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Financial statement analysis is the process of identifying the financial strengths and
weaknesses of the firm by establishing the relationships by means of ratios between the
balance sheet and profit and loss account.


 Liquidity of Firm

 Profitability

 Leverage

 Operational Efficiency

 Effective Utilization of Resources


 Ratio Analysis is widely used tool for analysis. Ratio is a quotient of two numbers and
is an expression of relationship between the figures or two amounts.


 Liquidity or short – term solvency ratio

 Leverage or Capital structure ratio

 Activity ratio or Turnover ratio

 Profitability ratio

o General Profitability ratio

o Overall profitability

They measure the short term solvency of the company.

1) Current Ratio: Current assets/ Current liabilities (Ideal = 2 :1)

2005-06: It has increased from 1.52 to 2.19, which is good for debt holders but at the
same time it also indicates idle cash balances, inventory levels that have become
excessive when compared to current needs and poor credit management that results
in overextended accounts receivable. The business might not have invested them

2006-07: It has decreased from 2.19 to 1.38. Here, the company might have gone
under an undertaking with its bankers to meet its working capital requirements at
short notice.

2007-08: It has decreased from 1.38 to 0.95. Here again company has stopped using
adequate liquidity.

2008-09: It has increased from 0.95 to 1.26, which means that company has started
using its liquidity. It is good for the debt holders of the company.

2) Absolute liquid ratio ( Super quick ratio): Absolute liquid assets/ Current liabilities
{Absolute liquid assets= cash + short term investments} (Ideal= 0.5:1)

Assumption: Here we have considered the investment given to be as the temporary


It has drastically decreased from 1.48 in 2005 to 0.222 in 2006 which means liquid
assets decreased down the year. And, because of this, the company was not in the
position of quickly meeting its short-term obligations. But then company has started
managing its resources carefully and its ratio started increasing and reached to 0.615
in 2009.


They indicate the relative interests of owners and creditors in a business. They refer to
the ability to meet long term obligations & the long-term financial position of the

1) Debt equity ratio: It measures the relative claims of outsiders and the owner’s equity
against the firm. (Ideal= 2:1)

Assumption: We are considering secured loans as long term.

Long term loans + Current liability/ Net worth

This ratio is tremendously increasing from 2005 to 2009, which means that this
company is taking more and more of loans without increasing its equity and in this
way it is exposing its creditors to risk.

2) Proprietary ratio: It expresses relationship between Net worth and total assets.

(Ideal: The higher the ratio, the better it is)

It is reducing from 2005 to 2009, which means its financial position is deteriorating
year by year as they are buying more and more of assets without increasing the equity.

3) Fixed assets ratio: It indicates the mode of financing the fixed assets.

Fixed assets / Capital employed

( Ideal = 0.67 and it can’t be more than 1)

It has decreased from 0.489 in 2005 to 0.187 in 2009. It means that the company has
stopped employing more capital for assets and has started to use it for some other
purpose like investments.

4) Interest coverage ratio: It indicates whether a business is earning sufficient profits to

pay the interest charges.

PBIT/ Fixed interest charges

(Ideal= 6:1)

Assumption: We have divided the financial expenses in fixed interest charges and
other financial expenses in 1:2 ratios.

It is good in 2005 and in 2006 but the problem started from the year 2007. It started
decreasing and became 1.47 in 2009 which is not a good indication about the financial
position of the company. It indicates almost null margin of safety to the lenders of
long term debt.

It measures the effectiveness and efficiency with which a firm manages its resources
or assets.

1) Working capital turnover ratio: Cost of goods sold/ Working capital

(Ideal: high)

It is good in 2009 when compared to the other years. Between the years 2007-08, it
had experienced a sharp decline to (-) 37.28 and the reason for this was the increase in
current liabilities as compared to current assets. At that time, Company was not
properly utilising the funds. But then, in the year 2008-09, it became 12.32 which can
be considered as the exponential increase in it and it has happened because the
company started utilising its resources properly and current assets became more than
the current liabilities.

2) Fixed assets turnover ratio: Net sales/ Fixed assets

(Ideal= 5:1)

Assumption: Consider “Operating income” as “Net sales”

It has increased to 2.99 in 2006 but then it started decreasing till the year 2008 and
became 0.774. In the year 2009, it has increased to 0.804. But in all these years it is
less than 5 which means, the company is not properly utilizing its fixed assets.

3) Total assets turnover ratio: Net sales/ Total assets

(Ideal= high)

It is fluctuating and ultimately it has become 0.657 which is not a good ratio. The
company can’t utilize the investments in the business as the total assets are more than
the sales.


1) Operating profit ratio: Operating profit/ Net sales

(Ideal= high)

It has a declining trend from 2005 to 2009 which shows that their operating profit is
decreasing year by year.

2) Net profit ratio: Net profit after tax/ Net sales

(Ideal = high)

It is also decreasing in a declining trend from 2005 to 2009 and it has become
negative in 2007 and is negative for rest of the years also. It indicates that company
has incurred losses in these years.

3) Operating expenses ratio: Operating expenses/ Net sales

(Ideal= low)

It has increased in increasing trend from 2005 to 2009, which is not a good sign
because its expenses are increasing at increasing rate with the increase in sales which
is increasing at decreasing rate.


1) Return on capital employed ratio: It indicates the earning capacity of the capital
employed in the business.

(Ideal = high)

Profit before interest and taxation/ Capital employed

As it is decreasing from 2005 to 2009, it can be said the company’s ability to generate
return for its shareholders is very less and the company should start looking for other
2) Return on net worth ratio: It indicates the return, which the shareholders are earning
on their resources invested in the business.

Profit after tax/ Net worth

(Ideal =high)

There is a decreasing trend till 2007 and then it has increased to 0.434 in 2008 but
then it has decreased to (-) 1.28 in 2009. It is negative, which means it is incurring
losses in the current year and it implies that the earnings of investors is not up to the
mark. It is not a good sign for the stakeholders. So, it shows the deterioration of the
profitability of the business.

3) Return on equity capital: Profit after tax – preference dividend/ Equity shareholder’s

(Ideal= high)

It is also decreasing year after year which means, the returns to the owners is also not
up to the mark. There is very less left to the owners i.e., equity shareholders after
paying to the preference shareholders. So, we can say there is very high risk for the
equity shareholders in this company.

4) Return on assets: Profit after tax/ Total assets

(Ideal= high)

It shows a decreasing trend year after year and is becoming negative which shows the
return earned by the company for the shareholders of the business on the investment
of all the financial resources committed to the business is not up to the mark and need
to be revised.

Based on all these ratios we can say that the liquidity position of the company is
becoming better in current year but the leverage ratios are showing that the company
is exposing the creditors to the risk which is not good on the part of financial position.
The turnover ratios show that its working capital is good and in turn can help its
business to improve its financial position. But, the profitability ratios has shown that
the condition of the company is not good as it is incurring losses and there is increase
in the expenses when compared to incomes.
So, the financial position is not satisfactory and need to be revised.

Cash Profits = PAT+ Loss on sale of Investment+ prelm exp writt off –Profit on sale
of Assets –FX Gains+ Operating Prov- Non Cash Adjustments.

Net Cash Flows = Cash profits-Dividend on Equity Share capital-Dividend on

preference share capital-Dividend tax- partner’s withdrawal.