Ratio Analysis – Part 1 - Overview Paper 3B: Financial Management Chapter 3 Unit I

CA B. Hari Gopal B.com, PGDBA, FCA, FCMA, DISA(ICAI), PMP (PMI, USA), EPBM (IIMC), MCT

Learning Objectives

1. Concept of Ratio Analysis

2. Classification of Ratios

3. Application of Ratio Analysis

4. Limitations of Financial Ratios

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Introduction to Ratio Analysis • Introduction • Basis • Objective • Purpose

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Ratio Analysis - Introduction

1. Basis for financial analysis, planning and decision making is financial statements - that is Balance Sheet and Profit and Loss account

2. However, the above statement does not disclose all the necessary and relevant information required for planning and decision making

3. Ratio analysis is an analytical tool in the hands of the Finance Manager to analyze the data depicted in the financial statement

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Ratio Analysis - Basis

4. And selected from financial statements of the concern

3. Connected with each other in some logical manner

2. Between two individual figures or group of figures

1. A relationship expressed in mathematical terms

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Ratio Analysis - Objective

Objective of financial ratios is that all stakeholders can draw conclusions about the –

1. Performance

2. Strengths and weaknesses of the firm

3. And take decisions in relation to the firm

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Ratio Analysis - Purpose

Quantitative process – may need to be supplemented by qualitative factors to get a complete picture

To identify aspects of a business’s performance to aid decision making

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Classification of ratios

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•Statement based classification •Functional Classification

Ratio - Classification

Statement Based

Functional

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Statement Based Classification

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• Current Ratio • Debt – Equity Ratio

Balance Sheet Ratios

• Gross Profit Ratio • Net Profit Ratio

Profit and Loss account Ratios

• Debtors Turnover Ratio • Inventory Turnover Ratio

Combined Ratios

Functional Classification

• Current Ratio • Quick Ratio Liquidity Ratios

• Equity Ratio • Debt Equity Ratio

Capital Structure Ratios

• Debt Service Coverage Ratio • Interest Coverage Ratio Coverage Ratios

• Capital Turnover Ratio • Inventory Turnover Ratio Activity Ratios

• Return on Equity Ratio • Price Earning Ratio Profitability Ratios

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Liquidity Ratios

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Liquidity Ratios

Current Ratio

Quick Ratio

Cash Ratio / Absolute Liquidity Ratio

Basic Defense Interval

Net Working Capital Ratio

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Capital Structure Ratios

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Capital Structure Ratios

Equity Ratio

Debt Ratio

Debt – Equity Ratio

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Coverage Ratios

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Coverage Ratios

Debt Service Coverage Ratio

Interest Coverage Ratio

Preference Dividend Coverage Ratio

Capital Gearing Ratio

Fixed Assets – Long Term Funds Ratio

Proprietary Ratio

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Activity Ratios

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Activity Ratios

Capital Turnover Ratio

Fixed Assets Turnover Ratio

Working Capital Turnover Ratio

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Activity Ratios – Working Capital Ratios

Inventory Turnover Ratio

Debtors Turnover Ratio

Creditors Turnover Ratio

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Profitability Ratios

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Profitability ratios

From Owner’s point of view

Based on assets / investments

Based on sales

Based on Capital Market information

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Profitability ratios – from Owner’s point of view

Price Earning Ratio

Dividend Per Share

Earnings Per Share

Return on Equity

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Return on Equity – DuPont Model

Dupont Model

Net Profit Margin

Asset Turnover

Equity Multiplier

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Profitability ratios based on Assets / Investment

1 • Return on Capital Employed (ROCE) /

Return on Investment (ROI)

2 • Return on Assets

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Profitability ratios based on Sales

Gross Profit Ratio

Operating Profit Ratio

Net Profit Ratio

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Profitability ratios based on Capital Market Info

Price Earning Ratio

Yield Ratio

Market Value / Book Value per share

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Performance Evaluation

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Financial ratios for Performance Evaluation

1. Liquidity Position

2. Long Term Solvency

3. Operating Efficiency

4. Overall Profitability

5. Inter-firm comparison

6. Financial Ratios for Budgeting

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Limitations of Ratios

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Limitations of Financial ratios

Diversified product lines

Financial data are badly distorted by Inflation

Seasonal factors

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Lesson Summary

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4. Finally we went through the limitations of ratio analysis

3. We had reviewed how the financial ratios helps in performance analysis

2. We had seen the classification of ratios and discussed the ratios under various groupings

1. We have learnt the meaning, objective and purpose of ratio analysis

What Next ……

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Follow the below Presentations

Ratio Analysis Part 2 - Liquidity Ratios

Ratio Analysis Part 3 – Leverage Ratios

Ratio Analysis Part 4 - Activity Ratios

Ratio Analysis Part 5 - Profitability Ratios

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Thank You

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