Description
liquidity ratios,acid ratio,current ratio,leverage ratios,turnover/activity ratios,profitability ratios,valuation,interest coverage,fixed asset ratio,inventory turnover,accounts receivable turnover,P/E ratio
Ratio Analysis
Purpose: ? To identify aspects of a business’s performance to aid decision making ? Quantitative process – may need to be supplemented by qualitative factors to get a complete picture ? 5 main areas:
1.
2.
3.
4.
5.
Liquidity – the ability of the firm to pay its way Investment/shareholders – information to enable decisions to be made on the extent of the risk and the earning potential of a business investment Gearing – information on the relationship between the exposure of the business to loans as opposed to share capital Profitability – how effective the firm is at generating profits given sales and or its capital assets Financial – the rate at which the company sells its stock and the efficiency with which it uses its assets
RATIO ANALYSIS (Liquidity Ratios)
1.
LIQUIDITY RATIOS: Refer to the ability of the firm to meet its obligations in the short-run, usually one year. Current Ratio: Current Assets Current Liabilities (C.A. includes cash, marketable securities, debtors, inventories, loans & advances, & prepaid expenses. C.L. includes loans & advances taken, trade creditors, accrued expenses & provisions)
(a)
The ideal Current Ratio preferred by Banks is 1.33 : 1
RATIO ANALYSIS (Liquidity Ratios) …….contd.
(b) Acid – Test Ratio: Quick Assets Current Liabilities Quick assets are current assets excluding inventories as it is the least liquid C.A. (c) Bank finance to Working Capital Gap Ratio: Short-term bank borrowings Working Capital Gap It shows the dependence on bank finance and the working capital is equal to C.A. less C.L. other than bank borrowings.
RATIO ANALYSIS (Leverage Ratios)
2. LEVERAGE RATIOS: Refer to the use of debt finance in the capital structure. (a) Debt – Equity Ratio: Debt Equity It shows the relative contribution of creditors & owners. Numerator consists of Short & Long-term Liabilities & denominator consists of Net Worth plus Preference Capital) * Net Worth = Equity Capital + Reserves & Surplus Lower the ratio, higher the degree of protection enjoyed by creditors.
RATIO ANALYSIS (Leverage Ratios) …….contd.
(b) Interest Coverage Ratio: Measures the ability of the firm to meet its interest obligations. Earnings before Interest & Tax (EBIT) Interest EBIT is used as numerator since the ability of the firm to pay interest is not affected by tax payment, as interest is a tax deductible expense.
RATIO ANALYSIS (Leverage Ratios) …….contd.
(c) Fixed Charges Coverage Ratio: EBIT + Depreciation Interest + (Repayment of loan/ 1-tax rate)
It measures debt servicing ability as it considers both the interest & principal repayment obligations – In the denominator, the repayment of loan is adjusted upwards for the tax factor as loan repayment, unlike interest, is not tax deductible.
RATIO ANALYSIS (Turnover/Activity Ratios)
3. TURNOVER / ACTIVITY RATIOS: Are based on the relationship between the level of activity, represented by COGS & the level of various other assets.
(a)
Inventory Turnover Ratio: COGS Sales Average Inventory Inventory It measures how fast the inventory is moving through the firm & generating sales - higher the ratio, more efficient is the management of inventory & vice versa.
RATIO ANALYSIS (Turnover Ratios)…..contd.
(b) Accounts Receivable Turnover Ratio( Debtors Turnover): Measures how many times the debtors turn over during the period. Net Credit Sales* Average Accounts Receivables (Debtors) *If the figure for net credit sales is not available, one may consider net sales figure. The higher the A/R turnover, the greater the efficiency of credit management.
RATIO ANALYSIS (Turnover Ratios)…..contd.
(c) Average collection period: Represents the number of days’ worth of credit sales that is locked in debtors. Average Accounts Receivable X 365 Average daily credit sales If the figure for credit sales is not available, one may consider with net sales figure. Average collection period & the A/R are related in the following way: Average Collection Period = 365 / A.R. Turnover
RATIO ANALYSIS (Turnover Ratios)…..contd.
(d) Fixed assets turnover Ratio: Measures sales per rupee of investment in fixed assets – A higher ratio indicates a high degree of efficiency in asset utilization. Net Sales Net Fixed Assets Caution: When fixed assets of a firm are old & substantially depreciated; this ratio tends to be high as the denominator is low.
RATIO ANALYSIS (Turnover Ratios)…..contd.
(e) Total assets turnover Ratio: Measures sales per rupee of investment in total assets – A higher ratio indicates a high degree of efficiency in asset utilization. Net Sales Total Assets Caution: When total assets of a firm are old & substantially depreciated; this ratio tends to be high as the denominator is low.
RATIO ANALYSIS (Profitability Ratios)
4. PROFITABILITY RATIOS: Reflect the final result of the business operations –(of two types) – Profit margin ratios & Rate of return ratios. (a) Gross Profit Margin Ratio: Shows the margin left after meeting manufacturing costs: Gross Profit Net Sales
RATIO ANALYSIS (Profitability Ratios)…. Contd.
(b) Net Profit Margin Ratio: Shows the earnings left for share holders (both equity & preference) as % of net sales. Net Profit Net Sales (c) Return on Equity Ratio: Measures the profitability of equity funds invested in the firm – reflects the productivity of the ownership capital employed in the firm. Equity Earnings Average Net Worth
RATIO ANALYSIS (Profitability Ratios)…. Contd.
(d) Return on Capital Employed: It is a measure of capital employment efficiency: Net Profit before Interest & Tax * 100 Average Capital Employed 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.
RATIO ANALYSIS (Valuation Ratios)
5. VALUATION RATIOS: Indicate how the equity stock of the firm is assessed in the capital market.
(a)
Price-earning Ratio (P/E ratio) : Commonly referred to as ‘price-earning multiple’. PE Ratio indicates the number of times the Earning Per Share is covered by its market price. Market Price per share (Av. market price)
Earning per share
RATIO ANALYSIS (Valuation Ratios)…. Contd.
(b) Earning per shares: 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 Profits after tax & Preference dividend No. of Equity Shares (c) Dividend Yield: Measure of the rate of return earned by the shareholders. Dividend per shares Market Price per shares Firms with low growth prospects offer a high dividend yield and a low capital gains yield.
doc_742416218.ppt
liquidity ratios,acid ratio,current ratio,leverage ratios,turnover/activity ratios,profitability ratios,valuation,interest coverage,fixed asset ratio,inventory turnover,accounts receivable turnover,P/E ratio
Ratio Analysis
Purpose: ? To identify aspects of a business’s performance to aid decision making ? Quantitative process – may need to be supplemented by qualitative factors to get a complete picture ? 5 main areas:
1.
2.
3.
4.
5.
Liquidity – the ability of the firm to pay its way Investment/shareholders – information to enable decisions to be made on the extent of the risk and the earning potential of a business investment Gearing – information on the relationship between the exposure of the business to loans as opposed to share capital Profitability – how effective the firm is at generating profits given sales and or its capital assets Financial – the rate at which the company sells its stock and the efficiency with which it uses its assets
RATIO ANALYSIS (Liquidity Ratios)
1.
LIQUIDITY RATIOS: Refer to the ability of the firm to meet its obligations in the short-run, usually one year. Current Ratio: Current Assets Current Liabilities (C.A. includes cash, marketable securities, debtors, inventories, loans & advances, & prepaid expenses. C.L. includes loans & advances taken, trade creditors, accrued expenses & provisions)
(a)
The ideal Current Ratio preferred by Banks is 1.33 : 1
RATIO ANALYSIS (Liquidity Ratios) …….contd.
(b) Acid – Test Ratio: Quick Assets Current Liabilities Quick assets are current assets excluding inventories as it is the least liquid C.A. (c) Bank finance to Working Capital Gap Ratio: Short-term bank borrowings Working Capital Gap It shows the dependence on bank finance and the working capital is equal to C.A. less C.L. other than bank borrowings.
RATIO ANALYSIS (Leverage Ratios)
2. LEVERAGE RATIOS: Refer to the use of debt finance in the capital structure. (a) Debt – Equity Ratio: Debt Equity It shows the relative contribution of creditors & owners. Numerator consists of Short & Long-term Liabilities & denominator consists of Net Worth plus Preference Capital) * Net Worth = Equity Capital + Reserves & Surplus Lower the ratio, higher the degree of protection enjoyed by creditors.
RATIO ANALYSIS (Leverage Ratios) …….contd.
(b) Interest Coverage Ratio: Measures the ability of the firm to meet its interest obligations. Earnings before Interest & Tax (EBIT) Interest EBIT is used as numerator since the ability of the firm to pay interest is not affected by tax payment, as interest is a tax deductible expense.
RATIO ANALYSIS (Leverage Ratios) …….contd.
(c) Fixed Charges Coverage Ratio: EBIT + Depreciation Interest + (Repayment of loan/ 1-tax rate)
It measures debt servicing ability as it considers both the interest & principal repayment obligations – In the denominator, the repayment of loan is adjusted upwards for the tax factor as loan repayment, unlike interest, is not tax deductible.
RATIO ANALYSIS (Turnover/Activity Ratios)
3. TURNOVER / ACTIVITY RATIOS: Are based on the relationship between the level of activity, represented by COGS & the level of various other assets.
(a)
Inventory Turnover Ratio: COGS Sales Average Inventory Inventory It measures how fast the inventory is moving through the firm & generating sales - higher the ratio, more efficient is the management of inventory & vice versa.
RATIO ANALYSIS (Turnover Ratios)…..contd.
(b) Accounts Receivable Turnover Ratio( Debtors Turnover): Measures how many times the debtors turn over during the period. Net Credit Sales* Average Accounts Receivables (Debtors) *If the figure for net credit sales is not available, one may consider net sales figure. The higher the A/R turnover, the greater the efficiency of credit management.
RATIO ANALYSIS (Turnover Ratios)…..contd.
(c) Average collection period: Represents the number of days’ worth of credit sales that is locked in debtors. Average Accounts Receivable X 365 Average daily credit sales If the figure for credit sales is not available, one may consider with net sales figure. Average collection period & the A/R are related in the following way: Average Collection Period = 365 / A.R. Turnover
RATIO ANALYSIS (Turnover Ratios)…..contd.
(d) Fixed assets turnover Ratio: Measures sales per rupee of investment in fixed assets – A higher ratio indicates a high degree of efficiency in asset utilization. Net Sales Net Fixed Assets Caution: When fixed assets of a firm are old & substantially depreciated; this ratio tends to be high as the denominator is low.
RATIO ANALYSIS (Turnover Ratios)…..contd.
(e) Total assets turnover Ratio: Measures sales per rupee of investment in total assets – A higher ratio indicates a high degree of efficiency in asset utilization. Net Sales Total Assets Caution: When total assets of a firm are old & substantially depreciated; this ratio tends to be high as the denominator is low.
RATIO ANALYSIS (Profitability Ratios)
4. PROFITABILITY RATIOS: Reflect the final result of the business operations –(of two types) – Profit margin ratios & Rate of return ratios. (a) Gross Profit Margin Ratio: Shows the margin left after meeting manufacturing costs: Gross Profit Net Sales
RATIO ANALYSIS (Profitability Ratios)…. Contd.
(b) Net Profit Margin Ratio: Shows the earnings left for share holders (both equity & preference) as % of net sales. Net Profit Net Sales (c) Return on Equity Ratio: Measures the profitability of equity funds invested in the firm – reflects the productivity of the ownership capital employed in the firm. Equity Earnings Average Net Worth
RATIO ANALYSIS (Profitability Ratios)…. Contd.
(d) Return on Capital Employed: It is a measure of capital employment efficiency: Net Profit before Interest & Tax * 100 Average Capital Employed 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.
RATIO ANALYSIS (Valuation Ratios)
5. VALUATION RATIOS: Indicate how the equity stock of the firm is assessed in the capital market.
(a)
Price-earning Ratio (P/E ratio) : Commonly referred to as ‘price-earning multiple’. PE Ratio indicates the number of times the Earning Per Share is covered by its market price. Market Price per share (Av. market price)
Earning per share
RATIO ANALYSIS (Valuation Ratios)…. Contd.
(b) Earning per shares: 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 Profits after tax & Preference dividend No. of Equity Shares (c) Dividend Yield: Measure of the rate of return earned by the shareholders. Dividend per shares Market Price per shares Firms with low growth prospects offer a high dividend yield and a low capital gains yield.
doc_742416218.ppt