ratios and leverages

1. RATIOS & LEVERAGES
HIMAL RUSTAGI

2. RATIOS
 Financial ratios are relationships determined from a company's financial information
and used for comparison purposes.
Classification:
 CURRENT RATIO
 QUICK RATIO (acid test ratio)
 GROSS PROFIT RATIO
 DEBT EQUITY RATIO

3. CURRENT RATIO
 Current Ratio is a popular tool to evaluate short-term solvency position of a business.
Short-term solvency refers to the ability of a business to pay its short-term obligations
when they become due.
 Short term obligations (also known as current liabilities) are the liabilities payable within a
short period of time, usually one year.
Standard Ratio: generally between 1.5 and 2 for healthy businesses.( 2:1)

4. QUICK RATIO
 The quick ratio is an indicator of a company’s short-term liquidity. The quick
ratio measures a company’s ability to meet its short-term obligations with its most
liquid assets. For this reason, the ratio excludes inventories from current assets.
 Standard Ratio: 1.5:1

5. Gross profit ratio
 Gross profit ratio (GP ratio) is a profitability ratio that shows the relationship between gross profit and
total net sales revenue. It is a popular tool to evaluate the operational performance of the business . The
ratio is computed by dividing the gross profit figure by net sales.
 GROSS PROFIT =Opening stock + Net purchases + Direct expenses + Wages – (Net Sales + Closing Stock)
 Net purchases = Purchases - Purchases Return
 Net Sales = Sales - Sales Return
 STANDARD RATIO : There is no norm or standard to interpret gross profit ratio (GP ratio). Generally, a
higher ratio is considered better.

6. DEBT EQUITY RATIO
 The debt-to-equity ratio (D/E) is a financial ratio indicating the relative proportion of
shareholders' equity and debt used to finance a company's assets. Closely related to
leveraging, the ratio is also known as Risk, Gearing or Leverage.
DEBT =long term liabilities
EQUITY=Paid up capital + preference capital + reserves+ Profit/ - Loss
STANDARD RATIO: 1.5:1

7. LEVERAGES
 Leverage is a practice which can help a business drive up its gains / losses.
 In business language, if a firm has fixed expenses in P/L account or debt in
capital structure, the firm is said to be levered.
CLASSIFICATION
 FINANCIAL LEVERAGE
 OPERATING LEVERAGE
 CONTRIBUTED LEVERAGE

8. CALCULATION

9. Financial leverage
 Financial leverage is a leverage created with the help of debt component in the capital structure of
a company. Higher the debt, higher would be the financial leverage because with higher debt
comes the higher amount of interest that needs to be paid.
 EBIT
EBT

10. OPERATING LEVERAGE
 Operating leverage, just like the financial leverage, is a result of operating fixed expenses. Higher the
fixed expense, higher is the operating leverage. Like the financial leverage had an impact on the
shareholder’s return or say earnings per share, operating leverage directly impacts the operating profits
(Profits before Interest and Taxes (PBIT)). Under good economic conditions, due to operating leverage,
an increase of 1% in sales will have more than 1% change in operating profits.
 CONTRIBUTION
EBIT

11. COMBINED LEVERAGE
 A degree of combined leverage (DCL) is a leverage ratio that summarizes the
combined effect that the degree of operating leverage (DOL) and the degree
of financial leverage have on earnings per share (EPS), given a particular
change in sales.
 COMBINED LEVERAGE = FINANCIAL LEVERAGE X OPERATING LEVERAGE

12. IN THE END
THANK
YOU