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CHAPTER - VI

EVALUATION OF FINANCIAL

PERFORMANCE OF SANGAM DAIRY

Financial statements comprising the balance sheet and profit and loss account give all the

information regarding the financial operations of a firm. An analysis of financial performance of

the Dairy can be brought through an analysis of the financial statements of the Dairy. Financial

statements analysis can be done using various tools such as transactional analysis, funds flow

statement, cash flow statement, ratio analysis, comparative statement, DuPont analysis etc., The

present study focuses on ‘Ratio Analysis’ for the purpose of analysis of financial performance of

Sangam Dairy.

Ratio analysis is a process of evaluating relationship between the component parts of

financial statements to obtain a better understanding of the firm’s position and performance. The

first task of the financial analysis is to select the information relevant to the decision under

consideration from the total contained in the financial statement.

FINANCIAL RATIO ANALYSIS

A ratio is simple mathematical expression. It is a number expressed in terms of another

number, expressing the quantitative relationship between the two ratios. Ratio analysis is the

technique of interpretation of financial statements with the help of various meaningful ratios.

Ratio does not add to any information that is already available but they show the relationship

between two items in a more meaningful way which helps us to draw certain conclusions.

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Comparison with related facts is the basis of ratio analysis. Ratio may be used for comparison in

any of the following ways.

Comparison of a firm with its own performance in the past.

Comparison of one firm with another firm in the industry.

Comparison of one firm with the industry as a whole.

Comparison of an achieved performance with predetermined standards.

Comparison of one department of a concern with another department.

NATURE OF RATIO ANALYSIS:

Ratio analysis is a powerful tool of financial analysis. A ratio is defined as “the

relationship between two or more things”. In financial analysis is a ratio is used as a benchmark

for evaluating the financial position and performance of a firm. The relationship between two

accounting figures expressed mathematically is known as a financial ratio. Ratio helps to

summarize large quantities of financial date and to make quantitative judgement about the firm

financial performance.

ADVANTAGES OF RATIO ANALYSIS:

Ratio analysis simplifies the understanding of financial statement.

Ratio analysis out the inter relationship among various financial figures and Bring to light

their financial significance. Ratio analysis is a device to analyse and interpret the

financial health of the enterprise.

Ratios contribute significantly towards effective planning and forecasting. A study of a

trend in the past works as a helpful guide for future.

Ratio facilitate inter firms and intra firm comparison there by bringing out the strengths

weakness efficiency of the firm and their departments.

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Ratio serves as effective control tools. They also facilitate establishment of a standard

costing system and budgetary control.

Ratios cater to the particular information person, depending upon his interest in the

business for which ratios are to be calculated. A creditor may be interested in liquidity

ratios while an investor may want to study profitability ratios.

GUIDELINES OR PRECAUTIONS FOR USE OF RATIOS:

The calculation of ratios may not be difficult task but their use is not easy. Following

guidelines or factors may be kept in mind while interpreting various ratios:

Accuracy of financial statements

Objective on purpose of analysis

Selection of ratios

Use of standards

Calibre of analyst

SIGNIFICANCE OF RATIO ANALYSIS:

The ratio analysis is one of the most powerful tools of financial analysis. It is used as a

device to analyse and interpret he financial health of enterprise. The use of Ratios is not confined

to financial managers only. The supplier of goods on credit, banks, financial institution, investors

and management all make use of ratio analysis as a tool in evaluating the financial position and

performance of a firm for granting credit, providing loans or making investments in the firm. The

following are some of the uses.

Managerial uses which include decision making financial forecasting coordination etc

Utility to shareholders/investors

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Utility to creditors

Utility to employees

TYPES OF RATIOS:

Various parties are interested in financial analysis to know the various features regarding the

firm like the short term creditors are interested to know the liquidity position or short term

solvency of the firm, the long term creditors are interested to know the long term solvency and

profitability of the firm. Similarly owners concentrate on the firm’s profitability and financial

condition. As well as, the management is interested in evaluating every aspect of the firm’s

performance. The management has to protect the interested of all parties and see that the firm

grows profitably. To fulfill the needs of all the parties the ratios are classified into three

categories. They are as follows:

a. Liquidity Ratios

b. Activity Ratios

c. Profitability Ratios

Liquidity ratios measure the firm ability to meet its current obligations. We analyse the

liquidity needs by the preparation of cash budgets cash and funds flow statements, but we can

conclude liquidity ratios, by establishing a relationship between cash and other current assets to

current obligations, provide a quick measure of liquidity. A firm should ensure that it does not

suffer from the lack of liquidity and that it does not have excess liquidity. There should be a

proper balance between high liquidity and lack of liquidity. To measure the liquidity of a firm,

the following ratios are calculated.

1. Current Ratio

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2. Liquidity Ratio

3. Quick Ratio

1. CURRENT RATIO

It may be defined as the relationship between current assets and current liabilities. This ratio is

known as working capital ratio. It is a measure of general liquidity and it is most widely used to

make analysis of a short -term financial position or liquidity of a firm. It is calculated by dividing

the total of current assets by total of current liabilities Thus,

Current Assets

Current Ratio=______________

Current Liabilities

A current ratio 2:1 is considered as ideal. If current ratio is less than 2, it indicates that

his business does not enjoy adequate liquidity. However a high current ratio of more than 3

indicates that the firm is having funds and has not invested them properly.

TABLE –VI.1

TABLE SHOWING THE CURRENT RATIO

Year Current Assets Current

Liabilities

Ratio

2005-2006 35,02,86,679.22 8,26,34,236.17 4.28

2006-2007 31,24,58,134.00 7,51,48,911.68 4.16

2007-2008 32,26,52,452.60 8,28,24,151.44 3.89

2008-2009 27,70,65,889.01 10,05,34,690.27 2.75

2009-2010 41,18,33,645.52 16,66,03,075.80 2.47

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CHART-VI.1 SHOWING

GRAPHICAL REPRESENTATION OF CURRENT RATIO

INTERPRETATION:

As a conventional rule, a ratio of 2 to 1 more is considered satisfactory. It represents a

margin of safety of creditors. The higher the ratio, the greater the safety. However, an arbitrary

standard 2:1 should not be blindly followed. This is so because the current ratio is a test

of quantity not quality. If firm’s current asset consists of doubtful and slow paying debtors and

obsolete stock, then its short-term solvency is threatened. Sangam Dairy is maintaining good

standards of current ratio. But the firm has to pay attention that the ratio should go beyond the

norms. But we compare the year 2008-09 ratio with year 2007-08 then it is not satisfactory.

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2. QUICK RATIO

The Quick or Acid test ratio is a more measure of the firm’s liquidity. These ratios establish

relationship quick or liquid assets and current liabilities. An asset is liquid if it can convert into

cash immediately or reasonable soon without loss of value. Cash is the most liquid asset. The

other assets, which are considered relatively liquid and included quick assets, are book debts and

marketable securities. Stock or inventory and prepared expenses are considered to be less liquid.

Quick Ratio= Quick Assets / Current Liabilities

TABLE-VI.2

TABLE SHOWING QUICK RATIO

Year Quick Assets Current Liabilities Ratio

2005-2006 11,67,92,238.00 8,26,34,236.17 1.41

2006-2007 9,01,65,185.21 7,51,48,911.68 1.19

2007-2008 8,00,40,932.40 8,28,24,151.44 0.96

2008-2009 6,57,99,949.41 10,05,34,690.27 0.65

209-2010 25,43,26,121.11 16,66,03,075.80 1.52

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CHART VI.2 DEPICTING

GRAPHICAL REPRESENTATION OF QUICK RATIO

INTERPRETATION:

Generally a quick ratio of 1:1 is considered to represent a satisfactory for current financial

condition. Though quick ratio is more penetrating test of liquidity than the current ratio, yet it

should be used cautiously. A quick ratio of 1:1 or more does not necessarily should liquid

position. The quick ratio for Sangam Dairy during past 3 years is nearly equal to the required

norm. So we can say the firm is maintaining good liquidity position. But in the year 2008-2009

the ratio is not satisfactory, because in that year the quick ratio was less than 1:1.

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3. ABSOLUTE LIQUID RATIO

This ratio is to judge the immediate ability of the company to pay off its current liabilities. It

obtained by subtracting both the debtors and inventory from current assets. A ratio of 0.5:1 is

usually considered good.

Absolute Liquid Ratio = Cash + Bank Balances / Current Liabilities

TABLE- VI.3

TABLE SHOWING ABSOLUTE LIQUID RATIO

Year Cash + Bank Balances Current Liabilities Ratio

2005-2006 5,55,05,742 8,26,34,236.17 0.67

2006-2007 4,46,04,335.00 7,51,48,911.68 0.59

2007-2008 4,02,24,818.42 8,28,24,151.44 0.48

2008-2009 5,28,45,323.44 10,05,34,690.27 0.52

2009-2010 10,03,97,691.96 16,66,03,075.80 0.60

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CHART VI.3 DEPICTING

GRAPHICAL REPRESENTATION OF ABSOLUTE LIQUID RATIO

INTERPRETATION:

Generally accepted norms of the absolute liquid assets are 0.5 to 1. It is a measure to know the

company’s ability to meet its immediate payments. By observing the above calculation, we can

say that cash balances of Sangam Dairy are adequate to meet the immediate obligations. But in

the year 2007-08 the absolute liquid ratio was less than 0.5 and so it is dissatisfactory. But from

the year 2008-2009 the absolute liquid ratio is a little bit better year after year than 2008 and so it

is in a bit satisfactory position.

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4. INVENTORY TURNOVER RATIO

This ratio indicates the number of times inventory or stock is replaced during the year. It

measures relationship between cost of goods sold and inventory level. It helps the management

to know whether the stock of finished goods held sales are reasonable or unreasonable as

compared with predetermined standard. Again it helps to determine even the liquidity of a

concern as it indicates the rate at which the inventory or stock is converted into sales and then

into cash.

Inventory Turnover Ratio = Cost of Goods Sold / Average Stock

Cost of Goods Sold = Sales – Gross Profit

Average Stock = Opening Stock + Closing Stock / 2

TABLE-VI.4

TABLE SHOWING INVENTORY TURNOVER RATIO

Year Cost of Goods Sold Average Stock Ratio

2005-2006 83,47,00,042.00 7,13,58,574.00 11.69

2006-2007 99,13,50,689.00 22,78,90,695.00 4.35

2007-2008 99,13,50,689.00 23,24,52,235.00 4.26

2008-2009 1,03,08,69,042.00 22,69,38,730.00 4.54

2009-2010 1,49,38,95,255.43 18,43,36,732.01 8.1

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CHART VI.4 DEPICTING

INVENTORY TURNOVER RATIO

INTERPRETATION:

Inventory turnover ratio indicates the efficiency of the firm in producing and selling its

production. It shows how rapidly the inventory is turning into receivable through sales.

Generally a high ratio is indicative of good inventory management. A low inventory ratio

implies excessive inventory level than warranted by production and sales activities.

The inventory ratio of Sangam Dairy gradually increased year by year. This causes to

claim that the inventory turnover ratio of Sangam Dairy is good.

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5. DEBTORS TURNOVER RATIO

It shows the relationship between sales and debtors of the firm. It also measures the

liquidity of the firm. This ratio indicates the rate at which debtors are collected influences the

liquidity of the concern. In other words this is the ratio, which indicates the average time taken

by the firm to collect debts. It is the ratio, which indicates the average collection period or the

average period of credit allowed to debtor. If the actual period of credit or the ideal period of

credit like 30 days the indication is that credit is not efficient.

TABLE-VI.5

TABLE SHOWING DEBTORS TURNOVER RATIO

Year Credit Sales Average Debtors Ratio

2005-2006 97,54,17,837.30 3,69,90,174.76 26.36

2006-2007 1,13,15,91,543.57 2,10,66,544.16 53.71

2007-2008 1,29,87,20,532.07 1,48,75,506.00 87.30

2008-2009 1,49,84,28,634.71 1,29,54,626.00 115.66

2009-2010 1,83,50,72,539.42 2,01,03,945.10 91.27

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CHART VI.5

CHART SHOWING DEBTORS TURNOVER RATIO

INTERPRETATION:

Debtors turnover ratio indicates the number of times debtors turnover each year. Generally

higher the value of debtor’s turnover, the more efficient is the management of credit.

The debtor’s turnover ratio of Sangam Dairy is gradually increasing over past 4 years, which is a

good indication about its credit receivables management. However in the 2009-2010, the ratio

decreased when compared with that of the previous year.

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6. CREDITORS TURNOVER RATIO

Creditor’s turnover ratio shows the relationship between credit purchases and creditors

including accounts payable. This ratio indicates the average period of credit received from

creditors further a comparison of this ratio with debt collection period ratio will indicate the time

lag between the two period of credit and the time lag between two credit periods will indicate the

duration for which working capital is required to be arranged.

Creditors Turnover Ratio = Credit Purchases / Sundry Creditors

TABLE-VI.6

TABLE SHOWING CREDITORS TURNOVER RATIO

Year Purchases Sundry Creditors Ratio

2005-2006 78,60,47,054.75 57,54,717.85 136.59

2006-2007 89,29,09,620.38 12,18,314.05 732.90

2007-2008 1,05,11,87,343.09 36,33,180.37 289.32

2008-2009 1,16,36,26,676.52 81,81,030.33 142.23

2009-2010 1,44,01,36,840.20 2,21,53,274.59 65.00

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CHART-VI.6

CHART SHOWING CREDITORS TURNOVER RATIO

INTERPRETATION

It is also similar to debtor’s turnover ratio. It indicates the speed with which the

payments for credit purchases are made to the creditors. Generally a low rate is preferable,

because Dairy has to get more credit period to its purchases.

But in this case of 2006-2007 the creditor’s turnover ratio seems to be very high. It

seems that the dairy cash purchases are more than credit purchases in that year. But in the year

2007-2008 the ratio is decreased to 289.33 and it is still decreased in the year 2009 to 142.23 and

it is still decreased in the year 2010 to 65.

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7. FIXED ASSETS TURNOVER RATIO

This ratio is calculated by dividing sales with fixed assets. Fixed assets, here means net fixed

assets, i.e. fixed assets less depreciation. This ratio indicates as to what extent the fixed assets of

a concern have contributed to sales. A fixed assets turnover ratio is 5 times or more indicates

better utilization of fixed assets. It may be note that a very high fixed assets turnover ratio means

under trading, which is not good for business.

Fixed Assets Turnover Ratio = Net Sales / Net Fixed Assets

TABLE-VI.7

TABLE SHOWING FIXED ASSETS TURNOVER RATIO

Year Net Sales Net Fixed Assets Ratio

2005-2006 97,54,17,837.30 23,36,69,462.60 4.17

2006-2007 1,13,15,91,543.57 23,96,67,380.20 4.72

2007-2008 1,29,87,20,532.07 24,47,07,190.80 5.30

2008-2009 1,49,84,28,634.71 24,62,16,886.50 6.08

2009-2010 1,83,50,72,539.42 25,67,21,363.64 7.14

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CHART-VI.7

CHART SHOWING FIXED ASSETS TURNOVER RATIO

INTERPRETATION:

The firm may wish to know its efficiency of utilizing fixed assets in generating sales. Higher the

ratio better utilization of assets and vice-versa. By observing the above data we can interpret that

for generating a sale of rupee, the Sangam Dairy needs nearly Rs. 0.20 to Rs. 0.25 investment in

fixed assets. In the year 2008-09 ratio is increased to 6.08 compared with the year 2007-08.

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8. TOTAL ASSETS TURNOVER RATIO

This ratio indicates the efficiency or inefficiency in the use of total resources of assets of a

concern. The standard ratio is that the sales should be at least true value of the assets. A total

assets turnover ratio of 2 times or more indicates that the assets of a concern have been utilized

effectively. This ratio is a good index of the utilization of the owner’s funds. It also indicates

whether there is over trading or under trading. Again it indicates whether there is over

capitalization or undercapitalization. If the volume of sales in relation to net worth is reasonable,

the indication is that owners’ funds have been effectively utilized.

Total Assets Turnover Ratio = Net Sales / Total Assets

TABLE-VI.8

TABLE SHOWING TOTAL ASSETS TURNOVER RATIO

Year Net Sales Total Assets Ratio

2005-2006 97,54,17,837.30 59,62,48,465.40 1.63

2006-2007 1,12,15,91,543.57 56,13,43,254.40 2.01

2007-2008 1,29,87,20,532.07 57,59,66,512.79 2.25

2008-2009 1,49,84,28,634.71 55,44,80,118.14 2.70

2009-2010 1,83,50,72,539.42 67,64,04,393.40 2.71

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CHART-VI.8

CHART SHOWING TOTAL SSSETS TURNOVER RATIO

INTERPRETATION:

The total turnover ratio of Sangam Dairy is increasing. This implies that growth of the Dairy

is sufficient. The Dairy succeeded to convert its total assets into sales efficiently and effectively.

The ratio is increasing year by year, so it is advisable to keep up the position.

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9. GROSS PROFIT RATIO

It is the ratio which expresses the relationship between gross profit and sales. The actual

gross profit ratio is compared with the gross profit of the previous year and those are concern

carrying on similar business. If it is high then it is an indication good results and vice versa. This

ratio indicates the gross results of trading or the overall margin within a business undertaking

most limit its operation expenses to earn sufficient profit.

Gross Profit Ratio = Gross Profit / Sales X 100

TABLE-VI.9

TABLE SHOWING GROSS PROFIT RATIO

Year Gross Profit Net Sales Ratio

2005-2006 14,07,17,795.00 97,54,17,837.30 1.63

2006-2007 17,42,12,457.39 1,13,15,91,543.57 2.01

2007-2008 23,63,33,910.51 1,29,87,20,532.07 2.25

2008-2009 26,24,10,612.51 1,49,84,28,634.71 2.70

2009-2010 27,99,16,027.39 1,83,50,72,539.42 2.71

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FIGURE-VI.9

CHART SHOWING GROSS PROFIT RATIO

INTERPRETATION:

The gross profit margin reflects the efficiency with which management produces each

unit of product. This ratio indicates the average between the cost of goods and the sales revenue.

The gross profit ratio of Sangam Dairy is increasing year by year. But in the year

2009-2010 it is slightly decreased, which is cautious indication.

0

0.5

1

1.5

2

2.5

3

2005-2006 2006-2007 2007-2008 2008-2009 2009-2010

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10. NET PROFIT RATIO

It is calculated by dividing net profit to sales. This ratio provides good insight into the

overall efficiency to the business and better utilization of the total resources. This ratio indicates

the quantum of profit earned by a concern. A low net profit ratio indicates that the profitability of

the concern is good. A low net profit ratio indicates that the profitability of the concern is good.

A low net profit ratio indicates that the profitability of the enterprise is poor.

Net Profit Ratio = Net Profit / Net Sales

TABLE-VI.10

TABLE SHOWING NET PROFIT RATIO

Year Total Assets Net Sales Ratio

2005-2006 4,38,639.92 97,54,17,837.30 0.044

2006-2007 5,10,622.58 1,12,15,91,543.57 0.045

2007-2008 7,64,527.28 1,29,87,20,532.07 0.058

2008-2009 5,32,318.25 1,49,84,28,634.71 0.035

2009-2010 91,57,394.49 1,83,50,72,539.42 0.499

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CHART-VI.10

FIGURE SHOWING NET PROFIT RATIO

INTERPRETATION:

Net profit margin establishes a relationship between net profit and sales. It is over all

measure of firms’ ability to turn each rupee sales into net profit. This ratio also indicates the

firms’ capacity to withstand adverse economic conditions. It would really be difficult for a low

net margin firm to withstand these adversities.

The net profit of the Dairy is lowering when compared with its gross profit results. It

shows that administrative and other expenses of Sangam Dairy, has to be controlled.

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11. RETURN ON EQUITY RATIO

This ratio is computed by dividing profit after tax divided by net worth. It measures the

productivity of shareholders funds. A higher ratio shows the better utilization of owner’s funds

and higher productivity.

This ratio indicates the productivity of shareholder’s fund.

It also gives the shareholders and idea of the return of their funds.

It is also useful for inter-firm and inter-industry comparison.

Return on Equity Ratio = Profit after Tax / Net Worth

TABLE-VI.11

TABLE SHOWING RETURN ON EQUITY RATIO

Year Profit After Tax Net Worth Ratio

2005-2006 4,38,639.92 7,13,58,574.00 0.006

2006-2007 5,10,622.58 9,60,53,867.00 0.531

2007-2008 7,64,257.28 9,68,03,125.41 0.79

2008-2009 5,32,315.25 9,63,24,781.82 0.015

2009-2010 91,57,394.49 34,30,48,679.25 0.026

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CHART-VI.11

CHART SHOWING RETURN ON EQUITY RATIO

INTERPRETATION:

Return on equity indicates how well the firm has used the resources of owners. In fact,

this ratio is one of the most important relationships in financial analysis. This ratio reflects the

extent to which the main objective i.e., earnings of satisfactory return to owners has been

accomplished. The return on equity of Sangam Dairy is low due to low net profit margin.

Assessment of management responsible to produce fair return to their owners should be made.

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12. RETURN ON CAPITAL EMPLOYED RATIO

This ratio is calculated by dividing the net profit with total capital employed in the firm. Net

profit means after tax but with interest. Capital employed is founded by subtracting intangible

assets from total investments. This ratio is dependable measure of overall performance of a

corporation.

Return on Capital Employed Ratio = Net Profit + Interests / Capital Employed X 100

TABLE-VI.12

TABLE SHOWING RETURN ON CAPITAL EMPLOYED RATIO

Year Net Profit + Interest Capital Employed Ratio

2005-2006 4,38,639.00 51,06,77,090.00 2013

2006-2007 5,10,623.00 48,36,72,711.00 1.49

2007-2008 7,64,257.00 49,06,11,515.20 1.47

2008-2009 5,32,315.25 44,58,21,977.59 1.94

2009-2010 91,57,394.49 50,72,75,267.74 0.02

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CHART-VI.12

CHART SHOWING RETURN ON CAPITAL EMPLOYED RATIO

INTERPRETATION:

The return on capital invested is a concept that measures the profit, which a firm earns on

investing a unit of capital. It is also known as return on capital employed which would show

whether the company’s policy was economically wise and whether the capital had need

employed fruitfully. Sangam Dairy is getting 2% return on average over past 3 years on its

investment. But in the year 2006 & 2007 the ratio is less than 2% but in the year 2007-08 it is

recovered.

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FINDINGS AND SUGGESTIONS

FINDINGS:

The ideal current ratio is 2:1. Sangam Dairy is consistently maintaining good ratio for the

last 5 years even though it is declining. It represents the margin of safety of creditors.

The ideal quick ratio is 1:1. Sangam Dairy is maintaining good ratio for the last 3 years.

But there is a sudden decline in this ratio for the last 2 years because of less quick assets

compared to current liabilities.

The ideal Absolute liquid ratio is 0.5:1. Though there is a slight decline of absolute liquid

ratio in 2006-07, in the year 2008-09 it increased which causes to claim that absolute

liquid ratio of Sangam Dairy is good.

Though there is a slight decrease of inventory turnover ratio in the year 2006-07, it

increased in the year 2007-08 which causes to state that the inventory turnover ratio of

Sangam Dairy is also good.

Debtors’ turnover ratio is increasing year by year which shows the credit management

efficiency of Sangam Dairy.

If the fixed turnover ratio is 5 times or more, it implies that the firm is using the assets

properly. Sangam Dairy is utilizing assets in good manner.

The total assets turnover ratio of Sangam Dairy is steadily increasing, which indicates

that it is utilizing owners’ assets properly.

Gross profit turnover ratio of Sangam Dairy is steadily increasing, which is a good

indication to the dairy.

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The net profit of Sangam Dairy is fluctuating which indicates the Dairy has to cautiously

exercise its expenses.

Return on equity of Sangam Dairy is declining. This indicates that shareholders funds are

not being properly utilized and profit after the tax is low.

Selling & Distribution expenses ratio of Sangam Dairy is increasing due to increase in

sales.

The return on capital employed of Sangam Dairy is declining, but in the year2008-09 this

is increased by 2%.

SUGGESTIONS:

The current ratio of the firm is good but Sangam Dairy management should take

immediate steps so that there should not be further decrease in the ratio.

For the last two years the quick ratio of Sangam Dairy is declining so it is better to

maintain more quick assets.

Absolute liquid ratio of the Sangam Dairy is good; this position has to be maintained in

future also.

The inventory turnover ratio levels are also good which confirms that Sangam Dairy is

efficiently using the inventory for production purpose.

The gross profit position of Sangam Dairy is good, whereas its net profit ratio is

fluctuating because of operating expenses so it is better to manage judiciously.

The selling and distribution expenses are increasing so necessary measures should be

undertaken with proper care to reduce those expenses.

Even though there is an increase in Return on Capital in 2007-08 it is decreasing which

shows that returns on the capital employed is not up to the mark which needs proper care.