RATIOS Introduction: Ratios are presentation technique, which helps the reader to get idea about the performances

& Position of a firm with least efforts. He can get overall view of the firm from the ratios presented to him. He can compare such ratios with the ratios of the past & also with ratios other firm in industry. For getting insight we must know how such ratios are calculated. Types of Ratios

&iquidity Ratios

Profitability Ratios

olvency Ratios

-ctivity Ratios

Liquidity Ratios: hort term solvency ratios. !Pure Ratio shown in "# " form$
1.

%urrent Ratio &iquid Ratio 'uick Ratio

Current Assets Current Ratio = Current Liabilities

Objective: (he ob)ective is to measure the ability of the firm to meet its short * term obligations and to reflect the short * term financial strength+ solvency of a firm. ,t suggests whether firm can meet its short term obligation from short * term -ssets. Current Assets refer to those assets which are held for their conversion into cash normally within a year. Current Liabilities refer to those liabilities which are e.pected to be matured normally within a year. Interpretation: ,t indicates rupees of current assets available for each rupee of current liability. Higher the ratio, greater is the margin of safety for short*term creditors and vice versa. However, too high+too low ratio calls for further investigation since the too high ratio may indicate the presence of idle funds with the firm or the absence of investment opportunities with the firm and too low ratio may indicate problem of short/term insolvency. (raditionally, a current ratio of 0#" is considered to be a satisfactory ratio.

2 .

Liquid Assets Liquid Ratio or Acid Test =Ratio Liquid Liabilities

Liquid Assets 1 %urrent -ssets * tock Liquid Liability 1 %urrent liabilities * 2ank 3+4 * cash credit Objective: (he ob)ective is to measure the ability of the firm to meet its short * term obligations as and when due without relying upon the reali5ation of stock. Interpretation: ,t indicates rupees of quick assets available for each rupee of liability due on short term notice. (raditionally, a quick ratio of "#" is considered to be a satisfactory ratio. However, this traditional rule should not be used blindly since a firm having a quick ratio of more than ", may not be meeting its short*term obligations in time if its current assets consist of doubtful and slow paying debtors while a firm having a quick ratio of less than ", may be meeting its short*term obligations in time because of its very efficient debtors management.

3.

Quick Assets Quick Ratio = Liquid Liabilities

Quick Assets %urrent ratio less stock and debtor. (his ratio suggests whether available cash & cash equivalent !which can quickly convertible in cash$ are sufficient to meet its short term liabilities. !rofitability Ratios "Al#ays is percenta$e e%cept &!S' In relation to Sales a$ 6ross profit ratio b$ 8et profit Ratio c$ 3perating Ratio In relation to Invest(ent a$ Return on %ap. 7mployed b$ Return on 7quity c$ Return on equity shareholder Fund d$ Return on equity share capital e$ 7arning per share f$ Return on total assets

Inco(e State(ent &ess# 1 &ess# -dd # 1 &ess# 8et ales %ost 3f 6oods old 6ross Profit 3perating 7.p !-dministrative & elling 7.pense$ 3perating income !commission, discount received.$ 3perating Profit !P2,($ 8on operating 7.penses# ,nt. on 4ebentures &oss on ale of assets or loss due to fire

-dd#

1 &ess# 1 &ess# 1
1.

8on/operating ,ncome# ,nterest & 4ividend on ,nvestment Profit on sale of -ssets & ,nvestment 8et Profit before ta. (a. 8et Profit after ta. Preference dividend 7quity Profit

Gross Profit Gross Profit Ratio = 1 ! ! Net ales

6ross Profit 1 ales * %ost of goods sold. %ost of goods sold 1 3pening stock : 8et purchase : Purchase 7.p :wages * closing stock

Objective: (he ob)ective is to determine the efficiency with which production and+or purchase operations are carried on. Interpretation: (his ratio indicates !a$ an average gross margin earned on a sale of Rs. "99, !b$ the limit beyond which the fall in sales prices will definitely result in losses. -nd !c$ what portion of sales is left to cover operating e.penses and non * operating e.penses like to pay dividend and to create reserves. Higher the ratio, the more efficient the production and +or purchase management. (his ratio may increase due to one of the following factors#
2 .

Higher ales Prices with constant %ost of 6oods old; &ower %ost of 6oods old with constant ales Prices; - combination of aforesaid two factors.
Net Profit After Ta" Net Profit Ratio = 1 ! ! Net ales

Objective: (he ob)ective is to determine the overall profitability due to various factors such as operational efficiency. Interpretation: (his ratio indicates !a$ an average net margin earned on a sale of Rs. "99 !b$ what portion of sales is left to pay dividend and to create reserves, and !c$ firm<s capacity to withstand adverse economic conditions when selling price is declining.

3.

#$eratin% Ratio =

Cost of Goods sold & Ad'inistrati(e ) ellin% ) *istribution ) +inancial ,"$enses 1! ! Net ales

Objective: (he ob)ective is to determine the operational efficiency with which production and +or purchases and selling operations are carried on. Interpretation: (his ratio indicates an average operating cost incurred on sales of goods worth Rs. "99. &ower the ratio, greater is the operating profit to cover the non * operating e.penses, to pay dividend and to create reserves and vice*versa.
1. P.../.T Return on Ca$ital ,'$lo-ed = 1! ! Ca$ital ,'$lo-ed

Capital e(ployed 1 total investment1long term fund Objective: (he ob)ective is to find out how efficiently the long * term funds supplied by the 4ebenture holder and shareholders have been used. Interpretation: Higher the ratio, the more is the efficient the management and utili5ation of %apital 7mployed. )* Return on &quity P. A. T "99 Equity

&quity 1 shareholder Fund 1 3wners fund 1 Proprietors Fund Objective:+ (he ob)ective is to find out how efficiently the funds belonging to the shareholders !equity and preference$ have been used. Interpretation: (his ratio indicates the firm<s ability of generating profit per "99 rupees of shareholders< funds. Higher the ratio, the more efficient the management and utili5ation of shareholders< funds is. ,* Return on &quity s-are-older fund

Equity Profit "99 Equity shareholder fund

Objective: (he ob)ective is to find out how efficiently the funds supplied by the equity shareholders have been used.

Interpretation: (his ratio indicates the firm<s ability of generating profit per "99 rupees of equity shareholders< funds. Higher the ratio, the more efficient the management and more is the utili5ation of equity shareholders< funds. .* Return on equity s-are capital 1
Equity Profit "99 EquityShare Capital

Objective: (he ob)ective is to find out how efficiently the funds supplied by the equity shareholders have been used. Interpretation: (his ratio indicates the firm<s ability of generating profit per "99 rupees of equity share capital. Higher the ratio, the more efficient the management and utili5ation of equity shareholders< %apital is. /* &arnin$ !er S-are 1
Equity Profit No. of EquityShares

Objective: (he ob)ective is to measure the profitability of the firm on per equity share basis. Interpretation: ,n, general, higher the 7P , better it is and vice versa. 7P helps in determining the market price of the equity shares of the company. ,t also helps in estimating the company<s capacity to pay dividend. Solvency Ratios "Lon$ ter( Solvency' 4ebt * 7quity Ratio %apital 6earing Ratio Proprietary Ratio 0* 1ebt 2 &quity Ratio "Levera$e Ratio' ,nterest %overage Ratio 4ebt ervice %overage Ratio &ong term fund to fi.ed -sset Debt "99 Equity

Objective: (he ob)ective is to measure the relative proportion of debt and equity in financing the assets of a firm. Interpretation: ,t indicates the margin of safety to long * term 4ebt. - low debt equity ratio implies the use of more equity than debt which means a larger safety margin for 4ebt providers since owner<s equity is treated as a margin of safety by debenture holder and vice versa. (he implications from the point of view of long term providers of loan and the firm may be seen as under.
Capital 3earin$ Ratio

Debt+ Pref. Shares "99 EquityShare Capital

Objective: (he ob)ective is to find proportion of fi. return bearing security to not fi. return bearing securities in total capital of firm. Interpretation: ,t indicate that for every "99 Rs. of equity capital what proportion of fi. return bearing capital e.isting. =ore this ratio higher is the risk of fi. commitment & more burdens for generating equity profit. However it may result in to benefit by effect on trading on equity. !roprietary ratio Objective: (he ob)ective is to find out how much the proprietors have financed for the purchases of assets. Interpretation: (his ratio indicates the e.tent to which the assets of the firm have been financed out by proprietors< fund. (otal -ssets 1 -ll -ssets !7.cluding Fictitious -ssets like preliminary e.p. underwriting e.p, debenture discount.$ )* Interest Covera$e Ratio 1

Prop.fund (equity) "99 Total Asset

P. !. . T nterestOn Loan

Objective: (he ob)ective is to measure the debt servicing capacity of a firm so far fi.ed interest on long * term debt and debenture is concerned. Interpretation: ,nterest coverage ratio shows the number of times the amount of interest on long * term debt is covered by the profits out of which that will be paid. ,t indicates the limit beyond which the ability of the firm to service its debt would be adversely affected. Higher the ratio, greater the firm<s ability to pay interest but very high ratio may imply lesser use of debt and very efficient operations.

,*

1ebt Service Covera$e Ratio

Cash A$ailable for DebtSer$i"e nt.On.Debt+ nstallDue On Loan durin# finan"e year

%ash available for debt payment means P.-.(. :4epreciation & other non cash e.penditure dr. to P & & account : ,nterest on debt Lon$ ter( 4und to 4i%ed Assets 1 Interpretation: ound business technique it to -cquire ma)or permanent assets from permanent capital & temporary capital should be invested in current assets. ,f temporary capital is invested in permanent assets than financial position may get disturb> (his ratio suggests how much proportion of permanent assets is purchased from permanent capital. Higher the ratio more is the finance from long term sources. Activity Ratios: Capital Turnover Ratio "In ti(es' 1 Objective: (he ob)ective is to determine the efficiency with which the capital employed is utili5ed. Interpretation: ,t indicates the firm<s ability to generate sales per rupee of capital employed. ,n general, higher the ratio, the more efficient the management and utili5ation of capital employed is. 4i%ed Assets Turnover Ratio "in ti(es' Objective: (he ob)ective is to determine the efficiency with which the fi.ed assets are utili5ed. Interpretation: ,t indicates the firm<s ability to generate sales per rupee of investment in fi.ed assets. ,n general, higher the ratio, the more efficient the management and utili5ation of fi.ed assets is and vice versa. Stock Turnover Ratio "in ti(es' Objective: (he ob)ective is to determine the efficiency with which the inventory is utili5ed. Interpretation: ,t indicates the speed with which the inventory is converted into sales. ,n general, a high ratio indicates efficient performance. However, too high ratio and too low ratio should be called for further investigation. - too high ratio may be the result of a very low inventory levels which may result in frequent stock * outs and thus the firm may incur high stock * out costs. 3n the other hand, a too low ratio may be the result of e.cessive inventory levels, slow moving or obsolete inventory and thus, the firm may incur high carrying costs. (hus, a firm should have neither very high ratio nor low ratio. ! tock out means customer going out of shop due to unavailability of stock.$ 1ebtors Turnover Ratio "in ti(es' 1 Objective: (he ob)ective is to determine the efficiency with which the trade debtors are managed. Interpretations: High 4ebtors (+3 ratio 1shorter debtors ratio 1 quick recovery of money. &ow debtors (+3 ratio 1 higher debtor ratio 1 delay in recovery of money. Creditors Turnover Ratio "in ti(es' Objective: (he ob)ective is to determine the efficiency with which the creditors are managed. Interpretation: High creditor (+3 ratio 1 low creditor ratio 1 quick payment to creditor &ow creditor (+3 ratio 1 high creditor ratio 1 delayed payment to creditor Total Assets Turnover Ratio "in ti(es' 1 Objective: How efficiently assets are employed in business. Interpretation: CostOf +oods Sold A$#. Sto"*
Net Sales (A$#.)%i&ed Assets

Lon# Ter'%und "99 %i&edAssets

Net Sales (A$#.)CapitalE'ployed)Debt+ Equity(

Cr. Sales (A$#.)Debtors + !,-

Net Credit Pur"hase (A$#) Creditors + !.P.

Net Sales Total Assets

(his ratio suggests how a rupee of asset contributes to earn sales more the ratio more efficiently assets are used in gainful operation.