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Amity Business School

Amity Business School


MBA Class of 2012, Semester I
ACCOUNTING FOR MANAGEMENT
Module III
BHAVNA RANJAN
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II. Profitability Ratios

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Profitability Ratios

Related to Sales

Related to Investments

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a) Profitability Ratios Related to Sales


(I) Gross Profit Ratio: Gross Profit * 100 Net Sales Sales Cost of Goods Sold *100 Net Sales Net Profit Net Sales * 100

Interpretation (II) Net Profit Ratio: Interpretation

P & L A/c

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Contd..
(III) Operating Ratio: Operating Costs * 100 Net Sales where operating costs = Cost of goods sold + Operating expenses Operating Expenses are : Administrative and office expenses + Selling and distribution expenses Interpretation IV) Expenses ratio: Expenses *100 Net sales
P & L A/c

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b) Profitability Ratios related to Investment


i) Return on Total Assets

Return on Total Assets

=Net Profit after tax * 100 Total Assets

Interpretation

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ii) Return on Capital Employed


Return on Capital Employed= Profit before interest, tax*100 Capital Employed Where Capital employed = Equity Share Capital + Preference Share Capital + Reserves and Surplus + long Loans + debentures fictitious Assets like preliminary expenses Interpretation

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iii) Return on Investment


Return on Investment= Profit after tax*100 Shareholders fund Shareholders funds = Equity Share Capital + Preference Share Capital + Reserves and Surplus fictitious Assets like preliminary expenses Interpretation

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iv) Return on Equity


Return on Equity = Net Profit after tax and Preference Div *100 Equity capital
Return on Equity Shareholders funds=Net Profit after tax&Preference Div *100 Equity Shareholders funds Shareholders funds = Equity share capital+ Reserves and SurplusAccumulated Losses Interpretation

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v) Earnings per share

Earnings per share =Net profit after tax&Preference Dividend Number of Equity Shares
Interpretation

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III. Turnover ratios


Turnover Ratios / Activity Ratios / Efficiency Ratios measure the efficiency with which a firm manages its resources.
Inventory Turnover ratio Debtors Turnover ratio Creditors turnover ratio Working capital turnover ratio Fixed assets turnover ratio The ratio is expressed in times

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i) Inventory Turnover Ratio


Inventory Turnover Ratio = Cost of goods sold Average inventory

Inventory Conversion Period = 365 Inventory Turnover Ratio (expressed in days)

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ii) Debtors Turnover Ratio


Debtor Turnover Ratio = Net Credit Sales Average Debtors (Debtors + B/R) This ratio measures how rapidly receivables are collected. A high ratio indicative of shorter time-lag between credit sales and cash collection. A low ratio shows that debts are not being collected rapidly. Average Collection Period/ Debtor days= 365 DTR

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iii) Creditors Turnover Ratio:


Creditor turnover Ratio = Net Credit Purchases Average Creditors (creditors+B/P) A low turnover ratio reflects liberal credit terms granted by suppliers, while a high ratio shows that accounts are to be settled rapidly.
Average payment period / Creditor Days = 365 Creditor Turnover Ratio

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IV) LEVERAGE RATIO


Financial leverage refers to the use of debt finance. Leverage ratios help in assessing the risk arising from the use of debt capital. two types of ratios: a) Structural ratios based on proportions of debt and equity in financial statements b) Coverage ratios show the relationship between debt service commitments and sources of meeting these burdens

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i) Debt Equity Ratio

Debt Equity ratio = Debt Equity shareholders funds Debt : All external long term liabilities Equity shareholders funds: Share Capital + Reserves and Surplus- Accumulated Losses

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ii) Debt to Total Assets


Debt to Total Assets Ratio= Debt Total assets

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iii) Capital Gearing Ratio


Fixed Interest bearing funds Equity shareholders funds Fixed Interest bearing funds : debentures + long term loans + preference share capital
Equity shareholders funds : equity share capital + reserves and surplus accumulated losses

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iv) Proprietary ratio


Shareholders Net Worth Total Assets Shareholders Net worth = equity share capital + preference share capital +Reserves and Surplus Intangible assets fictitious assets Total Assets = Net Fixed assets +Current assets fictitious assets

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v) Interest Coverage Ratio

Interest Coverage ratio = Net profit (before interest and tax) Interest

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vi) Debt Service Coverage Ratio

DSCR = PAT + Depreciation + other non cash expenses +Interest on term loan Interest on Term loan + Term loan Installments

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VALUATION RATIOS
Price-Earning Ratio = Market Price of the share Earnings Per Share Dividend payout ratio = Dividend per share * 100 Earning per share

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Numericals

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Profit & Loss A/c of a Ltd Co for the year ending 31st March, 2009 Dr To Opening Stock To Purchases To carriage Inward To Gross Profit c/d To Office expenses To Selling & Distribution Exp. To Financial Expenses To Loss on sale of asset To Net Profit Cr 9,950 54,525 1,425 34,000 99,900 15,000 3,000 1,500 400 15,000 34,900 By Sales By Closing Stock 85,000 14,900

99,900 By Gross Profit b/d By Profit on sale of shares By interest on investments 34,000 600 300 34,900

Ratio

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Balance Sheet as on March 31, 2009 Liabilities Share Capital Reserves and Surplus Profit and Loss Account Bank overdraft Sundry Creditors Outstanding expenses Assets Land and Buildings Plant Stock Debtors Bills Receivables Cash and Bank Balance

20,000 9,000 6,000 3,000 8,000 2,000


48,000

15,000 8,000 14,000 7,000 1,000 3,000


48,000

Ratio

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