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Rajveer Rawlin Senior Lecturer, Finance, MBA (VTU) Dayananda Sagar Institute

Ratio Analysis

Why look at ratio analysis? How can we make sense out of ratios? What are the groups of ratios? What are the limitations of ratio analysis? How can we use this to evaluate profitability, risk, and growth?

2

**Why Look at Ratios?
**

compare a company’s performance with itself overtime or a company versus competitors within its industry a basis for evaluating suppliers and customers Useful in historical analysis as well as projecting performance

**End Users of Ratios
**

Lenders – judge a company’s ability to repay loans Managers – look at gross margins to keep costs under control Investors can compare their company against the competition and the rest of the industry

Making Sense out of Ratios Trend Analysis How a company does over time Peer Group Analysis The company vs other competitors Industry Comparison Company vs the Industry .

Categories of Ratios Liquidity Look at the ability of a company to meet its short term obligations How cash rich a company is will determine its liquidity Can required payments be met? 2 Ratios Current Ratio Quick Ratio .

Categories of Ratios Asset Management How effective is the firm in managing it’s assets? How effective is the firm in using its assets to generate sales? 3 Ratios Total Asset Turnover Fixed Asset Turnover Inventory Turnover .

Categories of Ratios Debt Management Ratios How is the company financed? What is the mix of debt and equity? Does it generate enough cash flow to cover interest payments? 3 Ratios Debt Ratio Tie Ratio Debt to Equity Ratio .

Categories of Ratios Profitability How profitable is the company? Is the company generating the right returns on the assets deployed and capital invested? Are sales high enough to maintain profitability? .

Categories of Ratios 2 Ratios focusing on profit margins Gross Profit Margin Net Profit Margin 2 Ratios focusing on returns Return on Assets Return on Equity .

Categories of Ratios Market Value Ratios How is the company’s value reflected in the stock market? Is the company under or over-valued vis a vis it’s peers 2 Ratios Price / Earnings Price / Book Value .

000 612.000 6. expense EBT Taxes (40%) Net income 5.Income Statement 2007 Sales COGS Other expenses Depreciation Tot.960 5.834.600 5.816.400 4.056 253.640 169.000 422.424) (95.640 80.532.980.960 17.000 (158. op.584 .960 502.000 720.035. costs EBIT Int.560) (63.960 120.136) 2008 7.800.440 176.000 116.

000 1.Balance Sheets: Assets Cash S-T invest.632 878.802 939.000 71.000 632.790 2.480 2.946.282 20.840 3. AR Inventories Total CA Net FA Total assets 2007 7.360 1.716.592 2008 14.160 1.952 .680.516.112 836.287.886.

632 557.039.000 380.960 1.886.152 3.977.632 2.592 2008 359.516. earnings Total equity Total L&E 2007 324.000 460.Balance Sheets: Liabilities & Equity Accts.960 1.800 500.000 97.000 1. payable Notes payable Accruals Total CL Long-term debt Common stock Ret.936 296.328.000 1.680.000 720.000 284.000.216 1.800 300.952 .

4 .000 250.Other Data 2007 2008 Stock price Rs 6.11 Rs 0.22 Lease payments 40.4 0.000 DPS Rs 0.17 # of shares 100.000 Tax rate 0.00 Rs 12.000 40.

Liquidity Ratios Current Ratio (CR) = Current Assets (CA) ---------------------------------------- Current Liabilities (CL) CR08 = 2680112/1039800 = 2.Inventory ------------------------------- CL QR08 = (2680112-1716480)/1039800 = 0.58 Quick Ratio (QR) = CA .93 .

7x 1.46x 0.3x 0.5x 2006 2.0x Signs of improvement from 2007 but still below the industry average Liquidity position is weak as the quick ratio is < 1 and lower than that of the industry .58x 0. 2.8x Ind.Analysis of CR and QR 2008 CR QR 2.93x 2007 1.

Analysis CR and QR > 1 are a sign of good financial health However very high CR and or low QR could mean Cash build up Under utilization of the firms resources Build up in inventory Inability to generate sales from it’s inventory Slow collection of receivables .

00 .41 Total Asset Turnover Ratio = Sales ---------------Total Assets Total Asset TO08 = 7035600/ 3516952 = 2.Asset Management Ratios Fixed Asset Turnover Ratio = Sales ---------------Net Fixed Assets Fixed Asset TO08 = 7035600/836840 = 8.

7.0x 2.Analysis FA TO TA TO 2008 2007 2006 8. Good sign TA turnover not up to industry average. Caused by poor A/R collection and inventory build up These ratios tell us how effectively the firm is deploying it asset base and long term fixed assets to generate sales .3x Ind.0x 2.4x 6.2x 10.0x 2.0x 2.5x FA turnover exceeds industry average.

1x 2007 4. 4.1 Another Inv Ratio is calculated as cost of goods sold / Inventory 2008 Inv.5x 2006 4. 6.8x Ind.1x .Inventory Turnover Inventory Turnover Ratio = Sales ---------------Inventories Inventory TO08 = 7035600/1716480 =4. T.

by reducing turnover time Reduce shelf-life for perishable items .Analysis The inventory turnover declined from the last year and is also below industry average Firms Inventory may be becoming obsolete Need better inventory control measures Have to translate accumulated inventory to sales.

Days Sales Outstanding (DSO) It is a measure of how fast a company collects money due in sales from its customers How fast customers pay their bills In short. does the firm have a good credit policy High DSO’s are warning signs that a firm is unable to collect its bills on time .

5 2006 37.4 Ind.0 . 32.DSO DSO = Receivables / (Average Sales/day) DSO = Receivables / (Sales/365) DSO = 878000 / (7035600/365) = 45.5 2007 39. need improvement DSO 2008 45.5 Debtor’s TO Ratio = Sales / (Receivables + Debtors) DSO has been deteriorating and is far below industry norms Poor credit and collection policy.

Creditor and Debtor Turnover Debtors Turnover Ratio = Credit Sales ------------------------(Debtors + Receivables) Creditors Turnover Ratio = Credit Purchases ------------------------(Creditors + Payables) .

Debt Management or Leverage Ratios Tells you the proportion of debt financing used Right balance must be struck through a mix of debt and equity Too much equity can result in dilution issues. lower EPS Too much debt can pose challenges stemming from financial risk .

Exp TIE 08 = 502640/80000 =6.Debt Management or Leverage Ratios Debt Ratio = Total Liabilities ---------------Total Assets Debt Ratio 08 = (1039800+500000)/3516952 = 0.3 .44 TIE = EBIT ----------------Int.

Debt Management or Leverage Ratios Debt to Equity Ratio (D/E) = Total Liab. Holders EQ D/E 08 = (1039800+500000)/1977152 = 0.78 Debt to equity ratio is < 1 . ----------------Sh.

3x 0.1x 4. 0.2x 0.85 The company's debt reduction measures seem to be working All debt ratios better than industry levels The company seems to have emerged from serious financial risk it was exposed to in 2007 .18 2006 0.Analysis D/A TIE D/E 2008 0.44 6.78 2007 0.55 3.5 6.85 Ind.81 0.3x 0.

resulting in discounting .Profitability Ratios Measure the ability of the firm to generate profits effectively Gross Margin (GM) Gross Margin = (Sales – COG)X100/Sales Tells you how profitable the firm is after covering the cost of making the product Key measure of a firms financial health Negative Gross Margins can mean Pricing pressures from competitors are reducing sales.

Profitability Ratios Variable cost such as material and labour costs could be rising Negative GM’s are a sign of trouble ahead Net Profit Margin (NPM) The profit remaining after all expenses are paid A bottom-line ratio A very important ratio to assess profitability and compare against the available competition .

Profitability Ratios Gross Margin = (Sales – COG)X100/Sales GM08 = (7035600-5800000) /7035600 % GM08 = 28% NPM = Net Income X 100 / Sales NPM08 = 253584/7035600 % = 3.6% These two ratios can be increased by Increasing Sales Reducing costs .

6% The company’s Gross and Profit margins recovered from 2007 to reach Industry levels in 2008 The company seems to have grown sales faster than the rise in costs experienced .6% 2.Profitability Ratios 2008 2007 2006 Ind. GM 28% 15% 25% 27% NPM 3.6% -1.6% 3.

the company may be sitting on cash and not investing for the future Too low a ratio implies under utilization of its assets ROA = NI / TA = 253584 / 3516952 ROA08 =7.2% .Return on Assets (ROA) Tells you what % of money invested in the business was returned as profit If this ratio is too high.

8% .Return on Equity (ROE) Key Ratio Serves as a useful comparison parameter vs the competition and industry Tells you how much of the equity invested is returned as profit ROE = NI / Common Equity ROE08 = 253584 / (1680936+296216) ROE08 = 12.

Return on Capital Employed (ROCE) Measures the returns generated on the capital employed by the firm Capital Employed = Total Assets – Current Liabilities ROCE = EBIT / Capital Employed ROCE08 = 502640 / (3516952-1039800) ROCE08 = 20% .

Analysis of ROA. 9.0% 18.3% -17.3% 18% Ind.2% 12.1% 1% 2006 6. ROE & ROCE ROA ROE ROCE 2008 7.0% 22% Definite Improvement from 2007 but below industry average Reduction in debt has helped the recovery from 2007 Further debt reductions and cost cutting can help achieve industry levels .0% 13.8% 20% 2007 -3.

216) FANW08 = 0.516.Capital Structure Ratios Proprietary Ratio = Share holders Funds / Total Assets Proprietary Ratio08 = (1680936 + 296.952 Proprietary Ratio08 = 0.42 = 42% .216) / 3.56 =56% Fixed Assets to Net Worth Ratio = Fixed Assets / Share Holders Funds FANW08 = 836840 / (1680936 + 296.

Market Related Ratios These ratios factor in the current stock price We will look at 3 ratios Price / Earnings (P/E) Price / Cash Flow (P/CF) Price / Book Value (P/BV) These tell you how the company is valued in the market Important comparison metrics with the competition .

P/E Ratio Price08 = $12.01 P/E = Price per share EPS P/E08= 12.17/1.01 = 12 Higher the growth rate higher the P/E ratio Reference comparison with industry necessary .17 EPS = Net Income / Out. Shares EPS08 = Rs 253584/250000 = Rs 1.

14 CF per share = .) / Out.49 = 8. Shares CF per share08 = (253584 + 120000) / 250000 CF per share08 = Rs 1.49 P/CF = Price per share CF per share P/CF08= 12.P/CF Ratio (Net Income +Deprec.17/1.

216) / 250000 BVPS 08 = 7.54 .91 = 1.91 P/BV = (Price / Sh) / BVPS P/BV08 = 12.17/7.Price to Book Ratio Tells you what a firm is trading relative to its net worth Book Value / Sh = Shareholders Funds / Out Shares BVPS08 = (1680936 + 296.

9x General improvement in ratios from 2007 Near Industry levels Market seems to have recognized the company's turn around .Analysis 2008 P/E 12. 14.6x 2.2x P/BV 1.7x 8.3x Ind.2x 7.0x 1.5x 2007 -6.0x P/CF 8.3x 27.5x 1.1x 2006 9.

17 = 2% .22 Rs Dividend Payout Ratio (DPR) = DPS/EPS DPR 08 = 0.01 = 0.22/12.Dividend Ratios Dividend Per Share = Dividends / Shares (DPS) Outstanding DPS 08 = 55000/250000 = 0.22 = 22% Dividend Yield (DY) = DPS / (MP/Sh) DY 08 = 0.22/1.

So Mr Analyst What is your View? .

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