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This is one of the most important methods of financial analysis It is the technique of analyzing and interpreting financial statements with the help of accounting of ratios A ratio may be expressed in three methods. They are:

± Simple or pure ratios ± Percentage ± Rate

4. 3.Ratio Analysis Significance of Ratio Analysis 1. 6. 5. 2. Simplifying financial information Converting absolute figures Helps in control of the firm¶ Helps to make trend analysis Helps in decision making Helps in inter-firm comparison .

Solvency ratios 5. Liquidity ratios 3. Activity ratios 4.Ratio Analysis Types of Ratios 1. Leverage/Capital Structure Ratios . Profitability ratios 2.

Profitability Ratios Profitability is an indication of the efficiency with which the operations of the concern are carried on.Ratio Analysis 1. They are: General Profitability Ratios Overall Profitability Ratios . Profitability of a concern can be known through the analysis of general and overall profitability Thus profitability ratios are brought into two groups.

2. General Profitability Ratios The important general profitability ratios are: 1. 3.Ratio Analysis a. 5. 4. Gross profit ratio Net profit ratio Operating ratio Operating profit ratio Expense ratio .

It is usually represented as percentage and hence it is calculated by dividing the gross profit by sales GP Ratio = Gross Profit/Net sales x100 or GP Ratio = Net sales.COGS/Net sales x100 . Gross Profit Ratios Gross profit ratios measure the relationship of gross profit to net sales.Ratio Analysis 1.

lesser sales etc . It reflects the efficiency with which a firm produces it products A low gross profit ratio is an indication of the high cost of goods sold due to unfavorable purchasing policies.Ratio Analysis Significance of GP Ratios The GP ratio indicates the degree to which the selling price of goods per unit may decline without resulting in losses on operations of a firm.

It is calculated as: Net operating profit/Net Sales x100 . It indicates the efficiency of the management in manufacturing.Ratio Analysis 2. administrative and other activities of the concern. Net Profit Ratio Net profit ratio establishes the relationship between net profit and sales. selling.

the more successful the business is .Ratio Analysis Significance This ratio shows the number of dollars that remains out of every 100 dollar of sales An increase in the ratio over the previous period is an indication of improvement in the operational efficiency of the concern. provided the gross profit is constant Hence net profit is described as an index of operational efficiency The higher the ratio.

Operating Ratio Operating ratio measures the cost of operation per dollar of sales It is generally represented as a percentage The two elements of this ratio are operating cost and net sales Operating cost is the sum of operating expenses ( admn exp. office expense. selling and distribution exp etc) and the cost of goods .Ratio Analysis 3.

Ratio Analysis The formula for calculation of operating ratio is Operating cost/ Net sales x 100 Or COGS + Operating Expenses X 100 Net Sales .

income tax. the less favorable it is as it should have a small operating profit to cover interest .Ratio Analysis Significance ± This ratio is the yardstick of operational efficiency ± The higher the ratio. dividend and reserves .

Operating Profit Ratio Operating profit ratio is net sales minus operating cost.Ratio Analysis 4. operating profit is net sales minus (cost of goods sold + administrative and office expenses + selling and distribution expenses). This is always calculated as a percentage . In other words.

Expense Ratio It is the relationship of various expenses to net sales.Ratio Analysis 5. higher is the profitability and greater the ratio. the lower is the profitability . It is calculated by dividing each item of expense or groups of expenses with the net sales to analyze the cause of variation of the operating ratio The smaller the ratio.

Cost of Goods Sold Ratio Cost of goods sold X 100 = sales .Ratio Analysis The various expense ratios are: 1.

Ratio Analysis 2.Administrative & Office Expense Ratio = Admv & Office Expense X 100 Sales .

Ratio Analysis 3.Non-operating expense ratio . Selling and Distribution Expense 4.

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