Ratio Analysis

Formulas
1) Financial ratios
S.no

Ratio

Formula

Current ratio

Current assets
Current liabilities

Quick ratio

Quick assets
Current liabilities

1:1

Debt Equity ratios

long term debt

equity

1:2

Proprietary ratio

Shareholders funds
Total tangible
assets

Notes

Ideal
ratio
2:1/1.33:
1

Comments
Indicates firms
commitment to meet
financial obligations.
Avery heavy ratio is not
desirable as it indicates
less efficient use of
funds
This ratio also indicates
short term solvency of a
firm
Indicates long term
solvency
Higher ratio is riskier for
the creditors
Variant of debt-equity
ratio
Shows the extent of
shareholders funds in
the total assets employed
in the business
Higher ratio indicates
relatively little danger to
creditors and vice versa

1) Current assets are those assets which can be converted into cash within a
period of one year or normal operating cycle of the business whichever is
longer
Examples : Cash in hand, cash at bank ,stock, debtors, bills receivable,
prepaid expenses
2) Current liabilities are those liabilities payable within an year or operating
cycle
3) Quick assets = current assets (stock+prepaid expenses)
4) Quick ratio is also known as the acid test ratio or liquidity ratio
5) Tangible assets are those assets which have physical existence
6) Long term debt /external funds/external equities =debentures+termloans
7) Share holders funds/internal funds/proprietary funds/owners funds=equity
share capital+preference share capital+reserves+profit and loss accountfictitious assets

2) Profitability ratios

S.no Ratio

Formula

Ideal ratio

comments

Gross profit X 100

Net sales

Higher the
ratio better
it is

This ratio expresses the

relationship between
gross profit and net
sales

Gross Profit
Ratio

Net Profit ratio

Net operating
profit ratio

Net profit X100

Net sales
(Net operating profit/net
sales)X100

Gross profit should be

adequate to cover
operating expenses
Higher the
This ratio expresses the
ratio, better relationship between
it is
net profit and Net sales
Higher ratio Helps in determining
is better
the efficiency with

which the affairs of the

business being
managed
4

Operating Ratio

Operating cost X100

net sales

Ratio
should be
low

Fixed charges
cover

PBIT
Interest

6 -7 times
for an
industrial
concern

It indicates whether the

business would earn
sufficient profits to pay
periodically the interest
charges
Indicates ability of the
company to repay
principal
Higher ratio Indicates the
is better
percentage return on
capital employed in the
business

Debt Service
coverage ratio

Overall
profitability
Operating profit
ratio/Return on
Capital employed X100
investment/return
on capital
employed
Return on share
Higher ratio Indicates the
holders funds
Profit after tax(PAT)
is better
percentage return on
Share holders funds X100
share holders funds

PBIT/interest+
(principal)/1-taxrate

This ratio is a test of

operating efficiency
with which the
business is being
carried
Important from
lenders point of view

Return on Equity
share holders
Funds

PAT-pref.dividend X100
Eq.shareholders funds

10

Price Earnings

Market price per share

Higher ratio Indicates the

is better
percentage return on
equity shareholders
funds
Higher ratio Indicates the number of

Ratio

11

Earnings per
share

Earnings per share

PAT pref.dividend
No of Equity shares

is better

times the earning per

share is covered by the
market price

Helps the investor in

deciding whether to
buy or not to buy the
shares
Higher ratio Helps in estimating
is better
companys capacity to
pay dividend to the
shareholders

Notes
1) Calculation of Gross profit
Gross profit = Sales- Cost of goods sold
Cost of goods sold (COGS) = opening stock +purchases+ all direct expenses
closing stock
2) Operating profit = Gross profit-operating expenses
Operating expenses= COGS +administration expenses +selling and distribution
expenses
Note: does not include financial charges like interest and provision for tax
3) Capital employed= sum total of all the long term funds employed in the
business
C E= Equity share capital+ preference share capital+ reserves+ profit and loss
account+ long term loans-fictitious assets
Shareholders funds= Equity share capital +preference share capital +reserves
+profit and loss account-fictitious assets

Equity share holders funds= equity share capital + reserves+ profit and loss
account-fictitious assets

3) Turnover ratios

S.no

Ratio

Formula

Ideal
ratio
Higher
ratio is
better

Fixed assets turn over

ratios

Net sales
Fixed Assets

Working capital turnover

ratio

Net sales
Working capital

Higher
ratio is
better

Debtors turnover
ratio(DTR)/debtors
velocity

Net credit sales

Average debtors

Higher
ratio is
better

Debt collection period

Months in a year
DTR

Creditors Turnover
ratio(creditors velocity)
(CTR)

Credit purchases
Average creditors

Lower
ratio is
better
Higher
ratio is
better

comments
Indicates the extent to
which investment in
fixed assets contribute
towards sales
This ratio indicates
whether or not working
capital has been
effectively utilized in
making sales
Average
debtors=(opening
debtors+opening bills
receivable+closing
debtors+closing bills
receivable)/2
Indicates the extent to
which debts have been
collected in time
Indicates the speed with
which the payments for
the credit purchases are
made
Average creditors=
opening creditors+bills

Credit payment period

Months in a year
CTR

Stock turnover ratio

Cost of goods sold

Average Stock

receivable+closing
creditors+closing bills
payable
Low ratio Indicates the promptness
is better
with which the payments
are made to the creditors
Higher
Indicates whether
ratio is
investment in stock is
better
efficiently used or not
Average stock= (opening
stock+closing stock)/2