Professional Documents
Culture Documents
Of
To
1
CERTIFICATE
I, Mr. Mankirat Singh Bhinder, Roll No. 01624488815 certify that the Project
Report/Dissertation B.COM-311) entitled “A Study on Ratio Analysis of Cuemath” is
done by me and it is an authentic work carried out by me. The matter embodied in this
project work has not been submitted earlier for the award of any degree or diploma to the
best of my knowledge and belief.
Date:
Countersigned
(Director / Project Coordinator)
2
ACKNOWLEDGEMENTS
suggestions, and contribution & work involving many jobs. One of the most
important parts of writing a report is the opportunity of thanks all those who
have contributed to it. The list of expression of thanks, no matter how extensive,
This project has been a great learning opportunity for me due to the immense support and
have served its purpose sufficiently in the absence of her invaluable input. I would also
like to express my gratitude towards Director Sir, Mr. C.P CHAWLA whose inputs were
Last but not the least; I am grateful towards IITM as an institution for providing such a
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EXECUTIVE SUMMARY
Someone has rightly said that practical experience is far better and closer to the real
world than more theoretical exposure. The practical experience helps the student to view
the real business world closely, which in turn widely influences his/her perceptions and
management student has to do research work quite frequently during his entire life span.
The research work entitled “Ratio Analysis” aims to see the pattern followed by the
INDEX OPTIONS (BOTH CALL OPTIONS AND PUT OPTIONS) and there different
This project has offered me an opportunity to put all my efforts and the theoretical
knowledge to practice and enhance my knowledge, and at the same time, given me
projects too.
In the preparation of this report, I have made every effort to ensure that all steps involved
in development of this project are adequately covered and the report be completed in it.
I sincerely hope that this project will prove pure knowledge imparting, through provoking
4
CONTENTS
S No Topic Page No
1 Certificate (s) (i)
2 Acknowledgements (ii)
3 Executive Summary (iii)
4 List of Tables -
5 List of Graphs -
8 Chapter-1: Introduction 1
9 Chapter-2: Methodology 4
10 Chapter-3: Data Analysis 20
11 Chapter-4: Conclusions and Limitations 37
12 References/Bibliography 42
5
CHAPTER-1
INTRODUCTION
6
Cuemath
Our philosophy is of partnering with our clients and not being a distant service provider.
Since businesses are inherently different, we tailor our services to meet client’s specific
needs and banish the ‘one-size-fits-all’ standardization.
We recruit, train, motivate and retain highly capable and sharpest talent, who bring
quality in their work and deliver the best solutions to the students seeking math’s
education.
Serving to the wider business community since more than three decades, we enjoy
unparalleled reputation and respect of our clients, who trust and rely on us for our
professionalism. We recruit, train, motivate and retain highly capable and sharpest talent,
who bring quality in their work and deliver the best solutions. We nurture our people and
turn them in to our assets.
Cuemath offers a technology platform for women to run home-based learning centers for
young students from LKG to class 8. Started in mid-2013, Cuemath claimed to have the
fastest growing networks of math learning centers in India. Over 25,000 teachers have
applied to be a part of the Cuemath network and the startup has signed over 1200 teachers
from this pool.
CapitalG, formerly known as Google Capital, has led a series B round of $15 million in
education startup Cuemath. Along with CapitalG, the investing arm of tech major
Google, Cuemath's existing backer Sequoia Capital has also participated in this round.
This marks CapitalG's first bet on the Indian education startups, which have attracted
heavy investor interest in the recent past.
Three and a half-year-old math learning startup Cuemath has bagged its third infusion of
external funding, this time rounding up support to the tune of $15 million in a Series B
round from Sequoia India and CapitalG, formerly known as Google Capital, the growth
equity investment fund of Google’s parent company.
7
After receiving seed funding we thrived towards are our goals and objectives to provide
the best of best output.
8
CHAPTER-2
METHADOLOGY
9
METHADOLOGY AND DATA COLLECTED
The methodology used in the collection of the data is collection of information through
secondary data. Secondary data is data collected by someone other than the user.
Common sources of secondary data for social science include censuses, organizational
records and data collected through qualitative methodologies or qualitative
research. Primary data, by contrast, are collected by the investigator conducting the
research.
As is the case in primary research, secondary data can be obtained from two different
research strands:
Quantitative: Census, housing, social security as well as electoral statistics and other
related databases.
A clear benefit of using secondary data is that much of the background work needed has
already been carried out, for example: literature reviews, case studies might have been
carried out, published texts and statistics could have been already used elsewhere, media
promotion and personal contacts have also been utilized.
This wealth of background work means that secondary data generally have a pre-
established degree of validity and reliability which need not be re-examined by the
researcher who is re-using such data.
Furthermore, secondary data can also be helpful in the research design of subsequent
primary research and can provide a baseline with which the collected primary data results
can be compared to. Therefore, it is always wise to begin any research activity with a
review of the secondary data.
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(C) Importance of Secondary Data
Secondary data analysis saves time that would otherwise be spent collecting data and,
particularly in the case of quantitative data, provides larger and higher-
quality databases that would be unfeasible for any individual researcher to collect on their
own. In addition, analysts of social and economic change consider secondary data
essential, since it is impossible to conduct a new survey that can adequately capture past
change and/or developments.
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Meaning and definition of ratio analysis:
Ratio Analysis is a powerful tool of financial analysis. A ratio is defined as "the indicated
quotient of mathematical expression" and as "the relationship between two or more
things". A ratio is used as benchmark for evaluating the financial position and
performance of the firm. The relationship between two accounting figures, expressed
mathematically, is known as a financial ratio. Ratio helps to summarizes large quantities
of financial data and to make qualitative judgment about the firm's financial performance.
The persons interested in the analysis of financial statements can be grouped under three
head owners (or) investors who are desired primarily a basis for estimating earning
capacity. Creditors who are concerned primarily with Liquidity and ability to pay interest
and redeem loan within a specified period. Management is interested in evolving
analytical tools that will measure costs, efficiency, liquidity and profitability with a view
to make intelligent decisions.
STANDARDS OF COMPARISON
The ratio analysis involves comparison for a useful interpretation of the financial
statements. A single ratio in itself does not indicate favorable or unfavorable condition. It
should be compared with some standard.
Past Ratios: Ratios calculated from the past financial statements of the same firm.
Competitor's Ratios: Ratios of some selected firms, especially the most progressive and
successful competitor at the same point in time.
Industry Ratios: Ratios of the industry to which the firm belongs.
Projected Ratios: Ratios developed using the projected financial statements of the same
firm.
The easiest way to evaluate the performance of a firm is to compare its present ratios with
past ratios. When financial ratios over a period of time are compared, it is known as the
time series analysis or trend analysis. It gives an indication of the direction of change and
reflects whether the firm's financial performance has improved, deteriorated or remind
constant over time.
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CROSS SECTIONAL ANALYSIS
Another way to comparison is to compare ratios of one firm with some selected firms in
the industry at the same point in time. This kind of comparison is known as the cross-
sectional analysis. It is more useful to compare the firm's ratios with ratios of a few
carefully selected competitors, who have similar operations.
INDUSTRY ANALYSIS
To determine the financial conditions and performance of a firm. Its ratio may be
compared with average ratios of the industry of which the firm is a member. This type of
analysis is known as industry analysis and also it helps to ascertain the financial standing
and capability of the firm & other firms in the industry. Industry ratios are important
standards in view of the fact that each industry has its characteristics which influence the
financial and operating relationships.
TYPES OF RATIOS
1. Liquidity Ratio
2. Leverage Ratio
3. Activity Ratio
4. Profitability Ratio
13
1. Liquidity Ratio
It is essential for a firm to be able to meet its obligations as they become due.
Liquidity Ratios help in establishing a relationship between cast and other current
assets to current obligations to provide a quick measure of liquidity. A firm should
ensure that it does not suffer from lack of liquidity and also that it does not have
excess liquidity. A very high degree of liquidity is also bad, idle assets earn nothing.
The firm's funds will be unnecessarily tied up in current assets. Therefore it is
necessary to strike a proper balance between high liquidity.
Liquidity ratios can be divided into three types:
1.1.Current ratio
Current Ratio is an acceptable measure of firm’s short-term solvency Current assets
includes cash within a year, such as marketable securities, debtors and inventors.
Prepaid expenses are also included in current assets as they represent the payments
that will not made by the firm in future. All obligations maturing within a year are
included in current liabilities. These include creditors, bills payable, accrued
expenses, short-term bank loan, income-tax liability in the current year. The current
ratio is a measure of the firm's short term solvency. It indicated the availability of
current assets in rupees for every one rupee of current liability. A current ratio of 2:1
is considered satisfactory. The higher the current ratio, the greater the margin of
safety; the larger the amount of current assets in relation to current liabilities, the
more the firm's ability to meet its obligations. It is a cured -and -quick measure of the
firm's liquidity. Current ratio is calculated by dividing current assets and current
liabilities.
Current Assets
Current Ratio = _________________________
Current Liabilities
14
1.2.Quick Ratio
Quick Ratio establishes a relationship between quick or liquid assets and current
liabilities. An asset is liquid if it can be converted into cash immediately or
reasonably soon without a loss of value. Cash is the most liquid asset, other assets
that are considered to be relatively liquid asset and included in quick assets are
debtors and bills receivables and marketable securities (temporary quoted
investments). Inventories are converted to be liquid. Inventories normally require
some time for realizing into cash; their value also has a tendency to fluctuate. The
quick ratio is found out by dividing quick assets by current liabilities
1.3.Cash Ratio
Cash is the most liquid asset; a financial analyst may examine Cash Ratio and its
equivalent current liabilities. Cash and Bank balances and short-term marketable
securities are the most liquid assets of a firm, financial analyst stays look at cash
ratio. Trade investment is marketable securities of equivalent of cash. If the company
carries a small amount of cash, there is nothing to be worried about the lack of cash
if the company has reserves borrowing power. Cash Ratio is perhaps the most
stringent Measure of liquidity. Indeed, one can argue that it is overly stringent. Lack
of immediate cash may not matter if the firm stretch its payments or borrow money
at short notice.
2. Coverage ratios.
Structural Ratios are based on the proportions of debt and equity in the financial structure
of firm. Coverage Ratios shows the relationship between Debt Servicing, Commitments
and the sources for meeting these burdens.
The short-term creditors like bankers and suppliers of raw material are more
concerned with the firm's current debt-paying ability. On the other hand, long-term
creditors like debenture holders, financial institutions are more concerned with the firm's
long-term financial strength. To judge the long-term financial position of firm, financial
leverage ratios are calculated. These ratios indicated mix of funds provided by owners
and lenders.
There should be an appropriate mix of Debt and owner's equity in financing the
firm's assets. The process of magnifying the shareholder's return through the use of Debt
is called "financial leverage" or "financial gearing" or "trading on equity". Leverage
Ratios are calculated to measure the financial risk and the firm's ability of using Debt to
shareholder’s advantage.
16
2.1. Debt Equity Ratio
It indicates the relationship describing the lenders contribution for each rupee of
the owner's contribution is called debt-equity ratio. Debt equity ratio is directly
computed by dividing total debt by net worth. Lower the debt-equity ratio, higher
the degree of protection. A debt-equity ratio of 2:1 is considered ideal. The debt
consists of all short term as well as long-term and equity consists of net worth
plus preference capital plus Deferred Tax Liability.
Debt
Debt Ratio = ___________
Equity
Net Worth
Proprietary Ratio =______________________________ X 100
Total Tangible Assets
17
2.4. Interest Coverage Ratio
The interest coverage ratio or the time interest earned is used to test the firms’
debt servicing capacity. The interest coverage ratio is computed by dividing
earnings before interest and taxes by interest charges. The interest coverage ratio
shows the number of times the interest charges are covered by funds that are
ordinarily available for their payment. We can calculate the interest average ratio
as earnings before depreciation, interest and taxes divided by interest.
EBIT
Interest Coverage Ratio = ________________
Interest
3. Activity Ratios
Turnover ratios also referred to as activity ratios or asset management ratios, measure
how efficiently the assets are employed by a firm. These ratios are based on the
relationship between the level of activity, represented by sales or cost of goods sold
and levels of various assets. The improvement turnover ratios are inventory turnover,
average collection period, receivable turn over, fixed assets turnover and total assets
turnover.
Activity ratios are employed to evaluate the efficiency with which the firm
manages and utilize its assets. These ratios are also called turnover ratios because
they indicate the speed with which assets are being converted or turned over into
sales. Activity ratios thus involve a relationship between sales and assets. A proper
balance between sales and assets generally reflects that asset utilization.
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3.1. Total capital turnover ratio
This ratio expresses relationship between the amounts invested in this assets and the
resulting in terms of sales. This is calculated by dividing the net sales by total sales. The
higher ratio means better utilization and vice-versa.
Some analysts like to compute the total assets turnover in addition to or instead
of net assets turnover. This ratio shows the firm's ability in generating sales from all
financial resources committed to total assets.
Sales
Total Capital turnover ratio = _______________________
Capital Employed
This ratio measures the relationship between working capital and sales. The ratio shows
the number of times the working capital results in sales. Working capital as usual is the
excess of current assets over current liabilities. The following formula is used to measure
the ratio.
Sales
Working Capital turnover ratio = ______________________
Working Capital
Net Sales
Fixed asset turnover ratio = ____________________
19 Fixed Assets
3.4. Stock turnover ratio
Stock turnover ratio indicates the efficiency of firm in producing and selling its
product. It is calculated by dividing the cost of goods sold by the average stock. It
measures how fast the inventory is moving through the firm and generating sales. The
stock turnover ratio reflects the efficiency of inventory management. The higher the
ratio, the more efficient the management of inventories and vice versa .However, this
may not always be true. A high inventory turnover may be caused by a low level of
inventory which may result if frequent stock outs and loss of sales and customer
goodwill.
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4. PROFITABILITY RATIOS
A company should earn profits to survive and grow over a long period of time.
Profits are essential but it would be wrong to assume that every action initiated by
management of a company should be aimed at maximizing profits. Profit is the difference
between revenues and expenses over a period of time.
Profit is the ultimate 'output' of a company and it will have no future if it fails to
make sufficient profits. The financial manager should continuously evaluate the
efficiency of company in terms of profits. The profitability ratios are calculated to
measure the operating efficiency of company. Creditors want to get interest and
repayment of principal regularly. Owners want to get a required rate of return on their
investment.
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4.1. Gross profit ratio
First profitability ratio in relation to sales is the gross profit margin the gross profit
margin reflects. The efficiency with which management produces each unit of product.
This ratio indicates the average spread between the cost of goods sold and the sales
revenue. A high gross profit margin is a sign of good management. A gross margin ratio
may increase due to any of following factors: higher sales prices cost of goods sold
remaining constant, lower cost of goods sold, sales prices remaining constant. A low
gross profit margin may reflect higher cost of goods sold due to firm's inability to
purchase raw materials at favorable terms, inefficient utilization of plant and machinery
resulting in higher cost of production or due to fall in prices in market.
This ratio shows the margin left after meeting manufacturing costs. It measures
the efficiency of production as well as pricing. To analyze the factors underlying the
variation in gross profit margin, the proportion of various elements of cost (Labor,
materials and manufacturing overheads) to sale may studied in detail.
Gross Profit
Gross Profit Ratio = _________________ X 100
Net Sales
This ratio expresses the relationship between operating profit and sales. It is
worked out by dividing operating profit by net sales. With the help of this
ratio, one can judge the managerial efficiency which may not be reflected in
the net profit ratio.
Operating Profit
Operating Profit Ratio = _______________________ X 100
Net Sales
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4.3. Net Profit Ratio
Net profit is obtained when operating expenses, interest and taxes are subtracted from the
gross profit. Net profit margin ratio established a relationship between net profit and sales
and indicates management's efficiency in manufacturing, administering and selling
products.
This ratio also indicates the firm's capacity to withstand adverse economic
conditions. A firm with a high net margin ratio would be in an advantageous position to
survive in the face of falling selling prices, rising costs of production or declining
demand for product
This ratio shows the earning left for shareholders as a percentage of net sales. It
measures overall efficiency of production, administration, selling, financing. Pricing and
tax management. Jointly considered, the gross and net profit margin ratios provide a
valuable understanding of the cost and profit structure of the firm and enable the analyst
to identify the sources of business efficiency / inefficiency.
Net Profit
Net Profit Ratio = ______________ X 100
Net Sales
This is one of the most important profitability ratios. It indicates the relation of net profit
with capital employed in business. Net profit for calculating return of investment will
mean the net profit before interest, tax, and dividend. Capital employed means long term
funds.
E.B.I.T
Return of investment = ______________________ X 100
Capital Employed
23
4.5. Earnings per share
This ratio is computed by earning available to equity shareholders by the total amount of
equity share outstanding. It reveals the amount of period earnings after taxes which occur
to each equity share. This ratio is an important index because it indicates whether the
wealth of each shareholder on a per share basis as changed over the period.
Net Profit
Earnings Per share = _____________________________ X 100
Number of equity shares
It explains the changes in the profit margin ratio. A higher operating expenses ratio is
unfavorable since it will leave a small amount of operating income to meet interest,
dividends. Operating expenses ratio is a yardstick of operating efficiency, but it should be
used cautiously. It is affected by a number of factors such as external uncontrollable
factors, internal factors. This ratio is computed by dividing operating expenses by sales.
Operating expenses equal cost of goods sold plus selling expenses and general
administrative expenses by sales.
Operating Expenses
Operating Expense Ratio = ________________________ X 100
Sales
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CHAPTER-3
DATA
ANALYSIS
&
INTERPRETATION
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1. LIQUIDITY RATIO’S
The ratio between all current assets and all current liabilities; another way of
expressing liquidity. It is a measure of the firm’s short-term solvency. It
indicates the availability of current assets in rupees for every one rupee of
current liability. A ratio of greater than one means that the firm has more
current assets than current claims against them.
Current Assets
Current Ratio = _________________________
Current Liabilities
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Current Ratio
3.5
2.5
1.5
0.5
0
2013-2014 2014-2015 2015-2016 2016-2017
27
1.2. Quick Ratio
Quick ratio establishes a relationship between quick, or liquid, assets and current
liabilities. It is also called the quick assets ratio or the acid-test ratio - is a liquidity
indicator that further refines the current ratio by measuring the amount of the
liquid current assets there are to cover current liabilities. The quick ratio is more
conservative than the current ratio because it excludes inventory and other current
assets, which are more difficult to turn into cash. Therefore, a higher ratio means
a liquid current position.
Quick Ratio
2.5
1.5
0.5
0
2013-2014 2014-2015 2015-2016 2016-2017
28
1.3. Cash Ratio
The ratio between cash plus marketable securities and current liabilities
Cash Ratio
0.3
0.25
0.2
0.15
0.1
0.05
0
2013-2014 2014-2015 2015-2016 2016-2017
29
2. Leverage Ratio’s
Total Liabilities
Debt Ratio = _____________________
Total Assets
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2.2.Debt Equity Ratio
Debt equity ratio indicates the relationship describing the lenders contribution for
each rupee of the owner’s contribution is called debt- equity ratio. Debt equity ratio
is computed by dividing Long term Liabilities divided by Equity. Lower debt –
equity ratio higher the degree of protection. A debt-equity ratio of 2:1 is considered
ideal.
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2.3. Interest Coverage Ratio
The ratio shows the number of times the interest charges are covered by funds that
are ordinarily available for their payment.
EBIT
Interest Coverage Ratio = ________________
Interest
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3. Activity Ratio
It indicates the firm efficiency of the firm in producing and selling its product. It is
calculated by dividing the cost of goods sold by the average inventory.
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3.2. Fixed Asset Turnover Ratio
The ratio is supposed to measure the efficiency with which fixed assets employed, a
high ratio indicated a high degree of efficiency in asset utilization and a low ratio
reflects inefficient use of assets. However, in interpreting this ratio, one caution
should be borne in mind. When the fixed assets of the firm are old and substantially
depreciated, the fixed assets turnover ratio tends to be high because the denominator
of the ratio is very low.
Net Sales
Fixed asset turnover ratio = ____________________
Fixed Assets
0
2013-2014 2014-2015 2015-2016 2016-2017
34
3.3. Working Capital Turnover Ratio
A firm may also like to relate net current assets or net working capital to sales.
Working capital turnover indicates that for one rupee of sales the company needs
how many net current assets. This ratio indicates whether working capital has been
effectively utilized market sales.
Sales
Working Capital turnover ratio = ______________________
Working Capital
35
3.4. Total Capital Turnover ratio
Sales
Total Capital turnover ratio = _______________________
Capital Employed
1.5
0.5
0
2013-2014 2014-2015 2015-2016 2016-2017
36
4. Profitability Ratio
The ratio shows that the margin left after meeting manufacturing costs. It measures
the efficiency of production as well as pricing.
Gross Profit
Gross Profit Ratio = _________________ X 100
Net Sales
25
20
15
10
0
2013-2014 2014-2015 2015-2016 2016-2017
37
4.2. Net Profit Ratio
This ratio also indicates the firm’s capacity to with stand adverse economic
conditions. A firm with a high net margin ratio would be in an advantageous position
to survive in the face falling selling prices, rising costs of production or decling
demand of the product.
Net Profit
Net Profit Ratio = ______________ X 100
Net Sales
0
2013-2014 2014-2015 2015-2016 2016-2017
38
4.3. Operating expenses ratio
The operating expenses ratio explains the changes in the profit margin ratio. A higher
operating expense is unfavorable since it will leave a small amount of operating
income to meet interest, dividends.
Operating Expenses
Operating Expense Ratio = ________________________ X 100
Sales
14
12
10
0
2013-2014 2014-2015 2015-2016 2016-2017
39
4.4. Return on Investment
E.B.I.T
Return of investment = ______________________ X 100
Capital Employed
Return On Investment
0.3
0.25
0.2
0.15
0.1
0.05
0
2013-2014 2014-2015 2015-2016 2016-2017
40
4.5. Return on equity shareholder’s fund
The return on equity shareholders fund explains about the return of shareholders,
which they get on their investment. It is also known as earning per share.
Net Profit
Earnings Per share = _____________________________ X 100
Number of equity shares
25
20
15
10
0
2013-2014 2014-2015 2015-2016 2016-2017
41
CHAPTER-4
CONCLUSION
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Advantages.
Accounting ratios reveal the financial position of the concern. This helps the banks,
insurance companies and other financial institutions in lending and making investment
decisions.
Accounting ratios simplify, summarise and systematize the accounting figures in order to
make them more understandable and in lucid form. They highlight the inter-relationship
which exists between various segments of the business as expressed by accounting
statements. Often the figures standing alone cannot help them convey any meaning and
ratios help them to relate with other figures.
Accounting ratios helps to have an idea of the working of a concern. The efficiency of the
firm becomes evident when analysis is based on accounting ratio. They diagnose the
financial health by evaluating liquidity, solvency, profitability etc. This helps the
management to assess financial requirements and the capabilities of various business
units.
If accounting ratios are calculated for a number of years, then a trend is established. This
trend helps in setting up future plans and forecasting. For example, expenses as a
percentage of sales can be easily forecasted on the basis of sales and expenses of the past
years.
Accounting ratios are of great assistance in locating the weak spots in the business even
though the overall performance may be efficient. Weakness in financial structure due to
incorrect policies in the past or present are revealed through accounting ratios.
For example, if a firm finds that increase in distribution expenses is more than
proportionate to the results expected or achieved, it can take remedial steps to overcome
this adverse situation.
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Useful in Comparison of Performance:
Through accounting ratios comparison can be made between one departments of a firm
with another of the same firm in order to evaluate the performance of various
departments in the firm. Manager is naturally interested in such comparison in order to
know the proper and smooth functioning of such departments. Ratios also help him to
make any change in the organisation structure.
Limitations
Historical. All of the information used in ratio analysis is derived from actual
historical results. This does not mean that the same results will carry forward into the
future. However, you can use ratio analysis on pro forma information and compare it
to historical results for consistency.
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Historical versus current cost. The information on the income statement is stated in
current costs (or close to it), whereas some elements of the balance sheet may be
stated at historical cost (which could vary substantially from current costs). This
disparity can result in unusual ratio results.
Inflation. If the rate of inflation has changed in any of the periods under review, this
can mean that the numbers are not comparable across periods. For example, if the
inflation rate were 100% in one year, sales would appear to have doubled over the
preceding year, when in fact sales did not change at all.
Aggregation. The information in a financial statement line item that you are using for
a ratio analysis may have been aggregated differently in the past, so that running the
ratio analysis on a trend line does not compare the same information through the
entire trend period.
Operational changes. A company may change its underlying operational structure to
such an extent that a ratio calculated several years ago and compared to the same
ratio today would yield a misleading conclusion. For example, if you implemented a
constraint analysis system, this might lead to a reduced investment in fixed assets,
whereas a ratio analysis might conclude that the company is letting its fixed asset
base become too old.
Accounting policies. Different companies may have different policies for recording
the same accounting transaction. This means that comparing the ratio results of
different companies may be like comparing apples and oranges. For example, one
company might use accelerated depreciation while another company uses straight -
line depreciation, or one company records a sale at gross while the other company
does so at net.
Business conditions. You need to place ratio analysis in the context of the general
business environment. For example, 60 days of sales outstanding might be
considered poor in a period of rapidly growing sales, but might be excellent during
an economic contraction when customers are in severe financial condition and unable
to pay their bills.
Interpretation. It can be quite difficult to ascertain the reason for the results of a
ratio. For example, a current ratio of 2:1 might appear to be excellent, until you
realize that the company just sold a large amount of its stock to bolster its cash
45
position. A more detailed analysis might reveal that the current ratio will only
temporarily be at that level, and will probably decline in the near future.
Company strategy. It can be dangerous to conduct a ratio analysis comparison
between two firms that are pursuing different strategies. For example, one company
may be following a low-cost strategy, and so is willing to accept a lower gross
margin in exchange for more market share. Conversely, a company in the same
industry is focusing on a high customer service strategy where its prices are higher
and gross margins are higher, but it will never attain the revenue levels of the first
company.
Point in time. Some ratios extract information from the balance sheet. Be aware that
the information on the balance sheet is only as of the last day of the reporting period.
If there was an unusual spike or decline in the account balance on the last day of the
reporting period, this can impact the outcome of the ratio analysis.
In short, ratio analysis has a variety of limitations that can limit its usefulness.
However, as long as you are aware of these problems and use alternative and
supplemental methods to collect and interpret information, ratio analysis is still
useful.
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BIBLIOGRAPHY
1. http://www.investopedia.com/terms/r/ratioanalysis.asp
2. https://www.slideshare.net/Dharan178/ratio-analysis-2970642.
3. http://www.zenwealth.com/businessfinanceonline/RA/RatioAnalysis.
html
4. https://www.myaccountingcourse.com/financial-ratios/
5. http://www.accountingformanagement.org/classification-of-financial-
ratios/
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