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# 1 RATIO ANALYSIS:

Ratio analysis is a power full tool of financial analysis based on ratio. A ratio is defined the indicate quotient up to mathematical expression. In financial analysis ratio is used as a benchmark evaluating the financial position and performance of a firm. The absolute accounting figure reported in the financial statements do not provide as mining full understanding of the financial position of a firm, but well expressed int e r m s o f r e l a t e d f i g u r e , i t y i e l d s s i g n i f i c a n t i n f e r e n . R a t i o a n a l y s e s r e f l e c t a quantitative relationship that helps to form qualitative judgment.

Definition:
Ratio analysis is a systematic use of ratio to interpret of the financial statement s o t h a t the strength and weakness of the firm, it is a historical performance a n d i t current financial condition can be determine. --- Khan & Jain.

## Ratio analysis involves three steps that are as follows:

1. Selection of data, which is relevant to the objective of

analysis and calculation of the appropriate ratio. 2. C o m p a r i s o n o f the past and present ratio of the same

f i r m a n d / o r w i t h t h e industry standard. 3. E v a l u a t i o n a n d d r a w i n g i n f e r e n c e s .

Objective of ratio analysis:1. T o h e l p i n f o r e c a s t i n g : - F i n a n c i a l m a n a g e r f o r f u t u r e f i n a n c i a l p l a n n i n g c a n use the ratio. Ratio calculated for a number of your work as a guide for the future. 2. To help to control: - it is a very useful in controlling the areas of inefficiencies or weakness. 3. T o h e l p i n e f f i c i e n c y a p p r a i s a l : - t h e r a t i o s a r e t h e s c a l e o f c o m p a r i s o n ; b y conducting inter -firm and intra-firm comparison efficiency of the firm can be appraised.

4. T o h e l p i n e v a l u a t i o n o f f i n a n c i a l p o s i t i o n Classification of Ratio -

Ratios are classified as: > Turnover Ratio: - reflects the firms efficiency in utilizing its assets. > Coverage Ratio: - show the proposition of debt and equity in financing the firms assets. > Profitability ratios: - measures effectiveness of the firm. > Liquidity Ratio: - the ratio checks the ability of firm to fulfill in short term liability. all over all performance and

RATIO ANALYSIS 1.Liquidity Ratio:Liquidity means ability of the business to pay its short-term liabilities. In ability to payoff shot term liabilities affects its creditability. These ratio are also termed as Working capital or short - term solvency Ratio. An enterprise must have adequate Working Capital to run its day -to-day operation. The liquidity ratio provides a quick measure of liquidity of the firm by establishing a relationship between current assets and current liabilities. On the basis of Liquidity Ratio, the firm ensures a proper balance between high liquidity and lack of liquidity.

2.Current Ratio: Current Ratio measure short term debt paying ability. I t i n d i c a t e s t h e availability of current assets in rupee of current liability. A ratio greater than one means t h a t t h e f i r m h a s m o r e c u r r e n t a s s e t s a n d c u r r e n t c l a i m s a g a i n s t t h e m . A g e n e r a l l y acceptable current ratio is 2 to 1. But whether or not a specific Ratio is satisfactory depends on the nature of the business and the characteristic of its current assets and liabilities.

3.Quick Ratio: A Quick ratio is a more penetrating test of liquidity. It is a refined measure of the short-term debt paying ability by measuring short term liquidity. By excluding inventories it concentr ates on the really liquid assets, with value that is fairly certain. Quick Ratio tests the ability of the business to meet its current obligation even when the sales revenue disappears. A Ratio of 1:1 is considered to represent a satisfactory current financial condition; however it does not necessarily imply sound liquidity position.

4.TURN OVER RATIO:These ratios are concerned with measuring the efficiency in assets management. The turnover with which assets are managed/ used is reflected in the speed and rapidity with which they are converted into sales. Thus, the turnover ratio are the taste of relationship between sales/cost of goods sold and assets. The most common ratio which indicates the efficiency of the business is as follows. 1) I n v e n t o r y t u r n o v e r r a t i o 2) W o r k i n g c a p i t a l t u r n o v e r r a t i o 3) F i x e d t u r n o v e r r a t i o 4) T o t a l a s s e t s t u r n o v e r r a t i o

4 (a) Inventory Turn Over Ratio:This ratio finds out the number of times inventory is turned over on an average in a year. This ratio is calculated for findings at what extent the inventory has been utilized efficiently and what proportion of working Capital has been locked up in inventory.

## Formula: Stock Turnover Ratio = Cost of Goods Sold / Average Stock

4 (B) Working Capital Turnover Ratio:This ratio measures the number of times the working capital is turned over during the year. In a way this ratio also throws light on operating cycle (conversion of current assets into cash) of the company. A low ratio indicates slow moving operating cycle where as a high level implies that the companys current assets are utilized efficiently.

Formula :Working Capital Turnover Ratio = Cost of Goods Sold / Working Capital

4 ( c ) Fixed Assets Turnover Ratio:This ratio signifies the number of time to fixed assets are rotated or used in business. A high ratio indicates that fixed assets are contributing quit substantially in making sales, while low ratio indicates that fixed assets are not being used efficiently.

Formula:Fixed Assets Turnover Ratio = Cost of Goods Sold/ Net Fixed Assets

4 ( d )Total Assets Turnover Ratio:Measure the activity of the assets and the ability of the business to generate sales through the use of the assets. It revels the efficiency in managing an utilizing the total assets

5.LEVERAGE RATIOS: This is calculated to judge the long-term financial position of the firm. These ratios indicate mix of fund provided by owners and lenders. These ratios indicate the extent to which the interest of the person entitled to get a fixed return or a scheduled repayment s per the agreed term, are safe. The higher the cover the better it is.

6.Net Asset to Net-worth ratio: This is another alternative way of expressing the basic relationship between debt & Equity. This ratio gives the funds contributed together by lenders and owners for each rupee of owners contribution. Debt equity ratio: - It is also popular known as `external internal equity ratio. It relates all short-term &long-term recorded creditors claim on assets to the owners recorded claim in order to measures the firms obligation to creditor in relation to funds provided by the owner.

7.PROFITABILITY RATIO:Profitability reflects the final result of business operations. Profitability ratios are calculated t measure the operating efficiency of the company. Beside management of the organization, creditors and owners are also interested in the profitability of the firm. Various profitability Ratios are, 1) Gross Profit

2) Net Profit Ratio 3) Return on Assets 4) Return on Equity 5) Return on capital Emplo yed

7. (a) Gross Profit Ratio:This ratio reflects with which management produce each unit of product. Gross profit ratio show profit relative to sales after the deduction of production cost. A high gross profit margin relative to industry average implies that the firm is able to produce at relatively lower cost. Where as a low gross profit margin may reflect higher cost of goods sold. Due to the firms inability to purchase raw materials at favorable terms, inefficient utilization of plant and machinery, or over investment in plant and machinery, resulting in higher cost of production. This Ratio will also be low due to the fall in prices in the market or mark reduction in selling price.

## Formula : Gross Profit Ratio = Gross Profit / Net Sales *100

7 (b) Net Profit Ratio:This ratio is the overall measure of the firms ability to turn each rupee sales into Net profit. If the net margin is inadequate, the firm will fail to achieve satisfactory return on share holder funds. This ratio also indicates the firms capacity to with stand adverse economic conditions. A firm with a higher net margin ratio would be in an advantage position to survive in the face of falling selling price, rising cost of production or decline demand for the product of net profit

Formula: Net Profit Ratio = Net Profit / Net sales *100 Operating Net Profit = Operating Net Profit / Net Sales *100

Here, Operating Net Profit = Gross Profit Operating Expenses such as Office and Administrative Expenses, Selling and Distribution Expenses, Discount, Bad Debts, Interest on short-term debts etc.
Fixed Assets Turnover Ratio :- This ratio reveals how efficiently the fixed assets are being
utilized. This ratio is particular importance in manufacturing concerns where the investment in fixed asset is quit high. Compared with the previous year, if there is increase in this ratio, it will indicate that there is better utilization of fixed assets. If there is a fall in this ratio, it will show that fixed assets have not been used as efficiently, as they had been used in the previous year.

Formula:Fixed Assets Turnover Ratio = Cost of Goods Sold/ Net Fixed Assets Here, Net Fixed Assets = Fixed Assets Depreciation

7 ( d ).Return on Equity:A return on shareholder equity is calculated to see the profitability of owners investment. Return on equity indicates how well the firm has used the resources of owners. This ratio is, thus, of great interest to the present as well as the prospective shareholder and also of great concern to management, which has the responsibility of maximizing the owners welfare.

Formula:
Return on Equity Shareholders Funds = Net Profit (after int., tax & preference dividend) / Equity Shareholders Funds *100

7 (e) .Return on Capital Employed:This is a percentage of profit to capital employed. It is the only measure, which can be said to show the overall satisfactory performance of an under taking from the stand point of profitability. It enables the management to show whether the funds entrusted to it have been properly used or not. Higher the ratios better the result.

Formula: Return on Capital Employed = Profit before interest, tax and dividends/ Capital Employed *100 Where, Capital Employed = Equity Share Capital + Preference Share Capital + All Reserves + P&L Balance +Long-Term Loans- Fictitious Assets (Such as Preliminary Expenses OR etc.) Non-Operating Assets like Investment made outside the business. Capital Employed = Fixed Assets + Working Capital

8.Earning Per Share (E.P.S.) :- This ratio measure the profit available to the equity
shareholders on a per share basis. All profit left after payment of tax and preference dividend are available to equity shareholders. This ratio helpful in the determining of the market price of the equity share of the company. The ratio is also helpful in estimating the capacity of the company to declare dividends on equity shares.

Formula:
Earning Per Share = Net Profit Dividend on Preference Shares / No. of Equity Shares

9.Creditors Turnover Ratio :- This ratio indicates the relationship between credit
purchases and average creditors during the year . This ratio indicates the speed with which the amount is being paid to creditors. The higher the ratio, the better it is, since it will indicate that the creditors are being paid more quickly which increases the credit worthiness of the firm.

Formula:Creditors Turnover Ratio = Net credit Purchases / Average Creditors + Average B/P Note :- If the amount of credit purchase is not given in the question, the ratio may be calculated on the bases of total purchase.

10.Proprietary Ratio:- This ratio indicates the proportion of total funds provide by owners
or shareholders. This ratio should be 33% or more than that. In other words, the proportion of shareholders funds to total funds should be 33% or more. A higher proprietary ratio is generally treated an indicator of sound financial position from long-term point of view, because it means that the firm is less dependent on external sources of finance. If the ratio is low it indicates that long-term loans are less secured and they face the risk of losing their money.

Formula:
Proprietary Ratio = Shareholders Funds/Shareholders Funds + Long term loans