Importance of Ratio Analysis• It presents facts on a comparative basis andenables the drawing of inferences regardingthe performance of the firm.• It is relevant in assessing the performanceof a firm in respect of:– Liquidity position.– Long term solvency.– Operating efficiency.– Overall profitability.– Inter-firm comparison.– Trend analysis.
Limitation of Ratio Analysis• Difficulty in comparison:– Situations of two firms are never the same, theymay be operating in different situations.– Industry averages are not easily available.• Impact of inflation:– As financial statements are based on historicalcosts, price level changes due to inflation arenever considered.• Conceptual Diversity.– Difference of opinion of the various conceptsused to compute the ratios.
Liquidity Ratios• Current Ratio:• Acid Test Ratio:Current AssetsCurrent LiabilitiesQuick AssetsCurrent Liabilities – Bank Overdraft
Liquidity Ratios• Cash Ratio:Cash & Bank Balances + Current InvestmentsCurrent Liabilities
Profitability Ratios• Return on Assets:• Earning Power:Profit after taxAverage total assetsProfit before interest & taxAverage total assets
Profitability Ratios• Return on Capital Employed:*NOPAT (net operating profit after tax)• Return on Equity:Profit before interest & tax (1-tax rate)*Average total assetsEquity earningsAverage equity
Profitability Ratios• Earnings per share :• Dividends per share:Equity earningsNo. of equity shares issuedDividendsNo. of equity shares issued
Profitability Ratios• Dividend Pay-out Ratio :Dividend Per ShareEarnings Per Share
Valuation Ratios• Price-earnings Ratio:• Yield:Market Price Per ShareEarnings Per ShareDividend + Price ChangeInitial Price
Valuation Ratios• Market Value to Book Value:Market value per shareBook value per share