RATIO ANALYSIS

Importance of Ratio Analysis

It presents facts on a comparative basis and enables the drawing of inferences regarding the performance of the firm. It is relevant in assessing the performance of a firm in respect of:
Liquidity position. Long term solvency. Operating efficiency. Overall profitability. Inter-firm comparison. Trend analysis.

Limitation of Ratio Analysis

Difficulty in comparison:
Situations of two firms are never the same, they may be operating in different situations. Industry averages are not easily available.

Impact of inflation:
As financial statements are based on historical costs, price level changes due to inflation are never considered.

Conceptual Diversity.
Difference of opinion of the various concepts used to compute the ratios.

Liquidity Ratios
Current Ratio:
Current Assets Current Liabilities

Acid Test Ratio:

Quick Assets Current Liabilities Bank Overdraft

Liquidity Ratios

Cash Ratio:
Cash & Bank Balances + Current Investments Current Liabilities

Leverage Ratios

Debt-equity Ratio:
Debt Equity

Leverage Ratios

Debt-asset Ratio:
Debt Assets Debt Total Capital

Leverage Ratios
Interest Coverage Ratio:
Profit before interest & taxes
Debt Interest

Profit before interest & taxes + Depreciation Debt Interest

Leverage Ratios
Debt Service Coverage Ratio:
Profit after Tax + Depreciation + Interest on term loan Interest on term loan + Repayment of term loan

Turnover Ratios
Inventory Turnover Ratio:
Cost of goods sold
Average Inventory

Inventory Holding Period:

360 days or 12 months Inventory Turnover Ratio

Turnover Ratios
Debtors Turnover Ratio:
Net Credit Sales
Average Debtors

Debtors Collection Period:

360 days or 12 months Debtors Turnover Ratio

Turnover Ratios
Creditors Turnover Ratio:
Net Credit Purchases
Average Creditors

Creditors Payment Period:

360 days or 12 months Creditors Turnover Ratio

Turnover Ratios
Fixed Assets Turnover Ratio:
Net Sales
Average net fixed assets

Total Assets Turnover Ratio:

Net Sales Average total assets

Profitability Ratios
Gross Profit Margin Ratio:
Gross Profit
Net Sales

Net Profit Margin Ratio:

Net Profit Net Sales

Profitability Ratios
Return on Assets:
Profit after tax
Average total assets

Earning Power:
Profit before interest & tax Average total assets

Profitability Ratios
Return on Capital Employed:
Profit before interest & tax (1-tax rate)*
Average total assets *NOPAT (net operating profit after tax)

Return on Equity:
Equity earnings Average equity

Profitability Ratios
Earnings per share :
Equity earnings
No. of equity shares issued

Dividends per share:

Dividends No. of equity shares issued

Profitability Ratios
Dividend Pay-out Ratio :

Dividend Per Share Earnings Per Share

Valuation Ratios
Price-earnings Ratio:
Market Price Per Share
Earnings Per Share

Yield:
Dividend + Price Change Initial Price

Valuation Ratios
Market Value to Book Value:

Market value per share Book value per share