1. SYNOPSIS ON RATIO ANALYSISPresented by Mounika. RChand
Basha. M
2. WHAT IS RATIO? The term ratio refers to the mathematical
relationship between any two inter-related variables.In other
words,itestablishes relationship between two items expressed in
quantitative terms. WHAT IS RATIO ANALYSIS? Ratio analysis is the
process of determining and interpreting numerical relationship
based on financialstatements.It is the technique of interpretation
of financial statements with the help of accounting ratios derived
fromthe balance sheet and profit and loss account.
3. CLASSIFICATION OF RATIOS: I Analysis of Short Term Financial
Position or Test of Liquidity. I Analysis of Long Term Financial
Position or Test of Solvency. I Activity Ratios. K Profitability
Ratios.
4. I.Important Ratios In Test Of Liquidity: I Current ratio.I
Quick ratio.I Absolute liquid ratio.
5. a.CURRENT RATIO: It establishes relationship between liquid
assets and liquid liabilities.It is a refinement to current ratio
and second testing device for working capital. Current assets
Current ratio:Current liabilitiesIdeal ratio:2:1
6. b.QUICK RATIO OR ACID TEST RATIO: It establishes
relationship between liquid assets and liquid liabilities.It is a
refinement to current ratio and second testing device for working
capital.Quick assetsQuick ratio: Current liabilities Ideal
ratio:1:1 Usually,a high acid test ratio is an indication that the
firm is liquid and has ability to meet its current or liquid
liabilities in time and on the other hand a low quick ratio
represents that the firms liquidity position is not good.
7. c.ABSOLUTE LIQUIDITY RATIO: This ratio establishes a
relationship between absoluteliquid assets to quick
liabilities.Absolute liquid assetsAbsolute liquid ratio:Quick
liabilities Ideal ratio:1:2 It means that if the ratio is 1:2 or
more than this the concern can be taken as liquid.If the ratio is
less than thestandard of 1:2, it means the concern is not
liquid.
8. II.TEST OF SOLVENCY/ LEVERGAE: I Long term solvency ratios
denote the ability of theorganization to repay the loan and
interest.I When an organization's assets are more than its
liabilitiesis known as solvent organization.I Solvency indicates
that position of an enterprise where itis capable of meeting long
term obligations.
9. IMPORTANT RATIOS IN TEST OF SOLVENCY: Debt-equity
ratio.Proprietary ratio.Capital gearing ratio.Debt servicing ratio.
33 .7! H
10. a.DEBT EQUITY RATIO: It Is calculated to measure the
relative claims of outsiders and the owners against the firms
assets.This ratio indicatesthe relationship between the outsiders
funds and the shareholders funds. Outsiders funds Debt equity
ratio:Shareholders fundsIdeal ratio:2:1
11. b.PROPRIETARY RATIO OR NET WORTH RATIO: It establishes
relationship between the proprietors fund or shareholders funds and
the total assetsProprietary funds Capital employed Proprietary
ratio:L mTotal assets Total liabilitiesIdeal ratio:0.521 Higher the
ratio better the long term solvency (financial)position of the
company.This ratio indicates the extent to which the assets of the
company can be lost without affectingthe interest of the creditors
of the company
12. c.CAPITAL GEARING RATIO: It expresses the relationship
between equity capital and fixed interest bearing securities and
fixed dividend bearing shares. Equity share capitalCG R:Fixed
interest bearing securities
13. CI.DEBT SERVICE OR FIXED CHARGES COVER RATIO: Net profit
before deduction of interest and income tax Debt service
ratio:Fixed interest chargesIdeal ratio:6 or 7 times;if the ratio
is high it means there is higher margin of safety for the long term
lenders and as such it is not difficult for the business to obtain
further long term funds and vice-versa.
14. III.ACTIVITY OR TURNOVER RATIO: Activity ratios indicate
the performance of an organization. This indicate the effective
utilization of the various assets of the organization. Most of the
ratio falling under this category is based on turnover and hence
these ratios are called as turnover ratios.
15. IMPORTANT RATIOS IN TURNOVER OR ACTIVITY RATIO: I
Inventory/ Stock turnover ratio.I Debtors turnover ratio. I
Creditors turnover ratio. I Wording capital turnover ratio.I Fixed
assets turnover ratio.
16. a.INVENTORY/ STOCK TURNOVER RATIO: It tells us as to how
many times stock has turned over (sold) during the period.It
Indicates operational andmarketing efficiency.Helps in evaluating
inventory policy to avoid over stocking. Cost of goods sold
Inventory turnover ratio: Average stockIdeal Ratio:8 times
17. b.DEBTORS/ RECEIVABLES TURNOVER RATIO: This ratio explains
the relationship of net credit sales of a firm to its book debts
indicating the rate at which cash isgenerated by turnover of
receivables or debtors. Net credit sales Debtor turnover ratio:
Average DebtorsIdeal ratio:10 to 12 times,debt collection period of
30 to 36 days is considered ideal.
18. c.CREDITORS/ PAYABLE TURNOVER RATIO: This ratio indicates
the number of times the creditors are paid in a year.It is useful
for creditors in finding out how much time the firm is likely to
take in repaying its trade creditors. Net credit purchases
Creditors turnover ratio: Average creditorsIdeal ratio:12
times,debt payment period of 30 days is considered ideal.
19. d.WORKING CAPITAL TURNOVER RATIO: This ratio indicates the
number of times the working capital is turned over in the course of
the year.Measures efficiency in working capital usage.It
establishes relationship between cost of sales and working
capitalCost of sales Working capital turnover ratio: Average
working capital
20. e.FIXED ASSETS TURNOVER RATIO: This ratio establishes a
relationship between fixed assets and sales. Net sales Fixed assets
turnover ratio: Fixed assets Ideal ratio:5 times A high ratio
indicates better utilization of fixed assets.A low ratio indicates
under utilization of fixed assets.
21. f.TOTAL ASSET TURNOVER RATIO: This ratio establishes a
relationship between total assets and sales.This ratio enables to
know the efficient utilization of total assets of a business. Net
salesTotal assets turnover ratio:Total assetsIdeal ratio:2
timesHigh ratio indicates efficient utilization and ratio less than
2 indicates under utilization.
22. IV.PROFITABILITY RATIO: Profitability ratios indicate the
profit earning capacity of a business. Profitability ratios are
calculated either in relation to sales or in relation to
investments.
23. IMPORTANT RATIOS IN PROFITABILITY RATIO: Gross prot ratio.
Net prot ratio.Operating ratio.Return on investment.Earning per
share.Dividend payout ratio.Dividend yield ratio.Price earning
ratio.
24. a.GROSS PROFIT RATIO: This ratio is a tool that indicates
the degree to which selling price of goods per unit may decline
without resulting inlosses.Gross profitGross profit ratio:T X 100
Net salesA low gross profit ratio may indicate unfavorable
purchasing,the instability of management to develop sales
volumethereby making it impossible to buy goods in large
volume.Higher the gross profit ratio better the results.
25. b.NET PROFIT RATIO: It reveals the firms overall efficiency
in operating the business. Net profit after taxes Net profit
ratio:X 100Net salesHigher the ratio better is the
profitability.
26. c.OPERATING PROFIT: This ratio is calculated mainly to
ascertain the operational efficiency of the management in their
business operations. Cost of goods sold + operating expenses
Operating ratio:Net salesHigher the ratio the less favorable it is
because it would leavea smaller margin to meet interest,dividend
and other corporate needs.
27. d.RETURN ON INVESTMENT: Shareholders investment also called
return on proprietors funds is the ratio of net profit to
proprietors funds.It is calculated by the prospective investor in
the business to find out whether the investment would be
worth~making in terms of return as compared to the risk involved in
the business. Net profit (After tax and interest) Return on
shareholders investment: Proprietors funds
28. e.DIVIDEND YIELD RATIO: It refers to the percentage or
ratio of dividend paid per share to the market price per share.
Dividend paid per equity share Dividend yield ratio : :Market price
per equity share
29. f.PRICE EARNING RATIO: It shows how many times the annual
earnings the present shareholders are willing to pay to get a
share.This ratio helps investors to know the effect of earnings per
share on the market price of the share. Average market price per
sharePrice earning ratio:Earning per share
30. g.DIVIDEND PAYOUT RATIO: This ratio indicates the
proportion of earnings available which equity share holders
actually receive in the form of dividend. Dividend paid per share
Pay out ratio :T Earning per share
31. h.EARNING PER SHARE: This ratio indicates the earning per
equity share.It establishes the relationship between net profit
available forequity shareholders and the number of equity shares.
Net profit available for equity share holders Earning per share :
Number of equity shares
