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RATIO ANALYSIS

Ratio-analysis means the process of


computing, determining and presenting the
relationship of related items and groups of
items of the financial statements. They
provide in a summarized and concise form
of fairly good idea about the financial
position of a unit. They are important tools
for financial analysis.

Its a tool which enables the banker or


lender to arrive at the following factors :
Liquidity position
Profitability
Solvency
Financial Stability
Quality of the Management
Safety & Security of the loans & advances
to be or already been provided

Before looking at the ratios there are a number of cautionary


points concerning their use that need to be identified :
a.The dates and duration of the financial statements being
compared should be the same. If not, the effects of
seasonality may cause erroneous conclusions to be drawn.
b.The accounts to be compared should have been prepared
on the same bases. Different treatment of stocks or
depreciations or asset valuations will distort the results.
c.In order to judge the overall performance of the firm a group
of ratios, as opposed to just one or two should be used. In
order to identify trends at least three years of ratios are
normally required.

As

Percentage - such as 25% or 50% .

For example if net profit is Rs.25,000/- and


the sales is Rs.1,00,000/- then the net profit
can be said to be 25% of the sales.
As Proportion
- The above figures may be
expressed in terms of the relationship
between net profit to sales as 1 : 4.
As Pure Number /Times
- The same can
also be expressed in an alternatively way
such as the sale is 4 times of the net profit or
profit is 1/4th of the sales.

Balance
Sheet Ratio

Financial Ratio

Current Ratio
Quick Asset
Ratio
Proprietary
Ratio
Debt Equity
Ratio

P&L Ratio or
Balance Sheet
Income/Revenu and Profit &
e Statement
Loss Ratio
Ratio
Operating Ratio

Gross Profit Ratio


Operating Ratio
Expense Ratio
Net profit Ratio
Stock Turnover
Ratio

Composite Ratio

Fixed Asset
Turnover Ratio,
Return on Total
Resources Ratio,
Return on Own
Funds Ratio,
Earning per Share
Ratio, Debtors
Turnover Ratio,

1.

Current Ratio : It is the relationship between the


current assets and current liabilities of a concern.
Current Ratio = Current Assets/Current
Liabilities
If the Current Assets and Current Liabilities of a concern
are Rs.4,00,000 and Rs.2,00,000 respectively, then the
Current Ratio will be : Rs.4,00,000/Rs.2,00,000 = 2 : 1
The ideal Current Ratio preferred by Banks is
1.33 : 1

2.

Net Working Capital : This is worked out as surplus


of Long Term Sources over Long Tern Uses, alternatively
it is the difference of Current Assets and Current
Liabilities.
NWC = Current Assets Current Liabilities

Current Assets : Raw Material, Stores, Spares, Work-in Progress. Finished


Goods, Debtors, Bills Receivables, Cash.
Current Liabilities : Sundry Creditors, Installments of Term Loan, DPG etc.
payable within one year and other liabilities payable within one year.
This ratio must be at least 1.33 : 1 to ensure minimum margin of 25% of current
assets as margin from long term sources.
Current Ratio measures short term liquidity of the concern and its ability to
meet its short term obligations within a time span of a year.
It shows the liquidity position of the enterprise and its ability to meet current
obligations in time.
Higher ratio may be good from the point of view of creditors. In the long run very
high current ratio may affect profitability ( e.g. high inventory carrying cost)
Shows the liquidity at a particular point of time. The position can change
immediately after that date. So trend of the current ratio over the years to be
analyzed.
Current Ratio is to be studied with the changes of NWC. It is also necessary to
look at this ratio along with the Debt-Equity ratio.

3. ACID TEST or QUICK RATIO : It is the ratio between


Quick Current Assets and Current Liabilities. The should be at
least equal to 1.
Quick Current Assets : Cash/Bank Balances + Receivables upto 6
months + Quickly realizable securities such as Govt. Securities or
quickly marketable/quoted shares and Bank Fixed Deposits
Acid Test or Quick Ratio
Liabilities

= Quick Current Assets/Current

Example :
Cash
50,000
Debtors
1,00,000
Inventories
1,50,000
1,00,000
Total Current Assets 3,00,000

Current Ratio

=>

Current Liabilities

3,00,000/1,00,000

4. DEBT EQUITY RATIO : It is the relationship between


borrowers fund (Debt) and Owners Capital (Equity).
Long Term Outside Liabilities / Tangible Net Worth
Liabilities of Long Term Nature
Total of Capital and Reserves & Surplus Less
Intangible Assets
For instance, if the Firm is having the following :
Capital
Free Reserves & Surplus
Long Term Loans/Liabilities
Debt Equity Ratio will be

= Rs. 200 Lacs


= Rs. 300 Lacs
= Rs. 800 Lacs
=>

800/500

i.e. 1.6 : 1

5. PROPRIETARY RATIO : This ratio indicates the extent


to which Tangible Assets are financed by Owners Fund.
Proprietary Ratio = (Tangible Net Worth/Total
Tangible Assets) x 100
The ratio will be 100% when there is no Borrowing for
purchasing of Assets.
6. GROSS PROFIT RATIO : By comparing Gross Profit
percentage to Net Sales we can arrive at the Gross Profit
Ratio which indicates the manufacturing efficiency as well as
the pricing policy of the concern.

Gross Profit Ratio = (Gross Profit / Net Sales )


x 100
Alternatively , since Gross Profit is equal to Sales minus
Cost of Goods Sold, it can also be interpreted as below :

Gross Profit Ratio = [ (Sales Cost of goods


sold)/ Net Sales] x 100

7. OPERATING PROFIT RATIO :


It is expressed as
Sales ) x 100

=>

(Operating Profit / Net

Higher the ratio indicates operational efficiency


8. NET PROFIT RATIO :
It is expressed as
x 100

=>

( Net Profit / Net Sales )

It measures overall profitability.

9.

STOCK/INVENTORY TURNOVER RATIO :

(Average Inventory/Sales) x 365 for days


(Average Inventory/Sales) x 52
for weeks
(Average Inventory/Sales) x 12
for
months
Average Inventory or Stocks = (Opening
Stock + Closing Stock)
-----------------------------------------

10. DEBTORS TURNOVER RATIO : This is also


called Debtors Velocity or Average Collection Period or
Period of Credit given .
(Average Debtors/Sales ) x 365 for days
(52 for weeks &
12 for months)
11. ASSET TRUNOVER RATIO :
Sales/Tangible Assets

Net

12. FIXED ASSET TURNOVER RATIO :


Sales /Fixed Assets

Net

13. CURRENT ASSET TURNOVER RATIO : Net


Sales / Current Assets
14. CREDITORS TURNOVER RATIO : This is also
called Creditors Velocity Ratio, which determines the

15. RETRUN ON ASSETS :


Taxes/Total Assets

Net Profit after

16. RETRUN ON CAPITAL EMPLOYED :


( Net Profit before Interest & Tax / Average
Capital Employed) x 100

Average Capital Employed is the average of the


equity share capital and long term funds
provided by the owners and the creditors of the firm
at the beginning and end of the accounting period.

Composite Ratio
17. RETRUN ON EQUITY CAPITAL (ROE) :
Net Profit after Taxes / Tangible Net
Worth
18.EARNING PER SHARE
: EPS indicates the
quantum of net profit of the year that would be
ranking for dividend for each share of the company
being held by the equity share holders.
Net profit after Taxes and Preference
Dividend/ No. of Equity Shares
19. PRICE EARNING RATIO : PE Ratio indicates the
number of times the Earning Per Share is covered
by its market price.

20. DEBT SERVICE COVERAGE RATIO : This ratio is


one of the most important one which indicates the
ability of an enterprise to meet its liabilities by way
of payment of installments of Term Loans and
Interest thereon from out of the cash accruals and
forms the basis for fixation of the repayment
schedule in respect of the Term Loans raised for a
project. (The Ideal DSCR Ratio is considered to be
2)
PAT + Depr. + Annual Interest on Long Term
Loans & Liabilities
-------------------------------------------------------------------------------Annual interest on Long Term Loans &
Liabilities + Annual Installments payable on

EXERCISE 1
LIABILITES
Capital
Reserves

ASSETS
180 Net Fixed Assets
20 Inventories

Term Loan

300 Cash

Bank C/C

200 Receivables

Trade Creditors

50 Goodwill

Provisions

50
800

400
150
50
150
50
800

a.
b.
c.

What is the Net Worth : Capital + Reserve = 200


Tangible Net Worth is : Net Worth - Goodwill = 150
Outside Liabilities : TL + CC + Creditors + Provisions = 600

d.
e.
f.

Net Working Capital : C A - C L = 350 - 250 = 50


Current Ratio : C A / C L
= 350 / 300 = 1.17 : 1
Quick Ratio : Quick Assets / C L = 200/300 = 0.66 : 1

EXERCISE 2
LIABILITIES

200506

200607

200506

Capital

300

350 Net Fixed


Assets

Reserves

140

160 Security

Bank Term Loan

320

Bank CC (Hyp)

200607

730

750

30

30

280 Investments

110

110

490

580 Raw Materials

150

170

Unsec. Long T L

150

170 S I P

20

30

Creditors (RM)

120

140

170

30

20

310

240

Electricity

70 Finished
Goods

Bills Payable

40

80 Cash

Expenses
Payable

20

30 Receivables

Provisions
40+ Loans/Advanc
30
190
1.
Tangible Net Worth for 1st20
Year : ( 300
140) - 50 = 390
es
2. Current Ratio for 2nd Year : (170 + 30 +170+20+
240 + 190 ) / (580+70+80+70)
Goodwill
50
50
820 /800 = 1.02
Total
1600
1760
1600
1760
3. Debt Equity Ratio for 1st Year : 320+150 / 390 = 1.21

Exercise 3.
LIABIITIES

ASSETS

Equity Capital

200 Net Fixed Assets

800

Preference Capital

100 Inventory

300

Term Loan

600 Receivables

150

Bank CC (Hyp)

400 Investment In Govt.


Secu.

Sundry Creditors

100 Preliminary Expenses

Total

1400

1. Debt Equity Ratio will be : 600 / (200+100)

50
100
1400

= 2:1

2. Tangible Net Worth : Only equity Capital i.e. = 200


3. Total Outside Liabilities / Total Tangible Net Worth : (600+400+100) / 200
= 11 : 2
4. Current Ratio will be : (300 + 150 + 50 ) / (400 + 100 ) = 1 : 1

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