Description
A ratio is an arithmetical relationship between two figures., Financial ratio analysis is a study of ratios between various items or groups of items in financial statements.
RATIO ANALYSIS
Financial Ratio Analysis
? A ratio is an arithmetical relationship
between two figures.
? Financial ratio analysis is a study of ratios
between various items or groups of items
in financial statements.
? Ratios can be classified according to
financial statements. Mainly they are
profit and loss ratios (income statement
ratios), balance sheet ratios (position
statement ratios), mixed ratios (inter
statement ratios).
INTERPRETATION OF THE RATIOS
? Single Absolute Ratio.
? Group of Ratio.
? Historical Comparison.
? Projected Ratios.
? Inter-firm Comparison
GUIDELINES FOR USE OF RATIOS
? Accuracy of Financial Statements.
? Objective or Purpose of Analysis.
? Selection of Ratios.
? Use of Standards.
? Caliber of the Analyst.
SIGNIFICANCE OF RATIO
ANALYSIS
Managerial Uses of Ratio analysis
? Helps in decision-making.
? Helps in financial forecasting and
planning.
? Helps in communicating.
? Helps in co-ordination.
? Helps in controlling.
SIGNIFICANCE OF RATIO
ANALYSIS
? Useful to Shareholders/Investors
? Useful to Creditors
? Useful to Employees
? Useful to Government
LIMITATIONS OF RATIO ANALYSIS
? Limited Use of a Single Ratio.
? Lack of Adequate Standards.
? Inherent Limitations of
Accounting.
? Change of Accounting
Procedure.
Window Dressing
Balance sheet ratio
? It deals with the relationship
between two balance sheet items.
? these can be mainly classified as
liquidity ratio, long term solvency or
leverage ratio.
Liquidity Ratio
? These ratios are calculated to
comment upon the short term
paying capacity of a firm or
concerns ability to meet its current
obligation.
? The important liquidity ratios are
current ratio ,quick ratio & absolute
liquid ratio.
Current Ratio
? It is a measure of general liquidity
and is used to make the analysis of
a short-term financial position or
liquidity of an organization.
? Current Ratio= Current Assets/Current Liabilities
? Rules of thumb=2:1
Example
? Find out Current ratio
? Stock -60000
? Debtors-70000
? Cash -20000
? Bills receivable-30000
? Prepaid expences-10000
? Land and building-100000
? Goodwill-50000
? Creditors-20000
? Bills payable-15000
? Tax payable-18000
? Outstanding expenses-7000
? Bank overdraft-25000
? Debenture-75000
Solution
? Current Ratio= Current Assets/Current Liabilities
? CA=60000+70000+20000+30000+10000=190000
? CL=20000+15000+18000+7000+25000=85000
? CR=190000/85000=2.24
? The CR of 2.24 means that current assets are 2.24
times of current Liabilities
Quick Ratio
? It is also known as acid test ratio
Quick Ratio= Quick Assets/Current
Liabilities
? Quick Asset=Current Asset-
(Inventory+prepaid expenses)
? Rules of thumb=1:1
Example
? Calculate quick ratio from the information given below
? Stock -135000
? Debtors-70000
? Cash -125000
? Prepaid expences-5000
? Land and building-100000
? Goodwill-50000
? Short term investment-150000
? Creditors-150000
? Bills payable-20000
? Tax payable-10000
? Debenture-200000
? It is also known as acid test ratio Quick Ratio=
Quick Assets/Current Liabilities
? Quick asset=70000+125000+150000=345000
? Current Liabilities =150000+20000+10000=180000
? Quick ratio=345000/180000=1.916
Absolute liquid ratio
? Absolute liquid ratio=cash,bank &
marketable securities/current
liabilities
? Rules of thumb=0.5:1
Example
? Calculate absolute liquid ratio from the information given
below
? Stock -135000
? Debtors-70000
? Cash in hand -45000
? Cash at bank-30000
? Marketable securities-150000
? Land and building-400000
? Goodwill-50000
? Creditors-150000
? Bills payable-80000
? Tax payable-20000
? Debenture-200000
? Absolute liquid ratio=225000/250000=.9
Leverage Ratio
? To judge the long-term financial
position, leverage or capital
structure ratios are calculated.
Leverage ratios can calculate from
the balance sheet to determine the
portion of debt in total financing.
Debt Equity ratio
? It is calculated to measure the relative
claims of outsiders and the extent to
which debt financing has been used in the
organization.
? In this ratio the debt has been taken as
the long-term debt, and net worth has
been calculated by adding share capital
with reserves and surplus.
? Debt Equity Ratio=Debt/Net worth
Example
? Equity share-300000
? General reserve-100000
? Debenture-200000
? Current liabilities-100000
? Fixed asset-400000
? Current asset-200000
? Debt Equity Ratio=Debt/Net worth
? =200000/400000=1:2
Funded debt to total capitalisation ratio
? Funded debt to total capitalisation
ratio =(Funded debt/Total
capitalisation)
? Funded debt=Long term loan
? Total capitalisation=Total liabilities-
current liabilities
Proprietory ratio or equity ratio
? Shareholders fund/Total asset
Profit and Loss ratio
? These ratios deal with relationship
between profit and loss accounts
items.
? The main profitability ratios are
gross profit ratio, operating ratio
Operating profit ratio, expenses
ratio and net profit ratio .
Gross profit ratio
? Gross profit ratio measures the
relationship of gross profit to net
sales.
? Gross Profit ratio=(Gross Profit/Net
Sales)x100
? Gross profit=Sales-cost of goods
sold
Example
? Calculate gross profit ratio
? Total sales-520000
? Sales return-20000
? Cost of goods sold-400000
Solution
? (100000/500000)X100=20%
Operating ratio
? Operating ratio=(Operating
cost/Net sales ) x 100
? Operating cost= Cost of goods
sold+ operating expenses.
? Cost of goods sold= op.stock +
purchase+ wages- cl.stock
Example
? Find out operating ratio
? Cost of goods sold-350000
? Selling and distribution expenses-20000
? Administrative and office expenses-30000
? Net sales- 500000
Solution
? (400000/500000)x100=80%
? The ratio indicates that 80% of the
sales have been consumed by
operating cost.
Operating profit ratio
? Operating profit ratio shows the
relationship between operating
profit and sales.
? Operating Profit ratio =(Operating
Profit/Net Sales)x100
? Operating Profit=Net sales-(cost of
goods sold+ administrative & office
expenses)
Example
? Calculate operating profit ratio
? Cost of goods sold-400000
? Selling and distribution expenses-45000
? Administrative and office expenses-35000
? Net sales- 600000
? Operating profit=600000-
(400000+35000+45000)=120000
? Operating profit ratio=(120000/600000)x100=20%
Expenses Ratio
? Cost of goods sold ratio=(cost of
goods sold/Net sales)x100
? Administrative &office expenses
ratio=(Administrative &office
expenses /Net sales)x100
? Selling &distribution expenses
ratio= Selling &distribution
expenses /Net sales)x100
Net profit ratio
? Net profit ratio establishes a
relation ship between net profit
(profit after tax) and indicates the
efficiency of the management.
? Net Profit ratio =(Net Profit/Net
Sales)x100
Mixed ratio or inter statement ratios
? These ratios exhibit the relationship
between profit and loss item and
balance sheet item.
? Coverage Ratio
? The coverage ratio shows the firm’s
ability to pay interest and principals
due.
Interest coverage ratio
? It properly measures the margin of safety
the organization enjoys with respect to its
interest burden.
The interest coverage ratio indicates the
number of times interest is covered by
the profits available to pay the interest
charges.
? Interest coverage ratio=Profit Before
Interest and Taxes/Interest
Debt service coverage ratio
? Debt service coverage ratio gives
picture of long-term liquidity
position.
? Debt service coverage=(Profit After
Tax+ Depreciation+ Interest on
Long Term Loans)/(Interest+ Long
Term Loans)
Activity Ratio or Current Assets
movement Ratio
? Activity ratios are calculated to measure
the efficiency with which the resources of
a firm have been employed.
? These ratios are also called turnover
ratios because they indicate speed at
which the assets are being turned over
into sales.
? The important turnover ratios are debtor’s
turnover ratio ,inventory turnover ratio,
creditor turnover ratio ,working capital
turnover ratio, fixed assets turnover ratio
& total assets turnover ratio.
Debtor turnover ratio
? indicates the velocity of debt-collection of
an organization. In simple words, it
indicates the number of times debtors
(receivables) are turned over during a
year.
? Generally high turnover ratio is the more
efficiency of management of debtors .
? Debtor Turnover Ratio=Net Credit
Sales/Average Trade Debtor
Example
? Annual credit sales-25000
? Return-1000
? Debtors-3000
? Bills receivable-1000
Solution
? 24000/4000=6 times
? Debtors are turned over 6 times
during the year.
Average Collection Period
? It represents the average number of
days in which its debtors converted
into cash.
? The short collection period implies
quick payment by the debtors.
? Average Collection Period= Total
Trade Debtor/Sales Per Day or
? 365/Debtor turnover ratio
Example
? Total sales-100000
? Cash sales (Included in total sales)-20000
? Sales return-7000
? Total debtors-11000
? Bills receivable-4000
? Bad debt provision-1000
? Creditors-10000
? Average Collection Period= Total Trade Debtor/Sales
Per Day
? Total sales=100000-(20000+7000)=73000
? Sales per day=73000/365=200
? ACP=(11000+4000)/200=75 days
Creditor Turnover Ratio
? In course of business operations an
organization has to make credit purchases
and incurred short-term liabilities.
? Suppliers of goods naturally interested in
finding out how much time the
organization is likely to take to repay the
creditors.
? Creditors Turnover Ratio=Net Credit
Purchase/Average Trade Creditor
Average payment period
? Average payment period represent
the average number of days the
organization has to pay its creditors
? Average payment period=Total
Trade Creditors/Average Daily
Purchases or
? 365/creditor turnover ratio
Inventory Turnover Ratio
? Organization has to maintain the
inventory of finished goods so as to able
to meet the requirement of the business.
But the level of inventories should not
either too high or too low.
? Inventory Turnover Ratio=Costs Of Goods
Sold/ Average Inventory at costs
? Inventory conversion period=365/
Inventory Turnover Ratio
Profitability ratio in relation to
Investment
? Return on investment is one of the
important ratios used to measure
the efficiency of the organization, as
the objective of the organization is
to maximize it’s earning.
? Return on investment =Profit Before
Interest& Tax/Capital Employed
? Capital Employed=net fixed
asset+net working capital
Return on Equity
? Return on Equity is calculated to see the
profitability of the owner’s investment.
? It is regarded as an important measure
because it reflects the productivity of the
ownership in the organization.
? It is affected by several factors like
earning power, debt equity ratio, cost of
debt and tax rate.
? Return on Equity=Profit After Tax/Net
Worth
Dividend Per Share.
? The profit after tax belongs to
shareholders. But income, which they
really received, is the amount earning
received as cash dividend.
? Therefore a large number of present and
potential investors are interested in the
Dividend Per Share.
? Dividend Per Share=Dividend
Paid/Number of Shares
Earning Per Share
? Earning Per Share is a small variation of
equity capital and is calculated by dividing
the net profit after tax and preference
dividend by the total number of equity
shares.
? EPS calculated for a number of years
indicates the earning power of the
company has increased or decreased.
? Earning Per Share=Profit After
Tax/Number of Shares
For more slide visit: www.freembanotes.in
doc_315933203.ppt
A ratio is an arithmetical relationship between two figures., Financial ratio analysis is a study of ratios between various items or groups of items in financial statements.
RATIO ANALYSIS
Financial Ratio Analysis
? A ratio is an arithmetical relationship
between two figures.
? Financial ratio analysis is a study of ratios
between various items or groups of items
in financial statements.
? Ratios can be classified according to
financial statements. Mainly they are
profit and loss ratios (income statement
ratios), balance sheet ratios (position
statement ratios), mixed ratios (inter
statement ratios).
INTERPRETATION OF THE RATIOS
? Single Absolute Ratio.
? Group of Ratio.
? Historical Comparison.
? Projected Ratios.
? Inter-firm Comparison
GUIDELINES FOR USE OF RATIOS
? Accuracy of Financial Statements.
? Objective or Purpose of Analysis.
? Selection of Ratios.
? Use of Standards.
? Caliber of the Analyst.
SIGNIFICANCE OF RATIO
ANALYSIS
Managerial Uses of Ratio analysis
? Helps in decision-making.
? Helps in financial forecasting and
planning.
? Helps in communicating.
? Helps in co-ordination.
? Helps in controlling.
SIGNIFICANCE OF RATIO
ANALYSIS
? Useful to Shareholders/Investors
? Useful to Creditors
? Useful to Employees
? Useful to Government
LIMITATIONS OF RATIO ANALYSIS
? Limited Use of a Single Ratio.
? Lack of Adequate Standards.
? Inherent Limitations of
Accounting.
? Change of Accounting
Procedure.
Window Dressing
Balance sheet ratio
? It deals with the relationship
between two balance sheet items.
? these can be mainly classified as
liquidity ratio, long term solvency or
leverage ratio.
Liquidity Ratio
? These ratios are calculated to
comment upon the short term
paying capacity of a firm or
concerns ability to meet its current
obligation.
? The important liquidity ratios are
current ratio ,quick ratio & absolute
liquid ratio.
Current Ratio
? It is a measure of general liquidity
and is used to make the analysis of
a short-term financial position or
liquidity of an organization.
? Current Ratio= Current Assets/Current Liabilities
? Rules of thumb=2:1
Example
? Find out Current ratio
? Stock -60000
? Debtors-70000
? Cash -20000
? Bills receivable-30000
? Prepaid expences-10000
? Land and building-100000
? Goodwill-50000
? Creditors-20000
? Bills payable-15000
? Tax payable-18000
? Outstanding expenses-7000
? Bank overdraft-25000
? Debenture-75000
Solution
? Current Ratio= Current Assets/Current Liabilities
? CA=60000+70000+20000+30000+10000=190000
? CL=20000+15000+18000+7000+25000=85000
? CR=190000/85000=2.24
? The CR of 2.24 means that current assets are 2.24
times of current Liabilities
Quick Ratio
? It is also known as acid test ratio
Quick Ratio= Quick Assets/Current
Liabilities
? Quick Asset=Current Asset-
(Inventory+prepaid expenses)
? Rules of thumb=1:1
Example
? Calculate quick ratio from the information given below
? Stock -135000
? Debtors-70000
? Cash -125000
? Prepaid expences-5000
? Land and building-100000
? Goodwill-50000
? Short term investment-150000
? Creditors-150000
? Bills payable-20000
? Tax payable-10000
? Debenture-200000
? It is also known as acid test ratio Quick Ratio=
Quick Assets/Current Liabilities
? Quick asset=70000+125000+150000=345000
? Current Liabilities =150000+20000+10000=180000
? Quick ratio=345000/180000=1.916
Absolute liquid ratio
? Absolute liquid ratio=cash,bank &
marketable securities/current
liabilities
? Rules of thumb=0.5:1
Example
? Calculate absolute liquid ratio from the information given
below
? Stock -135000
? Debtors-70000
? Cash in hand -45000
? Cash at bank-30000
? Marketable securities-150000
? Land and building-400000
? Goodwill-50000
? Creditors-150000
? Bills payable-80000
? Tax payable-20000
? Debenture-200000
? Absolute liquid ratio=225000/250000=.9
Leverage Ratio
? To judge the long-term financial
position, leverage or capital
structure ratios are calculated.
Leverage ratios can calculate from
the balance sheet to determine the
portion of debt in total financing.
Debt Equity ratio
? It is calculated to measure the relative
claims of outsiders and the extent to
which debt financing has been used in the
organization.
? In this ratio the debt has been taken as
the long-term debt, and net worth has
been calculated by adding share capital
with reserves and surplus.
? Debt Equity Ratio=Debt/Net worth
Example
? Equity share-300000
? General reserve-100000
? Debenture-200000
? Current liabilities-100000
? Fixed asset-400000
? Current asset-200000
? Debt Equity Ratio=Debt/Net worth
? =200000/400000=1:2
Funded debt to total capitalisation ratio
? Funded debt to total capitalisation
ratio =(Funded debt/Total
capitalisation)
? Funded debt=Long term loan
? Total capitalisation=Total liabilities-
current liabilities
Proprietory ratio or equity ratio
? Shareholders fund/Total asset
Profit and Loss ratio
? These ratios deal with relationship
between profit and loss accounts
items.
? The main profitability ratios are
gross profit ratio, operating ratio
Operating profit ratio, expenses
ratio and net profit ratio .
Gross profit ratio
? Gross profit ratio measures the
relationship of gross profit to net
sales.
? Gross Profit ratio=(Gross Profit/Net
Sales)x100
? Gross profit=Sales-cost of goods
sold
Example
? Calculate gross profit ratio
? Total sales-520000
? Sales return-20000
? Cost of goods sold-400000
Solution
? (100000/500000)X100=20%
Operating ratio
? Operating ratio=(Operating
cost/Net sales ) x 100
? Operating cost= Cost of goods
sold+ operating expenses.
? Cost of goods sold= op.stock +
purchase+ wages- cl.stock
Example
? Find out operating ratio
? Cost of goods sold-350000
? Selling and distribution expenses-20000
? Administrative and office expenses-30000
? Net sales- 500000
Solution
? (400000/500000)x100=80%
? The ratio indicates that 80% of the
sales have been consumed by
operating cost.
Operating profit ratio
? Operating profit ratio shows the
relationship between operating
profit and sales.
? Operating Profit ratio =(Operating
Profit/Net Sales)x100
? Operating Profit=Net sales-(cost of
goods sold+ administrative & office
expenses)
Example
? Calculate operating profit ratio
? Cost of goods sold-400000
? Selling and distribution expenses-45000
? Administrative and office expenses-35000
? Net sales- 600000
? Operating profit=600000-
(400000+35000+45000)=120000
? Operating profit ratio=(120000/600000)x100=20%
Expenses Ratio
? Cost of goods sold ratio=(cost of
goods sold/Net sales)x100
? Administrative &office expenses
ratio=(Administrative &office
expenses /Net sales)x100
? Selling &distribution expenses
ratio= Selling &distribution
expenses /Net sales)x100
Net profit ratio
? Net profit ratio establishes a
relation ship between net profit
(profit after tax) and indicates the
efficiency of the management.
? Net Profit ratio =(Net Profit/Net
Sales)x100
Mixed ratio or inter statement ratios
? These ratios exhibit the relationship
between profit and loss item and
balance sheet item.
? Coverage Ratio
? The coverage ratio shows the firm’s
ability to pay interest and principals
due.
Interest coverage ratio
? It properly measures the margin of safety
the organization enjoys with respect to its
interest burden.
The interest coverage ratio indicates the
number of times interest is covered by
the profits available to pay the interest
charges.
? Interest coverage ratio=Profit Before
Interest and Taxes/Interest
Debt service coverage ratio
? Debt service coverage ratio gives
picture of long-term liquidity
position.
? Debt service coverage=(Profit After
Tax+ Depreciation+ Interest on
Long Term Loans)/(Interest+ Long
Term Loans)
Activity Ratio or Current Assets
movement Ratio
? Activity ratios are calculated to measure
the efficiency with which the resources of
a firm have been employed.
? These ratios are also called turnover
ratios because they indicate speed at
which the assets are being turned over
into sales.
? The important turnover ratios are debtor’s
turnover ratio ,inventory turnover ratio,
creditor turnover ratio ,working capital
turnover ratio, fixed assets turnover ratio
& total assets turnover ratio.
Debtor turnover ratio
? indicates the velocity of debt-collection of
an organization. In simple words, it
indicates the number of times debtors
(receivables) are turned over during a
year.
? Generally high turnover ratio is the more
efficiency of management of debtors .
? Debtor Turnover Ratio=Net Credit
Sales/Average Trade Debtor
Example
? Annual credit sales-25000
? Return-1000
? Debtors-3000
? Bills receivable-1000
Solution
? 24000/4000=6 times
? Debtors are turned over 6 times
during the year.
Average Collection Period
? It represents the average number of
days in which its debtors converted
into cash.
? The short collection period implies
quick payment by the debtors.
? Average Collection Period= Total
Trade Debtor/Sales Per Day or
? 365/Debtor turnover ratio
Example
? Total sales-100000
? Cash sales (Included in total sales)-20000
? Sales return-7000
? Total debtors-11000
? Bills receivable-4000
? Bad debt provision-1000
? Creditors-10000
? Average Collection Period= Total Trade Debtor/Sales
Per Day
? Total sales=100000-(20000+7000)=73000
? Sales per day=73000/365=200
? ACP=(11000+4000)/200=75 days
Creditor Turnover Ratio
? In course of business operations an
organization has to make credit purchases
and incurred short-term liabilities.
? Suppliers of goods naturally interested in
finding out how much time the
organization is likely to take to repay the
creditors.
? Creditors Turnover Ratio=Net Credit
Purchase/Average Trade Creditor
Average payment period
? Average payment period represent
the average number of days the
organization has to pay its creditors
? Average payment period=Total
Trade Creditors/Average Daily
Purchases or
? 365/creditor turnover ratio
Inventory Turnover Ratio
? Organization has to maintain the
inventory of finished goods so as to able
to meet the requirement of the business.
But the level of inventories should not
either too high or too low.
? Inventory Turnover Ratio=Costs Of Goods
Sold/ Average Inventory at costs
? Inventory conversion period=365/
Inventory Turnover Ratio
Profitability ratio in relation to
Investment
? Return on investment is one of the
important ratios used to measure
the efficiency of the organization, as
the objective of the organization is
to maximize it’s earning.
? Return on investment =Profit Before
Interest& Tax/Capital Employed
? Capital Employed=net fixed
asset+net working capital
Return on Equity
? Return on Equity is calculated to see the
profitability of the owner’s investment.
? It is regarded as an important measure
because it reflects the productivity of the
ownership in the organization.
? It is affected by several factors like
earning power, debt equity ratio, cost of
debt and tax rate.
? Return on Equity=Profit After Tax/Net
Worth
Dividend Per Share.
? The profit after tax belongs to
shareholders. But income, which they
really received, is the amount earning
received as cash dividend.
? Therefore a large number of present and
potential investors are interested in the
Dividend Per Share.
? Dividend Per Share=Dividend
Paid/Number of Shares
Earning Per Share
? Earning Per Share is a small variation of
equity capital and is calculated by dividing
the net profit after tax and preference
dividend by the total number of equity
shares.
? EPS calculated for a number of years
indicates the earning power of the
company has increased or decreased.
? Earning Per Share=Profit After
Tax/Number of Shares
For more slide visit: www.freembanotes.in
doc_315933203.ppt