grey Yarn Single / Double (Ring Double / TFO) Compact Single & Double, Elitwist Gassed Yarns Open-End Yarn GOTS certified organic cotton yarn in hank and cone (Ne 6s ,Ne 10s & Ne 2/10s) BCI cotton yarn in hank and cone (Ne 6s ,Ne 10s & Ne 2/10s) Conventional cotton yarn in hank and cone (Ne 10s )

To meet out the customer requirements we have various options in raw materials :

Indian Cotton GIZA GIZA Blends PIMA BCI cotton Organic Cottons

Constant commitment to high quality standards and innovation has been the secret of success ever since the company was founded. Superior Spinning units ensure the supply of consistent quality yarn to manufacture the garments. Our Spinning Units leads the quality of yarn in the market. Ultimately, the crunch lies in the infusion of hi-tech, state-of-the-art machinery that aids in the production of high quality 100% combed yarn, in counts that range from NE 20s to 120s in single and double. The testimony to modernisation and up gradation lies in the fact that the oldest machine in the plant is less than 10 years. Coupled with global standards of process manufacturing that turn out year of superior quality in durability as well as finish.



Production Capacity 60,000 Kgs per day Superior Quality imported machines installed at Super Spinning Mills include: RIETER

Vision Shield Foreign Fibre Remover in Blow Room Unifloc A10, A11 Drawframe RSB 851 & D30 Unilap E32, Combers E 7/5 A, E 7/6, E62 Suessen Elite Compact Ring Frame LAKSHMI RIETER

Flexifloc, Varioclean, Unimix Cards LC 300 A, LR C 1/3 Drawframes RSB 851 Combers LK 250 & E 7/4 Speed Frames LF 1400 & 1400A,1665 Ring Frames G 5/1, LR6 TRUTZSCHELER : Cards DK 803 & 903 CROSOL : Cards MK 5A & 5B

The company has a long reputation for quality, performance and innovation. Quality of final product is determined with quality of raw material. In Super Spinning Mills, we take meticulous care in the selection of cotton. Our dedicated, committed and involved cotton selectors at different stations headed by experienced supervisors, spares no pain in the selection of Kapas or Raw cotton available in the market. There are quality checks at every stage of manufacturing starting from Raw Cotton. Investments in sophisticated instruments from world-renowned manufacturers like Zellweger USTER are an integral part of the plan to implement Total Quality Assurance. In conformance with industry norms worldwide, the company has established laboratory facilities at each unit, equipped with ultra-modern testing instruments.

Social Responsibilities REACHING TO THE UNREACHED

Finding ways to marketing their rotational crops. Special price for seed cotton during conversion period in order to support the farmers. The farmers are given training on latest technologies of farming practices through Farmers field school. Farm equipments given to farmer groups for effective management Practices. The farm weeders helps to reduce labour cost and covers large area in short time. Post Harvest training is given to avoid contamination. Contamination Kits supplied to Farmers at free of cost Contamination controlstarts fromfarm level

The cotton cloth weavers of India have been known since the earliest days of recorded history. A fragment of madder-dyed cloth found in the Indus Valley excavation in northern India showed that weaving and dyeing were flourishing arts over 5,000 years ago. They were skills that were to increase and diversify down the centuries, attracting wider and more lasting acclaim. The Roman historian, Pliny, bewailed the flight of Roman gold to India because of the Roman passion for Indian fabrics. St. Jerome's Latin translation of the Bible (4th Century A.D.) quotes the ancient patriarch Job as saying that wisdom was more enduring than the dyed colors of India. Arab travelers in 9th Century India reported that "...they make garments of such extraordinary perfection that nowhere else is their likeness to be seen..." Marco Polo observed that the art of embroidery, as practised in Gujarat in the 13th Century, was incomparable. It was not only the technique of dyeing that made India's textiles famous. The fabrics were embellished with scintillating designs which India alone could offer. There were some of which every thread of warp and weft was dyed before being placed on the loom; a design appeared as the weaving progressed and was identical on either side. It was the craft of the individual artist who inherited his skill from his forbears and who gave his own aesthetic conception to the products he made with his own hands.

The need for change

Then it all changed. The 19th Century brought with it the industrial revolution and the era of mass-produced goods, versatile and cheap but with the impersonality of the machine. Hand-woven products, rich and warm as they were, became costly luxuries. The Indian textile industry--unchallenged for nearly 30 centuries--had to adapt to the new age or perish. A humble beginning was made in Bengal in 1818 with British patronage but the real foundation of the India's modern cotton mill industry was laid 36 years later in Mumbai (formerly known as Bombay). On 2nd February 1854, the Bombay Spinning Mills

started functioning with 20,000 spindles. It was the beginning of an era, not only in the sphere of textiles, but in the entire industrial world of India. Thus the new foundations were firmly laid; there was no looking back and despite upheavals, booms, depressions and all the uncertainties that have marked the last 156 years, the industry has gone further ahead, growing at the rate of an average of four mills a year over that period. The pioneers of the Indian industry were men of purpose, vision, integrity and devotion who were able to graft modern industrial techniques on to the inherent genius of the Indian textile craftsman. In spite of the many challenges they faced--notably from the long established and vigorously promoted cotton textile industry of Lancashire--these men never wavered in their belief that the Indian industry could lead the world. Had they been alive today they would have seen their dreams abundantly fulfilled. The cotton textile industry is the cornerstone of India's industrial progress held in esteem for the superiority of its products the world over.

The modern industry

The use of modern techniques and equipment in the latest processes has made possible increased manufactures of finer fabrics in a variety of mercerised, bleached, dyed and pre-shrunk textiles. With the growing demand from overseas countries--bigger populations, sophisticated ideas-all possibilities are explored to include the widest range of finished fabrics-twills, drills, sateens...prints, drapery fabrics, osnaburgs and ducks...broad cloth, poplins, towelling--the whole range of materials right down to industrial garments. Today, textiles are the largest organized industry in India. It employs more than 35 million workers, and has more than 34 million spindles and 2 million looms. It produced the enormous quantity of 3,052 million kilograms of yarn and 42,109 million square meters of cloth in 2004, and this does not include the 27,945 million square meters produced by the hand-loom and power-loom weavers. More significantly it is one of India's major sources of foreign exchange, being the second largest exporting industry and accounting for about 20 per cent of the total foreign exchange earnings of the country. Indian textiles are exported all over the world. The traditional gray goods have gradually given way to meet the colorful demands of the modern consumer. In fact, the marked increase in the export of finished goods and garments is the most noteworthy and encouraging feature of the Indian cotton industry's emergence on the world's markets.

So a timeless industry continues, taking new shifts in direction but never changing, being as unmistakably Indian as ever it was in its long history.

RATIO ANALYSIS Ratio analysis is a vital tool to help you understand and interpret the financial data of prospective borrowers and is sometimes referred to as the language of loan officers. Each ratio compares two items on the financial statements and shows the relationship between those items. Pertinent ratios help you assess a firm's financial health, evaluate how a loan will aid the business, and help determine if there is a reasonable assurance that the loan can be repaid. In addition, ratios enable you to spot trends in a company's financial condition and performance. Comparison of a company's ratios with industry averages reveals the company's relative strengths and weaknesses. Several publications, such as Robert Morris Associates' Annual Statement Studies, provide industry averages of selected ratios. Generally these sources give a range of ratios; RMA, for instance, presents the ratios in quartiles - the upper quartile representing the strongest ratios; the median representing average ratios; and the lower quartile representing the weakest ratios. As some ratios are calculated more than one way, you should determine how your source defines each of the ratios that you are interested in. Different ratios give you different information about a company. The business type (manufacturer, wholesaler, retailer, or service provider), mode of operations, seasonality of sales and collections, etc., all have a bearing on which ratios are the appropriate ones for you to examine and what an acceptable level for those ratios will be. A company may look favorable based on one ratio and less favorable based on another; so to correctly

appraise a company, you must calculate all pertinent ratios and examine them both individually and as a group. LIQUIDITY RATIOS CURRENT RATIO QUICK RATIO Accounts Receivable Turnover Ratio Inventory Turnover Ratio Accounts Payable Turnover Ratio Sales to Working Capital Ratio Interest Coverage Ratio Cash Flow to Current Portion of Long-Term Debt Ratio Fixed Assets to Net Worth Ratio Debt-to-Worth Ratio Profits Before Taxes to Tangible Net Worth Ratio


Ratio analysis compares income and liabilities that occur during the same period. The goal is to match an item, such as the income a company receives during the year, to another item, such as the debt the company pays during the year. When a ratio has a smaller time frame than a year, the ratio is a short term ratio. If a ratio has a longer time frame than a year, the ratio is a long term ratio. Businesses in the same industry usually have similar financial ratios, and the ratios will vary more between different industries.


A company's ability to pay its bills depends on its total available assets, as well as its liquidity. A company without available cash may have valuable inventory, but it won't be able to pay its bills unless a customer buys the inventory. The quick ratio includes the company's current assets minus inventory, divided by current liabilities, so it shows whether the company can pay its bills without selling products from inventory.

Ratio Analysis is used to obtain a fast indication of a firm's financial performance in several main areas. Ratio Analysis is a type of Financial Statement Analysis and the ratios used are considered to be Short Term Solvency Ratios, Debt Management Ratios, Asset Management Ratios, Profitability Ratios and Market Value Ratios.

Financial ratio analysis is the mathematical relationship between two selected numerical values pulled from a companys financial statement. There are many ratios used in business to figure such things out as a companys solvency, profitability, asset turnover, etc. Financial analystsuse financial ratios to compare strengths and weaknesses of different entities. Financial ratios compares values between companies, industries, time periods for a particular company and between a single company and its industry average. In order to effectively use ratios, they must be benchmarked against something else such as another company. Financial ratios can be expressed as a decimal value, 0.20 or as an equivalent percent value, 20%. Ratios that are usually less than 1, are normally expressed as a percentage.

The values we use in calculating financial ratios come from the income statement, balance sheet, statement of cash flows or statement of retained earnings. Financial ratios results in quantifiable data about a specific aspect of a company. Financial ratios are categorized basedon the financial topic of the business in which the ratio measures.

Activity ratios: measures how quickly a firm converts non-cash assets within the balance sheet to cash or sales. Liquidity ratios: measures the availability of cash to pay short-debt. Debt ratios: measures the firms ability to repay long-term debt. Profitability ratios: assesses a businesss ability to generate earnings as compared to its expenses and other costs. Market ratios: measures investor response to owning a companys stock and also the cost of issuing stock.

List of Ratios
Activity or Efficiency Ratios

Average Collection Period = Accounts Receivable/(Annual Credit Sales/365 days) Receivables Turnover = Net Credit Sales/Average Net Receivables Degree of Operating Leverage (DOL) = % Change in Net Operating Income/% Change in Sales Average Payment Period = Accounts Payable/(Annual Credit Purchase/365 days) Asset Turnover = Net Sales/Total Assets Stock Turnover Ratio = Cost of Goods Sold/Average Inventory Inventory Conversion = 365 days/Inventory Turnover Inventory Conversion Period = (Inventory/Cost of Goods Sold)/365 Days Receivables Conversion Period = (Receivables/Net Sales)/365 Days Payables Conversion Period = (Accounts Payables/Purchases)/365 Days Cash Conversion Cycle = Inventory Conversion Period + Receivables Conversion Period Payables Conversion Period Liquidity Ratios

Current Ratio (Working Capital Ratio) = Current Assets/Current Liabilities Cash Ratio = Cash and Marketable Securities/Current Liabilities Operating Cash Flow Ratio = Operating Cash Flow/Total Debts

Debt Ratios

Debt Ratio = Total Liabilities/Total Assets Debt to Equity Ratio = (Long-term Debt + Value of Leases)/Average Shareholders Equity Long-term Debt to Equity = Long-term Debt/Total Assets Times Interest Earned Ratio = Net Income/Annual Interest Expense Debt Service Coverage = Net Operating Income/Total Debt Service

Profitability ratios

Gross Margin, Gross Profit Margin or Gross Profit Rate = Gross Profit/Net Sales or Gross Margin = (Net Sales Cost of Goods Sold)/Net Sales Profit Margin = Net Profit/Net Sales Return on Equity (ROE) = Net Income/Average Shareholders Equity Return on Assets (ROA) = Net Income/Average Total Assets Return on Net Assets (RONA) = Net Income/(Fixed Assets + Working Capital) Return on Capital (ROC) = EBIT (1-Tax Rate)/Invested Capital Efficiency Ratio = Non Interest Expense/Revenue Net Gearing = Net Debt/Equity Basic Earning Power Ratio = EBIT/Total Assets Market Ratios

Earnings per share (EPS) = Net Earnings/# of Shares Payout Ratio = Dividends/Earnings or EPS P/E Ratio = Market Value per Share/Earnings per Share (EPS) Dividend Yield = Annual Dividends per Share/Price per Share Cash Flow Ratio = Market Price per Share/Present Value of Cash Flow per Share Price to Book Value Ratio = Market Price per Share/Balance Sheet Price per Share Price/Sales Ratio = Market Price per Share/Gross Sales

Ratio Analysis


The traditional financial statements that comprise of the balance sheet and profit and loss account do not give enough information related to financial operations of the company. These financial statements prepared as per the statutory requirement of law need to be analysed in order to evaluate the past performance of the company and the future prospects. There are many tools of financial statement analysis like: 1. Ratio Analysis 2. Dupont Analysis 3. Trend Analysis 4. Commonsize statements 5. Comparative Analysis The most widely used tool is Ratio Analysis. RATIO ANALYSIS It is the most widely used tool since it compares risk and return relationships of firms from various aspects. Ratio analysis is the method or process by which the relationship of items or group of items in the financial statements are computed, determined and presented. It is an attempt to derive quantitative measures or guides concerning the financial health and profitability of a business enterprise. It can be used both in trend and static analysis. There are several ratios at the disposal of an analyst but the group of ratios he would prefer depends on the purpose and objectives of analysis.

standing e. Effective utilization of resources f. Investment Analysis IMPORTANCE OF RATIO ANALYSIS Accounting ratios are very useful in assessing the financial position and profitability of a business enterprise. This can be achieved through comparison by ratios in the following ways: For same enterprise over a no. of years(horizontal analysis) For one enterprise against another in the same industry(third-dimension analysis) For one enterprise against the industry as a whole For one enterprise against the pre determined standards For inter departmental comparisons within an organization OBJECTIVES OF RATIO ANALYSIS Ratios are worked out to analyse the following aspects of an enterprise: a. Solvency: 1. Long term 2. Short term 3. Immediate b. Profitability c. Operational Efficiency d. Credit standing e. Effective utilization of resources f. Investment Analysis