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# What is a ratio?

A ratio:-
 It is the mathematical relationship between two
quantities in the form of a fraction or percentage.

##  A ratio on its own has little or no meaning at all.

Significance of using ratios:

## 1. It is compared with other ratios in the same set

of financial statements.
2. It is compared with the same ratio in previous
financial statements (trend analysis).
3. It is compared with a standard of performance
(industry average).
WHAT IS RATIO ANALYSIS?
DEFINITION:-

## It refers to an analysis of the relationships of

items in financial statements & thereby an
investigation into the financial performance of an
entity using a series of ratios.
Classification of ratios:-
Generally ratios are divided into four areas which provide different
kinds of information:-

• Leverage Ratios

• Liquidity Ratios

• Profitability Ratios

4. Other ratios
LIQUIDITY RATIOS
MEANING:-
It measures the ability of a firm to meet its short
term obligations & reflects the short term
financial solvency of firm.

Classification:-
5. Current ratio
6. Acid-test ratio
LIQUIDITY RATIOS
 Current ratio:-
It is the ratio of total current
assets to total current liabilities.
Formula:-

current assets
Current ratio =
current liabilities
LIQUIDITY RATIOS
 Acid-test ratio:-
It measures the firm’s ability to
convert its current assets quickly into cash in
order to meet its current liabilities. Hence also
known as Quick ratio.

Formula:
Quick assets
Acid-test ratio =
current liabilities
Leverage ratios

Meaning:-
It is defined as financial ratio which
throws light on long term solvency of a firm with
regards to the following two aspects:-

##  ability to repay the principal &

 regular payment of interest
Leverage ratios
Classification:-
2. Debt-equity ratio

## 8. Debt service coverage ratio

Leverage ratios

 Debt-equity ratio:-
It indicates the relationship between
borrowed funds and owners capital.

Formula:-

Total debt
D/E ratio =
Shareholders equity
Leverage ratios
 Capital gearing ratio:-
It indicates the relationship between equity
funds and fixed income bearing funds.

Formula:-

Equity funds
CGR =
Fixed income bearing funds
Leverage ratios
 Interest coverage ratio:-
It measures the debt servicing capacity of
the firm. It is determined by dividing the EBIT by
the fixed interest charges.
Formula:-

EBIT
Interest coverage ratio =
Interest
Leverage ratios
 Debt service coverage ratio:-
It computes the debt service capacity of a
business firm. In general 2:1 is considered as
satisfactory ratio.
Formula:-

EAT+Interest+Depreciation+OA
DSCR = Installment
Profitability ratios
Meaning:-
 These ratios tell us whether a business is
making profits - and if so whether at an
acceptable rate.

##  It uses margin analysis and show the return on

sales and capital employed.
Profitability ratios
Classification:-
The key profitability ratios are:
3. Gross profit ratio

## 7. Return on Capital employed ratio

Profitability ratios
 Operating profit ratio:-
It refers to a company's ability to control its other

Formula:-

EBIT
Operating profit ratio =
Net Sales
Profitability ratios
 Gross profit ratio:-
It refers to ability of the business to consistently
control its production costs or to manage the
margins its makes on products its buys and sells.
Formula:-

Gross Profit
Gross profit margin =
Sales
Profitability ratios
 Return on capital employed:-
It measures the profits related to return
on capital employed. The term capital employed
refers to long term funds supplied by lenders
and owners of the firm.
Formula:-

EBIT
ROCE =
Average total capital employed
Other Ratios
 Earning per share:-
It measures the profit available to the equity
shareholders on a share. It is calculated by
dividing the profits available to the equity
shareholders by the number of outstanding
shares.
Formula:-

## Net profit available to equity-holders

EPS =
Number of
ordinary shares outstanding
Other Ratios
 Price-earnings ratio:-
It measures investors’ expectations
and the market appraisal of the performance of a
firm.
Formula:-

P/E ratio =
EPS
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