FINANCIAL PERFORMANCE

APPRAISAL
USING RATIO ANALYSIS
GROUP MEMBERS
Name Roll No.
 Sunita Gowda 12
 Nimesh Moakni 26
 Vinit Raut 37
 Shivram Samant 40
 Swati Sangai 41
FINANCIAL ANALYSIS???

 Financial analysis is the process of identifying financial

strengths and weaknesses of firm to establish
relationship between items of balance sheet and profit
and loss account.
INTRODUCTION

 It helps the management,creditors,investors and others to

form judgment about operating performance and
financial position of the firm.
 Helps to identify the financial strengths and weaknesses
thereby prepare future plans .
 Financial analysis is the starting point for making plans
before using any planning procedures.
OBJECTIVES
 To get useful information from financial statements.
 To recognize the diagnostic role of financial ratios.

 To highlight utility in terms of credit analysis and

competitive analysis.
 To understand the limitations of financial ratios.
USERS OF FINANCIAL ANALYSIS

 Financial analysis can be undertaken by management of

the firm or by parties outside the firm viz
owners,creditors,investors.
 Nature of the analysis will differ depending on the
purpose of the analyst.
 Trade Creditors-interested in the firms ability to meet
their claims over a short period of time.
 Suppliers of long-term debt-concerned with long term
survival, profitability over time & ability to generate
cash.Also analyse historical statements but place
emphasis on firms projected analysis.
 Investors- people who have invested their money in
firms shares and are concerned about firms earnings.
They restore more confidence in those firms that show
steady growth in earnings.
 Management- Is interested in every aspect of the
financial analysis. Their overall responsibility is to see
that resources are used effectively and efficiently.
CATEGORIES OF RATIOS
o Liquidity Ratios
o Leverage Ratios
o Activity Ratios
o Profitability Ratios
LIQUIDITY RATIOS
 Measures the ability of the firm to meet its current
liabilities.
 Quick measurement of liquidity.

 Make sure-lack or excess of liquidity.

 Lack-poor credit worthiness ,loss of creditors confidence

,legal tangle result in closure of company.
 Excess-funds unnecessarily tied up with current assets.
TYPES OF LIQUIDITY RATIO
Two Types
 Current ratios

 Quick ratios
HOW TO INTERPRET CURRENT RATIOS?

 Ratio of 2 to 1 is satisfactory.
 Current ratio represent a ‘margin of safety’ for creditors.

 Higher ratio greater the margin of safety ,more the firms

ability to meet the obligations.
 Current ratio is test of quantity not quality.
 Current ratio measures total rupees worth of current asset and
total rupees worth of current liabilities.
 Never consider quality of asset

 Liabilities are not subject to any fall in value , They have to be

paid .
 Current asset can decline in value.

 Current asset consist of doubtful and slow moving debtors or

slow moving and obsolete stock then short term solvency
creates problems.
QUICK RATIO
IS QUICK RATIO A BETTER MEASURE OF
LIQUIDITY?
 1 to 1 is satisfactory.
 It does not necessarily imply sound liquidity position.

 All debtors may not be liquid and cash may be

immediately needed to pay operating expenses.
 Inventories are not absolutely non-liquid .
 With high value of quick ratio suffer from shortage of fund ,if
it has slow paying ,doubtful and long duration outstanding
debtors.
 On other hand low value ,shows paying its current obligations
in time.
NET WORKING CAPITAL RATIO
 Difference between current assets and current liabilities
is called NWC or Net current asset .
 NWC is used as measure of a firm’s liquidity.

 Larger NWC has the greater ability to meet its current

obligations.
LEVERAGE RATIOS
 Firms should have strong short as well as long term
financial position
 So Leverage ratio or capital structure ratio are
calculated.
 Two aspects

1.Between debt and equity ,debt is more risky .If firm fail
to pay then it can result into legal action.
2.Debt can be the advantageous for shareholders in two way:
a) They can retain control of the firm with a limited stake
b) Their earnings will be magnified .It is also called financial
leverage.
DEBT RATIO
 Firm more interested in knowing the proportion of the
interest bearing debt in capital structure.
 Total debt include short and long term borrowing ,
debenture/Bonds .
 Net current asset=current asset-current liabilities.
DEBT-EQUITY RATIO
 The relationship describing the lenders contribution for
each rupee of owner’s is called debt-equity ratio
 It is calculated by dividing total debt by net worth .
CAPITAL EMPLOYED TO NET WORTH
RATIO
 This is another way of expressing the basic relationship
between debt and equity.
 Aim is to find how much fund are being contributed
together by lenders and owners for each rupee of the
owner’s contribution .
WHAT DO DEBT RATIO IMPLY?
 These ratios shows extent to which debt financing has
been used in business.
 Two conditions- high ratio

1) claim of creditors greater than owners.

2) Inflexibility because of pressure from creditors.
3) Company is able to borrow fund on restrictive terms and
conditions.
 Low ratio:
1) Greater claim of owners than creditors.
2) A high proportion of equity provide a large margin of safety
for them.
COVERAGE RATIO
 Debt ratio fail to indicate firm’s ability to meet interest
obligations.
 Limitation is that it does not consider repayment of loan.
ACTIVITY RATIO / TURNOVER RATIO
1) Fixed assets turnover ratio.
2) Current assets turnover ratio.
3) Working capital turnover ratio.
4) Inventory / stock turnover ratio.
FIXED ASSETS TURNOVER RATIO
 Net sales / fixed assets

 A high FA turnover ratio indicates the capability of the

organisation to achieve maximum sales with the
minimum investment in fixed assets.
CURRENT ASSETS TURNOVER RATIO
 Net sales / current assets

 A high current assets turnover ratio indicates the

capability of the organisation to achieve maximum sales
with the minimum investment in current assets.
INVENTORY / STOCK TURNOVER RATIO
 A high Inventory / stock turnover ratio indicates that
maximum sales turnover is achieved with the minimum
investment in inventory.
 PROFITABILITY RATIO
1) Gross profit ratio.
2) Net profit ratio.
3) Operating ratio.
4) Return on assets.
5) Return on capital employed.
GROSS PROFIT RATIO
Gross profit
Net Sales 100

 A high gross profit ratio may indicate that the

organisation is able to produce or purchases at relatively
lowercost.
NET PROFIT RATIO

 Net profit after taxes / net sales * 100

 A high net profit ratio indicates higher profitability of the

business.
OPERATING RATIO

 Manufacturing COGS + operating expenses / net sales *

100
 A high operating ratio indicates that only a small margin
of sales is available to meet the expenses in the form of
interest, dividend and operating expenses.
RETURN ON ASSETS
 Net profit / assets * 100

 ROA measures the profitability of the investments in a

firm.
RETURN ON CAPITAL EMPLOYED

 A high ROCE indicates a better and profitable use of

long term funds of owners and creditors.
ADVANTAGES OF RATIO ANALYSIS
 Helpful in analysis financial statements
 It is helpful for forecasting purpose.

 To simplify the accounting information.

 To workout the solvency.

 To workout the profitability.

 Helpful in comparative analysis of the performance.

LIMITATIONS OF RATIO ANALYSIS
 Company differences:- Different firms apply different
accounting policies therefore the ratio of one firm cannot
be compared with the ratio of other firm.

 False results:- Accounting ratios are based on data drawn

from accounting records. In case that data is correct then
only the ratio will be correct.

 Effects of window dressing:- In order to cover up their

bad financial position some companies resort to window
dressing.
LIMITATIONS OF RATIO ANALYSIS
 Costly techniques:- Ratio analysis is a costly technique
and can be used by big firms whereas small firms are not
able to afford it.

 Absence of standard university accepted terminology:-

There are no standard ratio which are universally
accepted for comparison purpose. As such the
significance of ratio analysis techniques is reduced.

 Effect of price level changes:- Price level changes, often

make the comparison of figures difficult over a period
of time.
LIMITATIONS OF RATIO ANALYSIS

 Misleading results:- In the absence of absolute data,

the result may be misleading.

 Historical data:- the basis to calculate ratios are historical

financial statements. The financial analyst is more
interested in future, while the ratio indicate past.
LIMITATIONS OF RATIO ANALYSIS
 Historical data:- the basis to calculate ratios are historical
financial statements. The financial analyst is more
interested in future, while the ratio indicate past.
DU PONT ANALYSIS 
The Du Pont Company of the US pioneered a system of
financial analysis, which has received widespread
recognition and acceptance. This system of analysis
considers important interrelationships between different
elements based on the information found in the financial
statements. 

The Du Pont analysis can be depicted via the following

chart:
IMPORTANCE OF DU PONT ANALYSIS
 Any decision affecting the product prices, per unit costs,
volume or efficiency has an impact on the profit margin
or turnover ratios. Similarly any decision affecting the
amount and ratio of debt or equity used will affect the
financial structure and the overall cost of capital of a
company. Therefore, these financial concepts are very
important to evaluate as every business is competing for
limited capital resources. Understanding the
interrelationships among the various ratios such as
turnover ratios, leverage, and profitability ratios helps
companies to put their money areas where the risk
adjusted return is the maximum.
At the apex of the Du Pont chart is the Return On Total Assets
(ROTA), defined as the product of the Net Profit Margin (NPM) and
the Total Assets Turnover Ratio (TATR). As a formula this can be
shown as follows:

 (Net profit/Total asset)= (Net profit/Net sales)*(Net sales/Total assets)

(ROTA) (NPM) (TATR)

The basic Du Pont analysis can be extended to explore the

determinants of the Return On Equity (ROE).

 Return on equity= Asset turnover * Net profit margin*leverage

(Net profit/Equity)= (Net profit/Sales)*(Sales/Total assets)*(Total assets/Equity)
(ROE) (NPM) (TATR) 1/(1-DR)

 Where DR is the debt ratio= debt (D)/assets (A)

Thank You…..