28029905 ratio analysis financial management

8/9/2019 28029905 Ratio Analysis Financial Management

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RATIO ANALYSIS

PIYUSH AGARWAL


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What is a Ratio?

Refers to the establishment of relationship between any two

inter-related variables.

While determining a ratio, it is desirable to divide the more

favorable or desirable or significant variable by the less

favorable or desirable one.

Is an effective tool or a device to diagnose the financial andoperational weaknesses of business enterprises


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Classification of Ratios:

Long-term solvency ratios

Short-term solvency ratios

Profitability ratios

Activity ratios

Operating ratios

Market Test ratios


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Long-term Solvency Ratios

Helps determine the long-term financial stability of the firm

Can be used to assess ability of the firm to meet all its

liabilities.

Debt Equity Ratio:

Analyses the extent to which the assets are financed by the

outsiders and the owners.

If the proportion of debt to equity is low, a company is said

to be low geared and vice versa.


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Financial institutions for financing of projects accept a debtequity ratio of 2:1.

Debt

Debt Equity Ratio = ---------

Equity

Higher the gearing more volatile is the returns to the shareholders


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Shareholder Equity ratio:

Ratio establishes the relation between share capital and total

tangible assets

Shareholders funds represent both equity and preference capital

plus reserves and surplus less losses

Reduction in the shareholders funds indicates over dependence

on outside sources for long-term financial needs and this

obviously carries greater risk.

Share Capital

Proprietary Ratio = --------------------

Total Assets


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Capital Gearing Ratio:

Ratio reflects the proportion of fixed interest bearing securities to

equity shareholders funds

Fixed interest bearing securities include debentures, long-term

loans and preference share capital

Ratio indicates whether the firm is trading on equity or otherwise

A firm that has higher proportion of fixed interest bearing funds is

aid to be trading on equity and vice versa.

Debentures + Loans + Pref. Share Capital

Capital Gearing Ratio = -------------------------------------------------------------

Equity Shareholders Funds


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Proprietary Ratio:

Ratio expresses the relationship between net worth and total assets

Net Worth includes Equity Capital + Preference Capital + Reserves

- Fictitious assets

Reserves earmarked for a particular purpose not to be included incalculating the Net worth

Total assets on the other hand include Fixed Assets + Current assets

Higher the ratio the better it is for it indicates a strong financial

position of the business

Net Worth

Proprietary Ratio = -------------------

Total Assets


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Interest Cover ratio:

Ratio shows how any times interest charges are covered by funds

that are available for payment of interest.

Financial institutions consider a ratio of 2:1 as appropriate

High ratio indicates that the firm is conservative in using debt and

a low ratio indicates that the firm uses debt excessively.

Profit before Interest, Depreciation and Tax

Interest Cover Ratio = ----------------------------------------------------------------

Interest


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Short-term Solvency Ratios:

Helps in measuring the ability of the firm to meet its maturingshort-term obligations

Current ratio:

Establishes the relation between the current assets and currentliabilities

Current assets are those assets that can be converted into cash

within a year and include Sundry Debtors, Bills Receivable Cash,

Bank balance, Prepaid expenses, Outstanding Income and Stock

Current liabilities are those liabilities that are payable within a year

and include Sundry Creditors, Bills Payable, Bank Overdraft,

Outstanding Expenses and Income received in advance


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Current Assets

Current Ratio = -------------------------

Current Liabilities

Standard current ratio is 2:1 and it indicates a highly short-term

solvency position.

Banks accept a current ration of 1.33:1 for providing workingcapital to firms.


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Liquid Ratio

Ratio is concerned with the establishment of relationship between

quick assets and quick liabilities

Liquid assets are those that can be converted into cash without loss

of time and money

Liquid Assets include Current Assets Stock and Prepaid

Expenses.

Liquid Liabilities are Current liabilities Bank Overdraft

Liquid Assets Quick Or Liquid Ratio = --------------------------

Quick Liabilities

Standard ratio is 1:1


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Profitability Ratios:

Gross Profit Ratio

Establishes the relationship between gross profit on sales and

net sales

Measures the efficiency of the companys operations and can be

compared with the previous years figures to ascertain

improvements if any.

High ratio indicates the organizations successful attempt to

produce the product at a relatively lower cost


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If this is not done the loss arising in one product may be concealed

by the high gross margin in another.

Gross Margin Gross profit ratio = -------------------- X 100

Net Sales

In case of multi-product situation, it is advisable to compute therate for each product separately


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Operating Profit :

Ratio takes into account the aggregate of manufacturing cost

of goods sold and other operating expenses on one hand and the

net sales revenue on the other

Operating Expenses include administrative overheads and selling

and distribution overheads and finance overheads

A high operating ratio means the firm is left with a small margin

to absorb its other expenses like tax, dividend, etc

COGS + Operating Expenses Operating Profit Ratio = ----------------------------------------- X 100

Net Sales


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Net Profit Ratio:

Ratio establishes the relationship between the amount of net profit

and the sales revenue

Net profit is ascertained as Operating Profit + Non-operating

profits Non-operating losses

Profit after Taxes Net Profit Ratio = ------------------------- X 100

Net Sales


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Return on Capital Employed

Ratio is useful in ascertaining the profit that has been earned on

the capital employed

Return on capital employed can be increased by increasing theprofit margin, increasing the investment turnover or by increasing

both profit margin and investment turnover

Profit after tax

ROCE = -------------------------

Capital Employed


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Earnings Per Share:

Value is maximized when the market price of equity shares ismaximized

Helps in ascertaining the net profit earned per share

A steady growth in EPS year after year indicates a good track

record as far as the profitability of the firm is concerned.

PAT - Preference dividend EPS = ------------------------------------------

Number of Equity Shares


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Activity Ratios:

Measures the effectiveness with which the firm has employed

its resources

Ratios help in ascertaining the speed with which various accounts

are converted into sales or cash


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Debtors Turnover Ratio

Establishes the relation between net credit sales and the average

receivables

Useful in ascertaining the efficiency with which the company

converts its debtors into cash

Net Credit Sales

Debtors Turnover Ratio = -------------------------

Average debtors

Where average debtors are opening debtors + closing debtors / 2


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Creditors Turnover Ratio:

Ratio shows the average time taken to pay for the goods and

services purchased by the company

Longer the credit period the better it is. In other words this ratio

should be low

Credit Purchases

Creditors Turnover Ratio= -----------------------

Average Creditors

Average creditors are Opening Creditors + Closing Creditors / 2


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Assets Turnover Ratio:

Ratio measures the ability of the firm to generate sales revenue

in relation to the size of the asset investment

A low asset turnover may be remedied by increasing the sales or

by disposing of some of the fixed assets or both

Sales Fixed Assets Turnover Ratio = --------------------

Fixed Assets


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Operating Ratios :

Ratio of all operating expenses to sales is operating ratio.

Analysis of the operating ratio helps to understand whether the cost

content is high or low in relation to the sales

Indicative of the operational efficiency or inefficiency of the firm.


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Expenses Ratio:

Ratio is calculated to determine the relationship between sales

and their operating expense, either as a total or individually

Operating Expenses

Expenses Ratio = ------------------------------ X 100

Net Sales

Numerator can also be substituted by (i) Administrative Expenses

(ii) Selling Expenses or (iii) Finance Expenses.


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Stock Working Capital Ratio :

Ratio establishes the relationship between closing stock and the

working capital of the company

Closing Stock

Stock Working Capital Ratio = ----------------------

Working

Capital

Standard ratio is 1:1


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Market Test Ratios:

Ratios relate the firms stock price to its earnings and the book

value of the shares

Reflects the investors perception of the firm and its future prospects

If the profitability, solvency and turnover ratios are high, the

market test ratios will show a positive trend and accordingly

these ratios are expected to be high


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Dividend Yield Ratio:

Ratio reflects the percentage yield that an investor receives on

the investment at the current market price of the shares

Dividend per share

Dividend Yield ratio = --------------------------------- X 100

Market price per share


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Book Value Per Share:

Ratio reflects the net worth per equity share.

Reflects the past earnings and the distribution policy of the company

A high ratio indicates that the firm was conservative in declaring

dividend and has huge reserves.

Such a firm may declare a bonus in the near future.

A low ratio indicates that the firm has been liberal in declaring

dividend or alternatively the profitability track record is poor.

Equity Capital + Reserves - P and L (Debit balance)

Book Value = --------------------------------------------------------------------------

Total number of Equity Shares


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Price Earnings Ratio:

Ratio measures the number of times the earnings of the latest

year at which the share price is quoted.

Reflects the markets assessment of the future earning potential

of the company. Obviously a high P/E ratio is preferred.

Current Market Price

P/E Ratio = --------------------------------Earnings Per Share


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Advantages of Ratio Analysis:

Help to summarize and simplify the voluminous financial data

Helpful in discharging managerial duties and responsibilities such

as planning, controlling, etc. by providing insight into the financialdata

Trend ratios help the analysts to find out whether the company has

been improving its performance or not over the years

Capable of identifying the factors that are responsible for the

failure of the company


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Portray the relationship between two items of the financial

statement. Prior to the interpretation of the ratios, it is necessary to

study the factors, reasons, policies, etc. that have influenced the

figures used for calculating the ratios.

Based on the accounts that are prepared on the basis of thehistorical data

Are as correct as the financial statements on which they are based

Have no established standards

Difficult and for that matter wrong to compare the results of two

companies on the basis of ratios

Limitations Of Ratio Analysis :


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YOUR QUESTIONSPLEASE ????


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THANK YOU

28029905 ratio analysis financial management

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