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RATIO ANALYSIS

TOOLS AND TECHNIQUES


Group No.8
ACD Technique

ANALYZE
COMPARE
DIG DEEP
Learning Objectives

 Meaning of Ratio Analysis


 Tools and Techniques of Ratio Analysis
 Intra Firm and Inter Firm Analysis
 Ratios Predicting Financial Failure
 Different Frameworks of Ratio Analysis
Why Financial Analysis

Lenders’ need it for carrying out the following


 Technical Appraisal
 Commercial Appraisal
 Financial Appraisal
 Economic Appraisal
 Management Appraisal
Ratio Analysis
It’s a tool which enables the banker or lender to
arrive at the following factors :
 Liquidity position
 Profitability
 Solvency
 Financial Stability
 Quality of the Management
 Safety & Security of the loans & advances to be or
already been provided
Types of Ratios

 Liquidity Ratio
 Solvency Ratio
 Activity Ratio
 Profitability Ratio
 Shareholder’s Ratio
Liquidity Ratio
1. Current Ratio : It is the relationship between the current assets and
current liabilities of a concern.

Current Ratio = Current Assets/Current Liabilities

 Ideal Ratio = 2

2. Net Working Capital Ratio : Relation between sales and Net


Working Capital.

NWCR = Sales/NWC

where NWC = Current Assets – Current Liabilities


(contd.)

3. Quick Ratio : It is the ratio between Quick


Current Assets and Quick Current Liabilities.

Quick Ratio = Quick Current Assets/ Quick


Current Liabilities

 Ideal Ratio = 1
 Normally it is less than 1.
(contd.)

4. Operating Cash flow Ratio: It is the ratio of the cash


flow from operations to current liabilities.

OCR= Cash flow from Operations /Current


Liabilities
Solvency Ratios
1. Interest coverage ratio (ICR): This is the ratio
between earnings before interest and taxes
(EBIT) and interest expense.
ICR= EBIT/Interest Expense

2. Debt ratio: This is the ratio of total liabilities to


total assets.
Debt Ratio= Total Liabilities/Total Assets
(contd.)

3. Debt-Equity Ratio: .
This ratio measures
the proportion of
long term debt to
equity.

DER=Long Term
Debt/Equity
Activity Ratios

1. Inventory Turnover Ratio: It is the


ratio of cost of goods sold to inventory.
ITR=Cost of Goods Sold/Average
Inventory
2. Debtor’s Turnover Ratio: This is the
ratio of net sales to average debtors.
DTR=Net Sales/Average Debtors
(contd.)

3. Fixed Assets Turnover Ratio :


Sales/Fixed Assets
The higher the fixed asset turnover ratio, the
more sales the firm is generating with a Rupee
of fixed assets.
4. Asset turnover Ratio : This is the ratio of
sales to total assets.
Net Sales/Tangible Assets
AIM FOR HIGHER PROFITS
Profitability Ratio

1. Net Profit Margin Ratio: It is the ratio


of net profit to sales.
NPR=Net Profit/Sales

2. Gross Profit Margin Ratio: It is the


ratio of gross profit to net sales.
GPR=Gross Profit/Net Sales
(contd.)
3. Return on Total Assets: This is the measure of
return of assets invested in business.
ROA=Net Income After Tax/Total Assets

4. Return on Equity: This is the ratio of net


profit to common equity.
ROE=Net Profit After Tax/Common Equity
SELECTING THE RIGHT STOCK AMIDST
ALTERNATIVES
Shareholder’s Ratio
1. Earnings per Share: This ratio reflects
the earnings per share for the equity share
holders.
EPS=(Net profit-Preferred Dividend)/No.
of equity shares outstanding

2. Price-Earnings Ratio: This ratio is a multiple


obtained by dividing the market price of the share
with the earnings per share.
PE Ratio=Price of Share/EPS
(contd.)

3. Dividend Payout Ratio: This ratio is the


proportion of dividends per common share
to earnings per common share.
DPR=Dividends per common
share/Earnings per common share

4. Earnings Retained Ratio:


ERR=Earnings Retained/Net Income
Ratios Predicting Financial
Failure
Altman Multivariate Model

 1.2 x1+ 1.4x2 + 3.3 x3 + .60 x4 + 1 x5


 Combination of 5 ratios
 Predict financial failure
 Score less than 2.7, the company has the
probability of going BANKRUPT
 Score from 1.81 to 2.7 are in the GREY
area
Different Frameworks for
Ratio Analysis
 Du Pont Model
• Return of Assets x Net Profit Margin

– Secure Increasing Profit Margin


– Increase Productivity of Assets
– Liabilities not Included-Limitation
(contd.)

 Fruhan Model
• ROE=Net Profit x Capital Intensity x Financial
Leverage
Model is consistent with wealth maximization
Considers financial decision along with operating
decision
Considers the Liabilities along with the Return on
Assets
??? Any
Questions??