RATIO ANALYSIS

Ratio-analysis is a concept or technique

which is as old as accounting concept.
Financial analysis is a scientific tool. It has
assumed important role as a tool for
appraising the real worth of an enterprise, its
performance during a period of time and its
pit falls. Financial analysis is a vital apparatus
for the interpretation of financial statements. It
also helps to find out any cross-sectional and
time series linkages between various ratios.

RATIO ANALYSIS
Unlike in the past when security was considered to
be sufficient consideration for banks and financial
institutions to grant loans and advances, nowadays
the entire lending is need-based and the emphasis is
on the financial viability of a proposal and not only
on security alone. Further all business decision
contains an element of risk. The risk is more in the
case of decisions relating to credits. Ratio analysis
and other quantitative techniques facilitate
assessment of this risk.

RATIO ANALYSIS
Ratio-analysis means the process of
computing, determining and presenting the
relationship of related items and groups of
items of the financial statements. They
provide in a summarized and concise form
of fairly good idea about the financial
position of a unit. They are important tools
for financial analysis.

Lenders need it for carrying out the

following
Technical Appraisal
Commercial Appraisal
Financial Appraisal
Economic Appraisal
Management Appraisal

Its a tool which enables the banker or

lender to arrive at the following factors :
Liquidity position
Profitability
Solvency
Financial Stability
Quality of the Management
Safety & Security of the loans & advances
to be or already been provided

Before looking at the ratios there are a number of cautionary

points concerning their use that need to be identified :
a.The dates and duration of the financial statements being
compared should be the same. If not, the effects of
seasonality may cause erroneous conclusions to be drawn.
b.The accounts to be compared should have been prepared
on the same bases. Different treatment of stocks or
depreciations or asset valuations will distort the results.
c.In order to judge the overall performance of the firm a group
of ratios, as opposed to just one or two should be used. In
order to identify trends at least three years of ratios are
normally required.

The utility of ratio analysis will get further

enhanced if following comparison is
possible.
1.Between the borrower and its competitor
2.Between the borrower and the best
enterprise in the industry
3.Between the borrower and the average
performance in the industry
4.Between the borrower and the global
average

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.

Balance
Sheet Ratio

Financial Ratio

Current Ratio
Quick Asset
Ratio
Proprietary
Ratio
Debt Equity
Ratio

P&L Ratio or
Balance Sheet
Income/Revenu and Profit &
e Statement
Loss Ratio
Ratio
Operating Ratio

Gross Profit Ratio

Operating Ratio
Expense Ratio
Net profit Ratio
Stock Turnover
Ratio

Composite Ratio

Fixed Asset
Turnover Ratio,
Return on Total
Resources Ratio,
Return on Own
Funds Ratio,
Earning per Share
Ratio, Debtors
Turnover Ratio,

LIABILITIES

ASSETS

NET WORTH/EQUITY/OWNED FUNDS

Share Capital/Partners 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
Bank Working
Capital Limits such as
CC/OD/Bills/Export Credit
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

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.

1.

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

2.

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

Current Assets : Raw Material, Stores, Spares, Work-in Progress. Finished

Goods, Debtors, Bills Receivables, Cash.
Current Liabilities : Sundry Creditors, Installments of Term Loan, DPG etc.
payable within one year and other liabilities payable within one year.
This ratio must be at least 1.33 : 1 to ensure minimum margin of 25% of current
assets as margin from long term sources.
Current Ratio measures short term liquidity of the concern and its ability to
meet its short term obligations within a time span of a year.
It shows the liquidity position of the enterprise and its ability to meet current
obligations in time.
Higher ratio may be good from the point of view of creditors. In the long run very
high current ratio may affect profitability ( e.g. high inventory carrying cost)
Shows the liquidity at a particular point of time. The position can change
immediately after that date. So trend of the current ratio over the years to be
analyzed.
Current Ratio is to be studied with the changes of NWC. It is also necessary to
look at this ratio along with the Debt-Equity ratio.

3. ACID TEST or QUICK RATIO : It is the ratio between

Quick Current Assets and Current Liabilities. The should be at
least equal to 1.
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
Liabilities

= Quick Current Assets/Current

Example :
Cash
50,000
Debtors
1,00,000
Inventories
1,50,000
1,00,000
Total Current Assets 3,00,000

Current Ratio

=>

Current Liabilities

3,00,000/1,00,000

4. DEBT EQUITY RATIO : It is the relationship between

borrowers fund (Debt) and Owners 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
Free Reserves & Surplus
Long Term Loans/Liabilities
Debt Equity Ratio will be

= Rs. 200 Lacs

= Rs. 300 Lacs
= Rs. 800 Lacs
=>

800/500

i.e. 1.6 : 1

5. PROPRIETARY RATIO : This ratio indicates the extent

to which Tangible Assets are financed by Owners 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.
6. 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

7. OPERATING PROFIT RATIO :

It is expressed as
Sales ) x 100

=>

(Operating Profit / Net

Higher the ratio indicates operational efficiency

8. NET PROFIT RATIO :
It is expressed as
x 100

=>

( Net Profit / Net Sales )

It measures overall profitability.

9.

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)
-----------------------------------------

10. 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)
11. ASSET TRUNOVER RATIO :
Sales/Tangible Assets

Net

12. FIXED ASSET TURNOVER RATIO :

Sales /Fixed Assets

Net

13. CURRENT ASSET TURNOVER RATIO : Net

Sales / Current Assets
14. CREDITORS TURNOVER RATIO : This is also
called Creditors Velocity Ratio, which determines the

15. RETRUN ON ASSETS :

Taxes/Total Assets

Net Profit after

16. 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
17. RETRUN ON EQUITY CAPITAL (ROE) :
Net Profit after Taxes / Tangible Net
Worth
18.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
19. PRICE EARNING RATIO : PE Ratio indicates the
number of times the Earning Per Share is covered
by its market price.

20. 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

EXERCISE 1
LIABILITES
Capital
Reserves

ASSETS
180 Net Fixed Assets
20 Inventories

Term Loan

300 Cash

Bank C/C

200 Receivables

Trade Creditors

50 Goodwill

Provisions

50
800

400
150
50
150
50
800

a.
b.
c.

What is the Net Worth : Capital + Reserve = 200

Tangible Net Worth is : Net Worth - Goodwill = 150
Outside Liabilities : TL + CC + Creditors + Provisions = 600

d.
e.
f.

Net Working Capital : C A - C L = 350 - 300 = 50

Current Ratio : C A / C L
= 350 / 300 = 1.17 : 1
Quick Ratio : Quick Assets / C L = 200/300 = 0.66 : 1

EXERCISE 2
LIABILITIES

200506

200607

200506

Capital

300

350 Net Fixed

Assets

Reserves

140

160 Security

Bank Term Loan

320

Bank CC (Hyp)

200607

730

750

30

30

280 Investments

110

110

490

580 Raw Materials

150

170

Unsec. Long T L

150

170 S I P

20

30

Creditors (RM)

120

140

170

30

20

310

240

Electricity

70 Finished
Goods

Bills Payable

40

80 Cash

Expenses
Payable

20

30 Receivables

Provisions
20
40 Loans/Advanc
30
190
1. Tangible Net Worth for 1st Year : ( 300 + 140) - 50 = 390
es
2. Current Ratio for 2nd Year : (170 + 30 +170+20+
240 + 190 ) / (580+70+80+70)
Goodwill
50
50
820 /800 = 1.02
Total
1600
1760
1600
1760
st
3. Debt Equity Ratio for 1 Year : 320+150 / 390 = 1.21

Exercise 3.
LIABIITIES

ASSETS

Equity Capital

200 Net Fixed Assets

800

Preference Capital

100 Inventory

300

Term Loan

600 Receivables

150

Bank CC (Hyp)

400 Investment In Govt.

Secu.

Sundry Creditors

100 Preliminary Expenses

Total

1400

1. Debt Equity Ratio will be : 600 / (200+100)

50
100
1400

= 2:1

2. Tangible Net Worth : Only equity Capital i.e. = 200

3. Total Outside Liabilities / Total Tangible Net Worth : (600+400+100) / 200
= 11 : 2
4. Current Ratio will be : (300 + 150 + 50 ) / (400 + 100 ) = 1 : 1

Exercise 4.
LIABILITIES

ASSETS

Capital + Reserves

355

P & L Credit Balance

Net Fixed Assets

265

7 Cash

Loan From S F C

100 Receivables

1
125

Bank Overdraft

38 Stocks

Creditors

26 Prepaid Expenses

9 Intangible Assets

30

Provision of Tax
Proposed Dividend

15
550

Q. What is the Current Ratio ?

Q What is the Quick Ratio ?

128

550

Ans : (1+125 +128+1) / (38+26+9+15)

: 255/88 = 2.89 : 1

Ans : (125+1)/ 88 = 1.43 : 11

Q. What is the Debt Equity Ratio ?

Ans : LTL / Tangible NW

= 100 / ( 362 30)
= 100 / 332 = 0.30 : 1

Exercise 4.

contd

LIABILITIES
Capital + Reserves
P & L Credit Balance
Loan From S F C

ASSETS
355

Net Fixed Assets

7 Cash
100 Receivables

265
1
125

Bank Overdraft

38 Stocks

Creditors

26 Prepaid Expenses

9 Intangible Assets

30

Provision of Tax
Proposed Dividend

128

15
550

550

Q . What is the Proprietary Ratio ? Ans : (T NW / Tangible Assets) x 100

[ (362 - 30 ) / (550 30)] x 100
(332 / 520) x 100 = 64%
Q . What is the Net Working Capital ?
Ans : C. A - C L. = 255 - 88 = 167
Q . If Net Sales is Rs.15 Lac, then What would be the Stock Turnover
Ratio in Times ? Ans : Net Sales / Average Inventories/Stock
1500 / 128 = 12 times approximately

Exercise 4.

contd

LIABILITIES
Capital + Reserves
P & L Credit Balance
Loan From S F C

ASSETS
355

Net Fixed Assets

7 Cash
100 Receivables

265
1
125

Bank Overdraft

38 Stocks

Creditors

26 Prepaid Expenses

9 Intangible Assets

30

Provision of Tax
Proposed Dividend

128

15
550

550

Q. What is the Debtors Velocity Ratio ? If the sales are Rs. 15 Lac.
Ans : ( Average Debtors / Net Sales) x 12 = (125 / 1500) x 12
= 1 month
Q. What is the Creditors Velocity Ratio if Purchases are Rs.10.5 Lac ?
Ans : (Average Creditors / Purchases ) x 12 = (26 / 1050) x 12 = 0.3 months

Exercise 5. : Profit to sales is 2% and amount of profit is say

Rs.5 Lac. Then What is the amount of Sales ?
Answer : Net Profit Ratio = (Net Profit / Sales ) x 100
2
= (5 x100) /Sales
Therefore Sales = 500/2 = Rs.250 Lac
Exercise 6. A Company has Net Worth of Rs.5 Lac, Term
Liabilities of Rs.10 Lac. Fixed Assets worth RS.16 Lac and
Current Assets are Rs.25 Lac. There is no intangible Assets
or other Non Current Assets. Calculate its Net Working
Capital.
Answer
Total Assets
= 16 + 25 = Rs. 41 Lac
Total Liabilities = NW + LTL + CL = 5 + 10+ CL = 41 Lac
Current Liabilities = 41 15 = 26 Lac
Therefore Net Working Capital = C. A C.L
= 25 26 = (- )1 Lac

Exercise 7 : Current Ratio of a concern is 1 : 1. What will be the Net

Working Capital ?
Answer : It suggest that the Current Assets is equal to Current Liabilities
hence the NWC would be NIL ( since NWC = C.A - C.L )
Exercise 8 : Suppose Current Ratio is 4 : 1. NWC is Rs.30,000/-. What
is the amount of Current Assets ?
Answer : 4a - 1a = 30,000
Therefore a = 10,000 i.e. Current Liabilities is Rs.10,000
Hence Current Assets would be 4a = 4 x 10,000 = Rs.40,000/-

Exercise 9. The amount of Term Loan installment is Rs.10000/ per

month, monthly average interest on TL is Rs.5000/-. If the amount of
Depreciation is Rs.30,000/- p.a. and PAT is Rs.2,70,000/-. What
would be the DSCR ?
DSCR = (PAT + Depr + Annual Intt.) / Annual Intt + Annual Installment
= (270000 + 30000 + 60000 ) / 60000 + 120000
= 360000 / 180000 = 2

Exercise 10 : Total Liabilities of a firm is Rs.100 Lac and Current Ratio

is 1.5 : 1. If Fixed Assets and Other Non Current Assets are to the tune of
Rs. 70 Lac and Debt Equity Ratio being 3 : 1. What would be the Long
Term Liabilities?
Ans : We can easily arrive at the amount of Current Asset being Rs. 30 Lac
i.e. ( Rs. 100 L - Rs. 70 L ). If the Current Ratio is 1.5 : 1, then Current
Liabilities works out to be Rs. 20 Lac. That means the aggregate of Net
Worth and Long Term Liabilities would be Rs. 80 Lacs. If the Debt Equity
Ratio is 3 : 1 then Debt works out to be Rs. 60 Lacs and equity Rs. 20 Lacs.
Therefore the Long Term Liabilities would be Rs.60 Lac.

Exercise 11 : Current Ratio is say 1.2 : 1 . Total of balance sheet being

Rs.22 Lac. The amount of Fixed Assets + Non Current Assets is Rs. 10
Lac. What would be the Current Liabilities?
Ans : When Total Assets is Rs.22 Lac then Current Assets would be 22 10
i.e Rs. 12 Lac. Thus we can easily arrive at the Current Liabilities figure which
should be Rs. 10 Lac

EXERCISE 12. A firm sold its stocks in CASH, in order to meet its liquidity
needs. Which of the following Ratio would be affected by this?
1.Debt Equity Ratio
2.Current Ratio
3.Debt Service Coverage Ratio
4.Quick Ratio
EXERCISE 13. A company is found to be carrying a high DEBT EQUITY
Ratio. To improve this, a bank may suggest the company to :
1.Raise long term interest free loans from friends and relatives
2.Raise long term loans from Institutions
3.Increase the Equity by way of Bonus Issue
4.Issue Rights share to existing share holders.
EXERCISE 14. Which of the following is a fictitious Asset?
1.Goodwill
2.Preliminary Expenses
3.Pre-operative expenses
4.Book Debts which have become doubtful of recovery

EXERCISE 15. Under which of the following methods of depreciation on

Fixed Assets, the annual amount of depreciation decreases?
1.Written Down Value method
2.Straight Line method
3.Annuity method
4.Insurance policy method
EXERCISE 16 Debt Service Coverage Ratio (DSCR) shows :
1.Excess of current assets over current liabilities
2.Number of times the value of fixed assets covers the amount of loan
3.Number of times the companys earnings cover the payment of interest
and repayment of principal of long term debt
4.Effective utilisation of assets
EXERCISE 17. Which of the following is not considered a Quick Asset?
1.Cash and Bank balances
2.Bank Fixed Deposits
3.Current Book Debts
4.Loans and Advances

Exercise 18. From the following financial statement calculate (i) Current Ratio (ii)
Acid test Ratio (iii) Inventory Turnover (iv) Average Debt Collection Period (v)
Average Creditors payment period.
C.Assets
Sales
1500
Inventories
125
Cost of sales 1000
Debtors
250
Gross profit
500
Cash
225
C. Liabilities
Trade Creditors
200
(i) Current Ratio : 600/200 = 3 : 1
(ii)Acid Test Ratio : Debtors+Cash /Trade creditors = 475/200 = 2.4 : 1
(iii) Inventory Turnover Ratio : Cost of sales / Inventories = 1000/125 = 8 times
(iv) Average Debt collection period : (Debtors/sales) x 365 = (250/1500)x365 = 61
days
(v)Average Creditors payment period : (Trade Creditors/Cost of sales) x 365
(200/100) x 365 = 73 days

Questions on Fund Flow Statement

Q . Fund Flow Statement is prepared from the Balance sheet :
1.Of three balance sheets
2.Of a single year
3.Of two consecutive years
4.None of the above.
Q. Why this Fund Flow Statement is studied for ?
1.It indicates the quantum of finance required
2.It is the indicator of utilisation of Bank funds by the concern
3.It shows the money available for repayment of loan
4.It will indicate the provisions against various expenses
Q . In a Fund Flow Statement , the assets are represented by ?
1.Application of Funds
2.Sources of Funds
3.Surplus of sources over application
4.Deficit of sources over application

Q . In Fund Flow Statements the Liabilities are represented by ?

1.Sources of Funds
2.Use of Funds
3.Deficit of sources over application
4.All of the above.
Q . When the long term sources are more than long term uses, in the
fund flow statement, it would suggest ?
1.Increase in Current Liabilities
2.Decrease in Working Capital
3.Increase in NWC
4.Decrease in NWC
Q . When the long term uses in a fund flow statement are more than the
long term sources, then it would mean ?
1.Reduction in the NWC
2.Reduction in the Working Capital Gap
3.Reduction in Working Capital
4.All of the above