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RATIO ANALYSIS

A ratio is an arithmetical relationship between two


figures. Financial ratio analysis is a study of ratios
between various items or groups of items in financial
statements. Ratios can be classified according to
statements mainly they are profit and loss ratios or
income statement ratios, balance sheet ratios or position
statement ratios, mixed ratio or inter statement ratios
FINANCIAL RATIO ANALYSIS:
Single Absolute Ratio.
Group of Ratio.
Historical Comparison.
Projected Ratios.
Inter-firm Comparison
INTERPRETATION OF THE RATIOS
Accuracy of Financial Statements
Objective or Purpose of Analysis
Selection of Ratios
Use of Standards
Caliber of the Analyst
GUIDELINES FOR USE OF RATIOS
Managerial Uses of Ratio analysis
Helps in decision-making
Helps in financial forecasting and planning.
Helps in communicating.
Helps in co-ordination.
Helps in controlling.
Useful to Shareholders/Investors
Useful to Creditors
Useful to Employees.
Useful to Government
SIGNIFICANCE OF RATIO ANALYSIS
Limited Use of a Single Ratio.
Lack of Adequate Standards.
Inherent Limitations of Accounting.
Change of Accounting Procedure.
Window Dressing
LIMITATIONS OF RATIO ANALYSIS
It deals with the relationship between two balance sheet items: these
can be mainly classified as liquidity ratio, long term solvency or
leverage ratio.
BALANCE SHEET RATIO
These ratios are calculated to comment upon the short term paying
capacity of a firm or concerns ability to meet its current obligation. The
important liquidity ratios are current ratio ,quick ratio & absolute liquid
ratio
LIQUIDITY RATIO

It is a measure of general liquidity and is used to make the analysis of a
short-term financial position or liquidity of an organization
Current Ratio = Current Assets/Current Liabilities
Rules of thumb=2:1

CURRENT RATIO
Find out Current ratio

Stock -60000
Debtors-70000
Cash -20000
Bills receivable-30000
Prepaid expences-10000
Land and building-100000
Goodwill-50000

Creditors-20000
Bills payable-15000
Tax payable-18000
Outstanding expenses-7000
Bank overdraft-25000
Debenture-75000



EXAMPLE
Current Ratio= Current Assets/Current Liabilities
CA=60000+70000+20000+30000+10000=190000
CL=20000+15000+18000+7000+25000=85000
CR=190000/85000=2.24
The CR of 2.24 means that current assets are 2.24 times of current Liabilities
SOLUTION
It is also known as acid test ratio Quick Ratio= Quick Assets/Current
Liabilities
Quick Asset=Current Asset-(Inventory+prepaid expenses)
Rules of thumb=1:1




QUICK RATIO
Calculate quick ratio from the information given below
Stock -135000
Debtors-70000
Cash -125000
Prepaid expences-5000
Land and building-100000
Goodwill-50000
Short term investment-150000

Creditors-150000
Bills payable-20000
Tax payable-10000
Debenture-200000

EXAMPLE
It is also known as acid test ratio Quick Ratio= Quick Assets/Current
Liabilities
Quick asset=70000+125000+150000=345000
Current Liabilities =150000+20000+10000=180000
Quick ratio=345000/180000=1.916

Absolute liquid ratio=cash,bank & marketable securities/current
liabilities
Rules of thumb=0.5:1




ABSOLUTE LIQUID RATIO
Calculate absolute liquid ratio from the information given below
Stock -135000
Debtors-70000
Cash in hand -45000
Cash at bank-30000
Marketable securities-150000
Land and building-400000
Goodwill-50000

Creditors-150000
Bills payable-80000
Tax payable-20000
Debenture-200000

EXAMPLE
Absolute liquid ratio=225000/250000=.9
To judge the long-term financial position, leverage or capital structure
ratios are calculated. Leverage ratios can calculate from the balance
sheet to determine the portion of debt in total financing.
LEVERAGE RATIO
Debt Equity ratio is calculated to measure the relative
claims of outsiders and the extent to which debt
financing has been used in the organization. In this ratio
the debt has been taken as the long-term debt and net
worth has been calculated by adding share capital with
reserves and surplus
Debt Equity Ratio=Debt/Net worth
DEBT EQUITY RATIO
Equity share-300000
General reserve-100000
Debenture-100000
Current liabilities-100000
Fixed asset-400000
Current asset-200000

EXAMPLE
Debt Equity Ratio =Debt/Net worth
=200000/400000=1:2
(Funded debt/Total capitalisation)
Funded debt=Long term loan
Total capitalisation=Total liabilities-current liabilities

FUNDED DEBT TO TOTAL CAPITALIZATION RATIO
Shareholders fund/Total asset
PROPRIETARY RATIO OR EQUITY RATIO
These ratios deal with relationship between profit and loss accounts
items

The main profitability ratios are gross profit ratio,operating ratio
Operating profit ratio,expenses ratio and net profit ratio .
PROFIT AND LOSS RATIO
Gross profit ratio measures the relationship of gross profit to net sales.
Gross Profit ratio=(Gross Profit/Net Sales)x100
Gross profit=Sales-cost of goods sold
GROSS PROFIT RATIO
Operating ratio=(Operating cost/Net sales )*100
Operating cost=Cost of goods sold+operating expenses.
Cost of goods sold=op.stock+purchase+wages-cl.stock


OPERATING RATIO
Operating profit ratio shows the relationship between operating profit
and sales.
Operating Profit ratio =(Operating Profit/Net Sales)x100
Operating Profit=Net sales-(cost of goods sold+ administrative & office
expenses)

OPERATING PROFIT RATIO
Cost of goods sold ratio=(cost of goods sold/Net sales)x100
Administrative &office expenses ratio=(Administrative &office expenses
/Net sales)x100
Selling &distribution expenses ratio= Selling &distribution expenses
/Net sales)x100
EXPENSES RATIO
Net profit ratio establishes a relation ship between net profit (profit after
tax) and indicates the efficiency of the management.
Net Profit ratio =(Net Profit/Net Sales)x100
NET PROFIT RATIO
These ratios exhibit the relationship between profit and loss item and
balance sheet item.

MIXED RATIO OR INTER STATEMENT RATIOS
The coverage ratio shows the firms ability to pay interest and principals
due.

COVERAGE RATIO
It properly measures the margin of safety the organization enjoys with
respect to its interest burden. The interest coverage ratio indicates the
number of times interest is covered by the profits available to pay the
interest charges.
Interest coverage ratio=Profit Before Interest and Taxes/Interest
INTEREST COVERAGE RATIO
Debt service coverage ratio gives picture of long-term liquidity position.
Debt service coverage=(Profit After Tax+ Depreciation+ Interest on
Long Term Loans)/(Interest+ Long Term Loans)

DEBT SERVICE COVERAGE RATIO
Activity ratios are calculated to measure the efficiency
with which the resources of a firm have been employed.
These ratios are also called turnover ratios because they
indicate speed at which the assets are being turned over
into sales. The important turnover ratios are debtors
turnover ratio ,inventory turnover ratio, creditor turnover
ratio ,working capital turnover ratio, fixed assets turnover
ratio & total assets turnover ratio.
ACTIVITY RATIO OR CURRENT ASSETS
MOVEMENT RATIO
It indicates the velocity of debt-collection of an
organization. In simple words, it indicates the number of
times debtors (receivables) are turned over during a year.
Generally high turnover ratio is the more efficiency of
management of debtors .
Debtor Turnover Ratio=Net Credit Sales/Average Trade
Debtor
DEBTOR TURNOVER RATIO
It represents the average number of days in which its debtors converted
into cash. The short collection period implies quick payment by the
debtors.
Average Collection Period= Total Trade Debtor/Sales Per Day or
365/Debtor turnover ratio
AVERAGE COLLECTION PERIOD
In course of business operations an organization has to make credit
purchases and incurred short-term liabilities. Suppliers of goods
naturally interested in finding out how much time the organization is
likely to take to repay the creditors.

Creditors Turnover Ratio=Net Credit Purchase/Average Trade Creditor
CREDITOR TURNOVER RATIO
Average payment period represent the average number of days the
organization has to pay its creditors.
Average payment period=Total Trade Creditors/Average Daily
Purchases or 365/creditor turnover ratio
AVERAGE PAYMENT PERIOD
Organization has to maintain the inventory of finished
goods so as to able to meet the requirement of the
business. But the level of inventories should not either too
high or too low.
Inventory Turnover Ratio=Costs Of Goods Sold/ Average
Inventory at costs
Inventory conversion period=365/ Inventory Turnover
Ratio
INVENTORY TURNOVER RATIO
Return on investment is one of the important ratios used
to measure the efficiency of the organization, as the
objective of the organization is to maximize its earning.
Return on investment = Profit Before Interest&
Tax/Capital Employed
Capital Employed=net fixed asset+net working capital

PROFITABILITY RATIO IN RELATION
TO INVESTMENT
Return on Equity is calculated to see the profitability of
the owners investment. It is regarded as an important
measure because it reflects the productivity of the
ownership in the organization. It is affected by several
factors like earning power, debt equity ratio, cost of debt
and tax rate.
Return on Equity=Profit After Tax/Net Worth
RETURN ON EQUITY
The profit after tax belongs to shareholders. But income,
which they really received, is the amount earning received
as cash dividend. Therefore a large number of present
and potential investors are interested in the Dividend Per
Share.
Dividend Per Share=Dividend Paid/Number of Shares
DIVIDEND PER SHARE.

Earning Per Share is a small variation of equity capital
and is calculated by dividing the net profit after tax and
preference dividend by the total number of equity shares.
EPS calculated for a number of years indicates the
earning power of the company has increased or
decreased.
Earning Per Share=Profit After Tax/Number of Shares
EARNING PER SHARE