This document discusses ratio analysis and various types of ratios used to analyze financial statements. It defines ratio analysis as using ratios to interpret financial statements to evaluate a firm's strengths, weaknesses, historical performance, and current financial condition. The document outlines different types of ratios including liquidity ratios, capital structure ratios, profitability ratios, and efficiency ratios. It provides examples of calculating liquidity ratios like current ratio, acid-test ratio, inventory turnover ratio, debtors turnover ratio, and creditors turnover ratio. The ratios are used to measure a firm's ability to meet short-term obligations and how efficiently it manages inventory, collects from debtors, and pays creditors.
Ratio analysis is a widely used tool to interpret financial statements and determine a firm's strengths, weaknesses, historical performance, and current financial condition. Ratios can be used to compare a firm's performance over time through trend analysis or compare the firm to others through interfirm comparison. Common types of ratios include liquidity, capital structure, profitability, efficiency, and growth ratios. Liquidity ratios measure a firm's ability to meet short-term obligations, such as the current ratio and acid-test ratio. Capital structure ratios analyze long-term solvency and leverage, including the debt-equity ratio and interest coverage ratio. Ratio analysis provides useful insights but also has limitations since it only examines relationships and not causal factors.
Financial Discipline Through Working Capitaldanlekan
The document discusses working capital and its importance in M&A transactions. It defines working capital as current assets minus current liabilities, and describes how it is a measure of short-term financial health and ability to pay obligations. Purchasers typically require sellers to deliver a set amount of working capital, such as enough to cover 15-60 days of expenses, and this impacts the purchase price. Managing working capital requires fiscal discipline, planning, frequent evaluation, and generating adequate profits.
RATIO ANALYSIS in management accounting of companieskamikazekujoh
The document discusses various types of ratios used in accounting and ratio analysis. It defines ratios as mathematical relationships between two accounting items expressed quantitatively. There are three main types of ratios discussed: liquidity ratios which assess short-term financial position, long-term solvency ratios which evaluate long-term financial health, and activity/turnover ratios which measure how efficiently a company uses its assets. Specific ratios covered include current ratio, quick/acid test ratio, debt-to-equity ratio, and fixed assets ratio. Examples and calculations are provided. Limitations of ratio analysis are also noted.
Ratio analysis is an important tool for financial analysis that involves calculating and presenting relationships between financial statement items. There are three main forms ratios can take: pure ratios involving simple division, percentages, and rates expressed as number of times over a period. Ratios can be classified based on the financial statements they use, their function, or the intended user. Key ratios discussed include the current ratio, quick/liquidity ratio, and stock to working capital ratio, which measure liquidity and solvency. Understanding ratios and comparing them to standards helps analyze a company's financial performance and position.
Liquidity Ratios
This type of ratio helps in measuring the ability of a company to take care of its short-term debt obligations. A higher liquidity ratio represents that the company is highly rich in cash.
The types of liquidity ratios are: –
Current Ratio or Working Capital Ratio
Quick Ratio or Liquidity Ratio or Acid Test Ratio
Absolute Liquid Ratio or Cash Ratio
Stock to Working Capital Ratio
Current Ratio: The current ratio is the ratio between the current assets and current liabilities of a company. The current ratio is used to indicate the liquidity of an organization in being able to meet its debt obligations in the upcoming twelve months. A higher current ratio will indicate that the organization is highly capable of repaying its short-term debt obligations.
Current Ratio = Current Assets / Current Liabilities
Current Assets:
Current Assets means cash and those assets which can be converted into cash within one year in ordinary course of business.
Current Liabilities:
Current Liabilities are those which are to be paid by the firm in one year.
Quick Ratio or Liquidity Ratio or Acid Test Ratio :
The quick ratio is used to ascertain information pertaining to the capability of a company in paying off its current liabilities on an immediate basis.
The formula used for the calculation of a quick ratio is-
Quick Ratio = (Cash and Cash Equivalents + Marketable Securities + Accounts Receivables) / Current Liabilities
. Absolute Liquid Ratio or Cash Ratio:
The cash ratio measures a company’s ability to pay off short-term liabilities with cash and cash equivalents:
Cash ratio = Cash and Cash equivalents / Current Liabilities
Stock to Working Capital Ratio:
It is calculated by dividing the value of stock (or inventories such as raw materials, work in progress, finished goods, stores and packing materials) by the Working capital.
This document discusses financial ratio analysis and various types of ratios used to analyze companies. It provides definitions and formulas for current ratio, quick ratio, stock turnover ratio, debtors turnover ratio, creditors turnover ratio, working capital turnover ratio, debt-equity ratio, proprietary ratio, net profit ratio, operating profit ratio, return on investment ratio, and capital gearing ratio. These ratios are used to analyze different aspects of a company's financial health and performance, including liquidity, activity, solvency, profitability, and leverage. The document also notes some limitations of ratio analysis.
Accounting ratios are calculated from financial statements to analyze liquidity, profitability, and solvency. There are different types of accounting ratios that can be calculated. This document discusses liquidity ratios like current ratio and quick ratio, which measure a firm's ability to meet short-term obligations. It also covers activity or turnover ratios, such as stock turnover ratio, which indicate how efficiently a firm uses its resources. Sample calculations of various ratios are provided using information from income statements and balance sheets.
Ratio analysis is a widely used tool to interpret financial statements and determine a firm's strengths, weaknesses, historical performance, and current financial condition. Ratios can be used to compare a firm's performance over time through trend analysis or compare the firm to others through interfirm comparison. Common types of ratios include liquidity, capital structure, profitability, efficiency, and growth ratios. Liquidity ratios measure a firm's ability to meet short-term obligations, such as the current ratio and acid-test ratio. Capital structure ratios analyze long-term solvency and leverage, including the debt-equity ratio and interest coverage ratio. Ratio analysis provides useful insights but also has limitations since it only examines relationships and not causal factors.
Financial Discipline Through Working Capitaldanlekan
The document discusses working capital and its importance in M&A transactions. It defines working capital as current assets minus current liabilities, and describes how it is a measure of short-term financial health and ability to pay obligations. Purchasers typically require sellers to deliver a set amount of working capital, such as enough to cover 15-60 days of expenses, and this impacts the purchase price. Managing working capital requires fiscal discipline, planning, frequent evaluation, and generating adequate profits.
RATIO ANALYSIS in management accounting of companieskamikazekujoh
The document discusses various types of ratios used in accounting and ratio analysis. It defines ratios as mathematical relationships between two accounting items expressed quantitatively. There are three main types of ratios discussed: liquidity ratios which assess short-term financial position, long-term solvency ratios which evaluate long-term financial health, and activity/turnover ratios which measure how efficiently a company uses its assets. Specific ratios covered include current ratio, quick/acid test ratio, debt-to-equity ratio, and fixed assets ratio. Examples and calculations are provided. Limitations of ratio analysis are also noted.
Ratio analysis is an important tool for financial analysis that involves calculating and presenting relationships between financial statement items. There are three main forms ratios can take: pure ratios involving simple division, percentages, and rates expressed as number of times over a period. Ratios can be classified based on the financial statements they use, their function, or the intended user. Key ratios discussed include the current ratio, quick/liquidity ratio, and stock to working capital ratio, which measure liquidity and solvency. Understanding ratios and comparing them to standards helps analyze a company's financial performance and position.
Liquidity Ratios
This type of ratio helps in measuring the ability of a company to take care of its short-term debt obligations. A higher liquidity ratio represents that the company is highly rich in cash.
The types of liquidity ratios are: –
Current Ratio or Working Capital Ratio
Quick Ratio or Liquidity Ratio or Acid Test Ratio
Absolute Liquid Ratio or Cash Ratio
Stock to Working Capital Ratio
Current Ratio: The current ratio is the ratio between the current assets and current liabilities of a company. The current ratio is used to indicate the liquidity of an organization in being able to meet its debt obligations in the upcoming twelve months. A higher current ratio will indicate that the organization is highly capable of repaying its short-term debt obligations.
Current Ratio = Current Assets / Current Liabilities
Current Assets:
Current Assets means cash and those assets which can be converted into cash within one year in ordinary course of business.
Current Liabilities:
Current Liabilities are those which are to be paid by the firm in one year.
Quick Ratio or Liquidity Ratio or Acid Test Ratio :
The quick ratio is used to ascertain information pertaining to the capability of a company in paying off its current liabilities on an immediate basis.
The formula used for the calculation of a quick ratio is-
Quick Ratio = (Cash and Cash Equivalents + Marketable Securities + Accounts Receivables) / Current Liabilities
. Absolute Liquid Ratio or Cash Ratio:
The cash ratio measures a company’s ability to pay off short-term liabilities with cash and cash equivalents:
Cash ratio = Cash and Cash equivalents / Current Liabilities
Stock to Working Capital Ratio:
It is calculated by dividing the value of stock (or inventories such as raw materials, work in progress, finished goods, stores and packing materials) by the Working capital.
This document discusses financial ratio analysis and various types of ratios used to analyze companies. It provides definitions and formulas for current ratio, quick ratio, stock turnover ratio, debtors turnover ratio, creditors turnover ratio, working capital turnover ratio, debt-equity ratio, proprietary ratio, net profit ratio, operating profit ratio, return on investment ratio, and capital gearing ratio. These ratios are used to analyze different aspects of a company's financial health and performance, including liquidity, activity, solvency, profitability, and leverage. The document also notes some limitations of ratio analysis.
Accounting ratios are calculated from financial statements to analyze liquidity, profitability, and solvency. There are different types of accounting ratios that can be calculated. This document discusses liquidity ratios like current ratio and quick ratio, which measure a firm's ability to meet short-term obligations. It also covers activity or turnover ratios, such as stock turnover ratio, which indicate how efficiently a firm uses its resources. Sample calculations of various ratios are provided using information from income statements and balance sheets.
Financial ratio analysis is a technique used to analyze a company's financial statements and identify its strengths and weaknesses. Ratios can simplify financial statements and facilitate comparison between firms. There are four main categories of ratios: liquidity ratios measure short-term debt paying ability; leverage or solvency ratios measure long-term debt paying ability; activity ratios measure efficiency of asset usage; and profitability ratios measure operating results and return on investments. Common ratios calculated include the current ratio, debt-to-equity ratio, inventory turnover ratio, net profit margin, and price-earnings ratio. Ratio analysis provides useful information for decision makers to evaluate a company's financial performance and position.
This document provides a tutorial on financial ratios used to analyze companies. It discusses several types of ratios:
1. Liquidity ratios like the current ratio, quick ratio, and cash ratio which measure a company's ability to meet short-term obligations. The cash conversion cycle is also introduced which measures the time between expenditure for inventory and collection from customers.
2. Profitability, debt, operating performance, cash flow, and investment valuation ratios are also outlined.
3. Examples are provided for each ratio using financial data from Zimmer Holdings, with the current ratio, quick ratio, and cash ratio being explained in more detail to illustrate how they are calculated and interpreted.
BackgroundAnne Schippel, business banker, is analyzing Dry Supply.pdfpearlcoburnsanche303
Background:
Anne Schippel, business banker, is analyzing Dry Supply\'s financial statements. When
calclating ratios, many commercial lenders use a ratio summary. Figure 8.5 summarizes the key
ratios as they might appear on her spreadsheet.
In reviewing the Ratio Summary and Comparative Data for Dry Supply for 12/31/20xx through
12/31/20xz, Anne Schippel has developed some questions and observations regarding the ratios.
It is now your turn to do the same.
Figure 8.5 Ratio Summary: Dry Supply
12/31/20xx
12/31/20xy
12/31/20xz
Liquidity
Current Ratio
Quick Ratio
Working Capital
1.3x
0.8x
$47,000
1.5x
1.0x
$66,000
1.5x
1.0x
$92,000
Leverage
Debt to net worth
Tangible leverage
Tangible effective leverage
3.3x
3.3x
1.3x
2.7x
2.7x
1.0x
1.9x
1.9x
0.7x
Profitability
Gross profit margin
Operating profit margin
Pretax profit margin
Net Profit margin
Return-on-assets
Return-on-equity
27.9%
2.3%
2.2%
1.0%
8.2%
35.1%
28.8%
3.0%
2.8%
1.5%
10.0%
36.6%
31.3%
5.0%
4.4%
2.5%
14.8%
42.6%
Efficiency
Accounts receivable turnover
Inventory turnover
Accounts payable turnover
Sales to total assets
44.5d
41.3d
17.9d
3.4x
44.0d
39.4d
17.9d
3.4x
44.5d
38.8d
17.9d
3.4x
Coverage
Tradition cash flow coverage
Interest Coverage
Fixed charge coverage
Dividend payout ratio
n/a
4.3x
4.5x
0.0%
n/a
4.7x
4.7x
0.0%
n/a
4.6x
4.3x
0.0%
Figure 8.6 Wholesale Dry-Cleaning Equipment Industry Quartiles 20xz
Ration
Higher
Median
Lower
Current
Quick
Tangible Leverage
Pretax profit margin
Return-on-assets
Interest coverage
2.4x
1.2x
0.9x
n/a
10.7x
5.5x
1.5x
0.8x
2.5x
2.1x
3.2x
2.1x
1.2x
0.5x
5.1x
n/a
(0.3x)
1.0x
Part 1
For each of the ratios listed below, perform your own ratio analysis by stating your observation
and develop any necessary questions you would ask Dry Supply to complete your analysis.
A. Liquidity Ratios
B. Financial Leverage Ratios
C. Profitability Ratios
D. Efficiency Ratios
E. Coverage Ratios
Part 2
Using the commercial lending decision tree, Schippel deteremined that Dry Supply, as a
wholesaler, would likely show certain financial characteristics when she began to analyze the
financial statements. What are some examples of these characteristics within the ratios for 20xx
through 20 xz?
Figure 8.5 Ratio Summary: Dry Supply
12/31/20xx
12/31/20xy
12/31/20xz
Liquidity
Current Ratio
Quick Ratio
Working Capital
1.3x
0.8x
$47,000
1.5x
1.0x
$66,000
1.5x
1.0x
$92,000
Leverage
Debt to net worth
Tangible leverage
Tangible effective leverage
3.3x
3.3x
1.3x
2.7x
2.7x
1.0x
1.9x
1.9x
0.7x
Profitability
Gross profit margin
Operating profit margin
Pretax profit margin
Net Profit margin
Return-on-assets
Return-on-equity
27.9%
2.3%
2.2%
1.0%
8.2%
35.1%
28.8%
3.0%
2.8%
1.5%
10.0%
36.6%
31.3%
5.0%
4.4%
2.5%
14.8%
42.6%
Efficiency
Accounts receivable turnover
Inventory turnover
Accounts payable turnover
Sales to total assets
44.5d
41.3d
17.9d
3.4x
44.0d
39.4d
17.9d
3.4x
44.5d
38.8d
17.9d
3.4x
Coverage
Tradition cash flow coverage
Interest Coverage
Fixed charge coverage
Dividend payout ratio
n/.
This document discusses liquidity ratios and how they can change based on a company's financial decisions. It defines two key liquidity ratios: the current ratio and acid test ratio. The current ratio measures current assets available to cover current liabilities, while the acid test only considers more liquid current assets. The document then demonstrates how taking on short-term debt or increasing capital can impact these ratios, making liquidity stronger by applying long-term resources to current assets but weaker by using short-term debt for fixed assets.
Ratio analysis is a technique used to interpret financial statements and evaluate the operating performance and financial position of a company. It involves calculating and comparing various financial ratios related to liquidity, profitability, and solvency. Some key liquidity ratios discussed in the document include the current ratio, acid-test ratio, and cash ratio. Turnover ratios measure how efficiently a company manages its assets, such as inventory and accounts receivable. The document provides formulas and interpretations for various financial ratios.
The document discusses ratio analysis, which involves calculating and interpreting various financial ratios to evaluate aspects of a company's performance and financial position. It defines key ratios including liquidity ratios, activity ratios, profitability ratios, and leverage ratios. It provides formulas and examples for specific ratios like current ratio, inventory turnover, debt-to-equity ratio, and return on equity. The purpose of ratio analysis is to help assess a company's liquidity, profitability, financial stability, and management quality.
This document discusses various methods for analyzing financial statements, including horizontal analysis, vertical analysis, and common-sized statements. It then describes how these analytical methods can be used to assess the solvency and profitability of a business. Specifically, it discusses various ratios that can indicate a business's ability to pay current liabilities (current ratio, quick ratio) and manage inventory and receivables (inventory turnover, accounts receivable turnover, days in inventory/receivables). The document provides examples of calculating these ratios.
This document discusses ratio analysis, which involves interpreting numerical relationships based on financial statements to evaluate a company's performance. Ratios are classified into liquidity ratios, which assess short-term solvency, and solvency ratios, which evaluate long-term financial position. Key liquidity ratios discussed are current ratio, quick ratio, and absolute liquidity ratio. Important solvency ratios mentioned include debt-equity ratio, proprietary ratio, and fixed assets to net worth ratio. The document provides formulas and interpretations for these ratios.
Prepare a witten financial analysis. .This should include calculation.pdfarrowit1
Prepare a witten financial analysis. .This should include calculations and discussion related to
the Chapter 5 appendix (Appendix 5A). See illustration 5A-1 for a summary of financial ratios.
Be sure to include (1) these ratios, (2) what they mean and (3) how you interpret them: o Current
ratio o Accounts receivable turnover o Inventory turnover o Profit margin on sales o Return on
assets o Return on stockholders\' equity o Debt to assets ratio Submit a WORD document via
D2L- Assessments - Assignments
Solution
Ans ) The ratios are not meant for a particular person or firm.People in various fields of life are
interested in ratio analysis from their own angles.The parties attached with business or firm are
creditors i.e. mony lenders, shareholders.Management uses the toolof Ratio analysisto
interpretate the information from their own angles.For example creditors are interested in
liquidity and solvency for which they will make use of current ratio , liquidity ratio,
proprietaryRatio, debt equity Ratio,capital gearing Ratio.Shareholders are interested in
profitability and long term solvency.They want to know the rate of return on their capital
employed for which they willmake use of Gross Profit Ratio, Operating Ratio, Dividend ratio
and Price Earning Ratio.Management is interested in overall efficiency of business which can be
better jud ged through Ratios like turnover to fixed assets, turnover to capital employed, stock
turnover ratio etc.So, from the above discussion it is clear that different prties uses the tool of
Ratio analysis for taking their own decisions
The particular purpose of a user is determining the particular Ratios that might be used ofr
financial analysis.Here we will discuss and calculate various ratios to do fianacial analysis.
Current Ratio = Current Assests/Current Liabilities
Current Assests= Cash + Bank+ Prepaid Insurance+Inventory+ Accounts Recievables
Current Assests=44746.5 +510+500+5000+29000=79756.5
Current Laibilites =Accounts payable
Current Laibilites= 30064.83
Current Ratio = 79756.5/30064.83= 2.7
Interpretation : Generally a current ratio of 2 times or 2:1 is cosidered to be satisfactory.Here the
current ratio of greater than 2 denotes the good liquidity position but it also indicates assest
liabilty mis match.But current ratio greater than 2 is generally preferred as compared to less than
2.
2.Account receivables turnover :It represents the number of times the cash is collected from
debtors.Lower turnover denotes poor collection and means that funds are blocked ofr longer
period of tiem and vice-versa.It also measure the liquidity of the firm.It shows how quickly
debtors (receivables) are converted into sales.The Account receivables turnover shows the
relationship between sales and debtors of the firm.
Account receivables turnover= Net Credit Annual Sales/Average trade debtors
3. Inventory turnover :This ratio indicates the number of times inventory or stock is replaced
during the year.The turnover of invent.
Ratio analysis is a technique used to analyze and interpret financial statements. It involves calculating and comparing various financial ratios over time and between companies to gain insight into aspects like profitability, liquidity, leverage, and efficiency. Some key ratios discussed in the document include current ratio, quick ratio, debt ratio, return on equity, inventory turnover, and dividend coverage ratio. Ratio analysis provides a simplified and standardized way to analyze a company's financial health and performance.
Operating Ratios asPerformanceMeasure s 11C H A P T E RTHE.docxhopeaustin33688
Operating Ratios as
Performance
Measure s 11
C H A P T E R
THE IMPORTANCE OF RATIOS
Ratios are convenient and uniform measures that are
widely adopted in healthcare financial management.
They are important because they are so widely used, especially
because they are used for credit analysis. But a
ratio is only a number. It has to be considered within the
context of the operation. There is another caveat: ratio
analysis should be conducted as a comparative analysis. In
other words, one ratio standing alone with nothing to
compare it with does not mean very much. When interpreting
ratios, the differences between periods must be
considered, and the reasons for such differences should
be sought. It is a good practice to compare results with
equivalent computations from outside the organization—
regional figures from similar institutions would be a good
example of such outside sources. Caution and good managerial
judgment must always be exercised when working
with ratios.
Financial ratios basically pull together two elements of
the financial statements: one expressed as the numerator
and one as the denominator. To calculate a ratio, divide
the bottom number (the denominator) into the top
number (the numerator). The Case Study in Appendix
25-A entitled “Using Financial Ratios and Benchmarking:
A Case Study in Comparative Analysis” uses financial
ratios as indicators of financial position. We highly recommend
that you spend time with this Case Study, as it
will add depth and background to the contents of this
chapter.
In this chapter we examine liquidity, solvency, and
profitability ratios. Exhibit 11-1 sets out eight basic ratios
After completing this chapter,
you should be able to
1. Understand four types of
liquidity ratios.
2. Understand two types of
solvency ratios.
3. Understand two types of
profitability ratios.
4. Successfully compute ratios
CHAPTER 11 Financial and Operating Ratios as Performance Measures
Exhibit 11–1 Eight Basic Ratios Used in Health Care
Liquidity Ratios
1. Current Ratio
Current Assets
Current Liabilities
2. Quick Ratio
Cash and Cash Equivalents + Net Receivables
Current Liabilities
3. Days Cash on Hand (DCOH)
Unrestricted Cash and Cash Equivalents
Cash Operation Expenses ÷ No. of Days in Period (365)
4. Days Receivables
Net Receivables
Net Credit Revenues ÷ No. of Days in Period (365)
Solvency Ratios
5. Debt Service Coverage Ratio (DSCR)
Change in Unrestricted Net Assets (net income)
+ Interest, Depreciation, Amortization
Maximum Annual Debt Service
6. Liabilities to Fund Balance
Total Liabilities
Unrestricted Fund Balances
Profitability Ratios
7. Operating Margin (%)
Operating Income (Loss)
Total Operating Revenues
8. Return on Total Assets (%)
EBIT (Earnings before Interest and Taxes)
Total Assets
Courtesy of Resource Group, Ltd., Dallas, Texas.
that are widely used in healthcare organizations: four liquidity types, two solvency types, and
two profitability types. All are discussed later.
LIQUIDITY RATIOS
Liquidity r.
Types of Ratio analyis and their significanceFred Mmbololo
Ratio analysis is used to analyze financial statements and determine key metrics and relationships between items. It can help management with forecasting, planning, control, and decision making. There are various types of ratios that provide different insights. Liquidity ratios like current and quick ratios measure a company's ability to meet short-term obligations. Leverage or capital structure ratios like debt-to-equity examine how the company is financing its assets and level of financial risk. Activity/turnover ratios review how efficiently a company uses its assets. Profitability ratios assess return on sales, assets, and equity. Ratio analysis provides both opportunities to understand a business better but also has some limitations to consider.
This document provides an overview of ratio analysis for assessing the financial position and performance of a company. It begins with introducing ratio analysis and its uses. Then it discusses different types of ratios - liquidity ratios, leverage ratios, activity ratios, and profitability ratios. For each type, it explains the important ratios calculated under that category. For key ratios like current ratio, debt-equity ratio, inventory turnover ratio, it provides the formula to calculate them as well as guidelines on the ideal ratios. The document serves as a comprehensive guide to ratio analysis and interpreting various financial ratios.
This chapter discusses key accounting concepts such as the accounting equation, financial statements, and ratio analysis. It explains that accounting is used to collect, analyze, and communicate financial information to both internal and external users. The chapter outlines the main financial statements - the balance sheet, income statement, and statement of cash flows. It also describes how ratio analysis can be used to evaluate a company's solvency, profitability, and operational efficiency. Common ratios discussed include the current ratio, debt ratio, net profit margin, and inventory turnover ratio.
Ratio analysis is used to evaluate the financial performance and health of a business. Ratios show the mathematical relationship between two related figures and can be used for trend analysis and comparisons between firms. There are several types of ratios including liquidity ratios that measure short-term financial strength, activity/turnover ratios that measure efficiency, and profitability ratios. Current ratio, quick ratio, and inventory turnover ratio are some examples discussed. Ratios should be interpreted both individually and in comparison to past ratios and industry standards to evaluate performance over time.
The document discusses various financial ratios used for analysis. It begins by defining ratio analysis and its importance. It then categorizes ratios into liquidity ratios, activity ratios, profitability ratios, and leverage ratios. Specific ratios discussed in detail include current ratio, quick ratio, inventory turnover ratio, debtors turnover ratio, gross profit ratio, net profit ratio, operating profit ratio, EPS, and debt-equity ratio. Formulas for calculating these ratios are provided. Examples are given to demonstrate calculating some of these ratios.
The document provides an overview of ratio analysis, fund flow statements, and cash flow statements. It discusses various types of ratios like liquidity ratios, leverage ratios, and activity ratios. It explains key liquidity ratios like current ratio, quick ratio, and cash ratio. It also discusses leverage ratios like debt ratio and debt-equity ratio. The document then covers activity or turnover ratios and provides formulas for inventory turnover ratio and assets turnover ratio. It defines a fund flow statement and cash flow statement and discusses their purpose and limitations.
The document discusses ratio analysis and provides definitions and formulas for various types of ratios used to analyze company financial statements. It covers 18 different ratios organized into categories of liquidity/short term solvency ratios, capital structure/long term solvency ratios, asset management ratios, and profitability ratios. The ratios are used to evaluate a company's financial health, performance, and efficiency in areas such as liquidity, leverage, asset utilization, and profit generation.
Financial ratio analysis is a technique used to analyze a company's financial statements and identify its strengths and weaknesses. Ratios can simplify financial statements and facilitate comparison between firms. There are four main categories of ratios: liquidity ratios measure short-term debt paying ability; leverage or solvency ratios measure long-term debt paying ability; activity ratios measure efficiency of asset usage; and profitability ratios measure operating results and return on investments. Common ratios calculated include the current ratio, debt-to-equity ratio, inventory turnover ratio, net profit margin, and price-earnings ratio. Ratio analysis provides useful information for decision makers to evaluate a company's financial performance and position.
This document provides a tutorial on financial ratios used to analyze companies. It discusses several types of ratios:
1. Liquidity ratios like the current ratio, quick ratio, and cash ratio which measure a company's ability to meet short-term obligations. The cash conversion cycle is also introduced which measures the time between expenditure for inventory and collection from customers.
2. Profitability, debt, operating performance, cash flow, and investment valuation ratios are also outlined.
3. Examples are provided for each ratio using financial data from Zimmer Holdings, with the current ratio, quick ratio, and cash ratio being explained in more detail to illustrate how they are calculated and interpreted.
BackgroundAnne Schippel, business banker, is analyzing Dry Supply.pdfpearlcoburnsanche303
Background:
Anne Schippel, business banker, is analyzing Dry Supply\'s financial statements. When
calclating ratios, many commercial lenders use a ratio summary. Figure 8.5 summarizes the key
ratios as they might appear on her spreadsheet.
In reviewing the Ratio Summary and Comparative Data for Dry Supply for 12/31/20xx through
12/31/20xz, Anne Schippel has developed some questions and observations regarding the ratios.
It is now your turn to do the same.
Figure 8.5 Ratio Summary: Dry Supply
12/31/20xx
12/31/20xy
12/31/20xz
Liquidity
Current Ratio
Quick Ratio
Working Capital
1.3x
0.8x
$47,000
1.5x
1.0x
$66,000
1.5x
1.0x
$92,000
Leverage
Debt to net worth
Tangible leverage
Tangible effective leverage
3.3x
3.3x
1.3x
2.7x
2.7x
1.0x
1.9x
1.9x
0.7x
Profitability
Gross profit margin
Operating profit margin
Pretax profit margin
Net Profit margin
Return-on-assets
Return-on-equity
27.9%
2.3%
2.2%
1.0%
8.2%
35.1%
28.8%
3.0%
2.8%
1.5%
10.0%
36.6%
31.3%
5.0%
4.4%
2.5%
14.8%
42.6%
Efficiency
Accounts receivable turnover
Inventory turnover
Accounts payable turnover
Sales to total assets
44.5d
41.3d
17.9d
3.4x
44.0d
39.4d
17.9d
3.4x
44.5d
38.8d
17.9d
3.4x
Coverage
Tradition cash flow coverage
Interest Coverage
Fixed charge coverage
Dividend payout ratio
n/a
4.3x
4.5x
0.0%
n/a
4.7x
4.7x
0.0%
n/a
4.6x
4.3x
0.0%
Figure 8.6 Wholesale Dry-Cleaning Equipment Industry Quartiles 20xz
Ration
Higher
Median
Lower
Current
Quick
Tangible Leverage
Pretax profit margin
Return-on-assets
Interest coverage
2.4x
1.2x
0.9x
n/a
10.7x
5.5x
1.5x
0.8x
2.5x
2.1x
3.2x
2.1x
1.2x
0.5x
5.1x
n/a
(0.3x)
1.0x
Part 1
For each of the ratios listed below, perform your own ratio analysis by stating your observation
and develop any necessary questions you would ask Dry Supply to complete your analysis.
A. Liquidity Ratios
B. Financial Leverage Ratios
C. Profitability Ratios
D. Efficiency Ratios
E. Coverage Ratios
Part 2
Using the commercial lending decision tree, Schippel deteremined that Dry Supply, as a
wholesaler, would likely show certain financial characteristics when she began to analyze the
financial statements. What are some examples of these characteristics within the ratios for 20xx
through 20 xz?
Figure 8.5 Ratio Summary: Dry Supply
12/31/20xx
12/31/20xy
12/31/20xz
Liquidity
Current Ratio
Quick Ratio
Working Capital
1.3x
0.8x
$47,000
1.5x
1.0x
$66,000
1.5x
1.0x
$92,000
Leverage
Debt to net worth
Tangible leverage
Tangible effective leverage
3.3x
3.3x
1.3x
2.7x
2.7x
1.0x
1.9x
1.9x
0.7x
Profitability
Gross profit margin
Operating profit margin
Pretax profit margin
Net Profit margin
Return-on-assets
Return-on-equity
27.9%
2.3%
2.2%
1.0%
8.2%
35.1%
28.8%
3.0%
2.8%
1.5%
10.0%
36.6%
31.3%
5.0%
4.4%
2.5%
14.8%
42.6%
Efficiency
Accounts receivable turnover
Inventory turnover
Accounts payable turnover
Sales to total assets
44.5d
41.3d
17.9d
3.4x
44.0d
39.4d
17.9d
3.4x
44.5d
38.8d
17.9d
3.4x
Coverage
Tradition cash flow coverage
Interest Coverage
Fixed charge coverage
Dividend payout ratio
n/.
This document discusses liquidity ratios and how they can change based on a company's financial decisions. It defines two key liquidity ratios: the current ratio and acid test ratio. The current ratio measures current assets available to cover current liabilities, while the acid test only considers more liquid current assets. The document then demonstrates how taking on short-term debt or increasing capital can impact these ratios, making liquidity stronger by applying long-term resources to current assets but weaker by using short-term debt for fixed assets.
Ratio analysis is a technique used to interpret financial statements and evaluate the operating performance and financial position of a company. It involves calculating and comparing various financial ratios related to liquidity, profitability, and solvency. Some key liquidity ratios discussed in the document include the current ratio, acid-test ratio, and cash ratio. Turnover ratios measure how efficiently a company manages its assets, such as inventory and accounts receivable. The document provides formulas and interpretations for various financial ratios.
The document discusses ratio analysis, which involves calculating and interpreting various financial ratios to evaluate aspects of a company's performance and financial position. It defines key ratios including liquidity ratios, activity ratios, profitability ratios, and leverage ratios. It provides formulas and examples for specific ratios like current ratio, inventory turnover, debt-to-equity ratio, and return on equity. The purpose of ratio analysis is to help assess a company's liquidity, profitability, financial stability, and management quality.
This document discusses various methods for analyzing financial statements, including horizontal analysis, vertical analysis, and common-sized statements. It then describes how these analytical methods can be used to assess the solvency and profitability of a business. Specifically, it discusses various ratios that can indicate a business's ability to pay current liabilities (current ratio, quick ratio) and manage inventory and receivables (inventory turnover, accounts receivable turnover, days in inventory/receivables). The document provides examples of calculating these ratios.
This document discusses ratio analysis, which involves interpreting numerical relationships based on financial statements to evaluate a company's performance. Ratios are classified into liquidity ratios, which assess short-term solvency, and solvency ratios, which evaluate long-term financial position. Key liquidity ratios discussed are current ratio, quick ratio, and absolute liquidity ratio. Important solvency ratios mentioned include debt-equity ratio, proprietary ratio, and fixed assets to net worth ratio. The document provides formulas and interpretations for these ratios.
Prepare a witten financial analysis. .This should include calculation.pdfarrowit1
Prepare a witten financial analysis. .This should include calculations and discussion related to
the Chapter 5 appendix (Appendix 5A). See illustration 5A-1 for a summary of financial ratios.
Be sure to include (1) these ratios, (2) what they mean and (3) how you interpret them: o Current
ratio o Accounts receivable turnover o Inventory turnover o Profit margin on sales o Return on
assets o Return on stockholders\' equity o Debt to assets ratio Submit a WORD document via
D2L- Assessments - Assignments
Solution
Ans ) The ratios are not meant for a particular person or firm.People in various fields of life are
interested in ratio analysis from their own angles.The parties attached with business or firm are
creditors i.e. mony lenders, shareholders.Management uses the toolof Ratio analysisto
interpretate the information from their own angles.For example creditors are interested in
liquidity and solvency for which they will make use of current ratio , liquidity ratio,
proprietaryRatio, debt equity Ratio,capital gearing Ratio.Shareholders are interested in
profitability and long term solvency.They want to know the rate of return on their capital
employed for which they willmake use of Gross Profit Ratio, Operating Ratio, Dividend ratio
and Price Earning Ratio.Management is interested in overall efficiency of business which can be
better jud ged through Ratios like turnover to fixed assets, turnover to capital employed, stock
turnover ratio etc.So, from the above discussion it is clear that different prties uses the tool of
Ratio analysis for taking their own decisions
The particular purpose of a user is determining the particular Ratios that might be used ofr
financial analysis.Here we will discuss and calculate various ratios to do fianacial analysis.
Current Ratio = Current Assests/Current Liabilities
Current Assests= Cash + Bank+ Prepaid Insurance+Inventory+ Accounts Recievables
Current Assests=44746.5 +510+500+5000+29000=79756.5
Current Laibilites =Accounts payable
Current Laibilites= 30064.83
Current Ratio = 79756.5/30064.83= 2.7
Interpretation : Generally a current ratio of 2 times or 2:1 is cosidered to be satisfactory.Here the
current ratio of greater than 2 denotes the good liquidity position but it also indicates assest
liabilty mis match.But current ratio greater than 2 is generally preferred as compared to less than
2.
2.Account receivables turnover :It represents the number of times the cash is collected from
debtors.Lower turnover denotes poor collection and means that funds are blocked ofr longer
period of tiem and vice-versa.It also measure the liquidity of the firm.It shows how quickly
debtors (receivables) are converted into sales.The Account receivables turnover shows the
relationship between sales and debtors of the firm.
Account receivables turnover= Net Credit Annual Sales/Average trade debtors
3. Inventory turnover :This ratio indicates the number of times inventory or stock is replaced
during the year.The turnover of invent.
Ratio analysis is a technique used to analyze and interpret financial statements. It involves calculating and comparing various financial ratios over time and between companies to gain insight into aspects like profitability, liquidity, leverage, and efficiency. Some key ratios discussed in the document include current ratio, quick ratio, debt ratio, return on equity, inventory turnover, and dividend coverage ratio. Ratio analysis provides a simplified and standardized way to analyze a company's financial health and performance.
Operating Ratios asPerformanceMeasure s 11C H A P T E RTHE.docxhopeaustin33688
Operating Ratios as
Performance
Measure s 11
C H A P T E R
THE IMPORTANCE OF RATIOS
Ratios are convenient and uniform measures that are
widely adopted in healthcare financial management.
They are important because they are so widely used, especially
because they are used for credit analysis. But a
ratio is only a number. It has to be considered within the
context of the operation. There is another caveat: ratio
analysis should be conducted as a comparative analysis. In
other words, one ratio standing alone with nothing to
compare it with does not mean very much. When interpreting
ratios, the differences between periods must be
considered, and the reasons for such differences should
be sought. It is a good practice to compare results with
equivalent computations from outside the organization—
regional figures from similar institutions would be a good
example of such outside sources. Caution and good managerial
judgment must always be exercised when working
with ratios.
Financial ratios basically pull together two elements of
the financial statements: one expressed as the numerator
and one as the denominator. To calculate a ratio, divide
the bottom number (the denominator) into the top
number (the numerator). The Case Study in Appendix
25-A entitled “Using Financial Ratios and Benchmarking:
A Case Study in Comparative Analysis” uses financial
ratios as indicators of financial position. We highly recommend
that you spend time with this Case Study, as it
will add depth and background to the contents of this
chapter.
In this chapter we examine liquidity, solvency, and
profitability ratios. Exhibit 11-1 sets out eight basic ratios
After completing this chapter,
you should be able to
1. Understand four types of
liquidity ratios.
2. Understand two types of
solvency ratios.
3. Understand two types of
profitability ratios.
4. Successfully compute ratios
CHAPTER 11 Financial and Operating Ratios as Performance Measures
Exhibit 11–1 Eight Basic Ratios Used in Health Care
Liquidity Ratios
1. Current Ratio
Current Assets
Current Liabilities
2. Quick Ratio
Cash and Cash Equivalents + Net Receivables
Current Liabilities
3. Days Cash on Hand (DCOH)
Unrestricted Cash and Cash Equivalents
Cash Operation Expenses ÷ No. of Days in Period (365)
4. Days Receivables
Net Receivables
Net Credit Revenues ÷ No. of Days in Period (365)
Solvency Ratios
5. Debt Service Coverage Ratio (DSCR)
Change in Unrestricted Net Assets (net income)
+ Interest, Depreciation, Amortization
Maximum Annual Debt Service
6. Liabilities to Fund Balance
Total Liabilities
Unrestricted Fund Balances
Profitability Ratios
7. Operating Margin (%)
Operating Income (Loss)
Total Operating Revenues
8. Return on Total Assets (%)
EBIT (Earnings before Interest and Taxes)
Total Assets
Courtesy of Resource Group, Ltd., Dallas, Texas.
that are widely used in healthcare organizations: four liquidity types, two solvency types, and
two profitability types. All are discussed later.
LIQUIDITY RATIOS
Liquidity r.
Types of Ratio analyis and their significanceFred Mmbololo
Ratio analysis is used to analyze financial statements and determine key metrics and relationships between items. It can help management with forecasting, planning, control, and decision making. There are various types of ratios that provide different insights. Liquidity ratios like current and quick ratios measure a company's ability to meet short-term obligations. Leverage or capital structure ratios like debt-to-equity examine how the company is financing its assets and level of financial risk. Activity/turnover ratios review how efficiently a company uses its assets. Profitability ratios assess return on sales, assets, and equity. Ratio analysis provides both opportunities to understand a business better but also has some limitations to consider.
This document provides an overview of ratio analysis for assessing the financial position and performance of a company. It begins with introducing ratio analysis and its uses. Then it discusses different types of ratios - liquidity ratios, leverage ratios, activity ratios, and profitability ratios. For each type, it explains the important ratios calculated under that category. For key ratios like current ratio, debt-equity ratio, inventory turnover ratio, it provides the formula to calculate them as well as guidelines on the ideal ratios. The document serves as a comprehensive guide to ratio analysis and interpreting various financial ratios.
This chapter discusses key accounting concepts such as the accounting equation, financial statements, and ratio analysis. It explains that accounting is used to collect, analyze, and communicate financial information to both internal and external users. The chapter outlines the main financial statements - the balance sheet, income statement, and statement of cash flows. It also describes how ratio analysis can be used to evaluate a company's solvency, profitability, and operational efficiency. Common ratios discussed include the current ratio, debt ratio, net profit margin, and inventory turnover ratio.
Ratio analysis is used to evaluate the financial performance and health of a business. Ratios show the mathematical relationship between two related figures and can be used for trend analysis and comparisons between firms. There are several types of ratios including liquidity ratios that measure short-term financial strength, activity/turnover ratios that measure efficiency, and profitability ratios. Current ratio, quick ratio, and inventory turnover ratio are some examples discussed. Ratios should be interpreted both individually and in comparison to past ratios and industry standards to evaluate performance over time.
The document discusses various financial ratios used for analysis. It begins by defining ratio analysis and its importance. It then categorizes ratios into liquidity ratios, activity ratios, profitability ratios, and leverage ratios. Specific ratios discussed in detail include current ratio, quick ratio, inventory turnover ratio, debtors turnover ratio, gross profit ratio, net profit ratio, operating profit ratio, EPS, and debt-equity ratio. Formulas for calculating these ratios are provided. Examples are given to demonstrate calculating some of these ratios.
The document provides an overview of ratio analysis, fund flow statements, and cash flow statements. It discusses various types of ratios like liquidity ratios, leverage ratios, and activity ratios. It explains key liquidity ratios like current ratio, quick ratio, and cash ratio. It also discusses leverage ratios like debt ratio and debt-equity ratio. The document then covers activity or turnover ratios and provides formulas for inventory turnover ratio and assets turnover ratio. It defines a fund flow statement and cash flow statement and discusses their purpose and limitations.
The document discusses ratio analysis and provides definitions and formulas for various types of ratios used to analyze company financial statements. It covers 18 different ratios organized into categories of liquidity/short term solvency ratios, capital structure/long term solvency ratios, asset management ratios, and profitability ratios. The ratios are used to evaluate a company's financial health, performance, and efficiency in areas such as liquidity, leverage, asset utilization, and profit generation.
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Cryptocurrency, a digital or virtual form of currency that uses cryptography for security, has revolutionized the financial landscape. Originating with Bitcoin's inception in 2009 by the pseudonymous Satoshi Nakamoto, cryptocurrencies have grown from niche curiosities to mainstream financial instruments, reshaping how we think about money, transactions, and the global economy.
The birth of Bitcoin marked the beginning of the cryptocurrency era. Unlike traditional currencies issued by governments and controlled by central banks, Bitcoin operates on a decentralized network using blockchain technology. This technology ensures transparency, security, and immutability of transactions, fundamentally challenging the centralized financial systems that have dominated for centuries.
Bitcoin was conceived as a peer-to-peer electronic cash system, aimed at providing an alternative to the traditional banking system plagued by inefficiencies, high fees, and lack of transparency. The underlying blockchain technology, a distributed ledger maintained by a network of nodes, ensures that every transaction is recorded and cannot be altered, thus providing a secure and transparent financial system.
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CRYPTOCURRENCY: REVOLUTIONIZING THE FINANCIAL LANDSCAPE AND SHAPING THE FUTURE
Cryptocurrency: Revolutionizing the Financial Landscape and Shaping the Future
Cryptocurrency, a digital or virtual form of currency that uses cryptography for security, has revolutionized the financial landscape. Originating with Bitcoin's inception in 2009 by the pseudonymous Satoshi Nakamoto, cryptocurrencies have grown from niche curiosities to mainstream financial instruments, reshaping how we think about money, transactions, and the global economy.
#### The Genesis of Cryptocurrency
The birth of Bitcoin marked the beginning of the cryptocurrency era. Unlike traditional currencies issued by governments and controlled by central banks, Bitcoin operates on a decentralized network using blockchain technology. This technology ensures transparency, security, and immutability of transactions, fundamentally challenging the centralized financial systems that have dominated for centuries.
Bitcoin was conceived as a peer-to-peer electronic cash system, aimed at providing an alternative to the traditional banking system plagued by inefficiencies, high fees, and lack of transparency. The underlying blockchain technology, a distributed ledger maintained by a network of nodes, ensures that every transaction is recorded and cannot be altered, thus providing a secure and transparent financial system.
#### The Proliferation of Altcoins
Following Bitcoin's success, thousands of alternative cryptocurrencies, or altcoins, have emerged. Each of these altcoins aims to improve upon Bitcoin or serve specific purposes within the digital economy. Notable examples include Ethereum, which introduced smart contracts – self-executing contracts with the terms of the agreement
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Clive Bolton, CEO, Life Insurance M&G Plc
Jim Boyd, CEO, Equity Release Council
Molly Broome, Economist, Resolution Foundation
Nida Broughton, Co-Director of Economic Policy, Behavioural Insights Team
Jonathan Cribb, Associate Director and Head of Retirement, Savings, and Ageing, Institute for Fiscal Studies
Joanna Elson CBE, Chief Executive Officer, Independent Age
Tom Evans, Managing Director of Retirement, Canada Life
Steve Groves, Chair, Key Retirement Group
Tish Hanifan, Founder and Joint Chair of the Society of Later life Advisers
Sue Lewis, ILC Trustee
Siobhan Lough, Senior Consultant, Hymans Robertson
Mick McAteer, Co-Director, The Financial Inclusion Centre
Stuart McDonald MBE, Head of Longevity and Democratic Insights, LCP
Anusha Mittal, Managing Director, Individual Life and Pensions, M&G Life
Shelley Morris, Senior Project Manager, Living Pension, Living Wage Foundation
Sarah O'Grady, Journalist
Will Sherlock, Head of External Relations, M&G Plc
Daniela Silcock, Head of Policy Research, Pensions Policy Institute
David Sinclair, Chief Executive, ILC
Jordi Skilbeck, Senior Policy Advisor, Pensions and Lifetime Savings Association
Rt Hon Sir Stephen Timms, former Chair, Work & Pensions Committee
Nigel Waterson, ILC Trustee
Jackie Wells, Strategy and Policy Consultant, ILC Strategic Advisory Board
2. FINANCIAL STATEMENTS
ANALYSIS
Ratio Analysis
Common Size Statements
Importance and Limitations of
Ratio Analysis
Mini Case
6-2
6-2
3. Ratio Analysis
Ratio analysis is a widely used tool of financial
analysis. It is defined as the systematic use of
ratio to interpret the financial statements so
that the strengths and weaknesses of a firm as
well as its historical performance and current
financial condition can be determined.
6-3
6-3
4. Basis of Comparison
1) Trend Analysis involves comparison of a firm over a
period of time, that is, present ratios are compared with
past ratios for the same firm. It indicates the direction of
change in the performance – improvement, deterioration
or constancy – over the years.
2) Interfirm Comparison involves comparing the ratios of a
firm with those of others in the same lines of business or
for the industry as a whole. It reflects the firm’s
performance in relation to its competitors.
3) Comparison with standards or industry average.
6-4
6-4
6. Net Working Capital
Net working capital is a measure of liquidity calculated by
subtracting current liabilities from current assets.
Table 1: Net Working Capital
Particulars Company A Company B
Total current assets Rs 1,80,000 Rs 30,000
Total current liabilities 1,20,000 10,000
NWC 60,000 20,000
Table 2: Change in Net Working Capital
Particulars Company A Company B
Current assets Rs 1,00,000 Rs 2,00,000
Current liabilities 25,000 1,00,000
NWC 75,000 1,00,000
6-6
6-6
8. Current Ratio
Current Ratio is a measure of liquidity calculated dividing the current
assets by the current liabilities
Current Assets
Current Ratio =
Current Liabilities
Particulars Firm A Firm B
Current Assets Rs 1,80,000 Rs 30,000
Current Liabilities Rs 1,20,000 Rs 10,000
Current Ratio = 3:2 (1.5:1) 3:1
6-8
6-8
9. Acid-Test Ratio
The quick or acid test ratio takes into consideration the
differences in the liquidity of the components of current
assets.
Quick Assets
Acid-test Ratio =
Current Liabilities
Quick Assets = Current assets – Stock –
Pre-paid expenses
6-9
6-9
10. Example 1: Acid-Test Ratio
Cash Rs 2,000
Debtors 2,000
Inventory 12,000
Total current assets 16,000
Total current liabilities 8,000
(1) Current Ratio 2:1
(2) Acid-test Ratio 0.5 : 1
6 - 10
6 - 10
11. Supplementary Ratios for
Liquidity
Inventory Turnover Ratio
Debtors Turnover Ratio
Creditors Turnover Ratio
6 - 11
6 - 11
12. Inventory Turnover Ratio
The ratio indicates how fast inventory is sold. A high ratio is good from
the viewpoint of liquidity and vice versa. A low ratio
would signify that inventory does not sell fast and stays on the shelf or in
the warehouse for a long time.
Cost of goods sold
Inventory turnover ratio =
Average inventory
The cost of goods sold means sales minus gross profit.
The average inventory refers to the simple average of the opening
and closing inventory.
6 - 12
6 - 12
13. Example 2: Inventory Turnover Ratio
A firm has sold goods worth Rs 3,00,000 with a gross profit
margin of 20 per cent. The stock at the beginning and the end of
the year was Rs 35,000 and Rs 45,000 respectively. What is the
inventory turnover ratio?
(Rs 3,00,000 – Rs 60,000)
Inventory 6 (times per
= =
turnover ratio (Rs 35,000 + Rs 45,000) ÷ 2 year)
12 months
Inventory
= = 2 months
holding period Inventory turnover ratio, (6)
6 - 13
6 - 13
14. Debtors Turnover Ratio
The ratio measures how rapidly receivables are collected. A high
ratio is indicative of shorter time-lag between credit sales and
cash collection. A low ratio shows that debts are not being
collected rapidly.
Net credit sales
Debtors turnover ratio =
Average debtors
Net credit sales consist of gross credit sales minus returns, if any,
from customers.
Average debtors is the simple average of debtors (including
bills receivable) at the beginning and at the end of year.
6 - 14
6 - 14
15. Example 3: Debtors Turnover Ratio
A firm has made credit sales of Rs 2,40,000 during the year.
The outstanding amount of debtors at the beginning and at
the end of the year respectively was Rs 27,500 and Rs
32,500. Determine the debtors turnover ratio.
Rs 2,40,000
Debtors 8 (times per
= =
turnover ratio (Rs 27,500 + Rs 32,500) ÷ 2 year)
12 Months
Debtors 1.5
= =
collection period Debtors turnover ratio, (8) Months
6 - 15
6 - 15
16. Creditors Turnover Ratio
A low turnover ratio reflects liberal credit terms granted by
suppliers, while a high ratio shows that accounts are to be settled
rapidly. The creditors turnover ratio is an important tool of
analysis as a firm can reduce its requirement of current assets by
relying on supplier’s credit.
Net credit purchases
Creditors turnover
=
ratio Average creditors
Net credit purchases = Gross credit purchases - Returns to
suppliers.
Average creditors = Average of creditors (including bills payable)
outstanding at the beginning and at the end of the year.
6 - 16
6 - 16
17. Example 4: Creditors Turnover Ratio
The firm in previous Examples has made credit purchases of Rs
1,80,000. The amount payable to the creditors at the beginning
and at the end of the year is Rs 42,500 and Rs 47,500 respectively.
Find out the creditors turnover ratio.
(Rs 1,80,000)
Creditors 4 (times
= =
turnover ratio (Rs 42,500 Rs 47,500) ÷ 2 per year)
12 months
Creditor’s
= = 3 months
payment period Creditors turnover ratio, (4)
6 - 17
6 - 17
18. The summing up of the three turnover ratios (known as a
cash cycle) has a bearing on the liquidity of a firm. The cash
cycle captures the interrelationship of sales, collections
from debtors and payment to creditors.
The combined effect of the three turnover ratios
is summarised below:
Inventory holding period 2 months
Add: Debtor’s collection period + 1.5 months
Less: Creditor’s payment period – 3 months
0.5 months
As a rule, the shorter is the cash cycle, the better are the liquidity
ratios as measured above and vice versa.
6 - 18
6 - 18
19. DEFENSIVE INTERVAL RATIO
Defensive interval ratio is the ratio between quick
assets and projected daily cash requirement.
Liquid assets
Defensive-
=
interval ratio Projected daily cash requirement
Projected cash operating expenditure
Projected daily
=
cash requirement Number of days in a year (365)
6 - 19
6 - 19
20. Example 5: Defensive Interval Ratio
The projected cash operating expenditure of a firm from the
next year is Rs 1,82,500. It has liquid current assets
amounting to Rs 40,000. Determine the defensive-interval
ratio.
Rs 1,82,500
Projected daily cash requirement = = Rs 500
365
Rs 40,000
Defensive-interval ratio = = 80 days
Rs 500
6 - 20
6 - 20
21. Cash-flow From Operations Ratio
Cash-flow from operation ratio measures liquidity of a
firm by comparing actual cash flows from operations
(in lieu of current and potential cash inflows from
current assets such as inventory and debtors)
with current liability.
Cash-flow from operations
Cash-flow from
=
operations ratio Current liabilities
6 - 21
6 - 21
22. Leverage Capital Structure Ratio
There are two aspects of the long-term solvency of a firm:
(i) Ability to repay the principal when due, and
(ii) Regular payment of the interest .
Capital structure or leverage ratios throw light on the
long-term solvency of a firm.
Accordingly, there are two different types of leverage ratios.
First type: These ratios are Second type: These ratios are
computed from the balance computed from the Income
sheet Statement
(a) Debt-equity ratio (a) Interest coverage ratio
(b) Debt-assets ratio (b) Dividend coverage ratio
(c) Equity-assets ratio
6 - 22
6 - 22
23. I. Debt-equity ratio
Debt-equity ratio measures the ratio of long-term or total
debt to shareholders equity.
Long-term Debt + Short
Debt-equity ratio measures the ratio of long-term debt + Other Current
Total Debt
Debt-equitytotal de3bt to shareholders equity Liabilities = Total external
term or ratio =
Shareholders’ equity Obligations
If the D/E ratio is high, the owners are putting up relatively less
money of their own. It is danger signal for the lenders and
creditors. If the project should fail financially, the creditors would
lose heavily.
A low D/E ratio has just the opposite implications. To the creditors, a
relatively high stake of the owners implies sufficient safety
margin and substantial protection against shrinkage in assets.
6 - 23
6 - 23
24. For the company also, the servicing of debt is
less burdensome and consequently its credit
standing is not adversely affected, its
operational flexibility is not jeopardised and it
will be able to raise additional funds.
The disadvantage of low debt-equity ratio is
that the shareholders of the firm are deprived
of the benefits of trading on equity
or leverage.
6 - 24
6 - 24
25. Trading on Equity
Trading on equity (leverage) is the use of borrowed funds in
expectation of higher return to equity-holders.
Trading on Equity (Amount in Rs thousand)
Particular A B C D
(a) Total assets 1,000 1,000 1,000 1,000
Financing pattern:
Equity capital 1,000 800 600 200
15% Debt — 200 400 800
(b)Operating profit (EBIT) 300 300 300 300
Less: Interest — 30 60 120
Earnings before taxes 300 270 240 180
Less: Taxes (0.35) 105 94.5 84 63
Earnings after taxes 195 175.5 156 117
Return on equity (per cent) 19.5 21.9 26 58.5
6 - 25
6 - 25
26. II. Debt to Total Capital
The relationship between creditors’ funds and owner’s
capital can also be expressed using Debt to total capital
ratio.
Total debt
Debt to total capital ratio =
Permanent capital
Permanent Capital = Shareholders’ equity +
Long-term debt.
6 - 26
6 - 26
27. III. Debt to total assets ratio
Total debt
Debt to total assets ratio =
Total assets
Proprietary Ratio
Proprietary ratio indicates the extent to which assets
are financed by owners funds.
Proprietary funds
Proprietary ratio = X 100
Total assets
Capital Gearing Ratio
Capital gearing ratio is used to know the relationship between equity
funds (net worth) and fixed income bearing funds (Preference
shares, debentures and other borrowed funds.
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28. Coverage Ratio
Interest Coverage Ratio
Interest Coverage Ratio measures the firm’s ability to make
contractual interest payments.
EBIT (Earning before interest and taxes)
Interest coverage ratio =
Interest
Dividend Coverage Ratio
Dividend Coverage Ratio measures the firm’s ability to pay dividend
on preference share which carry a stated rate of return.
EAT (Earning after taxes)
Dividend coverage ratio =
Preference dividend
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29. Total fixed charge coverage ratio
Total fixed charge coverage ratio measures the firm’s ability to meet all fixed
payment obligations.
Total fixed charge EBIT + Lease Payment
coverage ratio = Interest + Lease payments + (Preference dividend
+ Instalment of Principal)/(1-t)
Total Cashflow Coverage Ratio
However, coverage ratios mentioned above, suffer from one major
limitation, that is, they relate the firm’s ability to meet its various
financial obligations to its earnings. Accordingly, it would be
more appropriate to relate cash resources of a firm to its
various fixed financial obligations.
EBIT + Lease Payments + Depreciation + Non-cash expenses
Total cashflow
=
coverage ratio (Principal repayment) (Preference dividend)
Lease payment +
+
+ Interest (1– t) (1 - t)
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30. Debt Service Coverage Ratio
Debt-service coverage ratio (DSCR) is considered a more
comprehensive and apt measure to compute debt service capacity
of a business firm.
n
∑ EATt + Interestt
+ Depreciationt + OAt
t=1
DSCR = n
∑ Instalmentt
t=1
DEBT SERVICE CAPACITY
Debt service capacity is the ability of a firm to make the
contractual payments required on a scheduled basis over the life
of the debt.
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31. Example 6: Debt-Service Coverage Ratio
Agro Industries Ltd has submitted the following projections. You are
required to work out yearly debt service coverage ratio (DSCR)
and the average DSCR.
(Figures in Rs lakh)
Year Net profit for the Interest on term loan Repayment of term
year during the year loan in the year
1 21.67 19.14 10.70
2 34.77 17.64 18.00
3 36.01 15.12 18.00
4 19.20 12.60 18.00
5 18.61 10.08 18.00
6 18.40 7.56 18.00
7 18.33 5.04 18.00
8 16.41 Nil 18.00
The net profit has been arrived after charging depreciation of Rs 17.68 lakh
every year.
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33. Profitability Ratio
Profitability ratios can be computed either from
sales or investment.
Profitability Ratios Profitability Ratios
Related to Sales Related to Investments
(i) Profit Margin (i) Return on Investments
(ii) Expenses Ratio (ii) Return on Shareholders’
Equity
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34. Profit Margin
Gross Profit Margin
Gross profit margin measures the percentage of each sales
rupee remaining after the firm has paid for its goods.
Gross profit margin = Gross Profit
X 100
Sales
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35. Net Profit Margin
Net profit margin measures the percentage of each sales rupee
remaining after all costs and expense including interest
and taxes have been deducted.
Net profit margin can be computed in three ways
Earning before interest and taxes
i. Operating Profit Ratio =
Net sales
Earnings before taxes
ii. Pre-tax Profit Ratio =
Net sales
Earning after interest and taxes
iii. Net Profit Ratio = Net sales
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36. Example 7: From the following information of a firm,
determine (i) Gross profit margin and (ii) Net profit
margin.
1. Sales Rs 2,00,000
2. Cost of goods sold 1,00,000
3. Other operating expenses 50,000
Rs 1,00,000
(1) Gross profit margin = = 50 per cent
Rs 2,00,000
Rs 50,000
(2) Net profit margin = = 25 per cent
Rs 2,00,000
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37. Expenses Ratio
Cost of goods sold
i. Cost of goods sold = X 100
Net sales
Administrative exp. + Selling exp.
ii. Operating expenses = X 100
Net sales
Administrative expenses
iii. Administrative expenses = X 100
Net sales
Selling expenses
iv. Selling expenses ratio = X 100
Net sales
Cost of goods sold + Operating expenses
v. Operating ratio = X 100
Net sales
Financial expenses
vi. Financial expenses = X 100
Net sales
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38. Return on Investment
Return on Investments measures the overall effectiveness
of management in generating profits with its available
assets.
i. Return on Assets (ROA)
EAT + (Interest – Tax advantage on interest)
ROA =
Average total assets
ii. Return on Capital Employed (ROCE)
EAT + (Interest – Tax advantage on interest)
ROCE =
Average total capital employed
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39. Return on Shareholders’ Equity
Return on shareholders equity measures the return on the
owners (both preference and equity shareholders)
investment in the firm.
Return on total shareholders’ equity =
Net profit after taxes
X 100
Average total shareholders’ equity
Return on ordinary shareholders’ equity (Net worth) =
Net profit after taxes – Preference dividend
X 100
Average ordinary shareholders’ equity
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40. Efficiency Ratio
Activity ratios measure the speed with which various
accounts/assets are converted into sales or cash.
Inventory turnover measures the efficiency of various types
of inventories.
i. Inventory Turnover measures theof goods sold
Inventory Turnover Ratio =
Cost activity/liquidity of
Average inventory
inventory of a firm; the speed with which inventory is sold
i. Inventory Turnover measures the activity/liquidityused
Raw materials turnover =
Cost of raw materials of
inventory of a firm; the speed with whichmaterial inventory
Average raw inventory is sold
i. Inventory Turnover measuresCost activity/liquidity of
the of goods manufactured
Work-in-progress turnover =
inventory of a firm; the speed with which inventory is sold
Average work-in-progress inventory
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41. Debtors Turnover Ratio
Liquidity of a firm’s receivables can be examined
in two ways.
Credit sales
i. Debtors turnover = measures the activity/liquidity of inventory of
i. Inventory Turnover
a firm; the speed with which inventoryAverage bills receivable (B/R)
Average debtors + is sold
Months (days) in a year
2. Average collection period =
Debtors turnover
i. Inventory Turnover(days) in a year activity/liquidity of inventory of a
Alternatively =
Months measures the (x) (Average Debtors + Average (B/R)
firm; the speed with which inventory is credit sales
Total sold
Ageing Schedule enables analysis to identify
slow paying debtors.
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42. Assets Turnover Ratio
Assets turnover indicates the efficiency with which firm
uses all its assets to generate sales.
Inventory Turnover measures the of goods sold of inventory of
i. Total assets turnover =
i.
Cost activity/liquidity
a firm; the speed with which inventory total assets
Average is sold
Cost of goods sold
ii. Fixed assets turnover =
Average fixed assets
Cost of goods sold
i. Inventory Turnover measures the activity/liquidity of inventory of
iii. Capital turnover =
a firm; the speed with which inventory is sold employed
Average capital
Cost of goods sold
iv. Current assets turnover =
Average current assets
i. Inventory capital turnover = Costactivity/liquidity of inventory of
v. Working Turnover measures the of goods sold
Net working capital
a firm; the speed with which inventory is sold
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43. 1) Return on shareholders’ equity = EAT/Average total shareholders’ equity.
2) Return on equity funds = (EAT – Preference dividend)/Average ordinary
shareholders’ equity (net worth).
3) Earnings per share (EPS) = Net profit available to equity shareholders’
(EAT – Dp)/Number of equity shares outstanding (N).
4) Dividends per share (DPS) = Dividend paid to ordinary
shareholders/Number of ordinary shares outstanding (N).
5) Earnings yield = EPS/Market price per share.
6) Dividend Yield = DPS/Market price per share.
7) Dividend payment/payout (D/P) ratio = DPS/EPS.
8) Price-earnings (P/E) ratio = Market price of a share/EPS.
9) Book value per share = Ordinary shareholders’ equity/Number of equity
shares outstanding.
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44. Integrated Analysis Ratio
Integrated ratios provide better insight about financial and
economic analysis of a firm.
(1) Rate of return on assets (ROA) can be decomposed in to
(i) Net profit margin (EAT/Sales)
(ii) Assets turnover (Sales/Total assets)
(2) Return on Equity (ROE) can be decomposed in to
(i) (EAT/Sales) x (Sales/Assets) x (Assets/Equity)
(ii) (EAT/EBT) x (EBT/EBIT) x (EBIT/Sales) x (Sales/Assets) x
(Assets/Equity)
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45. Rate of Return on Assets
EAT as percentage of Assets
sales turnover
EAT Divided by Sales Sales Divided by Total Assets
Fixed assets Plus Current assets
Gross profit = Sales less
cost of goods sold Alternatively
Minus Shareholder equity
Expenses: Selling Plus
Administrative Interest
Long-term borrowed
Minus funds
Income-tax Plus
Current liabilities
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46. Return on Assets
Earning Power
Earning power is the overall profitability of a firm; is computed
by multiplying net profit margin and assets turnover.
Earning power = Net profit margin × Assets turnover
Where, Net profit margin = Earning after taxes/Sales
Asset turnover = Sales/Total assets
i. Inventory Turnover measurestaxes x
Earning Power =
Earning after the activity/liquidity of inventory of
Sales
x
EAT
a firm; the speed with which inventory isTotal Assets Total assets
Sales sold
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47. EXAMPLE: 8
Assume that there are two firms, A and B, each having total assets
amounting to Rs 4,00,000, and average net profits after
taxes of 10 per cent, that is, Rs 40,000, each.
Firm A has sales of Rs 4,00,000, whereas the sales of firm B aggregate
Rs 40,00,000. Determine the ROA of firms A and B. Table 4 shows
the ROA based on two components.
Table 4: Return on Assets (ROA) of Firms A and B
Particulars Firm A Firm B
1. Net sales Rs 4,00,000 Rs 40,00,000
2. Net profit 40,000 40,000
3. Total assets 4,00,000 4,00,000
4. Profit margin (2 ÷ 1) (per cent) 10 1
5. Assets turnover (1 ÷ 3) (times) 1 10
6. ROA ratio (4 × 5) (per cent) 10 10
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48. Return on Equity (ROE)
ROE is the product of the following three ratios: Net profit ratio (x)
Assets turnover (x) Financial leverage/Equity multiplier
Three-component model of ROE can be broadened further to
consider the effect of interest and tax payments.
EAT EBT EBIT Net Profit
i. Inventory Turnover measures the activity/liquidity of
x x =
inventory of a firm; the EBIT Sales
Earnings before taxes speed with which inventory is sold
Sales
As a result of three sub-parts of net profit ratio, the ROE
is composed of the following 5 components.
EAT EBT EBIT Sales Assets
x x x x
EBT EBIT Sales Assets Equity
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49. A 5-way break-up of ROE enables the management of a firm to analyse the effect of interest
payments and tax payments separately from operating profitability. To illustrate further assume 8
per cent interest rate, 35 per cent tax rate and other operating expense of Rs 3,22,462 (Firm A) and
Rs 39,26,462 (Firm B) for the facts contained in Example 8. Table 5 shows the ROE (based on the
5 components) of Firms A and B.
Table 5: ROE (Five-way Basis) of Firms A and B
Particulars Firm A Firm B
Net sales Rs 4,00,000 Rs 40,00,000
Less: Operating expenses 3,22,462 39,26,462
Earnings before interest and taxes (EBIT) 77,538 73,538
Less: Interest (8%) 16,000 12,000
Earnings before taxes (EBT) 61,538 61,538
Less: Taxes (35%) 21,538 21,538
Earnings after taxes (EAT) 40,000 40,000
Total assets 4,00,000 4,00,000
Debt 2,00,000 2,50,000
Equity 2,00,000 1,50,000
EAT/EBT (times) 0.65 0.65
EBT/EBIT (times) 0.79 0.84
EBIT/Sales (per cent) 19.4 1.84
Sales/Assets (times) 1 10
Assets/Equity (times) 2 1.6
ROE (per cent) 20 16
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50. Common Size Statements
Preparation of common-size financial statements is an extension
of ratio analysis. These statements convert absolute sums into
more easily understood percentages of some base amount. It is
sales in the case of income statement and totals of assets and
liabilities in the case of the balance sheet.
Limitations
Ratio analysis in view of its several limitations should be
considered only as a tool for analysis rather than as an end in
itself. The reliability and significance attached to ratios will largely
hinge upon the quality of data on which they are based. They are
as good or as bad as the data itself. Nevertheless, they are an
important tool of financial analysis.
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52. From the following selected financials of Reliance Industries Ltd (RIL) for the period 2001-2006, appraise its financial
health from the point of view of liquidity, solvency, and profitability.
Selected financial data and ratios (Amount in Rs crore)
Particulars 2001 2002 2003 2004 2005 2006
(I) Related to Liquidity Analysis
Current assets 9,844.48 13,025.31 17,925.25 23,245.88 28,988.62 24,591.03
Marketable investments 3387.25 536.80 536.19 536.11 536.11 16.58
Inventory 2299.85 4976.07 7510.14 7,231.22 7,412.88 10,119.82
Debtors 1,134.17 2,722.46 2,975.49 3,189.93 3,927.81 4,163.62
Advances 2,922.58 3,310.27 6,756.22 12,064.38 13,503.03 8,144.85
Cash and bank balance 100.63 1,760.71 147.21 224.24 3,608.79 2,146.16
Current liabilities 5,312.06 9,830.10 18,160.39 16,966.15 21,934.45 21,441.88
Short-term bank borrowings 337.76 2,148.27 7,193.77 9,145.14 12,684.39 11,438.69
Sundry creditors 3,754.50 5,847.20 8288.10 366.78 366.95 310.42
Interest accrued 223.00 389.23 380.15 676.45 525.37 728.18
Creditors for capital goods 104.72 175.16 717.48 2,670.75 3471.80 3,890.98
Other current liabilities & provisions 892.08 1270.24 1580.89 4,107.03 4,885.94 2,073.61
Other data and ratios
Net working capital 4,532.42 3,195.21 -235.14 6,279.73 7,054.17 3,149.15
Credit sales 22,886.51 45,073.88 49,743.54 56,247.03 73,164.10 89,124.16
Cost of goods sold 21,290.91 45,957.85 54,642.60 41,657.92 53,345.03 65,535.84
Cost of raw material used 18,155.98 41,023.35 50,378.65 34,721.39 45,931.87 58,342.31
Credit purchases 21,608.85 45,083.06 56,884.49 60,246.91 70,014.80 68,516.87
Average debtors 988.31 1,928.31 2,848.97 3,094.02 3,558.87 4,045.71
Average creditors 3,170.68 4,800.85 7,067.65 9,413.58 11,515.6 12,688.31
Current ratio 1.85 1.33 0.99 1.75 1.66 1.49
Acid test ratio 0.87 0.51 0.20 .26 .55 .38
Debtors turnover 23 23 17 17.63 18.62 21.40
Creditors turnover 7 9 8 6.40 6.08 5.40
Debtors cycle (days) 16 16 21 21 20 17
Creditors cycle (days) 54 39 45 57 60 67
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53. CONTD.
Particulars 2001 2002 2003 2004 2005 2006
(II) Related to Solvency Analysis
Free reserves 9,307.89 21,834.29 23,656.31 33,056.50 39,010.23 48,411.09
Paid up capital 1,053.49 1,395.85 1,395.92 1,395.95 1,393.09 1,393.17
Preference capital 0.00 0.00 0.00 0.00 0.00 0.00
Bonus equity capital 481.77 481.77 481.77 481.77 481.77 481.77
Total equity 10,843.15 23,711.91 25,534.00 34,934.22 40,885.09 50,286.03
Long-term borrowings 9,798.03 16,780.21 12,564.54 11,149.38 6,172.98 8,185.60
Current liabilities 5,312.06 9,830.10 18,160.39 12,955.22 17,131.52 16,454.48
Total debt 15,110.09 26,610.31 30,724.93 24,104.60 23,304.50 24,640.08
EBIT 4,032.37 6,307.71 6,551.17 7,735.86 10,537.34 11,581.10
Interest 1,215.56 1,827.85 1,555.40 1,434.72 1,468.66 877.04
Total debt-equity ratio 1.39 1.12 1.20 0.69 0.57 0.49
Long-term debt-equity ratio 0.90 0.71 0.49 .31 .15 .16
Interest coverage ratio 3.32 3.45 4.21 5.39 7.17 13.20
(III) Related to Profitability Analysis
Sales (manufacturing) 22886.51 45073.88 49,743.54 56,247.03 73.164.10 89,124.46
Cost of goods sold 21290.91 45957.85 54,642.60 41,657.92 53,345.03 65,535.84
EBDIT (including other earnings) 5,597.48 9,123.85 9,388.26 10,982.88 14,260.84 14,982.01
EBIT 4,032.37 6,307.71 6,551.17 7,735.86 10,537.34 11,581.10
EBT 2,786.00 4,434.17 4,982.75 6,301.14 9,068.68 10,704.06
EAT 2,646.50 3,242.17 4,106.85 5,160.14 7,571.68 9,069.34
Interest 1,215.55 1,827.84 1,555.4 1,434.72 1,468.66 877.04
Average total capital employed 19235.95 27,053.32 34,388.04 50,030.24 54,560.80 61,738.85
Average total assets 29622.14 43,325.86 60,415.77 52,764.91 57,292.51 65,428.89
Average equity funds 10715.17 17,277.53 24,622.96 1,396.38 1,394.94 1,393.51
Gross profit % 24.46 20.24 18.87 18.41 19.40 17.43
Operating profit ratio % 17.62 13.99 13.17 13.75 14.40 12.99
Net profit ratio % 11.56 7.19 8.26 9.95 11.48 11.21
Cost of goods sold ratio % 93.03 101.96 109.85 80.34 80.92 81.03
Rate of return on capital employed (ROCE)1 20.07 18.74 16.47 13.18 16.56 16.11
ROR (Total assets)2 13.03 11.7 9.37 12.4 15.77 15.20
ROR (Equity funds) 24.70 18.77 16.68 16.26 20.09 20.08
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1. ROCE = (EAT + Interest)/ Average capital employed 2. ROR (Total assets) = (EAT + Interest)/ Average assets
54. Solution: The appraisal of financial health of RIL is presented below.
Liquidity Analysis:
The liquidity position of RIL does not appear to be commendable during all the
years under reference. In fact, its current ratio was less than one implying
negative working capital (in 2003) and acid-test ratio was at an alarming low level
of 0.2. Though the current ratio range of 1.33 – 1.85 (during 2001-2 and 2004-6) is
an indicative of satisfactory liquidity position, the acid-test ratios appear to be on
the lower side, the range being 0.20 – 0.55 (during 2002-6). The major reason for
the sharp difference in these two liquidity ratios may be ascribed to a significant
proportion of inventory (in current assets).
The other notable observation is that the RIL seems to be banking on bank
borrowings to finance its working capital requirements evidenced by a
substantial increase in such borrowings over the years. From 337.76 crore (in
2001), they steadily increased to 7,193.77 crore (by 2003) and to Rs 11,438.69
crore by 2006: (registering more than 30 times increase in 2006 compared to
2001). In fact, short-term borrowings constitute more than one-half of its total
current liabilities during the 6 year period. The reliance on short-term bank
borrowings, to such a marked extent, is contrary to sound tenets of finance.
Likewise, it appears that its net working capital is inadequate in relation to its
credit sales which stood at Rs. 89,124 crore in 2006 compared to Rs. 73,164
crore in 2005. Contrary to increase in net working capital, however, there has
been a more than 50 per cent decrease in net working capital of the RIL; (the
relevant figures being Rs 7,054.17 crore and Rs 3,149.15 crore in years 2005 and
2006 respectively).
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55. The RIL has the advantage of much higher creditors payment period
compared to debtors collection period. The debtors collection period (varying
from 16 days in 2001 and 2002 to 21 days in 2004) seems to be at a very
satisfactory level. In marked contrast, the creditors payment period is three-
times (varying in the range of 39-67 days) during the same period. This
favourable gap, provides some leverage to RIL to operate at relatively low
acid-test ratio.
To conclude, the liquidity position of the RIL does not appear to be
satisfactory. It is suggested that RIL should substitute a fair share of short-
term bank borrowings by long-term loans (which have shown sharp decrease
trend over the years). Such a step would help to improve its liquidity ratios.
Solvency Analysis:
The solvency position of the RIL is sound for two reasons: First, it has a
satisfactory level of interest coverage ratio during all the 6 years, being in the
range of 3.32 and 13.2. The RIL is not likely to commit default in payment of
interest to its lenders as even though its operating profits (EBIT) decline by
more than nine-tenth (2006), it l would stil have enough margin to meet its
interest obligations. Secondly, its total debt-equity ratio over the years has
shown a substantial decrease from 1.39 in 2001 to 0.49 by 2006. Likewise, the
long-term debt to equity ratio during over the years has improved
substantially.
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56. Profitability Analysis:
The profit margins (gross, operating and net) of the RIL over the years have
reduced, albeit recent improvements. For instance gross profit margin has
decreased from 24.46 per cent (in 2001) to 17.43 per cent (in 2006). Likewise
operating profit margins have declined from 17.62 per cent to 12.99 per cent
and net profit margins from 11.56 per cent to 11.21 per cent during these
years. The lower operating profit margins have an unfavourable effect on the
ROR on capital employed. It fell from 20.07 per cent in 2001 to 16.11 per cent
by 2006. However, it is gratifying to note that there has been an increase in
other rates of return. For instance, the ROR on total assets has improved from
13.03 per cent in 2001 to 15.20 per cent in 2006. Likewise a notable increase in
observed in ROR on equity funds. From 16.68 in 2003, it has increased to
more than 20 per cent in 2005 as well as in 2006. There seems to be a
potential for further improvement in its various ROR’s by increasing its gross
profit and operating profit margins.
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