Ratio analysis


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Ratio analysis

  1. 1. Ratio Analysis
  2. 2. Definition: On the basis of financial accounting, ratio analysis is defined as the systematic use of ratio to interpret the financial statements so that the strengths and weaknesses of a firm as well as its historical performance and current financial condition can be determined. It is also called accounting ratio. Use of Ratio Analysis: Ratio Analysis is primarily used in financial accounting to explain financial position of a company on the basis of 5 ratios which are further categorized in many different ratios.
  3. 3. Types of Ratio  These five types of ratios are given below:  Liquidity Ratios  Investment Ratios  Gearing Ratios  Profitability Ratios  Financial Ratios
  4. 4. Liquidity Ratios The term Liquidity actually explains the ability of a firm or a company to pay its liabilities within the given time interval. Liquidity ratio consists of two types of ratios: 1. Acid Test(Quick Ratio) Acid test tells you that by how much a company is owed by omitting the stock from the current assets to show that how much cash the firm has in relation to its liabilities (what it owes) Also known as the ‘Quick ratio’ Formula: (Current assets – stock) : liabilities Ideal Value: Its ideal value is 1:1
  5. 5. Example of Acid Test :  Current Assets= $150000  Stock= $50000  Current Liabilities= $100000 =150000-50000/100000 =1
  6. 6. 1 2. Current Ratio: Current Ratio tells about the ratio between the current assets and current liabilities. Formula: Current Ratio = Current Assets : Current Liabilities Ideal Value: Its ideal value is 2:1
  7. 7. Example of Current Ratio:  Current Assets = $120000  Current Liabilities = $80000 = 120000/80000 = 1.5:1  It is a below the ideal level.
  8. 8. Investment/Shareholders Ratios Investment ratios gives you information to enable decisions to be made on the extent of the risk and the earning potential of a business investment. Consists of three types of ratios: 1.Earnings per share: Gives you the profit per unit share. Formula: Profit after tax / Number of shares Example: Net Profit= 1000000 Number of Shares= 400000  Solution: =1000000 ÷ 400000 =$2.5 per share Earnings per Share is 2.5.
  9. 9. 1 2.Price earnings ratio: Gives you the market price of a unit or single share. Formula: Market price / Earnings per share Example: Market Price per share= $10 Earnings per share=$1 Price Earning Ratio=10/1 =10
  10. 10. 1 3.Dividend yield: Relates the return on the investment to the share price. Formula: Ordinary share dividend / market price x 100 Example:  Company M has an EPS of $4 in FY 2011, its dividend payout ratio is 50% and its share price is $20. Calculate the dividend yield.  Solution  Dividend per Share = EPS × Dividend Payout Ratio = $4 × 0.5 = $2 Dividend Yield = $2/$20 = 10%
  11. 11. Profitability:  Definition: Profitability actually tells you that how much profit the firm can generate by sales or through its capital assets.  Types: There are two types of profitability ratios: 1.Gross Profit : Gives you the difference between total revenue and variable costs. Formula: Total revenue (turnover) – variable costs (cost of sales) 2.Net Profit: Gives you the difference between total revenue and all costs. Formula: Total revenue (turnover) – variable costs and fixed costs (overheads)
  12. 12. 1  Gross Profit Margin: Gross Profit Margin enables the firm to assess the impact of its sales and how much it cost to generate such sales. Formula: Gross Profit Margin = Gross profit / turnover x 100 Example: Gross Profit= $400000 Sales= $1000000 Gross Profit Margin= 400000/1000000 x 100 =40
  13. 13. 1  Net Profit Margin: Net profit gives information about the fixed costs involved in production also known as the overheads. Formula: Net Profit Margin = Net Profit / Turnover x 100 Example: Net Profit= $200000 Turnover = $1000000 Net Profit Margin= 200000/1000000 x 100 =20%
  14. 14. 1  Return on Capital Employed: Gives you a review about the amount of returns you get on the amount you initially invested in the company. Formula: Return on Capital Employed (ROCE) = Profit / capital employed x 100 Example: Earnings before interest and tax= $250000 Total Capital Employed= $1250000 Return on Capital Employed= 250000/1250000 x 100 = 20%
  15. 15. Gearing Ratio: Explains the financial position of the company, relationship between the loans and the capital. Formula: Gearing Ratio = Long term loans / Capital employed x 100 The higher the ratio the more the business is exposed to interest rate fluctuations and to having to pay back interest and loans before being able to re-invest earnings
  16. 16. Example  Total Capital Employed= 10 million  Long term liability= 4 million =4/10×100 =40 percent  The gearing ratio of the company is 40 percent.
  17. 17. Financial Ratios: Financial Ratios comprises of three ratios: 1.Asset Turnover: Explains how assets are utilized to generate profits. Formula: Asset Turnover = Sales turnover / assets employed Example:  Revenue= 200000  Assets = 100000  Now we will use the formula to calculate asset turnover.  = 200000÷ 100000  =2:1  The asset turnover ratio is 2 which is good
  18. 18. 1 2.Stock Turnover Explains the rate at which a company’s stock is turned over. Formula: Stock turnover = Cost of goods sold / stock expressed as times per year Example:  Sales=1000000  Inventory=50000 =1000000/50000 =20  It shows that company’s stock was sold 20 times in a year.
  19. 19. Conclusion:  Ratio Analysis is used to determine liquidity, profitability, investment probabilities and financial position of a firm.  It helps us to compare with other businesses and tells us about the ratios of other industries and tells us where we stand in the industry.  It also tells us where we can improve and in which section we are good. Queries and Comments
  20. 20. CREDITS:  Hashim Pervaiz  Mehfooz Ali Khan  Mir Abdur Rehman  Shahrukh Habib  Urooj Iqbal  Yamna Rashid The End and Thank you!