Ratio

Analysis
Involves establishing a relevant
financial relationship between
components of financial statements
 • Rule of thumb indicators
• Past performance
• Internal standards

Standards of • Industry standards

comparison Techniques of financial statement analysis

• Horizontal analysis
• Vertical analysis
Profitability,
Liquidity,
Solvency, and
Capital market strength.
1. Profitability
Profitability

Measure degree of operating success of business,.

Commonly used ratios under profitability are

• Profit margin
• Assets turnover
• Return on assets
• Return on equity
• Earnings per share
Profit Margin

Also known as Return on sales Profit margin = Profit / Sales

(ROS)
Asset turnover (ATO)

Is a measure of firm's efficiency ATO = Sales / Assets

in utilizing the assets
Return on Assets (ROA)

ALSO KNOWN AS RETURN ROI = PROFIT / ASSETS

ON INVESTMENT (ROI).
Return on Equity
(ROE)
ROE = Profit / Equity
Earnings per share (EPS)

Earnings available to equity shares / No.

of shares
2. Liquidity Analysis
Liquidity ratios

Liquidity is the ability of the business to meet its

obligations when they fall due.
• Current ratio
• Quick ratio
• Receivable turnover
• Inventory turnover
Current ratio

• Current Assets / Current

liabilities
Quick • Current assets range from cash to sticky
inventories.

ratio or • Cash is readily available to make payment to

suppliers.

Acid test
• Inventories are two step away from cash,
sales and collection.
• QR = [ Current assets – inventories] /

ratio
Current liabilities
 • Efficiency of the firm's credit policy and
collection mechanism and shows the
number of times in each year the
receivables are turned into cash.

Receivable • RTO = Sales / Receivables

s Turnover • Average collection period or Days Sales

outstanding (DSO) = Receivables / daily
sales
• Average collection period = 360 / Receivable
turnover
Inventory • Number of times a company’s inventories

Turnover
are turned In to sales. Investments in
inventory represents idle cash.
• ITR = Cost of goods sold / Inventories or
Sales / Inventories

(ITR)
3. Solvency Analysis
Debt to • Debt is generally cheaper than equity.

Equity • Interest expense is tax deductible, not the

dividends.
• Debt / Equity

ratio
Liabilities
to equity
• Instead of borrowings it takes all liabilities.
• All liabilities / Equity

ratio
Interest • Measure the level of protection available to
the creditors for the payment of interest
charges by the company.

coverage • Profit before interest and tax / Interest

expenses.
4. Capital
market
standing
Capital market

• Capital market ratios relate the market price of

the companies share to the company's earnings.
• Price earnings ratio (P/E)
• Dividend yield
• Price to book ratio (P/B)
• Return
Price to • Market price of the share to the annual EPS.
• Many see PE multiples are the indicators of

earnings growth prospectus.

Dividen • Current cash return to shareholders.

d yield
• Dividend per share / market price per share
Stock return
[Change in stock price over the
period + dividend for the period ] /
beginning stock price
Price to • Market price per share / book value per

book share
• Book value = shareholder’s equity / no. of
shares

ratio (PB)
Beta
• Systematic risk
• Unsystematic risk
• Beta represents systematic risk
Ratio Analysis of
Financial Institutions
Ratio Analysis of Financial Institutions

• CAMELS is a recognized international rating system that bank

supervisory authorities use in order to rate financial institutions
according to six factors represented by its acronym.
•  A rating of one is considered the best, and a rating of five is considered
the worst for each factor.
CAMELS Model
• Capital Adequacy
• Asset quality
• Management efficiency
• Earnings quality
• Liquidity
• Sensitivity
Capital
Adequacy
• Examiners assess institutions'
capital adequacy through capital
trend analysis. Examiners also
check if institutions comply with
regulations pertaining to risk-
based net worth requirements
Asset Quality
• Asset quality covers an
institutional loan's quality, which
reflects the earnings of the
institution. Assessing asset quality
involves rating investment risk
factors the bank may face and
balance those factors against the
bank's capital earnings.
Managerial
efficiency
• Management assessment
determines whether an
institution is able to properly
react to financial stress. This
component rating is reflected by
the management's capability to
point out, measure, look
after and control risks of the
institution's daily activities. 
Earnings
quality
• A bank's ability to produce
earnings to be able to sustain its
activities, expand, remain
competitive are a key factor in
rating its continued viability.
Examiners determine this by
assessing the bank's earnings,
earnings' growth, stability,
valuation allowances, net
margins, net worth level, and the
quality of the bank's existing
assets.
Liquidity
• To assess a bank's liquidity,
examiners look at interest rate
risk sensitivity, availability of
assets that can easily be
converted to cash, dependence
on short-term volatile financial
resources and ALM technical
competence.
Sensitivity
• Sensitivity covers how particular
risk exposures can affect
institutions. Examiners assess an
institution's sensitivity to market
risk by monitoring the
management of credit
concentrations