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Ratio Analysis

B.V.Raghunandan,SVS College,

Bantwal

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Definition

Ratio Analysis is a financial technique of measuring the strength and weakness of an organisation out of information available from financial reports specifically from the Balance Sheet and Income Statement

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Advantages

• Measuring the efficiency of organisations• Measuring the liquidity position of the companies• Measuring the capacity of companies to borrow in the

future• Understanding the overall financial position of

organisations• Estimating the solvency of the companies• Helping in forecasting

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Disadvantages• Only quantitative tools• Manipulation of accounting

figures• Too many analytical tools lead to

varied interpretation• Based on past data• Same data may be interpreted in

different ways• Vested interests• Measuring the changes in price

levels• Accounting policies have the

impact• Only symptoms and not cure

Page 5Different Ratios

A] Liquidity Ratios

B] Solvency Ratios

C] Activity Ratios

D] Profitability Ratios

E] Shareholders’ Ratios

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A] Liquidity Ratio

• Current Ratio =

• Acid Test Ratio=

• Working Capital Turnover Ratio =

bilitiesCurrentLia

etsCurrentAss

bilityCurrentLia

gStockCloetsCurrentAss sin

italWorkingCap

Sales

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A. Liquidity Ratios

• Used to study the ability of the organisation in meeting short-term payments or obligations

• Includes:

1) Current Ratio,

2) Acid Test Ratio and

3) Working Capital Turnover Ratio

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1) Current Ratio

• Relation between current assets and current liabilities

• Long Term Sources Financing the Current assets give a stable base for the liquidity of the organisation

• Normally , the ratio should not be less than 2 i.e., the current assets should be double the size of current liabilities

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Measurement of Current Ratio

Current Ratio = bilitiesCurrentLia

etsCurrentAss

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Precautions to be Taken for Current Ratio

• Proper Valuation of assets and liabilities

• Provision for Bad Debts• Useless Inventory Deducted• Loose Tools are not current

assets• Short Term Investment can be

part of current assets• Long Term investment like

capital of subsidiary is not current asset

• Advance payments for fixed assets should be excluded

• Instalment payments are part of current liabilities

• Bank overdraft and cash credit are part of current liabilities

• Bills Receivables are a part of current assets

• Bank Loans should not be treated as current liabilities

• Advances to Employees or Utilities are to be treated as current assets

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2) Acid Test Ratio/Quick Ratio

• It is the ratio between quick assets and quick liabilities

• Quick assets include current assets except inventory and pre-paid expenses

• Quick liabilities include current liabilities other than bank overdraft

• A 1:1 ratio is healthy• Healthy indicator of cash management

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Measurement of Acid Test Ratio

Acid Test Ratio =

litiesQuickLiabi

sQuickAsset

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3) Working Capital Turn-over Ratio

• Shows the efficiency of usage of working capital

• Relation between Sales and Working Capital

• Determination of number of times the working capital is turned over to achieve the maximum profit

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Measurement of Working Capital Turnover Ratio

lkingCapitaAverageWor

NetSales

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B. Solvency Ratios

• Measure long-term liquidity ratio• Reflect the ability of the firm to pay interest

and repayment of loans at due dates on the long-term loans taken

• Avoidance of over-borrowing (over-leverage)

• Avoidance of bankruptcy by maintaining healthy solvency ratios

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Types of Solvency Ratios

1) Interest Coverage Ratio

2) Debt Ratio

3) Debt-Equity Ratio

4) Capital Gearing Ratio

5) Proprietary Ratio

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1.Interest Coverage Ratio

TermDebtLongIntereston

TaxInterestofitBefore

&Pr

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2. Debt Ratio (Debt to Total Funds ratio)

rsFundsShareholdeLTDebt

LTDebt

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3) Debt-Equity Ratio

rsFundsShareholde

btLongTermDe

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4) Capital Gearing Ratio

ndeholdersFuEquityShar

curitieseBearingSeFixedIncom

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5) Proprietary Ratio

sTotalAsset

rsFundsShareholde

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C] Activity Ratios

1) Inventory Turnover Ratio

2) Debtors Turnover Ratio

3) Average Collection Period

4) Fixed Assets Turnover Ratio

5) Total Assets Turnover Ratio

6) Capital Turnover Ratio

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1) Inventory Turnover Ratio

ckAverageSto

sSoldCostofGood

ckAverageSto

sSoldCostofGood

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2) Debtor Turnover Ratio

torsAverageDeb

sCreditSale

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3) Average Collection Period

overRatioDebtorTurn

monthsaYearday )(12/)sin(365

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4) Fixed Assets Turnover Ratio

setsNetFixedAs

NetSales

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5) Total Assets Turnover Ratio

sTotalAsset

NetSales

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6) Capital Turnover Ratio

TermFundsLong

NetSales

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D] Profitability Ratios

1) Net Profit Ratio

2) Gross Profit Ratio

3) Return on Total Assets

4) Return on Equity

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1) Net Profit Ratio

100Pr

XNetSales

axofitAfterT

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2) Gross Profit Ratio

100Pr

XSales

ofitGross

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3) Return on Total Assets

100Pr

XsTotalAsset

axofitAfterT

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4) Return on Equity

100'

PrX

FundsrsShareholde

axofitAfterT

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E) Shareholders‘ Ratio

1) Earning per Share (EPS)

2) Price-Earning Ratio (PE Ratio)

3) Dividend Yield Ratio

4) Dividend Pay-out Ratio

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1) Earning per Share

uitySharesNumberofEq

axofitAfterTPr

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2) PE Ratio

ShareEarningper

eiceperSharMar Prker

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3) Dividend Yield Ratio

100Pr

XeiceperSharMarket

rShareDividendpe

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4) Dividend Pay-out Ratio

100XShareEarningper

rShareDividendpe

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THANK YOU