You are on page 1of 14

ACCOUNTING RATIOS

Accounting ratios

Analysis of financial statements- balance sheet

and cash flow

Useful to determine firms financial health

Process of evaluating relationship between two


components of financial statement

Commonly used tool- converts the results in


comparable form

Advantages of Ratio Analysis

Simplifies the comprehension of financial status

Facilitates interfirm / intrafirm comparison


Helps in planning and to set targets

Assists management in its basic function of


forecasting, planning, control and

communication.

Shortcomings of Ratio Analysis

No conclusion can be drawn by studying a

single ratio. They are only indicators.

Critical aspects like attitude & policies followed

by the management & relations with the


workforce will not be revealed.

Window dressing Organizations may


manipulate their accounts to meet their targets.

Cash position Ratio

Absolute Cash Ratio = Cash + disposable investments Current Liabilities

This ratio is used to find the cash position of a company the higher this ratio is the better the liquidity of the company. However, a very high ratio indicates a poor funds management.

Liquidity Ratio

Current Ratio =

Current Assets Current Liabilities

Current assets are funds, inventory & receivables. Current Liabilities are all payables. A company should reduce the current assets to the maximum extent possible to utilize the resources Fully. Ideally this ratio should be 2:1 i.e., Current assets twice as much as current liabilities.

Liquidity Ratio

Liquid Ratio =

Current Assets - Inventories Current Liabilities

Indicates the ability of the company to meet its immediate liabilities out of its quickly realisable current assets. Ideally this ratio should be 2:1 i.e., Realisable current assets should be enough to meet current liabilities.

Turnover Ratio
Debtors turnover = Net credit sales Average debtors Creditors turnover =Net credit purchases Average creditors Inventory turnover = Cost of goods sold Average goods inventory These ratios determine how quickly assets are converted into cash

3. Capital Structure Ratios

Owners Equity Total Equity

* This ratio indicates what the owners stake is in the business. * This ratio indicates the extent of funds being financed by borrowing.

Debt Equity

These ratios are mainly of interest to the creditors, bankers, shareholders and generally any one who lends or invests in the company

4. Coverage Ratios

Debt Service =Earnings available for debt service


Interest + Installments

This ratio shows the earnings that can be made

available to the creditors. A high ratio indicates a comfortable position to repay the borrowings taken by the company.

This along with other factors determine the credit rating of the company.

5. Profitability Ratios

ROI =

Operating profit Capital Employed

Capital Employed = Share Capital + reserves & Surplus + Long Term Loans This ratio indicates the basic viability of the company's operations. For a profit driven company ROI is the basic reason for the companys existence. This also called as the return on capital Employed the ROCE.

5. Profitability Ratios

Gross Profit Ratios = Gross Profit Sales

Net profit Ratios = Net profit Sales

DUPONT CHART

As on Current Assets Inventories Debtors Cash and Bank Other advances Total Current Liabilities

Mar 07 1318 873 278 812 3281

Mar08 1116 755 494 636 3001

Mar09 922 464 96 524 2006

Creditors
Cust. Advances Provisions Others Total Net Working Cap.

883
653 260 49 1845 1436

704
774 208 21 1707 1294

540
622 159 18 1339 667