RATIO ANALYSIS

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.

WHY RATIO ANALYSIS?

Ratios are used for carrying out the following : Technical Appraisal (for overall performance) Commercial Appraisal (by the creditors) Financial Appraisal (by banks, stock holders) Economic Appraisal (for M&A) Management Appraisal (for improving efficiency)

RATIO ANALYSIS
Its a tool which enables the analyst 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

CLASSIFICATION OF RATIOS
Balance Sheet Ratio P&L Ratio or Income/Revenue Statement Ratio
Operating Ratio

Balance Sheet and Profit & Loss Ratio

Financial 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,

FORMAT OF BALANCE SHEET FOR RATIO ANALYSIS

LIABILITIES ASSETS
NET WORTH/EQUITY/OWNED FUNDS FIXED ASSETS : LAND & BUILDING, PLANT & Share Capital/Partners Capital/Paid up Capital/ MACHINERIES Owners Funds Original Value Less Depreciation Reserves ( General, Capital, Revaluation & Other Net Value or Book Value or Written down value Reserves) Credit Balance in P&L A/c 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 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

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 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 Net Working Capital : 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. 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.

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 = Quick Current Assets/Current Liabilities

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

Current Liabilities 1,00,000

Current Ratio = > Quick Ratio =>

3,00,000/1,00,000 1,50,000/1,00,000

= 3:1 = 1.5 : 1

4. DEBT EQUITY RATIO or LEVEAGE 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 Lacs Free Reserves & Surplus = Rs. 300 Lacs Long Term Loans/Liabilities = Rs. 800 Lacs Debt Equity Ratio will be => 800/500 i.e. 1.6 : 1

5. 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. 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 x 100

Cost of goods sold)/ Net Sales]

A higher Gross Profit Ratio indicates efficiency in production of the unit.

7. OPERATING PROFIT RATIO : It is expressed as => (Operating Profit / Net Sales ) x 100

Higher the ratio indicates operational efficiency

8. NET PROFIT RATIO : It is expressed as => ( Net Profit / Net Sales ) x 100

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

2
. This ratio indicates the number of times the inventory is rotated during the relevant accounting period

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. TOTAL ASSET TRUNOVER RATIO:Net Sales/Tangible Total Assets 12. FIXED ASSET TURNOVER RATIO : Net Sales /Fixed Assets

13. CURRENT ASSET TURNOVER RATIO : Net Sales / Current Assets

14. RETRUN ON ASSETS :

Net Profit after Taxes/Total Assets

15. 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
16. RETRUN ON EQUITY CAPITAL (ROE) : Net Profit after Taxes / Tangible Net Worth 17.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 18. 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

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 ) EBITD (earning before interest tax and deprciation) --------------------------------------------------------------------------------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)

EXERCISE 1 LIABILITES Capital Reserves Term Loan Bank C/C Trade Creditors Provisions ASSETS 180 Net Fixed Assets 20 Inventories 300 Cash 200 Receivables 50 Goodwill 50 800 800 400 150 50 150 50

a. b. c. d. e. f.

What is the Net Worth : Capital + Reserve = 200 Tangible Net Worth is : Net Worth - Goodwill = 150 Outside Liabilities : TL + CC + Creditors + Provisions = 600 Net Working Capital : C A - C L = 350 - 250 = 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 Capital Reserves Bank Term Loan Bank CC (Hyp) Unsec. Long T L Creditors (RM) Bills Payable Expenses Payable Provisions Total 2005-06 300 140 320 490 150 120 40 20 20 1600 2006-07 350 Net Fixed Assets 160 Security Electricity 280 Investments 580 Raw Materials 170 S I P 70 Finished Goods 80 Cash 30 Receivables 40 Loans/Advances Goodwill 1760 2005-06 2006-07 730 30 110 150 20 140 30 310 30 50 1600 750 30 110 170 30 170 20 240 190 50 1760

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

Exercise 3. LIABIITIES Equity Capital Preference Capital Term Loan Bank CC (Hyp) Sundry Creditors Total ASSETS 200 Net Fixed Assets 100 Inventory 600 Receivables 400 Investment In Govt. Secu. 100 Preliminary Expenses 1400 800 300 150 50 100 1400

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

= 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 Capital + Reserves P & L Credit Balance Loan From S F C Bank Overdraft Creditors Provision of Tax Proposed Dividend 355 ASSETS Net Fixed Assets 265 1 125 128 1 30 550 7 Cash 100 Receivables 38 Stocks 26 Prepaid Expenses 9 Intangible Assets 15 550 Q. What is the Current Ratio ?

Ans : (1+125 +128+1) / (38+26+9+15) : 255/88 = 2.89 : 1

Q What is the Quick Ratio ?

Ans : (125+1)/ 88 = 1.43 : 11 Ans : LTL / Tangible NW = 100 / ( 362 30) = 100 / 332 = 0.30 : 1

Q. What is the Debt Equity Ratio ?

Exercise 4. LIABILITIES

contd ASSETS 355 Net Fixed Assets 265 1 125 128 1 30 550 7 Cash 100 Receivables 38 Stocks 26 Prepaid Expenses 9 Intangible Assets 15 550

Capital + Reserves P & L Credit Balance Loan From S F C Bank Overdraft Creditors Provision of Tax Proposed Dividend

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. LIABILITIES

contd ASSETS 355 Net Fixed Assets 265 1 125 128 1 30 550 7 Cash 100 Receivables 38 Stocks 26 Prepaid Expenses 9 Intangible Assets 15 550

Capital + Reserves P & L Credit Balance Loan From S F C Bank Overdraft Creditors Provision of Tax Proposed Dividend

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 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. 2. 3. 4. Debt Equity Ratio Current Ratio Debt Service Coverage Ratio 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. 2. 3. 4. Raise long term interest free loans from friends and relatives Raise long term loans from Institutions Increase the Equity by way of Bonus Issue Issue Rights share to existing share holders.

EXERCISE 14. Which of the following is a fictitious Asset? 1. 2. 3. 4. Goodwill Preliminary Expenses Pre-operative expenses Book Debts which have become doubtful of recovery