Ratio Analysis

Formulas

1) Financial ratios

S.no Ratio Formula Ideal ratio Comments

1 Current ratio
2 Quick ratio
3 Debt –Equity ratios
4 Proprietary ratio
Current assets 2:1/1.33: Indicates firm’s
Current liabilities 1 commitment to meet
financial obligations.
Avery heavy ratio is not
desirable as it indicates
less efficient use of
funds
Quick assets 1:1 This ratio also indicates
Current liabilities short term solvency of a
firm
long term debt 1:2 Indicates long term
equity solvency
Higher ratio is riskier for
the creditors
Shareholders’ funds Variant of debt-equity
Total tangible ratio
assets Shows the extent of
shareholders’ funds in
the total assets employed
in the business
Higher ratio indicates
relatively little danger to
creditors and vice versa

Notes

1) Current assets are those assets which can be converted into cash within a
period of one year or normal operating cycle of the business whichever is
longer
 Examples : Cash in hand, cash at bank ,stock, debtors, bills receivable,
prepaid expenses

2) Current liabilities are those liabilities payable within an year or operating

cycle
3) Quick assets = current assets – (stock+prepaid expenses)
4) Quick ratio is also known as the acid test ratio or liquidity ratio
5) Tangible assets are those assets which have physical existence
6) Long term debt /external funds/external equities =debentures+termloans
7) Share holders’ funds/internal funds/proprietary funds/owners funds=equity
share capital+preference share capital+reserves+profit and loss account-
fictitious assets

2) Profitability ratios

S.no Ratio Formula Ideal ratio comments

1 Gross Profit Gross profit X 100 Higher the This ratio expresses the
Ratio Net sales ratio better relationship between
it is gross profit and net
sales

Gross profit should be

adequate to cover
operating expenses
2 Net Profit ratio Net profit X100 Higher the This ratio expresses the
Net sales ratio, better relationship between
it is net profit and Net sales
3 Net operating Higher ratio Helps in determining
profit ratio (Net operating profit/net is better the efficiency with
sales)X100 which the affairs of the
business being
managed

4 Operating Ratio Operating cost X100 Ratio This ratio is a test of

 net sales should be operating efficiency
low with which the
business is being
carried
5 Fixed charges PBIT 6 -7 times Important from
cover Interest for an lender’s point of view
industrial
concern It indicates whether the
business would earn
sufficient profits to pay
periodically the interest
charges
6 Debt Service PBIT/interest+ Indicates ability of the
coverage ratio (principal)/1-taxrate company to repay
principal
7 Overall Higher ratio Indicates the
profitability Operating profit is better percentage return on
ratio/Return on Capital employed X100 capital employed in the
investment/return business
on capital
employed
8 Return on share Higher ratio Indicates the
holders’ funds Profit after tax(PAT) is better percentage return on
Share holders funds X100 share holders’ funds

9 Return on Equity PAT-pref.dividend X100 Higher ratio Indicates the

share holders Eq.shareholders funds is better percentage return on
Funds equity shareholders
funds
10 Price Earnings Market price per share Higher ratio Indicates the number of
Ratio Earnings per share is better times the earning per
share is covered by the
market price

Helps the investor in

deciding whether to
buy or not to buy the
shares
11 Earnings per PAT – pref.dividend Higher ratio Helps in estimating
 share No of Equity shares is better company’s capacity to
pay dividend to the
shareholders

Notes

1) Calculation of Gross profit

Gross profit = Sales- Cost of goods sold

Cost of goods sold (COGS) = opening stock +purchases+ all direct expenses
–closing stock

2) Operating profit = Gross profit-operating expenses

Operating expenses= COGS +administration expenses +selling and distribution

expenses

Note: does not include financial charges like interest and provision for tax

3) Capital employed= sum total of all the long term funds employed in the
business

C E= Equity share capital+ preference share capital+ reserves+ profit and loss
account+ long term loans-fictitious assets

Shareholder’s funds= Equity share capital +preference share capital +reserves

+profit and loss account-fictitious assets

Equity share holder’s funds= equity share capital + reserves+ profit and loss
account-fictitious assets

3) Turnover ratios

S.no Ratio Formula Ideal ratio comments

1 Fixed assets turn over Net sales Higher Indicates the extent to
ratios Fixed Assets ratio is which investment in

2 Working capital turnover Net sales
ratio Working capital
3 Debtors turnover
ratio(DTR)/debtors
velocity
4 Debt collection period
5 Creditors Turnover
ratio(creditors velocity)
(CTR)
6 Credit payment period
7 Stock turnover ratio
better fixed assets contribute
towards sales
Higher This ratio indicates
ratio is whether or not working
better capital has been
effectively utilized in
making sales
Net credit sales Higher Average
Average debtors ratio is debtors=(opening
better debtors+opening bills
receivable+closing
debtors+closing bills
receivable)/2
Months in a year Lower Indicates the extent to
DTR ratio is which debts have been
better collected in time
Credit purchases Higher Indicates the speed with
Average creditors ratio is which the payments for
better the credit purchases are
made
Average creditors=
opening creditors+bills
receivable+closing
creditors+closing bills
payable
Months in a year Low ratio Indicates the promptness
CTR is better with which the payments
are made to the creditors
Cost of goods sold Higher Indicates whether
Average Stock ratio is investment in stock is
better efficiently used or not
Average stock= (opening
stock+closing stock)/2