Ratio analysis project on ONGC of year 2010-11 & 2011-12


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Title: ratio analysis for period 2010-11 & 2011-12 : case study of ONGC SCOPE:
a) Ratio Analysis: concept, definition, Objectives, merits and demerits;
b) Calculation of solvency ratios: short term & long term;
c) Analysis of last two year 2010-11 & 2011-12;
d) Conclusion.
( included bibliography, literature review , and ONGC balance sheet )

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Ratio analysis project on ONGC of year 2010-11 & 2011-12

  1. 1. Ratio Analysis 1.1 Definition of 'Ratio Analysis' A tool used by individuals to conduct a quantitative analysis of information in a company's financial statements. Ratios are calculated from current year numbers and are then compared to previous years, other companies, the industry, or even the economy to judge the performance of the company. Ratio analysis is predominately used by proponents of fundamental analysis. There are many ratios that can be calculated from the financial statements pertaining to a company's performance, activity, financing and liquidity. Some common ratios include the priceearnings ratio, debt-equity ratio, earnings per share, asset turnover and working capital. 1
  2. 2. 1.2 Objectives of Ratio Analysis The main objective of ratio analysis is to show a firm’s relative strengths and weaknesses. Other objectives of ratio analysis include comparisons for a useful interpretation of financial statements, finding solutions to unfavorable financial statements and to help take corrective measures when, in comparison to other similar firms, financial conditions and performance of the firm are unfavorable. Ratio analysis also determines the financial condition and financial performance of a firm. Financial ratios are true test of the profitability, efficiency and financial soundness of the firm. These ratios have following objectives: Measuring the profitability: Profitability is the profit earning capacity of the business. This can be measured by Gross Profit, Net Profit, Expenses and Other Ratios. If these ratios fall we can take corrective measures. Determining operational efficiency: Operational efficiency of the business can be determined by calculating operating / activity ratios. Measuring financial position: Short-term and long-term financial position of the business can be measured by calculating liquidity and solvency ratios. In case of unhealthy short or long-term position, corrective measures can be taken. 2
  3. 3. Facilitating comparative analysis: Present performance can be compared with past performance to discover the plus and minus points. Comparison with the performance of other competitive firms can also be made. Indicating overall efficiency: Profit and Loss Account shows the amount of net profit and Balance Sheet shows the amount of various assets, liabilities and capital. But the profitability can be known by calculating the financial ratios. Budgeting and forecasting: Ratio analysis is of much help in financial forecasting and planning. Ratios calculated for a number of years work as a guide for the future. Meaningful conclusions can be drawn for future from these ratios. 3
  4. 4. 1.3 Merits of ratio analysis Simplifies financial statements: Ratio analysis simplifies the comprehension of financial statements. Ratios tell the whole story of changes in the financial condition of the business. Facilitates inter-firm comparison: Ratio analysis provides data for inter-firm comparison. Ratios highlight the factor associated with successful and unsuccessful firms. They also reveal strong firms and weak firms, overvalued and undervalued firms. Makes intra-firm comparison possible: Ratio analysis also makes possible comparison of the performance of the different divisions of the firm. The ratios are helpful in deciding about their efficiency or otherwise in the past and likely performance in the future. Helps in planning: Ratio analysis helps in planning and forecasting. Over a period of time a firm or industry develops certain norms that may indicate future success or failure. If the relationship changes in firm’s data over different time periods, the ratios may provide clues on trends and future problems. 4
  5. 5. 1.4 Demerits of ratio analysis Accounting ratios are subject to certain limitations. They are: Comparative study required: Ratios are useful in judging the efficiency of business only when they are compared with the past results of the business or with the result of a similar business. Such comparison only provides a glimpse of the past performance and forecasts for future may not prove correct since several other factors like market conditions etc may affect the future operations. Limitations of financial statements: Ratios are based only on the information which has been recorded in the financial statements. For example: non-financial changes though important for the business are not revealed by the financial statements. Of the management of the company changes, it may have ultimately adverse effects on the future profitability of the company but this cannot be judged by having a glance at the financial statements of the company. Ratios alone are not adequate: Ratios are only indicators; they cannot be taken as final regarding good or bad financial position of the business. “Ratios must be used for what they are financial tools.” Too often they are looked upon as ends in themselves rather than as a means to an end. The value of a ratio should not be regarded as good or bad inter se. Window dressing: The term window dressing means manipulation of accounts in a way so as to conceal vital facts and present the financial statements in a way to show a better position 5
  6. 6. than what it actually is. On account of such a situation, presence of particular ratio may not a definite indicator of good or bad management. Problems of price level changes: Financial analysis based on accounting ratios will give misleading results if the effects of changes in price level are not taken into account. The financial statements of the companies should, therefore, be adjusted keeping in view the price level changes if a meaningful comparison is to be made through accounting ratio. No fixed standards: No fixed standards can be laid down for ideal ratios. For example: current ratios are considered to be ideal if the current assets are twice the current liabilities. It is necessary to avoid many rules of thumb. Financial analysis is an individual matter and value for a ratio which is perfectly acceptable for one company or one industry may not be at all acceptable in case of another. Ratios are composite of many figures: Ratios are a composite of many different figures. Some cover a time period, other are at an instant of time while still others are only averages. It has been said that “a man who has his head in the oven and his feet in the icebox is on the average, comfortable”! 6
  7. 7. 2.1 Short-term Solvency or Liquidity Ratios Short-term Solvency Ratios attempt to measure the ability of a firm to meet its short-term financial obligations. In other words, these ratios seek to determine the ability of a firm to avoid financial distress in the short-run. The two most important Short-term Solvency Ratios are following (a) Current Ratio (b) Quick ratio or acid ratio 2.1 (a) Current Ratio The Current Ratio is calculated by dividing Current Assets by Current Liabilities. Current Assets are the assets that the firm expects to convert into cash in the coming year and Current Liabilities represent the liabilities which have to be paid in cash in the coming year. The appropriate value for this ratio depends on the characteristics of the firm's industry and the composition of its Current Assets. However, at a minimum, the Current Ratio should be greater than one. Current ratio is used extensively in the financial reporting of the companies. Although the current ratio provide us with the glimpse of the financial strength of a company but this is always not the case. In some cases the current ratio analysis of two different companies can be misleading so investors must be careful while evaluating a particular company on the bases of its current ratio. 7
  8. 8. The ratio is mainly used to give an idea of the company's ability to pay back its short-term liabilities (debt and payables) with its short-term assets (cash, inventory, receivables). The higher the current ratio, the more capable the company is of paying its obligations. 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 Current ratio = current assets/ current liabilities Table No 2.1- table showing Current assets (Rs. in Cr) Particular 2011-12 2010-11 Inventories 5165.44 4118.98 Debtors 6194.82 3845.90 Cash/bank bal. 20124.57 356.55 Loans/adv. 30907.72 64693.91 Fixed deposited 0 22090 Total current assets 62392.55 95105.34 8
  9. 9. Table No 2.2- table showing Current liabilities: (Rs in Cr) Particulars 2011-12 2010-11 Total current liabilities 54270.87 70159.50 Table No 2.3- table showing Current ratio: (Rs in Cr) Particular 2011-12 2010-11 Current assets 62392.55 95105.34 Current liabilities 117456.73 115,068.69 Current ratio 0.86 0.87 9
  10. 10. current ratio 0.872 0.87 0.868 0.866 0.864 current ratio 0.862 0.86 0.858 0.856 0.854 2011-12 2010-11 Figure No 2.1 – figure showing current ratio of 2010-11 and 2011-12 INTERPRETATION- This calculation implies that the fluctuation in current ratio. As compared to previous year the current year’s ratio shows poor liquidity position. In 2010-11 the ratio is 0.87:1 and in 2011-12 the ratio is 0.86:1 which shows decrease in liquidity. 10
  11. 11. 2.1 (b) Quick Ratio The Quick Ratio recognizes that, for many firms, Inventories can be rather illiquid. If these Inventories had to be sold off in a hurry to meet an obligation the firm might have difficulty in finding a buyer and the inventory items would likely have to be sold at a substantial discount from their fair market value. This ratio attempts to measure the ability of the firm to meet its obligations relying solely on its more liquid Current Asset accounts such as Cash and Accounts Receivable. This ratio is calculated by dividing Current Assets less Inventories by Current Liabilities. The reason behind that is emergency requirement cash and business cannot get it from debtors, so quick assets include cash balance + investment certificate that can be immediately transferable into cash. The satisfactory ratio is 1:1 but lower limit is 0.5:1. Here quick assets do not include stock. Quick ratio = quick assets (current assets-inventories) / current liabilities 11
  12. 12. Table No 2.4- table showing Quick assets: (Rs. In Cr) Particular 2011-12 2010-11 Total current assets 62392.55 95105.34 inventories 5165.44 4118.98 Quick assets 57227.11 90986.36 Table No 2.5- table showing Quick liabilities: (Rs. In Cr) Particulars 2011-12 2010-11 Total quick liabilities 54270.87 70159.50 Table No 2.6- table showing Quick ratio: (Rs. In Cr) Particulars 2011-12 2010-11 Quick assets 57227.11 90986.36 Quick liabilities 54270.87 70159.50 Quick ratio 1.05 1.30 12
  13. 13. quick ratio 1.4 1.2 1 0.8 quick ratio 0.6 0.4 0.2 0 2011-12 2010-2011 Figure No 2.2 – figure showing quick ratio of 2010-11 and 2011-12 INTERPRETATION- So, as per the current year ratio of the company is up to some extent satisfactory. This ratio shows the repay ability of the company which is satisfactory as per lower level all over the year. As compared to previous year in current year it is not good. I 2010-11 it is 1.30:1 and in current year it is 1.05:1. 13
  14. 14. 2.2 LONG TERM SOLVENCY RATIO The long-term financial soundness of any business can be judged by its long-term creditors by testing its ability to pay interest charges regularly and its ability to repay the principal as per schedule. Thus long-term financial soundness (or solvency) of any business is examined by calculating ratios popularly, known as leverage of capital structure ratios. These ratios help us the interpreting repays long-term debt as per installments stipulated in the contract. Following are the most important solvency ratios: 2.2 (a) Debt-equity ratio: The debt-to-equity ratio (D/E) is a financial ratio indicating the relative proportion of shareholders' equity and debt used to finance a company's assets. Closely related to leveraging, the ratio is also known as Risk, Gearing or Leverage. In a general sense, the ratio is simply debt divided by equity. However, what is classified as debt can differ depending on the interpretation used. Thus, the ratio can take on a number of forms including: Lower values of debt-to-equity ratio are favorable indicating less risk. Higher debt-to-equity ratio is unfavorable because it means that the business relies more on external lenders thus it is at higher risk, especially at higher interest rates. A debt-to-equity ratio of 1.00 means that half of the assets of a business are financed by debts and half by shareholders' equity. A value higher than 1.00 means that more assets are financed by debt that those financed by money of shareholders' and vice versa. An 14
  15. 15. increasing trend in of debt-to-equity ratio is also alarming because it means that the percentage of assets of a business which are financed by the debts is increasing. Total Liabilities Debt-to-Equity Ratio = Shareholders' Equity Table No. 2.7 – table showing Long-term Debt (Rs. In Cr) Particulars 2011-12 2010-11 Secured loans 4500 - Unsecured loans - 17564.26 total 4500 17564.26 Table No. 2.8 – table showing Shareholder’s fund: (Rs. In Cr) particulars 2011-12 2010-11 Share capital 4277.76 4277.76 Reserves and surplus 108678.97 93226.67 Total 112956.73 97504.43 15
  16. 16. Table No. 2.9 – table showing Debt-Equity ratio (Rs. In Cr) Particulars 2012-11 2010-11 Total long-term Debt 4500 17564.26 Total shareholder’s fund 112956.73 97504.43 Debt-equity ratio 0. 4 0.18 debt-equit ratio 0.4 0.35 0.3 0.25 0.2 debt-equit ratio 0.15 0.1 0.05 0 2011-12 2010-11 Figure No 2.3 – figure showing debt-equity ratio of 2010-11 and 2011-12 16
  17. 17. INTERPRETATION- The ONGC has debt equity ratio indicate, numerator is an equity part while denominator is a debt part. So, we can easily say that equity part is more than debt part. 17
  18. 18. 2.2 (b) Debts to Total Funds or Solvency Ratio: Solvency is the term which is used to describe the financial position of any business which is capable to meet outside obligations in full out of its own assets. So this ratio establishes relationship between total liabilities and total assets. Current liabilities are generally excluded from the computation of leverage ratios. One may like to include them on the ground that they are important determinants of the firm’s financial risk since they represent obligations and expert pressure on the firm and restrict its activities. Formula: Debts to Total Funds or Solvency Ratio = Total liabilities / Total assets Table No. 2.10 – table showing Total liabilities: (Rs. In Cr) Particulars 2011-12 2010-11 Current liabilities 54270.87 70159.50 Secured loans 4500 - Unsecured loans - 17564.26 Total 58770.87 87723.76 18
  19. 19. Table No. 2.11– table showing Total assets: (Rs. In Cr) Particulars 2011-12 2010-11 Fixed assets 68056.97 18639.55 Current assets 62,392.55 95105.34 Total 130449.52 113744.89 Table No. 2.12 – table showing Debt to total fund ratio: (Rs in Cr) Particulars 2011-12 2010-11 Total liabilities 58770.87 87723.76 Total assets 130449.52 113744.89 Debt to total fund ratio 0.450 0.771 19
  20. 20. debt to total fund ratio 0.8 0.7 0.6 0.5 0.4 debt to total fund ratio 0.3 0.2 0.1 0 2011-12 2010-11 Figure No 2.4 – figure showing debt to total fund ratio of 2010-11 and 2011-12 INTERPRETATION- In the analysis the ratio is continuously increasing and decreasing by year to year. But in 2012 the debt total fund ratio is decreasing than previous year. The reason of fall is Total assets are less than total liabilities. 20
  21. 21. 2.2 (c) Proprietary Ratio: Proprietary ratio (also known as Equity Ratio or Net worth to total assets or shareholder equity to total equity).Establishes relationship between proprietor's funds to total resources of the unit. Where proprietor's funds refer to Equity share capital and Reserves, surpluses and Tot resources refer to total assets. This ratio relates the shareholder's funds to total assets. Proprietary / Equity ratio indicates the long-term or future solvency position of the business. Following formula is used to calculate proprietary ratio: Proprietary ratio = Proprietor's funds / Total assets Or Proprietary or Equity Ratio = Shareholders funds / Total Assets Components: Shareholder's funds include equity share capital plus all reserves and surpluses items. Total assets include all assets, including Goodwill. Some authors exclude goodwill from total assets. In that case the total shareholder's funds are to be divided by total tangible assets. As the total assets are always equal to total liabilities. The total liabilities may also be used as the denominator in the above formula. This ratio throws light on the general financial strength of the company. It is also regarded as a test of the soundness of the capital structure. Higher the ratio or the share of 21
  22. 22. shareholders in the total capital of the company better is the long-term solvency position of the company. A low proprietary ratio will include greater risk to the creditors. Table No. 2.13 – table showing Shareholder’s fund (Rs. In Cr) particulars 2011-12 2010-11 Share capital 4277.76 4277.76 Reserves and surplus 108678.97 93226.67 Total 112956.73 97504.43 Table No. 2.14 – table showing Total assets: (Rs. In Cr) Particulars 2011-12 2010-11 Fixed assets 68056.97 18639.55 Current assets 62,392.55 95105.34 Total 130449.52 113744.89 22
  23. 23. Table No. 2.15 – table showing Proprietary Ratio (Rs in Cr) Particular 2011-12 2010-11 Shareholder’s fund 112956.73 97504.43 Total assets 130449.52 113744.89 Proprietary Ratio 0.86 0.857 proprietary ratio 0.8605 0.86 0.8595 0.859 0.8585 0.858 0.8575 0.857 0.8565 0.856 0.8555 proprietary ratio 2011-12 2010-11 Figure No 2.5 – figure showing proprietary ratio of 2010-11 and 2011-12 23
  24. 24. INTERPRETATION- Higher the ratio or the share of shareholders in the total capital of the company better is the longterm solvency position of the company. In 2010-11 the ratio was 0.857:1 but it improves in 2011-12 to 0.86. 24
  25. 25. 2.2 (d) Return on Capital Employed (ROCE) A financial ratio that measures a company's profitability and the efficiency with which its capital is employed. Return on capital employed (ROCE) is calculated as ROCE = Earnings Before Income and Tax (EBIT) / Capital Employed “Capital Employed” as shown in the denominator is the sum of shareholders' equity and debt liabilities; it can be simplified as (Total Assets – Current Liabilities). Instead of using capital employed at an arbitrary point in time, analysts and investors often calculate ROCE based on “Average Capital Employed,” which takes the average of opening and closing capital employed for the time period. A higher ROCE indicates more efficient use of capital. ROCE should be higher than the company’s capital cost; otherwise it indicates that the company is not employing its capital effectively and is not generating shareholder value. ROCE is especially useful when comparing the performance of companies in capital-intensive sectors such as utilities and telecoms. This ratio indicates the efficiency with which management has effectively utilized funds or capital employed. Higher the rate of return on capital employed, greater will be the efficiency. ROCE is a useful measurement for comparing the relative profitability of companies. But ROCE is also an efficiency measure of sorts; it doesn't just gauge profitability as profit margin ratios do. ROCE measures profitability after factoring in the amount of capital used. To understand the significance of factoring in employed capital, let's look at an example. Say Company A makes a profit of $100 on sales of $1,000, and Company B make $150 on $1,000 of sales. In terms of 25
  26. 26. pure profitability, B, having a 15% profit margin and is far ahead of A, which has a 10% margin. Let's say A employs $500 of capital, however, and B employs $1,000. Company A has an ROCE of 20% [100/500] while B has an ROCE of only 15% [150/1,000]. The ROCE measurements show us that Company A makes better use of its capital. Like all performance metrics, ROCE has its difficulties, but it is a powerful tool that deserves attention. Think of it as a tool for spotting companies that can squeeze a high a return out of the capital they put into their businesses. ROCE is especially important for capital-intensive companies. Top performers are the firms that deliver above-average returns over a period of several years and ROCE can help you to spot them. Table No. 2.16 – table showing return on capital employed Ratio (Rs. In Cr) Particular 2011-12 2010-11 EBIT 9829271514 5785632572 Capital employed 303447217866 27307035284 Return on capital employed 32.39 21.19 26
  27. 27. return on capital employed 35 30 25 20 return on capital employed 15 10 5 0 2011-12 2010-11 Figure No 2.6 – figure showing return on capital employed ratio of 2010-11 and 2011-12 INTERPRETATION- From the table we can see that there is increase in 2011-12 and Higher the rate of return on capital employed, greater will be the efficiency. 27
  28. 28. 2.2 (e) Earnings per share (EPS) The term earnings per share (EPS) represents the portion of a company's earnings, net of taxes and preferred stock dividends, that is allocated to each share of common stock. The figure can be calculated simply by dividing net income earned in a given reporting period (usually quarterly or annually) by the total number of shares outstanding during the same term. Because the number of shares outstanding can fluctuate, a weighted average is typically used. Financial analyst regards the earning per share as an important measure of profitability. EPS measures the profit available to the equity shareholders on a per share basis that is the amount that they can get on every share held. It is computed by dividing the PAT to the No. of equity share. Earnings per share=profit after tax / no. of equity share Table No. 2.17 – table showing Earnings per share ratio (Rs. In Cr) Particulars 2011-12 2010-11 PAT 18924 16767.56 equity share 4277.76 2123.89 Earnings per share 4.42 7.83 28
  29. 29. Earnings per share 8 7 6 5 4 Earnings per share 3 2 1 0 2011-12 2010-11 Figure No 2.7 – figure showing Earnings per share ratio of 2010-11 and 2011-12 INTERPRETATION- If we see the table of Earnings per share, we can easily identify that ratio is decreased from 7.83 (2010-2011) to 4.42 (2011-12), which shows less returns from previous year. 29
  30. 30. 2.2 (f) Net profit ratio Net profit ratio (NP ratio) is a popular profitability ratio that shows relationship between net profit after tax and net sales. It is computed by dividing the net profit (after tax) by net sales. For the purpose of this ratio, net profit is equal to gross profit minus operating expenses and income tax. All non-operating revenues and expenses are not taken into account because the purpose of this ratio is to evaluate the profitability of the business from its primary operations. Examples of non-operating revenues include interest on investments and income from sale of fixed assets. Examples of nonoperating expenses include interest on loan and loss on sale of assets. The relationship between net profit and net sales may also be expressed in percentage form. When it is shown in percentage form, it is known as net profit margin. The formula of net profit margin is written as follows: Net profit ratio = (PAT/sales) X 100 Table No. 2.18 – table showing net profit ratio (Rs. In Cr) particulars 2011-12 2010-2011 N.P. 18924 16767.56 Sales 66164.34 60251.77 Net profit ratio 28.60 27.83 30
  31. 31. NET PROFIT RATIO 28.6 28.4 28.2 NET PROFIT RATIO 28 27.8 27.6 27.4 2011-12 2010-11 Figure No 2.8 – figure showing Earnings per share ratio of 2010-11 and 2011-12 INTERPRETATION- Net profit ratio shows the relationship of PAT with the sales. This ratio is in 2010-11, it is 27.83% and in 2011-2012, it is 28.60%. Because of tax charges is increasing year by year. 31
  32. 32. 3 Conclusion It was a great experience to analysis ratios of ONGC ltd because I learned lot of new things regarding my studies. I also got useful insights regarding financial analysis of this organization and about their proceeding and also its general background. I also got useful information about how the theory part of business management is actually practiced. After studying the details of ONGC ltd I reached at conclusion that ONGC has achieved its entire desire goal with its hard work and unique idea. The preponderance of current liabilities over current assets has escalated the net working capital requirement of ONGC. Thus the company’s short term solvency has got poorer than previous year, but return on capital employed, net profit ratio, Proprietary Ratio show great signs of progress of company and its efficiency is increased. 32