The document discusses ratio analysis, a financial statement evaluation method that measures a firm's performance across various financial aspects. It categorizes ratios into liquidity, solvency, turnover, and profitability ratios, each serving different analytical purposes. Key ratios are defined along with their formulas, illustrating how they assess business profitability, efficiency, and financial stability.

1. RATIO ANALYSIS
Presented By:
Rachna Anand

2. RATIO ANALYSIS
Ratio Analysis is a form of Financial Statement
Analysis that is used to obtain a quick indication
of a firm's financial performance in several key
areas.
“Ratio Analysis is a study of relationship
among the various financial factors in a
business.”
Ratio- It is a simple arithmetical expression
of the relationship of one number to another.
It can be expressed in:-
 In Proportion-e.g.(2:1)
 In Rate or Times- e.g. (6 times)
 In Percentage- e.g.20%

3. OBJECTIVE
 Measuring the Profitability
 Judging the Operational Efficiency of
Business
 Assessing the Solvency of the Business
 Measuring the Short and Long-term
Financial position of the company
 Facilitating comparative Analysis of the
Performance

4. TYPES OF RATIOS
The ratios can be classified into the following four broad categories
Liquidity Ratios
Solvency/Leverage Ratios
Turnover or Activity Ratios
Profitability Ratios

5. Liquidity Ratios
• Current Ratio
• Quick Ratio
• Absolute Liquidity Ratio
These are those ratios
which are computed to
evaluate the capacity
of the entity to meet
its short-term
liabilities. Commonly
used liquidity ratios
are :

6. CURRENT RATIO
Where, Current Assets = stock + sundry debtors + cash and bank + Receivables + marketable securities + prepaid expenses
And, Current Liabilities = Creditors + Short Term Loans + Overdraft+ Outstanding Exps. + Prov. For tax + Unclaimed dividend
The most common measure of short-term liquidity is also known as the working capital ratio because net working
capital is the difference between current assets and current liabilities
Ideal 2 : 1
QUICK RATIO
The Quick ratio is sometimes called the “acid” test ratio and is one of the best measures of liquidity.
Quick Ratio =
Quick Assets
Current Liabilities
Ideal 1 : 1
Where, Quick Assets = Current Assets − Inventories & prepaid expenses And Current Liabilities = As discussed in the current ratio
ABSOLUTE LIQUIDITY RATIO
The absolute liquidity ratio measures the absolute liquidity of the business. This ratio only considers the absolute liquidity
available to the firm.
Absolute Liquidity Ration =
Cash+ Marketable Securities
Current Liabilities
Ideal 0.5 : 1
Where, Marketable Securities = These are financial instruments that can be easily converted to cash such as government bonds, common stock
or certificates of deposit.
Current Ratio=
Current Assets
Current Liabilities

7. SOLVENCY /LEVERAGE RATIOS
Solvency/leverage ratio may be defined as those ratios which measure the long
term stability and structures of the firm.
 Debt Equity Ratio
 Proprietary Ratio
 Capital Gearing Ratio
 Interest Coverage Ratio

8. This ratio reflects the long-term financial position of a firm and is calculated in the
form of a relationship between external equities or outsider funds and internal equities
or shareholders funds.
DEBT EQUITY RATIO
Debt Equity Ratio =
Long-term& short-term
debt
Shareholder’s Fund
Ideal 1 : 1
Long-term Debts = Debentures + Loans + lease loans
Shareholder’s fund = Eq. share capital + Pref. share capital + Reserve & surplus- Fictitious Assets

9. This ratio indicates the relationship between proprietor’s fund and the total assets.
Proprietary Ratio =
Shareholder's fund
Total Assets
Shareholders fund = Eq. share capital + Pref. Share capital + reserve and surplus – Fictitious Asset
PROPRIETARY RATIO
Ideal 1 : 3

10. This ratio establishes the relationship between equity share capital including reserves
and surplus to preference share capital and other fixed interest-bearing loans.
CAPITAL GEARING RATIO
Equity share capital+ Reserve & Surplus
Capital
Gearing Ratio =
Preference share capital + long–term debt bearing fixed interest
Long-term debt = Debentures + Long Term Loan

11. INTEREST COVERAGE RATIO
This ratio measures the debt-servicing capacity of a firm so far as fixed
interest on long-term debt is concerned.
Interest Coverage Ratio =
Net profit before Interest and Taxes
Interest on Long-term debt
The standard ratio is 6 or 7 times. The higher the ratio the better it is. Lower the ratio, the
management may face difficulties in raising loans in the future.

12. These ratios are employed to evaluate the efficiency with which the firms manages and
utilizes its assets. For this reason, they are often called ‘Asset management ratios’.
A. Stock Turnover Ratio
B. Debtor Turnover Ratio
C. Creditor Turnover Ratio
D. Working Capital Turnover Ratio
TURNOVER OR ACTIVITY RATIOS

13. This ratio is also known as inventory turnover ratio. This ratio measures the
speed with which the stock of goods is converted into sales. It indicates whether
stock has efficiently been used or not. The higher the ratio, the better it is. A
higher ratio indicates that more sales are done with less investment in stock.
Stock Turnover Ratio = Cost of goods sold/Sales
Average Stock or
Inventory
Cost of Goods Sold = Sales – Gross Profit
Average Inventory = (Opening Stock + Closing Stock)/2
Average holding period= 365/stock turnover ratio
STOCK TURNOVER RATIO

14. This ratio is also known as Receivables Turnover Ratio. It establishes relationship
between net credit sales and average trade debtors of the year. This ratio measures how
efficiently receivables are managed in the business. It indicates how quickly the amount is
realised from them.
Net Credit Sales
Debtor Turnover Ratio =
DEBTOR TURNOVER RATIO
Net Credit Sales = Sales ― Cash sales― Sales Return
Accounts Receivable = Sundry Debtors+ Bills Receivables
Average collection period = 365days/Debtor turnover ratio
Average Accounts Receivable

15. This ratio indicates the number of times the payables rotates in a year or the velocity
with which the payment for credit purchases are made to creditors. Higher credit
turnover ratio indicates that firm pays its creditors quickly which increases its
creditworthiness.
Net Credit Purchase
Average Accounts Payable
Creditor Turnover Ratio =
Net Credit Purchases = Total Purchases ― Cash Purchases ― Purchases Return
Accounts Payable = Sundry creditors+ Bills Payable
Average payment period =365 days/Creditor Turnover Ratio
CREDITOR TURNOVER RATIO

16. This ratio indicates the velocity of the utilization of net working capital. In other
words it indicates the number of times the Working capital is converted into sales.
Working Capital Ratio =
Net Working Capital
Net Working Capital = Current Assets ― Current Liabilities
WORKING CAPITAL TURNOVER RATIO
Net Sales or Cost of Goods Sold

17. The profitability ratios measure the profitability or the operational efficiency of the
firm. They are some of the most closely watched and widely quoted ratios.
A. Profitability Ratio based on Sales :
I. Gross Profit Ratio
II. Net Profit Ratio
B. Profitability Ratios based on Investment :
I. Return on Assets
II. Return on Equity
III. Return on Investment/Capital Employed
PROFITABILITY RATIOS

18. It is also known as ‘Gross Profit Margin’. This ratio establishes relationship
of gross profit to net sales of the firm. This ratio indicates the margin on
sales. The higher the ratio,better it is.
Gross Profit Ratio =
Gross Profit
Net Sales
GROSS PROFIT RATIO
X 100
Net Sales = Total Sales ― Sales Return
Gross Profit = Sales ― Cost of Goods Sold

19. It measures the overall profitability of the business. The greater the ratio, the more
profitable the business will be. A high ratio indicates that the business can survive
even in case of rising costs or decreasing selling price of the goods.
Net Profit Ratio =
Net profit after tax
X 100
Sale
s
NET PROFIT RATIO/ PROFITMARGIN
Net Profit = Gross Profit - Indirect Expenses

20. Profitability Ratios based on Investment
 Return on Equity =
(Net profit for the financial year/total equity) × 100
 Return on Assets =
(Net profit for the financial year/total assets) × 100
 Earnings per share=
(Equity earnings/Number of outstanding equity shares)
 Return on Capital Employed/ ROI = EBIT/capital employed x 100
(capital employed = Equity + long - term & short - term debt)
 Assets turnover ratio = Sales/ Total Assets

21. Capital Market Standing Ratios:
 These ratios relate market price of a company’s share to the company’s
earnings and dividends.
 Price to earnings ratio (P/E ratio)
(Market price per share/ Earnings per share (EPS))
 Price to book value ratio (P/B ratio)
(Market price per share/ Book value per share)
 Dividend Yield
(Dividend per share/Market price per share)*100
 Dividend payout ratio
(Equity dividends/Net profit)
 Dividend per share
(Earnings per share x Dividend payout ratio