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Ratio analysis

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CA. Dhruv Seth
ds@sethspro.com

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It is an analysis of strength and
weakness of an organization by
establishing the quantitative
relation among the items of...

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Analysis of financial Position
Simplification of Accounting Figures
Assessment of Operational Efficiency
Determining T...

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Ratio analysis

  1. 1. CA. Dhruv Seth ds@sethspro.com
  2. 2. It is an analysis of strength and weakness of an organization by establishing the quantitative relation among the items of Balance Sheet or Income Statement of such an organization
  3. 3. Analysis of financial Position Simplification of Accounting Figures Assessment of Operational Efficiency Determining Trends in the long-run Identification of Strength & Weakness Taking Remedial Measures Comparison of Performance
  4. 4. Based on Historical Data Change in Real Value of Monetary Unit No Standard Interpretation Ignoring Qualitative Aspects Difference in Accounting Methods make comparison difficult Ambiguity in Terms Used
  5. 5. Liquidity Ratios – Ability to Pay Solvency Ratios – Loans to Capital Activity Ratios – Conversion of Stock to cash Profitability Ratios – Profit to sales Shareholders' Ratios - Enable decision making
  6. 6. Used for Study the ability of the organization in meeting short-term payments or obligations Includes: 1) Current Ratio 2) Acid Test Ratio 3) Working Capital Turnover Ratio
  7. 7. Current Assets Current Ratio = ------------------------------- Current Liabilities Current Assets – Recoverable within 12 months from reporting date Current Liabilities – Payable within 12 months from reporting date
  8. 8. Relation between current assets and current liabilities Long Term Sources Financing the Current assets give a stable base for the liquidity of the organisation Normally , the ratio should not be less than 2 i.e., the current assets should be double the size of current liabilities
  9. 9. Particulars ABC Ltd XYZ Ltd Fixed Assets 10.00 20.00 Inventory 20.00 25.00 Sundry Debtors 35.00 60.00 Cash and Bank 15.00 25.00 Deferred Revenue Expenditure 50.00 0.00 ASSETS TOTAL 130.00 130.00 Share Capital 70.00 60.00 Long Term Loans 40.00 30.00 Current Liabilities 20.00 40.00 LIABILITIES TOTAL 130.00 130.00
  10. 10. It is the ratio between quick assets and quick liabilities Quick assets include current assets except inventory and pre-paid expenses Quick liabilities include current liabilities other than bank overdraft
  11. 11. Quick Assets Acid Test Ratio = ---------------------- Quick Liabilities  A 1:1 ratio is healthy  Healthy indicator of cash management
  12. 12. Particulars ABC Ltd XYZ Ltd Fixed Assets 20.00 20.00 Inventory 30.00 25.00 Sundry Debtors 55.00 60.00 Cash and Bank 15.00 25.00 Deferred Revenue Expenditure 10.00 0.00 ASSETS TOTAL 130.00 130.00 Share Capital 50.00 60.00 Long Term Loans 20.00 30.00 Current Liabilities 60.00 40.00 LIABILITIES TOTAL 130.00 130.00
  13. 13. Shows the efficiency of usage of working capital Relation between Sales and Working Capital Determination of number of times the working capital is turned over to achieve the maximum profit
  14. 14. Turnover WCT = ---------------------- Average Working Capital  Average working capital = Opening Working capital plus closing working capital divided by two
  15. 15. Measure long-term liquidity ratio Reflect the ability of the firm to pay interest and repayment of loans at due dates on the long-term loans taken Avoidance of over-borrowing (over- leverage) Avoidance of bankruptcy by maintaining healthy solvency ratios
  16. 16. 1) Interest Coverage Ratio 2) Debt Ratio 3) Debt-Equity Ratio 4) Proprietary Ratio
  17. 17. EBIT Interest Coverage = ------------------ Interest Acts as a cushion to the lenders with regard to the availability of profit to serve the interest. Ideal Ratio is 1.5
  18. 18. Total Debt Debt to total fund = ------------------ Debt + Equity AND Total Debt Debt Equity Ratio = ------------------ Total Equity
  19. 19. Equity Proprietary Ratio = ------------------ Total Assets High Ratio = Comfort for creditors / Highlights under utilization of capital Low Ratio = Over Leveraged / High utilization of capital
  20. 20. Particulars ABC Ltd XYZ Ltd Earning Before Interest and Tax 45.00 40.00 Interest 8.00 8.00 Tax 18.00 17.00 Net Profit 19.00 15.00 Balance Sheet Liabilities side Share Capital 50.00 60.00 Long Term Loans 20.00 30.00 Current Liabilities 60.00 40.00 LIABILITIES TOTAL 130.00 130.00 Industry Average Debt Equity 0.60 0.60
  21. 21. 1) Inventory Turnover Ratio 2) Debtors Turnover Ratio 3) Average Collection Period 4) Fixed Assets Turnover Ratio 5) Total Assets Turnover Ratio
  22. 22. Sales Inventory Turnover = ------------------ Inventory Low turnover = bad products Extreme High Turnover = Cases of fraudulent sales possible
  23. 23. Sales Debtors Turnover = ----------------------- Average Debtors High turnover = Better realization Low Turnover = Cases of fraudulent sales
  24. 24. 365 days ACP = ----------------------- Debtors Turnover Approximate time for a business to receive payments from debtors High turnover = Better realization Low Turnover = Slow realization
  25. 25. Particulars ABC Ltd XYZ Ltd Sales 150.00 200.00 Expenses 100.00 140.00 Net Profit 35.00 40.00 Balance Sheet Assets side Fixed Assets 200.00 300.00 Cash and Bank Balances 50.00 60.00 Inventories 80.00 100.00 Sundry Debtors 75.00 120.00 Assets TOTAL 405.00 580.00 Industry Avg Inventory turnover 2.00 2.00 Industry Avg Debtors recovery 150 days 150 days
  26. 26. 1) Net Profit Ratio 2) Gross Profit Ratio 3) Return on Total Assets 4) Return on Equity
  27. 27. NP after tax Net Profit Ratio = ----------------------- Net Turnover Interpretation Against Industry average Against previous years
  28. 28. Gross Profit Gross Profit Ratio = ----------------------- Net Turnover Interpretation Against Industry average Against previous years
  29. 29. EBIT ROTA = ----------------------- Total Net Assets Interpretation Higher Number = Better Realization Lower Lumber = Less Utilization of assets
  30. 30. Net Profit Equity Return = --------------------------- Shareholders Equity
  31. 31. Particulars 2014 2013 Sales 150.00 160.00 Purchases 60.00 55.00 Interest Paid 12.00 15.00 Staff Salary 50.00 48.00 Administrative Expenses 20.00 22.00 Bad Debts 10.00 12.00 Staff Welfare 3.00 9.00 Electricity 6.00 7.00 Opening Stock 35.00 50.00 Closing Stock 55.00 35.00 Debtors 30.00 80.00
  32. 32. Particulars 2014 2013 Shareholders Equity 150.00 160.00 Reserves and Surplus 100.00 90.00 Unsecured Loans 70.00 80.00 Current Liabilities 80.00 90.00 LIABILITIES TOTAL 400.00 420.00 Fixed Assets 200.00 220.00 Inventories 50.00 50.00 Sundry Debtors 120.00 130.00 Cash and Bank 30.00 20.00 ASSETS TOTAL 400.00 420.00 Sales 150.00 160.00
  33. 33. Particulars 2014 2013 Sales 175.00 185.00 Purchases 85.00 95.00 Interest Paid 15.00 17.00 Staff Salary 30.00 31.00 Administrative Expenses 30.00 29.00 Staff Welfare 7.00 9.00 Electricity 8.00 4.00 Opening Stock 45.00 50.00 Debtors 30.00 80.00 Closing Stock 55.00 35.00 Gross Profit %age 20.00% 27.00%

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