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  1. 1. RATIO ANALYSIS Meaning of Ratio Analysis Ratio Analysis is defined as the systematic use of ratio to interpret financial statements so that strengths and weaknesses of a firm as well as its historical performance and current financial condition can be determined.
  2. 2. Importance or significance of Ratio Analysis • 1) Liquidity position • 2) Long term solvency • 3) Operating efficiency • 4) Overall profitability • 5) Inter-firm comparison • 6) Trend analysis
  3. 3. Limitations of the Ratio Analysis • 1) Difficulty in comparison • 2) Impact of inflation • 3) Conceptual diversity
  4. 4. Types of ratios Liquidity ratios A) Current Ratio B) Quick Ratio C) Cash Ratio Profitability ratios a) Gross profit ratio (GP ratio) b) Operating ratio c) Net profit ratio (NP ratio) d) Return on investment (ROI) e) Return on capital employed ratio f) Earnings per share (EPS) ratio g) Dividend payout ratio h) Dividend yield ratio i) Price earnings ratios (P/E ratio) j)The net worth ratio Turnover ratios a) Inventory Turnover Ratio b) Debtors Turnover Ratio c) Creditor turnover ratio d) Working Capital Turnover Ratio e) Fixed assets turnover ratio f) Capital Employed Solvency ratios A) Debt-to-Equity Ratio B) The proprietary ratio C) Capital gearing ratio D) 'Debt-Service Coverage Ratio - DSCR' E) Overall profitability ratio
  5. 5. Liquidity Ratios Liquidity represents one's ability to pay its current obligations or short-term debts within a period less than one year. Liquidity ratios, therefore, measures a company's liquidity position. The ratios are important from the viewpoint of its creditors as well as management. The liquidity position of the company can be measured mainly by using two liquidity ratios such as follows. A) Current Ratio B) Quick Ratio C) Cash Ratio
  6. 6. A. Current Ratio Current ratio is also known as short-term solvency ratio or working capital ratio. Current ratio is used to assess the short-term financial position of the business. In other words, it is an indicator of the firm's ability to meet its short-term obligations. Current ratio is calculated by using following formula: Current ratio = Current assets/Current liabilities Sr. no Current assets Current liabilities 1 Cash in hand Sundry creditors(accounts payable) 2 Cash at bank Bills payable 3 Sundry debtors Outstanding expenses 4 Bills receivables Income tax payable 5 Marketable securities Short term advances 6 Other Short term investments Unpaid or unclaimed dividend 7 Inventories: (a)Stock of raw materials Bank overdraft
  7. 7. B. Quick Ratio Quick ratio is also known as liquid ratio or acid test ratio. However, although it is used to test the short-term solvency or liquidity position of the firm, Liquid assets are cash and other assets which are either equivalent to cash or convertible into cash within a very short period of time. The following formula is used to calculate quick ratio: Quick Ratio = Liquid assets/Current Liabilities Liquid assets = Total current assets - stock- prepaid expenses
  8. 8. C) Cash ratio • It the most conservative liquidity ratio. It excludes all current assets except the most liquid: cash and cash equivalents. The cash ratio is defined as follows: • Cash Ratio = Cash + Marketable Securities/Current Liabilities The cash ratio is an indication of the firm's ability to pay off its current liabilities if for some reason immediate payment were demanded.
  9. 9. 2)Profitability Ratios • Profitability ratios measure a company’s ability to generate earnings relative to sales, assets and equity. These ratios assess the ability of a company to generate earnings, profits and cash flows relative to relative to some metric, often the amount of money invested. They highlight how effectively the profitability of a company is being managed. Following are the types of profitability ratios • a) Gross profit ratio (GP ratio) • b) Operating ratio • c) Net profit ratio (NP ratio) • d) Return on investment (ROI) • e) Return on capital employed ratio • f) Earnings per share (EPS) ratio • g) Dividend payout ratio • h) Dividend yield ratio • i) Price earnings ratios (P/E ratio) • j)The net worth ratio
  10. 10. a)Gross profit ratio (GP ratio) It is a profitability ratio that shows the relationship between gross profit and total net sales revenue. It is a popular tool to evaluate the operational performance of the business. Formula: profit ratio: Gross profit *100 net sales
  11. 11. b) Operating ratio It is computed to measure the relationship between total operating expenses and sales Formula: Operating ratio=operating cost *100 net sales net sales=sales-sales return(or)inwards Operating ratio=cost of goods sold +administrative expenses + selling and distribution expenses
  12. 12. C) Net profit ratio (NP ratio) It is a popular profitability ratio that shows relationship between net profit after tax and net sales. • Formula: Net profit ratio= net profit after tax *100 net sales
  13. 13. d) Return on investment (ROI) It is performance measure used to evaluate the efficiency of investment. It compares the magnitude and timing of gains from investment directly to the magnitude and timing of investment costs. Formula • Return on Investment = Net profit after interest and tax / shareholders funds or investments *100
  14. 14. e) Return on capital employed ratio • It measures the success of a business in generating satisfactory profit on capital invested. • Return on capital employed =net profit after tax/gross capital employed *100 • gross capital employed =fixed asset+current assets
  15. 15. f) Earnings per share (EPS) ratio • The earnings per share ratio (EPS ratio) measures the amount of a company's net income that is theoretically available for payment to the share holders. • Earnings per share (EPS) ratio=net profit after tax and preference dividend /number of share*100
  16. 16. g) Dividend payout ratio (or payout ratio) • it is the ratio of dividend per share divided by earnings per share. It is a measure of how much earnings a company is paying out to its shareholders as compared to how much it is retaining for reinvestment. Formula Dividend Payout Ratio = Dividend per Share/Earnings per Share*100
  17. 17. h) Dividend yield ratio • The dividend yield ratio shows the amount of dividends that a company pays to its investors in comparison to the market price of its stock. • Dividend yield ratio =dividends per share /Market value per share*100
  18. 18. i) Price earnings ratios (P/E ratio) • it measures how many times the earnings per share (EPS) have been covered by current market price of an ordinary share. • Price earnings ratios=market price per equity share/earnings per share
  19. 19. J) The net worth ratio • It states the return that shareholders could receive on their investment in a company, if all of the profit earned were to be passed through directly to them. • Net worth ratio=net profit after taxes/shareholders net worth *100 • Shareholders net worth=total tangible net worth • Total tangible net worth =shareholders fund+profits earned in business
  20. 20. 3) Turnover ratios • Meaning: Turnover ratios are also known as activity or efficiency ratios. The total funds raised by the company are invested in acquiring various assets for its operations. The assets are acquired to generate the sales revenue and the position of profit depends upon the value of sales. Turnover ratios establish the relationship of sales with various assets. Turnover ratios are as follows: • a) Inventory Turnover Ratio • b) Debtors Turnover Ratio • c)creditor turnover ratio • d) Working Capital Turnover Ratio • e) Fixed assets turnover ratio • f) Capital Employed Turnover Ratio
  21. 21. a) Inventory Turnover Ratio Inventory turnover ratio is also known as stock turnover ratio. Inventory turnover ratio shows the relationship between the cost of good sold and the average inventory. This ratio measures how frequently the company's inventory turned into sales. formula. Inventory turnover ratio = Cost of good sold/Average stock = ........... times. In the absence of the cost of good sold and average stock, the following formula can be used to calculate inventory turnover ratio. Inventory turnover ratio = Sales/Closing Inventory = .......... times. * Cost Of Goods Sold = Opening stock+ Purchases+Carriage inward+Direct wages and expenses- Closing Stock * Cost of Goods Sold =Sales - Gross profit * Average stock = (Opening stock + closing stock)/2
  22. 22. b) Debtors Turnover Ratio Debtors turnover ratio is also called receivable turnover ratio. This ratio establishes the relationship between net credit sales and average debtors for the year. Debtors turnover ratio shows how quickly the credit sales of the company have been converted into cash Debtors Turnover Ratio = Net credit sales/Average account receivable * the term account receivable includes 'trade debtors and bills receivable'.
  23. 23. c) creditors 's turnover ratio It is a reflection of how quickly a company pays its creditors. This is also known as a payable turnover ratio. Low turnover means it takes longer for a company to pay off creditors, while high turnover reflects rapid processing of credit accounts. Changes in the creditor's turnover ratio can provide information about a company's financial circumstances. formula Creditor or Payable Turnover Ratio = Net Credit Annual Purchase / Average Trade Creditors
  24. 24. d) Working Capital Turnover Ratio • The working capital turnover ratio measures how well a company is utilizing its working to support a given level of sales • Net sales working capital(Beginning working capital + Ending working capital) / 2
  25. 25. e) Fixed assets turnover ratio • Fixed assets turnover ratio indicates how efficiently the fixed assets are used. It measures the efficiency with which the firm has been using its fixed assets to generate sales. • Fixed Assets Turnover Ratio = Sales/ Net fixed assets. •
  26. 26. f) Capital Employed Turnover Ratio • It shows how efficiently capital employed in the company has been utilized in generating sales revenue. • Capital Employed Turnover Ratio = Sales/Capital employed
  27. 27. 4)Solvency ratios Solvency ratio is one of the various ratios used to measure the ability of a company to meet its long term debts. Following are solvency ratios • A) Debt-to-Equity Ratio • B) The proprietary ratio • C) Capital gearing ratio
  28. 28. A) Debt-to-Equity Ratio Debt-to-Equity ratio is the ratio of total liabilities of a business to its shareholders' equity. It is a leverage ratio and it measures the degree to which the assets of the business are financed by the debts and the shareholders' equity of a business. • Formula Debt-to-equity ratio is calculated using the following formula: Debt-to-Equity Ratio = Total Liabilities Shareholders' Equity
  29. 29. B) The proprietary ratio It is also known as net worth ratio or equity ratio is used to evaluate the soundness of the capital structure of a company. The proprietary ratio =stockholders equity /total asset*100
  30. 30. C) Capital gearing ratio The term "capital gearing" or "leverage" normally refers to the proportion of relationship between equity share capital including reserves and surpluses to preference share capital and other fixed interest bearing funds or loans. Capital gearing ratio= equity share capital/fixed interest bearing funds
  31. 31. D) 'Debt-Service Coverage Ratio - DSCR' • The debt service coverage ratio (DSCR), also known as "debt coverage ratio," (DCR) is the ratio of cash available for debt servicing to interest, principal and lease payments. • 'Debt-Service Coverage Ratio =net profit before interest and tax/fixed interest charges
  32. 32. E) Overall profitability ratio Objective: - The objective of computing this ratio is to find out how efficiently the long term funds supplied by the creditors and the shareholders have been used. • Formula:- Overall profitability Ratio = net profit/total asset •