Ratio analysis is a quantitative method of analyzing financial statements to assess a company's liquidity, turnover, solvency, and profitability. It involves calculating key financial ratios and comparing them over time and against industry benchmarks. Common ratios include current ratio, quick ratio, debt-to-equity ratio, profit margin, and return on assets. Ratio analysis provides valuable insights into a company's financial health and performance.

1. RATIO ANALYSIS
Presented By:
Vikash Barnwal
Assistant Professor
Faculty of Business

2. RATIO ANALYSIS
 Ratio analysis is a quantitative analysis of data
enclosed in an enterprise’s financial statements. It is
used to assess multiple perspectives of an
enterprise’s working and financial performance such
as its liquidity, turnover, solvency and profitability.
 To put it in other words, Ratio analysis is the method
of analyzing and comparing financial data by
computing meaningful financial statement value
percentages rather than comparing line items from
each financial statement.

3. Ratio analysis is the quantitative interpretation of
the company’s financial performance. It provides
valuable information about the organization’s
profitability, solvency, operational efficiency and
liquidity positions as represented by the financial
statements.

4. ADVANTAGES OF RATIO ANALYSIS ARE AS
FOLLOWS:
 Helps in forecasting and planning by performing
trend analysis.
 Helps in estimating budget for the firm by analyzing
previous trends.
 It helps in determining how efficiently a firm or an
organization is operating.
 It provides significant information to users of
accounting information regarding the performance
of the business.
 It helps in comparison of two or more firms.
 It helps in determining both liquidity and long term
solvency of the firm.

5. DISADVANTAGES OF RATIO ANALYSIS ARE AS
FOLLOWS
 Financial statements seem to be complicated.
 Several organizations work in various enterprises each
possessing different environmental positions such as
market structure, regulation, etc., Such factors are
important that a comparison of two organizations from
varied industries might be ambiguous.
 Financial accounting data is influenced by views and
hypotheses. Accounting criteria provide different
accounting methods, which reduces comparability and
thus ratio analysis is less helpful in such circumstances.
 Ratio analysis illustrates the associations between prior
data while users are more concerned about current and
future data.

7. 1. Liquidity Ratios: Liquidity ratios are helpful in
determining the ability of the company to meet its debt
obligations by using the current assets. At times of
financial crisis, the company can utilise the assets and
sell them for obtaining cash, which can be used for
paying off the debts.
2. Profitability ratios: The purpose of profitability ratios
is to determine the ability of a company to earn profits
when compared to their expenses. A better profitability
ratio shown by a business as compared to its previous
accounting period shows that business is performing
well.
The profitability ratio can also be used to
compare the financial performance of a similar firm, i.e it
can be used for analyzing competitor performance.

8. 3. Solvency Ratios: Solvency ratios are used for
determining the viability of a company in the long
term or in other words, it is used to determine the
long term viability of an organization.
 Solvency ratios calculate the debt levels of a
company in relation to its assets, annual earnings
and equity. Some of the important solvency ratios
that are used in accounting are debt ratio, debt to
capital ratio, interest coverage ratio, etc.

9.  Turnover ratios are used to determine how
efficiently the financial assets and liabilities of an
organization have been used for the purpose of
generating revenues.
 Earnings Ratios: Earnings ratio is used for the
purpose of determining the returns that an
organization generates for its investors.

10.  Liquidity ratios asses a business‘s liquidity, i.e. its
ability to convert its assets to cash and pay off its
obligations without any significant difficulty (i.e.
delay or loss of value). Liquidity ratios are
particularly useful for suppliers, employees, banks,
etc.
 Important liquidity ratios are:
 Current ratio
 Quick ratio (also called acid-test ratio)
 Cash ratio

11.  Current ratio : it is one of the most fundamental liquidity
ratio. It measures the ability of a business to repay current
liabilities with current assets.
 Current assets are assets that are expected to be converted to
cash within normal operating cycle, or one year.
Examples of current assets: include cash and cash
equivalents, marketable securities, short-term investments,
accounts receivable, short-term portion of notes receivable,
inventories and short-term prepayments.
o Current liabilities are obligations that require settlement within
normal operating cycle or next 12 months.
o Examples of current liabilities include accounts payable,
salaries and wages payable, current tax payable, sales tax
payable, accrued expenses, etc.
o Current Ratio = Current Assets / Current Liabilities

12. 2. Quick 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
3. Cash ratio : The cash ratio compares a company's most
liquid assets to its current liabilities. The ratio is used to
determine whether a business can meet its short-term
obligations
(Cash + Cash equivalents) ÷ Current liabilities = Cash
ratio

13. FORMULA
Profitability Ratios: This type of ratio helps in measuring the
ability of a company in earning sufficient profits.
 The types of profitability ratios are: –
1. Gross Profit Ratios: Gross profit ratios are calculated in order
to represent the operating profits of an organization after
making necessary adjustments pertaining to the COGS or cost
of goods sold.
Formula
Gross Profit Ratio = (Gross Profit / Net Sales) * 100
Net sales = cash sales + Credit sales – Sales Return
Gross profit = Net Sales – Cogs
Cogs= Opening stock + Purchase+ direct expenses-
Closing stock

14. 2.Net Profit Ratio: Net profit ratios are calculated in order
to determine the overall profitability of an organization
after reducing both cash and non-cash expenditures.
The formula used for the calculation of net profit ratio is
Net Profit Ratio = (Net Profit / Net Sales) * 100
3.Operating Profit Ratio: Operating profit ratio is used to
determine the soundness of an organization and its
financial ability to repay all the short term and long term
debt obligations.
 The formula used for the calculation of operating profit
ratio is-
Operating Profit Ratio = (Earnings Before Interest
and Taxes / Net Sales) * 100

15. 4. Return on Capital Employed (ROCE): Return on
capital employed is used to determine the profitability of
an organization with respect to the capital that is invested
in the business.
 The formula used for the calculation of ROCE is:
 ROCE = Earnings Before Interest and Taxes / Capital
Employed

16. 3. Solvency Ratios: Solvency ratios can be defined as a
type of ratio that is used to evaluate whether a company is
solvent and well capable of paying off its debt obligations
or not.
The types of solvency ratios are: –
A. Debt Equity Ratio:
B. Interest Coverage Ratio
A. Debt Equity Ratio: The debt-equity ratio can be defined
as a ratio between total debt and shareholders fund. The
debt-equity ratio is used to calculate the leverage of an
organization. An ideal debt-equity ratio for an organization
is 2:1.
 The formula for debt-equity ratio is-
Debt Equity Ratio = Total Debts / Shareholders Fund

17. B. Interest Coverage Ratio: The interest coverage
ratio is used to determine the solvency of an
organization in the nearing time as well as how
many times the profits earned by that very
organization were capable of absorbing its interest-
related expenses.
 The formula used for the calculation of interest
coverage ratio is-
 Interest Coverage Ratio = Earnings Before
Interest and Taxes / Interest Expense

18. TURNOVER RATIO
4. Turnover Ratios: Turnover ratios are used to determine how
efficiently the financial assets and liabilities of an organization have
been used for the purpose of generating revenues.
The types of turnover ratios are: –
 Fixed Assets Turnover Ratios: Fixed assets turnover ratio is used
to determine the efficiency of an organization in utilizing its fixed
assets for the purpose of generating revenues.
Formula
Fixed Assets Turnover Ratio = Net Sales / Average Fixed Assets
 Inventory Turnover Ratio: Inventory turnover ratio is used to
determine the speed of a company in converting its inventories into
sales.
Formula
Inventory Turnover Ratio = Cost of Goods Sold / Average
Inventories

19.  3. Receivable Turnover Ratio: Receivable
turnover ratio is used to determine the efficiency of
an organization in collecting or realizing its account
receivables.
 Formula
Receivables Turnover Ratio = Net Credit Sales /
Average Receivables

20.  5. Earnings Ratios : Earnings ratio is used for the
purpose of determining the returns that an
organization generates for its investors.
 The types of earnings ratios are: –
 1. Profit Earnings Ratio: P/E ratio indicates the
profit earning capacity of the company.
 The formula used for the calculation of profit
earnings ratio is:
 Profit Earnings Ratio = Market Price per Share /
Earnings per Share
 2. Earnings per Share (EPS): EPS signifies the
earnings of an equity holder based on each share.
 The formula used for EPS is:
 EPS = (Net Income – Preferred Dividends) /
(Weighted Average of Outstanding Shares)