CA Sonal Joglekar

Ratio is the indicated quotient of two mathematical expressions and as a relationship between two or more things. Ratio is used as a benchmark for evaluating the financial position and performance of the firm. Ratios help to summarise large quantities of financial data and to make qualitative judgement about the firms performance.

Note that a financial ratio reflecting a quantitative relationship helps to form qualitative judgement.

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Ratio analysis involves comparison for a useful interpretation of the financial statements. A single ratio in itself does not indicate a favourable or an unfavourable condition. It should be compared with some standard. Standards of comparison - Past Ratios, Competitors ratios, industry ratios, projected ratios.

When financial ratios over a period of time are compared, it is known as the time series analysis. Comparing ratios of one firm with another firm in the same industry at the same point in time is cross-sectional or inter-firm analysis. Comparing the ratios of the particular firm with those of the industry is industry analysis. Future or projected ratios are prepared from proforma financial statements.

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Liquidity Ratios Leverage ratios Activity Ratios Profitability Ratios

Liquidity Ratios: Measure the firms ability to meet current obligations. Leverage Ratios: Show the proportions of debt and equity in financing the firms assets. Activity Ratios: Reflect the firms efficiency in utilising its assets. Profitability ratios: Measure overall performance and effectiveness of the firm.

Liquidity Ratios: Measure the firms ability to meet current obligations. A firm should have sufficient liquidity, neither excess (idle assets earn nothing) not insufficient (defaulting on payments affects creditworthiness).

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Current ratio Quick ratio Cash ratio Net Working Capital ratio

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Current Ratio: Current Assets/Current Liabilities It is a measure of the firms short term solvency. It indicates the availability of current assets in rupees for every one rupee of current liability. Margin of safety for creditors. The current ratio, or, ratio of current assets to current liabilities is a measure of an entity's ability to meet its maturing short-term obligations. 2:1 or more is considered sufficient.

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Current ratio = 1870.92 / 1555.75 = 1.20 : 1 The company is not sufficiently liquid.

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Quick ratio: aka Acid-test ratio Relationship between quick or liquid assets and current liabilities. Quick assets: cash, debtors, bills receivables. Inventories not included. Quick ratio = Current Assets Inventories / Current Liabilities 1:1 is considered good

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Quick ratio = 720.53 / 1555.75 = 0.46 : 1 If the company cannot sell the inventories and has to pay the current liabilities, it may not be possible as the quick assets are 0.46 times the current liabilities.

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Cash ratio = Cash + marketable Securities / Current Liabilities

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Cash ratio = 26.08 / 1555.75 = 0.017

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NWC Ratio = NWC / Net Assets NWC (aka Net Current Assets) is difference between current assets and current liabilities excluding short term bank borrowing.

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NWC ratio = 1154.04 / 1901.87 = 0.61

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Cautions: 1. The current ratio considers the quantity and not quality of current assets. Hence its a crude and quick measure of liquidity. . The quality of liabilities doesnt change, ie they have to be paid. The current assets may lose value, bad debts, obsolete stock, etc. 2. Quick ratio is a more penetrating test of liquidity yet should be used with caution. All debtors may not be liquid and cash may be needed to pay operating expenses; inventories are not always non-liquid.
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Leverage ratios assess the long term financial position of the firm. Capital Structure Debt or Equity Debt is more risky Use of debt is advantageous for shareholders; control with a limited stake and earning magnified with financial leverage. (When the firm earns a rate of return on the total capital employed higher than the interest on borrowed funds) High debt reduces the ability in raising future debt.

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Debt ratio Debt-Equity ratio Capital employed to net worth ratio Coverage ratios (interest coverage or times-interest-earned) (Leverage ratios can be calculated from the balance sheet as well as from the profit and loss items to determine the extent to which operating profits are sufficient to cover the fixed charges.)

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Debt ratio = Total debt / Capital Employed Debt ratio = Total Debt / Net Assets Capital Employed = Total debt + Net Worth Helps in analysing the long term liquidity of the firm.

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Debt ratio = 389.19 + 839.17 / 389.19 + 839.17 + 672.81 = 1229.06 / 1901.87 = 0.646 Lenders have financed 64.6 % of the capital. Owners have provided the remaining, app 1/3 rd of the capital

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Describes the lenders contribution for each rupee of the owners contribution Debt-Equity ratio = Total Debt / Net Worth

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Debt-equity ratio = 1229.06 / 672.81 = 1.83

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CE to NW ratio = CE / NW or NA / NW Calculates the funds contributed together by lenders and owners for each rupee of the owners contribution. It is 1 plus debt-equity ratio CE / NW = NW + TD / NW = 1 + TD / NW

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CE to NW ratio = 1901.87 / 672.81 = 2.83 Note that this is always 1 + debt-equity ratio

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Interest Coverage = EBIT / Interest Taxes are computed after interest. Depreciation is a noncash item and is usually included in the funds available Interest Coverage = EBITDA / Interest

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Interest coverage = 342.61 / 143.46 = 2 Or interest coverage = 342.61 + 41.59 / 143.46 = 2.7

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Use to test the firms debt-serving capacity. Number of times the interest charges are covered by ordinarily available funds. A higher ratio is desirable; but too high indicates firm is not using debt to the best advantage of shareholders. Low ratio indicates excessive use of debt.

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Evaluates the efficiency of the firm to manage and utilise the assets. Aka Turnover ratios as they indicate the speed with which the assets are being converted or turned over into sales. Inventory turnover, Debtors turnover, Net Assets turnover, Total Assets turnover, Fixed and Current Assets turnover, Working Capital turnover.

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Inventory turnover = COGS / Average inventory Indicates the efficiency of the firm in producing and selling its products. Days of inventory holding (DIH) = 360 / inventory turnover High IT indicates good inventory management, low indicates excessive inventory levels than required by the production and sales or obsolete/slow moving inventories.

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Inventory turnover = 3053.66 / 353.03 = 8.6 times Average inventory = 244.26 + 461.81 / 2 = 353.03 DIH = 360 / 8.6 = 42 days

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Debtors turnover = Credit sales / Average debtors or Sales / Debtors Indicates number of times debtors turnover each year. Higher values signals better credit management. Average collection period (ACP) = 360 / debtors turnover It indicates the quality of debtors and how long they remain outstanding.

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Debtors turnover = 3717.23 / 483.18 = 7.7 times ACP = 360 / 7.7 = 47 days

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Net Assets turnover = Sales / Net Assets NA = NFA + NCA ; NCA = CA CL NA = Capital Employed Aka Capital employed turnover A high ratio indicates efficiency in operating performance. Low ratio indicates under-utilised assets requiring costly financing and maintenance.

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Net assets turnover = 3717.23 / 1901.87 = 1.95 times

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Total Assets turnover = Sales / Total Assets Total Assets = NFA + CA Total assets turnover = 3717.23 / 2617.75 = 1.42 times

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Fixed Assets turnover = Sales / NFA Current Assets turnover = Sales / CA FA turnover = 3717.23 / 746.83 = 4.98 times CA turnover = 3717.23 / 1870.92 = 1.99 times FA is better than the CA as the fixed assets are turned over faster than the current assets

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Net Current Assets turnover = Sales / NCA Net Current Assets = Working capital Net current assets turnover = 3717.23 / 1155.04 = 3.2 times

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Profitability in relation to Sales Profitability in relation to Investment Gross Profit is considered as EBITDA Operating Profit is EBIT Gross profit margin, Net profit margin, Operating expense ratio, Return on Investment and return on equity.

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Gross Profit Margin = Sales COGS / Sales A higher margin compared to the industry average means the firm is able to produce at relatively lower costs. A high margin could imply: Higher Sale price, COGS remaining constant Lower COGS, sale price remaining constant Increase in the proportion of high margin items

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Gross profit margin = 663.57/ 3717.23 = 0.179 or 17.9 %

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Net Profit Margin = Profit after Tax / sales Net profit margin = 134.86 / 3717.23 = 0.036 or 3.6% Indicates the firms ability to turn each rupee sales into net profit.

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Operating expense ratio = Operating expenses / Sales Operating expenses = COGS + Other operating expenses High operating expense ratio indicates less funds are available for interest, dividends, etc Operating expense ratio = 3411.53 / 3717.23 = 0.918 or 91.8 %

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ROI can be calculated for either TA or for NA ROI (considering income before tax) = EBIT / Assets (either total or net) ROI for TA = 342.61 / 2615.75 = 0.131 ROI for CA = 342.61 / 1901.87 = 0.180

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ROE = PAT / Net Worth Net Worth aka Equity EPS = PAT / Number of shares ROE = 134.86 / 672.81 = 0.20 or 20% EPS = 134.86 / 22.5 = Rs 6.00

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