E5-E6 Finance Core Module

Ratio Analysis

25 June 2011

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WELCOME
This is a presentation for the E5-E6 (Finance) Module for the Topic: Ratio analysis Eligibility: Those who have got the Upgradation from E5 to E6. This presentation is last updated on 15-3-2011. You can also visit the Digital library of BSNL to see this topic.

25 June 2011

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RATIO ANALYSIS

FINANCIAL ANALYSIS : Is the process of identifying the financial strengths and weakness of the firm by properly establishing relationships between the items of Balance Sheet and Profit and Loss Account RATIO ANALYSIS : is a tool of financial analysis.

25 June 2011

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RATIO ANALYSIS
Ratio analysis is the analysis of the relationship between items of financial data, or between financial and non financial data. Ratios sometimes prove themselves to be more meaningful than the absolute figures

25 June 2011

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Advantages of Ratio Analysis

I. Simplifies, Summarizes and Systematizes accounting figures for easy understanding; II. Ratios helps the management in measuring things like Long-term Solvency, Operational Efficiency, etc. of the firm III. It can be used to compare the risk and return relationships of firms of different sizes.

25 June 2011

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Advantages of Ratio Analysis

IV. Facilitates inter-firm comparison showing relative performance of enterprise in the industry; Facilitates intra-firm comparison showing the improvement/degradation in the performance of the enterprise; It provides a profile of a firm, its economic characteristics and competitive strategies, and its unique operating, financial and investment characteristics.

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25 June 2011

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Standards of comparison:
A single ratio does not indicate any condition. It should be compared with some standard. Standards of comparison may consist of: 1) Ratios calculated from the past financial statements of the same firm. 2) Ratios developed using the projected, or pro forma, financial statements of the same firm. 3) Ratios of some selected firms, ( most progressive & successful,) 4) Ratios of the industry to which the firm belongs.
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Limitations of Ratio Analysis

They are arithmetical expressions. Qualitative aspects cannot be presented directly. They are calculated from accounting records which have their own limitations. Ratios are indicators only and must be supplemented by a detailed analysis to discover the reality. Strongly affected by manipulations of financial statements & this fact is not revealed by Ratio Analysis. Factors like Inflation also distort the Ratio Analysis.

25 June 2011

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Precautions
Points to be borne in mind while using ratio analysis technique Only figures that have a mutual cause and effect relationship should be considered Particular characteristics of the industry should always be kept in mind while a firm is being studied. Ratios are only symptoms and not the real disease in itself Good profits rather than good ratios is the objective of the firm
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RATIO ANALYSIS
Classification of Ratios:
Structural Classification Functional Classification

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Structural Classification of Ratios

This is the Conventional mode of classifying ratios where the ratios are classified on the basis of information given in the financial statements.

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Structural Classification of Ratios

S.N 1 Type Balance Sheet Ratios What it is Ratios for which the components for computation are drawn from the Balance Sheet. (Financial Ratios.) Examples * Current Ratio * Liquid Ratio * Debt Equity Ratio * Proprietary Ratio

* Capital Gearing Ratio

* Fixed Assets Ratio 2 P&L A/c Ratios Ratios for which the components are drawn from the P&L Account. (Income Statement Ratios or Operating Ratios ) * Gross Profit Ratio * Net Profit Ratio * Operating Ratio * Stock Turnover Ratio * Expenses Ratio 3 Inter-statement Ratios or Combined Ratios Ratios for which the components are drawn both from the Balance Sheet and P&L Account. ( Financial Ratios. ) * Return on Capital Employed * Return on Investments [ROI] * Debtors Turnover Ratio * Creditors Turnover Ratio * Fixed Assets Turnover Ratio * Working Capital Turnover Ratio [ROCE]

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Functional Classification Of Ratios:

Financial ratios are broadly categorized in four broad heads Activity analysis Liquidity analysis Long term debt and solvency analysis Profitability analysis

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Activity analysis
Activity ratios describe the relationship between the firms level of operations and the assets needed to sustain operating activities. Short term (operating) activity ratios Inventory turnover Receivables turnover Payable turnover Working capital turnover Long term (investment) activity ratios Fixed assets turnover Total asset turnover
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Liquidity analysis
Liquidity ratios helps in assessing the ability of a firm to meet its current obligations. This ability depends on the cash resources available as on the balance sheet date. Current ratio Quick ratio Cash ratio

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Long term debt and solvency analysis

Analysis of a firms capital structure is essential to evaluate its long term risk and return prospects. Debt ratio Debt to total capital Debt to equity Interest coverage ratio

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Profitability analysis
Investors are concerned with the firms ability to generate, sustain and increase profits Return on sales Gross margin Operating margin Profit margin Return on investments Return on assets Return on equity

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EPS and P/E ratios

EPS is the most widely available and commonly used performance statistics for publicly traded firms Calculation of EPS is governed and mandated by the financial reporting standards Earnings per share Price earning ratio

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