University School of Business

DEPARTMENT - MBA
Master of Business Administration
Financial Reporting and Analysis 21BAT- 602
Chapter: 2.2

Faculty Name: Dr Charu Saxena

(Assistant Professor)

Topic: FINANCIAL RATIO DISCOVER . LEARN . EMPOWER

ANALYSIS II
 FINANCIAL RATIO
ANALYSIS II

Course Outcome
To understand the methods of preparation of various
CO1 financial statements

To examine the impact of information obtained from

CO2 financial statements on the financial position of the
business
To compare the business organizations based upon Will be covered in this
CO3 various financial statement analysis techniques lecture
Financial decision making by evaluating different
CO4 financial statements

To create financial statements and annual reports in

CO5 accordance with the companies’ act
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 Financial Ratio Analysis

Financial ratios are mathematical comparisons of financial statement accounts or

categories.

These relationships between the financial statement accounts help investors,

creditors, and internal company management understand how well a business is
performing and of areas needing improvement

Ratios are easy to understand and simple to compute.

They can also be used to compare different companies in different industries.

Since a ratio is simply a mathematically comparison based on proportions, big and

small companies can be use ratios to compare their financial information.

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Ratios allow us to compare companies across industries, big and small, to
identify their strengths and weaknesses.

Financial ratios are often divided up into following categories:

•Liquidity,

•Solvency,

•Efficiency,

•Profitability,

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 C- Profitability ratios:

This ratio compare income statement accounts and categories to show a company’s ability
to generate profits from its operations.

It focus on a company’s ROI in inventory and other assets.

“How well companies can achieve profits from their operations”.

Investors and creditors can use profitability ratios to judge a company’s return on investment.

In other words, profitability ratios can be used to judge whether companies are making
enough operational profit from their assets.

In this sense, profitability ratios relate to efficiency ratios because they show how well
companies are using their assets to generate profits.

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1- Gross margin/Profit ratio :

This ratio measures how profitable a company sells its inventory or merchandise.

This is the pure profit from the sale of inventory that can go to paying operating
expenses.

Gross margin Vs Profit margin.

Gross margin ratio only considers the cost of goods sold in its calculation. Profit
margin ratio on the other hand considers other expenses.

Gross Margin/ Profit ratio= Gross profit

Sales

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2- The profit margin ratio: ROS

It is also called the return on sales ratio.

Gross profit ratio, is a profitability ratio that measures the amount of net
income earned with each rupee of sales generated by comparing the net income
and net sales of a company.

In other words, the profit margin ratio shows what percentage of sales are left
over after all expenses are paid by the business.

Profit Margin ratio = Net Income

Net sales

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3- The return on assets ratio: (ROA)

It is also called the return on total assets.

It is a profitability ratio that measures the net income produced by total assets
during a period by comparing net income to the average total assets.

In other words, the return on assets ratio or ROA measures how efficiently a
company can manage its assets to produce profits during a period.

ROA= Net Income

Average Total Assets

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4- Return on capital employed :

ROCE is a profitability ratio that measures how efficiently a company can

generate profits from its capital employed by comparing net operating profit to
capital employed.

In other words, return on capital employed shows investors how much rupee in
profits each rupee of capital employed generates.

ROCE= EBIT
Capital Employed

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5- The return on equity ratio :

It measures the ability of a firm to generate profits from its shareholders

investments in the company.

In other words, the return on equity ratio shows how much profit each rupee of
common stockholders’ equity generates.

This is an important measurement for potential investors because they want to

see how efficiently a company will use their money to generate net income.

ROE = Net Income

Share holder equity

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D-Efficiency ratios :

It is also called activity/turnover ratios measure how well companies utilize

their assets to generate income.

Efficiency ratios often look at the time it takes companies to collect cash from
customer or the time it takes companies to convert inventory into cash—in
other words, make sales.

These ratios are used by management to help improve the company as well as
outside investors and creditors looking at the operations of profitability of the
company.

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1-Accounts receivable turnover:

It is an efficiency ratio or activity ratio that measures how many times a

business can turn its accounts receivable into cash during a period.

In other words, the accounts receivable turnover ratio measures how many
times a business can collect its average accounts receivable during the year.

ART = Net credit sales

Average account receivable

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2- The asset turnover ratio :

It is an efficiency ratio that measures a company’s ability to generate sales from

its assets by comparing net sales with average total assets.

In other words, this ratio shows how efficiently a company can use its assets to
generate sales.

Assets Turn over ratio = Net sales

Average total assets

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3-The total asset turnover ratio:

It is an efficiency ratio that measures a company’s ability to generate sales

from its assets by comparing net sales with average total assets.

In other words, this ratio shows how efficiently a company can use its assets to
generate sales.

Total Assets turnover = Net sales

Total assets

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4- Debtors turnover ratio=
Net credit sales/ Average accounts receivable

5- Creditors turnover ratio=

Net credit purchase / Average accounts payable

6- Capital turnover ratio =

Sales/ Capital employed

7- Working capital turnover ratio =

Net sales / Working capital

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Du Pont Analysis
ROE ANALYSIS
ROE has been defined as :

ROE = Net Income

Average net worth

Now this can be written as a combination of the:

•Margin on sales ratio,

•Assets efficiency ratio,
•Financial leverage ratio.
ROE =

Net Income x Sales x Total Assets

Sales Total Assets Average Net Worth

ROE= NPM X Total Assets turnover X Equity Multiplier

NPM stand for Net profit margin

TAT stand for Assets Efficiency
EM stands for Equity Multiplier
The Du Pont break up conveys that one can maximize profitability
(ROE) by focusing on Playing a margin based game, assets utilization
and financial leverage game.

It helps in identifying & pinpointing the reasons behind high or low

profitability of a firm with its competitors or industries or economies.

Profitability = Margin game x Volume Game x

Financial leverage game.
Banking Industry = Deposits & Loans (Focus on
financial leverage game)

Automobile sector= Margin based &

Volume based.

FMCG Sector= Margin games

Assessment Pattern

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 References

• Reference book- Maheshwari S.N, Accounting for Management, Vikas Publishing House, New Delhi,2010
• Reference Website: https://www.investopedia.com/terms/f/financial-statement-analysis.asp
• Reference Journal for advance study: Journal of Accountancy (JOA)

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THANK YOU

For queries
Email: charu.e8966@cumail.in