This document discusses financial ratio analysis, which involves establishing quantitative relationships between financial statement items to analyze a company's financial position, performance, and trends over time. It provides definitions and formulas for various types of ratios, including liquidity, solvency, activity, and profitability ratios. Examples are given to demonstrate how to calculate and interpret common ratios like current ratio, acid test ratio, debt-to-equity ratio, and return on assets. The document aims to explain ratio analysis as a tool for evaluating the strengths and weaknesses of a business.

1. CA. Dhruv Seth
ds@sethspro.com

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. 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. 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. 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. 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. 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. 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. 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. 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. Quick Assets
Acid Test Ratio = ----------------------
Quick Liabilities
 A 1:1 ratio is healthy
 Healthy indicator of cash management

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. 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. Turnover
WCT = ----------------------
Average Working Capital
 Average working capital = Opening Working
capital plus closing working capital divided by
two

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. 1) Interest Coverage Ratio
2) Debt Ratio
3) Debt-Equity Ratio
4) Proprietary Ratio

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. Total Debt
Debt to total fund = ------------------
Debt + Equity
AND
Total Debt
Debt Equity Ratio = ------------------
Total Equity

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. 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. 1) Inventory Turnover Ratio
2) Debtors Turnover Ratio
3) Average Collection Period
4) Fixed Assets Turnover Ratio
5) Total Assets Turnover Ratio

22. Sales
Inventory Turnover = ------------------
Inventory
Low turnover = bad products
Extreme High Turnover = Cases of
fraudulent sales possible

23. Sales
Debtors Turnover = -----------------------
Average Debtors
High turnover = Better realization
Low Turnover = Cases of fraudulent sales

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. 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. 1) Net Profit Ratio
2) Gross Profit Ratio
3) Return on Total Assets
4) Return on Equity

27. NP after tax
Net Profit Ratio = -----------------------
Net Turnover
Interpretation
Against Industry average
Against previous years

28. Gross Profit
Gross Profit Ratio = -----------------------
Net Turnover
Interpretation
Against Industry average
Against previous years

29. EBIT
ROTA = -----------------------
Total Net Assets
Interpretation
Higher Number = Better Realization
Lower Lumber = Less Utilization of assets

30. Net Profit
Equity Return = ---------------------------
Shareholders Equity

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. 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. 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%