FINANCIAL ACCOUNTING

TOPIC RATIO ANALYSIS

Ratio Analysis Purpose: To identify aspects of a businesss performance to aid decision making Quantitative process may need to be supplemented by qualitative factors to get a complete picture 5 main areas:
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Ratio Analysis
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Liquidity the ability of the firm to pay its way Investment/shareholders information to enable decisions to be made on the extent of the risk and the earning potential of a business investment Gearing information on the relationship between the exposure of the business to loans as opposed to share capital Profitability how effective the firm is at generating profits given sales and or its capital assets Financial the rate at which the company sells its stock and the efficiency with which it uses its assets
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Classification of ratios Financial position Ratios ( Balance sheet Ratio ) Operating /profitability ratio (Revenue statement ratio) Overall Efficiency of Business(combined Ratio)
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Balance sheet Ratios

Current ratio Liquid Ratio Proprietory Ratio Stock working capital Ratio Capital gearing Ratio Debt Equity Ratio

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CURRENT RATIO
Objectives of analysis Short term liquidity Formula CA CL Std 2:1 Point for comments Higher than Std. 1.Very good Short term liquidity/solvency. Liquidity/Solvency. 2.Excess stock, Book debt, Idle cash. 3.Under Trading. Lower than Std. 1.Unsatisfactory short term liquidity/solvency. 2.Shortage of stock, cash, credit sale. 3.Over trading.

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QUICK RATIO/Liquid ratio

Objectives of analysis Immediate liquidity Formula QA QL Std 1:1 Point for comments Higher than Std. 1.Very good day to day Liquidity/Solvency. 2.Idle cash balance. 3.Under Investment. Lower than Std. 1.Unsatisfactory liquidity./Solvency . 2.Low cash balance. 3.Over Investment.

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PROPRIETARY RATIO
Objectives of analysis Long term solvency & Stability Formula Prop. Fund Tot. Asst * 100 Std 65% To 75% Point for comments Higher than Std. 1.Very good Solvency position. 2. No trading on Equity Lower than Std. 1. Unsatisfactory solvency position. 2.Trading on Equity.

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STOCK TO Working CAPITAL

Objectives of analysis Liquidity of Stock Formula STOCK W.C Std Point for comments Higher than Std. 100% 1.More other C.A available to pay C.L overstocking Lower than Std. 1.Less than C.A available to pay C.L. understocking

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CAPITAL GEARING RATIO

Objectives Formula of analysis Capital Structure Std Point for comments Higher than Std. 1.Higher return for equity shareholder. If rate of fixed returns is less than Rate of Interest. Lower than Std. 1.Low returns/loss to shareholders. If rate of return is more than Rate of fixed return.

Pref. Cap+ Co. Deb+loan Std. Eq.cap+Re s

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DEBT EQUITY RATIO

Objectives Formula of analysis Std Point for comments Higher than Std. 1.Low safety margin for lenders. 2.More interest payment 3.Less scope for more loan. 4.Trading on Equity. Lower than Std. 1.High safety margin for lenders. 2.Less interest payment. 3.Scope for more loan. 4.No trading on Equity.

Long term Bow. Fund 2:1 solvency Prop. & Stability. Fund

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Profitability Ratios/Revenue Ratios

Gross profit Ratio Operating Ratio Expenses Ratio Net profit Ratios Stock Turnover Ratios Net Operating Profit Ratios

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GROSS PROFIT RATIO

Objectives of analysis Operating OR Trading Efficiency Ratio. Formula G.P Net Sale * 100 Std Co. Std Point for comments Higher than Std. 1.High efficiency in managing purchase, production, labour, sales & Inventory (stock). 2.High Productivity. 3.Large Amt. available to meet other expenses. Lower than Std. 1.Low efficiency in managing purchase, production, labour, sales & Inventory (stock). 2.Low productivity. 3.Small Amt. available to meet other expenses.

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Expenses Ratio
Cost of goods sold Ratio = cogs *100 net sales Office &Admin Ratio = off & Ad *100 net sales Selling & Distribution Exp Ratio = S&D *100 net sales Finance expense Ratio = Finance Exp * 100 Net sales This ratio brings out the relationship between various element of operating cost and net sales.
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NET PROFIT RATIO

Objectives of analysis Net profitability Formula Std Point for comments Higher than Std. NPBT Co. N. Sale * Std. 100 NPAT N. Sale * 100 1.Good control over all expenses. 2.Unusual gains. 3.Large amt. available for appropriations. 4.High increase in net worth. Lower than Std. 1.Less control over all expenses. 2.Unusual losses. 3.Small amt. available for appropriations. 4.Less increase in net worth.

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STOCK TURNOVER/STOCK VELOCITY

Objectives Formula of analysis Liquidity Stock COGS AV.STOCK Days/ Month 365OR 12/STR Std Co. Std Point for comments Higher than Std. 1.Stock is sold out fast. 2.Same volume of sale from less stock. 3.More sale from less st. 4.W.C req. is less. 5.Too high ratio show over trading. Lower than Std. 1.Stock is sold out slow speed. 2.Same volume of from more stock. 3.Less sale from same st. 4.W.C req. is more. 5.Too low ratio shows under trading.

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Combined Ratios
Return on Capital Employed Ratio Return on proprietors fund Ratio Return on equity capital ratio Dividend payout Ratio Earning per share(Eps) Debtors turnover ratio Creditors turnover Ratio Debt service Ratio

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RETURN ON CAPITAL EMPLOYED

Objectives of analysis Overall Profitability Formula NPBIT Cap. Emp. * 100 Std Co. std Point for comments Higher than Std. 1.Good profit ratios. 2.Good turnover ratio. 3.Large amount for appropriation. 4.Scope to attract fresh fund from investors. Lower than Std. 1. Ubsatisfactory ratios. 2.Unsatisfactory turnover ratios. 3.Small amt for approp. 4.Less scope to attract fresh fund from invest.

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RETURN ON PROPERIETORS FUND

Objectives of analysis Return on Owners Investment Formula NPAT Prop. Fund * 100 Std Co. Std. Point for comments Higher than Std. 1.Large amount for appropriation. 2.Scope to attract fresh fund from investors. Lower than Std. 1.Small amount for appropriation. 2.Less scope to attract fresh fund from investors.

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RETURN ON EQUITY CAPITAL

Objectives Formula of analysis Return on equity shareholde rs fund NPATPref.Div Eq.cap + Res.-Misc Exp. Std Co. Std Point for comments Higher than Std. 1.Large amount for appropriation. 2.Scope to attract fresh fund from investors. 3.High increase in net worth. 4.High price for each equity share on stock exchange or in merger. Lower than Std. 1.Small amount for appropriation. 2.Less Scope to attract fresh fund from investors. 3.Low increase in net worth. 4.Low price for each equity share on stock exchange or in merger.

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DIVIDEND PAYOUT RATIO

Objectives of analysis Coverage Formula DPS EPS * 100 Std Co. Std. Point for comments Higher than Std. 1.Very high divd. make short term equity shareholder very happy. Scope to issue fresh share at high price. 3.High price on stock exchange or merger. Lower than Std. 1.Very low divd. Make short term equity shareholder very happy. 2.Less Scope to issue fresh share at high price. 3.Low price on stock exchange or merger.

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Earning Per Share

Earnings Per Share - EPS = NPAT - Dividends on Preference share No. of equity paid up shares = Rs __ per share This is the amount which every shareholder is liable to receive from the company at the end of year.

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Dividend Per Share

The information of DPS is given in the question . This means the actual dividend which is given to the shareholder by the company.

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DEBTORS TURNOVER Ratio DEBTORS VELOCITY

Objectives of analysis Liquidity of Debtors Formula Std Point for comments Higher than Std. Cr. Sales Co. Std. DR + B/R Day or Month/ DTR 1.Debtors are collected at a slow speed. 2.More credit is given to debtors. 3.More chance of B.D. Lower than Std. 1.Debtors are collected at regular intervals. 2.Less credit is given to debtors. 3.Less chance of B.D

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CREDITORS TURNOVER CREDITORS VELOCITY

Objectives of analysis Short term liquidity Formula Std Point for comments Higher than Std. Cr.Purch Co. CR+B/P Std Day of Month / CTR 1.Creditors are paid late. 2.More credit is available from creditor. 3.W.C req. Is less. Lower than Std. 1.Creditors paid in advance. 2.Less Cr. Available. 3.W.C. req. is more.

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Debt Service Ratio

Objectives of analysis Interest Coverage Fixed int charges : int on loan ,int on debenture, dividend on pref.share Formula NPBT +Int. F. Int. * 100 Std 6 to 7 time s. Point for comments Higher than Std. 1. Lower than Std. More is the vie versa margin of safety for lenders. It show company is highly efficient in paying the interest on time

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Solve numerical

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