Ratio analysis

Ratio analysis
Ratio analysis
 Is a method or process by which the
Is a method or process by which the
relationship of items or groups of items in the
relationship of items or groups of items in the
financial statements are computed, and
financial statements are computed, and
presented.
presented.
 Is an important tool of financial analysis.
Is an important tool of financial analysis.
 Is used to interpret the financial statements so
Is used to interpret the financial statements so
that the strengths and weaknesses of a firm, its
that the strengths and weaknesses of a firm, its
historical performance and current financial
historical performance and current financial
condition can be determined.
condition can be determined.

Ratio
Ratio
 ‘
‘A mathematical yardstick that measures
A mathematical yardstick that measures
the relationship between two figures or
the relationship between two figures or
groups of figures which are related to
groups of figures which are related to
each other and are mutually inter-
each other and are mutually inter-
dependent’.
dependent’.
 It can be expressed as a pure ratio,
It can be expressed as a pure ratio,
percentage, or as a rate
percentage, or as a rate

Words of caution
Words of caution
 A ratio is not an end in itself. They are only a
A ratio is not an end in itself. They are only a
means to get to know the financial position of
means to get to know the financial position of
an enterprise.
an enterprise.
 Computing ratios does not add any information
Computing ratios does not add any information
to the available figures.
to the available figures.
 It only reveals the relationship in a more
It only reveals the relationship in a more
meaningful way so as to enable us to draw
meaningful way so as to enable us to draw
conclusions there from.
conclusions there from.

Utility of Ratios
Utility of Ratios
 Accounting ratios are very useful in
Accounting ratios are very useful in
assessing the financial position and
assessing the financial position and
profitability of an enterprise.
profitability of an enterprise.
 However its utility lies in comparison of
However its utility lies in comparison of
the ratios.
the ratios.

Utility of Ratios
Utility of Ratios
 Comparison may be in any one of the following
Comparison may be in any one of the following
forms:
forms:
 For the same enterprise over a number of years
For the same enterprise over a number of years
 For two enterprises in the same industry
For two enterprises in the same industry
 For one enterprise against the industry as a whole
For one enterprise against the industry as a whole
 For one enterprise against a pre-determined standard
For one enterprise against a pre-determined standard
 For inter-segment comparison within the same
For inter-segment comparison within the same
organisation
organisation

Classification of Ratios
Classification of Ratios
Ratios can be broadly classified into four groups
Ratios can be broadly classified into four groups
namely:
namely:
 Liquidity ratios
Liquidity ratios
 Capital structure/leverage ratios
Capital structure/leverage ratios
 Profitability ratios
Profitability ratios
 Activity ratios
Activity ratios

Liquidity ratios
Liquidity ratios
These ratios analyse the short-term financial
These ratios analyse the short-term financial
position of a firm and indicate the ability of the firm
position of a firm and indicate the ability of the firm
to meet its short-term commitments (current
to meet its short-term commitments (current
liabilities) out of its short-term resources (current
liabilities) out of its short-term resources (current
assets).
assets).
These are also known as ‘solvency ratios’. The
These are also known as ‘solvency ratios’. The
ratios which indicate the liquidity of a firm are:
ratios which indicate the liquidity of a firm are:
 Current ratio
Current ratio
 Liquidity ratio or Quick ratio or acid test ratio
Liquidity ratio or Quick ratio or acid test ratio

Current ratio
Current ratio
It is calculated by dividing current assets by
It is calculated by dividing current assets by
current liabilities.
Current ratio =
Current ratio = Current assets
Current assets where
where
Current liabilities
Current liabilities
Conventionally a current ratio of 2:1 is
Conventionally a current ratio of 2:1 is
considered satisfactory
considered satisfactory

CURRENT ASSETS
CURRENT ASSETS
include –
include –
Inventories of raw material, WIP, finished goods,
Inventories of raw material, WIP, finished goods,
stores and spares,
stores and spares,
sundry debtors/receivables,
sundry debtors/receivables,
short term loans deposits and advances,
short term loans deposits and advances,
cash in hand and bank,
cash in hand and bank,
prepaid expenses,
prepaid expenses,
incomes receivables and
incomes receivables and
marketable investments and short term securities
marketable investments and short term securities.
.

CURRENT LIABILITIES
CURRENT LIABILITIES
include –
include –
sundry creditors/bills payable,
sundry creditors/bills payable,
outstanding expenses,
outstanding expenses,
unclaimed dividend,
unclaimed dividend,
advances received,
advances received,
incomes received in advance,
incomes received in advance,
provision for taxation,
provision for taxation,
proposed dividend,
proposed dividend,
instalments of loans payable within 12 months,
instalments of loans payable within 12 months,
bank overdraft and cash credit
bank overdraft and cash credit

Quick Ratio or Acid Test Ratio
Quick Ratio or Acid Test Ratio
This is a ratio between quick current assets and current
This is a ratio between quick current assets and current
liabilities (alternatively quick liabilities).
liabilities (alternatively quick liabilities).
It is calculated by dividing quick current assets by
It is calculated by dividing quick current assets by
current liabilities (quick current liabilities)
current liabilities (quick current liabilities)
Quick ratio =
Quick ratio = quick assets
quick assets where
where
Current liabilities/(quick liabilities)
Current liabilities/(quick liabilities)
Conventionally a quick ratio of 1:1 is considered
Conventionally a quick ratio of 1:1 is considered
satisfactory.
satisfactory.

QUICK ASSETS & QUICK
QUICK ASSETS & QUICK
LIABILITIES
LIABILITIES
QUICK ASSETS
QUICK ASSETS are current assets (as stated
are current assets (as stated
earlier)
earlier)
less prepaid expenses and inventories.
less prepaid expenses and inventories.
QUICK LIABILITIES
QUICK LIABILITIES are current liabilities (as
are current liabilities (as
stated earlier)
stated earlier)
less bank overdraft and incomes received in
less bank overdraft and incomes received in
advance.
advance.

Capital structure/ leverage ratios
These ratios indicate the long term solvency
These ratios indicate the long term solvency
of a firm and indicate the ability of the firm
of a firm and indicate the ability of the firm
to meet its long-term commitment with
to meet its long-term commitment with
respect to
respect to
(ii)
(ii) repayment of principal on maturity or in
repayment of principal on maturity or in
predetermined instalments at due dates and
predetermined instalments at due dates and
(iii)
(iii) periodic payment of interest during the
periodic payment of interest during the
period of the loan.
period of the loan.

The different ratios are:
The different ratios are:
 Debt equity ratio
Debt equity ratio
 Proprietary ratio
Proprietary ratio
 Debt to total capital ratio
Debt to total capital ratio
 Interest coverage ratio
Interest coverage ratio
 Debt service coverage ratio
Debt service coverage ratio

Debt equity ratio
Debt equity ratio
This ratio indicates the relative proportion of debt and
This ratio indicates the relative proportion of debt and
equity in financing the assets of the firm. It is
equity in financing the assets of the firm. It is
calculated by dividing long-term debt by shareholder’s
calculated by dividing long-term debt by shareholder’s
funds.
funds.
Debt equity ratio =
Debt equity ratio = long-term debts
long-term debts where
where
Shareholders funds
Shareholders funds
Generally, financial institutions favour a ratio of 2:1
Generally, financial institutions favour a ratio of 2:1.
.
However this standard should be applied having regard
However this standard should be applied having regard
to size and type and nature of business and the degree of
to size and type and nature of business and the degree of
risk involved.
risk involved.

LONG-TERM FUNDS
LONG-TERM FUNDS are long-term loans whether
are long-term loans whether
secured or unsecured like – debentures, bonds, loans
secured or unsecured like – debentures, bonds, loans
from financial institutions etc.
from financial institutions etc.
SHAREHOLDER’S FUNDS
SHAREHOLDER’S FUNDS are equity share
are equity share
capital plus preference share capital plus reserves and
capital plus preference share capital plus reserves and
surplus minus fictitious assets (eg. Preliminary
surplus minus fictitious assets (eg. Preliminary
expenses, past accumulated losses, discount on issue
expenses, past accumulated losses, discount on issue
of shares etc.)
of shares etc.)

Proprietary ratio
Proprietary ratio
This ratio indicates the general financial strength of the
This ratio indicates the general financial strength of the
firm and the long- term solvency of the business.
firm and the long- term solvency of the business.
This ratio is calculated by dividing proprietor’s funds by
This ratio is calculated by dividing proprietor’s funds by
total funds.
total funds.
Proprietary ratio =
Proprietary ratio = proprietor’s funds
proprietor’s funds where
where
Total funds/assets
Total funds/assets
As a rough guide a 65% to 75% proprietary ratio is
As a rough guide a 65% to 75% proprietary ratio is
advisable
advisable

PROPRIETOR’S FUNDS
PROPRIETOR’S FUNDS are same as
are same as
explained in shareholder’s funds
explained in shareholder’s funds
TOTAL FUNDS
TOTAL FUNDS are all fixed assets and all
are all fixed assets and all
current assets.
current assets.
Alternatively it can be calculated as
Alternatively it can be calculated as
proprietor’s funds plus long-term funds plus
proprietor’s funds plus long-term funds plus

In this ratio the outside liabilities are related to
In this ratio the outside liabilities are related to
the total capitalisation of the firm. It indicates
the total capitalisation of the firm. It indicates
what proportion of the permanent capital of the
what proportion of the permanent capital of the
firm is in the form of long-term debt.
firm is in the form of long-term debt.
Debt to total capital ratio =
Debt to total capital ratio =long- term debt
long- term debt
Shareholder’s funds + long- term debt
Shareholder’s funds + long- term debt
Conventionally a ratio of 2/3 is considered
Conventionally a ratio of 2/3 is considered
satisfactory
satisfactory.
.

This ratio measures the debt servicing capacity of a firm
This ratio measures the debt servicing capacity of a firm
in so far as the fixed interest on long-term loan is
in so far as the fixed interest on long-term loan is
concerned. It shows how many times the interest
concerned. It shows how many times the interest
charges are covered by EBIT out of which they will be
charges are covered by EBIT out of which they will be
paid.
paid.
Interest coverage ratio =
Interest coverage ratio = EBIT
EBIT
Interest
Interest
A ratio of 6 to 7 times is considered satisfactory
A ratio of 6 to 7 times is considered satisfactory.
.
Higher the ratio greater the ability of the firm to pay
Higher the ratio greater the ability of the firm to pay
interest out of its profits. But too high a ratio may
interest out of its profits. But too high a ratio may
imply lesser use of debt and/or very efficient operations
imply lesser use of debt and/or very efficient operations

This is a more comprehensive measure to compute the
This is a more comprehensive measure to compute the
debt servicing capacity of a firm. It shows how many
debt servicing capacity of a firm. It shows how many
times the total debt service obligations consisting of
times the total debt service obligations consisting of
interest and repayment of principal in instalments are
interest and repayment of principal in instalments are
covered by the total operating funds after payment of
covered by the total operating funds after payment of
tax.
tax.
Debt service coverage ratio =
Debt service coverage ratio =
EAT+ interest + depreciation + other non-cash exp
EAT+ interest + depreciation + other non-cash exp
Interest + principal instalment
Interest + principal instalment
EAT is earnings after tax.
EAT is earnings after tax.
Generally financial institutions consider 2:1 as a
Generally financial institutions consider 2:1 as a
satisfactory ratio
satisfactory ratio.
.

These ratios measure the operating efficiency of
These ratios measure the operating efficiency of
the firm and its ability to ensure adequate returns
the firm and its ability to ensure adequate returns
to its shareholders.
to its shareholders.
The profitability of a firm can be measured by its
The profitability of a firm can be measured by its
profitability ratios.
profitability ratios.
Further the profitability ratios can be determined
Further the profitability ratios can be determined
(i) in relation to sales and
(i) in relation to sales and
(ii) in relation to investments
(ii) in relation to investments

Profitability ratios in relation to sales:
Profitability ratios in relation to sales:
 gross profit margin
gross profit margin
 Net profit margin
Net profit margin
 Expenses ratio
Expenses ratio

Profitability ratios in relation to investments
Profitability ratios in relation to investments
 Return on assets (ROA)
Return on assets (ROA)
 Return on capital employed (ROCE)
Return on capital employed (ROCE)
 Return on shareholder’s equity (ROE)
Return on shareholder’s equity (ROE)
 Earnings per share (EPS)
Earnings per share (EPS)
 Dividend per share (DPS)
Dividend per share (DPS)
 Dividend payout ratio (D/P)
Dividend payout ratio (D/P)
 Price earning ratio (P/E)
Price earning ratio (P/E)

Gross profit margin
Gross profit margin
This ratio is calculated by dividing gross
This ratio is calculated by dividing gross
profit by sales. It is expressed as a percentage.
profit by sales. It is expressed as a percentage.
Gross profit is the result of relationship
Gross profit is the result of relationship
between prices, sales volume and costs.
between prices, sales volume and costs.
Gross profit margin =
Gross profit margin = gross profit
gross profit x 100
x 100
Net sales
Net sales

Gross profit margin
Gross profit margin
 A firm should have a reasonable gross profit
A firm should have a reasonable gross profit
margin to ensure coverage of its operating
margin to ensure coverage of its operating
expenses and ensure adequate return to the
expenses and ensure adequate return to the
owners of the business ie. the shareholders.
owners of the business ie. the shareholders.
 To judge whether the ratio is satisfactory or
To judge whether the ratio is satisfactory or
not, it should be compared with the firm’s
not, it should be compared with the firm’s
past ratios or with the ratio of similar firms in
past ratios or with the ratio of similar firms in
the same industry or with the industry average.
the same industry or with the industry average.

Net profit margin
Net profit margin
This ratio is calculated by dividing net profit by
This ratio is calculated by dividing net profit by
sales. It is expressed as a percentage.
sales. It is expressed as a percentage.
This ratio is indicative of the firm’s ability to
This ratio is indicative of the firm’s ability to
leave a margin of reasonable compensation to
leave a margin of reasonable compensation to
the owners for providing capital, after meeting
the owners for providing capital, after meeting
the cost of production, operating charges and the
the cost of production, operating charges and the
cost of borrowed funds.
cost of borrowed funds.
Net profit margin =
Net profit margin =
net profit after interest and tax
net profit after interest and tax x 100
x 100
Net sales
Net sales

Net profit margin
Net profit margin
Another variant of net profit margin is operating
Another variant of net profit margin is operating
profit margin which is calculated as:
profit margin which is calculated as:
Operating profit margin =
Operating profit margin =
net profit before interest and tax
net profit before interest and tax x 100
x 100
Net sales
Net sales
Higher the ratio, greater is the capacity of the
Higher the ratio, greater is the capacity of the
firm to withstand adverse economic conditions
firm to withstand adverse economic conditions
and vice versa
and vice versa

Expenses ratio
Expenses ratio
These ratios are calculated by dividing the various expenses by
These ratios are calculated by dividing the various expenses by
sales. The variants of expenses ratios are:
sales. The variants of expenses ratios are:
Material consumed ratio =
Material consumed ratio = Material consumed
Material consumed x 100
x 100
Net sales
Net sales
Manufacturing expenses ratio =
Manufacturing expenses ratio = manufacturing expenses
manufacturing expenses x
x
100
100
Net sales
Net sales
Administration expenses ratio =
Administration expenses ratio = administration expenses
administration expenses x 100
x 100
Net sales
Net sales
Selling expenses ratio =
Selling expenses ratio = Selling expenses
Selling expenses x 100
x 100
Net sales
Net sales
Operating ratio =
Operating ratio = cost of goods sold plus operating expenses
cost of goods sold plus operating expenses x
x
100
100
Net sales
Net sales
Financial expense ratio =
Financial expense ratio = financial expenses
financial expenses x 100
x 100
Net sales
Net sales

Expenses ratio
Expenses ratio
The expenses ratios should be compared over
The expenses ratios should be compared over
a period of time with the industry average as
a period of time with the industry average as
well as with the ratios of firms of similar type.
well as with the ratios of firms of similar type.
A low expenses ratio is favourable.
A low expenses ratio is favourable.
The implication of a high ratio is that only a
The implication of a high ratio is that only a
small percentage share of sales is available for
small percentage share of sales is available for
meeting financial liabilities like interest, tax,
meeting financial liabilities like interest, tax,
dividend etc.
dividend etc.

This ratio measures the profitability of the total funds of
This ratio measures the profitability of the total funds of
a firm. It measures the relationship between net profits
a firm. It measures the relationship between net profits
and total assets. The objective is to find out how
and total assets. The objective is to find out how
efficiently the total assets have been used by the
efficiently the total assets have been used by the
management.
management.
Return on assets =
Return on assets =
net profit after taxes plus interest
net profit after taxes plus interest x 100
x 100
Total assets
Total assets
Total assets exclude fictitious assets. As the total assets
Total assets exclude fictitious assets. As the total assets
at the beginning of the year and end of the year may not
at the beginning of the year and end of the year may not
be the same, average total assets may be used as the
be the same, average total assets may be used as the
denominator.
denominator.

This ratio measures the relationship between net profit and
This ratio measures the relationship between net profit and
capital employed. It indicates how efficiently the long-term
capital employed. It indicates how efficiently the long-term
funds of owners and creditors are being used.
funds of owners and creditors are being used.
Return on capital employed =
Return on capital employed =
net profit after taxes plus interest
net profit after taxes plus interest x 100
x 100
Capital employed
Capital employed
CAPITAL EMPLOYED
CAPITAL EMPLOYED denotes shareholders funds and long-
denotes shareholders funds and long-
term borrowings.
term borrowings.
To have a fair representation of the capital employed, average
To have a fair representation of the capital employed, average
capital employed may be used as the denominator.
capital employed may be used as the denominator.

Return on shareholders equity
Return on shareholders equity
This ratio measures the relationship of profits to
This ratio measures the relationship of profits to
owner’s funds. Shareholders fall into two
owner’s funds. Shareholders fall into two
groups i.e. preference shareholders and equity
groups i.e. preference shareholders and equity
shareholders. So the variants of return on
shareholders. So the variants of return on
shareholders equity are
shareholders equity are
Return on total shareholder’s equity =
Return on total shareholder’s equity =
net profits after taxes
net profits after taxes x 100
x 100
Total shareholders equity
Total shareholders equity
.
.

 TOTAL SHAREHOLDER’S EQUITY
TOTAL SHAREHOLDER’S EQUITY
includes preference share capital plus equity
includes preference share capital plus equity
share capital plus reserves and surplus less
share capital plus reserves and surplus less
accumulated losses and fictitious assets. To
accumulated losses and fictitious assets. To
have a fair representation of the total
have a fair representation of the total
shareholders funds, average total shareholders
shareholders funds, average total shareholders
funds may be used as the denominator
funds may be used as the denominator

Return on ordinary shareholders equity =
Return on ordinary shareholders equity =
net profit after taxes – pref. dividend
net profit after taxes – pref. dividend x 100
x 100
Ordinary shareholders equity or net
Ordinary shareholders equity or net
worth
worth
ORDINARY SHAREHOLDERS EQUITY
ORDINARY SHAREHOLDERS EQUITY
OR NET WORTH
OR NET WORTH includes equity share capital
includes equity share capital
plus reserves and surplus minus fictitious assets.
plus reserves and surplus minus fictitious assets.

This ratio measures the profit available to the
This ratio measures the profit available to the
equity shareholders on a per share basis. This
equity shareholders on a per share basis. This
ratio is calculated by dividing net profit available
ratio is calculated by dividing net profit available
to equity shareholders by the number of equity
to equity shareholders by the number of equity
shares.
shares.
Earnings per share =
Earnings per share =
net profit after tax – preference dividend
net profit after tax – preference dividend
Number of equity shares

This ratio shows the dividend paid to the
This ratio shows the dividend paid to the
shareholder on a per share basis. This is a better
shareholder on a per share basis. This is a better
indicator than the EPS as it shows the amount of
indicator than the EPS as it shows the amount of
dividend received by the ordinary shareholders,
dividend received by the ordinary shareholders,
while EPS merely shows theoretically how much
while EPS merely shows theoretically how much
belongs to the ordinary shareholders
belongs to the ordinary shareholders
Dividend per share =
Dividend per share =
Dividend paid to ordinary shareholders
Dividend paid to ordinary shareholders

This ratio measures the relationship between the
This ratio measures the relationship between the
earnings belonging to the ordinary shareholders and the
earnings belonging to the ordinary shareholders and the
dividend paid to them.
dividend paid to them.
Dividend pay out ratio =
total dividend paid to ordinary shareholders
total dividend paid to ordinary shareholders x 100
x 100
Net profit after tax –preference dividend
Net profit after tax –preference dividend
OR
OR
Dividend pay out ratio = Dividend per share
Dividend per share x 100
x 100
Earnings per share
Earnings per share

This ratio is computed by dividing the market
This ratio is computed by dividing the market
price of the shares by the earnings per share. It
price of the shares by the earnings per share. It
measures the expectations of the investors and
measures the expectations of the investors and
market appraisal of the performance of the firm.
market appraisal of the performance of the firm.
Price earning ratio =
Price earning ratio = market price per share
market price per share
Earnings per share
Earnings per share

Activity ratios
Activity ratios
These ratios are also called efficiency ratios / asset
These ratios are also called efficiency ratios / asset
utilization ratios or turnover ratios. These ratios
utilization ratios or turnover ratios. These ratios
show the relationship between sales and various
show the relationship between sales and various
assets of a firm. The various ratios under this group
assets of a firm. The various ratios under this group
are:
are:
 Inventory/stock turnover ratio
Inventory/stock turnover ratio
 Debtors turnover ratio and average collection
Debtors turnover ratio and average collection
period
period
 Asset turnover ratio
Asset turnover ratio
 Creditors turnover ratio and average credit
Creditors turnover ratio and average credit
period
period

Inventory /stock turnover ratio
This ratio indicates the number of times inventory is
This ratio indicates the number of times inventory is
replaced during the year. It measures the relationship
replaced during the year. It measures the relationship
between cost of goods sold and the inventory level.
between cost of goods sold and the inventory level.
There are two approaches for calculating this ratio,
There are two approaches for calculating this ratio,
namely:
namely:
Inventory turnover ratio =
Inventory turnover ratio = cost of goods sold
cost of goods sold
Average stock
Average stock
AVERAGE STOCK
AVERAGE STOCK can be calculated as
can be calculated as
Opening stock + closing stock
Opening stock + closing stock
2
2
Alternatively
Alternatively
Inventory turnover ratio =
Inventory turnover ratio = sales
sales_________
_________
Closing inventory
Closing inventory

A firm should have neither too high nor too
A firm should have neither too high nor too
low inventory turnover ratio. Too high a ratio
low inventory turnover ratio. Too high a ratio
may indicate very low level of inventory and a
may indicate very low level of inventory and a
danger of being out of stock and incurring high
danger of being out of stock and incurring high
‘stock out cost’. On the contrary too low a
‘stock out cost’. On the contrary too low a
ratio is indicative of excessive inventory
ratio is indicative of excessive inventory
entailing excessive carrying cost.
entailing excessive carrying cost.

Debtors turnover ratio and average
collection period
collection period
This ratio is a test of the liquidity of the debtors
This ratio is a test of the liquidity of the debtors
of a firm. It shows the relationship between
of a firm. It shows the relationship between
credit sales and debtors.
credit sales and debtors.
Debtors turnover ratio =
Debtors turnover ratio =
Credit sales
Credit sales
Average Debtors and bills receivables
Average Debtors and bills receivables
Average collection period =
Average collection period =
Months/days in a year
Months/days in a year
Debtors turnover
Debtors turnover

collection period
collection period
These ratios are indicative of the efficiency of
These ratios are indicative of the efficiency of
the trade credit management. A high turnover
the trade credit management. A high turnover
ratio and shorter collection period indicate
ratio and shorter collection period indicate
prompt payment by the debtor. On the
prompt payment by the debtor. On the
contrary low turnover ratio and longer
contrary low turnover ratio and longer
collection period indicates delayed payments
collection period indicates delayed payments
by the debtor.
by the debtor.
In general a high debtor turnover ratio and
In general a high debtor turnover ratio and
short collection period is preferable
short collection period is preferable.
.

Depending on the different concepts of assets employed, there
Depending on the different concepts of assets employed, there
are
are
many variants of this ratio. These ratios measure the efficiency
many variants of this ratio. These ratios measure the efficiency
of a firm in managing and utilising its assets.
of a firm in managing and utilising its assets.
Total asset turnover ratio =
Total asset turnover ratio = sales/cost of goods sold
sales/cost of goods sold
Average total assets
Average total assets
Fixed asset turnover ratio =
Fixed asset turnover ratio = sales/cost of goods sold
Average fixed assets
Average fixed assets
Capital turnover ratio =
Capital turnover ratio = sales/cost of goods sold
Average capital employed
Average capital employed
Working capital turnover ratio =
Working capital turnover ratio = sales/cost of goods sold
Net working capital
Net working capital

Higher ratios are indicative of efficient
Higher ratios are indicative of efficient
management and utilisation of resources while
management and utilisation of resources while
low ratios are indicative of under-utilisation of
low ratios are indicative of under-utilisation of
resources and presence of idle capacity.
resources and presence of idle capacity.

Creditors turnover ratio and average
credit period
credit period
This ratio shows the speed with which payments
This ratio shows the speed with which payments
are made to the suppliers for purchases made
are made to the suppliers for purchases made
from them. It shows the relationship between
from them. It shows the relationship between
credit purchases and average creditors.
credit purchases and average creditors.
Creditors turnover ratio =
Creditors turnover ratio =
credit purchases
credit purchases
Average creditors & bills payables
Average creditors & bills payables
Average credit period =
Average credit period = months/days in a year
months/days in a year
Creditors turnover ratio
Creditors turnover ratio

credit period
credit period
Higher creditors turnover ratio and short credit
Higher creditors turnover ratio and short credit
period signifies that the creditors are being
period signifies that the creditors are being
paid promptly and it enhances the
paid promptly and it enhances the
creditworthiness of the firm.
creditworthiness of the firm.

Ratio analysis

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Ratio analysis