2.
Ratio Analysis
› Is a method or process by which the relationship of items
or groups of items in the financial statements are
computed, and presented.
› Is an important tool of financial analysis.
› Is used to interpret the financial statements so that the
strengths and weaknesses of a firm, its historical
performance and current financial condition can be
determined.
3.
Ratio Analysis
It’s 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
4.
Why Financial Analysis
› Lenders need it for carrying out the following
› Technical Appraisal
› Commercial Appraisal
› Financial Appraisal
› Economic Appraisal
› Management Appraisal
5.
Why Financial Analysis
Before looking at the ratios there are a number of cautionary
points concerning their use that need to be identified :
› 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.
› 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.
› 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.
6.
Why Financial Analysis
The utility of ratio analysis will get further enhanced if
following comparison is possible.
› Between the borrower and its competitor
› Between the borrower and the best enterprise in the
industry
› Between the borrower and the average performance in the
industry
› Between the borrower and the global average
7.
How a Ratio is expressed?
› 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.
8.
Classification of Ratios
Balance Sheet Ratio
P&L Ratio or
Income/Revenue
Statement Ratio
Balance Sheet and Profit
& Loss Ratio
Financial Ratio / Liquidity
Ratio
Operating Ratio /
Profitability / Leverage
Ratio
Composite Ratio / Market
Valuation Ratio
›
›
›
›
›
›
›
›
›
Fixed Asset Turnover Ratio,
Return on Total Resources
Ratio,
Return on Own Funds
Ratio, Earning per Share
Ratio, Debtors’ Turnover
Ratio, P/E
Current Ratio
Quick Asset Ratio
Proprietary Ratio
Debt Equity Ratio
Gross Profit Ratio
Operating Ratio
Expense Ratio
Net profit Ratio
Stock Turnover Ratio
9.
Format of Balance Sheet for Ratio Analysis
LIABILITIES
ASSETS
NET WORTH/EQUITY/OWNED FUNDS
› Share Capital/ Partner’s Capital/ Paid up Capital/
Owners Funds
› Reserves ( General, Capital, Revaluation & Other
Reserves)
› Credit Balance in P&L A/c
FIXED ASSETS : LAND & BUILDING, PLANT &
MACHINERIES
› Original Value Less Depreciation
LONG TERM LIABILITIES/ BORROWED FUNDS :
› Term Loans (Banks & Institutions)
NON CURRENT ASSETS
› Investments in quoted shares & securities
› Old stocks or old/ disputed book debts
› Long Term Security Deposits
› Other Misc. assets which are not current or fixed in nature
› Debentures/Bonds, Unsecured Loans, Fixed Deposits,
Other Long Term Liabilities
CURRENT LIABILTIES
› Bank Working Capital Limits such as CC/ OD/ Bills/
Export Credit
› Sundry/ Trade Creditors/ Creditors/ Bills Payable, Short
duration loans or deposits
› Expenses payable & provisions against various items
› Net Value or Book Value or Written down value
CURRENT ASSETS :
Cash & Bank Balance, Marketable/ quoted Govt. or other
securities, Book Debts/ Sundry Debtors, Bills Receivables,
Stocks & inventory (RM,SIP,FG) Stores & Spares, Advance
Payment of Taxes, Prepaid expenses, Loans and Advances
recoverable within 12 months
INTANGIBLE ASSETS
Patent, Goodwill, Debit balance in P&L A/c, Preliminary or
Preoperative expenses
10.
Some important notes
› Liabilities have Credit balance and Assets have Debit balance
› Current Liabilities are those which have either become due for payment or shall fall due for
payment within 12 months from the date of Balance Sheet
› Current Assets are those which undergo change in their shape/form within 12 months.
These are also called Working Capital or Gross Working Capital
› Net Worth & Long Term Liabilities are also called Long Term Sources of Funds
› Current Liabilities are known as Short Term Sources of Funds
› Long Term Liabilities & Short Term Liabilities are also called Outside Liabilities
› Current Assets are Short Term Use of Funds
11.
Some important notes
› Assets other than Current Assets are Long Term Use of Funds
› Instalments of Term Loan Payable in 12 months are to be taken as Current Liability
only for Calculation of Current Ratio & Quick Ratio.
› If there is profit it shall become part of Net Worth under the head Reserves and if
there is loss it will become part of Intangible Assets
› Investments in Govt. Securities to be treated current only if these are marketable
and due. Investments in other securities are to be treated Current if they are
quoted. Investments in allied / associate / sister units or firms to be treated as Noncurrent.
› Bonus Shares as issued by capitalization of General reserves and as such do not
affect the Net Worth. With Rights Issue, change takes place in Net Worth and
Current Ratio.
12.
Ratio analysis
Ratio analysis is a tool which enables the banker or lender to arrive at the following factors
:
1. Liquidity – the ability of the firm to pay its way
2. Investment / Shareholders – information to enable decisions to be made on the extent
of the risk and the earning potential of a business investment
3. Gearing – information on the relationship between the exposure of the business to
loans as opposed to share capital
4. Profitability – how effective the firm is at generating profits given sales and or its capital
assets
5. Financial – the rate at which the company sells its stock and the efficiency with which it
uses its assets
13.
Liquidity Ratios
› Liquidity Ratios : measure a firm’s ability to meet its financial obligations. The overall health
of a firm has traditionally been measured by these ratios.
› Current Ratio :
Total Current Assets .
Total 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
› Acid Test ration Or Quick Ratio :
It is the ratio between Quick Current, Assets and Current Liabilities.
The ratio should be at least equal to 1.
› Quick Ratio
: Cash and Equivalents – Inventory
Total Current Liabilities
14.
Leverage / Solvency / Profitability Ratios
› Leverage of a firm: Proportion of its long term liabilities that are debts
› Debt/Equity ratio:
Long term Debt .
Shareholders’ Funds
For instance, if the Firm is having the following :
Capital
= Rs. 200 Lacs
Free Reserves & Surplus = Rs. 300 Lacs
Long Term Loans/Liabilities = Rs. 800 Lacs
Debt Equity Ratio will be
= 800/500 i.e. 1.6 : 1
› Debt to Assets: (Debts /Total Assets) X 100
15.
Asset Utilization Ratios (AUR)/Capital
structure
› Return to Total Assets: (Net Profit /Total Assets) X 100
› Return on Capital Employed (ROCE) :
(Net Profit / Capital Employed) X 100
OR
Net Profit before Interest and tax / 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.
› Return on Shareholders’ Equity (ROE) :
Net Profit / Shareholders Funds X 100
16.
Market Value /Investment /Valuation Ratios)
› EPS (Earning Per Share) :
(Net Profit – Preference Dividend)
No. of equity Shares
› P/E : Market Price / Earnings Per Share :
Market Price of Share
EPS
› Earning Yields : (EPS / Market Price) X 100
17.
Management / Turnover / Financial Ratios
› Sales / Inventory :
High and low turnover relative to the industry could mean either poor inventory
management (high turnover) or poor utilization of related resources (low turnover).
› Interest Coverage : (PBIT : Interest + Income Tax+ Net Profit) / Interest )
› Fixed Charge Coverage : PBIT / (Interest + Preference Dividend)
› Stock Turn Over : Cost of Goods Sold / Average Inventories
› Debtors Turn Over : Credit Sales / Debtors
› Average Collection Period : 360 days / Debtors Turnover
18.
Ratio Analysis - Assignments
› Compare the performance of the company for three/five
successive years
› The absolute numbers change so compare ratios
› Compare two companies of differing size but from the
same industry, e.g., HUL and Godrej
› Calculate industry-wide numbers (net profit margins for
consumer-able products )
19.
Assignment - Undertaken
We have compared balance sheets / Profit and loss account
statements of two companies viz. Hindustan Unilever Ltd.
and Godrej Consumer products.
20.
Comparative Financial Analysis
The following are various analysis metrics considered to
compare the performance of HUL and GCPL:› Short term Investment
› Long term Investment
› Short term Lending
› Long term Lending
21.
Short Term Investment
Short term investment is the investment wherein it happens the continual
buying and selling of stock of companies. Normally investments are done
for less than a year.
Short term investment includes investment in stocks and other short term
debt. The various ratios and factors to be taken into consideration are:› P/E ratio
› P/BV ratio
› EPS
22.
P/E Ratio
The P/E ratio tells us how much an investor in common stock pay per rupee of current earnings'
Computation: PE Ratio = Market Value per share / Earning per share
Interpretation:
A higher P/E ratio means that investors are paying more for each unit of net income, so the stock is more
expensive, that is overvalued, compared to one with a lower P/E ratio
Ratio
Profit Earning Ratio
45
40
35
30
25
20
15
10
5
0
41.15
32.48
26.72
24.44
40.53
27.18
24.77
26.65
21.6
HUL
21.13
GCPL
2008
2009
2010
2011
2012
HUL
26.72
24.44
24.77
26.65
41.15
GCPL
21.6
21.13
32.48
27.18
40.53
Trend Analysis:
P/E ratios for both the companies are increasing with almost equal rate and the absolute values are also more
or less equal. Hence, we can’t conclude anything on the basis of this ratio alone.
23.
P/BV Ratio
This ratio is used to compare a stock's market value to its book value.
Computation: Price to Book Value = Market price per share / book value per share
Interpretation:
A lower P/BV ratio could mean that the stock is undervalued. Higher the P/BV ratio better is the shareholders
position in terms of capital gain
Profit Book Value Ratio
35
32.5
30
25.25
Ratio
25
20
23.12
20.16
18.96
15
9.74
10
25.22
6.36
HUL
7.71
6.47
GCPL
5
0
2008
2009
2010
2011
2012
HUL
32.5
25.25
20.16
23.12
25.22
GCPL
18.96
6.36
9.74
7.71
6.47
Trend Analysis:
P/BV ratio of GCPL is 6.46 and it is decreasing but for HUL, it is 25.22 and increasing. So, we can say that
GCPL share is under-valued as compared to HUL. This ratio for GPCL is not too low to get tense about returns
from investment
24.
EPS
The earnings per share is a good measure of profitability. It gives a view of the comparative earnings of the
similar firm.
Computation: Earnings per share (EPS) Ratio = (Net profit after interest, tax and Preference dividend) /
of equity shares (common shares)
Interpretation:
Higher the EPS better it is and vice versa. It helps the company in estimating its capacity to pay dividend.
Ratio
EPS
20
18
16
14
12
10
8
6
4
2
0
17.76
11.47
13.44
10.09
8.12
12.45
10.68
6.29
8.05
2008
2009
2010
2011
2012
HUL
8.12
11.47
10.09
10.68
12.45
GCPL
6.56
6.29
8.05
13.44
17.76
6.56
Trend Analysis:
EPS has been increasing for both the companies but GCPL is at a better position since the percentage
increase in EPS and the absolute value of EPS is much better as compared to HUL
No.
25.
Long Term Investing
Long Term Investing refers to the fact that investment is made for a period greater than 1
year. The various factors to be considered are:› Fixed asset turnover ratio
› Return on Equity
› Return on capital employed
› Operating profit margin
Each of these factors has a role to play in the selection of the company for investment.
However, the degrees to which they affect the returns vary in response to the other
factors as well. Hence, for arriving at a decision for the investment, the entire basket
needs to be considered. Following is a brief discussion for each of them.
26.
Fixed-asset Turnover Ratio:
This ratio measures a company's ability to generate net sales from fixed-asset investments - specifically
property, plant and equipment (PP&E) - net of depreciation.
Computation:
Interpretation:
A higher fixed-asset turnover ratio shows that the company has been more effective in using the investment in
fixed assets to generate revenues.
Fixed-asset Turnover Ratio
12
9.8
10
7.81
7.49
Ratio
8
6
4.6
5.35
6.09
4.18
4
4.73
5.63
6.26
HUL
GCPL
2
0
2008
2009
2010
2011
2012
HUL
9.8
7.81
5.35
5.63
6.26
GCPL
4.6
4.18
4.73
6.09
7.49
Trend Analysis:
The ratio is increasing for both the companies but for GCPL, it is increasing at a higher rate as compared to
HUL, also, the absolute value for GCPL is higher than HUL. So, GCPL is more efficient of the two
27.
Return on Equity
The objective of computing this ratio is to find out how efficiently the funds supplied by the suppliers (Equity and
Preference) have been used.
Computation: Return on Equity = Net Income/Shareholder's Equity
Interpretation:
Return on equity measures a corporation's profitability by revealing how much profit a company generates with
the money shareholders have invested. So higher the ROE, better is the performance of the company.
ROE
140.00%
122.91%
121.27%
120.00%
98.47%
Ratio
100.00%
85.25%
87.54%
76.62%
80.00%
60.00%
HUL
30.08%
29.98%
28.36%
23.94%
2008
2009
2010
2011
2012
HUL
122.91%
121.27%
85.25%
87.54%
76.62%
GCPL
98.47%
30.08%
29.98%
28.36%
23.94%
40.00%
GCPL
20.00%
0.00%
Trend Analysis : ROE for both the companies are decreasing but for HUL the absolute value is much higher as
compared to GCPL. Hence, of the two, HUL is a better option.
28.
Return on Capital Employed (ROCE)
It is used to find out how efficiently the total assets have been utilized by the management.
Computation: ROCE = EBIT / (Total asset – current liabilities)
Interpretation:
ROCE indicates firm’s ability of generating profit per rupee of total assets. So higher the ROCE, better is the
performance of the company
ROCE
160
138.72
140
118.59
106.78
Ratio
120
102.47
100
80
93.08
66.03
HUL
60
32.65
40
35.73
28.43
21.42
GCPL
20
0
2008
2009
2010
2011
2012
HUL
138.72
118.59
106.78
102.47
93.08
GCPL
66.03
32.65
35.73
28.43
21.42
Trend Analysis : ROCE has been decreasing for both the companies but the absolute value of ROCE for HUL
is more than 4 times than GCPL, which shows that HUL is performing much better and hence, it is a better
option
29.
Operating Profit Margins
A ratio used to measure a company's pricing strategy and operating efficiency.
Computation: Operating Profit Margin = Operating Income / Net Sales
Interpretation: Operating margin gives analysts an idea of how much a company makes (before interest and
taxes) on each rupee of sales. If a company's margin is increasing, it is earning more per rupee of sales.
Higher the operating profit margin, the better the performance of the company.
Ratio
Operating Profit Margin
0.2
0.18
0.16
0.14
0.12
0.1
0.08
0.06
0.04
0.02
0
0.175
0.136
0.122
0.127
0.128
0.142
0.131
0.12
0.118
0.111
HUL
GCPL
2008
2009
2010
2011
2012
HUL
0.127
0.122
0.136
0.128
0.142
GCPL
0.175
0.118
0.131
0.12
0.111
Trend Analysis : HUL is a better option as its operating margin is high as well as it is increasing from the last
year which is not the case with GCPL
Overall Analysis : After considering all the parameters, we can say that HUL is better for long term investment
since it provides better dividends as compared to GCPL.
30.
Short Term Lending
The analysis of short term will depend on how much returns our investment will give us in the
short run. A bank will thus lend only to the company, which is more efficient in running
business, and will have higher sales in the near future that will ensure that the loan will be repaid
on time.
Thus we must analyze why the company is borrowing money and what will be the application of
funds. We must find out whether the company will apply the funds to pay back loans (principal or
interest) or to raise fixed assets or to increase current assets. For short term lending the primary
concern for any bank are the liquidity ratios of the company(s) concerned. So the parameters that
we will take into consideration are:› Current Ratio
› Debtors Turnover Ratio
› Inventory Turnover Ratio
31.
Current Ratio
A liquidity ratio that measures a company's ability to pay short-term obligations.
Computation:
Interpretation: The higher the current ratio, the more capable the company is of paying its obligations. It
indicates rupees of current assets available for each rupee of current liability. Traditionally , a current ratio of 2:1
is considered to be satisfactory ratio. A ratio under 1 suggests that the company would be unable to pay off its
obligations if they came due at that point. While this shows the company is not in good financial health, it does
not necessarily mean that it will go bankrupt - as there are many ways to access financing - but it is definitely
not a good sign.
Current Ratio
2.5
2.23
2
Ratio
1.46
1.5
1.2
0.95
1
0.5
0
0.88
1.32
1.01
HUL
0.74
0.85
0.86
2008
2009
2010
2011
2012
HUL
0.85
1.32
1.01
0.88
0.86
GCPL
0.95
2.23
1.46
0.74
GCPL
1.2
Trend Analysis : When we compare the ratios for both the companies, HUL has a lower current ratio as
compared to GCPL. The current ratio for HUL is decreasing as well unlike GCPL. This means that GCPL is a
better company in paying off its obligations
32.
Debtors Turnover Ratio
This ratio shows how efficiently the company is making its credit sales and thereby making use of its assets.
Computation: Debtors Turnover ratio = Sales / Average Debtors
Interpretation: A high ratio indicates the company is doing well at lending credit and collecting debts. A low ratio
indicates that company has to look back its credit policies.
Receivable Turnover Ratio
120
100
99.37
81.1
Ratio
80
59.25
60
35.1
40
20
0
41.83
31.41
29.24
30.17
24.28
27.27
HUL
GCPL
2008
2009
2010
2011
2012
HUL
31.41
41.83
29.24
24.28
27.27
GCPL
81.1
99.37
59.25
35.1
30.17
Trend Analysis : In the last 5 years, the ratio has decreased for both the companies but it is decreasing at a
much faster rate for GCPL as compared to HUL. The absolute value of GCPL is, however, marginally more than
HUL. But, according to the trend HUL is doing better at lending credit and collecting debts
33.
Inventory Turnover Ratio
This ratio gives number of times inventory is sold i.e. for it is sales to inventory ratio.
Computation: Inventory turnover ratio= sales/inventory
Interpretation: High value of this ratio indicates that a lot of inventory is either being sold or there is ineffective
buying because of low prices. Low value indicates high inventory which is not good. It shows that sales are not
happening.
Inventory Turnover Ratio
12
9.26
10
Ratio
8
7.2
8.2
9.25
7.93
6
4
9.93
8.99
7.91
7.16
5.7
HUL
GCPL
2
0
2008
2009
2010
2011
2012
HUL
7.2
9.26
8.99
7.91
9.93
GCPL
5.7
9.25
7.93
8.2
7.16
Trend Analysis: Inventory turnover ratio of GCPL is low and decreasing from last year but for HUL, it is
increasing which shows that HUL is more efficient in utilizing inventory
Overall Analysis: HUL is better at Receivable turnover ratio and Inventory turnover ratio signifying that for
providing short term loans, HUL is a better company as compared to GCPL
34.
Long Term Lending
The main purpose of long term lending is:
› Steady return for a long period of time
› Reduce risk
The lender generally looks at four ratios apart from the above analysis:
› Debt equity ratio
› Interest coverage ratio
› Fixed asset turnover ratio
› ROCE
35.
D/E Ratio
It is a measure of a company's financial leverage. It indicates what proportion of equity and debt the company
is using to finance its assets.
Computation: D/E = Total liabilities / Net worth
Interpretation:
While a lower total debt to equity ratio generally reflects conservative financial policies and mean diluted
earnings for equity investors as it probably suggests that the company is not leveraging itself optimally to
achieve growth in return on equity funds.
A high debt/equity ratio generally means that a company has been aggressive in financing its growth with debt.
This can result in volatile earnings as a result of the additional interest expense.
Ratio
D/E Ratio
0.9
0.8
0.7
0.6
0.5
0.4
0.3
0.2
0.1
0
HUL
GCPL
0.83
HUL
0.17
0.1
0.09
0
2008
0
2009
0
0
2010
0
0
0
0
0
0.83
0.1
0
0.17
0.09
0
2011
0
2012
GCPL
36.
Interest Coverage Ratio
A ratio used to determine how easily a company can pay interest on outstanding debt.
Computation:
Interpretation: The lower the ratio, the more the company is burdened by debt expense. When a company's
interest coverage ratio is 1.5 or lower, its ability to meet interest expenses may be questionable. An interest
coverage ratio below 1 indicates the company is not generating sufficient revenues to satisfy interest expenses.
Interest Coverage Ratio
14000
12238.54
12000
Ratio
10000
8000
6000
2796.6
4000
2000
0
92.3
25
2008
119.5
28.87
2009
404.94
226.79
2010
86.33
2011
44.17
2012
HUL
92.3
119.5
404.94
12238.54
2796.6
25
28.87
226.79
86.33
44.17
GCPL
Trend Analysis : Interest coverage ratio of HUL is higher than GCPL and it has increased by almost 3000% and
for GCPL, it has increased by almost 90% which clearly tells that HUL will be in better condition to repay
interest on loans.
37.
Fixed Asset Turnover Ratio
This ratio measures a company's ability to generate net sales from fixed-asset investments - specifically
property, plant and equipment (PP&E) - net of depreciation.
Computation:
Interpretation: A higher fixed-asset turnover ratio shows that the company has been more effective in using the
investment in fixed assets to generate revenues.
Fixed-asset Turnover Ratio
12
9.8
10
7.81
7.49
Ratio
8
6
4.6
5.35
4.18
4
6.09
5.63
6.26
4.73
GCPL
2
0
HUL
2008
2009
2010
2011
2012
HUL
9.8
7.81
5.35
5.63
6.26
GCPL
4.6
4.18
4.73
6.09
7.49
Trend Analysis : From the last 3 years, the ratio is increasing for both the companies but the increase in
percentage of GCPL as well as absolute value is greater as compared to HUL and hence, GCPL is a better
option
38.
Return on Capital Employed
It is a ratio that indicates the efficiency and profitability of a company's capital investments.
Computation: ROCE = EBIT / (Total asset – Current Liabilities)
Interpretation: ROCE measures a corporation's profitability by revealing how much profit a company generates
with respect to the total investment made. So higher the ROCE, better is the performance of the company
ROCE
160
138.72
140
118.59
106.78
Ratio
120
102.47
100
80
93.08
66.03
HUL
60
32.65
35.73
2008
2009
2010
2011
2012
HUL
138.72
118.59
106.78
102.47
93.08
GCPL
66.03
32.65
35.73
28.43
21.42
40
28.43
21.42
GCPL
20
0
Trend Analysis : ROCE has been decreasing for both the companies but the absolute value of ROCE for HUL is
more than 4 times than GCPL, which shows that HUL is performing much better and hence, it is a better option
Overall Analysis : While comparing the two companies, we can see that HUL is better than GCPL for long term
lending on parameters like ROCE, Interest coverage which signify that HUL is doing well in business.
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