This document discusses ratio analysis, which involves calculating relationships between financial statement items to analyze a company's performance and financial position. Ratio analysis can be used to evaluate profitability, solvency, operating efficiency, short-term financial position, and more. Some common ratios mentioned include the current ratio, quick ratio, debt-to-equity ratio, and gross profit ratio. The document outlines how ratios are calculated and expressed, and provides examples of liquidity, activity, profitability, and long-term financial position ratios. Caution is advised when interpreting ratios, as different accounting treatments, time periods, or single ratios can provide misleading results.

1. RATIO ANALYSIS
Ratio-analysis means the process of computing,
determining and presenting the relationship of
related items and groups of items of the financial
statements. They provide in a summarized and
concise form of fairly good idea about the
financial position of a unit. They are important
tools for financial analysis.
According to Myers, " Ratio analysis of financial
statements is a study of relationship among
various financial factors in a business as disclosed
by a single set of statements and a study of trend
of these factors as shown in a series of
statements."

2. Advantages and Uses of Ratio Analysis
• To workout the profitability:
• To workout the solvency:
• Helpful in analysis of financial statement:
• Helpful in comparative analysis of the
performance:
• To simplify the accounting information:
• To workout the operating efficiency:
• To workout short-term financial position:
• Helpful for forecasting purposes:

3. Limitations of Ratio Analysis
• Limited Comparability
• False Results
• Effect of Price Level Changes
• Qualitative factors are ignored
• Effect of window-dressing
• Costly Technique
• Misleading Results

4. Before looking at the ratios there are a number of cautionary
points concerning their use that need to be identified :
a. The dates and duration of the financial statements being
compared should be the same. If not, the effects of
seasonality may cause erroneous conclusions to be drawn.
b. The accounts to be compared should have been prepared on
the same bases. Different treatment of stocks or depreciations
or asset valuations will distort the results.
c. In order to judge the overall performance of the firm a group
of ratios, as opposed to just one or two should be used. In
order to identify trends at least three years of ratios are
normally required.

5. HOW A RATIO IS EXPRESSED
• As Percentage - such as 25% or 50% . For
example if net profit is Rs.25,000/- and the sales is
Rs.1,00,000/- then the net profit can be said to be
25% of the sales.
• As Proportion - The above figures may be
expressed in terms of the relationship between
net profit to sales as 1 : 4.
• As Pure Number /Times - The same can also be
expressed in an alternatively way such as the sale
is 4 times of the net profit or profit is 1/4th of the
sales.

6. Liquidity Ratios.
• Liquidity refers to the ability of the concern to
meet its current obligation as and when these
become due the short- term obligations are
met by releasing amounts from current
floating or circulating assets. The current asset
should either be liquid and near liquidity.

7. •Current Ratio = Current Assets
Current Liabilities
Rule Of Thumb is 2:1
•Quick Ratio or Acid Test Ratio = Quick Assets
Current Liabilities
Rule Of Thumb is 1:1

8. Absolute Liquid Asset =
Cash& Bank+ Short Term Securities+ Temporary Investments
Current Liabilities
Rule of thumb = .5:1
CURRENT ASSETS CURRENT LIABILITIES
Cash in hand Creditors
Cash at bank Bills payables
Debtors Bank overdraft
Temporary investment Dividend payables
Stock Income recd. In adv
Bills receivables Outstanding expenses
Prepaid expenses
Accrued incomes

9. Current Asset Movement and
efficiency ( Activity Ratio)
• Funds are invested in various assets in
business to make sales and earn profit the
efficiency with which assets are managed
directly effect the volume of sales. The better
the management the larger is the amount of
sales and the profits. Activity ratio measures
the efficiencies and the effectiveness with
which firm manages its resources and assets.
These ratios are called turnover ratios.

10. Working Capital Turnover ratios = Cost of goods sales
Average Working Capital
Cogs = op stock+purchses+direct expenses-closing stock
Creditors or Payable Turnover Ratio = Net Credit Purchases
Average Creditors
A suppliers of good of i.e. creditors, is naturally interested in
finding out how much time the firm is likely to take in repaying
its trade creditors.

11. Average Payment Period = Number of days in year
Creditors’ turnover ratio
Debtor and Receivable Turnover Ratio = Net Credit Sales
Average debtors
Debtors turnover ratio indicates the velocity of debt collection of
firm. In simple words, it indicates the number of time average
debtors( receivables) are turned over during a year.

12. Average Collection Period = Number of days in year
Debtors’ turnover ratio
•Inventory Turnover Ratio = Cost of goods sold
Average inventory
Every firm has to maintain a certain level of inventory of finished
goods so as to be able to meet the requirement of the business.
Inventory Conversion Period = Number of days in a year
Inventory turnover Ratio

13. Profitability Ratios
Gross Profit Ratio = Gross Profit X 100
Net Sales
Gross profit = sales – cost of goods sold
Net Profit Ratio = Net Profit x 100
Net Sales
Operating Ratio = Operating cost x 100
Net Sales

14. Operating Profit Ratio = Operating Profit x 100
Net Sales
Or
Operating Profit Ratio = 100-Operating Ratio
Expense Ratio
or
Particular expense ratio = Particular Expense x 100
Net Sales

15. Long-term financial position and Test
of Solvency.
– Debt Equity Ratio = Outsiders Fund
Shareholder’s funds
Or = External Equities
Internal Equities
– Funded Debt to Total Capitalization = Funded debt X 100
Total Capitalization
Funded Debt = Debentures + Mortgage Loans + Bonds + Other Long Term
Loans
Total Capitalization = Equity Share Capital + Preference share capital +
Reserves
+ Surplus Other undistributed funds + Debentures +
Mortgage Loans + Bonds + Other long term Loans.

16. Proprietary and Equity Ratio = Shareholder’s Funds
Total Assets
Shareholder fund= eq. share cap + pref. share cap + reserves & surpluses-
fictitious assets
Fixed assets to Net Worth Ratio = Fixed Assets After depreciation
Total Long- Term Funds
Solvency Ratios = Total Liabilities to Outsiders
Total Assets

17. Fixed Assets to Total Long Term Funds
= Fixed assets after depreciation
Total Long- Term funds
•Debt Service Ratio and Interest Coverage Ratio
= Net Profit( Before Interest & Tax)
Fixed Interest charges