Introduction
A tool used by individuals to conduct a quantitative analysis of information in a company's financial statements. Ratios are calculated from current year numbers and are then compared to previous years, other companies, the industry, or even the economy to judge the performance of the company. Ratio analysis is predominately used by proponents of fundamental analysis
Definition
“a ratio is simply one number expressed in terms of another. It is found by dividing one number into the other”
- R.N.Anthony
Sources of these ratios:
1. Balance sheet
2. Income statement
3. Statement of cash flow
4. Statement of retained earning
5. Financial statements
Uses of ratio analysis
Helpful in analysis of financial statement: -
It is helpful to analysis the balance sheet and profit and loss account
Simplification of accounting data: -
With the help of ratio analysis we easily understand the accounting data
Helpful in comparative study: -
one firm compare his growth to another firm growth with the help of ratio analysis very easily
Helpful in locating the weak spots of the business: -
Ratio analysis helpful to know the weak points of business organization
Helpful in forecasting: -
In forecasting we use the ratio analysis because of this reduce the uncertainty of future
10/25/2009
Types of ratio
1. Liquidity ratios
2. Activity ratios
3. Debt ratios
4. Profitability ratios
5. Market ratios
Liquidity ratio helpful to measure the availability of cash to pay debt
Activity ratio helpful to measure how quickly a firm converts non-cash assets to cash assets
Debt ratio helpful to measure the firm's ability to repay long-term debt
Profitability ratio helpful to measure the firm's use of its assets and control of its expenses to generate an acceptable rate of return
Market ratio helpful to measure investor response to owning a company's stock and also the cost of issuing stock.
How a ratio is to expressed:-
As Percentage: -
Such as 25% or 50% . For example if net profit is Rs.25,000/- and the sales is Rs.1,00,000/- then the net profit can be said to be 25% of the sales.
As Proportion -
The above figures may be expressed in terms of the relationship between net profit to sales as 1: 4.
As Pure Number /Times: -
The same can also be expressed in an alternatively way such as the sale is 4 times of the net profit or profit is 1/4th of the sales.
10/25/2009
Classification of ratio: -
Balance Sheet Ratio P&L Ratio or Income/Revenue Statement Ratio Balance Sheet and Profit & Loss Ratio
Financial Ratio Operating Ratio Composite Ratio
Current Ratio
Quick Asset Ratio
Proprietary Ratio
Debt Equity Ratio
Gross Profit Ratio
Operating Ratio
Expense Ratio
Net profit Ratio
Stock Turnover Ratio
Fixed Asset Turnover Ratio, Return on Total Resources Ratio,
Return on Own Funds Ratio, Earning per Share Ratio, Debtors’ Turnover Ratio,
10/25/2009
Format of balance sheet on the basis of Ratio analysis
LIABILITIES ASSETS
Net Worth/Equity/Owned Funds
Share Capital/Partner’s Capital/Paid Up Capital/ Owners Funds
Reserves ( General, Capital, Revaluation & Other Reserves)
Credit Balance In P&L A/C
Fixed Assets : Land & Building, Plant & Machineries
Original Value Less Depreciation
Net Value Or Book Value Or Written Down Value
Long Term Liabilities/Borrowed
Funds : Term Loans (Banks & Institutions)
Debentures/Bonds,
Unsecured Loans,
Fixed Deposits,
Other Long Term
Liabilities Non Current Assets
Investments In Quoted Shares &
Securities
Old Stocks Or Old/Disputed Book Debts
Long Term Security Deposits
Other Misc. Assets Which Are Not
Current Or Fixed In Nature
Current Liabilties
Sundry /Trade Creditors
Creditors/Bills Payable, Short Duration Loans Or
Deposits
Expenses Payable & Provisions Against Various Items Current Assets : Cash & Bank Balance, Marketable/Quoted Govt. Or
Other Securities, Book Debts/Sundry Debtors, Bills Receivables, Stocks & Inventory (Rm,Sip,Fg) Stores & Spares, Advance Payment Of Taxes, Prepaid Expenses,
Loans And Advances Recoverable Within 12 Months
Intangible Assets
Patent, Goodwill, Debit Balance In P&L A/C, Preliminary Or Preoperative Expenses
10/25/2009
Some important notes: -
• Liabilities have Credit balance and Assets have Debit balance
• Current Liabilities are those which have either become due for payment or shall fall due for payment within 12 months from the date of Balance Sheet
• Current Assets are those which undergo change in their shape/form within 12 months. These are also called Working Capital or Gross Working Capital
• Net Worth & Long Term Liabilities are also called Long Term Sources of Funds
• Current Liabilities are known as Short Term Sources of Funds
• Long Term Liabilities & Short Term Liabilities are also called Outside Liabilities
• Current Assets are Short Term Use of Funds
• Assets other than Current Assets are Long Term Use of Funds
• Installments of Term Loan Payable in 12 months are to be taken as Current Liability only for Calculation of Current Ratio & Quick Ratio.
• If there is profit it shall become part of Net Worth under the head Reserves and if there is loss it will become part of Intangible Assets
• Investments in Govt. Securities to be treated current only if these are marketable and due. Investments in other securities are to be treated Current if they are quoted. Investments in allied/associate/sister units or firms to be treated as Non-current.
• Bonus Shares as issued by capitalization of General reserves and as such do not affect the Net Worth. With Rights Issue, change takes place in Net Worth and Current Ratio.
10/25/2009
Current Ratio:-
It is the relationship between the current assets and current liabilities of a concern.
Current Ratio = Current Assets/Current Liabilities
If the Current Assets and Current Liabilities of a concern are Rs.4,00,000 and Rs.2,00,000 respectively, then the Current Ratio will be :Rs.4,00,000/Rs.2,00,000 = 2 : 1
The ideal Current Ratio preferred by Banks is 1.33 : 1
Net Working Capital: -
This is worked out as surplus of Long Term Sources over Long Tern Uses, alternatively it is the difference of Current Assets and Current Liabilities.
NWC = Current Assets – Current Liabilities
ACID TEST or QUICK RATIO: -
It is the ratio between Quick Current Assets and Current Liabilities.
Quick Current Assets: -
Cash/Bank Balances + Receivables upto 6 months + Quickly realizable securities such as Govt. Securities or quickly marketable/quoted shares and Bank Fixed Deposits
Acid Test or Quick Ratio = Quick Current Assets/Current Liabilities
Example:
Cash 50,000
Debtors 1, 00,000
Inventories 1, 50,000 Current Liabilities 1,00,000
Total Current Assets 3, 00,000
Current Ratio = > 3, 00,000/1, 00,000 = 3: 1
Quick Ratio = > 1, 50,000/1, 00,000 =1.5: 1
10/25/2009
DEBT EQUITY RATIO: -
It is the relationship between borrower’s fund (Debt) and Owner’s Capital (Equity).
Long Term Outside Liabilities / Tangible Net Worth
Liabilities of Long Term Nature
Total of Capital and Reserves & Surplus Less Intangible Assets
For instance, if the Firm is having the following :
Capital = Rs. 200 Lacks
Free Reserves & Surplus = Rs. 300 Lacks
Long Term Loans/Liabilities = Rs. 800 Lacks
Debt Equity Ratio will be => 800/500 i.e. 1.6 : 1
PROPRIETARY RATIO: -
This ratio indicates the extent to which Tangible Assets are financed by Owner’s Fund.
Proprietary Ratio = (Tangible Net Worth/Total Tangible Assets) x 100
The ratio will be 100% when there is no Borrowing for purchasing of Assets.
GROSS PROFIT RATIO: -
By comparing Gross Profit percentage to Net Sales we can arrive at the Gross Profit Ratio which indicates the manufacturing efficiency as well as the pricing policy of the concern.
Gross Profit Ratio = (Gross Profit / Net Sales) x 100
Alternatively, since Gross Profit is equal to Sales minus Cost of Goods Sold, it can also be interpreted as below :
Gross Profit Ratio = [(Sales – Cost of goods sold)/ Net Sales] x 100
A higher Gross Profit Ratio indicates efficiency in production of the unit.
10/25/2009
OPERATING PROFIT RATIO:-
It is expressed as => (Operating Profit / Net Sales) x 100
Higher the ratio indicates operational efficiency
NET PROFIT RATIO:-
It is expressed as => (Net Profit / Net Sales) x 100
It measures overall profitability.
STOCK/INVENTORY TURNOVER RATIO: -
(Average Inventory/Sales) x 365 for days
(Average Inventory/Sales) x 52 for weeks
(Average Inventory/Sales) x 12 for months
Average Inventory or Stocks = (Opening Stock + Closing Stock)
-----------------------------------------
2
. This ratio indicates the number of times the inventory is rotated during the relevant accounting period
DEBTORS TURNOVER RATIO: -
This is also called Debtors Velocity or Average Collection Period or Period of Credit given .
(Average Debtors/Sales) x 365 for days
(52 for weeks & 12 for months)
ASSET TRUNOVER RATIO: - Net Sales/Tangible Assets
FIXED ASSET TURNOVER RATIO: -
Net Sales /Fixed Assets
CURRENT ASSET TURNOVER RATIO: -
Net Sales / Current Assets
CREDITORS TURNOVER RATIO: -
This is also called Creditors Velocity Ratio, which determines the creditor payment period.
(Average Creditors/Purchases)x365 for days
(52 for weeks & 12 for months)
RETRUN ON ASSETS: - Net Profit after Taxes/Total Assets
RETRUN ON CAPITAL EMPLOYED: -
(Net Profit before Interest & Tax / Average Capital Employed) x 100
Average Capital Employed is the average of the equity share capital and long term funds provided by the owners and the creditors of the firm at the beginning and end of the accounting period.
Composite Ratio
RETRUN ON EQUITY CAPITAL (ROE): -
Net Profit after Taxes / Tangible Net Worth
EARNING PER SHARE: -
EPS indicates the quantum of net profit of the year that would be ranking for dividend for each share of the company being held by the equity share holders.
Net profit after Taxes and Preference Dividend/ No. of Equity Shares
10/25/2009
PRICE EARNING RATIO: -
PE Ratio indicates the number of times the Earning Per Share is covered by its market price.
Market Price Per Equity Share/Earning Per Share
DEBT SERVICE COVERAGE RATIO: -
This ratio is one of the most important one which indicates the ability of an enterprise to meet its liabilities by way of payment of installments of Term Loans and Interest thereon from out of the cash accruals and forms the basis for fixation of the repayment schedule in respect of the Term Loans raised for a project. (The Ideal DSCR Ratio is considered to be 2 )
PAT + Depr. + Annual Interest on Long Term Loans & Liabilities
---------------------------------------------------------------------------------
Annual interest on Long Term Loans & Liabilities + Annual Installments payable on Long Term Loans & Liabilities
( Where PAT is Profit after Tax and Depr. is Depreciation)
A tool used by individuals to conduct a quantitative analysis of information in a company's financial statements. Ratios are calculated from current year numbers and are then compared to previous years, other companies, the industry, or even the economy to judge the performance of the company. Ratio analysis is predominately used by proponents of fundamental analysis
Definition
“a ratio is simply one number expressed in terms of another. It is found by dividing one number into the other”
- R.N.Anthony
Sources of these ratios:
1. Balance sheet
2. Income statement
3. Statement of cash flow
4. Statement of retained earning
5. Financial statements
Uses of ratio analysis
Helpful in analysis of financial statement: -
It is helpful to analysis the balance sheet and profit and loss account
Simplification of accounting data: -
With the help of ratio analysis we easily understand the accounting data
Helpful in comparative study: -
one firm compare his growth to another firm growth with the help of ratio analysis very easily
Helpful in locating the weak spots of the business: -
Ratio analysis helpful to know the weak points of business organization
Helpful in forecasting: -
In forecasting we use the ratio analysis because of this reduce the uncertainty of future
10/25/2009
Types of ratio
1. Liquidity ratios
2. Activity ratios
3. Debt ratios
4. Profitability ratios
5. Market ratios
Liquidity ratio helpful to measure the availability of cash to pay debt
Activity ratio helpful to measure how quickly a firm converts non-cash assets to cash assets
Debt ratio helpful to measure the firm's ability to repay long-term debt
Profitability ratio helpful to measure the firm's use of its assets and control of its expenses to generate an acceptable rate of return
Market ratio helpful to measure investor response to owning a company's stock and also the cost of issuing stock.
How a ratio is to expressed:-
As Percentage: -
Such as 25% or 50% . For example if net profit is Rs.25,000/- and the sales is Rs.1,00,000/- then the net profit can be said to be 25% of the sales.
As Proportion -
The above figures may be expressed in terms of the relationship between net profit to sales as 1: 4.
As Pure Number /Times: -
The same can also be expressed in an alternatively way such as the sale is 4 times of the net profit or profit is 1/4th of the sales.
10/25/2009
Classification of ratio: -
Balance Sheet Ratio P&L Ratio or Income/Revenue Statement Ratio Balance Sheet and Profit & Loss Ratio
Financial Ratio Operating Ratio Composite Ratio
Current Ratio
Quick Asset Ratio
Proprietary Ratio
Debt Equity Ratio
Gross Profit Ratio
Operating Ratio
Expense Ratio
Net profit Ratio
Stock Turnover Ratio
Fixed Asset Turnover Ratio, Return on Total Resources Ratio,
Return on Own Funds Ratio, Earning per Share Ratio, Debtors’ Turnover Ratio,
10/25/2009
Format of balance sheet on the basis of Ratio analysis
LIABILITIES ASSETS
Net Worth/Equity/Owned Funds
Share Capital/Partner’s Capital/Paid Up Capital/ Owners Funds
Reserves ( General, Capital, Revaluation & Other Reserves)
Credit Balance In P&L A/C
Fixed Assets : Land & Building, Plant & Machineries
Original Value Less Depreciation
Net Value Or Book Value Or Written Down Value
Long Term Liabilities/Borrowed
Funds : Term Loans (Banks & Institutions)
Debentures/Bonds,
Unsecured Loans,
Fixed Deposits,
Other Long Term
Liabilities Non Current Assets
Investments In Quoted Shares &
Securities
Old Stocks Or Old/Disputed Book Debts
Long Term Security Deposits
Other Misc. Assets Which Are Not
Current Or Fixed In Nature
Current Liabilties
Sundry /Trade Creditors
Creditors/Bills Payable, Short Duration Loans Or
Deposits
Expenses Payable & Provisions Against Various Items Current Assets : Cash & Bank Balance, Marketable/Quoted Govt. Or
Other Securities, Book Debts/Sundry Debtors, Bills Receivables, Stocks & Inventory (Rm,Sip,Fg) Stores & Spares, Advance Payment Of Taxes, Prepaid Expenses,
Loans And Advances Recoverable Within 12 Months
Intangible Assets
Patent, Goodwill, Debit Balance In P&L A/C, Preliminary Or Preoperative Expenses
10/25/2009
Some important notes: -
• Liabilities have Credit balance and Assets have Debit balance
• Current Liabilities are those which have either become due for payment or shall fall due for payment within 12 months from the date of Balance Sheet
• Current Assets are those which undergo change in their shape/form within 12 months. These are also called Working Capital or Gross Working Capital
• Net Worth & Long Term Liabilities are also called Long Term Sources of Funds
• Current Liabilities are known as Short Term Sources of Funds
• Long Term Liabilities & Short Term Liabilities are also called Outside Liabilities
• Current Assets are Short Term Use of Funds
• Assets other than Current Assets are Long Term Use of Funds
• Installments of Term Loan Payable in 12 months are to be taken as Current Liability only for Calculation of Current Ratio & Quick Ratio.
• If there is profit it shall become part of Net Worth under the head Reserves and if there is loss it will become part of Intangible Assets
• Investments in Govt. Securities to be treated current only if these are marketable and due. Investments in other securities are to be treated Current if they are quoted. Investments in allied/associate/sister units or firms to be treated as Non-current.
• Bonus Shares as issued by capitalization of General reserves and as such do not affect the Net Worth. With Rights Issue, change takes place in Net Worth and Current Ratio.
10/25/2009
Current Ratio:-
It is the relationship between the current assets and current liabilities of a concern.
Current Ratio = Current Assets/Current Liabilities
If the Current Assets and Current Liabilities of a concern are Rs.4,00,000 and Rs.2,00,000 respectively, then the Current Ratio will be :Rs.4,00,000/Rs.2,00,000 = 2 : 1
The ideal Current Ratio preferred by Banks is 1.33 : 1
Net Working Capital: -
This is worked out as surplus of Long Term Sources over Long Tern Uses, alternatively it is the difference of Current Assets and Current Liabilities.
NWC = Current Assets – Current Liabilities
ACID TEST or QUICK RATIO: -
It is the ratio between Quick Current Assets and Current Liabilities.
Quick Current Assets: -
Cash/Bank Balances + Receivables upto 6 months + Quickly realizable securities such as Govt. Securities or quickly marketable/quoted shares and Bank Fixed Deposits
Acid Test or Quick Ratio = Quick Current Assets/Current Liabilities
Example:
Cash 50,000
Debtors 1, 00,000
Inventories 1, 50,000 Current Liabilities 1,00,000
Total Current Assets 3, 00,000
Current Ratio = > 3, 00,000/1, 00,000 = 3: 1
Quick Ratio = > 1, 50,000/1, 00,000 =1.5: 1
10/25/2009
DEBT EQUITY RATIO: -
It is the relationship between borrower’s fund (Debt) and Owner’s Capital (Equity).
Long Term Outside Liabilities / Tangible Net Worth
Liabilities of Long Term Nature
Total of Capital and Reserves & Surplus Less Intangible Assets
For instance, if the Firm is having the following :
Capital = Rs. 200 Lacks
Free Reserves & Surplus = Rs. 300 Lacks
Long Term Loans/Liabilities = Rs. 800 Lacks
Debt Equity Ratio will be => 800/500 i.e. 1.6 : 1
PROPRIETARY RATIO: -
This ratio indicates the extent to which Tangible Assets are financed by Owner’s Fund.
Proprietary Ratio = (Tangible Net Worth/Total Tangible Assets) x 100
The ratio will be 100% when there is no Borrowing for purchasing of Assets.
GROSS PROFIT RATIO: -
By comparing Gross Profit percentage to Net Sales we can arrive at the Gross Profit Ratio which indicates the manufacturing efficiency as well as the pricing policy of the concern.
Gross Profit Ratio = (Gross Profit / Net Sales) x 100
Alternatively, since Gross Profit is equal to Sales minus Cost of Goods Sold, it can also be interpreted as below :
Gross Profit Ratio = [(Sales – Cost of goods sold)/ Net Sales] x 100
A higher Gross Profit Ratio indicates efficiency in production of the unit.
10/25/2009
OPERATING PROFIT RATIO:-
It is expressed as => (Operating Profit / Net Sales) x 100
Higher the ratio indicates operational efficiency
NET PROFIT RATIO:-
It is expressed as => (Net Profit / Net Sales) x 100
It measures overall profitability.
STOCK/INVENTORY TURNOVER RATIO: -
(Average Inventory/Sales) x 365 for days
(Average Inventory/Sales) x 52 for weeks
(Average Inventory/Sales) x 12 for months
Average Inventory or Stocks = (Opening Stock + Closing Stock)
-----------------------------------------
2
. This ratio indicates the number of times the inventory is rotated during the relevant accounting period
DEBTORS TURNOVER RATIO: -
This is also called Debtors Velocity or Average Collection Period or Period of Credit given .
(Average Debtors/Sales) x 365 for days
(52 for weeks & 12 for months)
ASSET TRUNOVER RATIO: - Net Sales/Tangible Assets
FIXED ASSET TURNOVER RATIO: -
Net Sales /Fixed Assets
CURRENT ASSET TURNOVER RATIO: -
Net Sales / Current Assets
CREDITORS TURNOVER RATIO: -
This is also called Creditors Velocity Ratio, which determines the creditor payment period.
(Average Creditors/Purchases)x365 for days
(52 for weeks & 12 for months)
RETRUN ON ASSETS: - Net Profit after Taxes/Total Assets
RETRUN ON CAPITAL EMPLOYED: -
(Net Profit before Interest & Tax / Average Capital Employed) x 100
Average Capital Employed is the average of the equity share capital and long term funds provided by the owners and the creditors of the firm at the beginning and end of the accounting period.
Composite Ratio
RETRUN ON EQUITY CAPITAL (ROE): -
Net Profit after Taxes / Tangible Net Worth
EARNING PER SHARE: -
EPS indicates the quantum of net profit of the year that would be ranking for dividend for each share of the company being held by the equity share holders.
Net profit after Taxes and Preference Dividend/ No. of Equity Shares
10/25/2009
PRICE EARNING RATIO: -
PE Ratio indicates the number of times the Earning Per Share is covered by its market price.
Market Price Per Equity Share/Earning Per Share
DEBT SERVICE COVERAGE RATIO: -
This ratio is one of the most important one which indicates the ability of an enterprise to meet its liabilities by way of payment of installments of Term Loans and Interest thereon from out of the cash accruals and forms the basis for fixation of the repayment schedule in respect of the Term Loans raised for a project. (The Ideal DSCR Ratio is considered to be 2 )
PAT + Depr. + Annual Interest on Long Term Loans & Liabilities
---------------------------------------------------------------------------------
Annual interest on Long Term Loans & Liabilities + Annual Installments payable on Long Term Loans & Liabilities
( Where PAT is Profit after Tax and Depr. is Depreciation)
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