Of

NATIONAL ALUMINIUM CO.LTD.

 CONTENTS
CHAPTERS PAGE NO.

Declaration

Preface

Acknowledgement

CHAPTER – I

INTRODUCTION 1

1.1 Objectives of the study 2

1.2 Place of the study 2
1.3 Research Methodology 3
1.4 Scope of the study 4
1.5 Limitation 5

CHAPTER – II

PROFILE OF NALCO 6

2.1 Background 6
2.2 Segments 7
2.3 Partners 8
2.4 Opening results 9
2.5 Marketing 9
2.6 Man power 9
2.7 Industrial Relations/ HRD / Work culture 9
CHAPTER –III

FINANCIAL STATEMENT ANALYSIS 11

: A conceptual Study

3.1 Objectives of financial Statement Analysis 11

3.2 Methods of Financial Analysis. 12
3.3 Ratio Analysis Fund. 17
3.4 Cash Flow Statement. 17
3.5 Fund Flow Statement. 17
3.6 Interpretation of Ratio. 18
3.7 Precautions for use of Ratio. 20
3.8 Uses and significance of Ratio Analysis. 21
3.9 Managerial uses of Ratio Analysis. 22
3.10 Limitations of Ratio Analysis. 23
3.11 Classification of Ratios. 25
3.12 Liquidity Ratios. 28
3.13 Leverage Ratios. 30
3.14 Activity Ratios. 32
3.15 Profitability Ratios. 35

CHAPTER – IV

ANALYSIS OF FINANCIAL RATIOS 43

CHAPTER – V

SUMMARY AND CONCLUSION 68

ANNEXURE - BIBLIOGRAPHY
 INTRODUCTION

Financial Analysis is fundamental to financial planning and financial

processing. It is quite extensive-right from determining the sources of finance and the
funds needs of the organizations, right up to financial reporting of actual results as
compared to plants.

Financial analysis is the process of identifying the financial strengths and

weakness of the firm by properly establishing relationship between the items of the
balance sheet and profit and loss account. The balance sheet summarizes the asserts,
liabilities and incomes and expenses of the firm over a particular period of time. The
analysis of financial statement is a process of evaluating relationship between
component parts of financial statements to obtain a better understanding between the
firm’s position and performance. In brief financial analysis is the process of selection,
relation and evaluation. Through analysis and interpretation it can be of intense use in
decision-making.

Financial analysis is so far as considered the best way for analyzing a

company’s performance & lastly the holding period yield etc. This analysis is
considered to be quite reliable because it makes use of several statistical &
mathematical tools & is based on certain rules & methods.

This analysis is done on National Aluminium Company Limited, which is one

of the biggest public sector & of course a profit making one of its kind.

1
1.1 OBJECTIVES OF THE STUDY

Financial analysis is the indicator of the financial health of a company.

As like a doctor gives medicine only after due diagnosis, in a similar fashion
ratio analysis is the important tool used to measure the financial health indices
and to take necessary action at the appropriate time to achieve the corporate
goal.

The objectives of the study relates :

• To study the operating efficiency and performance of the company.
• To know the company’s position through evaluation between
component parts of financial statements.
• To provide a framework for optimum financial decision-making.
• To maximize company’s profit.
• To minimize cost of production.
• To know the charges in cash position.
• To know the charges in total financial resources of the company.
• To know the ability of the company to meet its obligations.

1.2 PLACE OF STUDY

All the activities of this project are carried out at SMELTER PLANT of
National Aluminium Company Limited, Angul and Corporate Office,
Bhubaneswar.

2
1.3 RESEARCH METHODOLOGY

The research involved extensive and intensive study of the National

Aluminium Company Limited (NALCO) :
1- Published annual reports for last five years.
2- Audited accounts of the company for last five years.
3- Physical stock verification report.

The data collected from the annual reports are analysed and interpreted
in the light of the prevailing economic and industrial conditions.
The data collected from the financial statements of the company are
analysed with the help of different accounting and financial ratios and
statistical tools.
The data collected from the physical stock verification reports are
analysed on the strength of stock records maintained as regards to different
items and their movements during the years.
During the tenure of study the help of the following secondary data of
NALCO are taken :

1.3 I- DATA SOURCE :

i- Annual Reports.
ii- Annual Accounts.
iii- Balance Sheet.
iv- Profit and Loss Account.
II- TOOLS AND TECHNIQUES USED :
1- Liquidity Ratios.
-Current Ratio
-Acid Test Ratio/Quick Ratio

3
 2- Leverage Ratios
-Debt Equity Ratio
-Debt Ratio
-Interest Coverage Ratio
3- Activity Ratios
-Inventory Turnover Ratio
-Debtors Turnover Ratio
-Fixed Asset Turnover Ratio
-Total Asset Turnover Ratio
-Working Capital Turnover Ratio
4- Profitability Ratios
-Operating Ratio
-Expense Ratio
-Net Profit Ratio

-Return on Investment
-Return on equity.
-Return Capital Employed.

1.4 SCOPE OF THE STUDY

(i) The data and information are collected during summer session of
the year 2004.

(ii) The scope is limited to the company data only collected from
Annual Reports, Annual accounts, Balance sheet & profit & loss
accounts of the Company (NALCO).

4
1.5 LIMITATIONS
(1) The company has not finalized their accounts for the year 2003-
04 as a result of which figures of 2002-03 are considered for
financial Analysis.

(2) The study is strictly based on mathematical interpretations of the

figures and ignore the factors such as management style,
motivation of workers, leadership etc.

(3) Time being a constraint, it was not possible to go for an extensive

study of the topic.

5
 CHAPTER-2

PROFILE OF NALCO
 PROFILE OF NALCO

2.1 Background

National Aluminium Company Limited (NALCO) was incorporated in 1981

as a wholly owned Govt. Company to exploit a part of the large deposits of bauxite
discovered in the east coast. Aluminium Pechiney of France, a world leader in the
field, provided the technology and basic engineering for bauxite mining, alumina
refinery and Smelter. The project cost of Rs 2408 Cr. was party financed by Rs 1119
Cr. equivalent of Euro-Dollar loans extended by a consortium of international banks
and the balance Rs 1289 Cr. through equity from Govt. of India.

In November 1980, Govt. of India sanctioned the establishment of the Orissa

aluminium complex, which was christened and registered as National Aluminium
Company Limited on 7th January 1981. The then Prime Minister of India Late Smt.
Indira Gandhi laid the foundation stone at Damanjodi on 29th March 1981. Thus
began a turning point in the 50years old history of Indian Aluminium Industry with
NALCO.

Commissioned during 1985-87, under extremely difficult logistics of project

management, that too without time or cost over-runs, Nalco has emerged to be a star
performer in production and export of alumina and aluminium more signifivcantly,, in
propelling self-sustained growth.

Leveraging the technical collaboration with Aluminium Pechineey of France,

ISO 9000 : 2001 certification of quality management, LME registration of products,
environment care conforming to ISO 14001, low cost operations, international
customer base, Nalco has continued to add value and is poised to grow further.

6
 Transparent and successful operations of Nalco, as well as its contributions,
have brought about remarkable socio-economic progress in the two underdeveloped
districts of Orissa, where the company’s palnt and facilities are located.

2.2 Segments :

The NALCO Project mostly located in backward districts of Orissa were

expeditiously completed on schedule under very difficult logistics of project
management NALCO’s various production units, their location and installed
capacities are :

Segment / Capacity Special Technological Features

Bauxite Mine, - Fully mechanized Open Cast

Mines with
Panchapatmali, computerised mine palnning.
Orissa - 370 million tones deposit estimated
48,00,000 tpa - 14.6 kms-long single-flight multi curve.
- 1800 tph capacity computerized
conveyor
system for transporation of ore.

Alumina Plant - Atmospheric pressure digestion process

15,75,000 tpa Energy efficient fluidized Bed Calciners
Chemical Plant Co-generation of 3x18.5 MW power by
Back pressure turbine from process
Steam.
- Integrated facilities for manufacture
specially aluminas, hydrates and zeolite.
Aluminium Plant - Advanced 180 KA Cell technology.
Angul, Orissa - Micro-Processor based Pot-Regulation
3,45,000 tpa system.
Metallurgical Plant - Fume Treatment with dry-scrubbing
system.
- Integrated anode making, aluminium
casting & rolling facilities
7
Power Plant - Micro-processor based Burner
Angul, Orissa Management
960 MW - Automatic turbine run up system
Coal fired thermal power Specially designed high pressure
Plant turbines - Advanced Electronic Precipitators

Port Facilities - Mechanised storage facility of 3 x

25,000 T Capacity.
Vizag, A.P.
For export of Alumina - Mechanised Mobile Ship loader of 2200
tph
& Import of Caustic Capacity.
Soda Lye import - capacity to handle ships up to 35,000
DWT.

2.3 Partner

The setting up of NALCO has been a team effort of following consulting

organizations.
Aluminium pechiney, France know how Basic Engineer for mine, Alumina
and aluminium plant Engineers India Ltd., New Delhi, Prime Indian consultant for
mine, Alumina and Aluminium and over all project monitoring.

D.C.P.L. Calcutta- Captive power plant.

H.I.P.L. Calcutta – Port Facilities.

RITES, New Delhi – Rail Facilities.

8
2.4 Operating Results

The company has registered a net profit of Rs 520.92 crores in 2002-03,

against Rs 409.35 crores achieved in 2001-02, registering an increase in 27.26%. The
sales turnover has also been showing an increasing trend in 2002-03. It has increased
14.85% from that of last year. In 2001-02 the export earnings touched an all time high
of Rs 1500.65 crores, which is 24.50% more than that of previous year. All these were
the results of improvement of overall efficiency, cost reduction methods, better
management and impact of policy measures taken by Government.

2.5 Marketing

On the marketing font, the company has performed excellently. It has

achieved highest ever metal sale of 2,42,495 MT during the year 2002-03 including
1,07,302 MT of metal exports and again an all time achievement and sold 1,35,193
MT in domestic market.

2.6 Manpower

The total manpower strength of the company as on 31st March 2004 was 6702
including 1702 executives, 809 supervisors, 3069 skilled workers and 1122 unskilled
workers.

2.7 Industrial Relations/HRD/Work Culture

The Industry relations situation during the year under report remained
peacefully and large. The open door policy adopted by the company has been
conducted to maintenance of cordial industrial relations despite the multiplicity of
unions.
9
 GRD subsystems like open Forum, Suggestion & Reward Scheme and
monitoring scheme are being implemented in various divisions of the company. The
impact is clearly visible in employee empowerment and participation, transparency
and openness.

Training and development of it’s employees which includes skill improvement

and attitudinal/ behavioral changes continues as a priority area. A well equipped
“HRD center of Excellence” has since become operational at company’s corporate
office at Bhubaneswar. It also provided an opportunity of idea sharing among the
eminent practicing managers, academicians, trade unionists and students.

10
 CHAPTER-3

FINANCIAL STATEMENT

ANALYSIS
 FINANCIAL STATEMENT ANALYSIS :

Financial statement analysis and interpretation refer to a systematic and

constant effort to determine the significance and meaning of the financial statement
data to enable forecasting the prospects of future earnings, ability to repay debts and
the probability of adopting a sound dividend policy. It is designated to be the last of
the four major steps of accounting, which involves the presentation of information
that aids business managers, investors, debenture holders, creditors and bankers, trade
union and employers, security analysts, auditors, Government, stock exchange and
other persons such as researchers, economists, The company law Board, Public
Accounts Committee and the Estimate Committee. Analysis and interpretation are
closely connected because interpretation is impossible without analysis.

3.1 OBJECTIVES OF FINANCIAL STATEMENT ANALYSIS:

The main objectives are :

i) To know the present and future earning capacity or profitability of the

concern.
ii) To know the operational efficiency of the concern as a whole and of
it’s various parts or departments.
iii) To know the short term and long term solvency of the concern for the
benefit of the debenture holders and trade creditors.
iv) To know the comparative study in regard to one firm or one
department with other.
v) To know the possibility of development in the future by making
forecasts and preparing budgets.
vi) To know the financial stability of a business concern.
vii) To know the long-term liquidity of its funds.
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3.2 METHODS OF FINANCIAL ANALYSIS :

The analysis and interpretation of financial statements is used to determine the

financial position and results of operations as well. A number of methods or devices
are used to study the relationship between different statements. An effort is made to
use those devices, which clearly analyses the position of the enterprise. The following
methods of analysis are generally used :-

1- Comparative financial and operating statements.

2- Trend analysis.
3- Common size statements.
4- Average Analysis
5- Funds Flow Analysis.
6- Cash Flow Analysis.
7- Ratio Analysis.

1. COMPARATIVE STATEMENTS :

These statements indicate the direction of movement with respect to financial

position and operating results. They are very useful for the analysis because they
contain only information necessary for the study of financial and operating trend over
a period of years. Comparative statements may be made to show :-

(a) absolute data (money values or rupee account)

(b) increases or decreases in absolute data in terms of percentages.
(c) comparisons expressed in ratios.
(d) percentage of totals.

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 The more common types of such statements are :

(1) Comparative balance sheet

(2) Comparative income statement
(3) Comparative statement of working capital and
(4) Comparative statement of manufacturing costs.

2 TREND ANALYSIS :

Under this technique a statement of one period is taken as base with reference
to which all other statements are to be studied. Every item is to be stated as 100 in the
statement which is taken as the base. If the amount of the item in another statement is
less than that in the base statement, the trend percentage will be below 100 and if the
amount is more than the base amount, the trend percentage would be above 100
percentage. Trend ratio can be computed by dividing each amount in the statement
with the corresponding items in the statement taken as the base. Any one trend by
itself is not very informative and therefore comparison of related trend alone is
valuable to the analyst as the analysis of the ratios over the past few year suggest the
trend or direction in which the enterprise is moving weather upward or backward.
However it should be borne in mind that the comparability of trend ratios is adversely
affected to the extent to which accounting principles and policies reflected by the
accounts have not been followed consistently throughout the period under study.

3. COMMON SIZE STATEMENTS :

The analyst is able to draw useful conclusions when figures are given in a
comparative position. The figures of Sales for a quarter, half year or one year may tell
only the present position of sales efforts. When sales figures of previous periods are
given along with the figures of current periods, then the analyst will be able to study
the trends of sales over different periods of time. Similarly comparative figures will
indicate the trend and direction of financial position and operating results.
13
 The financial data will be comparative only when some accounting principles
are used in preparing these statements. The common size statement (balance sheet and
income statement) are shown in analytical percentages. The figures are shown as
percentage of total assets, total liabilities and total assets are taken as 100 and
different assets are expressed as a percentage of the total. Similarly, various liabilities
are taken as part of total liabilities. Statements prepared in this way are referred to as
common size statements.

Common size comparative statements prepared for one firm over the year
would highlight the relative changes in each group of expenses, assets and liabilities.
These statements can be equally useful for inter firm comparison given that absolute
figures of two firm of the same industry are not comparable.

a) Common Size balance sheet :

The statement in which balance sheet items are expressed as the ratio of each
assets and the ratio of each liabilities is expressed as a ratio of total liabilities is called
common size balance sheet.

b) Common size Income statement :

The items in income statement can be shown as percentage of sales to show

the relation of each item to sales. A significant relationship can be established
between terms of income statement and volume of sales. The increase in sales will
certainly increase selling expenses and not administration expenses. In case the
volume of sales are declining the selling expenses should be reduced at once so that a
relationship is established between sale and other items in income statement and this
relationship is helpful in evaluating operational activities of the enterprise.

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4. AVERAGE ANALYSIS :
Averages are another important tool of interpretation and this technique is an
improvement over trend analysis method. When trend ratios have been determined for
the firm, these figures are compared with industry averages. Some of the important
averages which the management can use are average stocks, average monthly sales,
average gross profit etc.

5. FUNDS FLOW STATEMENT

This statement is prepared in order to reveal clearly the various sources from
which the funds are procured to finance the activities of a business concern during the
period and also to highlight the uses to which these funds are put during the said
period.

USES AND IMPORTANTACE OF FUNDS FLOW STATEMENT :

The Financial statements reveal the net effect of various transactions on the
operational and financial position of a concern. The funds flow statement explains
causes for such changes and also the effect of their change on the liquidity position of
the company.

(a) Helps in the formation of realistic dividend policy :-

Sometimes a firm has sufficient profits available for distribution as dividend.

But yet it may not be advisable to distribute for lack of liquid or cash resources. In
such cases a funds Flow statement helps in the formation of a realistic dividend
policy.

15
(b) Helps in proper allocation of resources :-

The resources of a concern are always limited and it wants to make the best
use of their resources. A projected Funds Flow Statement constructed for the future
helps in making management decisions. The firm can plan the deployment of its
resources and allocate them among various applications.

( c) Helps in appraising the use of working capital :-

A funds Flow Statement helps in explaining how effectively the management

has used its working capital and also suggests ways to improve working capital
position of the firm.

(d) Helps in knowing the overall creditworthiness of the firm :-

The financial institutions and banks such as State Financial Institution,

Industrial Development Corporate, IDBI etc. also use trends.

Statement constructed for a number of years before granting loans to know the credit
worthiness and paying capacity of firm.

6. CASH FLOW STATEMENT

A Statement of changes in the financial position of a firm in the cash basis is

called a cash flow statement . Such a statement enumerates the net effect of the
various business transactions in cash and takes into account receipts and
disbursements of cash. It summarizes the causes of changes in cash position of a
business enterprise between dates of Balance Sheet. It is called cash flow statement
because it describes the inflows and outflows of cash.

16
USES AND SIGNIFICANCE OF THE CASH FLOW STATEMENT

1- Since a cash flow statement is based on the cash basis of accounting it is very
useful in the evaluation of cash position of a firm.

2- A project cash flow statement can be prepared in order to know the future cash
position of a concern so as to enable the firm to plan and co-ordinate its
financial positions properly. By preparing this statement a firm can come to
know as to how much cash will be generated into the firm and how much will
be needed to make various payments and how the firm can well plan to
arrange for the future requirement of the cash.

3- A comparison of the historical and projected cash flow statement can be made
so as to find the varieties and the deficiency of otherwise in the performance
so as to enable the firm to take immediate and effective action.

4- Cash flow statement helps in planning the repayment of loan, replacement of

fixed assets and other similar long-term planning of cash. It is also significant
for capital budgeting decisions.

5- A series of inter-firm and intra-firm cash flow statements reveal weather the
firm’s liquidity is improving or deteriorating over a period of time and in
comparison to other over a given of time.

3.3 RATIO ANALYSIS

The ratio analysis is one of the most powerful tools of financial analysis. In
financial analysis a ratio is used as an index for evaluating the financial position and
performance of an organization. The absolute accounting figures reported in the
financial statements do not provide a meaningful understanding of the performance
and financial position of the firm.

17
 An accounting figure conveys meaning when it is related to some other
relevant information. The accounting ratio shows relationship between the two
interrelated accounting figures as gross profit to sales, current assets to current
liabilities, loaned capital to owned capital etc.

A ratio is a simple arithmetical expression of the relationship of one number to

another. It is defined as the systematic use of ratio to interpret the financial statements
so that the strengths and weakness of a firm as well as its historical performance and
current financial condition can be determined.

NATURE OF RATIO ANALYSIS :-

Ratio analysis is a technique of analysis and interpretation of financial

statements. It is the process of establishing and interpreting various ratios for helping
in making certain decisions. It involves four steps.

(i) Selection of relevant data from the financial statement depending upon
the objective of the analysis.
(ii) Calculation of appropriate ratios from the above data.
(iii) Comparison of the calculated ratios with the ratios of the same firm in
the past or the ratios developed from projected financial statements or
the ratios of some other firm or the comparison with ratios of the
industry to which the firm belongs.
(iv) Interpretation of the ratios.

3.4 INTERPRETATION OF THE RATIOS :-

The interpretation of ratios is an important factor. Though calculation of ratios
is also important but it is only a clerical task whereas interpretation needs skill,
intelligence and foresightedness. The impact of the factors such as price level
changes, changes in accounting policies, window dressing etc. should also be kept in
18
mind when attempting to interpret ratios. The interpretation of the ratios can be made
in the following ways.

(i) Single absolute ratios :-

Generally speaking one can not draw any meaningful conclusion when a
single ratio is considered in isolation. But single ratios may be studied in relation to
certain rules of thumb which are based upon well proven conventions as for examples
2:1 is considered to be good ratio for current assets to current liabilities.

(ii) Group ratios :-

Ratios may be interpreted by calculating a group of related ratios. A single

ratio supports by other related additional ratios supported by other related additional
ratios becomes more understandable and meaningful for example. The ratio of current
assets to current liabilities may be supported by the ratio of liquid liabilities to draw
more dependable conclusion.

(iii) Historical comparison :-

One of the easiest and more popular ways of evaluating the performance of the
firm is to compare its present ratios with the past ratios called comparison overtime.
When financial ratios are compared over a period of time, it gives indication of the
direction of changes and reflects whether the firm performance and financial position
has improved, deteriorated or remained constant over a period of time.

(iv) Projected ratios :-

Ratios can be calculated for future standard based the projected or proforma
financial statements. These future ratios may be taken as standard comparison and the
ratios calculated on actual financial statements can be compared with the standard
ratios to and out variances, if any. Such variances help in interpreting and taking
corrective action for improvement in future.
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 Inter-firm comparison:- Ratios of one firm can be compared with the ratios of
some other selected firms in the same industry at the same point of time. This kind of
comparison helps in evaluating relative financial position and performance of the
firm. But while making use of such comparison one has to be very careful regarding
the different accounting methods, policies and producers adopted by different firms.

3.5 PRECAUTIONS FOR USE OF RATIOS :-

The calculation of ratios may not be different task but their use is not easy.
The information on which these are based, the constraints of financial statements,
objective for using them, the caliber of the analyst etc. are important factor which
influences the use of ratios. Following guidelines or may be kept in mind while
interpreting various ratios:-

1. Accuracy of financial statements :-

The ratio are calculated from the data available in financial statements. The
reliability of ratios is linked to the accuracy of information in these statements. Before
calculating ratios one should see whether proper concepts and conventions have been
used for preparing financial statements or not.

2. Objectives or purpose of analysis :-

The type of ratios to be calculated will depend upon the purpose for which
these are required. If the purpose is to study current financial position then ratios
relating to current assets and current liabilities will be studied. The purpose of user is
also important for the analysis of ratios. The purpose or object for which ratios are
required to be studied should always be kept in mind for studying various ratios.

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3. Selection of ratios :-

Another precaution in ratio analysis is the proper selection of appropriate

ratios. The ratio should match the purpose for which these are required. Only those
ratios should be selected which can throw proper light on the matter to be discussed.

4. Use of Standards :-

The ratios will give an indication of financial position only when discussed
with reference to certain standards. Unless otherwise these ratios are compared with
certain standards one will not be able to reach at conclusion. These standards may be
rule of thumbs as in case of current ratios and acid-test ratio.

5. Caliber of the Analyst :-

The ratios are only the tools analysis and their interpretation will depend upon
caliber and competence of the analyst. He should be familiar with various financial
statements and the significance of changes, etc. A wrong interpretation may create
wave for the concern, since wrong conclusions may lead to wrong decisions.

6. Ratios provide only a base :-

The ratios are only guidelines for the analyst, he should not base his decisions
entirely on them. The interpreter should use the ratios as guide and may try solicit any
other relevant information which helps in reaching a correct decision, before reaching
final conclusions.

3.6 USES AND SIGNIFICANCE OF RATIO ANALYSIS :-

The use of ratio is not confined to financial managers only. As discussed

earlier, there are different parties interested in the ratio analysis for knowing the
financial position of a firm for different purpose.
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 When the use of ratio analysis one can measure the financial condition of a
firm and can point out whether the condition is strong, good, questionable or poor.
The conclusions can also be drawn as to whether the performance of the firm is
improving or deteriorating. The ratios have wide applications and are of immense use
today.

3.7 MANAGERIAL USES OF RATIO ANALYSIS :-

1. Helps in decision making :

Financial statements are prepared primarily for decision making. But the
information provided in financial statements is not an end in itself and no meaningful
conclusion can be drawn from these statements alone. Ratio analysis helps in making
decision from the information provided in these financial statements.

2. Helps in financial forecasting and planning :

Ratio analysis is of much help in financial forecasting and planning. Planning

is looking ahead and the ratio calculated for a number of years work as a guide for the
future. Meaningful conclusions can be drawn for future from these ratios.

3. Helps in communicating :

The financial strength and weakness of a firm are communicated in more easy
and understandable manner by the use of ratios. The information contained in the
financial statements is conveyed in a meaningful manner to the one for whom it is
meant.

4. Helps in co-ordination :

Ratio even help in co-ordination which is of utmost importance in effective

business management. Better communication of efficiency and weakness of an
enterprise results in better co-ordination in the enterprise.
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5. Helps in control :

Ratio analysis even helps in making effective control of the business. Standard
ratios can be based upon proforma financial statements and variance or deviation if
any can be found out by comparing the actual with the standard so as to take a
corrective action at the right time.

6. Other uses :

There are so many other uses of the ratio analysis. It is an essential part of
budgetary control and standard costing. Ratios are immense importance in the
analysis and interpretation of financial statements as they bring the strength or
weakness of a firm.

3.8 LIMITATIONS OF RATIO ANALYSIS :-

The ratio analysis is one of the most powerful tools of financial management.
Though ratios are simple to calculate and easy to understand, they suffer from some
serious limitations.

1. Limited use of a single ratio :

A single ratio, usually does not convey much of a sense. To make a better
interpretation a number of ratios have to be calculated which is likely to confuse the
analyst than help him in making any meaningful conclusion.
2. Lack of adequate standard :

There are no well acceptance standards or rules of thumb for all ratios which
can be accepted as norms. It renders interpretation of the ratio difficult.

23
3. Inherent limitations of accounting ;

Like financial statements, ratios also suffer from the inherent weaknesses of
accounting records such as their historical nature. Ratios of the past are not
necessarily true indicators of the future.

4. Change of accounting procedures :

Changes in accounting procedure by a firm makes ratio analysis misleading,

i.e. a change in the valuation of methods of inventories from FIFO to LIFO increase
the cost of sales and reduce considerably the value of closing stocks which makes
stock turn over ratio to be lucrative and an unfavourable gross profit ratio.

5. Window dressing :

Financial statements can easily be window dressed to present a better picture

of its financial and profitability position to outsiders. Hence, one has to be very
careful in making a decision for ratio calculation for such financial statements. But it
may be very difficult for an outsider to know about the window dressing made by a
firm.

6. Personal bias :

Ratios are means of financial analysis and not an end in itself. Ratios have to
be interpreted in different ways.

7. Uncomparable :

Not only industries differ in their nature but also the firms of the similar
business widely differ in their size and accounting procedure etc.

24
 It makes comparison of ratios difficult and misleading. Moreover comparisons
are made difficult due to difference in definition of various financial terms used in the
ratio analysis.

8. Absolute figure distortive :

Ratios devoid of absolute figures may prove distortive as ratio analysis is

primarily a quantitative analysis and not a qualitative analysis.

9. Price level changes :

While making ratio analysis, no consideration is made to the changes in prioce

levels and this makes the interpretation of ratios invalid.

10. Ratios no substitutes :

Ratios analysis is merely a tool of financial statements. Hence ratios become

useless if separated from the statements from which they are computed.

3.9 CLASSIFICATION OF RATIOS :-

The use of ratio analysis is not confined to financial managers only. There are
different parties interested in the ratio analysis for knowing the financial position of a
firm for different purposes. In view of various users of ratios, there are many types of
ratios which can be calculated from the information given in the financial statements.
The particular purpose of the user determines the particular ratios that might be used
for financial analysis.

25
 Various accounting ratios can be classified as follows :

Ratios

(A) (B) (C)

Traditional classification Functional classification Significance ratios
or or or
Statement Ratios. Classification According Ratios According
to
To Tests. Importance.

(A) Traditional Classification or Statement Ratios :

Traditional classification or classification according to the statement, from

which these ratios are calculated is as follows :-

Traditional Classification or Statement Ratios

(A) (B) (C)

Balance Sheet Ratios Profit / loss Account Ratios Composite /
mixed
or or or
Position Statement Ratios. Revenue/Income Inter statement
Ratios
Statement ratios

26
(B) Functional classification or classification according to tests :-
In view of the financial management or according to the tests satisfied, various
ratios have been classified as below :-
Classification according to tests

Liquidity Ratios Long Term solvency Activity Profitability

And Leverage Ratios Ratios
Ratios
Financial Operating (A) In relation
to sales
1.Current Ratio
1.Inventory turnover Ratio
1.Gross profit
Ratio
Composite 2. Debtors turnover Ratio
2.Operating
Ratio
2. Liquid Ratio(Auid) 3.Fixed Assets turnover
Ratio
3.Operating
profit ratio
Test or Quick Ratio 4.Total Assets
turnover 4.Net profit
Ratio Ratio
3.Absolute liquid 5.Expense
Ratio
1.Debt Equity Ratio 5.Working capital turnover
3.Absolute liquid Ratio
6. Payable turnover ratio
2.Debt to Total 7.Capital Employed turnover
Capital Ratio ratio (B)In Relation
To investments

3.Interest Coverage 1.Return on

Investments
4.Cash flow/Debt 2.Return on
capital
5.Capital Gearing 3.Return on
equity capital
4.Return on
total resources
5.Earning per
share
 6.Price-Earning
ratio

27
(A) LIQUIDITY RATIOS:-

Liquidity Ratios measures the ability of the firm to meet its current
obligations. In fact analysis of liquidity ratios measure the ability of cash budgets and
cash and funds flow statements but liquidity ratios by establishing a relationship
between cash and other current assets to current obligations provide a quick measure
of liquidity. A very high degree of liquidity is also bad. Ideal assets earn nothing, so it
is necessary to strike a proper balance between high liquidity and lack of liquidity.

The most common ratios which indicate the extent of liquidity or lack of it
are:-
i) Current Ratios
ii) Acid test or Quick Ratio
iii) Absolute Ratios

i) Current Ratios:-

Current ratio may be defined as the relationship between current assets and
current liabilities. This ratio also known as working capital ratio is a measure of
general liquidity and is most widely used to make the analysis of a short-term
financial position or liquidity of a firm.

Current assets include cash and those assets, which can be converted into
cash within a year such as marketable securities, debtors and inventories, bills
receivable and prepaid expenses. All obligations maturing within a year are included
in current liabilities. Current liabilities include creditors, Bills payable accrued
expenses, short-term bank loans.

Income –tax liabilities and long-term debt maturing in the current year. It
is calculated by dividing the total current assets by total of the current liabilities. Thus
 28

Current Assets
Current Ratio =
Current Liabilities

Or Current Assets: Current Liabilities

ii) Acid test or Quick ratios:-

Acid test or quick ratio is a more rigorous test of liquidity than the current
ratio. The term ‘’Liquidity” refers to the ability of a firm to pay its short-term
obligations as and when they become due. Quick ratio may be defined as the
relationship between quick liquid assets and current or liquid liabilities. An asset is
liquid if it ca be converted into cash immediately or reasonably soon without a loss of
value. Cash in hand and cash at bank are the most liquid assets. The other assets,
which can be included in the liquid assets, are bills receivable, sundry debtors,
marketable securities and short-term or temporary investments.

The quick ratio can be calculated by dividing the total of the quick assets
by total temporary investments. Thus,

Quick or Liquid Assets

Acid test/Quick ratio =
Current Liabilities

iii) Absolute Liquid Ratio:-

Although receivable, debtors and bills receivable are generally more liquid
than inventories. Yet there are many doubts regarding their realization into cash
immediately or in time. Hence some authorities are of the opinion that the absolute
liquid ratio should also be calculated together with current ratio and acid test ratio so
as to exclude even receivable from the current assets and find out the absolute liquid
assets. Absolute liquid assets include cash in hand and at bank and marketable
securities or temporary investments.
29
The absolute liquid ratio can be calculated by dividing Absolute Liquid
assets by Current liabilities.

Absolute Liquid Assets

Absolute Liquid Ratio =
Current Liabilities

LIVERAGE RATIOS:-

Long term solvency and leverage ratios convey a firm’s ability to meet the
interest cost and repayments schedules of its long term obligation e.g. Debt equity
Ratio and Interest Coverage ratio. Accounting leverage ratio defines the firms ability
to meet the fixed interest and costs and repayment schedule associated with its long-
term borrowings leverage ratios show the proportions of debt and equity in financing
of the firm. These ratios measure the financing by outsider. Usually three types of
ratios are more popular under this category.

(i) Debt-Equity Ratio:-

Debt –Equity Ratio is calculated to measure or shareholder against the firm’s

assets. The ratio indicate the relationship between the external equities or the outsider
funds and the internal equities or the shareholder’s funds, thus:-

Outsider funds

Debt-Equity Ratio =
Shareholder’s funds

Total Debt
Or
 Net worth

30

Or Long term debt

Shareholder’s funds

ii) Debt ratio :-

Debt ratio can be calculated by dividing total debt by capital employed or

total net assets. Total debt will include short and long-term borrowings from financial
institutions, debentures/bonds, deferred payment arrangements for buying capital
equipment and borrowing public deposits and any interest-bearing loan. Capital
employed will included total debt and net worth.

Total debt

Debt Ratio =
Total debt + Net Worth

Total debt

Or
Capital Employed

Because of the equality of capital employed and net assets, debt ratio can be defined
as total debt divided by net assets:-

Total debt
Debt Ratio =
Net Assets

iii) Interest Coverage Ratio:-

 Interest coverage ratio measure the debt servicing capacity of the firm in so
far as fixed interest on long-term loan is concerned. It is determined by dividing the
operating profits or earning before interest and tax by interest charges on loans.
31

EBIT
Interest Coverage Ratio =
Interest

From the point of view of the creditors, the larger the coverage the larger the
ability of the firm to handle fixed charge liabilities and more assumed the payment of
interest to the creditors. However too high a ratio may imply unused debt capacity.
However a low ratio is a danger signal to the firm.

(C) ACTIVITY RATIO: -

Every firm has to maintain certain level of inventory of finished goods so as

to be able to meet the requirement of the business. But the level of inventory should
neither be too high nor too low. Inventory Turn over ratio indicates the number of
times the stock has been turned over during the period and evaluates the efficiency
with which a firm is able to manage its inventory. Inventory turnover ratio also known
as stock velocity is normally calculated by dividing sales by average inventory or cost
of goods sold by average inventory. It would indicate whether inventory has been
efficiently used or not.

Cost of goods sold

i) Inventory Turnover Ratio =
Average Inventory at cost
 32

Inventory conversion period:-

It may also be of interest to see average time taken for clearing the
stocks. This can be possible by calculating inventory conversion period. This period is
calculated by dividing the number of days by inventory turnover. The formula may be
as:

No of working days in a year

Inventory conversion period =
Inventory Turnover ratio

ii) Debtors turnover Ratio:-

Debtors turnover ratio indicates the velocity of debt collection of firm. The
liquidity position of the firm depends on the quality of debtors to a great extent.
Debtors turnover ratio is one of the ratios financial analysts apply to judge the quality
or liquidity of debtors.
Debtors turnover ratio is found out by dividing credit sales by average
debtors:-

Credit Sales
Debtors turnover =
Debtors

Total Sales
Or Debtors

33
Debtors turnover ratio indicates the number of times debtors turnover each
year. Generally the higher the value of debtors turnover, the more efficient is the
management of credit.

Average Collection period:-

The average collection period represents the average number of days for
which a firm has o wait before its receivable are converted in to cash. The ratio can be
calculated as follows:-

Average collection period

No of working days ------------------------------------- = No. of
Days
Debtors turnover ratio

(iii) Fixed Assets Turnover ratio:-

Assets are used to generate sales. Therefore a firm should manage its assets.
Several assets turnover ratios can be calculated.

The firm may wish to know its efficiency of utilizing fixed assets. The
fixed assets turnover ratio is :-

Sales
Fixed Assets Turnover ratio =
No of fixed assets
 34
iv) Total Assets Turnover Ratio:-

This ratio shows the firm’s ability in generating sales from all financial
resources committed to total assets. Thus:-

Sales
Total assets turnover =

Total assets

v) Working Capital Turnover Ratio:-

Working capital of a concern is directly related to sales. The current assets

like debtors, bills receivable, cash stock etc, changes with the increase or decrease in
sales. Working capital turnover ratio indicates the velocity of the utilization of net
working capital. This indicates the number of times the working capital is turned over
in the course of a year. This ratio measures the efficiency with which the working
capital is being used by a firm. A higher ratio indicates efficient utilization of working
capital and a low ratio indicates otherwise. But a very high working capital turnover
ratio is not good situation for any firm and hence can must be taken while interpreting
the ratio. The ratio can be calculated as :-

Cost of sales
Working Capital Turnover Ratio =
Average working capital

(D) PROFITABILITY RATIOS:-

The primary objective of a business undertaking is to earn profit. In the

words of Lord Keynes:’ Profit is the engine that drives the business enterprise’. A
business needs profits not only for its existence but also for expansion and
diversification .
35

Therefore the financial manager should continuously evaluate the

efficiency of the company in terms of profits. The profitability ratios are calculated to
measure the operating efficiencies of the company. Besides management, the
company ,creditors and owners are also interested in the profitability of the firm.

Generally two major types of profitability ratios are calculated: -

(a) Profitability in relation to sales

(b) Profitability in relation to investment.

(a) Profitability in relation to sales:-

The following ratios are profitability ratios in relation to sales:-

i) Gross profit Ratio

ii) Operating Ratio

iii) Operating profit Ratio

iv) Expense Ratio

v) Net profit Ratio

The above mentioned ratios are discussed as follows:-

i) Gross profit Ratio:-

Gross profit ratio measures the relationship of gross to net sales and is
usually represented as a percentage.
 36

The ratio is calculated by dividing the gross profit by sales:-

Gross profit
Gross Profit Ratio = X 100
Net sales

Sales – cost of good sold

= X 100

Sales
i) Operating Ratio:-

Operating ratio establishes the relationship between cost of goods sold an

other operating expenses on one hand and sales on the other. In other words, it
measures the cost of operations per rupee of sales. The ratio is calculated by dividing
operating costs with the sales and is generally represented as a percentage.

Operating Cost
Operating Ratio = X 100
Net sales

Cost of goods sold + operating expenses

= X 100
Net sales

iii) Operating profit Ratio:-

 This ratio is calculated by dividing operating profit by sales.

37

Operating profit calculated:-

Operating profit = Net Sales - Operating Cost

= Net sales- ( Cost of goods + Admn. And office expenses

+ Selling and Distribution expenses)

i.e Operating profit = Net profit + Non-operating expenses- Non-operating

income.
Operating profit
So, Operating Profit Ratio = X 100
Sales

iv) Expenses Ratio:-

Expenses ratios indicate the relationship of various expenses to net sales. The
operating ratio reveals the average total variations in expenses. But some of the
expenses may be increasing while some may be decreasing. Hence expenses ratios are
calculated by dividing each item of expenses or group of expenses with the net sales
to analyse the cause of variation of the operating ratio. The lower the ratio, the greater
is the profitability and higher the ratio, lower is the profitability.

Individual’s specific expense ratio may be calculated as :-

i) Cost of goods sold ratio = Cost of goods sold / Sales X 100

ii) Administrative & Office Expenses Ratio =

Admn & Office expenses / Sales X 100

iii) Selling & Distribution Expenses Ratio

 = Selling & Distributive Expenses/SalesX 100
38

iv) Non-operating Expenses Ratio

= Non-operating Expenses / Sales X 100

v) Net Profit Ratio:-

Net profit ratio establishes a relationship between net profit ( after taxes)
and sales and indicates the efficiency of the management in manufacturing, selling,
administrative and other activities of the firm.

This ratio is the overall measure of firm’s profitability and is calculated as:-

Net profit after tax

Net profit Ratio = x 100

Net Sales

The ratio is very useful because if the profit is not sufficient, the firm shall
not able to achieve a satisfactory return o its investment. This ratio also indicates the
firm’s capacity to face adverse economic conditions such as price competition, low
demand, etc. Obviously, higher the ratio, the better is the profitability, but while
interpreting the ratio, it should be kept in mind that the performance of profits must
also be seen in relation to investments or capital of the firm and not only in relation to
sales.
 39

(b) Profitability in relation to investment:-

The following ratios are the profitability ratios in relation to investment:-

(i) Return On Investment :-

The term investment may refer to total assets. The funds employe in net
assets is known as capital employed. Net assets equal to net fixed assets plus current
assets minus current liabilities excluding bank loans.

The calculation of R O I is
EBIT (I–T)

ROI = R O T A = X 100

Total Assets

EBIT (I–T)

ROI = RONA = X 100

Net assets

Where ROTA and RONA are respectively return on total assets and
return on net assets.

ii) Return On Equity ( R O E ):-

 Common or ordinary shareholders are the real owners of the company. They
assume the highest risk in the company. Preference shareholders have a preference
over ordinary shareholders in the payment of dividend as well as capital. Preference
share holders get a fixed rate of the company.
40
The rate of the dividend varies with the availability of profits in case of ordinary
shares only. Thus ordinary shareholders are more interested in the profitability of a
company and the performance of a company should be judged on the basis of return
on capital of the company.

Return on equity capital, which is the relationship between profits of a

company and its equity capital can be calculated as: -

Profit after Taxes

Return on Equity ( R O I ) =
Net Worth

iii) Earning Per Share ( E P S ) :-

Earning per share is a small variation of return on equity capital and is

calculated by dividing the profit after taxes by the total number of common
( ordinary) shares outstanding. Thus

Profit after tax

EPS =
No of common shares outstanding

The earning per share is a good measure of profitability and when

compared with E P S of other similar companies, it gives a view of the comparative
earning or earning power of a firm. EPS calculated for a number of years indicates
whether or not earning power of the company has increased.

41

iv) Return On Capital employed ( ROCE):-

Here the profits are related to the total capital employed. The term capital
employed refers to long-term funds supplied by the creditors and the owners of the
firm. It can be computed in two ways, first it is equal to non-current liabilities plus
owners equity. Alternatively it is equal to net working capital plus fixed assets.

A comparison of this ratio with similar firms, with the industry average
and overtime would provide sufficient insight into how efficiently long term funds of
owners and creditors are being used.

Net profit after tax + Interest

Thus ROCE =
Average total capital employed
 CHAPTER-4

ANALYSIS

OF

FINANCIAL RATIO
 ANALYSIS OF FINANCIAL RATIOS

In view of the financial management and the requirement of various users

of ratios, we may classify them into the following four important categories:
a) Liquidity Ratios
b) Leverage Ratios
c) Activity Ratios
d) Profitability Ratios
A) LIQUIDITY RATIOS :
Liquidity ratios measures the ability of the firm to meet its current
obligations. In fact analysis of liquidity ratios measures the ability of cash
budgets and cash and funds flow statements but liquidity ratios by establishing
relationship between cash and other current assets, current obligations, provide
a quick measure of liquidity. The various liquidity ratios are current ratio,
liquidity ratio and absolute liquid ratio.

B) CURRENT RATIO :
The current ratio is calculated by dividing the total current assets by total
current liabilities. Thus :

Current Assets
Current ratio =
Current Liabilities
CURRENT ASSETS CURRENT
LIABILITIES
 1) cash in hand 1) Outstanding
Expenses
2) Cash at Bank 2) Bills
payable
3) Marketable Securities 3) Sundry
creditors
4) Short term investments 4) Short term
advances
5) Bills receivable 5) Income tax
payable
6) Sundry Debtors 6) Dividends
payable
7) Inventories 7) Bank overdraft
8) Work in process 8) Prepaid
expenses
43
The current ratios of NALCO from the year 1998-99 to 2002-03 are
as follows :

TABLE – 4.1

1998- 1999- 2000- 2001- 2002-

99 00 01 02 03

1049.4 1011.0 1013.0 1138.4

1006.50
4 1 7 5
1011.60
414.43 493.62 814.03 719.20
2.532 2.05 1.24 1.58 0.99
 3
2.532
2.5
2.05
2
1.58
1.5 1.24
0.99
1
0.5
0
1998-99 1999-00 2000-01 2001-02 2002-03

3
2.5 2.532
2 2.05
1.5 1.58
1.24
1 0.99
0.5
0
1998-99 1999-00 2000-01 2001-02 2002-03

44

As we see from the table 5.1. the current ratio is more than 2 in the year
1998,1999 and 2000. The increase is current ratio is partly as a result of the increase
in debtors balances. In 1998, it is excessively high because of high cash and bank
balances and comparative less current liabilities than other year.

An increase in the current ratio represents improvement in the liquidity

positions of a firm while a decrease in the current ratio indicates that there has been a
deterioration in the liquidity position of the firm. A ratio equal or near to 2 is
considered to be satisfactory. In case of NALCO the current ratio is decreasing year
by year from 4.30 to 1.24. But during the year 2002 the ratio increases from 1.24 to
1.58. Though in the year 1998 the ratio is high, but during other year it is quite
satisfactory because it lies between 1.5 and 2.5.

ii) Acid Test or Quick Ratios :-

This ratio is ascertained by comparing the liquid assets (i.e. assets which are
immediately convertible into cash without much loss) to current liabilities. The ratio
may be expressed as :

Quick Assets
Quick Ratio = -----------------------------
Current Liabilities

Quick assets can also be calculated as :

Current Assets – (Inventories + Prepaid Expenses)

Quick ratio of Nalco from the year 1998-99 to 2002-03 are as follows :-

45

TABLE – 4.2

1998-99 1999-00 2000-01 2001-02 2002-03

1049.44 1011.01- 1013.07- 1138.45- 1006.50-

-440.24 443.37 407.20 484.32 489.25
 414.43 493.62 814.03 719.20 1011.60
1.46 1.15 0.74 0.90 0.51

1.46
1.5
1.15
1 0.9
0.74
0.51
0.5

0
1998-99 1999-00 2000-01 2001-02 2002-03

1.6
1.46
1.4
1.2 1.15
1
0.9
0.8 0.74
0.6
0.51
0.4
0.2
0
1998-99 1999-00 2000-01 2001-02 2002-03

46

Usually a high acid test ratio is an indication that the firm is liquid and has the
ability to meet its current or liquid liabilities in time and on the other hand a low quick
ratio represents that the firms liquidity position is not good. As a rule of thumb a
quick ratio of 1:1 is considered satisfactory.

In case of NALCO, the quick ratio is nearer to one in all the years excepting
the year 1998 in comparison to other years.
 (B) LEVERAGE RATIO :-

leverage ratio is defined as the firm’s ability to meet the fixed interest and cost
and repayment schedules associated with its long-term borrowing leverage ratios
show the proportions of debt and equity in financing of the firm. The various leverage
ratio are debt-equity ratio and interest coverage ratio.

i) Debt-Equity Ratio :

The debt-equity ratio is determined to assertion the soundless of the long-term

financial policies of the company. It shows the relative contributions of creditors and
workers. It is also calculated by dividing total debt by net worth.

Debt
Debt -Equity Ratio = ------------------
Equity

Outsiders Fund
Debt- Equity Ratio = --------------------
Insiders Fund

47

The Debt-Equity Ratio of Nalco from 1998-99 to 2002-03 are as follows :

TABLE – 4.3

1998-99 1999-00 2000-01 2001-02 2002-03

 643.58 663.54 801.53 1563.45 1324.44
2835.48 3200.50 3572.37 3225.24 3310.04
0.227=0.23 0.207=0.21 0.224=0.22 0.484=0.48 0.400=0.40

0.48
0.5
0.4
0.4
0.3 0.23 0.21 0.22
0.2
0.1
0
1998-99 1999-00 2000-01 2001-02 2002-03

0.6
0.5 0.48
0.4 0.4
0.3
0.2 0.23 0.21 0.22
0.1
0
1998-99 1999-00 2000-01 2001-02 2002-03

48
As we see from the above chart, the debt to equity ratio are 0.23, 0.21, 0.22,
0.48, 0.40 for the years 1998-99, 1999-00, 2000-01, 2001-02 and 2002-03
respectively. The fluctuating trend of the ratio tell us that the creditors are providing
22.7%, 20.7%, 22.4%, 48.4% and 40.0% of financing for the year 1998-99 to 2002-03
respectively. This shows that degree of protection provided to lenders are in
fluctuating order.
 The debt equity ratio is calculated to measure the extent to which debt
financing has been used in a business. The ratio indicates the proportionate claims of
owners and the outsiders against firm’s assets. A ratio of 1:1 may be usually
considered to be satisfactory although there cannot a high ratio of 2:1 or even more
may be considered satisfactory.

ii) Interest coverage Ratio :-

It is also called the times interest earned. Interest coverage ratio shows the
number of times the interest charges are covered by funds that are ordinarily available
for their payment. Interest coverage ratio is used to test the firm’s debt servicing
capacity. The interest- Coverage Ratio is calculated by diving EBIT by interest.

EBIT
Interest coverage Ratio = -------------------
Interest

49

The Interest- Coverage Ratio of NALCO from the year 1998-99 to 2002-03
are as follows :-

TABLE – 4.4

1998-99 1999-00 2000-01 2001-02 2002-03

337.22+38.06 681.0+63.43 843.37+97.61 525.61+116.90 751.43+105.66
38.06 63.43 97.61 116.90 105.66
9.86% 11.73% 9.64% 5.50% 8.11%

11.73%
12.00%
9.86% 9.64%
10.00% 8.11%
8.00%
6.00% 5.50%

4.00%
2.00%
0.00%
1998-99 1999-00 2000-01 2001-02 2002-03

14.00%
12.00% 11.73%
10.00% 9.86% 9.64%
8.00% 8.11%
6.00% 5.50%
4.00%
2.00%
0.00%
1998-99 1999-00 2000-01 2001-02 2002-03

50

This ratio is an indicator of safety to lenders of recovery of interest. Normally

the standard for this ratio for an industrial company like NALCO is 6 to 7. This ratio
measures the debt servicing capacity of a firm in so far as a fixed interest on long term
loan is concerned. A too high interest coverage ratio may not be good for the firm
because it may imply that firm is not using debt as sources of finance so as to increase
the EPS. In contrast a low ratio is a danger signal that the firm is using excessive debt
and does not have the ability to offer assured payment of interest to the creditors.
( C) ACTIVITY RATIOS :-

Activity Ratios measures the efficiency of effectiveness with which a firm

manage its sources or assets. Activity ratios thus involve a relationship between sales
& assets. These ratios are also called turnover ratios because they indicate the speed
with which assets are converted or turned over into sales. The various activity ratios
are inventory turnover, Debtors turnover, Fixed assets turnover, total assets turnover
and working capital turnover.

i) Inventory Turnover Ratios :

The Inventory turnover ratio measures how fast the inventory is moving
through the firm and generating sales. It is defined as :

Cost of goods sold

Inventory Ratio =
Average Inventory

51

The inventory Turnover Ratio of NALCO from the year 1998-99 to 2002-03
are as follows :

TABLE – 4.5

1998- 1999- 2000- 2001- 2002-

99 00 01 02 03

676.5 789.0 857.5 988.7

7 7 8 1 1165.41
419.6 441.8 423.7 453.5 486.79
5 0 2 3
1.61 1.78 2.02 2.18 2.39

2.5 2.39
2.18
2.02
2 1.78
1.61
1.5
1
0.5
0
1998-99 1999-00 2000-01 2001-02 2002-03

3
2.5 2.39
2.18
2 2.02
1.78
1.5 1.61

1
0.5
0
1998-99 1999-00 2000-01 2001-02 2002-03
 42

CHAPTER-5

SUMMARY

AND

CONCLUSION
SUMMARY AND CONCLUSION

The importance of ratio analysis lies in the fact that it presents facts on a
comparative basis and enables the drawing of inference regarding the performance of
a firm. Ratio analysis is relevant in assessing the performance of a firm in respect of
the following aspects.

Liquidity Position,
Long Term Solvency,
Operating Efficiency,
Over-all Profitability,
Inter Firm Comparison,
Financial statements contain a wealth of information which if properly
analyzed and interpreted, can provide valuable insights into a firm’s performance and
position. Analysis of financial statements is of interest to several groups for variety of
purposes. The principal tool of financial statement analysis is Financial Ratio
analysis, which essentially involves a study of ratios between various items or groups
of terms in financial statements.
During the tenure of my stud I have taken help of following secondary data.

• Annual Report
• Annual Account
• Balance Sheet
• Profit & Loss Account

The tools which are used for the study are:

• Liquidity Ratios
• Leverage Ratios
• Activity Ratios
 • Profitability Ratios

68
Through tabulation the data are put in the form of tables.

Analysis work after tabulation is based on the computation of various

percentages by applying various statistical formulae, drawing of charts and graphs etc.

Major Findings:

1. The current ratio since 1998 are relatively high enough as NACO is
not dependent on long term sources of raising funds. The ratio is
decreasing over the period due to increase in current liabilities.
2. The debt-equity ratio indicates that NALCO utilizes very little debt
fund through debentures.
3. The interest coverage ratio is higher than the requirement. This is an
indicative feature for higher safety margin to its lenders on terms of
recovering interests.
4. The inventory s continuously increasing throughout the period which
is good because less money is blocked in inventories.
5. The rising debtors turnover ratio shows the decrease in debtors
without hampering the sales.
6. The return on investment in 2002-2003 is more convincing and the
ratio is higher than that of other years. This is favorable for NALCO.

Suggestions/Recommendations :

1. NALCO should have control over increase inventory level and other
current assets, which should be consistently proportional to forecasted
sales.
2. The management of NALCO should revise the credit policy and
involve in a strategy to remove weakness of credit policy. This may
improve control over the collection department.
69
3. NALCO should follow a trend volume business and should keep
required volume of inventory that suit to its forecasted sales, so as to
give up a high inventory ratio.
4. Since NALCO produces different varieties of products, their profit
margin should be evenly balanced, so as to give a sound Gross and Net
Profit Margin.
5. The management of NALCO may be directed to counter check and
provide additional control over the cost of producing goods. This may
improve the operating efficiency.
6. Proper monitoring of accumulation of goods may prove to yield good
Return on Investment.
7. Enhancement of asset turnover may also yield better Return on
Investment.
8. There should be a regulating mechanism to avoid imbalance between
Depreciated assets and Replacement of assets against depreciated
assets.
9. NALCO seems to be upgrading its technology obsolescence from time
to time. NALCO requires strategy of expansion and diversification to
be evolve as a major competitor in Aluminium Industry. Thus
borrowing of loans may be compulsory for further expansion and
diversification. As the Interest Coverage Ratio is sufficiently high,
borrowing of funds is recommended by the analyst for NALCO. This
ma increase the Working Capital of NALCO to match with the
foreseeing future prospects.
10. Since NALCO is a centralized cash managed company as it showed
better performance in Overall Liquidity position, it should open up its
avenues in new emerging technology in different products it produces.
11. The Export can be improved in Calcinated Alumina and Aluminium
standards and sow ingots better than earlier.
 70

CONCLUSION:

The “FINANCIAL ANALYSIS’’ play a vital role in helping the financial

manager and top management of company to plan and control their financial
structural operations. An efficient analysis would therefore highlight the pitfalls in
management in terms of financial matters such as income, expenditure, export and
domestic sales, profitability, fund availability, working capital requirement etc. This
gives an idea about controllable and uncontrollable variables. These can be re-
examined and integrated to evolve an innovative idea which can give efficient
financial decision. A sound financial decision gives the way for higher profitability
and performance. It is nothing but a fine tuning of control system in financial
structure.

The suggestions given by analyst in this chapter emphasize the control system
that should be adopted by NALCO. This may prove to be corrective measures for
improving the financial structure of NALCO. But the fact remains that the
suggestions, which will be accepted and fully implemented in NALCO will only be
decided by the relevant financial system that followed by NALCO and its adaptability
in the Aluminium complex of NALCO.
 71

ANNEXURE – A

TABLE OF VARIOUS RATIOS

RATIOS 1998 1999 2000 2001 2002 2003

Current Ratios 4.3 2.532 2.05 1.24 1.58 0.99

Quick Ratio 3.2 1.46 1.15 0.74 0.90 0.51

Debt equity Ratio 0.18 .023 0.21 0.22 0.48 0.40

Interest Coverage Ratio 19.66 9.86 11.73 9.64 5.51 8.11

Inventory Turnover Ratio 1.95 1.61 1.78 2.02 2.18 2.39

Debtors Turnover Ratio 5.139 4.563 6.833 9.155 9.251 26.90

Fixed Assets Turnover Ratio 0.646 0.567 0.858 1.029 0.884 0.777

Total Assets Turnover Ratio 0.476 0.413 0.687 0.885 0.787 0.731

Gross Profit Ratio 51% 44% 50% 50% 37% 44%

Net Profit Ratio 32% 17% 25% 29% 18% 20%

Operating Profit Ratio 49% 40% 51% 53% 42% 46%

Return on Investment(RoI) 18% 11% 25% 36% 22% 24%

Return on Equity (RoE) 17% 7% 16% 19% 12% 16%

Price Earning Ratio 6.18% 11.43 6.26 5.44 7.88 6.36

Inventory Conversion
Period 184 days 123days 202days 178days 165days 151dys
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