Profitability Ratio Analysis & Example

List of profitability ratios and formulas:

1) Gross Profit ratio = (Gross profit / Net sales) * 100 %
2) Net Profit ratio = (Net profit / Net sales) * 100 %
3) Operating profit margin = Operating income / Net sales
4) Return on Capital Employed = (Profit before interest / Capital employed) * 100 %
5) Return on Equity (ROE) = Net income / Average shareholders equity
6) Return on Assets (ROA) = Net income / Total assets
7) Cash flow return on investment (CFROI) = Cash flow / Market recapitalisation
8) Risk adjusted return on capital (RAROC) = Expected return / Economic capital
9) Return on net assets = Net income / Net assets
Example:
Calculate the profitability ratios, given the following figures:
Stock at the start of the year: Rs.10,000
Stock at the end of the year: Rs.6,000
Sales: Rs.18,000
Sales returns: Rs.3,000
Purchases: Rs.2,000
Overhead expenses: Rs.3,000
Capital at start of year: Rs.17,000
Capital at end of year: Rs.15,000
Solution:
Net sales = Rs.18,000 - Rs.3,000 = Rs.15,000
Cost of sales = Stock at start + purchases - Stock at end = 10,000 + 2,000 - 6,000 = Rs.6,000
Gross profit = Net sales - Cost of sales = Rs.15,000 - Rs.6,000 = Rs.11,000
Gross profit ratio = (11,000 / 15,000 ) * 100% = 73.33 %
Net profit = Gross profit - overhead expenses = 11,000 - 3,000 = Rs.8,000
Net profit ratio = (8,000 / 15,000 ) * 100% = 53.33 %
Average capital employed = 1/2 (Capital at start + Capital at end) = 1/2 (17,000+15,000) = Rs.16,000
ROCE = ( 8,000 / 16,000) * 100% = 50%

Investment Ratio Analysis & Example

List of investment ratios and formulas:

1) Dividend cover = Profit after tax / dividends

2) Dividend yield = ( Dividend per share/ Market price per share ) * 100 %
3) Earnings per share (EPS) = Profit available to equity shareholders / Number of equity shares
4) Price earnings ratio (P/E) = Market price per share / Earnings per share
5) Price to sales ratio = Market price per share / Sales per share
6) Price earnings growth (PEG) ratio = Price per earnings / Annual EPS growth
7) Price to book value (PBV) = Market price per share / Balance sheet price per share
8) Payout Ratio = Dividend per share / EPS
Examples:
1) Camry Ltd made a net profit of Rs.80,000 that is available to ordinary shareholders, and the dividend declared
is Rs.20,000, then:
Dividend cover = 80,000 / 20,000 = 4 times
2) An investor bought a share at Rs.6.00 and he received a dividend of Rs.0.30 on it, then:
Dividend yield = (0.30 / 6.00) * 100 % = 5 %
3) Company ABC has an annual earning of Rs.140,000 dollars. Total dividends of Rs.70,000 are to be paid out, and
the company has 350,000 outstanding shares.
Solution:
Earnings per share (EPS) = Rs.140,000 / 350,000 = Rs.0.40
Dividend per share = 70,000 / 350,000 = Rs.0.20
The dividend payout ratio = 0.20 / 0.40 = 50%
4) Sports Ltd has ordinary share capital of 200,000 shares at Rs.1 each. It made a net profit of Rs.400,000 that is
available to the ordinary shareholders. The market price of a share is Rs.6.00.
Then:
EPS = Rs.400,000 / 200,000 = Rs.2 per share
P/E ratio = Rs.6 / Rs.2 = 3

Financial Leverage Ratio Analysis

Definition: Financial Leverage Ratio (also called long-term solvency ratio) is used to measure the firm's ability to
repay its long-term debts. It gives an indication of the long-term solvency of the firm.
Formula:
1) Debt to Equity = Total Debt / Total Equity
2) Total Debts to Assets = Total Liabilities / Total Assets
3) Interest Coverage Ratio = Earnings Before Interest and Taxes / Interest Charges
4) Debt service coverage ratio = Net Operating Income / Total Debt Service
5) Capitalization Ratio = Long-term Debt / (Long-term debt + Shareholder equity)
Example 1:
CK Ltd has total liabilities of Rs.700,000 and total stockholders equity of Rs.380,000, then the debt/capital ratio is:
700,000 / (700,000 + 380,000) = 700,000 / 1,080,000 = 0.6481 = 64.81%
Example 2:
Saint Ltd. is looking at an investment property with a net operating income of Rs.87,000 and an annual debt
service of Rs.58,000. The debt service coverage ratio for this property = 87,000 / 58,000 = 1.5
Example 3:
Jimmy plc has total sales revenue of Rs.99,000 for the year. It has cost sales Rs.9,000 and operating expenses of
Rs.5,000. The companys interest expense for the year is Rs.25,000.
Then,
Earnings Before Interest and Taxes = Sales Cost of sales Operating expenses
EBIT = Rs.99,000 - Rs.9,000 - Rs.5,000
EBIT = Rs.85,000
Interest Coverage Ratio = Rs.85,000/Rs.25,000 = 3.4 times
Example 4:
Peters Ltd has the following information:
Creditors Rs.2,000
Loan Rs.38,000
Buildings Rs.60,500
Debtors Rs.7,000
Bank Rs.5,000
Stocks Rs.4,500
Then, the Total Liabilities = 2,000 + 38,000 = Rs.40,000
Total Assets = 60,500 + 7,000 + 5,000 + 4,500 = Rs.77,000
Total Debts to Assets = 40,000 / 77,000 = 0.519

Efficiency Ratio Analysis & Example

Definition: Efficiency Ratios (also known as Activity ratios) are used to measure the effectiveness of the firm's use
of resources.
Formula:
1) Average Collection Period = (Average Trade Debtors / Credit Sales) * No. of Days
2) Average Payment Period = (Average Trade Creditors / Credit Purchases) * No. of Days
3) Inventory Turnover Ratio = Cost of goods sold / Average inventory held
4) Debtors Turnover Ratio = Net Credit Sales / Average Trade Debtors
5) Total Assets Turnover = Net Sales / Total Assets
6) Degree of Operating Leverage = % change in EBIT / % change in Sales
7) Creditors Turnover Ratio = Net Credit Purchases / Average Payable
8) Days Sales Outstanding Ratio = Accounts Receivable / Average sales per day
9) Working capital turnover Ratio = Cost of sales / Average net working capital
10) Current Asset Turnover Ratio = Cost of goods sold / Current assets
11) Stock Turnover Period = (Average stock / Cost of goods sold) * No. of Days
12) Cash Cycle = Stock Turnover Period + Average Collection Period - Average Payment Period
Example:
Emily Ltd has the following information:
Trade debtors Rs.100,000
Trade creditors Rs.80,000
Credit sales Rs.300,000
Credit purchases Rs.120,00
Cost of sales Rs.70,000
Opening stock Rs.60,000
Closing stock Rs.20,000
Bank Rs.66,000
Calculate the relevant Efficiency Ratios.
Solution:
Average Collection Period = (100,000 / 300,000) * 365 = 121.7 days
Average Payment Period = (80,000 / 120,000) * 365 = 243.3 days
Current Asset Turnover = 70,000 / (100,000 + 20,000 + 66,000) = 0.38
Average stock = (60,000 + 20,000) / 2 = Rs.40,000
Stock Turnover Period = (40,000 / 70,000) * 365 = 208.6 days
Cash Cycle = 208.6 + 121.7 - 243.3 = 87 days

Liquidity Ratio Analysis & Example

Definition: Liquidity ratios provide a general estimate of solvency of a company.
List of common liquidity ratios and formulas:
1) Current ratio (also known as working capital ratio)
= Current Assets / Current Liabilities
2) Quick ratio, in times (also known as acid test ratio or quick assets ratio)
= (Current Assets - Stock) / Current Liabilities
3) Interest Coverage = Profit Before Tax / Interest Charge
4) Gearing ratio = Long Term Liabilities / Equity Shareholders' Funds
5) Cash Ratio = Cash / Current Liabilities
6) Operating Cash Flow Ratio = Operating Cash Flow / Current Liabilities
Example:
Calculate the working capital, acid test and gearing ratios, given the following figures:
Debtors: Rs.2,000
Creditors: Rs.5,000
Bank: Rs.11,000
Cash: Rs.1,000
Closing stock: Rs.6,000
Opening stock: Rs.7,000
Total Capital and Reserves: Rs.25,000
Long term loan: Rs.15,000
Solution:
Current assets = debtors + bank + cash + closing stock = 2000 + 11000 + 1000 + 6000 = Rs.20,000
Working capital ratio = 20,000 / 5,000 = 4 (This means that current assets are 4 times current liabilities)
Acid test ratio = (20,000 - 6,000) / 5,000 = 2.8 (This means that current assets in liquid form are 2.8 times
current liabilities)
Equity Shareholders' Funds = Total Capital and Reserves + Long term Liabilities = 25000 + 15000 = Rs.40,000
Gearing ratio = 15,000 / 40,000 = 0.375