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FINANCIAL STATEMENTS
ANALYSIS
Ratio Analysis
Liquidity
LiquidityRatios
Ratios Capital
Capital Structure
StructureRatios
Ratios
Profitability
ProfitabilityRatios
Ratios Efficiency
Efficiencyratios
ratios
Integrated
Integrated Growth
Growth Ratios
Ratios
Analysis
AnalysisRatios
Ratios
Net Working Capital
Net working capital is a measure of liquidity calculated by
subtracting current liabilities from current assets.
Table 1: Net Working Capital
Particulars Company A Company B
Total current assets Rs 1,80,000 Rs 30,000
Total current liabilities 1,20,000 10,000
NWC 60,000 20,000
Cash Rs 2,000
Debtors 2,000
Inventory 12,000
Total current assets 16,000
Total current liabilities 8,000
(1) Current Ratio 2:1
(2) Acid-test Ratio 0.5 : 1
Supplementary Ratios for
Liquidity
Inventory
Inventory Turnover
Turnover Debtors
Debtors Turnover
Turnover Ratio
Ratio
Ratio
Ratio
Creditors
Creditors Turnover
Turnover Ratio
Ratio
Inventory Turnover Ratio
The ratio indicates how fast inventory is sold. A high ratio is good
from the viewpoint of liquidity and vice versa. A low ratio
would signify that inventory does not sell fast and stays
on the shelf or in the warehouse for a long time.
A firm has sold goods worth Rs 3,00,000 with a gross profit margin of
20 per cent. The stock at the beginning and the end of the year
was Rs 35,000 and Rs 45,000 respectively. What is the
inventory turnover ratio?
A firm has made credit sales of Rs 2,40,000 during the year. The
outstanding amount of debtors at the beginning and at the end
of the year respectively was Rs 27,500 and Rs 32,500.
Determine the debtors turnover ratio.
If the D/E ratio is high, the owners are putting up relatively less
money of their own. It is danger signal for the lenders and
creditors. If the project should fail financially, the
creditors would lose heavily.
A low D/E ratio has just the opposite implications. To the creditors, a
relatively high stake of the owners implies sufficient safety
margin and substantial protection against
shrinkage in assets.
For the company also, the servicing of debt is less
burdensome and consequently its credit standing
is not adversely affected, its operational flexibility
is not jeopardised and it will be able to
raise additional funds.
Total debt
Debt to total capital ratio =
Permanent capital
Proprietary funds
Proprietary ratio = X 100
Total assets
n
∑ EATt + Interestt
+ Depreciationt + OAt
t=1
DSCR = n
∑ Instalmentt
t=1
The net profit has been arrived after charging depreciation of Rs 17.68 lakh
every year.
Solution
Table 3: Determination of Debt Service Coverage Ratio
(Amount in lakh of rupees)
Year Net Depreciation Interest Cash Principal Debt DSCR [col. 5
profit available instalment obligation ÷ col. 7
(col. (col. 4 + col. 6) (No. of times)]
2+3+4)
1 2 3 4 5 6 7 8
1 21.67 17.68 19.14 58.49 10.70 29.84 1.96
2 34.77 17.68 17.64 70.09 18.00 35.64 1.97
3 36.01 17.68 15.12 68.81 18.00 33.12 2.08
4 19.20 17.68 12.60 49.48 18.00 30.60 1.62
5 18.61 17.68 10.08 46.37 18.00 28.08 1.65
6 18.40 17.68 7.56 43.64 18.00 25.56 1.71
7 18.33 17.68 5.04 41.05 18.00 23.04 1.78
8 16.41 17.68 Nil 34.09 18.00 18.00 1.89
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Return on Shareholders’ Equity
Return on shareholders equity measures the return on the
owners (both preference and equity shareholders )
investment in the firm.
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Efficiency Ratio
Activity ratios measure the speed with which various
accounts/assets are converted into sales or cash.
Inventory turnover measures the efficiency of various types
of inventories.
i. Debtors
Inventoryturnover
Turnover Credit sales
i. = measures the activity/liquidity of inventory
of a firm; the speedAverage
with which
debtors
inventory
+ Average
is soldbills receivable (B/R)
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1) Return on shareholders’ equity = EAT/Average total shareholders’ equity.
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Rate of Return on Assets
Income-tax Plus
Current liabilities
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Return on Assets
Earning Power
Earning power is the overall profitability of a firm; is computed
by multiplying net profit margin and
assets turnover.
i. Inventory Earning
Turnover after taxes
measures the Sales of inventory
activity/liquidity EAT
Earning Power = x x
of a firm; the speed withSales
which inventoryTotal
is sold
Assets Total assets
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EXAMPLE: 8
Assume that there are two firms, A and B, each having total assets
amounting to Rs 4,00,000, and average net profits after
taxes of 10 per cent, that is, Rs 40,000, each.
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Return on Equity (ROE)
ROE is the product of the following three ratios: Net profit ratio (x)
Assets turnover (x) Financial leverage/Equity multiplier
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Common Size Statements
Preparation of common-size financial statements is an extension
of ratio analysis. These statements convert absolute sums into
more easily understood percentages of some base amount. It is
sales in the case of income statement and totals of assets and
liabilities in the case of the balance sheet.
Limitations
Ratio analysis in view of its several limitations should be
considered only as a tool for analysis rather than as an end in
itself. The reliability and significance attached to ratios will largely
hinge upon the quality of data on which they are based. They are
as good or as bad as the data itself. Nevertheless, they are an
important tool of financial analysis.