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due) and leverage (the extent to which the business is dependent on creditors' funding). They include the following ratios: Liquidity Ratios These ratios indicate the ease of turning assets into cash. They include the Current Ratio, Quick Ratio, and Working Capital. Current Ratios. The Current Ratio is one of the best known measures of financial strength. It is figured as shown below: Total Current Assets Current Ratio = ____________________ Total Current Liabilities The main question this ratio addresses is: "Does your business have enough current assets to meet the payment schedule of its current debts with a margin of safety for possible losses in current assets, such as inventory shrinkage or collectable accounts?" A generally 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 characteristics of its current assets and liabilities. The minimum acceptable current ratio is obviously 1:1, but that relationship is usually playing it too close for comfort. If you decide your business's current ratio is too low, you may b e able to raise it by: y y y y y Paying some debts. Increasing your current assets from loans or other borrowings with a maturity of more than one year. Converting non-current assets into current assets. Increasing your current assets from new equity contributions. Putting profits back into the business.

Quick Ratios. The Quick Ratio is sometimes called the "acid-test" ratio and is one of the best measures of liquidity. It is figured as shown below: Cash + Government Securities + Receivables Quick Ratio = _________________________________________ Total Current Liabilities The Quick Ratio is a much more exacting measure than the Current Ratio. By excluding inventories, it concentrates on the really liquid assets, with value that is fairly certain. It helps answer the question: "If all sales revenues should disappear, could my business meet its current obligations with the readily convertible `quick' funds on hand?" An acid-test of 1:1 is considered satisfactory unless the majority of your "quick assets" are in accounts receivable, and the pattern of accounts receivable collection lags behind the schedule for paying current liabilities. Working Capital. Working Capital is more a measure of cash flow than a ratio. The result of this calculation must be a positive number. It is calculated as shown below: Working Capital = Total Current Assets - Total Current Liabilities

Bankers look at Net Working Capital over time to determine a company's ability to weather financial crises. Loans are often tied to minimum working capital requirements. A general observation about these three Liquidity Ratios is that the higher they are the better, especially if you are relying to any significant extent on creditor money to finance assets. Leverage Ratio This Debt/Worth or Leverage Ratio indicates the extent to which the business is reliant on debt financing (creditor money versus owner's equity): Total Liabilities Debt/Worth Ratio = _______________ Net Worth Generally, the higher this ratio, the more risky a creditor will perceive its exposure in your business, making it correspondingly harder to obtain credit.

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Income Statement Ratio Analysis

The following important State of Income Ratios measure profitability: Gross Margin Ratio This ratio is the percentage of sales dollars left after subtracting the cost of goods sold from net sales. It measures the percentage of sales dollars remaining (after obtaining or manufacturing the goods sold) available to pay the overhead expenses of the company. Comparison of your business ratios to those of similar businesses will reveal the relative strengths or weaknesses in your business. The Gross Margin Ratio is calculated as follows: Gross Profit Gross Margin Ratio = _______________ Net Sales (Gross Profit = Net Sales - Cost of Goods Sold) Net Profit Margin Ratio This ratio is the percentage of sales dollars left after subtracting the Cost of Goods sold and all expenses, except income taxes. It provides a good opportunity to compare your company's "return on sales" with the performance of other companies in your industry. It is calculated before income tax because tax rates and tax liabilities vary from company to company for a wide variety of reasons, making comparisons after taxes much more difficult. The Net Profit Margin Ratio is calculated as follows: Net Profit Before Tax Net Profit Margin Ratio = _____________________ Net Sales

Management Ratios Other important ratios, often referred to as Management Ratios, are also derived from Balance Sheet and Statement of Income information. Inventory Turnover Ratio This ratio reveals how well inventory is bei ng managed. It is important because the more times inventory can be turned in a given operating cycle, the greater the profit. The Inventory Turnover Ratio is calculated as follows: Net Sales Inventory Turnover Ratio = ___________________________ Average Inventory at Cost Accounts Receivable Turnover Ratio This ratio indicates how well accounts receivable are being collected. If receivables are not collected reasonably in accordance with their terms, management should rethink its collection policy. If receivables are excessively slow in being converted to cash, liquidity could be severely impaired. The Accounts Receivable Turnover Ratio is calculated as follows: Net Credit Sales/Year __________________ = Daily Credit Sales 365 Days/Year Accounts Receivable Accounts Receivable Turnover (in days) = _________________________ Daily Credit Sales Return on Assets Ratio This measures how efficiently profits are being generated from the assets employed in the business when compared with the ratios of firms in a similar business. A low ratio in comparison with industry averages indicates an inefficient use of business assets. The Return on Assets Ratio is calculated as follows: Net Profit Before Tax Return on Assets = ________________________ Total Assets Return on Investment (ROI) Ratio. The ROI is perhaps the most important ratio of all. It is the percentage of return on funds invested in the business by its owners. In short, this ratio tells the owner whether or not all the effort put into the business has been worthwhile. If the ROI is less than the rate of return on an alternative, risk-free investment such as a bank savings account, the owner may be wiser to sell the company, put the money in such a savings instrument, and avoid the daily struggles of small business management. The ROI is calculated as follows: Net Profit before Tax Return on Investment = ____________________ Net Worth

These Liquidity, Leverage, Profitability, and Management Ratios allow the business owner to identify trends in a business and to compare its progress with the performance of others through data published by various sources. The owner may thus determine the business's relative strengths and weaknesses.

Profitability Ratios These ratios tell us whether a business is making profits - and if so whether at an acceptable rate. The key ratios are: Ratio Gross Profit Margin Calculation [Gross Profit / Revenue] x 100 (expressed as a percentage Comments This ratio tells us something about the business's ability consistently to control its production costs or to manage the margins its makes on products its buys and sells. Whilst sales value and volumes may move up and down significantly, the gross profit margin is usually quite stable (in percentage terms). However, a small increase (or decrease) in profit margin, however caused can produce a substantial change in overall profits. Assuming a constant gross profit margin, the operating profit margin tells us something about a company's ability to control its other operating costs or overheads. ROCE is sometimes referred to as the "primary ratio"; it tells us what returns management has made on the resources made available to them before making any distribution of those returns.

Operating [Operating Profit / Profit Revenue] x 100 Margin (expressed as a percentage) Return on Net profit before tax, capital interest and dividends employed ("EBIT") / total assets ("ROCE") (or total assets less current liabilities Efficiency ratios

These ratios give us an insight into how efficiently the business is employing those resources invested in fixed assets and working capital. Ratio Sales /Capital Employed Calculation Sales / Capital employed Comments A measure of total asset utilisation. Helps to answer the question - what sales are being generated by each pound's worth of assets invested in the business. Note, when combined with the return on sales (see above) it generates the primary ratio - ROCE. Sales or profit / Fixed This ratio is about fixed asset capacity. A reducing sales or Assets profit being generated from each pound invested in fixed assets may indicate overcapacity or poorer-performing equipment. Cost of Sales / Stock turnover helps answer questions such as "have we got too Average Stock Value much money tied up in inventory"?. An increasing stock turnover figure or one which is much larger than the "average" for an industry, may indicate poor stock management.

Sales or Profit / Fixed Assets Stock Turnover

Credit (Trade debtors Given / (average, if possible) "Debtor (Sales)) x 365 Days" Credit ((Trade creditors + taken / accruals) / (cost of "Creditor sales + other Days" purchases)) x 365 Liquidity Ratios

The "debtor days" ratio indicates whether debtors are being / allowed excessive credit. A high figure (more than the industry average) may suggest general problems with debt collection or the financial position of major customers. A similar calculation to that for debtors, giving an insight into whether a business i taking full advantage of trade credit available to it.

Liquidity ratios indicate how capable a business is of meeting its short-term obligations as they fall due: Ratio Current Ratio Calculation Current Assets / Current Liabilities Comments A simple measure that estimates whether the business can pay debts due within one year from assets that it expects to turn into cash within that year. A ratio of less than one is often a cause for concern, particularly if it persists for any length of time. Not all assets can be turned into cash quickly or easily. Some notably raw materials and other stocks - must first be turned into final product, then sold and the cash collected from debtors. The Quick Ratio therefore adjusts the Current Ratio to eliminate all assets that are not already in cash (or "near-cash") form. Once again, a ratio of less than one would start to send out danger signals.

Quick Ratio Cash and near cash (or "Acid (short-term Test" investments + trade debtors)

Stability Ratios These ratios concentrate on the long-term health of a business - particularly the effect of the capital/finance structure on the business: Ratio Gearing Calculation Borrowing (all longterm debts + normal overdraft) / Net Assets (or Shareholders' Funds) Comments Gearing (otherwise known as "leverage") measures the proportion of assets invested in a business that are financed by borrowing. In theory, the higher the level of borrowing (gearing) the higher are the risks to a business, since the payment of interest and repayment of debts are not "optional" in the same way as dividends. However, gearing can be a financially sound part of a business's capital structure particularly if the business has strong, predictable cash flows. This measures the ability of the business to "service" its debt. Are profits sufficient to be able to pay interest and other finance costs?

Interest cover

Operating profit before interest / Interest

Investor Ratios There are several ratios commonly used by investors to assess the performance of a business as an investment: Ratio Earnings per share ("EPS") Calculation Earnings (profits) attributable to ordinary shareholders / Weighted average ordinary shares in issue during the year Comments A requirement of the London Stock Exchange - an important ratio. EPS measures the overall profit generated for each share in existence over a particular period.

PriceEarnings Ratio ("P/E Ratio") Dividend Yield

Market price of share At any time, the P/E ratio is an indication of how highly the / Earnings per Share market "rates" or "values" a business. A P/E ratio is best viewed in the context of a sector or market average to get a feel for relative value and stock market pricing. (Latest dividend per This is known as the "payout ratio". It provides a guide as to the ordinary share / ability of a business to maintain a dividend payment. It also current market price measures the proportion of earnings that are being retained by of share) x 100 the business rather than distributed as dividends.

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