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Ratio: It is the quantitative relation between two amounts showing the number of
times one value contains or is contained within the other.
Accounting Ratio: It means ratio calculated on the basis of accounting
information.
Ratio analysis: A ratio analysis is a quantitative analysis of information contained
in a company's financial statements. Ratio analysis is used to evaluate various
aspects of a company's operating and financial performance such as its efficiency,
liquidity, profitability and solvency.
Objective of Ratio Analysis:
1. To assess the earning capacity, financial soundness and operating efficiency
of an enterprise.
2. To simplify the accounting information.
3. To help in comparative analysis.
Ratios are categorized into following basic categories:
1. Liquidity Ratios
2. Solvency Ratios
3. Activity or Turnover Ratios
4. Profitability Ratios
1. Liquidity Ratios:
These ratios measure the paying capacity of the entity to meet its short-term
financial obligations. These includes: Current Ratio and Quick Ratio/Liquid
Ratio/Acid Test Ratio.
i. Current Ratio/Working Capital Ratio:
𝑪𝒖𝒓𝒓𝒆𝒏𝒕 𝑨𝒔𝒔𝒆𝒕𝒔
Current Ratio = 𝑪𝒖𝒓𝒓𝒆𝒏𝒕 𝑳𝒊𝒂𝒃𝒊𝒍𝒊𝒕𝒊𝒆𝒔
Current Assets = (Current Investments + Inventories + Trade Receivable +
Cash & Cash Equivalents + Short-Term Loans & Advances
+ Other Current Assets)
Current Liabilities = (Short-term Borrowings + Trade Payables + Other
Current Liabilities + Short-term Provisions)
This Ratio Shows short-term financial soundness of the business.
Higher ratio means better capacity to meet its current obligation. The ideal
Current Ratio Is 2:1. In case it is very high it shows the idleness of funds.
Compiled By: CHIRANJIBI BISOI (9776700287)
ii. Quick Ratio/Liquid Ratio/Acid Test Ratio:
𝑳𝒊𝒒𝒖𝒊𝒅 𝑨𝒔𝒔𝒆𝒕𝒔
Quick Ratio/Liquid Ratio/Acid Test Ratio =
𝑪𝒖𝒓𝒓𝒆𝒏𝒕 𝑳𝒊𝒂𝒃𝒊𝒍𝒊𝒕𝒊𝒆𝒔
Liquid/Quick Assets = (Current Assets - Inventories – Prepaid Expenses)
Current Liabilities = (Short-term Borrowings + Trade Payables + Other
Current Liabilities + Short-term Provisions)
This Ratio is a fairly stringent measure of liquidity. It is based on those
current assets which are highly liquid, i.e., can be converted into cash and
cash equivalents quickly. Quick Ratio of 1:1 is considered as ideal. Higher
the Quick Ratio better the short-term financial position.
2. Solvency Ratios:
These ratios measure the long-term financial position of the enterprise. These
includes: Debt to Equity Ratio; Total Asset to Debt Ratio; Proprietary Ratio;
Interest Coverage Ratio; Debt Service Coverage Ratio and Capital Gearing Ratio.
i. Debt to Equity Ratio:
𝑫𝒆𝒃𝒕
Debt to Equity Ratio =
𝑬𝒒𝒖𝒊𝒕𝒚 (𝑺𝒉𝒂𝒓𝒆𝒉𝒐𝒍𝒅𝒆𝒓𝒔 𝑭𝒖𝒏𝒅)
Debt = Long-term Borrowings (i.e., Debenture+Mortgage public deposits)
+ Long-term Provisions
Equity = Share Capital + Reserve and Surplus
Or
= Non-current Assets + Working Capital – Non-current Liabilities
This Ratio assesses the long-term financial position and soundness of
enterprises. In general, lower the Debt to Equity Ratio higher the degree of
protection enjoyed by the lenders.
ii. Total Asset to Debt Ratio:
𝑻𝒐𝒕𝒂𝒍 𝑨𝒔𝒔𝒆𝒕𝒔
Total Assets to Debt Ratio =
𝑫𝒆𝒃𝒕
Total Assets = Non-Current Assets + Current Assets + Inventories + Trade
Receivables + Cash & Cash Equivalent + Short-term Loans
& Advances + Other Current Assets
Debt = Long-term Borrowings (i.e., Debenture+Mortgage public deposits)
+ Long-term Provisions
This Ratio measures the safety margin available to lenders of long-term
debts. It measures the extent to which debt is being covered by Assets.
Compiled By: CHIRANJIBI BISOI (9776700287)
iii. Proprietary Ratio:
𝑺𝒉𝒂𝒓𝒆𝒉𝒐𝒍𝒅𝒆𝒓′ 𝒔 𝑭𝒖𝒏𝒅
Proprietary Ratio =
𝑻𝒐𝒕𝒂𝒍 𝑨𝒔𝒔𝒆𝒕𝒔
Shareholder’s Fund/Equity = Share Capital + Reserve and Surplus
Or
= Non-current Assets + Working Capital – Non-
current Liabilities
Total Assets = Non-Current Assets + Current Assets + Inventories + Trade
Receivables + Cash & Cash Equivalent + Short-term Loans
& Advances + Other Current Assets
This Ratio shows the extent to which total assets have been financed
by the proprietor. Higher the Ratio, higher the safety margin for lenders &
creditors.
iv. Interest Coverage Ratio:
𝑬𝑩𝑰𝑻
Interest Coverage Ratio=
𝑰𝒏𝒆𝒓𝒆𝒔𝒕 𝒐𝒏 𝑳𝒐𝒏𝒈−𝒕𝒆𝒓𝒎 𝑫𝒆𝒃𝒕
EBIT = Profit After Tax + Tax + Interest
Interest on L.T. Debt = Interest on Debenture + Interest on L.T. Loan
This Ratio shows how many times the interest charges are covered by
the profits available to pay interest. Higher the Ratio, more secure the lender
is in respect of payment of interest regularly.
v. Debt Service Coverage Ratio:
𝑷𝒓𝒐𝒇𝒊𝒕 𝑨𝒇𝒕𝒆𝒓 𝑻𝒂𝒙 𝑩𝒆𝒇𝒐𝒓𝒆 𝑰𝒏𝒕𝒆𝒓𝒆𝒔𝒕(𝑷𝑨𝑻𝑩𝑰)
Debt Service Coverage Ratio =
𝑰𝒏𝒆𝒓𝒆𝒔𝒕 𝒐𝒏 𝑳.𝑻. 𝑳𝒐𝒂𝒏𝒔 & 𝑫𝒆𝒃𝒕𝒔 + 𝑰𝒏𝒔𝒕𝒂𝒍𝒍𝒎𝒆𝒏𝒕𝒔
PATBI = Profit After Tax + Interest
This is a measure of the cash flow available to pay current debt
obligations. The ratio states net operating income as a multiple of debt
obligations due within one year, including interest, principal, sinking-fund
and lease payments.
vi. Capital Gearing Ratio:
𝑬𝒒𝒖𝒊𝒕𝒚 𝑺𝒉𝒂𝒓𝒆 𝑪𝒂𝒑𝒊𝒕𝒂𝒍
Capital Gearing Ratio =
𝑭𝒖𝒏𝒅𝒔 𝑩𝒆𝒂𝒓𝒊𝒏𝒈 𝑭𝒊𝒙𝒆𝒅 𝑷𝒂𝒚𝒎𝒆𝒏𝒕𝒔
Equity Share Capital = Share Capital + Reserve and Surplus
FBFP = L.T. Loans + L.T. Debts + Preference Share Capital
The gearing ratio is a measure of financial risk and expresses the
amount of a company's debt in terms of its equity. A company with a gearing
ratio of 2.0 would have twice as much debt as equity.