RATIO ANALYSIS

Dr. A. Xavier Mahimairaj

 FOCUSES ON FUTURE DECISION BASED ON ACCOUNTING FINANCIAL STATEMENTS

▪ Share Capital
▪ Equity
▪ Preference
Capital structure and
▪ Reserve &Surplus
Cost of Capital
▪ Secured Loans
▪ Debentures
▪ Loans and advances
▪ Unsecured Loans
Working Capital
▪ Current Liabilities and Provisions
financing policy
▪ Trade Creditors
▪ Provisions
▪ Fixed Assets (net)
▪ Gross block
Capital Budgeting
▪ Less: depreciation
▪ Investments
Portfolio Management
▪ Current Assets, loans and advances
▪ Cash and bank
Cash Management
▪ Receivables Credit Management

▪ Inventories Inventory Management

▪ Miscellaneous expenditure and losses

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 FOCUSES ON FUTURE DECISION BASED ON ACCOUNTING FINANCIAL STATEMENTS

▪ Net Sales Revenue Risk

▪ Cost of goods sold
▪ stocks
▪ Wages and salaries
▪ Other manufacturing expenses
▪ Gross Profit Gross Profit Margin
▪ Operating expenses
▪ Selling & Administration expenses
▪ Depreciation Depreciation Policy
▪ Operating Profit
▪ Non-operating surplus/deficit
▪ Earnings before income and tax Business Risk
▪ Interest
Financial Risk
▪ Profit before tax
▪ Tax Tax Planning
▪ Profit after Tax Return on Equity
▪ Dividends
Dividend Policy
▪ Retained earnings

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 Solvency Ratios

1. Debt-Equity Ratio;

2. Proprietary Ratio;

3. Interest Coverage Ratio.

Different types of accounting ratios are used for
different purposes:
◦ Profitability/Performance Ratios – to assess profitability levels
◦ Liquidity Ratios – to assess solvency levels
◦ Gearing Ratio – to assess debt levels
◦ Financial Efficiency Ratios – to assess efficiency levels
◦ Shareholder Ratios – to assess equity investments
◦ Return On Capital Employed (ROCE)
◦ Gross Profit Margin
◦ Net Profit Margin
 Debt-Equity Ratio
◦ Debt-Equity Ratio measures the relationship between long-term debt and equity.
◦ Normally, it is considered to be safe if debt equity ratio is 2 : 1. However, it may vary from industry
to industry. It is computed
◦ as follows:
◦ Debt-Equity Ratio = Long − term Debts / Shareholders’ Funds
◦ where:
◦ Shareholders’ Funds (Equity) = Share capital + Reserves and Surplus + Money received against
share warrants + Share application money pending allotment
◦ Share Capital = Equity share capital + Preference share capital
◦ or
◦ Shareholders’ Funds (Equity) = Non-current sssets + Working capital – Non-current liabilities
◦ Working Capital = Current Assets – Current Liabilities
◦ Debts / Equity
◦ Debt = Long-term borrowings + Other long-term
liabilities + Long-term provisions
◦ = Rs. 4,00,000 + Rs. 40,000 + Rs. 60,000
◦ = Rs. 5,00,000
◦ Equity = Share capital + Reserves and surplus +
Money received against share warrants
◦ = Rs. 12,00,000 + Rs. 2,00,000 + Rs.1,00,000
◦ = Rs. 15,00,000
◦ Debt Equity Ratio = 5,00,000 / 15,00,000

= 0.33 : 1
Proprietary Ratio

◦ Proprietary ratio expresses relationship of proprietor’s (shareholders)

funds to net assets

◦ Proprietary Ratio =

Shareholders’, Funds / Capital employed (or net assets)

Current Ratio

◦ Current Ratio = Current Assets / Current Liabilities

◦ Current Ratio = 7,00,000 / 5,00,000

◦ = 1.4
Liquidity Ratio

◦ Liquidity Ratio = Liquid Assets / Liquid Liabilities

◦ Liquid Assets = Current Assets excluding Stock and Prepaid Expenses

◦ Liquid Liabilities = Current Liabilities excluding Bank Overdraft

◦ Liquidity Ratio = 5,50,000 / 5,00,000 = 1.1

◦ Proprietary Ratio =

◦ Shareholders’, Funds / Capital employed (or

net assets)

◦ Rs. 15,00,000 / Rs. 20,00,000 = 0.75 : 1

◦ Higher proportion of shareholders funds in

financing the assets is a positive feature as it
provides security to creditors.
Interest Coverage Ratio
◦ It is a ratio which deals with the servicing of interest on loan. It is a
measure of security of interest payable on long-term debts. It expresses
the relationship between profits available for payment of interest and
the amount of interest payable.
◦ Interest Coverage Ratio = Net Profit before Interest and Tax / Interest
on long-term debts
◦ Significance: It reveals the number of times interest on long-term debts
is covered by the profits available for interest. A higher ratio ensures
safety of interest on debts.
◦ From the following details, calculate interest coverage ratio: Net Profit after tax Rs. 60,000;
15% Long-term debt 10,00,000; and Tax rate 40%.
◦ Net Profit after Tax = Rs. 60,000
◦ Tax Rate = 40%
◦ Net Profit before tax = Net profit after tax × 100/(100 – Tax rate) = Rs. 60,000 × 100/(100 – 40)
= Rs. 1,00,000
◦ Interest on Long-term Debt = 15% of Rs. 10,00,000 = Rs. 1,50,000
◦ Net profit before interest and tax = Net profit before tax + Interest
◦ = Rs. 1,00,000 + Rs. 1,50,000 = Rs. 2,50,000
◦ Interest Coverage Ratio = Net Profit before Interest and Tax / Interest on long-term debt
◦ = Rs. 2,50,000/Rs. 1,50,000
◦ = 1.67 times.
 1. Inventory Turnover;

2. Trade receivable Turnover;

Activity (or 3. Trade payable Turnover;

Turnover) Ratio 4. Investment (Net assets) Turnover

5. Fixed assets Turnover; and

6. Working capital Turnover.

 Inventory Turnover Ratio
◦ It determines the number of times inventory is converted into revenue from
operations during the accounting period under consideration. It expresses the
relationship between the cost of revenue from operations and average
inventory.
◦ Inventory Turnover Ratio = Cost of Revenue from Operations / Average
Inventory
◦ Where average inventory refers to arithmetic average of opening and closing
inventory, and the cost of revenue from operations means revenue from
operations less gross profit.
◦ From the following information,
calculate inventory turnover ratio :
◦ Inventory in the beginning =
Rs. 18,000
◦ Inventory at the end = Rs. 22,000
◦ Net purchases = Rs. 46,000
◦ Wages = Rs. 14,000
◦ Revenue from operations =
Rs. 80,000
◦ Carriage inwards = Rs. 4,000
◦ Inventory Turnover Ratio = Cost of Revenue
from Operations / Average Inventory
◦ Cost of Revenue from Operations = Inventory in
the beginning + Net Purchases + Wages +
Carriage inwards – Inventory at the end
◦ = Rs. 18,000 + Rs. 46,000 + Rs. 14,000 + Rs.
4,000 – Rs. 22,000 = Rs. 60,000
◦ Average Inventory = Inventory in the beginning
+ Inventory at the end / 2
◦ = Rs. 18,000 + Rs. 22,000 / 2
◦ = Rs. 20,000
◦ ∴ Inventory Turnover Ratio = Rs. 60,000 / Rs.
20,000
◦ = 3 Times
 ◦ Revenue from operations = Rs. 4,00,000
◦ From the following
◦ Gross Profit = 10% of Rs. 4,00,000 = Rs.
information, calculate 40,000
◦ Cost of Revenue from operations =
inventory turnover ratio: Revenue from operations – Gross Profit

◦ Revenue from ◦ = Rs. 4,00,000 – Rs. 40,000 = Rs.

3,60,000
operations = 4,00,000 ◦ Inventory Turnover Ratio = Cost of
Revenue from Operations / Average
◦ Average Inventory = Inventory

55,000
◦ Rs. 3,60,000 / Rs. 55,000
◦ Gross Profit Ratio = 10% ◦ = 6.55 times
Trade Receivables Turnover Ratio
◦ It expresses the relationship between credit revenue from operations
and trade receivable. It is calculated as follows :
◦ Trade Receivable Turnover ratio = Net Credit Revenue from Operations
/ Average
◦ Trade Receivable Where Average Trade Receivable = (Opening
Debtors and Bills Receivable + Closing Debtors and Bills Receivable) /
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 ◦ Trade Receivables Turnover Ratio =
◦ Calculate the Trade
◦ Net Credit Revenue from Operations
receivables turnover ratio
◦ Average Trade Receivables
from the following ◦ Credit Revenue from operations = Total revenue from operations – Cash
information: revenue from operations

◦ Total Revenue from ◦ Cash Revenue from operations = 20% of Rs. 4,00,000

operations 4,00,000 ◦ = Rs. 4,00,000 x 20% = Rs. 80,000

◦ Credit Revenue from operations = Rs. 4,00,000 – Rs. 80,000 = Rs.

◦ Cash Revenue from
3,20,000
operations 20% of Total ◦ Opening Trade Receivables + Closing Trade Receivables / 2
Revenue from operations ◦ = Rs. 40,000 + Rs. 1,20,000 / 2
◦ Trade receivables as at ◦ = Rs. 80,000
1.4.2016 40,000 ◦ Trade Receivables Turnover Rations = Net Credit Revenue Form
Operations / Average Trade Receivables
◦ Trade receivables as at
◦ Trade Receivables Turnover Ratio = Rs. 3,20,000 / Rs. 80,000
31.3.2017 1,20,000
◦ = 4 times.
 Trade Payable Turnover Ratio
◦ Trade payables turnover ratio indicates the pattern of payment of trade
payable. As trade payable arise on account of credit purchases, it expresses
relationship between credit purchases and trade payable.
◦ Trade Payables Turnover ratio = Net Credit purchases / Average trade payable
◦ Where Average Trade Payable = (Opening Creditors and Bills Payable +
Closing Creditors and Bills Payable)/2
◦ Average Payment Period = No. of days/month in a year / Trade Payables
Turnover Ratio
◦ Calculate the Trade payables ◦ Trade Payables Turnover Ratio = Net
Credit Purchases / Average Trade
turnover ratio from the following
Payables
figures:
◦ Creditors in the beginning + Bills payables
◦ Credit purchases during 2016-17 = in the beginning + Creditors at the end +
12,00,000 Bills payables at the end / 2

◦ Creditors on 1.4.2016 = 3,00,000 ◦ = Rs. 3,00,000 + Rs. 1,00,000 + Rs.

1,30,000 + Rs. 70,000 / 2
◦ Bills Payables on 1.4.2016 =
◦ = Rs. 3,00,000
1,00,000
◦ ∴ Trade Payables Turnover Ratio =
◦ Creditors on 31.3.2017 = 1,30,000
◦ Rs. 12,00,000 / Rs. 3,00,000
◦ Bills Payables on 31.3.2017 = ◦ = 4 times
70,000
◦ From the following information, calculate – ◦ (i) Trade receivables turnover
◦ (i) Trade receivables turnover ratio ratio
◦ (ii) Average collection period
8.18 times
◦ (iii) Trade rayable turnover ratio
◦ (iv) Average payment period
◦ (ii) Average collection period
◦ Given : ◦ 45 days
◦ Revenue from Operations 8,75,000 ◦ (iii) Trade payable turnover
◦ Creditors 90,000 ratio
◦ Bills receivable 48,000
◦ 2.96 times
◦ Bills payable 52,000
◦ Purchases 4,20,000
◦ (iv) Average payment period
◦ Trade debtors 59,000 ◦ 123 days
Profitability Ratios
◦ The profitability or financial performance
is mainly summarized in the statement of
profit and loss. Profitability ratios are
calculated to analyze the earning capacity
of the business which is the outcome of
utilization of resources employed in the
business
◦ 1.Gross profit ratio
◦ 2. Operating ratio
◦ 3. Operating profit ratio
◦ 4. Net profit ratio
◦ 5. Return on Investment (ROI) or Return on Capital
Employed (ROCE)
◦ 6. Return on Net Worth (RONW)
◦ 7. Earnings per share
◦ 8. Book value per share
◦ 9. Dividend payout ratio
◦ 10. Price earning ratio.
◦ Given the following information:
◦ Revenue from Operations 3,40,000
◦ Cost of Revenue from Operations 1,20,000
◦ Selling expenses 80,000
◦ Administrative Expenses 40,000
◦ Calculate Gross profit ratio
◦ and Operating ratio
◦ Gross profit ratio of a company was 25%. Its credit revenue from operations was Rs.
20,00,000 and its cash revenue from operations was 10% of the total revenue from
operations. If the indirect expenses of the company were Rs.50,000, calculate its net
profit ratio.

◦ Cash Revenue from Operations = Rs.20,00,000 × 10/90 = Rs.2,22,222

◦ Hence, total Revenue from Operations are = Rs.22,22,222
◦ Gross profit = 0.25 × 22,22,222 = Rs. 5,55,555
◦ Net profit = Rs.5,55,555 – 50,000 = Rs.5,05,555
◦ Net profit ratio = Net profit/Revenue from Operations × 100
◦ = Rs.5,05,555/Rs.22,22,222 × 100 = 22.75%.
Thank you!