Ratio analysis in Management Accounting.

1. Management Accounting
Topic: Ratio Analysis
VADIVEL M
B.COM – PA
.

6. Purpose of Ratios
Ratios measure the relationship between two or more
components of financial statements. They are used most
effectively when results over several periods are compared.
Financial Ratios
Financial ratios indicate the financial position of the
company.

7. Financial Ratios
Financial ratios can be divided into two broad categories.
1. Liquidity ratios
2. Stability Ratios
1. Liquidity ratios
* Current Ratio
* Liquid Ratio
* Absolute Liquid Ratio (Or) Cash Ratio (Or) Super Quick Ratio
* Defensive Interval Ratio

8. 2. Stability Ratios
*Fixed Assets Ratio
*Capital Gearing Ratio
*Debt Equity Ratio
*Proprietary Ratio
*Interest Coverage Ratio

9. Purpose of Current Ratio
The current ratio is an indicator of the
firms commitment to meet its short-term
liabilities.
Current Assets
Current Ratio =
Current Liabilities
Standard Norm: 2:1

10. Purpose of Liquid Ratio
The liquid ratio is ascertained by
comparing the liquid assets.
Quick / Liquid Assets
Liquid Ratio =
Liquid (or) Current Liabilities
Standard Norm: 1:1

11. Purpose of Absolute Liquid Ratio (Or) Cash Ratio (Or) Super Quick
Ratio
To measures the total liquidity available to the company.
Absolute liquid Assets
Absolute Liquid Ratio =
Current Liabilities
(Or)
Cash & bank + Short term securities
Absolute Liquid Ratio =
Current Liabilities
Standard Norm: 0.5

12. Purpose of Defensive Interval Ratio
This ratio examine the firms liquidity position in terms of ability to
meet daily expenditure from operations.
Quick Assets
Defensive Interval Ratio =
Projected Daily Cash Requirements
Projected cash operating expenses
Projected Daily Cash Requirements =
Number of days in a year

13. Purpose of Fixed Assets Ratio
To know whether the firm has raised adequate long-term
funds to meet its fixed assets requirements.
Fixed Assets
Fixed Assets Ratio =
Long term Funds
Purpose of Debt – Equity Ratio
The ratio indicates the relationship between the outsiders equities or Outsiders
funds and internal equities or shareholders funds.
Debts / External Equities / Outsiders Funds
Debt Equity Ratio =
Equity / Internal Equities / Shareholders Funds
(Or)
Debt Equity Ratio = Total Assets – Total Debts
Standard Norm: 2:1

14. Purpose of Proprietary Ratio
It indicates that the extent of shareholders funds in the total assets
employed in the business.
Proprietary Funds (or) Shareholders Funds
Proprietary Ratio =
Total tangible Assets
(Or)
Proprietary Ratio Capital Employed
Proprietary Ratio =
Total Liabilities

15. Purpose of Interest Coverage Ratio
Interest coverage ratio or Debt service ratio is used to test the
debt-servicing capacity of a firm.
Net Profit (before interest & tax)
Interest Coverage Ratio =
Fixed Interest Charges

16. Purpose of Capital Gearing ratio
The gearing ratio is a measure of financial risk
and expresses the amount of a company's debt in terms of
its equity.
Pref. Share capital + Long term debt + Fixed Asset
Capital Gearing Ratio =
E. Share Capital + Reserves & Surplus

17. Thank You…..

18. Profitability Ratios
Purpose of Profitability ratios
Profitability ratios used to assess a
business's ability to generate earnings relative to its
revenue, operating costs, balance sheet assets, or
shareholders' equity over time, using data from a
specific point in time.
A. In related to Sales
B. In Related to Investments

19. Why is profitability ratio important?
Ratios that show returns represent the
firm's ability to measure the overall efficiency of
the firm in generating returns for its shareholders.
Purpose of Gross Profit Ratio
Performance of a company's sales and
production. It also relationship between gross
profit and net sales.

20. Purpose of Net Profit Ratio
It reveals the remaining profit after all costs of
production, administration, and financing have been deducted from
sales, and income taxes recognized.
Purpose of Operating Ratio
The operating ratio shows the efficiency of a
company's management by comparing the total operating expense
(OPEX) of a company to net sales. The operating ratio shows how
efficient a company's management is at keeping costs low while
generating revenue or sales.

21. Purpose of Operating Profit ratio
The operating profit ratio indicates
how much profit a company makes after paying
for variable costs of production such as wages,
raw materials, etc. It is also expressed as
a percentage of sales and then shows the
efficiency of a company controlling the costs and
expenses associated with business operations.

22. Purpose of Return on Investments (ROI)
ROI tries to directly measure the amount of return on
a particular investment, relative to the investment's cost.
Purpose of Return on Equity Capital
The return on equity ratio or ROE is a
profitability ratio that measures the ability of a firm to
generate profits from its shareholders investments in the
company. ... This is an important measurement for potential
investors because they want to see how efficiently a
company will use their money to generate net income.

23. Purpose of Earnings per share (EPS)
Earnings per share or EPS is an
important financial measure, which indicates
the profitability of a company. It is calculated
by dividing the company's net income with its
total number of outstanding shares.

24. Thank you…….

27. Turnover Ratios
The turnover ratios are also known as
activity or efficiency ratios. They indicate the
efficiency with which the capital employed is rotated
in the business.
The overall profitability of the business depends on two
factors:
i). The Rate of return on capital employed
ii). The Turnover ratios.

28. Overall Profitability Ratios
1. Net Profit Ratio
2. Turnover Ratio
Net Profit / Net Operating Profit
Net Profit Ratio =
Sales
Sales
Turnover Ratio =
Capital Employed

29. Purpose of Turnover Ratio
Turnover ratio indicates the number of times the capital has
been rotated in the process of doing business.
How to calculate the Overall Profitability Ratio
Overall Profitability Ratio = Net Profit Ratio x Turnover Ratio

30. Overall Profitability Ratio = Net Profit Ratio x Turnover Ratio
Net Profit Sales
= 100 x x
Sales Capital Employed
Net Profit
= x 100
Capital Employed

31. Purpose of Debtor Turnover Ratio
The Debtors Turnover Ratio also called as Receivables Turnover
Ratio shows how quickly the credit sales are converted into the cash. This ratio
measures the efficiency of a firm in managing and collecting the credit issued to the
customers.
Net Credit Sales / Total Sales
Debtors Turnover Ratio =
Average Debtors /Avg Accounts Receivables / Debtors
Net Credit Sales = Credit Sales – Sales Return
Opening Debtors + Opening Bills Receivables + Closing Debtors + Closing Bills
Receivables
Average Debtors =
2

32. Purpose of Credit Turnover Ratio
The ratio shows how well a company uses and
manages the credit it extends to customers and how quickly
that short-term debt is collected or is paid. The
accounts payable turnover ratio is used to quantify
the rate at which a company pays off its suppliers.

33. Credit Turnover Ratio
Net Credit Purchase
Creditors Turnover Ratio =
Average Payable / Average total Creditors
How to Calculate ?
Net Credit Purchase = Credit Purchase – Purchase Return
Accounts Payable Include = Trade Creditors & Bills Payable
Opening Creditors + Opening Bills Payables+ Closing Creditors
+ Closing Bills Payable
Average Payable / Average total Creditors =
2

34. Purpose of Stock (Or) Inventory Turnover Ratio
The ratio indicates whether investment in inventory is
efficiently used or not.
Cost of goods sold during the year
Inventory Turnover Ratio =
Average Inventory
Opening stock + Closing Stock
Average stock / Inventory =
2