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RATIO ANALYSIS – A TOOL OF FINANCIAL ANALYSIS

RATIO ANALYSIS – A TOOL OF FINANCIAL ANALYSIS

- 1. PROJECT WORK PRESENTATION ON RATIO ANALYSIS – A TOOL OF FINANCIAL ANALYSIS NAME : JIGAR THAKKAR ADMISSION NO. : HPGD/JL20/2449 SPECIALISATION : FINANCE MANAGEMENT PRIN. L.N. WELINGKAR INSTITUTE OF MANAGEMENT DEVELOPMENT & RESEARCH YEAR OF SUBMISSION : JUNE,2021
- 2. TABLE OF CONTENT Sr. No. Pg. No 1 1 2 3 3 5 4 6 5 6 6 7 7 9 8 10 9 11 10 12 11 13 12 14 13 16 14 17 15 18 16 19 Importance of Ratio Analysis Advantages of Ratio Analysis Conclusion Bibliography Limitastions of Ratio Anaylsis Leverage Ratios Liquidity Ratios Profitability Ratios Turnover or Assest Utilization Ratios Valuations Ratios Introduction Defination Objectives Procedure Key Terms Classification Particulars
- 3. INTRODUCTION Ratio analysis allows the interested parties like Shareholders, investors, creditors, government, and bankers to come to a conclusion about the company’s performance. The appraisal of the ratio will make a proper analysis of the strength and weaknesses of the firms. The ratio calculation is an easy and straightforward task, but the appropriate analysis and interpretation can be made only by exposure. While interpreting the financial data the analyst has to be careful about the limitations imposed by the accounting concepts and methods. Ratio analysis is helpful in providing valuable insight when a company is in a financial position. 1
- 4. WHAT IS RATIO ANALYSIS ? • The term ratio is used to describe the relationships between figures in a balance sheet or in a profit and loss account or in a budgetary control system or in any other part of the accounting organization. The accounting ratio indicates the quantitative relationship which is used for analysis and decision making. It gives data for analysis of inter-firm and intra-firm comparisons. A ratio is a quotient of two numbers and the relation expressed between two accounting figures is known as the `accounting ratio’. Ratio analysis is a very powerful analysis tool useful for measuring the performance of an organization. The ratio analysis concentrates on the internal relationship among the figures in the financial statement. The analysis helps the management to make future projections on the basis of the past records. 2
- 5. DEFINITIONS “Ratio is a yardstick used to evaluate the financial condition and performance of a firm, relating two pieces of financial data to each other.” - James C. Van Harne “Ratio is a fraction whose numerator is the antecedent and denominator the consequent.” - H.G. Guthmann “Ratio is the relationship or proportion that one amount bears to another, the first number being the numerator and the later denominator.” - H.G. Guthmann Ratio analysis is a quantitative method of gaining insight into a company's liquidity, operational efficiency, and profitability by studying its financial statements such as the balance sheet and income statement. Ratio analysis is a cornerstone of fundamental equity analysis. “The relation of one amount, a to another b, expressed as the ratio of a to b”. - Kohler 3
- 6. 4
- 7. OBJECTIVES OF RATIO ANALYSIS Ratio analysis is indispensable part of interpretation of results revealed by the financial statements. It provides users with crucial financial information and points out the areas which require investigation. Ratio analysis is a technique which involves regrouping of data by application of arithmetical relationships, though its interpretation is a complex matter. It requires a fine understanding of the way and the rules used for preparing financial statements. Once done effectively, it provides a lot of information which helps the analyst: 1. To know the areas of the business which need more attention; 2. To know about the potential areas which can be improved with the effort in the desired direction; 3. To provide a deeper analysis of the profitability, liquidity, solvency and efficiency levels in the business; 4. To provide information for making cross-sectional analysis by comparing the performance with the best industry standards; and 5. To provide information derived from financial statements useful for making projections and estimates for the future. 5
- 8. PROCEDURE FOR COMPUTATION OF RATIOS Generally, ratio analysis involves four steps for procedure for computation of ratios: (i) Collection of relevant accounting data from financial statements. (ii) Constructing ratios of related accounting figures. (iii) Comparing the ratios thus constructed with the standard ratios which may be the corresponding past ratios of the firm or industry average ratios of the firm or ratios of competitors. (iv) Interpretation of ratios to arrive at valid conclusions. KEY TERMS I. Budgeting II. Window-dressing III. Profitability ratios IV. Liquidity ratios V. Activity ratios VI. Solvency ratios VII. Trend analysis 6
- 9. Ratio analysis is a commonly used tool for financial statement analysis. A ratio is a mathematical relationship between one number to another number. For exhaustive financial analysis, experts classify financial ratios into the following five groups: 1. Structural or debt utilization ratios :- Debt, or leverage, ratios measure the firm’s ability to repay long-term debt. 2. Liquidity ratios :- Liquidity ratios measure the availability of cash to pay debt. 3. Profitability ratios :- Profitability ratios measure the firm’s use of its assets and control of its expenses to generate an acceptable rate of return. 4. Turnover or asset utilization ratio :- Turnover or Asset Utilization ratios, also called efficiency ratios, measure the effectiveness of a firm’s use of resources, or assets. 5. Valuation ratios :- Valuation ratios are concerned with shareholder audiences. They measure the cost of issuing stock and the relationship between return and the value of an investment in company’s shares. CLASSIFICATION 7
- 10. Leverage Ratios Liquidity Ratios Profitability Ratios Turnover or Asset Utilization Ratios Valuation Ratios Funded Debt to Capitalization Current Ratio Gross Profit Margin Receivables Turnover Yield Debt to Equity Quick Ratio Operating Profit Margin Ratio Average Collection Period Price Earnings Ratio Interest Coverage Ratio Net Profit Margin Ratio Inventory Turnover Market Value/ Book Value Ratio Fixed Charges Coverage Ratio Return on Assets Ratio Fixed Assets Turnover Price to Sales Ratio Return on Equity Ratio Total Assets Turnover Price to Book (P/B) Ratio 8
- 11. 1. LEVERAGE RATIOS A leverage ratio is any one of several financial measurements that assesses the ability of a company to meet its financial obligations. Common leverage ratios include the debt-equity ratio, equity multiplier, degree of financial leverage, and consumer leverage ratio. Banks have regulatory oversight on the level of leverage they can hold. Too much debt can be dangerous for a company and its investors. Some important Leverage Ratio is given below: A. Funded Debt to Capitalization B. Debt to Equity C. Interest Coverage Ratio D. Fixed Charges Coverage Ratio 9
- 12. 2. LIQUIDITY RATIOS Liquidity ratios measure the adequacy of current and liquid assets and help evaluate the ability of the business to pay its short-term debts. The ability of a business to pay its short-term debts is frequently referred to as short-term solvency position or liquidity position of the business. Generally a business with sufficient current and liquid assets to pay its current liabilities as and when they become due is considered to have a strong liquidity position and a businesses with insufficient current and liquid assets is considered to have weak liquidity position. Short-term creditors like suppliers of goods and commercial banks use liquidity ratios to know whether the business has adequate current and liquid assets to meet its current obligations. Two commonly used liquidity ratios are given below: A. Current ratio or working capital ratio B. Quick ratio or acid test ratio 10
- 13. 3. PROFITABILITY RATIOS Profit is the primary objective of all businesses. All businesses need a consistent improvement in profit to survive and prosper. A business that continually suffers losses cannot survive for a long period. Profitability ratios measure the efficiency of management in the employment of business resources to earn profits. These ratios indicate the success or failure of a business enterprise for a particular period of time. Profitability ratios are used by almost all the parties connected with the business. Following are the categories of profitability ratio A. Gross profit (GP) ratio B. Operating Profit Margin ratio C. Net Profit Margin Ratio D. Return on Assets Ratio E. Return on Equity Ratio 11
- 14. 4. TURNOVER OR ASSEST UTILIZATION RATIOS Turnover or Asset utilization ratios measure the efficiency of a firm or company in generating revenues by converting its production into cash or sales. Generally a fast conversion increases revenues and profits. Activity ratios show how frequently the assets are converted into cash or sales and, therefore, are frequently used in conjunction with liquidity ratios for a deep analysis of liquidity. Some important activity ratios are: A. Receivables turnover ratio B. Average collection period C. Inventory turnover ratio D. Fixed assets turnover ratio E. Total Asset turnover ratio 12
- 15. 5. VALUATION RATIOS Valuation ratios are some of the most commonly quoted and easily used ratios for analyzing the attractiveness of an investment in a company. These measures primarily integrate a company’s publicly traded stock price to give investors an understanding of how inexpensive or expensive the company is in the market. In general, the lower the ratio level, the more attractive an investment in a company becomes. Often, analysts will take the reciprocal of a valuation ratio, or its multiple, as a measure of relative value. Some important activity ratios are: A. Yield B. Price Earnings Ratio C. Market Value/ Book Value Ratio D. Price to sales Ratio E. Price to Book Ratio 13
- 16. IMPORTANCE OF RATIO ANALYSIS The major importance that arise from ratio analysis are as follows : 1. Ratio analysis is a very powerful analytical tool, useful for measuring the performance of an organization. 2. Ratio analysis concentrates on the inter-relationship among the figures appearing in the financial statements. 3. Ratios make comparison easy. The said ratio is compared with the standard ratio and this shows the degree of efficient utilization of assets, etc. 4. The results of two companies engaged in the same business can be easily compared (inter-firm comparison) with the help of ratio analysis. 5. Short-term liquidity position and long-term solvency position can be easily ascertained with the help of ratio analysis. 14
- 17. 6. Ratio analysis helps the management to analyze the past performance of the firm and to make further projections. 7. Ratio analysis allows interested parties to make an evaluation of certain aspects of the firm’s performance. 8. Its importance lies in analyzing the probable casual relationship between two past results. 9. By effectively using the ratios, one can find out the growth or decline of an enterprise with the help them, and future actions can be taken. 10. Ratio analysis helps the management to analyze the past performance of the firm and to make further projections. 11. Ratio analysis allows interested parties, like shareholders, investors, creditors, and analysts to make an evaluation of certain aspects of a firm’s performance. 12. The appraisal of the ratios will make a proper analysis of the strengths and weaknesses of the firm’s operations. 15
- 18. ADVANTAGES OF RATIO ANALYSIS Ratio analysis is widely used as a powerful tool of financial statement analysis. It establishes the numerical or quantitative relationship between two figures of a financial statement to ascertain strengths and weaknesses of a firm as well as its current financial position and historical performance. It helps various interested parties to make an evaluation of certain aspect of a firm’s performance. The following are the principal advantages of ratio analysis: I. Forecasting and Planning II. Budgeting III. Measurement of Operating Efficiency IV. Communication V. Control of Performance and Cost: VI. Inter-firm Comparison VII. Indication of Liquidity Position VIII. Indication of Long-term Solvency Position IX. Indication of Overall Profitability X. Signal of Corporate Sickness 16
- 19. LIMITATIONS OF RATIO ANALYSIS The technique of ratio analysis is a very useful device for making a study of the financial health of a firm. But it has some limitations which must not be lost sight of before undertaking such analysis. Some of these limitations are: I. Limitations of Financial Statements: II. Historical Information: III. Different Accounting Policies: IV. Lack of Standard of Comparison: V. Quantitative Analysis: VI. Window-Dressing: VII. Changes in Price Level: VIII. Causal Relationship Must: IX. Ratios Account for one Variable: X. Seasonal Factors Affect Financial Data: 17
- 20. CONCLUSION Ratio Analysis is the basic tool of financial analysis and Financial analysis itself is an important part of any business planning process as SWOT ,being basic tool of the strategic analysis plays a vital role in a business planning process and no SWOT analysis would be complete without an analysis of companies financial position. In this way Ratio Analysis is very important part of whole business strategic planning. Accounting ratios are very helpful in analyzing any company’s performance but on the flip side, these ratios calculated using balance sheet on a specific date. As such, may not reflect the financial position of the company during other periods of the year. Hence, it is always better for the analyst to do the in-depth analysis of the company’s performance rather to only rely on ratios. 18
- 21. BIBLIOGRAPHY https://www.investopedia.com/articles/stocks/06/ratios.asp https://www.investopedia.com/terms/l/leverageratio.asp#:~:text=are%20discussed%2 0below.- ,A%20leverage%20ratio%20is%20any%20one%20of%20several%20financial%20measu rements,output%20will%20affect%20operating%20income. https://old.mu.ac.in/wp-content/uploads/2014/04/Accountancy-Paper-III-Advance- Financial-Management-Final-Book.pdf 19
- 22. THANK YOU

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