# RATIO ANALYSIS Single most important technique of financial analysis in which quantities are converted into ratios for

meaningful comparisons, with past ratios and ratios of other firms in the same or different industries. Ratio analysis determines trends and exposes strengths or weaknesses of a firm.

1. Liquidity Ratios:Meaning:Liquidity ratio, expresses a company's ability to repay short-term creditors out of its total cash. The liquidity ratio is the result of dividing the total cash by short-term borrowings. These includes in liquidity ratios: 1. Current Ratio 2. Acid test Ratio 3. Sales to Working capital ratio 4. Working capital ratio

(1) Current Ratio:Meaning:The current ratio is also known as the working capital ratio and is normally presented as a real ratio. The current ratio is another test of a company's financial strength. Formula:-

Improvement:This ratio shows that company has how much assets to pay its current liabilities. This ratio improves if current assets increase. If there are more current assets then company is a in beater situation. (2) Acid Test Ratio The acid test ratio is also known as the liquid or the quick ratio. Ideally this figure should also be above 1 for the firm to be comfortable. That would mean that they can meet all their liabilities without having to sell any of their stock. This would make potential investors feel more comfortable about their liquidity. If the figure is far below 1 they may begin to get worried about the firm's ability to meet its debts. The primary difference between the current ratio and the quick ratio is the quick ratio does not include inventory and prepaid expenses in the calculation. Consequently, a business's quick ratio will be lower than its current ratio. Cash + Marketable Securities + Accounts Receivable

Formula:-

Improvement:Ideally this figure should also be above 1 for the firm to be comfortable. This is calculate by deducting stock from current assets. This ratio shows more pure financial situation of paying current liabilities. It can be improve by enhancing cash. Accounts receivable, short term investments.

. (5) Working Capital Ratio:Meaning:A measure of both a company's efficiency and its short-term financial health. minus account payable. the working capital ratio is considered a prime indicator of a company's ability to expand its operations without taking on additional debt.(3) Sales to working capital ratio:Meaning:It is exceedingly important to keep the amount of cash used by an organization at a minimum. plus inventory. compare annualized net sales to working capital. accounts receivable and inventory). Because expansion requires capital on hand. One of the best ways to determine changes in the overall usage of cash over time is the sales to working capital ratio. Negative working capital means that a company currently is unable to meet its shortterm liabilities with its current assets (cash. so that its financing needs are reduced. which is accounts receivable. Positive working capital means that the company is able to pay off its short-term liabilities. Formula:- Annualized Net Sales (Accounts Receivable + Inventory ± Accounts Payable) Improvement:Cash and short-term assets expected to be converted to cash within a year as a percentage of the amount of annual sales. To calculate the sales to working capital ratio. This ratio shows the amount of cash required to maintain a certain level of sales.

There should be more current asset that would increase working capital and ultimately it would expand business. equity. These include: y y y y y y y y y y Time interest earned Fixed charge coverage Debt ratio Debt/Equity Ratio Debt to Tangible Net Worth Ratio Current Worth/Net worth Ratio Total capitalization Ratio Fixed asset Ratio/Equity Ratio Long term assets versus Long term Debt Debt coverage Ratio . LEVERAGE RATIO:- Leverage ratios measure the degree of protection of suppliers of long term funds. A leverage ratio is a comparison of a combination of a company's debt. accounts receivable and inventory). assets and interest payments to ascertain its long-term solvency and ability to meet its financial obligations. 2.Formula:- Improvement:Negative working capital means that a company currently is unable to meet its short-term liabilities with its current assets (cash.

This ratio should be high and it can be improved by enhancing equity. It is usually quoted as a ratio and indicates how many times a company can cover its interest charges on a pretax basis. For example. Formula:- Time Interest Earned Ratio: Total DebtTotal Equity Improvement:A measure of a company's ability to service its debts. Fixed Charge Coverage Ratio:Meaning:Fixed charge coverage ratio. Time Interest Earned Ratio:Meaning:A metric used to measure a company's ability to meet its debt obligations. A low ratio indicates an inability to service debts. the worse negative effects of fixed payments will become. . Failing to meet these obligations could force a company into bankruptcy. It is calculated by taking a company's earnings before interest and taxes (EBIT) and dividing it by the total interest payable on bonds and other contractual debt. 2. Also referred to as "interest coverage ratio" and "fixed-charged coverage". is a strong indicator of a company¶s future problems if sales drop to any extent. It is especially important for a company who spends heavily on leases.1. a company will feel heavier burden of lease payments combined with interest expense with declining sales. while too high a ratio indicates a lack of debt that investors may find undesirable.. Indicates a company's capacity to meet interest payments. explained. The lower the operation profit. Investors prefer publicly-traded companies to have a middling times-interest-earned ratio.

As higher this will go will be better for the organization. This can be improved by increasing total assets. Formula:- Improvement:A debt ratio greater than 1 indicates that a company has more debt than assets. . a debt ratio less than 1 indicates that a company has more assets than debt.Formula:Times Interest Earned Ratio = (EBIT+ fixed charge) ÷ (total interest + fixed charge) Improvement:It can be improved by increasing earnings of the company or by reducing the fixed charge on assets and interest. The measure gives an idea to the leverage of the company along with the potential risks the company faces in terms of its debt-load. It is better as high 3. Debt Ratio:Meaning:A ratio that indicates what proportion of debt a company has relative to its assets. It can be deteriorate by increasing interest and fixed charge on assets.

Thus. Formula:- Improvement:- A debt ratio greater than 1 indicates that a company has more debt than assets. it represents the supposed liquidation proceeds a company would fetch if its operations were to cease immediately and the firm was sold off. Debt to Equity Ratio:- Meaning:Indicates the relationship between the external equities or outsiders funds and the internal equities or shareholders funds. It should be higher and it can be improved by increasing our total assets.. Debt to Tangible Net Worth Ratio:Meaning:A measure of the physical worth of a company. which does not include any value derived from intangible assets such as copyrights. It is also known as external internal equity ratio. 5. a debt ratio less than 1 indicates that a company has more assets than debt. Formula:[Debt Equity Ratio = External Equities / Internal Equities] Or [Outsiders funds / Shareholders funds] . patents and intellectual property. It is determined to ascertain soundness of the long term financial policies of the company.4.

As the ratio reveals how well the resources of the firm are being used. This ratio establishes the profitability from the share holders' point of view. It is the relationship between net profit (after interest and tax) and share holder's/proprietor's fund. the higher the ratio. This ratio is one of the most important ratios used for measuring the overall efficiency of a firm. better are the results. Formula:- Net profit (after interest and tax)/Share holder fund *100 Improvement:This ratio is of great importance to the present and prospective shareholders as well as the management of the company. Generally. 6. The ratio is generally calculated in percentage. . higher the ratio.Long term financial ratio it calculated as: [Total Long Term Debts / Total Long Term Funds] Or [Total Long Term Debts / Shareholders Funds] Improvement:The greater that a company's leverage is. Current Worth/Net Worth Ratio:- Meaning:It is the ratio of net profit to share holder's investment. companies with higher ratios are thought to be more risky because they have more liabilities and less equity. The inter firm comparison of this ratio determines whether the investments in the firm are attractive or not as the investors would like to invest only where the return is higher.

8. Formula:- Equity Ratio = Shareholders funds / Total Assets . Total assets include all assets. Proprietary / Equity ratio indicates the long-term or future solvency position of the business. This ratio relates the shareholder's funds to total assets. Fixed Asset Ratio/Equity Ratio:- Meaning:It is a variation to debt to equity ratio. This ratio is considered to be one of the more meaningful of the "debt" ratios . Total Capitalization Ratio:- Meaning:Capitalization ration measure the debt component of the company capital structure or capitalization of long term debt liabilities and share holder equity to support company and growth.7. including Goodwill.it delivers the key insight into a company's use of leverage. It is also known as equity ratio or net worth to total assets ratio. Shareholder's funds include equity share capital plus all reserves and surpluses items. Long-term debt is divided by the sum of long-term debt and shareholders' equity.

This ratio is good if its higher. Debt Coverage Ratio:- Meaning:Also known as the Debt Service Coverage Ratio (DSCR).Improvement:Shareholders fund is a liability on a company. This ratio shows that how much assets we have to pay shareholders funds. but not your escrow payments. the principal and accrued interest. the debt coverage ratio measures your ability to pay the property's monthly mortgage payments from the cash generated from renting the property.e. 9.A ratio of 1. The DCR is calculated by dividing the property's annual net operating income (NOI) by a property's annual debt service. Annual debt service is annual total of your mortgage payments (i. It can be improved by increasing total assets. . Formula:Interest Coverage Ratio = Net Profit before Interest and Tax / Fixed Interest Charges Improvement:The ratio is used by lenders to evaluate loans on income-producing property.2 or better will usually support the extension of credit. Bankers and lenders use this ratio as a guide to help them understand whether the property will generate enough cash to pay rental expenses and whether you will have enough left over to pay them back on the money you borrowed.

The higher the profit margin is.3. 1. Thus. incomes such as interest on investments outside the business. Formula:[Net Profit Ratio = (Net profit / Net sales) × 100] Improvement:A measure of how well a company controls its costs. this is a sign that the company is doing well. Net Profit Margin:- Meaning:Net profit ratio is the ratio of net profit (after taxes) to net sales. It is expressed as percentage. When these ratios are higher than a competitor's ratio or than the company's ratio from a previous period. etc are excluded. Investors use the profit margin to compare companies in the same industry and well as between industries to determine which are the most profitable. The two basic components of the net profit ratio are the net profit and sales. non-operating expenses and incomes are excluded from the net profits for calculating this ratio. Profitability Ratios:A class of financial metrics that help investors assess a business's ability to generate earnings compared with its expenses and other relevant costs incurred during a specific period. profit on sales of fixed assets and losses on sales of fixed assets. The net profits are obtained after deducting income-tax and. the better the company is thought to control costs. generally. .

the gross profit earned should be sufficient to recover all operating expenses and to build up reserves after paying all fixed interest charges and dividends. Return on Assets:Meaning:An indicator of how profitable a company is relative to its total assets. Calculated by dividing a company's annual earnings by its total assets. Formula: Gross Profit Ratio = (Gross profit / Net sales) × 100 Improvement:We can improve this ratio by increasing our sales if our sales will increase ultimately our gross profit will increase.2. ROA is displayed as a percentage. However. It reflects efficiency with which a firm produces its products. 3. There is no standard GP ratio for evaluation. Gross profit ratio may be indicated to what extent the selling prices of goods per unit may be reduced without incurring losses on operations. higher the gross profit better it is. It expresses the relationship between gross profit and sales. ROA gives an idea as to how efficient management is at using its assets to generate earnings. It may vary from business to business. Gross Profit Margin:Meaning:Gross profit ratio (GP ratio) is the ratio of gross profit to net sales expressed as a percentage. Formula: . As the gross profit is found by deducting cost of goods sold from net sales.

Also known as "operating profit margin" or "net profit margin".This is a good measure of the short and medium-term financial health of a company. Formula: 5. etc. It can be deteriorate by decreasing profits and sales. Operating margin is a measurement of what proportion of a company's revenue is left over after paying for variable costs of production such as wages. or will have. Working capital is calculated by subtracting current liabilities from current assets. Improvement:The amount of money a company has on hand. and may indicate by how much it can expand its operations without resorting to borrowing or another capital raising tactic . It is as good as high 4. such as interest on debt. in a given year.Improvement:It can be improved by increasing all the multiplied values. Operating Asset turn over Ratio:Meaning:The total asset turnover represents the amount of revenue generated by a company as a result of its assets on hand. Operating income margin :Meaning:A ratio used to measure a company's pricing strategy and operating efficiency. raw materials. Formula: Operating Asset Turnover= net sales/operating assets. A healthy operating margin is required for a company to be able to pay for its fixed costs. This equation is a basic formula for measuring how efficiently a company is operating.

Sometimes this is referred to as "return on investment Formula: Net Income + Interest Expense Total Assets Improvement:It can be improved by selling the assets fast.Thus. Return On operating Assets:Meaning:An indicator of how profitable a company is relative to its total assets. It is better as moderate 7. . Calculated by dividing a company's annual earnings by its total assets. That is. Formula: Sales revenue ÷ net fixed assets Improvement:A measure of how efficiently a business generates sales from its investments. A low sale to fixed assets ratio means inefficient utilization or obsolescence of fixed assets. if a company has a high ratio. this means that its sales have kept pace with or exceeded the amount it has invested in fixed assets. ROA gives an idea as to how efficient management is at using its assets to generate earnings. it is the ratio of the amount a company earns in sales to the average value of its fixed assets. which may be caused by excess capacity or interruptions in the supply of raw materials.6. ROA is displayed as a percentage. Sales to Fixed Assets:Meaning:The sales to fixed assets ratio is often called the asset turnover ratio. which is a positive sign for the company. It can be deteriorate by retaining the assets for a long time of period.

Formula:- Improvement:ROE is useful for comparing the profitability of a company with that of other firms in the same industry. the benefit (return) of an investment is divided by the cost of the investment. . Formula: The return on investment formula: 9. Return on equity measures a corporation's profitability by revealing how much profit a company generates with the money shareholders have invested. Return on total Equity:Meaning:The amount of net income returned as a percentage of shareholders equity.8. To calculate ROI. Return on investment:Meaning:A performance measure used to evaluate the efficiency of an investment or to compare the efficiency of a number of different investments. the result is expressed as a percentage or a ratio.

It can be deteriorate by receiving money from accounts receivable late. The average collection period ratio represents the average number of days for which a firm has to wait before its debtors are converted into cash. . Accounts receivable turnover is a way to determine how a business' credit risk compares to that of its competitors. This is better if the collection period is high.4. Activity Ratios:Activity ratio measure a firm ability to convert different accounts within their balance sheets into cash or sales. It is better as high in times. of Working Days) / Net Credit Sales] Improvement:The average amount of time it takes for a business to collect on its accounts receivable. Formula: [(Trade Debtors × No. measuring how efficiently a firm uses its assets. The receivables turnover ratio is an activity ratio. Account Receivable Turn over:Meaning:An accounting measure used to quantify a firm's effectiveness in extending credit as well as collecting debts. Average collection Period:Meaning:The Debtor or receivable turn over when calculated in terms of days is known as Average Collection Period or Debtors Collection Period Ratio. Formula: Improvement:It can be improved by receiving money from accounts receivable as many times as possible in a financial year. 2. 1.

Accounts payable turnover ratio is calculated by taking the total purchases made from suppliers and dividing it by the average accounts payable amount during the same period. Formula: Improvement:It can be improved by making late payments to vendors after long period. It can be deteriorate by making early payments to vendors in short time period. Average Payment Period:Meaning:A ratio showing how many times a company's inventory is sold and replaced over a period. It is better as low in number of days. Account payable turnover:Meaning:A short-term liquidity measure used to quantify the rate at which a company pays off its suppliers.3. Formula: Improvement:It can be improved by making late payments to vendors and keep retain that money for business operations. It is better as low as possible 4. . It can be deteriorate by making early payments to vendors.

Formula: Operating Cycle = age of inventory + collection period. To improve this we should change our inventory into sales as early as possible. Average age of Inventory:Meaning:The Age of Inventory shows the number of days that inventory is held prior to being sold. The operating cycle reveals how long cash is tied up in receivables and inventory. An increasing age of inventory ratio indicates a risk in the company's inability to sell its products. The age of inventory collection period. Days Inventory or Inventory Holding Period.5. The operating cycle is listed in our efficiency ratio. Operating Cycle:Meaning:The operating cycle is the number of days from cash to inventory to accounts receivable to cash. which provide formulas. A long operating cycle means that less cash is available to meet short term obligations. Individual inventory items should be examined for obsolete or overstocked items. The Age of Inventory Ratio is also referred to as the Number of Days Inventory. and Operating Cycle ratios are included in the financial statement ratio analysis spreadsheets highlighted in the left column. definitions. Improvement:The time between the purchase of an asset and its sale. Higher the turnover higher suitable for the company. A decreasing age of inventory may represent under-investment in inventory. Formula: Age of Inventory = 365 days / inventory turnover ratio Improvement:This ratio shows in how much time inventory is converting into sales. calculation. or the sale of a product made from the asset. Most companies desire short operating cycles because it creates cash flow to cover the . charts and explanations of each ratio. 6.

A long operating cycle often necessitates borrowing and thereby reduces profitability. It can be deteriorate by using fewer assets to generate revenues. Total Asset Turnover:Meaning:The total asset turnover represents the amount of revenue generated by a company as a result of its assets on hand. Formula: Revenue Total Assets Improvement:Sales are listed on the firm's income statement and assets are listed on its balance sheet.company's liabilities. It can be improved by generating more revenue from assets. This equation is a basic formula for measuring how efficiently a company is operating. Also called asset turnover. 7.. It is better as high as possible .

Market Ratios:Market ratios measure investor response to owing a company¶s stock and also the cost of issuing stock. 1.5. Formula: Calculated as: . It can be deteriorate by increasing total number of outstanding shares. Dividend per Share:Meaning:The the sum of declared dividends for every ordinary share issued. Earning Per Share:- Meaning:The portion of a company's profit allocated to each outstanding share of common stock. It is better as high. 2. Dividend per share (DPS) is the total dividends paid out over an entire year (including interim dividends but not including special dividends) divided by the number of outstanding ordinary shares issued. Formula: DPS can be calculated by using the following formula: Improvement:It can be improved be increasing the total amount of dividend. because it improve investment also. Earnings per share serve as an indicator of a company's profitability.

Percentage of earning Retained:Meaning:The percentage of net earnings not paid out as dividends. It can be deteriorate by increasing total number of ordinary shares. It is good as high 4. It can be deteriorate by decrease in market value of shares. Price earning Ratio:Meaning:A valuation ratio of a company's current share price compared to its per-share earnings. It can be improved by increasing net profit. It is recorded under shareholders' equity on the balance sheet.Improvement:Diluted EPS expands on basic EPS by including the shares of convertibles or warrants outstanding in the outstanding shares number. but retained by the company to be reinvested in its core business or to pay debt. The formula calculates retained earnings by adding net income to (or subtracting any net losses from) beginning retained earnings and subtracting any dividends paid to shareholders: Formula: . because it generate funds for business 3. It is better as high. Calculated as: Improvement:It can be improved by increase in market value per share.

Dividend payout :Meaning:The percentage of earnings paid to shareholders in dividends. the dividend yield is the return on investment for a stock. In the absence of any capital gains.5. Formula: Calculated as: 6. Dividend Yield:Meaning:A financial ratio that shows how much a company pays out in dividends each year relative to its share price. Dividend yield is calculated as follows: Formula: .

It can be deteriorate by decreasing shareholders equity or increasing outstanding shares. Book value per share is calculated by subtracting liabilities and the par value of any outstanding preferred stock from assets and dividing the remainder by the number of outstanding shares of stock. . book value. Book Value Per Share:Meaning:Common stockholders' equity determined on a per-share basis.7. It is better as high. Also called book. Formula: Stockholders Equity .Preferred Stock Average Outstanding Shares Improvement:It can be improved by increasing shareholders equity.