RATIO ANALYSIS

SUGGESTED ADDITIONAL REFERENCE:

FINANCIAL MANAGEMENT , 9TH ED,BY I.M.
PANDEY
 Nature of Ratio Analysis
2

A financial ratio is a relationship between two

accounting numbers. Ratios help to make a
qualitative judgment about the firm’s financial
performance.

FRCC, Prof. Ansuman Chatterjee, AU

 Utility of Ratio Analysis
3

Assessment of the firm’s financial conditions and

capabilities.
Diagnosis of the firm’s problems, weaknesses and
strengths.
Credit analysis
Security analysis
Comparative analysis
Time series analysis

FRCC, Prof. Ansuman Chatterjee, AU

 Using Financial Ratios…
4

 Many pieces of information do not have significant meaning in isolation

– they become more meaningful when related to an appropriate base

 Ratios reduce large figures to an easily understood relationship

 Ratios do not make conclusions – It is for the analyst to draw

conclusion by evaluating and relating the ratios

 There are no “good” ratios and “bad” ratios – It is only possible to

make relative inferences

FRCC, Prof. Ansuman Chatterjee, AU

 Types of Financial Ratios
5

Company performance is usually analyzed on following parameters

Liquidity ratios
Solvency ratios
Turnover ratios
Profitability ratios
Equity-related ratios

FRCC, Prof. Ansuman Chatterjee, AU

 Liquidity Ratios
6

Liquidity ratios measure a firm’s ability to meet its

current obligations.
Also called as Short-term Solvency ratios.

Trade creditors / suppliers are more interested in

these ratios.

FRCC, Prof. Ansuman Chatterjee, AU

 Liquidity Ratios contd…
7

Current assets
Current ratio =
Current liabilities
Current assets – Inventories
Quick ratio =
Current liabilities
Cash + Marketable securities
Cash ratio =
Current liabilities

RATIO RULE OF
THUMB
Current Ratio 2: 1
Quick Ratio or 1: 1
Acid Test Ratio
Cash ratio 0.5: 1

FRCC, Prof. Ansuman Chatterjee, AU

 Tickle Your Brain…… 1
8

Now based on discussion so far, comment on the

Short term solvency (liquidity) position of your
company using Ratio Analysis.

For better analysis compare calculated ratios with

industry averages / past ratios.

FRCC, Prof. Ansuman Chatterjee, AU

 Solvency Ratios
9

Solvency ratios measure the ability of a firm to serve

long-term borrowed funds.
Also called as Long-term Solvency ratios.

Financial institutions/ Lenders are more interested

in these ratios.

FRCC, Prof. Ansuman Chatterjee, AU

 Solvency Ratios contd…
10

Total Debt or Loan

Debt-Equity Ratio =
Equity or Shareholders’ Fund

EBIT
Interest Coverage Ratio =
Interest

RATIO RULE OF THUMB

Debt Equity Lesser the better

Int. Coverage Ratio Higher the Better

(ICR)

FRCC, Prof. Ansuman Chatterjee, AU

 Tickle Your Brain…… 2
11

Now based on discussion so far, comment on the

Long term solvency position of your company using
Ratio Analysis.

For better analysis compare calculated ratios with

industry averages / past ratios.

FRCC, Prof. Ansuman Chatterjee, AU

 Turnover Ratios
12

Turnover Ratios measure the firm’s efficiency in

utilising its assets.
Also called as Activity or Efficiency ratios.
Anyone who want to judge firm’s efficiency checks
these ratios.

Mostly used to Substantiate Profitability/ Solvency/

Liquidity position of the company.

FRCC, Prof. Ansuman Chatterjee, AU

 Turnover Ratios contd…
13

Cost of goods sold or net sales

Inventory turnober 
Average (or closing) inventory
Number of days in the year (say, 360)
Days of inventory holding 
Inventory turnover
Credit sales or net sales
Debtors turnover 
Average (or closing) debtors
Number of days in the year (say, 360)
Collection period 
Debtors turnover
RATIO RULE OF THUMB
Inventory Turnover Higher the Better
Days Of Inv. Holding or Inv. Holding period Lesser the Better
Debtors Turnover Higher the Better
Collection Period or Debtors Collection Period Lesser the Better
FRCC, Prof. Ansuman Chatterjee, AU
 Turnover Ratios contd…
14

Net Sales
Fixed Assets Turnover Ratio =
Net Fixed Assets

Net Sales
Total Assets Turnover Ratio =
Total Assets

RATIO RULE OF THUMB

Fixed Assets Turnover Higher the Better
Total Assets Turnover Higher the Better

FRCC, Prof. Ansuman Chatterjee, AU

 Tickle Your Brain……3
15

Now based on discussion so far, comment on the

Efficiency /Turnover capacity of your company using
Ratio Analysis.

For better analysis compare calculated ratios with

industry averages / past ratios.

FRCC, Prof. Ansuman Chatterjee, AU

 Profitability Ratios
16

Profitability ratios measure a firm’s overall efficiency

and effectiveness in generating profit.

Investors (present/ potential) are interested in these

ratios.

FRCC, Prof. Ansuman Chatterjee, AU

 Profitability Ratios contd….
17

Operating profit Margin

= EBIT / Net Sales
Return on Assets (ROA) or Return on Investment
(ROI) = PAT / Total Net Assets
(note: Total Net Asset= NFA + NCA + Investments)
Return On Equity (ROE)
= PAT/ Shareholders’ funds

FRCC, Prof. Ansuman Chatterjee, AU

 Profitability Ratios contd….
18

RATIO RULE OF THUMB

Operating profit Margin Higher The Better

ROA or ROI Higher The Better

ROE Higher The Better

FRCC, Prof. Ansuman Chatterjee, AU

 Tickle Your Brain……4
19

Now based on discussion so far, comment on the

Profitability Position of your company using Ratio
Analysis.

For better analysis compare calculated ratios with

industry averages / past / competitor’s ratios.

FRCC, Prof. Ansuman Chatterjee, AU

 Equity-related Ratios
20

Equity-related ratios measure the shareholders’

return and value.
Also refered as Capital market ratios.

Investors (present/ potential) are interested in

these ratios.

FRCC, Prof. Ansuman Chatterjee, AU

 Equity-related Ratios contd…
21
Profit after tax
EPS 
Number of ordinary shares
Dividends
DPS 
Number of ordinary shares
DPS Dividends
Payout ratio  
EPS Pr ofit after tax
DPS
Dividend yield 
Market value per share

RATIO RULE OF THUMB

EPS Higher the Better
DPS Higher the Better
Dividend Pay out Ratio Higher the Better
Dividend yield Higher the Better
FRCC, Prof. Ansuman Chatterjee, AU
 Equity-related Ratios contd…
22

P/E ratio = Market value per Share / EPS

Book Value per Share = Net Worth or Shareholders’ Funds/ No. of Ordinary Shares

RATIO RULE OF THUMB

P/ E Ratio Judgmental
B.V. Per Share Higher the Better

FRCC, Prof. Ansuman Chatterjee, AU

 Tickle Your Brain……5
23

Now based on discussion so far, comment on the

Equity Related Ratios of your company.

For better analysis compare calculated ratios with

industry averages / past /competitor’s ratios.

FRCC, Prof. Ansuman Chatterjee, AU

 Cautions in Using Ratio Analysis
24

Standards of comparisons
Company differences
Market and Price level changes
Different definition
Past data

FRCC, Prof. Ansuman Chatterjee, AU

 USERS’ INFO NEED MATRIX
25

Info-need of Primary Stakeholder Groups

INVESTOR LENDERS SUPPLIER CUSTOME
Priority S S RS
Level

Equity Solvency Liquidity Credit policy

related
PRIMARY Profitability Efficiency Abundant-
Profitability Inventory
Solvency Liquidity Profitability Profitability
SECONDARY
Efficiency Efficiency

FRCC, Prof. Ansuman Chatterjee, AU