1 INTRODUCTION LUPIN PHARMACEUTICALMandideep Ankleshwar Tarapur Goa Mandideep Aurangabad Jammu The chairman of Lupin pharmaceutical is Dr. Desh Bandhu Gupta. Lupin ltd was founded on 9th April 1968. In India Lupin have 20 brands in the “TOP 3” of their respective products segments. The company is named after Roussel Hybrid, an Australian plant which has for centuries, served man and the environment. There are different branches of Lupin spread all over India. These branches are producing different product. The product wise location is given bellow Mandideep I-: this branch is working on API’S and formulation. Mandideep II-: This branch is producing herbal products. Ankleshwar-: This branch is producing API’S. Aurangabad-: This branch is working on formulation. Tarapur-: this is for API’S.
2Jammu-: This branch is for formulation. Goa-: This is producing Non Cephalosporin Dosage forms.API’S-: This is the active pharmaceutical ingredient. This is in the form ofpowder and this is generally using in the formulation of medicine. It is thekind of production.FORMULATION -: This is production of capsules, tablets and syrup withthe help of API’S. A branch which is producing API’S will send this forformulation. In India Lupin have 20 brands in the “TOP 3” of their respectiveproducts segments. Global leader in anti-tuberculosis products andcephalosporin. Lupin products sold in over 70 countries. When it comes to reliability and quality, Lupin’s name is amongst inthe mind of specialists. More and more specialists such as chest physicians,consulting physicians, general surgeons, pediatricians, cardiologists anddiabetologists are choosing its products everyday. Despite the fact that theIndian urban prescription market showed stagnation with only 0.1% ofgrowth, Lupin has bucked the trend by recording a strong growth of 8.2%during the year.AAMLA (Asia, Africa, Middle East & Latin America)-:In its pursuit to be an innovation led translation pharmaceutical company,Lupin has ventured penetrated into chosen markets represented by itsAAMLA division. The AAMLA geographic provide unique challenge andopportunity. On one hand, there are highly regulated markets such asJapan, Australia, South Korea, Mexico, U.A.E., Saudi Arabia etc. while,on the there, there are less regulated markets such as Myanmar, Nigeria,Kenya and Peru.
3 1200 1000 800 600 400 200 0 2002-03 2003-04 2004-05 2005-06 sales (rs. in million)INDIA PHARMACEUTICAL MARKET- Today, the pharmaceutical industry in India is estimated to be over aUS $5 billion. 2005 marked the beginning of an era in the Indianpharmaceutical industry with the introduction product patent regime. Thebill not only provided the confidence to multinational companies to bring intheir research molecule but, it also gave Indian companies reason to focus ondeveloping brands and exploring in-licensing and marketing alliances. TheIndian pharmaceutical market continued to grow in size, powered by 9%value and 7%volume growth respectively.FINANCIAL OVERVIEW-:In financial year 2005-06, the net sales of the company increased by 38%from Rs. 11611.3 million to Rs. 16061 million in net profit, a 117% increaseover the previous year’s Rs. 843.6 million. Higher sales volume, especiallyin the high value market of US and in formulations in the domestic marketstriggered the higher profitability. These entire factors contributed to thegrowth in earning before interest, tax, depreciation and amortization(EBITDA) by 106%, from Rs. 1457.9 million. During the year EBITDAconstituted 19% of net sales. The company registered strong export salesconstituted 46% of gross sales.
4350030002500200015001000500 0 2004-05 2005-06 --EBITDA (Rs, in million)1- On the strength of the various ANDA’s filled by the company in the previous year, the company, the company was able to launch 7 new products in the US, from which sales of Rs. 2233 million were added to the company’s top line. In particular, Ceftriaxone has been a major success for the company, for which it now enjoys around 25% market share. The price drop for the product was about 70% in hospital market, being less intense, with fewer competitors participating in this high-end niche generic product.2- Domestically, the company’s strong performances within the recently entered Anti-Asthma segment and its overall market penetration of its multitude of leading products in other therapeutic areas have generated significant revenues additions.3- In terms of other product, Lupin has been able to maintain optimal cost positioning and quality maintenance, the keys to success in this industry. Despite price drops in various products, the company has been able to maintain and grow its market share to make strong margins from these products, contributed to the strong financial performance of the company.
5 45 40 35 30 25 20 15 10 5 0 2004-05 2005-06 --EPS (Rs. In million)As a result of these factors, the profit after tax recorded was Rs. 1827.2million, with cash profits amounting to Rs. 2230.7 million. The earning pershare was Rs. 44.59. The Board recommended a dividend of 65%, absorbinga sum of Rs. 297.5 million, inclusive of tax on dividend. 8000 7000 6000 5000 4000 3000 2000 1000 0 2000-01 2001-02 2002-03 2003-04 2004-05 2005-06--API SALES GROWTH
6FINANCIAL OVERVIEW (2004-05)-:In financial year 2004-05, the net sales of the company by 4% fromRs.11192.8 million to Rs.11611.3 million. The net profit after extraordinaryitems was Rs.843.6 million as against Rs.987.1 million in the previous year.The company made a strategic decision to significantly increase investmentin intellectual capital, marketing and R&D. The company witnessed a dip inmargin in its Pen G based API product and faced market uncertainty in thelast quarter owing to the introduction of VAT. These entire factorscontributed to the reduction of the Earning before tax, Depreciation andAmortization (EBITDA) from Rs.2801.7 million in the previous year toRs.1457.9 million. 2500 2000 1500 1000 500 0 2004-05 2005-06 --PBT (Rs. In million) The company registered strong export sales worth Rs.5619.1 million,thereby constituting 48% of the net sales. The company expanded its productpipe line, R&D Company investing substantially higher amount in R&D(Rs.760.1 million in revenue, Rs.76 million in capex). The R&D expenditureincreased to7.2% of net sales in the previous financial year 2004-05 up from4.11% in the previous year.
7 90 80 70 60 50 40 30 20 10 0 2004-05 2005-06 --REGULATED MARKETS -- SEMI REGULATED MARKETRatio Analysis: IntroductionA ratio is a quantity that denotes the proportional amount ormagnitude of one quantity relative to anotherRatio Analysis is the most commonly used analysis to judge thefinancial strength of a company. A lot of entities like researchhouses, investment bankers, financial institutions and investorsmake use of this analysis to judge the financial strength of anycompany.Fundamental Analysis has a very broad scope. One aspect looks at thegeneral (qualitative) factors of a company. The other side considers tangibleand measurable factors (quantitative). This means crunching and analyzingnumbers from the financial statements. If used in conjunction with othermethods, quantitative analysis can produce excellent results.
8Ratio analysis isnt just comparing different numbers from the balance sheet,income statement, and cash flow statement. Its comparing the numberagainst previous years, other companies, the industry, or even the economyin general. Ratios look at the relationships between individual values andrelate them to how a company has performed in the past, and might performin the future.Financial ratios are calculated from one or more pieces of information froma companys financial statements. For example, the "gross margin" is thegross profit from operations divided by the total sales or revenues of acompany, expressed in percentage terms. In isolation, a financial ratio is auseless piece of information. In context, however, a financial ratio can give afinancial analyst an excellent picture of a companys situation and the trendsthat are developing.A ratio gains utility by comparison to other data and standards. Taking ourexample, a gross profit margin for a company of 25% is meaningless byitself. If we know that this companys competitors have profit margins of10%, we know that it is more profitable than its industry peers which is quitefavorable. If we also know that the historical trend is upwards, for examplehas been increasing steadily for the last few years, this would also be afavorable sign that management is implementing effective business policiesand strategies.This analysis makes use of certain ratios to achieve the above-mentionedpurpose. There are certain benchmarks fixed for each ratio and the actualones are compared with these benchmarks to judge as to how sound thecompany is. The ratios are divided into various categories, which arementioned below:Financial ratio analysis groups the ratios into categories which tell us aboutdifferent facets of a companys finances and operations. An overview ofsome of the categories of ratios is given below. • Leverage Ratios which show the extent that debt is used in a companys capital structure. • Liquidity Ratios which give a picture of a companys short term financial situation or solvency.
9 • Operational Ratios which use turnover measures to show how efficient a company is in its operations and use of assets. • Profitability Ratios which use margin analysis and show the return on sales and capital employed. • Solvency Ratios which give a picture of a companys ability to generate cash flow and pay it financial obligations. CLASSIFICATION OF RATIOSThe use of ratio analysis is not confined to financial manager only. There aredifferent parties interested in the ratio analyses for knowing the financialposition of a firm for different purposes. In vies of various users of ratios,there are many types of ratio which can be calculated from the informationgiven in the financial statements. The particular purpose of the userdetermines the particular ratios that might be used for financial analysis.Similarly the interests of the owners and the management also differ. Theshareholders are generally interested in the profitability or dividend positionof a firm while management requires information on almost all the financialaspects of the firm to enable it to protect the interests of all parties. RATIOS(A) (B) (C)TRADITIONAL FUNCTIONAL CLASSIFICATION SIGNIFICANCE RATIOSCLASSIFILCATION OR ORORSTATEMENT RATIOS CLASSIFICATION ACCORDING TO RATIOS ACCORDING TO TESTS IMPORTANCE 1. BALANCE SHEET RATIOS1.LIQUIDITY RAT IOS 1.PRIMARY RATIOS POSI TION STATEMENT 2.LEVERAGE RATIOS 2.SECONDARY RATIOS RATIOS 3.ACTIVITY RATIOS2. PROFIT AND LOSS A/C 4.PROFITABILITY RATIOS OR REVENUE/INCOME STATEMENT RATIOS3.COMPOSITE/MIXED RATIOS OR INTER STATEMNT RATIOS
10 (A)TRADITIONAL CLASSIFICATION OR STATEMNT RATIOSTraditional classification or classification according to statement, from which theseratios are calculated, is as follows. TRADITIONAL CLASSIFICATION OR STATEMENT RATIOS (A) (B)BALANCE SHEET RATIOS PROFIT AND LOSS A/C RATIOS COMPOSITE/MIXEDOR OR ORPOSITON STATEMENT RATIOS REVENUE/INCOME STATEMENT RATIOS INTER-STATEMENT RATIOS1. CURRENT RATIO 1.GROSS PROFIT RATIO 1. STOCK TURNOVER RATIO2. LIQUID RATIO (ACID TEST 2.OPERATING RATIO 2. DEBTORS TURNOVER OR QUICK RATIO) 3. OPERATING PROFIT RATIO 3. PAYABLE TURNOVER RATI03. ABSOLUTE LIQUIDITY RATIO 4.NET PROFIT RATIO 4. FIXED ASSET4. DEBT EQUITY RATIO 5.EXPENSE RATIO TURNOVER RATIO5. PROPRIETORY RATIO 6.INTEREST COVERAGE RATIO 5. RETURN ON EQUITY6. CAPITAL GEARING RATIO 6. RETURN ON7. ASSETS-PROPRIETORSHIP SHAREHOLDERS FUNDS RATIO 7. RETURN ON CAPITAL8. CAPITAL INVENTORY TO CAPITAL EMPLOYED WORKING CAPITAL RATIO 8. CAPITAL TURNOVER RATIO9. RATIO OF CURRENT 9. WORKING CAPITAL ASSETS TO FIXED ASSETS TURNOVER RATIO. 10. RETURN ON TOTAL RESOURCES 11. TOTAL ASSETS TURNOVEREXPLAINATION 1. BALANCE SHEET OR POSITION STATEMENT RATIOS: Balance sheet ratios deal with the relationship between the two balance sheet items. Both its items must however, pertain to the same balance sheet. 2. PROFIT AND LOSS A/C OR REVENUE/INCOME STATEMENT RATIOS: These ratios however deal with the relationship between two profit and loss A/C items. Both the items must however belong to the same profit and loss A/C. 3. COMPOSITE/MIXED RATIOS OR INTER STATEMNT RATIOS: These ratios exhibit the relation between a profit and loss A/C of income statement item and a balance sheet item.
11 (B) FUNCTIONAL CLASSIFICATION OR CLASSIFICAITON ACCORDING TO TESTSIn view of the financial management or according to the tests satisfied,various ratios have been classified as below: FUNCTIONAL CLASSIFICATION IN VIEW OF FINANCIAL MANAGEMENT OR CLASSIFICATION ACCORDING TO TESTSLIQUIDITY RATIOS LONGTERM SOLVENCY AND ACTIVITY RATIOS PROFITABILITY RATIOS LEVERAGE RATIOS(a)1.CURRENT RATIO FINANCIAL OPERATING 1.INVENTORY TURNOVER (a)IN RELATION TI SALE 2.LIQUID RATIO(ACID COMPOSITE RATIO 1.GROSS PROFIT TEST OR QUICK RATIOS 1.DEBT EQITY RATIO 2.DEBTORS TURNOVER RATIO 3.ABSOLUTE LIQUID 2.DEBT TO TOTAL CAPITAL 3.FIXED ASSET TURNOVER 2.OPERATING RATIOOR CASH RATIO 3.INTEREST COVERAGE 4.TOTAL ASSET TURNOVER 3.OPERATING PROFIT 4. INTERNAL MEASURE 4.CASH FLOW/DEBT RATIO RATIO 5. CAPITAL GEARING 5.WORKING CAPITAL 4.NET PROFIT RATIO(b)1. DEBTORS TURNOVER TURNOVER RATIO 5.EXPENSE RATIO RATIO 6.PAYABLE TURNOVER (b)IN RELATION TO2. CREDITOR TURNOVER RATIO INVESTMENTS RATIO 7.CAPITAL EMPLOYED 1. RETURN ON3. INVENTORY TURNOVER TURNOVER INVESTMENTS RATIO 2. RETURN ON CAPITAL 3. RETURN ON EQITY CAPITAL 4. RETURN ON TOTAL RESOURCES 5. EARNING PER SHAR 6. PRICE EARNING RATIOEXPLAINATION 1. LIQUIDITY RATIOS: There are ratios, which measure the short- term solvency or financial position of a firm. These ratios are calculated to comment upon the short term paying capacity of a concern or the firm ability to meet its current obligations. 2. LONG TERM SOLVENCY AND LEVERAGE RATIOS: Long- term solvency ratios convey a firm’s ability to meet the interest cots and repayments schedules of its long term obligations. 3. ACTIVITY RATIOS: 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 the speed with which assets are being turned over into sales.
12 4. PROFITABILITY RATIOS: These ratio measures the results of business operations or overall performance and effectiveness of the firm. There are two type of profitability ratios 1.in relation to sales 2.in relation to investments. (C) CLASSIFICATION ACCORDING TO SIGNIFICANCE OR IMPORTANCE The ratios have also been classified according to their significance or importance. Some ratios are more important then others and the firm may classify them al primary and secondary ratios. The British Institute of management has recommended the classification of the ratios according to importance for inter firm comparison. For inter-firm comparisons the ratios may be classified as Primary and Secondary ratios. The primary ratios is one of which is of the prime importance to a concern; thus return on the capital is employed is named as primary ratio. The other ratios, which support the other ratios, are called secondary ratios. IMPORTANT FORMULA USED IN RATION ANALYSISLiquidity Analysis Ratios Current Ratio Current Assets Current Ratio = ------------------------ Current Liabilities Quick Ratio Quick Assets Quick Ratio = ---------------------- Current Liabilities
13Quick Assets = Current Assets - Inventories Net Working Capital Ratio Net Working Capital Net Working Capital Ratio = -------------------------- Total AssetsNet Working Capital = Current Assets - Current LiabilitiesProfitability Analysis Ratios Return on Assets (ROA) Net Income Return on Assets (ROA) = ---------------------------------- Average Total AssetsAverage Total Assets = (Beginning Total Assets + Ending Total Assets) / 2 Return on Equity (ROE) Net Income Return on Equity (ROE) = -------------------------------------------- Average Stockholders EquityAverage Stockholders Equity= (Beginning Stockholders Equity + Ending Stockholders Equity) / 2 Return on Common Equity (ROCE) Net Income Return on Common Equity (ROCE) -------------------------------------------- = Average Common Stockholders EquityAverage Common Stockholders Equity= (Beginning Common Stockholders Equity + Ending Common Stockholders Equity) / 2 Profit Margin Net Income Profit Margin = ----------------- Sales
14 Earnings Per Share (EPS) Net Income Earnings Per Share (EPS) = --------------------------------------------- Number of Common Shares OutstandingActivity Analysis Ratios Assets Turnover Ratio Sales Assets Turnover Ratio = ---------------------------- Average Total AssetsAverage Total Assets = (Beginning Total Assets + Ending Total Assets) / 2 Accounts Receivable Turnover Ratio Sales Accounts Receivable Turnover Ratio = ----------------------------------- Average Accounts ReceivableAverage Accounts Receivable= (Beginning Accounts Receivable + Ending Accounts Receivable) / 2 Inventory Turnover Ratio Cost of Goods Sold Inventory Turnover Ratio = --------------------------- Average InventoriesAverage Inventories = (Beginning Inventories + Ending Inventories) / 2Capital Structure Analysis Ratios Debt to Equity Ratio Total Liabilities Debt to Equity Ratio = ---------------------------------- Total Stockholders Equity Interest Coverage Ratio
15 Income Before Interest and Income Tax Expenses Interest Coverage Ratio = ------------------------------------------------------- Interest ExpenseIncome Before Interest and Income Tax Expenses= Income Before Income Taxes + Interest ExpenseCapital Market Analysis Ratios Price Earnings (PE) Ratio Market Price of Common Stock Per Share Price Earnings (PE) Ratio = ------------------------------------------------------ Earnings Per Share Market to Book Ratio Market Price of Common Stock Per Share Market to Book Ratio = ------------------------------------------------------- Book Value of Equity Per Common ShareBook Value of Equity Per Common Share= Book Value of Equity for Common Stock / Number of Common Shares Dividend Yield Annual Dividends Per Common Share Dividend Yield ------------------------------------------------ = Market Price of Common Stock Per ShareBook Value of Equity Per Common Share= Book Value of Equity for Common Stock / Number of Common Shares Dividend Payout Ratio Cash Dividends Dividend Payout Ratio = -------------------- Net Income
16ROA = Profit Margin X Assets Turnover Ratio ROA = Profit Margin X Assets Turnover Ratio Net Income Net Income Sales ROA = ------------------------ = -------------- X ------------------------ Average Total Assets Sales Average Total AssetsProfit Margin = Net Income / SalesAssets Turnover Ratio = Sales / Averages Total Assets INTERPRETATIONS THEORY OF THE RATIOS The interpretations of the ratios are an important factor. Though calculation of the ratios is important but it is only a clerical task whereas interpretation needs skill, intelligence and foresightedness. The inherent limitations of the ratio analysis should be kept in mind while interpreting them. The impact of the factors such as price level changes, change in accounting policies, window dressing etc., should be also be kept in mind when attempting to interpret ratios. The interpretation of the ratios can be made in the following ways. 1. SINGLE ABSOLUTE RATIOS: the single ratios can be studied in relation to certain rules of thumb, which are based upon well-proven conventions. 2. GROUP OF RATIOS: Ratios may be interpreted by calculating a group of related ratios. A single ratios supported by a group of related ratios become more understandable and meaningful. 3. HISTORICAL COMPARISION: one of the earliest and most popular ways of evaluating the performance of the firm is to compare its present ratios with the past ratios called comparision overtime.
17 4. PROJECT RATIOS: Ratios can be also calculated for future standards based upon the projected or perform financial statements. These future ratios may be taken as standard for comparison and the ratios calculated on actual financial statements can be compared with the standard ratios to find out variances. 5. INTER FIRM COMPARISION: Ratios of one firm can also be calculated with the ratios of the other selected firm in the same industry at the same point of time. This kind of comparison helps in evaluating relative financial position and performance of the firm. GUIDELINES OR PRECUATIONS FOR THE USE OF RATIOSThe calculation of the ratios may not be a difficult task but their use is noteasy. The information on which these are based, the constraints of thefinancial statements, objective for using them, the caliber of the analyst, etc.are the important factors which influence the use of ratios. Following are theguidelines for interpreting ratios. 1. ACCURACY OF THE FINANCIAL STATEMENTS: The reliability of the ratios are linked with the data available in the financial statements. Before calculating the ratios one should see whether the proper conventions have been used for preparing financial statements or not. 2. OBJECTIVE OF THE PURPOSE OF ANALYSIS: The type of ratios to be calculated will depend upon the purpose for which these are required. If the purpose is to study the financial position then the ratios of current assets and liabilities will be studied. The purpose of “user” is important for the analysis of ratios. 3. SELECTION OF RATIOS: another precaution in ratio analysis is the proper selection of appropriate ratios. The ratios should match the purpose for which these are required.
18 4. USE OF STANDARDS: The ratios will give an indication of financial position only when discussed with the reference to certain standards. Unless otherwise these ratios are compared with certain standards one will not be able to reach at conclusions. 5. CALIBER OF THE ANALYST: The ratios are only the tools of the analysis and their interpretation will depend upon the caliber and competence of the analyst. He should be familiar with the various financial statements and significant changes etc. 6. RATIOS PROVIDE ONSY A BASE: The ratios are only guidelines for there analyst, he should not base his decisions entirely on them. He should study any other relevant information, situation in concern, other economic environment. USE AND SIGNIFICANCE OF RATIO ANALYSIS The ratio analysis is one of the most powerful tools of financialanalysis. It is used as a device to analyze and interpret the financial health ofenterprise. Just like the doctor examines the patient by recording his bodytemperature, blood pressure, and etc. before making his conclusionregarding the illness and before giving his treatment. The use of ratios is not confined to financial managers only butthere are different parties also which are interested in the ratio analysis forknowing the financial position of a firm for different purposes like supplierof goods on credit, financial institutions, invertors, shareholders etc. Withthe use of ratio analysis one can measure the financial condition of a firmand can point our whether the condition is strong, good, poor etc.Applications of the ratio analysis are: MANAGERIAL USES OF RATIO ANALYSIS 1. HELPS IN DECISION MAKING: Financial statements are prepared primarily for decision-making. Ratio analysis helps in
19 making decisions from the information provided in these financial statements. 2. HELPS IN FINANCIAL FORECASTING AND PLANNING: Ration analysis is of much help in financial forecasting and planning. Planning is looking ahead and the ratios calculated for a number of years work as a guide for the future. Meaningful conclusions can be drawn from these ratios. 3. HELPS IN COMMUNICATING: The financial strengths and weakness of the firm are communicated in a more easy and understandable manner by the use of these ratios. The ratios help in communication and enhance the value of the financial statements. 4. HELPS IN COORDINATION: Ratios even help in coordination, which is of utmost importance in effective business management. Better communication of efficiency and weakness of an enterprise results on better coordination in the enterprise. 5. HELPS IN CONTROL: Ratio analysis even helps in making effective control of the business. Standard ratios can be based upon Performa of financial statements and variance or deviations, if any, helps in comparing the actual with the standards so as to take a corrective action at the right time. 6. OTHER USES: There are so many other uses of the ratio analysis. It is an essential part of the budgetary control and standard costing. Ratios are of immense importance in the analyses and interpretation of financial statements as they bring the strength or weakness of the firm UTILITY TO SHARE HOLDERS AND INVESTORS The investor in the company will like to assess the financialposition of the concern where he is going to invest. Firstly the investor
20will try to ass3ess the value of fixed assets and the loans raised againstthem. The investor will feel satisfied only if the concern has sufficientamount of assets. Long-term solvency ratios will help him in assessingthe financial position of the concern. Profitability ratios, on the otherhand, will be useful to determine profitability position. Ratio analysiswill be useful to the investor in making up his mind whether presentfinancial position of the concern warrants further investment or not. UTILITY TO THE CREDITORS The creditors or the suppliers extend short-term credit to theconcern. They are interested to know whether financial position of theconcern warrants their payments at a specified time or not. The concernpays short-term creditors out of its current assets. If the current assets arequiet sufficient to meet current liabilities then the creditor will nothesitate in extending credit facilities. Current and acid test ratios will givean idea about their current financial position of the concern. UTILITY TO THE EMPLOYEES The employees are also interested in the financial position of the concern especially profitability. Their wage increase and amount of fringe benefits are related to the volume of profits earned by the concern. The employees make use of information available in the financial statements. Various profitability ratios relating to gross profit, operating, net profit, etc., enable the employees to put forward their viewpoint for the increase of wages and other benefits. UTILITY TO GOVERNMENT Government is interested to know the overall strength of theindustry. Various financial statements published by industrial units are
21 used to calculate ratios for determining short-term. Long-term and overall financial position of concerns. Profitability indexes can also be prepared with the help of ratios. Government may base its future policies on the bases of industrial information available from various units. The ratios may be used as indicators of overall financial strength of public as well as private sector. In the absence of the reliable economic information, government plans and policies may not prove successful. TAX AUDIT REQUIREMENTS The Finance Act, 1984, inserted section 44 AB in the Income Tax Act.Under this section every assessed engaged in any business and havingturnover or gross receipts exceeding Rs. 40 lakh is required to get theaccounts audited by a charted accountant and submit the tax audit reportbefore the due date for filing the return of income under section 139(1). Incase of a professional, a similar report is required if the gross receiptsexceeds Rs. 10 lacks. Clause 32 of the income Tax Act trequires that thefollowing accounting ratios should be given: 1. Gross Profit/turnover 2. Net Profit/turnover 3. Stock-in-trade/turnover 4. Materials consumed/Finished Goods Produced
22 LIMITATIONS OF THE RATIO ANALYSIS LIMITED USE OF A SINGLE RATIO: A single ratio, usually, does not convey much of a sense. To make a better interpretation a number of ratios have to be calculated which is likely to confuse the analyst than help him in making any meaningful conclusion. LACK OF ADEQUATE STANDARDS: There are no well-accepted standards or rules of thumb for all ratios, which can accept as norms. It renders interpretation of the ratios difficult. INHERENT LIMITATIONS OF ACCOUNTING: like financial statements, ratios also suffer from the inherent weakness of accounting records such as their historical nature. CHANGES OF ACCOUNTING PROCEDRURE: Changes in accounting procedure by a firm often makes ratio analysis misleading e.g. Changes in the valuation of inventories. WINDOW DRESSING: Financial statements can easily be window dressed to present a better picture of its financial and profitability position to outsiders. Hence one has to be very careful from making a decisions from ratios calculated from such financial statements. PERSONAL BIAS: Ratios are only a means to financial analysis and not an end in itself. Ratios have to be interpreted and different people may interpret the same ratios in different ways. UNCOMPARABLE: Not only industries differ in their nature but also the firms of the similar business widely differ in their size and accounting procedures etc., It makes the comparison of ratios difficult and misleading. Moreover, comparisons are made difficult due to differences in definitions of various financial terms used in the ratio analysis. ABSOLUTE FIGURES DISTORTIVE: Ratios devoid of absolute figures may prove distractive as ratio analysis is primarily a quantitative analysis and not qualitative analysis.
23 PRICE LEVEL CHANGES: While making ratio analysis, no consideration is made to the changes in price levels and this makes the interpretation of the ratios invalid. RATIOS NO SUBSTITUTE: Ratio analysis is merely a tool of financial statements. Hence, ratios become useless if separated from the statements from which they are computed. CURRENT RATIOCurrent ratio may be defined as the relationship between current assets andcurrent liabilities. This ratio is also known as working capital ratio, is ameasure of general liquidity and is most widely used to make the analysis ofthe short-term position or liquidity of a firm. It is calculated by dividing thetotal of current assets by total of the current liabilities. CURRENT RATIO = __CURRENT ASSETS__ CURRENT LIABILITIESTwo basic components of this ratio are: current assets and current liabilities.Current assets include cash and those assets, which can be easily convertedinto cash within a short period of time generally, one year, such asmarketable securities, bills receivable, sundry debtors etc. Current liabilitiesare those obligations which are payable within a short period of generallyone year and include outstanding expenses, bills payable, sundry creditors,accrued expenses, dividend payable etc.
24SIGNIFICANCE AND LIMITATIONS OF CURRENT RATIOCurrent ratio is a general and a quick measure of liquidity of a firm. Itrepresents the ‘margin of safety’ or ‘cushion’ available t the creditors andcurrent liabilities. It is most widely used for making short-term analyses ofthe financial position or short-term solvency of the firm. But one has to becareful while using current ratio as a measure of liquidity because it suffersfrom the following limitations: CRUDE RATIO: It is the crude ratio because it measures only the quantity but not the quality if the current assets. WINDOW DRESSING: Valuation of current assets and window dressing is another problem of the current ratio. Current assets and liabilities are manipulated in such a way that current ratio loses its significance.IMPORTANT FACTORS FOR REACHING A CONCLUSIONA number of factors should be taken into consideration before reaching aconclusion about short-term financial position. Sone of these factors is.
25 I. TYPE OF BUSINESS II. TYPE OF PRODUCTS III. REPUTATION OF THE CONCERN IV. SEASONAL INFLUENCE V. TYPE OF ASSETS AVAILABLE PRACTILCAL CALCULATION OF CURRENT RATIOCURRENT RATIO = CURRENT ASSETS : CURRENT LIABILITIES TABLE YEAR 2004 2005 2006CONTENTSASSETS 4461.7 5102.5 11144.8LIABILITIES 1967.3 2396.4 2995.4CURRENT RATIO 2.267:1 2.111:1 3.720:1WORKING NOTES-:CURRENT ASSETS= INVENTORIES+SAUNDRY DEBTORS+CASHAND BANK BALANCES
262004 = 2153+2158.3+150.4 =4461.72005 = 2480.8+2353.9+177.8 = 5102.52006 = 3102.0+3483.9+4558.0 = 111444.8CURRENT LIBILITIES2004= 1967.32005 = 2396.42007 = 2995.4 GRAPH 4 3.702 3.5 3 2.5 2.267 2.111 2 CURRENT 1.5 RATIO 1 0.5 0 2004 2005 2006 INTERPRETATION OF CURRERENT RATIO In the year 2004 the current ratio of LUPIN LABORATORIES PVT (LTD) was satisfactory as the ratio was 2.26:1 which was more than the standard ratio 2:1 for the current ratio. This means that the firm
27 was liquid and has the ability to pay its current obligations in time as and when they become due. In the year 2005 the current ratio of the company was 2.11:1, which was also satisfactory as was more than the standard ratio of 2:1. Thus the company at that time also was in the position to pay the current obligations as and when they become due. In the year 2006 the current ratio of the company was 3.72:1, which was, much more than the standard figure of the current ratio i.e. 2:1. This means that the firm was liquid but the cash and the bank balance was high which showed that the cash and the bank balance is lying idle due to many reasons. The current ratio in the year 2005 was less than the year 2004, which indicates that the liquidity of the company was reduced and that the liabilities were more than the paying capacity. The main reason of the reduction of the ratio was reduction in the bank balances. The current ratio in the year 2006 was more than the year 2005, which indicates that the liquidity of the company was increased and the capacity to pay the liabilities was more. The main reason of this was the increase in the bank balances, which increased drastically nearly 20% in the year 2006. WEIGHTED CURRENT RATIO (PART OF CURRENT RATIO)
28The two basic determinants pf current ratio as measure of liquidity arecurrent assets and current liabilities. However all types of current assets arenot equally liquid and all current liabilities are not repayable with the samedegree of quickness. So the discrimination can be made among the differentcomponents of current assets and current liabilities, the former on the basisof relative quickness with which each individual item of current liabilitiesmature for payment. The discrimination can be expressed by assigning byassigning proper weight among each component of current assets andcurrent liabilities. Weights to be assigned on each individual components ofcurrent assets and current liabilities, will depend upon the degree of theirrelative liquidity in case of current assets and relative urgency payments incase of current liabilities having due regard, however in each case the natureand types of business. For e.g. cash and bank balance being most liquid assetmay be assigned a weightage of 100% followed by short-term securities90% receivables 80% inventories 70%and so on. In the same manner,advances received from the customers, tax payable and proposed dividendmay be assigned an weighted of 100% followed by trade creditors andaccounts payable 90%, bank overdraft 80%. Formula of weighted currentratio:
29WEIGTED CURRENT RATIO=TOTAL PRODUCT OF CURRENT RATIOTOTAL PRODUCT OF CURRENT LIABILITYPRACTICAL CALCULATLION OF WEIGHTED CURRENT RATIOWIGHTED CURRENT RATIO=TOTAL PRODUCT OS CURRENT ASSETS : TOTAL PRODUCT OF CURRENT LIABILITIES TABLE YEAR 2004 2005 2006CONTENTS PRODUCT OF 309684 354940 920686CURRENT ASSETS PRODUCT OF 157384 189944 204752 CURRENT LIABILITIES WEIGHTED 1.96 1.86 4.49CURRENT RATIOWORKING NOTES TOTAL PRODUCT OF CURRENT ASSETS=(AMOUNT OF A PERTICULAR CURRENT ASSET) X (PERCENTAGE WEIGHT)
302004= CASH AND BANK BALANCES X 100% =150.4 X 100% = 15040 DEBTORS X 80% = 2158.3 X 80% = 172664 INVENTORIES X 60% = 2153.0 X 60% = 129180 TOTAL = 309684SIMILARLY FOR YEARS 2005 AND 2006 AND ALSOCURRENT LIABILITIES TOTAL PRODUCT OF CURRENT LIABILITIES=(AMOUNT OF A PETICULAR CURRENT LIABILITY) X (PERCENTAGE WEIGHT) GRAPH 4.5 4.49 4 3.5 3 2.5 weighted current 2 1.96 ratio 1.86 1.5 1 0.5 0 2004 2005 2006 ANALYSIS OF THE WEIGHTED CURRENT RATIO The weighted current ratio is measured on the basis of the weightage given to the current assets and current liabilities so it is more reliable than the current ratio.
31 In the year 2004 the weighted current ratio of Lupin Ltd. was 1.96:1 which indicates the satisfactory ratio and the liquidity of the company is more and that the company is at the capacity to pay the liabilities due as the current assets are more than the current liabilities. In the year 2005 the ratio was 1.86:1 which indicates that the company is in a good position as the current assets are more than the current liabilities and the company is in the position to pay all the current liabilities due to the company. In the year 2006 the ratio was 4.49:1 which was almost double than the standard ratio, which is 2:1. This is basically because of the increase in the bank balance and the cash in hand which increased almost 20 times to that of the 2005. But this is not a very good sign for the company as the cash in bank is so much that it is remaining idles after paying dues to the creditors and there are not many opportunities to invest that money. In the year 2005 the ratio was decreased as compared to the 2004 ratio basically because the more increase in the current liabilities less increase in the current assets (bank balance, inventories). In the year 2006 the ratio had increased drastically mainly due to the great increase in the bank balance in the current assets. QUICK OR ACID TEST OR LIQUID RATIOQuick Ratio, also known as acid test or Liquid Ratio is more rigorous test ofliquidity than the current ratio. The term ‘liquidity’ refers t o the ability of afirm to pay its short-term obligations as and when they become due. The twodeterminants of current ratio, as a measure of liquidity are current assets andcurrent liabilities. Current assets include inventories and prepaid expenses,which are not easily convertible into cash within a short period. Currentassets include inventories and prepaid expenses, which are not easily
32convertible into cash within a short period. Quick ratio may be defined asthe relationship between quick/liquid assets and current or liquid liabilities.An asset is said to be liquid if it can be converted into cash within a shortperiod without loss of value. In that sense, cash in hand and cash art bank aremost liquid assets. The other assets, which can be included in the liquidassets and sundry debtors, marketable securities and short-term or temporaryinvestments. Inventories cannot be termed to be liquid asset because theycannot be converted into cash immediately without a sufficient loss of value.In the same manner, prepaid expense is also excluded from the list ofquick/liquid assets because they are not expected to be converted into cash.The quick ratio can be calculated by dividing the total of the quick assets bytotal current liabilities. Thus:QUICK/LIQUID OR ACID TEST RATIO=QUICK OR LIQUID ASSETS QUICK/LIQUID LIABILITIESPRACTICAL CALCULATION OF THE LIQUID, ACID TEST ORQUICK RATIO QUICK/LIQUID OR ACID TEST RATIO = QUICK OR LIQUID ASSETS______ LIQUID/CURRENT LIABILITIES TABLE YEARCONTENTS 2004 2005 2006 2308.7 2531.7 8041.9 LIQUID ASSETS LIQUID 1967.3 2374.3 2995.4 LIABILITIES 1.17:1 1.06:1 2.68:1 LIQUID RATIO
33WORKING NOTES LIQUID ASSETS=CURRENT ASSETS-INVENTORIES 2004 = 4461.7 – 2153.0 = 2308.7 2005 = 5102.5 – 2480.8 = 2531.7 2006 = 11144.8 – 3102.9 = 8041.9 CURRENT LIABILITIES = REFER FROM ABOVE CALCULATION GRAPH (REFERRING THE ABOVE TABLE) 3 2.68 2.5 2 1.5 LIQUID RATIO 1.17 1 1.06 0.5 0 2004 2005 2006 ANALYSIS OF QUICK, ACID TEST OR LIQUID RATIO In the year 2004 the current ratio was 1.17:1 which indicates the high liquidity of the company and good ratio for paying the liabilities for lupin laboratories. The ratio is good as there are funds left after paying the liabilities to put in some more new emerging opportunities.
34 In the year 2005 the liquid ratio of Lupin was 1.06:1 which indicates the satisfactory liquidity position of the company because during the payment of the dues of the creditors there will be hardly any funds left to use in any other opportunity as the funds left will be reserved for the next years liability. In the year 2006 the ratio was 2.68:1 which was more than double if the satisfactory ratio i.e. the company is in an a high liquidity position. But such high ratio is also not good for the company as the funds are left idle as they are not fully in the further opportunities due to many reasons The ratio was decreased in the year 2005 mainly because of the high increase in the liquid liabilities and less increase in the liquid assets. The ratio was increased in the year 2006 mainly because of the very high increase in the cash and bank balance and less increase in the liquid liabilities. ABSOLUTE LIQUID RATIO OR CASH RATIOAlthough receivables, debtors and bills receivables are generally more liquidthan inventories, yet there may be doubts regarding their realization intocash immediately or in time. Hence, some authorities are of the opinion thatthe absolute liquid ratio should also be calculated together with current ratioand acid test ratio so as to exclude even receivables from the current assetsand find our the absolute liquid assets. Absolute liquid assets include cash in
35hand and at bank and marketable securities or temporary investments. Theacceptable norm for this ratio is 50% or .5:1 or 1:2 i.e. Re. 1 worth absoluteliquid assets are considered are considered adequate to pay Rs. 2 worthcurrent liabilities in time as ass the creditors are not expected to demandcash at the same time and then cash may also be realized from debtors andinventories. Thus ABSOLUTE LIQUID RATIO=ABSOLUTE LIQUID ASSETS CURRENT LIABILITIES CASH RATIO= CASH AND BANK+SHORT-TERM SECURITIES CURRENT LIABILITIESPRACTICAL CALCULATION OF ABSOLUTE LIQUID RATIO ORCASH RATIO CASH RATIO = CASH & BANK+SHORT TERM SECURITIES CURRENT LIABILITIES TABLE YEAR 2004 2005 2006CONTENTS CASH & BANK + 604.7 631.3 5070 SHORT TERM SECURETIES
36 CURRENT 1967.3 2396.4 2995.4 LIABILITIES CASH RATIO 0.30 : 1 0.26 : 1 1.62 : 1WORKING NOTES: CASH AND BANK + SHORT TERM SECURITIES 2004 = 150.4 + 454.3 = 604.7 2005 = 177.8 + 453.5 = 631.3 2006 = 4558 + 512 = 5070 CURRENT LIABILITIES= REFER FROM ABOVE CALCULATION GRAPH (REFERRING THE ABOVE TABLE) 1.8 1.6 1.62 1.4 1.2 1 0.8 CASH RATIO 0.6 0.4 0.3 0.26 0.2 0 2004 2005 2006 ANALYSIS OF THE CASH RATIO OR ABSOLUTE LIQUIDITY RATIO 1. The absolute liquid ratio in 2004 was .30:1 which is less than the accepted norm i.e. .5:1. the ratio less than the standard ratio denotes that the liabilities for LUPIN is more and that its liquid assets are less
37 but all the creditors do not ask for the cash at the same time so the situation can be handled. 2. The absolute liquid ratio in 2005 was .26:1 which is very less than the accepted norm and thus the asset liquidity condition of LUPIN is not good and thus the creditors are more. 3. The absolute liquid ratio in 2006 is 1.62:1 which is very favorable for LUPIN but it is advisable that the company should try to collect funds from public more to use its ideal liquid assets on other big projects. 4. The absolute liquid ratio in 2006 is more favorable than 2004 and 2005 mainly because of the increase in the liquidity of the assets and decrease in the creditors for LUPIN. CURRENT ASSETS MOVEMENT OR EFFICIENCY/ACTIVITY RATIOSFunds are invested in various assets in business to make sales and earnprofits. The efficiency with which asserts are managed directly affect thevolume of sales. The better the management of assets, the larger is theamount of sales and the profits. Activity ratios measure the efficiency oreffectiveness with which a firm manages its resources or assets. These ratiosare also called turnover ratios because they indicate the speed rate at whichthe funds invested in inventories are converted into sale. Depending uponthe purpose a number of turnover ratios can be calculated as debtorsturnover capital turnover, etc.There are 4 types of current assets movement or efficiency ratios: I. INVENTORY OR STOCK TURNOVER RATIO. II. CREDITORS/PAYABLES TURNOVER RATIO. III. WORKING CAPITAL TURNOVER RATIO. IV. DEBTORS/RECEIVIBLES TURNOVER RATIO.EXPLAINATION
38 CREDITORS/PAYABLES TURNOVER RATIOIn the course of business operations, a firm has to make credit purchases andincur short-term liabilities. A supplier of goods i.e. creditor is naturallyinterested in finding out how much time the firm is likely to take in repayingits trade creditors. The analysis for creditor’s turnover is basically the sameas of debtor’s turnover ratio except that in place of average daily sales,average daily purchases are taken as the other component of the ratio and inplace of average daily sales; creditor’s turnover ratio can be calculated as: CREDITORS/PAYABLE TURNOVER RATIO=NET CREDIT ANNUAL PURCHASES AVERAGE TRADE CREDITORSIf the information about the credit purchases is not available, the figure oftotal purchases may be taken as the numerator and the trade creditors includesundry creditors and bills payable. If opening and closing balances of thecreditors are not known, the creditors are turned over in relation to purchase.Generally, higher the creditor’s velocity better it is or otherwise lower thecreditor’s velocity less favorable are the results.PRACTICAL CALCULATLION ON CREDITORS/PAYABLESTURNOVER RATIOCREDITORS TURNOVER RATIO=NET CREDIT ANNUAL PURCHASES AVERAGE TRADE CREDITORS TABLE YEAR 2004 2005 2006CONTENTSNET CREDIT 846.2 1192.2 1861
40 7 6.8 6 5.7 5.3 5 4 CREDITORS TURNOVER 3 RATIO 2 1 0 2004 2005 2006 ANALYSIS OF CREDITORS/PAYABLE TURNOVER RATIOS The creditor’s turnover ratio in the year 2004 was 5.7 times which indicates that velocity with which the creditors are turned over in relation to purchases is in a satisfactory position. The creditors turnover ratio in the year 2005 was 5.3 times which indicate the velocity with which the creditors are turned over in relation to purchases is in a satisfactory position. Basically the ratio should be more than 5 times.
41 The creditors turnover ratio in the year 2006 was 6.8 times which indicates that the velocity with which the creditors are turned over in relation to purchases is high which indicates a good sign for LUPIN. The creditor’s turnover ratio in the year 2004 was more that 2005 which indicates that the turn over of creditor’s rate had decreased which is not a good sign. This is mainly due to the increase in the net credit annual purchases. The creditor’s turnover ratio in the year 2006 had increased from 2005, which is a good sign for the liquidity position of LUPIN. This is mainly due to the increase in the net credit purchases. WORKING CAPITAL TURNOVER RATIOWorking capital of a concern is directly related to sales, the current assetslike debtors, bills receivables, cash, and stock, etc. change with the increaseor decrease in sales. The working capital is taken as:WORKING CAPITAL = CURRENT ASSETS-CURRENT LIABILITIESWorking capital turnover ratio indicates the velocity of the utilization of networking capital. This ratio indicates the number of times the working capitalis turned over in the course of a year. The ratio measures the efficiency with
42which the working capital is being used by the firm. The higher ratioindicated the efficient utilization of the working capital and low rationindicated otherwise. But a very high working capital turnover ratio is notgood situation for any firm and hence care must be taken while interpretingthe ratio. Making of comparative and trend analysis can use the ratio fordifferent firms in the same industry and for various periods. The ratio can becalculated as:Working capital turnover ratio = Cost of Sales_____ Average working capitalAverage working capital = Opening working capital + closing working capital 2If the figure of the cost of sale is not given then the figure of sales can beused instead. On the other hand if opening working capital is not disclosed,then working capital at the year-end will be used, In that case the ratios willbe:WORKING CAPITAL TURNOVER RATIO= _________SALES________ NET WORKING CAPITALPRACTICAL CALCULATION ON WORKING CAPITAL TURNOVERRATIOWORKING CAPITAL TURNOVER RATIO= COST OF SALES AVERAGE WORKING CAPITAL
43 TABLE YEAR 2004 2005 2006CONTENTSCOST OF SALES 11192.8 11611.3 16061AVERAGE 2638.2 2627.15 5517.75WORKINGCAPITALWORKING 2.91 times 4.41 times 4.20 timesCAPITALTURNOVERRATIOWORKING NOTES WORKING CAPITAL=CURRENT ASSETS-CURRENT LIABILITIES 2004 = 4461.7 - 1967.3 = 2494.4 2005 = 5102.5 - 2374.3 = 2728.2 2006 = 11144.8 - 2995.4 = 8149.4 AVERAGE WORKING CAPITAL= OPENING WOKING CAPITAL+CLOSING WORKING CAPITAL 2 2004 = 2242+2494.4 / 2 = 2638.2 2005 = 2494.4+2728.2 / 2 = 2627.15
44 2006 = 2728.2+8149.4 / 2 = 5517.75 NET CREDIT ANNUAL SALES = REFER FROM THE EXCEL SHEET GRAPH 4.5 4.41 4.2 4 3.5 3 2.91 2.5 W.C 2 TURNOVER RATIO 1.5 1 0.5 0 2004 2005 2006ANALYSIS OF WORKING CAPITAL TURNOVER RATIO The working capital turnover ratio in the year 2004 was 2.91 times, which is not a satisfactory ratio, and the company does not use which indicates that LUPIN is not in a good position and the working capital efficiently. The working capital turnover ratio in the year 2005 was 4.41 times which a satisfactory ratio for the company and which indicates that LUPIN is using efficiently the working capital and that the resources are efficiently being utilized.
45 The working capital turnover ratio in the year 2006 was 4.20 times which indicates the satisfactory position of LUPIN and the working capital is being reutilized efficiently more and more times by the company. The working capital turnover ratio in the year 2004 was less than 2005 mainly because of the decrease in the cost of sales and the average working capital of LUPIN. The working capital turnover ratio in the year 2005 was more than the year 2006 mainly because of the increase in the working capital and the decrease in the cost of sales of the company. I. INVENTORY/STOCK TURNOVER RATIOEvery firm has to maintain a certain level on inventory for finished goodsso as to be able to meet the requirements of the business. But the level ofinventory should neither to be too high or too low. But the level ofinventory should neither be too high nor too low. It is harmful to hold moreinventories for the following reasons. a) It unnecessarily blocks capital which can otherwise be profitability used somewhere else. b) Over stocking will require more godown space, so more rent will be paid.
46 c) There are chances of obsolescence of stocks. Consumers will prefer goods of latest design, etc. d) Slow disposal of stocks means slow delivery of cash also which will adverselu affect liquidity. e) There are chances of deterioration in quality if the stock are held for more periods.Inventory turnover ratio also known as stock velocity is normally calculatedas sales/average inventory. It would indicate whether inventory has beenefficiently used or not. The purpose is to see whether only the requiredminimum funds have been locked up in inventory. Inventory turnover ratio(I.T.R.) indicates the number of times the stock has been turn over duringthe period and evaluates the efficiency with which a firm is able to managethe inventory. Inventory turnover ratio = _cost of goods sold______ Average inventory at costPRACTICAL CALCUALTION ON INVENTORY/STOCK TURNOVERRATIOINVENTORY TURNOVER RATIO = NET SALES__ AVERAGE INVENTORY AT COST TABLE
47 YEAR 2004 2005 2006CONTENTS NET SALES 11192.8 11611.3 16061.0 AVERAGE 1785.8 2316.9 2791.85INVENTORY AT COST INVENTORT 6.26 : 1 5.01 : 1 5.75 : 1 TURNOVER RATIOWORKING NOTES NET SALES = 2004 = 11192.8 2005 = 11611.3 2006= 16061.0 AVERAGE INVENTORY AT COST=OPENING STOCK+CLOSING STOCK 2 2004 = 1418.6+2153.0 = 1785.8 2 2005 = 2153.0+2480.8 = 2316.9 2 2006 = 2480.8+3102 = 2791.85 2 GRAPH (REFERRING THE ABOVE TABLE)
48 7 6.26 6 5.75 5.01 5 4 Inventory 3 turnover ratio 2 1 0 2004 2005 2006 ANALYSIS OF THE INVENTORY/STOCK TURNOVER RATIO The inventory turnover ratio of the LUPIN in the year 2004 was 6.26:1, which is more than the standard ratio i.e. 5:1. The increased amount of ratio indicates that the sales are high but the stock is not sufficient in the company so as to meet the high demand which in turn decreases the market share. The inventory turnover ratio in the year 2005 was 5.01:1, which was very accurate, and up to the mark of the standard ratio. This ratio indicates that there was a perfect balance in LUPIN of the sales and there the market demands were timely fulfilled and there was no shortage of goods. The inventory turnover ratio in the year2006 was 5.75:1, which indicates that the sales of LUPIN were good but the stock of sales was some less than required.
49 The inventory turnover ratio decreased from 2004 to 2005 from 6.26:1 to 5.01:1, which indicates that the net sales were less and that the balance was gained between the sales and the stock in LUPIN. The inventory turnover ratio was increased from 2005 to 2006 from 5.01:1 to 5.75:1, which indicates that the the sales of the product has increased but the balance of the stocks in LUPIN has decreased.DEBTORS OR RECEIVIBLES TURNOVER RATIOA concern may sell goods on cash as well credit. Credit is one of the mostimportant elements of sales promotion. The volume of sales can be increasedbut following a liberal credit policy. But the effect of a liberal credit policymay result in tying up substantial funds of a firm in the form of trade debtors(or receivables i.e. debtors plus bills receivables). Trade debtors are expected
50to be converted into cash within a short period and are included in currentassets. Hence the liquidity position of a concern to pay its short-termobligations in time depends upon the quality of its trade debtors. Debtor’s turnover ratio indicates the velocity of debtcollection of firm. In simple words, it indicates the number of times averagedebtors (receivables) are turned over during a year, thus: DEBTORS(RECEIVIBLES)TURNOVER/VELOCITY=NET CREDIT ANNUAL SALE AVERAGE TRADE DEBTORSTRADE DEBTORS=SUNDRY DEBTORS+BILLS RECEIVIBLES AND ACCOUNTS RECEIVIBLESAVERAGE TRADE DEBTORS=OPENING TRADE DEBTORS+CLOSING TRADE DEBTOR 2PRACTICAL CALCULATION ON DEBTORS/RECEIVIBLESTURNOVER RATIODEBTORS/RECEIVIBLES TURNOVER RATIO= NET CREDIT ANNUAL SALES AVERAGE TRADE DEBTORS TABLE YEAR 2004 2005 2006CONTENTS NET CREDIT 11192.8 12611.4 16954.0ANNUAL SALES
52 1.85 1.81 1.8 1.75 1.7 debtor turnover 1.69 ratio 1.66 1.65 1.6 1.55 2004 2005 2006 ANALYSIS OF THE DEBTORS TURNOVER RATIO The ratios in the year 2004 indicate that the ratio turned over 1.69 times in a year which is satisfactory for LUPIN. The more times the ratio turnovers in a year the more efficient are it for the company. The ratio in the year 2005 indicates that the ratio turned over for 1.66 times in a year which is satisfactory for a company. The ratio in the year 2006 indicates that the ratio is turned over for 1.81 times in a year which is approximately equal to 2 times which is good for LUPIN which denotes that the management of the debtors is good as well as more liquid are the debtors. ANALYSIS OF LONG TERM FINANCIAL POSITION OR LONG TERM SOLVENCY
53The term solvency refers to the ability of a concern to meet its long-termobligations. The long-term in debt ness of a firm includes debenturesholders, financial institutions providing medium and long-term loans andother creditors selling goods on installment bases. The long-term creditors ofa firm are primarily interested in knowing the firms ability to pay regularlyinterested on long term borrowings, repayment of the principal amount at thematurity and the security of their loans. Accordingly, long-term solvencyratios indicate a firm’s ability to meet the fixed interest and costs andrepayments schedules associated with its long-term borrowings. Thefollowing ratios serve the purpose of determining the solvency of theconcern. DEBT-EQUITY RATIO. FUNDED DEBT TO TOTAL CAPIT ALISATION RATIO. PROPRIETORY RATIO OR EQUITY RATIO. SOLVENCY RATIO OR RATIO OF TOTAL LIABILITIES TO TOTAL ASSETS. FIXED ASSETS TO NET WORTH OR PROPRIETORS FUNDS RATIO. FIXED ASSETS TO LONG-TERM FUNDS OR FIXED ASSETS RATIO. RATIO OF CURRENT ASSETS TO PROPRIETOR’S FUNDS. DEBT SERVICE RATIO OR INTEREST COVERAGE RATIO. CASH TO DEBT SERVICE RATIO. (I) DEBT EQUITY RATIO
54Debt equity ratio is also known as External internal equity ratio is calculatedto measure the relative claims of outsiders and the owners against the firm’sassets. These ratios indicates the relationship between the external equitiesor the outsider’s funds and the internal equities or the share holders funds,thus: DEBT-EQUITY RATIO = OUTSIDERS FUNDS SHARE HOLDERS FUNDSThe two basic components of the ratio are outsider’s funds, i.e.., externalequities and shareholders funds, i.e. internal equities. The outsiders fundsinclude all debts/liabilities to outsiders, whether long-term or short term orwhether in the form of debentures bonds, mortgage or bills. Theshareholders funds consist of equity share capital, preference share capital,capital reserves, revenue for contingencies, sinking funds etc. theaccumulated losses and differed expenses, if any, should be deducted fromthe total to find out shareholders funds. When the accumulated losses ordiffered expenses are deducted from the shareholders funds, it is called networth and the ratio may be termed as the ratio ma be termed as debt to networth ratio. (II) FUNDED DEBT TO TOTAL CAPITALISATION RATIO
55The ratio establishes a link between the long-term funds raised fromortsiders and total long-term funds available in the business. The two wordsused in this ratio are 1. Funded debt 2. Total capitalization Funded debt or total capitalization ratio = Funded debt_____ Total capitalizationFunded debt is a part of total capitalization, which is financed by outsiders.Though there is no ‘rule of thumb’ but still the lesser the reliance onoutsiders the better it will be. If this ratio is smaller, better it will be, up to50% or 55% this ratio may be to tolerable and not beyond.PRACTICAL CALCULATION OF FUNDED DEBT TO TOTALCAPITALISATION RATIOFUNDED DEBT OR TOTAL CAPITALISATION RATIO=FUNDED DEBT TOTAL CAPITALISATION FUNDED DEBT=DEBENTURE+MORTGAGE LOANS+BONDS+OTHER LONG TERM LOANS TOTAL CAPITALISATION=EQUITY SHARE CAPITAL+PREFERENCE SHARE CAPITAL+RESERVES AND SURPLUS+OTHER UNDISTRIBUTED RESERVES+DEBENTURES+FUNDED DEBT
57 ANALYSIS OF FUNDED DEBT TO TOTAL CAPITALISATION RATIO The ratios in the year 2004-.33:1, 2005-.34:1, 2006-.46:1 indicate that LUPIN has not much relied on the outsiders for taking long-term funds and tried to raise all the finance from its own working capital. The ratio has constantly increased from 2004 to 2006 mainly due to increase in the long-term borrowings from the outsiders but in a small amount.
58 (III) PROPRIETORY RATIO OR EQUITY RATIOThe variant to the debt-equity ratio is the proprietary, which is also known asEquity Ratio or shareholders to total equities ratio or net worth to totalassets ratio. The ratio establishes the relationship between shareholdersfunds to total assets of the firm. The ratio of proprietor’s funds to total fundsis an important ratio for determining long-term solvency of a firm. Thecomponents of this ratio are shareholders funds or proprietor’s funds andtotal assets. The shareholders funds are equity share capital, preference sharecapital, undistributed profits, reserves and surpluses. Ort of this amount,accumulated losses should be deducted. The total assets on t he other handdenote total resources of the concern. The ratio can be calculated as under: PROPRIETORY RATIO OR EQUITY RATIO=SHAREHOLDERS FUNDS TOTAL ASSETSPRACTICAL CALCULATION OF EQUITY OR PROPRIETORY RATIO EQUITY RATIO = SHAREHOLDERS FUNDS TOTAL ASSETS TABLE
60 (REFERRING THE EQUITY RATIO TABLE) 0.5 0.45 0.46 0.44 0.4 0.35 0.36 0.3 0.25 EQUITY RATIO 0.2 0.15 0.1 0.05 0 2004 2005 2006ANALYSIS OF THE PROPRIETORY RATIO OR EQUITY RATIO The long-term financial position of LUPIN the company in the year 2004 was not so good but it gradually increased in the year 2005 due to the decrease of the total assets. The ratio in the year 2006 was more than the year 2005 because of the more decreasing in the assets. The more is the equity ratio the more is the liquidity position of the company.
61 (IV) SOLVENCY RATIO OR THE RATIO OF TOTAL LIABILITIES TO TOTAL ASSETSThis ratio is a small variant of equity ratio and can be simply calculated as100-equity ratio i.e., continuing the example taken for the equity ratio,solvency ratio = 100-66.7% or say 33.33%. The ratio indicates therelationship between the total liabilities to outsiders to total assets of a firmand can be calculated as follows: SOLVENCY RATIO=TOTAL LIABILITIES TO OUTSIDERS TOTAL ASSETSGenerally, lower the ratio of total liabilities to total assets, more satisfactoryor stale is the long-term solvency position of a firm.
62 PRACTICAL CALCULATION FOR SOLVENCY RATIO OR THE RATIO IF TOTAL LIABILITIES TOTOTAL ASSETSSOLVENCY RAITO= TOTAL LAIBILITIES TO OUTSIDERS / TOTAL ASSETS TABLE YEAR 2004 2005 2006CONTENTSTOTAL 11404.8 6328 6275.5LIABILITIES TOOUTSIDERSTOTOAL ASSETS 17820 11300 9805.5SOLVENCY .54 .44 .42RATIO GRAPH (REFERRING THE SOLVENCY RATIO TABLE)
63 0.6 0.54 0.5 0.44 0.42 0.4 0.3 SOLVENCY RATIO 0.2 0.1 0 2004 2005 2006ANALYSIS OF SOLVENCY RATIO OR THE RATIO OF TOTAL LIABILITIES TO TOTAL ASSETS The solvency ratio in the year 2004 was .54 which is not sufficient for LUPIN to for the long-term solvency position of the firm. The solvency ratio in the year 2005 was less than the year 2004 mainly due to the decrease in the assets. Thus the ratio .44 in the year 2005 is satisfactory. The solvency ratio in the year 2006 was less than 2005 which indicates the great financial position of LUPIN.(V) FIXED ASSETS TO NET WORTH RATIO OR FIXED ASSETS TO PROPRIETORS FUNDS
64The ratio establishes the relationship between fixed assets and shareholdersfunds, i.e., share capital plus reserves, surpluses and retained earnings. Theratio fcan be calculated as follows:FIXED ASSET TO NET WORTH RATIO=FIXED ASSETS SHAREHOLDERS FUNDSThe ratio of the fixed assets to net worth indicates the extent to whichshareholders funds are sunk into the fixed assets. Generally the purchase offixed assets should be financed by shareholders equity including reserves,surpluses and retained earnings.PRACTICAL CALCULATIO ON FIXED ASSET TO NET WORTHRATIOFIXED ASSET TO NET WORTH RATIO=FIXED ASSET SHAREHOLDERS FUNDS TABLE YEAR 2004 2005 2006CONTENTSFIXED ASSET 5343.8 6287.5 6676.1SHAREHOLDERS 6439.5 5005 4480.3FUNDSFIXED ASSET TO .82 1.25 1.49NET WORTHRATIO GRAPH OF THE FIXED ASSET TO NET WORTH RATIO
65 1.6 1.49 1.4 1.25 1.2 1 0.8 0.82 fixed assets to net worth ratio 0.6 0.4 0.2 0 2004 2005 2006 INTERPRETATION The ratio in the year 2004, 2005 and 2006 indicates that the net worth ratio of the company is good and that the company has sufficient fixed assets and that the share holders are less than the fixed assets in the organization. The ratio in 2004 is .82:1 indicates that the there are sufficient fixed assets with the company. The ratio in 2005 is 1.25:1 indicates that the company does not have the sufficient fixed assets and the company has to depend more on the public funds for sufficient working capital. The ratio in 2006 is 1.45:1 which is not at all satisfactory and thus the company has to depend totally on the shareholders for sufficient working capital.
66 RATIO OF CURRENT ASSETS TO PROPRIETORY’S FUNDSThe ratio is calculated by dividing the total of current assets by the amountof shareholders funds.RATIO OF CURRENT ASSETS TO PROPRIETORY’S FUNDS = CURRENT ASSETS SHAREHOLDERS FUNDSThe ratio indicates the extent to which proprietor’s funds are invested incurrent assets. There is no ‘rule of thumb’ for this ratio and depending uponthe nature of the business there may be different ratios for different firms.PRACTICAL CALCULATLION ON RATIO OF CURRENT ASSETS TO PROPRIETORY FUNDS RATIO OF CURRENT ASSETS TO PROPRIETORY’S FUNDS=CURRENT ASSET SHAREHOLDERS FUNDS TABLE YEAR 2004 2005 2006CONTENTSCURRENT 4461.7 5102.5 11144.8ASSETSSHAREHOLDERS 6439.5 5005 4480.3FUNDSNET WORTH .69 : 1 1.01 : 1 2.48:1RAITO
67 GRAPH(REFERRING THE ABOVE TABLE OF CURRENT ASSETS TO PROPRIETORY FUNDS) 2.5 2.48 2 1.5 NET WORTH 1 1.01 RATIO 0.69 0.5 0 2004 2005 2006 INTERPRETATION The ratio in the year 2004 and 2005 is satisfactory as the main part of the proprietor’s funds are invested in the current asserts through which the production increases and thus the profit also increases. The ratio in 2006 indicates that the funds are invested in the current assets also but a large part of the assets are remaining idle and LUPIN has to use its own capital more as due to the less amount of public funds as compared to the current assets.
68 (VII) DEBT SERVICE RATIO OR INTEREST COVERAGE RATIONet income to debt service ratio or simple debt service ratio is used to testthe debt servicing capacity of a firm. The ratio is also known as interestcoverage ratio or coverage ratio or fixed charges cover or times interestearned. This ratio is calculated by dividing the net profit before interest andtaxes by fixed interest charges:DEBT SERVICE RATIO/INTEREST COVERAGE= __NET PROFIT________ FIXED INTEREST CHARGES PRACTICAL CALCULATION OF DEBT SERVICE RATIO/INTEREST COVERAGEDEBT SERVICE RATIO/INTEREST COVERAGE= __NET PROFIT________ FIXED INTEREST CHARGES TABLE YEAR 2004 2005 2006CONTENTSNET PEOFIT 1481.1 578.9 2299FIXED 515.1 273.1 303INTERESTCHARGESDEBT SERVICE 2.87 2.11 7.58RATIOVALUES ARE FROM THE BALANCE SHEET
69 GRAPH (REFERRING THE DEBT SERVICE TABLE) 8 7.58 7 6 5 4 DEBT SERVICE RATIO 3 2.67 2 2.11 1 0 2004 2005 2006 INTERPRETATION In the year 2004 and 2005 the ratio is satisfactory for the company as well as for the long-term creditors because even if the earnings of the firm’s earnings fall then also LUPIN will be in the position to pay the interest. In the year 2006 the ratio is not satisfactory for the company as well for the shareholders as it implies that LUPIN is not using debt as a source of finance so as to increase the earnings per share.
70 ANALYSIS OF PROFITABILITY OR PROFITABILITY RATIOSThe primary objective of the business undertaking is to earn profit. Profitearning is considered essential for the survival of the business. In the worksof Lord Kenyes, “Profit is the engine that drives the business enterprise”. Abusiness needs profits not only for its existence but also for expansion anddiversification. The investors want an adequate return on their investments,workers want higher wages, creditors want higher security for their interestand loan and so on. A business enterprise can discharge its obligations to thevarious segments of the society only through earning of profits. Profits arethus a useful measure of overall efficiency of a business. Profits to themanagement are the test of efficiency and a measurement of control; toowners, a measure of worth of their investment to the creditors etc.Generally, the profitability ratios are calculated either in the relation of theirsales or in relation to investment. The various profitability ratios arediscussed. GENERAL PROFITABILITY RATIO 1. GROSS PROFIT RATIO 2. OPERATING RATIO 3. OPERATING PROFIT RATIO 4. EXPENSES RATIO 5. NET PROFIT RATIO OVERALL PROFITABLITY RATIOS 1. RETURN ON SHAREHOLDERS INVESTMENT OR NET WORTH RATIO 2. RETURN ON EQUITY CAPITAL RATIO 3. EARNING PER SHARE RATIO 4. RETURN ON CAPITAL EMPLOYED RATIO 5. CAPITAL TURNOVER RATIO 6. DIVIDEND YIELD RATIO 7. DIVIDEND PAYOUT RATIO 8. PRICE EARNING RATIO
71 GROSS PROFIT RATIO Gross profit ratio measures the relationship of gross profit to net sales and is usually represented as percentage. Thus it is calculated by dividing the gross profit by sales GROSS PROFIT RATIO =GROSS PROFIT X 100 NET SALES PRACTICAL CALCULATION ON GROSS PROFIT RATIOGROSS PROFIT RATIO =GROSS PROFIT X 100 NET SALES GROSS PROFIT= SALES – COST OF GOODS SOLD NET SALES=SALES – EXISE DUTY TABLE 2004 2005 2006 YEARCONTENTS 1996.2 852 2302GROSS PROFITNET SALES 11192.8 11611.3 16061GROSS PROFIT 17.83% 7.33% 14.33%RATIO(%)
72 GRAPH (REFERRING THEGROSS PROFIT TABLE) 18 17.83 16 14 14.33 12 10 GROSS 8 PROFIT 7.33 RATIO(% ) 6 4 2 0 2004 2005 2006 INTERPRETATION The ratio in 2004 and 2006 are satisfactory as the company is in the position to sell its product at a low price without resulting in losses on operations of a firm. But the ratio in 2005 is not at all satisfactory for LUPIN and a low ratio indicates that the high cost of goods sold due to unfavorable purchasing policies, lesser sales, lower selling prices, excessive competition, over-investment in plant and machinery, etc. OPERATING RATIO
73Operating ratio establishes the relationship between cost of goods sold andother operating expenses on the one hand and the sales on the other. In otherwords, it measures the cost of the operating per rupee of sales. The ratio iscalculated by dividing operating costs with the net sales and its generallyrepresented as a percentage.OPERATING RATIO= OPERATING COST X 100 NET SALESThe two basic elements of this ratio are operating cost and net sales.Operating cost can be founded by adding operating expenses to the cost ofgoods. PRACTICAL CALCULATION ON OPERATING RATIO OPERATING RATIO= OPERATING COST X 100 NET SALES OPERATING COST= OPERATING EXPENSES+COST OF GOODS SOLD NET SALES=GROSS SALES-EXISE DUTY TABLE YEAR 2004 2005 2006CONTENTSOPERATING 10196.4 10522.6 14263.1COSTNET SALES 11648.3 11799 16061.0OPERATING 87.53% 89.18% 88.80%
74RATIO(%) GRAPH (PREFERRING THE TABLE OF OPERATING RATIO) 89.5 89.18 89 88.8 88.5 88 OPERATING RATIO (% ) 87.5 87.53 87 86.5 2004 2005 2006 INTERPRETATION The ratios in 2004, 2005 and 2006 are satisfactory as the favorable rations are considered between 80 to 90%. This shows that the operating efficiency of LUPIN in these three years is good and that it has the margin to cover the interest, income tax, dividend and reserves. The ratio in 2004 is the most favorable operating ratio in all the three years.