Amity Business School

Ratio Analysis
Ratio refers to the numerical or quantitative
relationship between two items or variables for
the purpose of comparison.
Ratio analysis is the systematic use of ratios
to interpret/ assess the performance and
status of the firm.
Ratio can be expressed as
a) A percentage
b)Fraction
c) Times

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I. Liquidity Ratios
Liquidity means ability of the firm to pay its
short-term debts in time. Liquidity ratios are
calculated to measure the short term financial
position or short term solvency of the firm.
To understand the liquidity position of the
business, following ratios can be used:
Current Ratio
Acid Test Ratio/ Quick ratio/ Liquid Ratio
Absolute Liquid Ratio/ Cash Ratio

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a) Current Ratio
Current ratio may be defined as the relationship
between current assets and current liabilities. This ratio
is also called Working Capital Ratio.
Current Ratio =

Current Assets
Current Liabilities

Current Assets
Current Liabilities
Interpretation : Thumb rule : 2:1
Factors affecting interpretation

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b) Liquid Ratio/ Acid Test/

Quick Ratio
Quick ratio may be defined as a relationship
between quick/ liquid assets and current
liabilities. This ratio measures the capacity of
the firm to pay its current liabilities
immediately.
Liquidity Ratio =
Liquid Assets*
Current Liabilities
Liquid Assets: Current Assets Stock Prepaid
Expenses
Interpretation: Thumb rule: 1:1

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c) Absolute Liquid Ratio or

Cash Ratio
Liquid Ratio =

Absolute Liquid Assets*

Current Liabilities
Liquid Assets: Cash & Bank + Short term
securities
Interpretation: Thumb rule: 0.5:1

II. Profitability Ratios Amity Business School

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a) Profitability Ratios Related to

Sales
(I)Gross Profit Ratio:
Gross Profit * 100
Net Sales
Sales Cost of Goods Sold
*100
Net Sales
(II) Net Profit Ratio:
Net Profit
Net Sales

* 100

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(III) Operating Ratio:

Operating Costs * 100
Net Sales
where operating costs = Cost of goods sold +
Operating expenses
Operating Expenses are : Administrative and
office expenses + Selling and distribution
expenses
IV) Expenses ratio:

Expenses *100
Net sales

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b) Profitability Ratios related to

Investment
Return on Total Assets
Return on Total Assets
=Net Profit after tax
Total Assets
Total Assets = NFA + Investments + current Assets

* 100

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b) Return on Capital
Employed
Return on Capital Employed= Profit before
interest, tax*100
Capital Employed
Where Capital employed = Equity Share
Capital + Preference Share Capital + Reserves
and Surplus + long Loans + debentures
fictitious Assets like preliminary expenses

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c) Return on Investment
Return on Investment= Profit after tax*100
Shareholders fund
Shareholders funds = Equity Share Capital +
Preference Share Capital + Reserves and
Surplus fictitious Assets like preliminary
expenses

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d) Return on Equity
Return on Equity
Div *100

= Net Profit after tax and Preference

Equity capital

Return on Equity Shareholders funds=Net Profit after

tax&Preference Div *100
Equity Shareholders funds
Shareholders funds = Equity share capital+ Reserves and
Surplus- Accumulated Losses

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e) Earnings per share

Earnings per share = Net profit after tax and Preference
Dividend
Number of Equity Shares

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III. Turnover ratios

Turnover Ratios / Activity Ratios / Efficiency
Ratios measure the efficiency with which a firm
manages its resources.
Inventory Turnover ratio
Debtors Turnover ratio
Creditors turnover ratio
The ratio is expressed in times

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a) Inventory Turnover Ratio

Inventory Turnover Ratio =

Cost of goods sold

Average inventory

Inventory Conversion Period = 365

Inventory Turnover
Ratio
(expressed in days)

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b) Debtors Turnover Ratio

Debtor Turnover Ratio =
Net Credit Sales
Average Debtors
(Debtors + B/R)
This ratio measures how rapidly receivables
are collected. A high ratio indicative of shorter
time-lag between credit sales and cash
collection. A low ratio shows that debts are not
being collected rapidly.
Average Collection Period/ Debtor days=
365
DTR

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c) Creditors Turnover Ratio:

Creditor turnover Ratio = Net Credit
Purchases
Average Creditors
(creditors+B/P)
A low turnover ratio reflects liberal credit
terms granted by suppliers, while a high ratio
shows that accounts are to be settled rapidly.
Average payment period / Creditor Days =
365
Creditor Turnover

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LEVERAGE RATIO
Financial leverage refers to the use of debt
finance. Leverage ratios help in assessing the
risk arising from the use of debt capital.
two types of ratios:
a) Structural ratios based on proportions of
debt and equity in financial statements
b) Coverage ratios show the relationship
between debt service commitments and
sources of meeting these burdens

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Debt Equity Ratio

Debt Equity ratio = Debt

Equity
Debt : All external long term liabilities
Equity: Share Capital + Reserves and SurplusAccumulated Losses

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Capital Gearing Ratio

Fixed Interest bearing funds
Equity shareholders funds
Fixed Interest bearing funds : debentures + long
term loans + preference share capital
Equity shareholders funds : equity share capital
+ reserves and surplus accumulated losses

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Proprietory ratio
Shareholders Net Worth
Total Assets
Shareholders Net worth = equity share capital +
preference share capital +Reserves and Surplus
Intangible assets fictitious assets
Total Assets = Net Fixed assets +Current assets
fictitious assets

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Interest Coverage Ratio

Interest Coverage ratio = Net profit (before

interest and tax)
Interest

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Debt Service Coverage Ratio

DSCR = PAT + Depreciation + other non cash

expenses
+Interest on term loan
Interest on Term loan + Term loan Installments

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VALUATION RATIOS
Price-Earning Ratio = Market Price of the share
Earnings Per Share
Dividend payout ratio =
Dividend per share *
100
Earning per share