2. Financial Analysis
• Assessment of the firm’s past, present and future financial
conditions
• Done to find firm’s financial strengths and weaknesses
• Primary Tools:
• Financial Statements
• Comparison of financial ratios to past, industry, sector and all
firms
4. Objectives of Ratio Analysis
• Standardize financial information for comparisons
• Evaluate current operations
• Compare performance with past performance
• Compare performance against other firms or
industry standards
• Study the efficiency of operations
• Study the risk of operations
5. Measurement of liquidity
The liquidity level of the firm should be measured time to
time in order to:
i. Identify liquidity shortages or surpluses
ii. Compare liquidity position of the firm with other firms
in the same industry
Financial statements( B/S and P&L A/C) can be used to
measure the liquidity of a firm by calculating financial
ratios
10. Classification of Ratios
Balance Sheet Ratio P&L Ratio or Income/Revenue
Statement Ratio
Balance Sheet and Profit &
Loss Ratio
Financial Ratio Operating Ratio Composite Ratio
Current Ratio
Quick Asset Ratio
Proprietary Ratio
Debt Equity Ratio
Gross Profit Ratio
Operating Ratio
Expense Ratio
Net profit Ratio
Stock Turnover Ratio
Fixed Asset Turnover Ratio,
Return on Total Resources Ratio,
Return on Own Funds Ratio,
Earning per Share Ratio, Debtors’
Turnover Ratio,
11. Calculation and classification of ratios
• Operations and financial position of a firm can be described by studying its
profitability, long term and short term liquidity position and its operational
activities.
• Thus ratios can be classified as:
1. Liquidity ratios
2. Activity ratios
3. Leverage ratios
4. Profitability ratios
12. Liquidity ratios
• Liquidity refers to maintenance of cash, bank balance and those assets which are
easily convertible into cash in order to meet the liabilities
• Liquidity ratios study the firm’s short term solvency and its ability to pay off
liabilities.
• They may be termed as balance sheet ratios because the information required
for their calculation is available in the balance sheet only.
• Some of the common liquidity ratios are:
1. Current ratio
2. Quick/Acid Test/Liquid ratio
3. Absolute liquidity/Super quick/cash ratio
4. Defensive interval ratio
5. Current assets to fixed assets ratio
13. Current ratio= Current Assets/Current Liabilities
Also known as working capital ratio, Standard = 2:1
14. Accounting ratios are important tools used by:
A. Managers
B. Researchers
C. Investors
D. All of the above
15. Quick Ratio (QR)
QR = Liquid assets / Current Liabilities
QR = Liquid assets / Quick Liabilities
Inventory, pre exp,
overdraft
16. Liquid ratio is also termed as:
A. Cash ratio
B. Absolute liquidity ratio
C. Acid test ratio
D. None of these
17. •Standard Quick Ratio 1:1
Total CA of Rs. 500000 includes inventory Rs.
150000 and total CL Rs. 200000 includes bank
overdraft Rs. 50000 then calculate QR.
https://www.youtube.com/watch?v=BCaoQNkeoy0
18. Debtors 900000 Creditors 280000
Stock 800000 Overdraft 170000
Cash 250000 Debentures 700000
Land 370000 Tax Provision 600000
S. Capital 400000 Prep. Exp. 30000
Reserves 180000 Bills Payable 130000
Calculate Quick Ratio
19. Cash 70000 Bank Overdraft 25000
Debtors 80000 Creditors 20000
Stock 75000 Bills Payable 90000
Prepaid Exp. 10000 Tax Provision 10000
Marketable Sec. 50000 O/S Exp. 15000
Other CA 65000
Calculate : Current ration, Quick ratio
20. Current liabilities are payable in:
A. 1to 3 yrs
B. 1 to 5 yrs
C. Less than 1 yr
D. Less than 3 yrs
21. • Liquidity ratios help in analyzing the cash position of the firm
True
False
23. • Ratios calculated for a firm can be used in comparison with other
firms.
True
False
24. Absolute Liquidity Ratio:
Super Quick Ratio/Cash Ratio/Cash Reservoir Ratio
Cash Ratio = Cash and Bank + Marketable Securities
Total Current Liabilities
25. Debtors 900000 Creditors 280000
Stock 800000 Overdraft 170000
Cash 250000 Debentures 700000
Land 370000 Tax Provision 600000
S. Capital 400000 Prep. Exp. 30000
Reserves 180000 Bills Payable 130000
Calculate Cash Ratio
26. Q. A current ratio of less than one means:
A. Current liabilities < Current assets
B. Fixed assets > Current assets
C. Share capital > Current assets
D. Current assets < Current liabilities
27. Defensive Interval Ratio
Instead of looking at the firm’s liquid assets, it is better to measure whether the
liquid assets are large enough relative to the firm’s regular cash outgoing.
Defensive Interval Ratio=Total Defensive Assets/Projected daily cash requirements
=Total Liquid Assets /Projected daily cash requirements
= Cash+Bank+Debtors+Marketable Securities /Projected daily cash requirements
=Current Assets-Inventory-Prepaid Expenses /Projected daily cash requirements
Projected daily cash requirements= COGS+ Gen. Expenses- Depreciation
28. •Current Assets to Fixed Assets Ratio:
CA to FA Ratio = Current Assets / Fixed Assets
Higher CA to FA ?
Lower CA to FA ?
29. Significance of Liquidity Ratios
In terms of consequensive
• Inability to meet commitments ,thus loosing goodwill and
creditworthiness
• Loosing profitable opportunities
Liquidity ratios – short term creditors
30. Q. Suppliers and Creditors of a firm are interested in:
A. Profitability position
B. Liquidity position
C. Market share position
D. Debt position
