Once we are done with the presentation, you will be able to:
Ok now, how cum ratio analysis came into the picture 2) ) i.e they do not provide information regarding changes in d firms financial positions
The aim of analysing the financial statements is to build up a picture of how the company has been performing and how it is likely to perform in future in order to take decisions.
i.e what we called it as Inter firm comparison I.e Trend analysis Next is comparing the performance of a company with the standards performances of industry
Now moving over to the purpose of ratio analysis 1)
A ratio can be expressed in 3 forms
RATIOS are classified as- 1 liquidity- it depicts the ability of the firm to pay its debts 2)Activity ratios depict how easily or efficiently we Increase our turnover 3) profitability- it tells us, how effective the firm is at generating profits 4) Leverage ratios looks at the balance between loans and shares in a business, how v r using our debts for the growth of the firm 5)Market value ratio is used to determine if a company is over or undervalued
Liquidity ratios Aims at finding How solvent the business is? Deals with current assets n current liabilities
---For every 1Re of a firms current obligations, firm has 2Rs ---Current assets normally includes cash , bank balance, marketable securities, accounts receivable and inventories. Current liabilities consist of accounts payable, short term notes payable, short-term loans, current maturities of long term debt, accrued income taxes and other accrued expenses ---More the current ratio, more is the stability of a firm
If we look at the current ratios of both the firms, the liquidity position is better in case of B as compared to A. because a slight decline in value of assets of firm A, will adversely affect the ability of a firm A to meet its obligations.
Quick current assets are those assets that are quickly converted into cash and they are compared with current liabilities. Quick assets are- cash, bank balance, recivables etc
Cash equivalents are short-term investments, such as Treasury bills, that can be quickly converted to cash. i.E it is the money which is left in our hand once we pay the debts
COGS- cost of goods sold (year) Example: a business has $ 2,500 in accounts payable, $ 12,500 in cost of goods sold. Days payable outstanding = (2,500 / 12,500) * 365 = 73 days
We are done with the liquidity ratios, next is activity ratios Under these ratios we will b studying various imp ratios ……
It is also known as debtors collection period -On the other hand, too low “collection period” is not necessarily favorable, rather it may indicate a very restrictive credit and collection policy which may affect profit. Debtors- is the amount of money owed
i.E how quickly we convert our inventories to sales Opening stock is nothing but the finished goods which can be sold as our end product and any stock which remains during the first year becomes the ending stock for 1 st year and opening for the 2 nd year.,
Asset turnover gives the relationship between sales and assets. The firm should manage its assets efficiently to maximise sales.
==Cash turn over indicates a firms efficiency in its use of cash for generation of sales revenue. == accounts recievables turnover measures the efficiency of business in collecting its credit sales ==Fixed assets- furniture, property, house, lands Accounts payable turnover measures the speed with which a company pays its suppliers . If the turnover ratio declines from one period to the next, this indicates that the company is paying its suppliers more slowly, and may be an indicator of worsening financial condition
The working capital turnover ratio measure the efficiency with which the working capital is being used by a firm. A high ratio indicates efficient utilization of working capital and a low ratio indicates otherwise. But a very high working capital turnover ratio may also mean lack of sufficient working capital which is not a good situation.
An operating cycle is very important as it defines how a company uses its cash to produce a product or provide services. It starts and end with cash. It is the time period involves in the conversion of raw material into finished goods including d credit period. == suppose on 1 st jan we purchase raw material, it takes 1month to convert them into finished goods i.e 1 feb,, on 1feb the goods are ready n they r kept in stock fr anothr 1month as thr is no demnd rite now i.e upto 1march,, thn on 1 st march, goods r being sold to customers on credit,, afta a month i.e 1 st april,, v get the money from customers n d revenue we got will b used to buy another raw materials. So operating cycle is of 3months
Leverage is The amount of debt that has been used to finance activities. A company with much more debt than equity is generally called "highly leveraged."
-It measures how well a company can meet its interest expense obligations. -Higher value of times interest earned ratio is favourable i.e greater ability of a business to repay its interest and debts. Lower values are unfavourable. In general, times interest earned ratio of 1.5 or below is unsafe. If TIE = 1 all the income is used to pay debts n interests If TIE= 10 that means one tenth of income is used to service the debts
- It is the ratio of (the sum of current liabilities and long-term liabilities) and (the sum of current assets, fixed assets) -If the ratio is less than 0.5, most of the company's assets are financed through equity. If the ratio is greater than 0.5, most of the company's assets are financed through debt
Profitability is the ability of a business to earn profit over a period of time. Although the profit figure is the starting point for any calculation of cash flow, as already pointed out, profitable companies can still fail for a lack of cash. Note: Without profit, there is no cash and therefore profitability must be seen as a critical success factors. A company should earn profits to survive and grow over a long period of time. Profits are essential, but it would be wrong to assume that every action initiated by management of a company should be aimed at maximising profits, irrespective of social consequences. The ratios examined previously have tendered to measure management efficiency and risk. Profitability is a result of a larger number of policies and decisions. The profitability ratios show the combined effects of liquidity, asset management (activity) and debt management (gearing) on operating results. The overall measure of success of a business is the profitability which results from the effective use of its resources.
Interpretation: Obviously the higher the profit margin a business makes the better. However, the level of gross profit margin made will vary considerably between different markets. For example the amount of gross profit percentage put on clothes, (especially fashion items), is far higher than that put on food items. So any result gained must be looked at in the context of the industry in which the firm operates.
Interpretation: As with gross profit, a higher percentage result is preferred. This is used to establish whether the firm has been efficient in controlling its expenses. It should be compared with previous years’ results and with other companies in the same industry to judge relative efficiency. The net profit margin should also be compared with the gross profit margin. For if the gross profit margin has improved but the net profit margin declined, this shows that profits made on trading are becoming better, however the expenses incurred in the running of the business are also increasing but at a faster rate than profits. Thus efficiency is declining.
Income is earned by using the assets of a business productively. The more efficient the production, the more profitable the business. The rate of return on total assets indicates the degree of efficiency with which management has used the assets of the enterprise during an accounting period. This is an important ratio for all readers of financial statements. Investors have placed funds with the managers of the business. The managers used the funds to purchase assets which will be used to generate returns. If the return is not better than the investors can achieve elsewhere, they will instruct the managers to sell the assets and they will invest elsewhere. The managers lose their jobs and the business liquidates.
et income is for the full fiscal year (before dividends paid to common stock holders but after dividends to preferred stock.) Shareholder's equity does not include preferred shares.
Whatever income remains in the business after all prior claims, other than owners claims (i.e. ordinary dividends) have been paid, will belong to the ordinary shareholders who can then make a decision as to how much of this income they wish to remove from the business in the form of a dividend, and how much they wish to retain in the business. The shareholders are particularly interested in knowing how much has been earned during the financial year on each of the shares held by them.
Now we come to another head of the kinds of ratios. That is Market Value Ratios These ratios indicate the relationship of the firm’s share price to dividends and earnings. Note that when we refer to the share price, we are talking about the Market value and not the Nominal value as indicated by the par value. For this reason, it is difficult to perform these ratios on unlisted companies as the market price for their shares is not freely available. One would first have to value the shares of the business before calculating the ratios. Market value ratios are strong indicators of what investors think of the firm’s past performance and future prospects.
The dividend yield ratio indicates the return that investors are obtaining on their investment in the form of dividends. This yield is usually fairly low as the investors are also receiving capital growth on their investment in the form of an increased share price. It is interesting to note that there is strong correlation between dividend yields and market prices. Invariably, the higher the dividend, the higher the market value of the share.
P/E ratio is a useful indicator of what premium or discount investors are prepared to pay or receive for the investment. The higher the price in relation to earnings, the higher the P/E ratio which indicates the higher the premium an investor is prepared to pay for the share. This occurs because the investor is extremely confident of the potential growth and earnings of the share High P/E generally reflects lower risk and/or higher growth prospects for earnings
CONTENTS How does Ratio Analysis came into picture? What is Ratio Analysis? Significance of Ratio Analysis Purpose of Ratio Analysis Precautions to be taken while using ratio analysis Types of Ratios Case study
Learning Outcomes Understand the contextual environment in whichwe apply financial ratios Explain the calculation and application of ratiosin the areas of profitability, efficiencies, liquidity,etc. and apply them to a set of financialstatements Calculate different ratios from supplied companydetails and interpret these ratios Explain the different classifications of financialratios Explore the results of ratio analysis in terms ofwhat it tell us about the organisation
NEED FOR A CHANGE.. Traditional financial statements( balance sheet,profit and loss accounts) do not give all theinformation related to the firm It ignores the significance of financial operationsthat the firm has undertaken in the entire year. Understanding Financial statements is acomplex task for a lay man(non commerce), thisgave rise to ratio analysis.
WHAT IS RATIO ANALYSIS ?? Ratio-analysis means the process of computing,determining and presenting the relationship ofrelated items and groups of items of the financialstatements. It is the systematic use of ratios to interpret theperformance and status of the firm. They provide information in a summarized andconcise form.
SIGNIFICANCE OF RATIOANALYSISThe significance of a ratio can only truly be appreciatedwhen: It is compared with other ratios in the same set offinancial statements of the competitors. It is compared with the same ratio in previousfinancial statements. It is compared with a standard of performance(industry average). Such a standard may be either theratio which represents the typical performance of thetrade or industry, or the ratio which represents thetarget set by management as desirable for thebusiness.
PURPOSE OF RATIOANALYSIS-It’s a tool which enables the banker or lender toarrive at the following factors i.e : Liquidity position Profitability Solvency Financial Stability Quality of the Management Safety & Security of the loans.
Before looking at the ratios there are a number ofcautionary points concerning their use that need tobe identified :a. The dates and duration of the financial statements beingcompared should be the same. If not, then wrongconclusions will be drawn.b. The accounts to be compared should have been prepared onthe same bases. Different treatment of stocks ordepreciations or asset valuations will distort the results.c. In order to judge the overall performance of the firm, agroup of ratios, as opposed to just one or two should beused. In order to identify trends at least three years ofratios are normally required.
HOW A RATIO IS EXPRESSED? As Percentage - such as 25% or 50% . Forexample if net profit is Rs.25,000/- and the salesis Rs.1,00,000/- then the net profit can be said tobe 25% of the sales. As Proportion - The above figures may beexpressed in terms of the relationship betweennet profit to sales as 1 : 4. As Pure Number /Times - The same can alsobe expressed in an alternatively way such as thesale is 4 times of the net profit or profit is 1/4thofthe sales.
A: LIQUIDITY RATIOS The main concern of liquidity ratio is tomeasures the ability of a firm to meet their short-term obligations. Failure to do this will result in the total failure ofthe business. These ratios are concerned with the examinationof the financial stability of the organization.
1: CURRENT RATIOS It expresses the relationship between currentassets and current liabilities The concept behind this ratio is to find outwhether a companys short-term assets arereadily available to pay off its short-termliabilities or not. Current Ratio = Current Assets/CurrentLiabilities The ideal Current Ratio is 2 : 1
COMPARISON AMONG TWO FIRMSParticulars Firm A Firm BCurrent assetsCurrent liabilities1,80,0001,20,00030,00010,000Current Ratio = 3 : 2 = 3 : 1
2:QUICK RATIO OR ACID TEST It is the ratio between Quick Current Assets and CurrentLiabilities. Acid Test or Quick Ratio = Quick CurrentAssets/Current Liabilities Example : Cash 50 Debtors 100 Inventories 200 Current Liabilities 100 Total Current Assets 350 Current Ratio = > 350/100 = 3.5 : 1 Quick Ratio = > 150/100 = 1.5 : 1
3:CASH RATIOS The cash ratio is an indicator of a companysliquidity by measuring the amount of cash, cashequivalents or invested funds there in thecurrent assets to cover current liabilities. Cash ratio = cash + cash equivalentscurrent liabilities4: NET WORKING CAPITAL It indicates the amount of money in hand to meetcurrent obligations. Net Working Capital = Current Assets – CurrentLiabilities
5: DAYS PAYABLE OUTSTANDINGIt indicates the number of days to settle all payables.Days payable outstanding is an efficiency ratio thatmeasures the average number of days a companytakes to pay its suppliers Days Payable outstanding =Average Accounts Payable * 365COGSAverage Accounts Payable is the average of the openingand closing balances of Accounts Payable.
B: ACTIVITY RATIOS If a business does not use its assets effectively,investors in the business would rather take theirmoney and place it somewhere else. It is also known as Asset Management process. Activity ratios are used to assess how activevarious assets are in the business.
1: AVERAGE COLLECTION PERIOD The average collection period measures the quality ofdebtors since it indicates the speed of their collection. The shorter the average collection period, the betterwill be the quality of debtors, as a short collectionperiod implies the quick payment by the debtors. An excessively long collection period implies a veryliberal and inefficient credit and collectionperformance. Debtor collection period= debtors x 365credit sales
2: INVENTORY TURNOVER It determines how often the stock turns over inthe business. It indicates the efficiency of the firm in selling itsproduct. This ratio measures the number of times in oneyear that a business turns over its stock of goodsfor sale. Stock Turnover= average stock x 365 (days)cost of goods soldAverage Inventory = (Opening Stock + Closing Stock)2
3: TOTAL ASSETS TURNOVER It indicates the efficiency with which the firmuses all its assets to generate sales. Asset turnover = salesnet assets
Cash turnover = sales / cash and cash equivalents Accounts Receivable ratio= Annual Sales / averageAccounts Receivable Current Asset Turnover Ratio = Annual Sales /Current Assets Fixed Assets Turnover ratio = Sales / Net FixedAssets Accounts Payable ratio= Annual Sales / AccountsPayable
Working capital turnover = sales / workingcapital Days in Inventory = Average inventory / cost ofsales per day Days in Accounts Receivable = AccountsReceivable / sales per day Days in Accounts Payable = Accounts Payable /sales per day Operating cycle = Days in Inventory + Days inAccounts Receivables.
C: LEVERAGE RATIOS A financial leverage ratio is the comparison betweendebts and assets. This means that the values beingcompared here are the size of debts and whatevermeasurement of assets value is available. Technically , these ratios speak volumes about acompany’s reliance on loans and other sources ofborrowed money. The leverage ratio is used to calculate the financialleverage of a company.
1:DEBT TO EQUITY RATIO The debt-to-equity ratio is a financial ratio indicatingthe relative proportion of equity and debt used to financethe assets. It is the key of financial ratios and is used as a standardfor judging a companys financial standing. Debt to Equity Ratio = Total debt/ total equity2: TIMES INTEREST EARNED RATIOIt is used to measure the long term viability of a business topay off its debts.Times Interest Earned = Earnings before Interest & TaxNet Interest Expense
3: GEARING The most common use of the term gearing is to describethe level of a companys net debts compared with itsequity capital. It is expressed as a percentage. In simpler terms, gearing explains how a companyfinances its operations - either through outside lenders orthrough shareholders. Gearing =Long-term debt + Short-term debt + Bank overdraftsShareholders equity4: DEBT RATIOSDebt Ratio is a financial ratio that indicates thepercentage of a companys assets that are providedvia debt.Debt ratio= Total debts/ total assets
D:PROFITABILITY RATIOSGross profit MarginNet Profit MarginReturn On InvestmentReturn On EquityEarning Per Share
1:GROSS PROFIT MARGINThis ratio examines the relationship between theprofits made on trading activities only (grossprofit) against the level of turnover/sales made.It is given by the formulaGross Profit Margin = gross profit x 100turnover (sales)
2:NET PROFIT MARGINAs opposed to gross profit margin this ratiomeasures the relationship between the net profit(profit made after all other expenses have beendeducted) and the level of turnover or sales madeNet Profit Margin = net profit x 100turnover (sales)
3:RETURN ON INVESTMENTA performance measure used to evaluate theefficiency of an investment or to compare theefficiency of a number of different investments.To calculate ROI, the benefit (return) of aninvestment is divided by the cost of theinvestment; the result is expressed as apercentage or a ratioROI = After tax earnings/ total assets
4:RETURN ON EQUITYThe amount of net income returned as apercentage of shareholders equity. Return onequity measures a corporations profitability byrevealing how much profit a companygenerates with the money shareholders haveinvested. ROE = After tax Earnings/ Stockholder’s equity
5:EARNING PER SHAREThe portion of a companys profit allocated to eachoutstanding share of common stock. Earnings pershare serves as an indicator of a companysprofitability.EPS = Net income after tax- pref. dividend / no.of issued equity shares
E:MARKET VALUE RATIODividend Yield RatioPrice Earning Ratio
1:DIVIDEND YIELD RATIOA financial ratio that shows how much a companypays out in dividends each year relative to itsshare price. In the absence of any capital gains,the dividend yield is the return on investment fora stock.Dividend yield = Dividend per share / share priceDividend per share = total dividend / no. ofshares outstanding
2:PRICE EARNING RATIO A valuation ratio of a companys current shareprice compared to its per-share earnings.P/E ratio = Market price per share/ currentearnings per shareFor example: a company is currently trading atRs.43 a share and earnings over the last 12months were Rs.1.95 per share, the P/E ratio forthe stock would be 22.05
~~CASE STUDY~~RATIO ANALYSIS FOR JETAIRWAYS Jet Airways was incorporated on April 1, 1992 as aprivate company with limited liability under theCompanies Act. In 2005, Jet Airways Limited has filed its draft RedHerring Prospectus with the Securities and ExchangeBoard of India (Sebi) to enter the capital market withits initial public offering. The company will offer17,266,801 (1.72 crore shares) equity shares of Rs 10each for cash at a price to be decided through thebook-building process. It is learnt that the value ofeach share will be Rs 870. The IPO proceeds willessentially be used to fund its international expansionplans. Jet Airways IPO was subscribed 4.25 times on thefirst day of the offer.
MANAGEMENTDesignation NamesChairman / Chair Person Naresh GoyalDirector Ali GhandourDirector Javed AkhtarDirector Aman MehtaDirector Victoriano P DungcaDirector I M KadriDirector Yash Raj Chopra