Ratio analysis

Chaksh Sharma, Assistant Professor, PCTE

Types of ratios
Profitability
Coverage
Turnover
Financial
Liquidity
Stability (solvency)
Leverage
Operating
Financial

Chaksh Sharma, Assistant Professor, PCTE

Profitability ratios
Gross profit ratio
 for adequate cover to fixed expenses
For adjustment in sales price
Gross Profit *100
Net Sales

Net profit ratio

 Net profit after tax *100
Net Sales

Chaksh Sharma, Assistant Professor, PCTE

Operating ratio
Cost of sales (administration, selling and distribution
expenses)
Cost of goods sold + operating expenses *100
Net Sales
Cost of goods sold =
 opening stock + purchases + direct expenses + manufacturing
expenses – closing stock – gross profit
Operating expenses
 Administrative expenses + selling and distribution expenses

Chaksh Sharma, Assistant Professor, PCTE

Expenses ratio
 Material consumed ratio
 Material consumed *100
Net sales
 Conversion cost ratio
 Labour expenses + manufacturing expenses * 100
Net Sales
 Administrative expenses ratio
 Administrative expenses *100
Net Sales.
 Selling and distribution expenses ratio
 Selling and distribution expenses *100
Net Sales.
Chaksh Sharma, Assistant Professor, PCTE
Operating profit ratio
 Operating profit *100
Net Sales
Or
 100 – operating ratio

Where
 Operating profit = Net profit + non operating expenses

(interest and tax) – non operating income (investments,

currency gain, asset sales)
or
 Operating profit = gross profit – operating expenses

Chaksh Sharma, Assistant Professor, PCTE

Sales 500000
Less: Cost of goods sold 300000
Gross profit ??
Less: operating expenses 120000
Operating profit ??
Add: Non operating income 12000
Less: Non operating expenses 4000
Net profit ??
Tax @ 30% ??
Net profit after tax ??

Calculate:
•Gross profit ratio
•Operating ratio
•Operating profit ratio
•Net profit ratio
Chaksh Sharma, Assistant Professor, PCTE
Sales 500000
Less: Cost of goods sold 300000
Gross profit 200000
Less: operating expenses 120000
Operating profit 80000
Add: Non operating income 12000
Less: Non operating expenses 4000
Net profit 88000
Tax @ 30% 26400
Net profit after tax 61600

Calculate:
•Gross profit ratio – 40%
•Operating ratio – 84%
•Operating profit ratio – 16%
•Net profit ratio – 12.32%
Chaksh Sharma, Assistant Professor, PCTE
Return on capital employed
Operating profit * 100
Capital employed
Operating profit
 Profit before interest and tax
Capital employed
 Equity share capital + preference share capital + undistributed
profit + reserves and surplus + long term liabilities – fictitious
assets –non business assets
Or
 Tangible fixed and intangible assets + current assets – current

liabilities

Chaksh Sharma, Assistant Professor, PCTE

Return on shareholder’s fund
Net profit after interest and tax * 100
Shareholder’s funds

Return on equity shareholder’s fund

 Net profit after interest and tax and preference dividend * 100
Equity Shareholder’s funds
Equity Shareholder’s funds
 Equity share capital + capital reserves + revenue reserves +
balance of profit and loss account – fictitious assets – non
business assets

Chaksh Sharma, Assistant Professor, PCTE

Return on total assets
Net profit after tax * 100
Total assets

Earning per share

Net profit after tax and preference dividend
Number of equity shares

Chaksh Sharma, Assistant Professor, PCTE

Numerical -
Calculate:
Return on capital employed
Return on total assets
Return on shareholder’s funds

Particulars Amount
Net profit before interest and tax 2,75,000
Net profit after tax 2,20,000
Net profit after interest and tax 1,10,000
Preference dividend 35,000
Capital employed 11,00,000
Total assets 12,65,000
Net worth or equity shareholders fund 7,50,000

Chaksh Sharma, Assistant Professor, PCTE

Price Earning ratio
Market price per equity share
Earning per share

Payout ratio
Dividend per equity share * 100
Earning per share

Retained earning ratio

Retained earnings * 100
Total earnings

Chaksh Sharma, Assistant Professor, PCTE

Dividend Yield ratio
Dividend per share * 100
Market price per share

Chaksh Sharma, Assistant Professor, PCTE

Turnover ratios
Capital turnover (Sales to capital employed) ratio
 Sales
Capital employed (i.e. Shareholder’s fund + long term liabilities)
 The higher the sales greater are the profits

Fixed assets turnover (sales to fixed assets) ratio

 Sales
Net fixed assets (i.e. Fixed assets less depreciation)
Higher the ratio, better is the performance of company

Chaksh Sharma, Assistant Professor, PCTE

Working capital turnover ratio
 Sales
Net working capital(i.e. Current assets – current liabilities)
The higher is the ratio, lower is the investment in
working capital and greater the profits

Total assets turnover ratio

 Sales
Total assets
The higher is the ratio, lower is the investment in
working capital and greater the profits

Chaksh Sharma, Assistant Professor, PCTE

Inventory (stock) turnover ratio
 Cost of goods sold
Average stock held during the period
Cost of goods sold = opening stock + purchases +
manufacturing expenses –
closing stock
Or
Sales – gross profit
Average stock = opening stock + closing stock
2
High ratio is good for company

Chaksh Sharma, Assistant Professor, PCTE

Debtors (Receivables) turnover ratio
 Net credit sales
Average debtors (& Bills receivables)
Collection period
 365 .
Debtors turnover ratio
Average debtors = opening balance + closing balance
2
Higher the ratio, the more is efficient management of
debtors and cash collected at time

Chaksh Sharma, Assistant Professor, PCTE

Creditors (Account payable) turnover ratio
 Net purchases
Average creditors (& bills payable)
Average age of payables
 365 .
Creditors turnover ratio
Average creditors= opening balance + closing balance
2
High ratio indicates that creditors are not paid in time
Low ratio indicates that company pays early to creditors

Chaksh Sharma, Assistant Professor, PCTE

Numerical
Liabilities Rs. Assets Rs.
Issued capital 2,00,000 Land and buildings 150000
Reserves 90,000 Plant and machinery 80000
Profit and loss a/c 60000 Stock in trade 149000
Bills payable 40000 Sundry debtors 41000
Other current liabilities 90000 Cash and bank balance 30000
Bills receivable 30000
4,80,000 4,80,000

Calculate:
Sales to capital employed, sales to fixed assets, sales to working capital, sales to
total assets, stock turnover ratio, receivable turnover ratio, creditors turnover ratio
with following information:
Sales (credit) 850000, cost of goods sold 510000, average inventory 124250, average
accounts receivable 85000, average accounts payable 80000, credit purchases
545250
Chaksh Sharma, Assistant Professor, PCTE
Liquidity ratios
Current ratio
Current assets
Current liabilities
Generally 2:1 is considered as ideal

Quick (liquid or acid test) ratio

Liquid assets (inventories and prepaid expenses not included)
Current liabilities
Generally 1:1 is considered as ideal

Chaksh Sharma, Assistant Professor, PCTE

Absolute liquidity ratio
 Cash in hand and at bank + short term marketable securities

Current liabilities

Inventory to working capital ratio

Inventory
Working capital
1:1 is desirable

Chaksh Sharma, Assistant Professor, PCTE

Solvency ratios
Fixed assets ratio
 Fixed assets
Capital employed
If less than 1 then its good
Ideal ratio is .67

Current assets to fixed assets

 Current assets
Fixed assets
 Increase in ratio accompanied by increase in profits means
company is expanding
Chaksh Sharma, Assistant Professor, PCTE
Debt equity ratio
Long term debts
Shareholder’s funds
2:1 is acceptable

Proprietary ratio
Shareholder’s funds
Total tangible assets

Chaksh Sharma, Assistant Professor, PCTE

Capital gearing ratio
Fixed interest bearing securities
Equity shareholder’s fund
If less than 1 then low geared
If 1 then evenly geared
If more than 1 then high geared

Chaksh Sharma, Assistant Professor, PCTE