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# Ratio analysis

## on Feb 24, 2014

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## Ratio analysisPresentation Transcript

• FINANCIAL RATIO ANALYSIS: A ratio is an arithmetical relationship between two figures. Financial ratio analysis is a study of ratios between various items or groups of items in financial statements. Ratios can be classified according to statements mainly they are profit and loss ratios or income statement ratios, balance sheet ratios or position statement ratios, mixed ratio or inter statement ratios
• INTERPRETATION OF THE RATIOS • • • • • Single Absolute Ratio. Group of Ratio. Historical Comparison. Projected Ratios. Inter-firm Comparison
• GUIDELINES FOR USE OF RATIOS • • • • • Accuracy of Financial Statements Objective or Purpose of Analysis Selection of Ratios Use of Standards Caliber of the Analyst
• SIGNIFICANCE OF RATIO ANALYSIS •Managerial Uses of Ratio analysis •Helps in decision-making •Helps in financial forecasting and planning. •Helps in communicating. •Helps in co-ordination. •Helps in controlling. •Useful to Shareholders/Investors •Useful to Creditors •Useful to Employees. •Useful to Government
• LIMITATIONS OF RATIO ANALYSIS • Limited Use of a Single Ratio. • Lack of Adequate Standards. • Inherent Limitations of Accounting. • • Change of Accounting Procedure. Window Dressing
• BALANCE SHEET RATIO It deals with the relationship between two balance sheet items: these can be mainly classified as liquidity ratio, long term solvency or leverage ratio.
• LIQUIDITY RATIO These ratios are calculated to comment upon the short term paying capacity of a firm or concerns ability to meet its current obligation. The important liquidity ratios are current ratio ,quick ratio & absolute liquid ratio
• CURRENT RATIO It is a measure of general liquidity and is used to make the analysis of a short-term financial position or liquidity of an organization Current Ratio = Current Assets/Current Liabilities Rules of thumb=2:1
• EXAMPLE Find out Current ratio Stock -60000 Debtors-70000 Cash -20000 Bills receivable-30000 Prepaid expences-10000 Land and building-100000 Goodwill-50000 Creditors-20000 Bills payable-15000 Tax payable-18000 Outstanding expenses-7000 Bank overdraft-25000 Debenture-75000
• SOLUTION Current Ratio= Current Assets/Current Liabilities CA=60000+70000+20000+30000+10000=190000 CL=20000+15000+18000+7000+25000=85000 CR=190000/85000=2.24 The CR of 2.24 means that current assets are 2.24 times of current Liabilities
• QUICK RATIO It is also known as acid test ratio Quick Ratio= Quick Assets/Current Liabilities Quick Asset=Current Asset-(Inventory+prepaid expenses) Rules of thumb=1:1
• EXAMPLE Calculate quick ratio from the information given below Stock -135000 Debtors-70000 Cash -125000 Prepaid expences-5000 Land and building-100000 Goodwill-50000 Short term investment-150000 Creditors-150000 Bills payable-20000 Tax payable-10000 Debenture-200000
• It is also known as acid test ratio Quick Ratio= Quick Assets/Current Liabilities Quick asset=70000+125000+150000=345000 Current Liabilities =150000+20000+10000=180000 Quick ratio=345000/180000=1.916
• ABSOLUTE LIQUID RATIO Absolute liquid ratio=cash,bank & marketable securities/current liabilities Rules of thumb=0.5:1
• EXAMPLE Calculate absolute liquid ratio from the information given below Stock -135000 Debtors-70000 Cash in hand -45000 Cash at bank-30000 Marketable securities-150000 Land and building-400000 Goodwill-50000 Creditors-150000 Bills payable-80000 Tax payable-20000 Debenture-200000
• Absolute liquid ratio=225000/250000=.9
• LEVERAGE RATIO To judge the long-term financial position, leverage or capital structure ratios are calculated. Leverage ratios can calculate from the balance sheet to determine the portion of debt in total financing.
• DEBT EQUITY RATIO Debt Equity ratio is calculated to measure the relative claims of outsiders and the extent to which debt financing has been used in the organization. In this ratio the debt has been taken as the long-term debt and net worth has been calculated by adding share capital with reserves and surplus Debt Equity Ratio=Debt/Net worth
• EXAMPLE Equity share-300000 General reserve-100000 Debenture-100000 Current liabilities-100000 Fixed asset-400000 Current asset-200000
• Debt Equity Ratio =Debt/Net worth =200000/400000=1:2
• FUNDED DEBT TO TOTAL CAPITALIZATION RATIO (Funded debt/Total capitalisation) Funded debt=Long term loan Total capitalisation=Total liabilities-current liabilities
• PROPRIETARY RATIO OR EQUITY RATIO Shareholders fund/Total asset
• PROFIT AND LOSS RATIO These ratios deal with relationship between profit and loss accounts items The main profitability ratios are gross profit ratio,operating ratio Operating profit ratio,expenses ratio and net profit ratio .
• GROSS PROFIT RATIO Gross profit ratio measures the relationship of gross profit to net sales. Gross Profit ratio=(Gross Profit/Net Sales)x100 Gross profit=Sales-cost of goods sold
• OPERATING RATIO Operating ratio=(Operating cost/Net sales )*100 Operating cost=Cost of goods sold+operating expenses. Cost of goods sold=op.stock+purchase+wages-cl.stock
• OPERATING PROFIT RATIO Operating profit ratio shows the relationship between operating profit and sales. Operating Profit ratio =(Operating Profit/Net Sales)x100 Operating Profit=Net sales-(cost of goods sold+ administrative & office expenses)
• EXPENSES RATIO Cost of goods sold ratio=(cost of goods sold/Net sales)x100 Administrative &office expenses ratio=(Administrative &office expenses /Net sales)x100 Selling &distribution expenses ratio= Selling &distribution expenses /Net sales)x100
• NET PROFIT RATIO Net profit ratio establishes a relation ship between net profit (profit after tax) and indicates the efficiency of the management. Net Profit ratio =(Net Profit/Net Sales)x100
• MIXED RATIO OR INTER STATEMENT RATIOS These ratios exhibit the relationship between profit and loss item and balance sheet item.
• COVERAGE RATIO The coverage ratio shows the firm’s ability to pay interest and principals due.
• INTEREST COVERAGE RATIO It properly measures the margin of safety the organization enjoys with respect to its interest burden. The interest coverage ratio indicates the number of times interest is covered by the profits available to pay the interest charges. Interest coverage ratio=Profit Before Interest and Taxes/Interest
• DEBT SERVICE COVERAGE RATIO Debt service coverage ratio gives picture of long-term liquidity position. Debt service coverage=(Profit After Tax+ Depreciation+ Interest on Long Term Loans)/(Interest+ Long Term Loans)
• ACTIVITY RATIO OR CURRENT ASSETS MOVEMENT RATIO Activity ratios are calculated to measure the efficiency with which the resources of a firm have been employed. These ratios are also called turnover ratios because they indicate speed at which the assets are being turned over into sales. The important turnover ratios are debtor’s turnover ratio ,inventory turnover ratio, creditor turnover ratio ,working capital turnover ratio, fixed assets turnover ratio & total assets turnover ratio.
• DEBTOR TURNOVER RATIO It indicates the velocity of debt-collection of an organization. In simple words, it indicates the number of times debtors (receivables) are turned over during a year. Generally high turnover ratio is the more efficiency of management of debtors . Debtor Turnover Ratio=Net Credit Sales/Average Trade Debtor
• AVERAGE COLLECTION PERIOD It represents the average number of days in which its debtors converted into cash. The short collection period implies quick payment by the debtors. Average Collection Period= Total Trade Debtor/Sales Per Day or 365/Debtor turnover ratio
• CREDITOR TURNOVER RATIO In course of business operations an organization has to make credit purchases and incurred short-term liabilities. Suppliers of goods naturally interested in finding out how much time the organization is likely to take to repay the creditors. Creditors Turnover Ratio=Net Credit Purchase/Average Trade Creditor
• AVERAGE PAYMENT PERIOD Average payment period represent the average number of days the organization has to pay its creditors. Average payment period=Total Trade Creditors/Average Daily Purchases or 365/creditor turnover ratio
• INVENTORY TURNOVER RATIO Organization has to maintain the inventory of finished goods so as to able to meet the requirement of the business. But the level of inventories should not either too high or too low. Inventory Turnover Ratio=Costs Of Goods Sold/ Average Inventory at costs Inventory conversion period=365/ Inventory Turnover Ratio
• PROFITABILITY RATIO IN RELATION TO INVESTMENT Return on investment is one of the important ratios used to measure the efficiency of the organization, as the objective of the organization is to maximize it’s earning. Return on investment = Profit Before Interest& Tax/Capital Employed Capital Employed=net fixed asset+net working capital
• RETURN ON EQUITY Return on Equity is calculated to see the profitability of the owner’s investment. It is regarded as an important measure because it reflects the productivity of the ownership in the organization. It is affected by several factors like earning power, debt equity ratio, cost of debt and tax rate. Return on Equity=Profit After Tax/Net Worth
• DIVIDEND PER SHARE. The profit after tax belongs to shareholders. But income, which they really received, is the amount earning received as cash dividend. Therefore a large number of present and potential investors are interested in the Dividend Per Share. Dividend Per Share=Dividend Paid/Number of Shares
• EARNING PER SHARE Earning Per Share is a small variation of equity capital and is calculated by dividing the net profit after tax and preference dividend by the total number of equity shares. EPS calculated for a number of years indicates the earning power of the company has increased or decreased. Earning Per Share=Profit After Tax/Number of Shares