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DEFINATIONWHAT DO YOU MEAN BY RATION ANALYSISADVANTAGES & USESLIMITATIONSBIBLOGRAPHY
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According to Myers, “Ratio analysisof financial statements is a study ofrelationship among various financialfactors in a business as disclosed bya single set of statements and astudy of trend of these factors asshown in a series of statements.”
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A TOOL USED BY INDIVIDUAL TO CONDUCT AQUANTITATIVE ANALYSIS OF INFORMATIONONE OF THE TECHNIQUE OF FINANCIAL ANALYSIS TOEVALUATE THE FINANCIAL CONDITION ANDPERFORMANCE OF A BUSINESS CONCERNTHE COMPARISION OF ONE FIGURE TO OTHERRELEVANT FIGURE OR FIGURES
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TO WORKOUT THE PROFITABILITYTO WORK THE SOLVENCYHELPFUL IN ANALYSIS OF FINANCIAL STATEMENTHELPFUL IN COMPARATIVE ANALYSIS OF THE PERFORMANCETO SIMPLIFY THE ACCOUNTING INFORMATIONTO WORKOUT THE OPERATING EFFICIENCYTO WORKOUT SHORT-TERM FINANCIAL POSITIONHELPFUL FOR FORECASTING PURPOSES
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LIMITED COMPARABILITYFALSE RESULTSEFFECT OF PRICE LEVEL CHANGESQUALITATIVE FACTORS ARE IGNOREDEFFECT OF WINDOW-DRESSINGCOSTLY TECHNIQUEMISLEADING RESULTSABSENCE OF STANDARD UNVERSITY ACCEPTEDTERMINOLOGY
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Current assets are those which are usuallyconverted into cash or consumed with in shortperiod (say one year). Current liabilities arerequired to be paid in short period (say one year). Formula of Current ratio = Current assets Current Ratio: / current liabilities
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Quick ratio is also known as liquid ratio or acid test ratio. Current ratio provides a rough idea of the liquidity of a firm so subsequently a second testing device was developed named as acid test ratio or quick ratio. It establishes relationship between liquid assets and current liabilities. In many businesses a significant proportion of current assets may comprise of inventory. Inventory, by nature, cannot be converted into ready cash abruptly. The term liquid assets does not include inventory. Quick ratio = Liquid Formula of (quick) assets / Current Quick ratio Liabilities*The term liquid or quick assets includes all the current assets minusinventory at prepaid expenses.
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Ratio of net credit sales to average trade debtors is called debtors turnover ratio. Itis also known as receivables turnover ratio. This ratio is expressed in times.Accounts receivables is the term which includes trade debtors and bills receivables.It is a component of current assets and as such has direct influence on workingcapital position (liquidity) of the business. Perhaps, no business can afford to makecash sales only thus extending credit to the customers is a necessary evil. But caremust be taken to collect book debts quickly and within the period of credit allowed.Otherwise chances of debts becoming bad and unrealizable will increase. Howeffective or efficient is the credit collection? To provide answer debtors turnover ratioor receivable turnover ratio is calculated. FORMULA OF Receivables turnover ratio = DEBTOR’S Annual net credit sales / TURNOVER RATIO Average accounts receivables*Where accounts receivables = Trade debtors + Bills receivables
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Gross profit ratio is the ratio of gross profit to net sales i.e.sales less sales returns. The ratio thus reflects the margin ofprofit that a concern is able to earn on its trading andmanufacturing activity. It is the most commonly calculatedratio. It is employed for inter-firm and inter-firm comparisonof trading results. Formula of gross Gross profit = Gross profit / (Net profit ratio sales × 100)*Where Gross profit = Net sales - Cost of goods sold*Cost of goods sold = Opening stock + Net purchases + Direct expenses - Closing stock*Net sales = Sales - Returns inwards
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The operating ratio is determined by comparing the cost of the goods sold and other operating expenses with net sales. Operating Ratio = [(Cost of goods Formula for sold + Operating expenses / Operating Ratio Net sates)] × 100 OR Net sales - Gross profit*Here cost of goods sold = Operating stock + Net purchases + Manufacturingexpenses - Closing stock*Operating expenses = Office and administrative expenses + Selling anddistribution expenses
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Net profit ratio (NP ratio) expresses the relationship betweennet profit after taxes and sales. This ratio is a measure of theoverall profitability net profit is arrived at after taking into accountboth the operating and non-operating items of incomes andexpenses. The ratio indicates what portion of the net sales is leftfor the owners after all expenses have been met. Formula of Net Net Profit Ratio = Profit Ratio (Net profit after tax / Net sales) × 100*It is expressed in percentage. Higher the net profit ratio, higheris the profitability of the business.
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The total revenue expenditure may be sub-divided into two categories with fixed and variable. In the case of a fixed expense, the ratio will fall with increase in sales and for a variable expense, the ratio in proportion to sales shall nearly remain the same. Expense ratios are calculated to ascertain the relationship that exists between operating expenses and volume of sales. Expense ratios are calculated by dividing each item of expense or group of expenses with the net sales so analyze the cause of variation of the operating ratio. It indicates the portion of sales which is consumed by various operating expenses.Ratio of material (Direct material cost / used to sales Net sales) × 100 Ratio of labor (Direct labor cost / Net to sales sales) × 100
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Ratio of factory (Factory expenses / Net sales) overheads to × 100 salesRatio of office and (Office and administration administration expensesexpenses to sales / Net sales) × 100 Ratio of selling (Selling and and distribution distribution expenses / expenses to sales Net sales) × 100 *These ratios are expressed in terms of percentage. The total of the above ratios will be equal to the operating ratio.
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The relationship between borrowed funds and internal owners funds is measured by Debt-Equity ratio. This ratio is also known as debt to net worth ratio. The total revenueexpenditure may be sub-divided into two categories with fixed and variable. Inthe case of a fixed expense, the ratio will fall with increase in sales and for avariable expense, the ratio in proportion to sales shall nearly remain the same.Expense ratios are calculated to ascertain the relationship that exists betweenoperating expenses and volume of sales. Expense ratios are calculated bydividing each item of expense or group of expenses with the net sales soanalyze the cause of variation of the operating ratio. It indicates the portion ofsales which is consumed by various operating expenses. Formula of Debt Debt Equity Ratio = Equity Ratio DEBT/DEBT+EQUITY
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Proprietary ratio (also known as Equity Ratio or Net worthto total assets or shareholder equity to total equity).Establishes relationship between proprietors funds to totalresources of the unit. Where proprietors funds refer toEquity share capital and Reserves, surpluses and Totresources refer to total assets. Proprietary Ratio = Formula of Proprietors funds / Proprietary Ratio Total assets*This relationship highlights the fact as to what is the proportion of Proprietorsand outsiders in financing the total business
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A ratio used to compare a stocks market value to its book value. It iscalculated by dividing the current closing price of the stock by the latestquarters book value per share.A lower P/B ratio could mean that the stock is undervalued. However, itcould also mean that something is fundamentally wrong with the company.As with most ratios, be aware that this varies by industry.This ratio also gives some idea of whether youre paying too much for whatwould be left if the company went bankrupt immediately. P/B RATIO = FORMULA OF P/B RATIO STOCK PRICES/TOTAL ASSETS – INTANGIBLE ASSETS & LIABILITIES *Also known as the “Price-Equity Ratio”
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A valuation ratio of a companys current share price compared to its per-share earnings.In general, a high P/E suggests that investors are expecting higher earnings growth in thefuture compared to companies with a lower P/E. However, the P/E ratio doesnt tell usthe whole story by itself. Its usually more useful to compare the P/E ratios ofone company to other companies in the same industry, to the market in general oragainst the companys own historical P/E. It would not be useful for investors using theP/E ratio as a basis for their investment to compare the P/E of a technology company(high P/E) to a utility company (low P/E) as each industry has much different growthprospects. P/E RATIO = FORMULA OF P/E RATIO MARKET VALUE PER SHARE/ EARNINGS PER SHARE (EPS) *Also known as “Price Multiple" or “Earnings Multiple"
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A financial ratio of net sales to fixed assets. The fixed-asset turnover ratio measuresa companys ability to generate net sales from fixed-asset investments - specificallyproperty, plant and equipment (PP&E) - net of depreciation. A higher fixed-assetturnover ratio shows that the company has been more effective in using theinvestment in fixed assets to generate revenues. This ratio is often used as ameasure in manufacturing industries, where major purchases are made for PP&E tohelp increase output. When companies make these large purchases, prudentinvestors watch this ratio in following years to see how effective the investment inthe fixed assets was. FORMULA OF FIXED-ASSET TURNOVER = FIXED-ASSET NET PROPERTY, PLAN, TURNOVER RATIO EQUIPMENT
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A ratio used to determine how easily a company can pay interest onoutstanding debt. The interest coverage ratio is calculated by dividing acompanys earnings before interest and taxes (EBIT) of one period by thecompanys interest expenses of the same period. The lower the ratio,the more the company is burdened by debt expense. When a companysinterest coverage ratio is 1.5 or lower, its ability to meet interest expensesmay be questionable. An interest coverage ratio below 1 indicates thecompany is not generating sufficient revenues to satisfy interest expenses. FORMULA OF INTEREST COVERAGE RATIO INTEREST = EBIT/INTEREST EXPENSE COVERAGE RATIO
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A ratio that indicates what proportion of debt a company hasrelative to its assets. The measure gives an idea to the leverage ofthe company along with the potential risks the company faces interms of its debt-load. A debt ratio of greater than 1 indicates thata company has more debt than assets, meanwhile, a debt ratio ofless than 1 indicates that a company has more assets than debt.Used in conjunction with other measures of financial health, thedebt ratio can help investors determine a companys level of risk. DEBT RATIO = FORMULA OF DEBT RATIO TOTAL DEBT/TOTAL ASSETS
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Indicates what portion of sales contribute to the income ofa company. FORMULA OF PROFIT PROFIT MARGIN RATIO = MARGIN RATIO NET INCOME/REVENUE*This ratio is not useful for companies losing money, since they have no profit.*A low profit margin can indicate pricing strategy and/or the impact competition has onmargins.
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An indicator of how profitable a company is relative to its total assets. ROA gives anidea as to how efficient management is at using its assets to generateearnings. Calculated by dividing a companys annual earnings by its total assets, ROAis displayed as a percentage. Sometimes this is referred to as "return on investment".ROA tells you what earnings were generated from invested capital (assets). ROA forpublic companies can vary substantially and will be highly dependent on theindustry. This is why when using ROA as a comparative measure, it is best to compareit against a companys previous ROA numbers or the ROA of a similar company. FORMULA OF RETURN ON ASSET = NET RETURN ON INCOME/TOTAL ASSET ASSET (ROA)
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The amount of net income returned as a percentage of shareholdersequity. Return on equity measures a corporations profitability byrevealing how much profit a company generates with the moneyshareholders have invested. The ROE is useful for comparing theprofitability of a company to that of other firms in the same industry. ROE = FORMULA OF RETURN ON EQUITY NET (ROE) INCOME/SHAREHOLDER’S EQUITY *ROE is expressed as a percentage. *Also known as "return on net worth" (RONW).
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A ratio that indicates the efficiency and profitability of acompanys capital investments. ROCE should always be higherthan the rate at which the company borrows, otherwise anyincrease in borrowing will reduce shareholders earnings.A variation of this ratio is return on average capital employed(ROACE), which takes the average of opening and closing capitalemployed for the time period. ROCE = RETURN ON CAPITAL EMPLOYES (ROCE) EBIT/TOTAL ASSETS- CURRENT LIABILITIES
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The rate a taxpayer would be taxed at if taxingwas done at a constant rate, instead ofprogressively. This is the net rate a taxpayer paysif you include all forms of taxes. EFFECTIVE TAX RATE (%) = FORMULA OFEFFECTIVE TAX RATE INCOME TAX EXPENSES/PRETAX INCOME