explains ratio analysis and why we find them and what we interpret from them

1. Group Members
1. Ahmad Nawaz
2. Haseeb Ahmed
3. Yousaf Nadeem
4. Shujah Ahmed
5. Muhammad Ibrahim
UNIVERSITY OF HARIPUR, PAKISTAN

2. Table Of Content
1. What is ratio analysis?
2. What is liquidity ratio?
3. Why we find?
4. What we interpret?

3. Introduction
 To make rational decisions in keeping with the objectives of the firm, the
financial manager must have analytical tools.

4. What is ratio Analysis?
 Ratio analysis is the process of determining and interpreting numerical relationships based on financial
statements.
 A ratio is a statistical yardstick that provides a measure of the relationship between two variables or figures.
 Ratios are simple to calculate and easy to understand.
 The persons interested in the analysis of financial statements can be grouped under three heads,
 Owners or investors
 Creditors
 Financial executives

5. Liquidity ratio;
 Liquidity ratios are the ratios that measure the ability of a company to
meet its short term debt obligations.
 The liquidity ratios are a result of dividing cash and other liquid assets
by the short term borrowings and current liabilities.
 From these ratios, much insight can be obtained into the present cash
solvency of the firm and the firm’s ability to remain solvent in the event
of adversity.
 Current ratio
 Quick ratio

6.  Current Ratio
Looks at the ratio between current
assets and current liabilities

7. Ratios 2008 2009 2010 2011 2012
Current
Ratio
1.31 1.25 1.49 1.45 1.45
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑟𝑎𝑡𝑖𝑜 =
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
Mostly Current Ratio of 2 is consider acceptable. For Atlas Honda, current ratio is less
than acceptable but improved during last 5 years and remain stable in last 2 years at
level of 1.45 which is quite acceptable.

8. Quick Ratio
Is similar to the current ratio but it
excludes inventory from current
assets.
𝑄𝑢𝑖𝑐𝑘 𝑟𝑎𝑡𝑖𝑜 =
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠 − 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠

9. Ratios 2008 2009 2010 2011 2012
Quick
Ratio
0.84 0.70 1.02 0.9 1
𝑄𝑢𝑖𝑐𝑘 𝑟𝑎𝑡𝑖𝑜 =
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠 − 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
A Quick Ratio of 1 or greater is acceptable. For Atlas Honda, Quick Ratio mostly remain
below 1 and remain deteriorating.

10. Liquidity Ratios
 According to company financial statement they are in Strong Liquidity
position but their liquidity position is not as good as they stated
 Company liquidity position appear to have remain stable but below
acceptable criteria.
 Company may have problem to satisfy its short term obligations when they
come due.
 But, it is also a fact that company do not have pay all its short term
obligations at the same time so company should manage to pay its short
liabilities.

11. Financial Leverage (Debt) Ratios
 That show the extent to which the firm is financed by debt

12. Ratios 2008 2009 2010 2011 2012
Debt
Ratio
60.89 55.63 54.33 51.95 50.54
The higher degree of debt ratio shows the greater the
firm’s degree of indebtedness.
Debt ratio for Atlas Honda in 2008 was nearly 61%
which was not very favorable for the organization.
But during the last 5 years, the debt ratio decrease
continuously and reach to nearly 50% which is not very
good but fair enough.

13. Three New Types Of Ratio
 Coverage,
 Activity and
 Profitability ratios

14. Coverage Ratios :
 Ratios that relate the financial charges of a firm to its ability to service, or cover,
them.
 One of the most traditional of the coverage ratios is the interest coverage ratio, or
times interest earned.
 This ratio is simply the ratio of earnings before interest and taxes for a particular
reporting period to the amount of interest charges for the period;

15. Ratios 2008 2009 2010 2011 2012
Times
Interest
Earned
Ratio
4.98 2.4 10.56 16 139.26
𝑇𝑖𝑚𝑒𝑠 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝐸𝑎𝑟𝑛𝑒𝑑 𝑅𝑎𝑡𝑖𝑜 =
𝐸𝑎𝑟𝑛𝑖𝑛𝑔 𝐵𝑒𝑓𝑜𝑟𝑒 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 & 𝑇𝑎𝑥𝑒𝑠
𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡
Interest Coverage Ratio of Atlas Honda increase during the last 5 years but
you can see a surprising increase in this ratio in 2012.
You can understand this increase by comparing Debt and Interest coverage
ratio.

16. Activity Ratios
Measures the speed with which various accounts
are converted into sales or cash-inflows or cash-
outflows.

17. Inventory Turnover
Ratio
Activity Ratios
Average Collection
Period
Average Payment
Period
Asset Turnover
Ratio

18. Inventory Turnover Ratio
Measures the activity of a firm’s
inventory.
𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟 =
𝐶𝑜𝑠𝑡 𝑜𝑓 𝐺𝑜𝑜𝑑𝑠 𝑆𝑜𝑙𝑑
𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦

19. Ratios 2008 2009 2010 2011 2012
𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟 =
𝐶𝑜𝑠𝑡 𝑜𝑓 𝐺𝑜𝑜𝑑𝑠 𝑆𝑜𝑙𝑑
𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦
Inventory turnover for ATLAS HONDA is improved very fast during last 5 years and a
level of 16.3 is quite remarkable.
Higher Inventory Turnover leads to reducing holding cost and increase the net
income and profitability.
But company need to remain conscious about inventory turnover because higher
level of inventory turnover may indicate inadequate inventory level, which may
leads to a loss for the business.

20. Asset Turnover Ratio
Indicates the firm’s efficiency to use
assets for generating sales.
𝐴𝑠𝑠𝑒𝑡𝑠 𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟 =
𝑆𝑎𝑙𝑒𝑠
𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠

21. Ratios 2008 2009 2010 2011 2012
𝐴𝑠𝑠𝑒𝑡𝑠 𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟 =
𝑆𝑎𝑙𝑒𝑠
𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠
It is generally consider that the higher the firm total asset turnover, the
more efficiently its assets have been used.
Asset turnover for ATLAS HONDA is improving and have excellent level.

22. Average Collection Period
 Shows the time needed to collect accounts
receivables.
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐶𝑜𝑙𝑙𝑒𝑐𝑡𝑖𝑜𝑛 𝑝𝑒𝑟𝑖𝑜𝑑 =
𝐴𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑅𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒
𝐴𝑛𝑛𝑢𝑎𝑙 𝑆𝑎𝑙𝑒𝑠
× 365

23. Average Payment Period
Shows the time needed to pay accounts
payables.
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑃𝑎𝑦𝑚𝑒𝑛𝑡 𝑝𝑒𝑟𝑖𝑜𝑑 =
𝐴𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑃𝑎𝑦𝑎𝑏𝑙𝑒
𝐴𝑛𝑛𝑢𝑎𝑙 𝑃𝑢𝑟𝑐ℎ𝑎𝑠𝑒𝑠
× 365

24. Profitability Ratios
 Ratios that relate profits to sales and investment
 Profitability ratios are of two types :
o Those showing profitability in relation to sales
and
o Those showing profitability in relation to
investment.
 Together, these ratios indicate the firm’s overall
effectiveness of operation.

25. Profitability in Relation to Sales
Profitability to sales = Gross profit
Sales
 This ratio tells us the profit of the firm relative
to sales, after we deduct the cost of producing
the goods.
 It is a measure of the efficiency of the firm’s
operations, as well as an indication of how
products are priced.

26. Profitability in Relation to Investment
 The second group of profitability ratios relates
profits to investment. One of these measures is
the rate of return on investment (ROI), or return
on assets:
= Net profit after taxes
Total Assets

27. Importance of Ratio Analysis
 In order to establish the relationship between two accounting figures,
application of Ratio Analysis is necessary
 Application of the same provides the significant information to the
management or users who can analyze the business situation.
Some advantages are :
It facilitates the accounting information to be summarized and simplified in a
concise and concrete form which is comprehensible to the user.
It depicts the inter-relationship between the facts and figures of various
segments of business which are instrumental in taking important financial
decisions.
Ratio analysis clears all the impediments and inefficiencies related to
performance of the firm/individual.

28.  Ratio analysis is used as a benchmark for effective control of performance of
business activities.
 Ratio analysis aids in accurate determination of the performance of liquidity,
profitability and solvency position of the business concern.
 Ratio analysis is an effective tool which is used for measuring the operating
results of the enterprises.

29. Limitations of Ratio Analysis
 Various environmental conditions such as regulation, market structures etc.
vary for different companies, operating in different industries. Significance of
such factors is extremely high. This variation may lead to a difference or an
element of discrepancy, while comparing the two companies from diverse
industries.
 Financial accounting information is impacted and often subject to change, by
estimates and assumptions. Accounting standards allow scope for
incorporating different accounting policies, which impairs comparability and
hence functionality of ratio analysis is less in such situations.
 Ratio analysis explicates association between past information while current
and future information is of more relevance and application to the users.

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