Financial Analysis tool containing all four types of ratios (liquidity ratio, capital structure or leverage ratio, turnover or activity ratio and profitability ratio)
2. Ratio Analysis is a form of Financial Statement Analysis that is
used to obtain a quick indication of a firm's financial
performance in several key areas.
Lets see how it is calculated and what the objective of this
calculation is ?
a. Calculation basis
A relationship expressed in mathematical terms
Between two individual figures or group of figures
Connect with each other in some logical manner
Selected from financial statements of the concern
RATIO ANALYSIS
3. Objective for financial ratios is that all the stakeholders
(owners, investors, lenders, employees etc.) can draw
conclusion about the
Performance(present, past and future)
Strength & weaknesses of a firm
Can take decisions in relation to firm
OBJECTIVE:
4. The ratios can be classified into the following four broad
categories :
i. Liquidity Ratios
ii. Capital Structure/Leverage Ratios
iii. Turnover or Activity Ratios
iv. Profitability Ratios
TYPES OF RATIOS
5. These are those ratios which are computed to evaluate
the capacity of the entity to meet its short term
liabilities. Commonly used liquidity ratios are :
a. Current Ratio
b. Quick Ratio
c. Absolute Liquidity Ratio
LIQUIDITY RATIOS
6. Most common measure of short-term liquidity also known as
the working capital ratio because net working capital is the
difference between current assets and current liabilities
Where,
Current Assets = stock + sundry debtors + cash and bank +
Receivables + Disposable investments + Loan & Adv.
Current Liabilities = Creditors + Short Term Loans + Overdraft
+ Outstanding Exps. + Prov. For tax + Unclaimed dividend
CURRENT RATIO
Current Ratio =
Current Assets
Current Liabilities
Ideal 2 : 1
7. The Quick ratio is sometimes called as the “acid” test ratio
and is one of the best measure of liquidity.
Quick Ratio =
Quick Assets
Current Liabilities
Where,
Quick Assets = Current Assets − Inventories
Current Liabilities = As discussed in current ratio
QUICK RATIOS
Ideal 1 : 1
8. The absolute liquidity ratio measures the absolute liquidity of the
business. This ratio only considers the absolute liquidity available
with the firm.
Absolute Liquidity Ratio =
Cash + Marketable Securities
Current Liabilities
Where,
Marketable Securities = These are financial instruments that can
be easily converted to cash such as government bonds, common
stock or certificates of deposit.
ABSOLUTE LIQUIDITY RATIO
Ideal 0.5 : 1
9. Capital structure/leverage ratio may be defined as those
ratios which measure the long term stability and structures of
the firm.
a. Debt Equity Ratio
b. Proprietary Ratio
c. Capital Gearing Ratio
d. Fixed Asset Ratio
CAPITAL STRUCTURES/LEVERAGE
RATIOS
10. This ratio reflects the long-term financial position of a firm
and is calculated in the form of relationship between
external equities or outsider funds and internal equities or
shareholders fund.
Debt-Equity Ratio =
Debt
Equity
Where,
Debt = Debentures + Loans + Other long term liabilities
Equity = Eq. share capital + Pref. share capital + Reserve &
surplus
DEBT EQUITY RATIO
Ideal 2 : 1
11. This ratio indicates the relationship between proprietor’s
fund and total assets
Proprietary Ratio =
Shareholder′s fund
Total Assets
Where,
Shareholders fund = Eq. share capital + Pref. Share capital +
reserve and surplus – (Loss + Fictitious Asset)
PROPRIETARY RATIO
Ideal 1 : 3
12. This ratio establishes the relationship between fixed cost
bearing capital.
Capital Gearing Ratio =
Eq. share capital+Reserve & surplus
pref.capital+Int. Bearing Finance
Where,
Interest Bearing Finance = Debentures + Long Term Loan
CAPITAL GEARING RATIO
13. This ratio specifically measures how able a company is to
generate net sales from fixed-asset investments, namely
property, plant and equipment, net of depreciation.
Fixed Asset Ratio =
Net Fixed Asset
Shareholders fund+Long Term Liability
Where,
Net Fixed Asset = Total Fixed Asset – Depreciation
FIXED ASSETS RATIO
Ideal >1
14. These ratios are employed to evaluate the efficiency with
which the firms manages and utilizes its asset. For this reason,
they are often called as ‘Asset management ratio’.
a. Stock Turnover Ratio
b. Debtor Turnover Ratio
c. Creditor Turnover Ratio
d. Working Capital Turnover Ratio
TURNOVER OR ACTIVITY RATIOS
15. This ratio is also known as inventory turnover ratio. This ratio
establishes relationship between cost of goods sold during a
given a period and the average amount of inventory carried
during that period.
Stock Turnover Ratio =
Cost of goods sold
Average Stock or Inventory
Where,
Cost of Goods Sold = Sales – Gross Profit
Average Inventory = (Opening Stock + Closing Stock)/2
STOCK TURNOVER RATIO
16. This ratio is also known as Receivables Turnover Ratio. It
establishes relationship between net credit sales and average
debtors of the year.
Debtor Turnover Ratio =
Net Credit Sales
Average Debtors
Where,
Net Credit Sales = Sales ― Cash ― Sales Return
Average Debtors =
Opening Debtors +Closing Debtors
2
DEBTOR TURNOVER RATIO
17. This ratio indicates the number of times the payables rotates in
a year or the velocity with which the payment for credit
purchases are made to creditors.
Creditor Turnover Ratio =
Net Credit Purchase
Average Creditors
Where,
Net Credit Purchases = Total Purchases ― Cash Purchases ―
Purchases Return
CREDITOR TURNOVER RATIO
18. This ratio indicates the velocity of the utilization of net
working capital. In other words it indicates the number of
times the Working capital is rotated in coarse of a year.
Working Capital Ratio =
Cost of Goods Sold
Working Capital
Where,
Working Capital = Current Assets ― Current Liabilities
WORKING CAPITAL TURNOVER RATIO
19. The profitability ratios measures the profitability or the
operational efficiency of the firm. They are some of the most
closely watched and widely quoted ratios.
a. General profitability Ratio :
I. Gross Profit Ratio
II. Net Profit Ratio
III. Operating Profit Ratio
PROFITABILITY RATIOS
20. b. Overall Profitability Ratios :
I. Return on Equity
II. Return on Capital Employed
III. Return on Proprietor Fund
PROFITABILITY RATIOS
21. It is also called as ‘Gross Profit Margin’. This ratio establishes
relationship of gross profit to net sales of the firm. This ratio is a
indicator to the adequacy of selling price and efficiency of trading
activities.
Gross Profit Ratio =
Gross Profit x 100
Net Sales
Where,
Net Sales = Total Sales ― Sales Return
Gross Profit = Sales ― Cost of Good Sold
GROSS PROFIT RATIO
22. It measures overall profitability of the business. Net Profit
Ratio finds the proportion of revenue that finds its way into
profits.
Net Profit Ratio =
Net Profit X 100
Sales
Where,
Net Profit is derived by deducting admin. Exps, selling Exps,
finance charges, etc from Gross Profit
NET PROFIT RATIO
23. Operating Profit measures the percentage of each sales in
rupees that remains after the payment of all cost and
expenses except for Interest and Taxes.
Operating Profit Ratio =
Operating Profit X 100
Sales
Where,
Operating Profit = Earning before interest and taxes.
OPERATING PROFIT RATIO
24. Return on Equity measures the profitability of equity funds
invested in the firm. This ratio reveals how profitability of the
owner’s fund has been utilized by the firm.
R.O.E =
Net profit
Equity Shareholder′s Funds
X 100
Where,
Shareholder’s Funds = Equity Capital + Reserves and
surplus – Accumulated Losses.
RETURN ON EQUITY
25. It is the most important ratio of all. It is the percentage of
return on funds invested in the business by it’s owner’s.
R.O.C.E =
Net Profit
Capital employed
X 100
Where,
Capital Employed = Total Assets – Current Liabilities.
RETURN ON CAPITAL
EMPLOYED
26. This ratio is also known as return on net worth and it
determines the earning capacity related to owner’s capital.
R.O.P.F =
Net Profit
Shareholders Fund
X 100
Where,
Shareholders Fund = Equity Share Capital + Preference Share
Capital + Reserves and Surplus – Accumulated Loss and
Fictitious Assets.
RETURN ON PROPRIETOR
FUND
27. Diversified product lines.
Financial data are badly distorted by inflation.
Seasonal factors may also influence financial data.
To give a good shape to the popularly used financial ratio.
Differences in accounting policies and accounting period.
It is very difficult to generalize weather a particular ratio is
good or bad.
LIMITATION OF RATIO ANALYSIS