ratio analysis
TRANSCRIPT
RATIO ANALYSIS
1. INTRODUCTION & MEANING: -
Profit & loss A/c & balance sheet are 2 basis parameters to judge the financial health of a company. By looking to these statements one can know gross profit, net profit, current asset, current liabilities etc. However making decision based on absolute figure without relating them to some other figure becomes meaning less.Meaning: - Ratio analysis is a technique by which various figures in the profit & loss a/c in b/s are related to each other to give a meaningful conclusion got interpreting & deciding the line of action for decision making & control.
2. Importance/Advantages of Ratio Analysis can be highlighted on following points.
It revels inter-relationship that may exist among different items in financial statement.
It is a powerful tool majoring, liquidity, Solvency, profitability & efficiency of business.
Ratio analysis is useful to management of company, investors, creditors, government, banks & other outside parties.
Ratio analysis is useful to reduce expenditure & increased rate of profit.
It is useful for planning & formulating future policies. It is useful for control purposes. Standard ratios are compared with actual ratios & if there is
difference correct actions are taken. Analysis reflects utilization of asset employed in business. It is useful to locate trouble areas of business. It is useful for compression between different units of same firm or
between two firms.
3. Limitations of Ratio Analysis It communicates only a relative picture. Every organization in one
way or other is unique and comparison may not be valid. Ratios are only a tool. Their ultimate use depends upon
management who use it. They only pass guiding signals. Sometimes attempts are made to window dress the accounts, i.e.
efforts are made to manipulate the accounts in a manner, that the picture being better than what actually it is.
Inflation distorts financial ratio analysis. Changes in the reported performance of a company may be entirely due to inflation and not due to management.
Following Parties are interested in Ratio analysis.
PartyInterested in which Ratio
I) Shareholder
1. Return on Capital employed. 2. Rate of dividend.3. Long term solvency. 4. Earning per share.
II) Creditors
1. Current ratio.2. Liquidity ratio. 3. Debts equity ratio.
III) Government
1. G.P. ratio.2. N.P. ratio.3. Capacity utilisation.
IV) Management
1. All turn over ratio.
A. Liquidity Ratios
Means ability of company to make cash available as & when required. The liquidity ratios study the firm’s short term solvency and ability to pay off the liabilities. Consequently, these ratios focus on current assets and current liabilities. Some of the common liquidity ratios areCurrent RatioQuick Ratio/Acid Test RatioAbsolute Quick ratio
B. The Activity/ Turnover/ Performance RatiosThese ratios measure the effectiveness with which the firm uses its resources. It shows how efficiently and effectively the assets of the firm being utilized. Some of the important activity ratios are as followsWorking Capital Turnover RatioInventory/Stock Turnover RatioDebtors Turnover RatioCreditors Turnover RatioFixed Assets Turnover RatioCapital Turnover Ratio
A. Leverage/Solvency Ratios The term leverage in general refers to a relationship between two interrelated variables. In financial analysis it represents the influence of one financial variable over some other related variable. It is an ability of the firm to use fixed costs to magnify the returns to the shareholders.Debt-Equity RatioInterest Coverage RatioFixed Charge Coverage RatioTotal debt ratio/ Debt-Asset RatioFixed Assets Ratio
D. Profitability RatiosProfits are the ultimate test of the management. It can be measured by variety of ways. Profitability ratios communicate the profitability of events that have already taken place. Important profitability ratios are as followsGP RatioNP RatioOperating Profit RatioOperating RatioReturn on AssetReturn on Capital EmployedReturn on EquityProprietary Ratio E. Valuation Ratios/Miscellaneous Group Earning Per ShareDividend Payout RatioPrice Earning RatioCapital gearing Ratio
SR RATIO DETAILS PURPOSE1 Current Ratio
Current AssetsCurrent Liabilities
Current assets = S. Debtors. + Cash or Bank + Bills receivable + Prepaid Expenses + Closing Stock +Advances + Marketable security
Current Liabilities = S Creditors + Bills payable + Outstanding expenses + Bank Overdraft
The ratio tells us about the about the capabilities of a company to discharge its short term liabilities. Ideally the ratio should be 2:1 i.e. current asset should be double that of current liability. CR of 1.33:1 is considered by banks as the minimum acceptable level for providing working capital finance.
2 Liquid /Acid Liquid Assets = CA – This ratio indicates
Test / Ratio Quick /Liquid Assets Current Liabilities
Quick RatioQuick /Liquid Assets Quick liabilities
Stock – Prepaid exp. Quick Liabilities = CL – Bank o/d If bank overdraft is usually availed by the firm on more or less regular basis, and is not payable in real sense, is therefore, deducted from the amount of total current liabilities.
immediate liquidity of company; ideally this ratio should be 1:1 that means immediate & quick liabilities can be repaid by collecting money from sundry Drs. & cash available with company. If ratio goes below one it indicate that liquidity of company is disturbed.
3 Absolute Liquid Ratio =
Cash + Mkt. Securities Quick Liabilities
This ratio is also called as Super Quick / Cash/ cash reservoir Ratio.Mkt. Investment means short term investments.
This ratio indicates abilities of company to fulfill its immediate commitments on time.Ideal ratio 1:2.
4 Gross Profit RatioGP X 100Sales
GP = Sales – cost of goods soldSales = Cash and Credit Sales – sales returns
Indicate efficiency of
production
department.
5 Net Profit RatioNP X 100Sales
Sales = Cash and Credit Sales – sales returns
This ratio shows
overall efficiency of
business
6 Working Capital Turnover RatioNet SalesWorking Capital
Net Sales = Sales – Sales returnsWorking Capital = Current Assets – Current Liabilities
Ratio indicates efficiency of working capital management of the company. Higher the ratio better is the efficiency better is the utilization of working capital.
SR.NO
RATIO DETAILS PURPOSE
7 Inventory / Stock Turnover RatioCost of Goods SoldAverage InventoryORCost of Goods SoldClosing Inventory
Cost of goods sold = Sales – Gross ProfitAverage Inventory = Opening Stock + Closing stock 2
This ratio indicates the efficiency of inventory management when inventory turnover ratio is goes down management has to review its inventory policies & inventory stock levels.
8 Debtors Turnover RatioNet Credit SalesAvg. Accounts Receivable
Net Credit Sales = Credit Sale – Sales return Accounts receivable = Bills Receivable + DebtorsAvg. Accounts receivable = Op. Receivable + Cl. Receivable / 2
This ratio indicates efficiency of recovery department.
Debt Collection Period12 monthsDTROR365 daysDTR
This ratio indicate collection period in moths or days.
9 Creditors Turnover RatioNet Credit PurchaseAvg. Accounts Payable
Net Credit Purchase = Credit Purchase – Purchase return Accounts payable = Bills Payable + CreditorsAvg. Accounts payable = Op. payable+ Cl. payable / 2
This ratio indicates credit given by suppliers.
Debt Payment Period12 months
This ratio indicate payment period in moths or days.
CTROR365 daysCTR
10 Fixed Assets Turnover RatioNet SalesFixed AssetsORCOGS / Fixed Assets
Net Sales = Sales – Sales returnsFixed assets after depreciation
This ratio indicate how efficiently fixed assets have been utilized in the business. Every company will try to maximise this ratio.
SR.NO
RATIO DETAILS PURPOSE
11 Capital Turnover RatioNet SalesCapital Employed
Capital Employed= share Capital + Reserve & Surplus + Long term Loans +Debentures - Fictitious assets ORFixed Assets + Working Capital
This ratio indicates the efficiency of the organization with which capital employed is being utilized to generate revenue.
12 Debt- Equity RatioDebtNet Worth/Equity/Shareholder Fund/Proprietors Fund
Debts = Debentures + Long term loans payable after yearEquity = Capital employed – Long term Loans ORShareholders Funds + Reserves & surplus – Fictitious assets
Debt equity ration of 2:1 is the norms accepted by financial institution for financing the projects. It indicates the cushion available to the creditors on liquidation of the organisation. High debt equity ratio is maintained to maximize returns given to shareholders.
13 Proprietary RatioShareholders FundTotal Tangible Assets
Shareholders Funds = Capital employed – Long term LoansTotal Assets = Fixed assets + Current assets – Fictitious assets – Intangible assets
It expresses the relationship between shareholders funds to total assets.
14 Fixed Assets Ratio or Fixed assets to long term ratioFixed Assets
Long Term Funds
This ratio indicates whether the firm has raised adequate long-term funds to meet its fixed assets requirement. This ratio should not be more than one.
15 Interest Coverage RatioPBDITInterest Charges
PBIT = Profit before depreciation, interest and taxInterest = Interest on long term loans only.
This ratio indicates funds available to pay interest. An interest cover of more than 7 times is regarded as safe & more than 3 is desirable.
16 Fixed Charge Coverage Ratio PBIT
Interest Charges + Preference Dividend
17
SR
Operating ratio
COGS +Operating
Expenses X 100
Sales
RATIO
COGS = Sales – GPOperating Expenses = Administrative Expenses + Sales & Distribution Expenses + Depreciation
DETAILS
This ratio helps to establish relationship between sales and Operating Cost.
PURPOSE
19 Return on Capital Employed / Return on
Capital Employed= share Capital + Reserve & Surplus + Long term Loans +Debentures - Fictitious assets
ROCE measures profitability of the capital employed in the business.
InvestmentsPBIT X 100 Capital Employed
20 Return Shareholder FundsPAT X
100
Total Shareholders’ fundsORReturn on EquityPAT X
100
Total Shareholders’ funds – Pref. Share Capital
Shareholders funds = Equity capital +Pref. Capital + Reserves & surplus – Fictitious assets
This ratio indicates the profitability of a firm in relation to the funds supplied by the shareholders or owners.
21 Capital gearing ratioFixed Income Bearing Securities
Equity Capital
Fixed income bearing Security = Preference share capital and DebenturesEquity Capital = Equity Share Capital + reserve & Surplus
A high gearing ratio indicate that in the capital structure; fixed income bearing securities are more in comparison to the equity share capital and in that case company is said to be highly geared and vice versa.
22 Earning Per SharePAT - Preference
Dividend
No. of Equity Shares
No of equity share=Paid up capitalFace value per share
This ratio is used to measure profit available to shareholder. Higher EPS indicate increasing trend of profit.
23 Price Earning RatioMarket Price Per
This ratio indicates the expectations of the equity
Share
Earning Per Share
investors about the earnings of the firm. The investor’s expectations are reflected in the market price of the share. The ratio indicates how much an investor is prepared to pay per rupee of earnings.
24
SR
Dividend Payout RatioDividend Per Share X 100Earning Per Share
RATIO
DETAILS
This ratio explains relationship between earnings belonging to shareholder and amount finally paid to them in the form of Dividend.
PURPOSE25 Total Debt Ratio
(Debt-Asset Ratio)Total DebtsTotal Assets
Total debts = Long Term Debts + Current LiabilitiesTotal Assets = Fixed Asset + Current Assets
The Total debt ratio depicts the proportion of total assets financed by the shareholders.
26 Operating Profit RatioOperating profit X 100Net Sales
Operating Profit = Gross profit – operating expenses
Operating profit indicates pure profit generated by the operation of the firm hence it is calculated on the basis of EBIT.
27 Total Assets turnover ratioNet Sales Total Assets
Total assets = Fixed assets + Current assets
Share capital + Loans + Current liabilities = Fixed assets + Current assets
Shareholder’s funds + Borrowed capital = Fixed assets + Working capital
STEPS INVOLVED IN THE FINANCIAL STATEMENT ANALYSIS
The analysis of the financial statements requires:
(1) Methodical classification of the data given in the financial
statements.
Methodical classification. In order to have a meaningful
analysis it is necessary that figures should be arranged properly.
Usually instead of the two-column (T form statements as ordinarily
prepared, the statements are prepared in single (vertical) column
form "which should throw up significant figures by adding or
subtracting." This also facilitates showing the figures of a number of
firms or number of years side by side for comparison purposes.
OPERATING (INCOME) STATEMENT
For the year ending
Particulars Rs. Rs.
Gross Sales ......
..
........
Les
s:
Sales Returns
Sales Tax/Excise ......
..
........
Net Sales (or sales) for the year (1) ........
Les
s:
Cost of Goods sold : (2) ........
Raw Materials consumed
(Op. stock of R.M + Purchase of
R.M. + Expenses on Purchases –
Cl. Stock R.M)
......
..
Direct Wages ......
..
Manufacturing Expenses ......
..
........
Add
:
Opening Stock of Finished Goods ........
Les
s:
Closing Stock of Finished Goods
= Gross Profit (1) - (2) =
(3)
........
Les
s:
Operating Expenses : (4) ____ ____
Administration Expenses ......
..
Selling and Distribution Expenses
Depreciation
......
..
........
= Net Operating Profit (OPBIT) (3) - (4) =
(5)
____
Add
:
Non-trading Income ........
(Such as dividends, interest
received, etc.)
........
Les
s:
Non-trading Expenses (such as
discount on issue of shares written
off)
......
..
........
= Income or Earning before Interest
and Tax (EBIT)
(6) ........
Les
s:
Interest on Loans and Debentures (7) ........
= Income or Profit Before Tax (PBT) (6) – (7) =
(8)
........
Les
s
Provision for Tax (9) ........
= Profit after Tax (8) – (9) =
(10)
........
Les
s
Preference Dividend (11) ........
= Profit Available to Shareholders (10) – (11)
= (12)
........
Les
s
Equity Dividend (13) ........
= Retained Earnings (12) – (13)
= (14)
........
BALANCE SHEET AS ON -------
PARTICULARS RS RS
Add
Less
=
Add
=
Less
=
ADD
Preference Share CapitalEquity Share Capital
Total Share Capital (1)Capital reserveGeneral reserveShare PremiumCapital Redemption ReserveProfit & Loss A/c
Preliminary ExpensesAccumulated Losses
Shareholders fund / Proprietors Funds / Net Worth (2)Long Term FundsDebentures
Capital Employed (3)Represented ByFixed AssetsLand & BuildingPlant & MachineryFurniture & FixturesGross Block
Depreciation
Net Fixed Assets (4)
Current Assets (5)Cash & BankDebtorsBills Receivables
………. ……….
………. ………. ………. ………. ………._________ ………. ………._________
………. ……….
………. ………. ………. ……….
……….
……….
……….
……….
………._______
_______
……….……….………._______ ……….
……….
……….
Less
=
=
Closing StockPre-paid Expenses etc
Current Liabilities (6)
Trade CreditorsBills PayableBank OverdraftOutstanding ExpensesProvision for Tax
Net Working Capital (7) = (5) – (6)
Total Assets (4) + (7)
……….
……….
………. ………. ………. ………. ………. ……….
……….
……….
PROBLEMS ON RATIO ANALYSIS
Illustration 1
XYZ Company’s financial statements contain the following
information:
Year 1 Year 2
Cash Rs. 2, 00,000 Rs. 1, 60,000
Sundry debtors 3, 20,000 4,
00,000
Temporary investments 2, 00,000 3,
20,000
Stock 18, 40,000 21, 60,000
Prepaid expenses 28,000 12,000
Total current assets 25, 88,000 30,
52,000
Total assets 40, 68,000 44,
12,000
Current liabilities 6, 40,000 8,
00,000
Loans 16, 00,000 16,
00,000
Capital 20, 00,000 20,
00,000
Retained earning 4, 68,000 8, 12,000
Statement of Profit for the current year
Sale Rs. 40, 00,000
Less cost of good sold 28, 00,000
Less interest 1, 60,000
Net profit 10, 40,000
Less taxes @ 50% 5, 20,000
Profit after taxes 5, 20,000
Profit distributed 2, 20,000
From the above, appraise the financial position of the company
from the points if view of: (i) Liquidity, (ii) Profitability, and (iii)
Activity.
Illustration 2
Certain items of the annual accounts of ABC Ltd. are missing as
shown below:
TRADING AND PROFIT & LOSS ACCOUNT for the year ended 31st
March, 2005
Particulars Amount Particulars Amount
To Opening stock
To Purchase
To Direct Expenses
To Gross Profit c/d
To Office and other
Expenses
To Interest on
Debentures
To Provision for Taxation
To Net Profit for the year
Rs.
3,50,000
___
87,500
_____
Rs.
2,13,421
30,000
By Sales
By Closing Stock
By Gross Profit
b/d
By Commission
_____
_____
_____
50,000
To Proposed Dividends
To Transfer to General
reserve
To Balance transferred
to BS
____
____
____
____
____
By Balance b/d
By Net Profit for
the year
70,000
_____
BALANCE SHEET
As on 31st March, 2005
Liabilities Amount Assets
Amount________
Paid up Capital 5, 00,000 Fixed Assets:
General Reserve: Plan and Machinery Rs. 7,
00,000
Balance at the beginning _______ Other Fixed Assets:
____
Of the year
Proposed Addition _______ Current Assets:
Profit and Loss A/c _______ Stock-in-trade
____
10% Debenture _______ Sundry Debtors ____
Current Liabilities _______ Bank Balance
62,500
Total Total
You are required to supply the missing figures with the help of the
following information:
i) Current ratio 2:1
ii) Closing Stock is 25% of sales.
iii) Proposed dividends are 40% of the Paid up capital.
iv) Gross Profit ratio is 60%
v) Ratio of Current liabilities to Debentures 2:1.
vi) Transfer to General reserve is equal to proposed dividends.
vii) Profit carried forward are 10% of the Proposed dividend.
viii) Provision for taxation is 50% of profit after tax.
ix) Balance to the credit of General reserve at the beginning of the
year is twice the mount transferred to that account from the
current profits.
Illustration 3 As on 31st March, 2003, the paid up capital of Navroj Ltd. was Rs. 1,
00, 00,000. The ratios as on that date were as under:
Current debt to Total debt 0.40
Total debt to Equity 0.60
Fixed assets to Equity 0.60
Total assets turnover (based on sales) 2 times
Inventory turnover (based on sales) 8 times
Draw the balance sheet of Navroj Ltd.
(C.S., Final, (NS), Dec. 2003)
Illustration 4 From the following details, prepare a Statement for Proprietary
Funds with as many details as possible.
a) Stock turnover 6
b) Capital turnover 2
c) Fixed assets turnover 4
d) Gross profit ratio 20%
e) Debtors turnover 2 Months
f) Creditors turnover 73 days
The Groff profit was Rs. 60,000; Reserves and Surplus amounted to
Rs. 20,000;
Closing stock was Rs. 5,000 in excess of Opening stock.
Illustration 5
The following are the Ratios extracted from the Balance Sheet
of a company as at 31st December, 2005. Draw up the Balance sheet of
the firm.
Current liabilities 1.0
Current Assets 2.5
Working Capital Rs. 3, 00,000
Liquidity Ratio 1.5
Stock Turnover Ratio 6
Gross Profit Ratio 20%
Debt Collection period 2 months
Shareholders' Capital Rs. 5, 00,000
Reserve and Surplus Rs. 2, 50,000
Fixed Asset Turnover (on cost of sales) 2
Illustration 6From the following information, prepare a summarized Balance Sheet
s at 31st March, 2002:
Working Capital Rs. 2, 40,000
Bank Overdraft Rs. 40,000
Fixed Assets to Proprietary ratio 0.75
Reserves and Surplus Rs. 1, 60,000
Current ratio 2.5
Liquid ratio 1.5
Illustration 7ABC Ltd has made plan for the next year. It estimated that the company will employ total assets of Rs 8, 00,000, 50% of the assets being financed by borrowed capital at an interest @ 16% p.a. The direct costs for the year estimated at Rs 4, 80,000 and all other operating expenses are estimated at Rs 80,000. The goods will be sold to customers at 150% of the direct costs. Income-tax is assumed to be 50%. You are required to calculate
1. Income statement of ABC Ltd
2. Net Profit Margin3. Assets Turnover4. Return on Assets5. return on owner’s equity
Illustration 8The following figures extracted from the book of XYX Ltd as on 30.09.2000Particulars RsNet Sales 24, 00,000(-)Operating Expenses 18, 00,000Gross Profit 6, 00,000(-)Non operating expenses 2, 40,000Net profit 3, 60,000
Current Assets 7, 60,000Inventories 8, 00,000Fixed Assets 14, 40,000Total Assets 30, 00,000
Net Worth 15, 00,000Debts 9, 00,000Current Liabilities 6, 00,000Total Liabilities 30, 00,000
Working Capital 9, 60,000Calculate
1. GP Ratio2. NP Ratio3. Return on Assets4. Inventory Turnover5. Working Capital Turnover6. Net worth to Debts
Illustration 9Using the following information prepare balance sheet.Sales 36lacsSales/Total assets 3Sales/Fixed assets 5Sales/Current assets 7.5Sales/Inventories 20Sales/Debtors 15Current ratio 2Total asset/Net worth 2.5Debt/Equity 1
Balance sheet
Liabilities Rs Assets RsNet worthLong term debtCurrent liabilities
Fixed AssetsInventoriesDebtorsLiquid assets
TOTAL TOTAL
Illustration 10Using the following data prepare balance sheet.Gross profit (20% of sales) Rs 60,000Shareholders equity Rs 50,000Credit sales to total sales 80%Total assets turnover 3 timesInventory turnover 8 timesACP (360days a year) 18 daysCurrent ratio 2 timesLong term debt to equity 40%
Illustration 11Using the following information prepare balance sheet.Long term debt to net worth 0.5 to 1Total assets turnover 2.5 timesAverage collection period ½ monthInventory turnover 9 timesGP ratio 10%Acid test ratio 1:1
Balance sheet of XYZ LtdLiabilities Rs Assets Rs
Equity share capitalRetained earningsLong term debtCreditors
100000100000
100000
Fixed AssetsInventoriesDebtorsCash
TOTAL TOTAL
Illustration 12The following is the balance sheet of Amit Ltd.
Balance sheet of AMIT LtdLiabilities Rs Assets Rs
Equity share capital of Rs 10 eachRetained earningsLong term debtCreditorsProfit & loss a/cOther current liabilities
5,00,000
3,50,00017,50,000
2,50,0005,50,0002,50,000
Fixed Assets 30,00,000Less: Depreciation 4,50,000InventoriesDebtorsCash
25,50,000
5,00,0004,00,0001,00,000
TOTAL 35,50,000 TOTAL 35,50,000
Additional information1) Profit during the year Rs 4,00,0002) The company has declared 25% dividend3) Market price of share is Rs 500
CalculateDebt equity ratio, Current ratio, Acid test ratio, EPS, P/E ratio, DPR, Dividend yield ratioIllustration 13The following is the balance sheet of Aditi Ltd.
Balance sheet of ADITI LtdLiabilities Rs Assets Rs
Equity share capital of Rs 100 eachRetained earningsCreditorsBills payableOther current liabilities
10,00,000
3,68,0001,04,0002,00,000
20,000
Plant & machineryLandInventoriesCashDebtors 4,00,000Less: RDD 40,000Prepaid insurance
6,40,00080,000
4,80,0001,60,000
3,60,00012,000
TOTAL 16,92,000 TOTAL 16,92,000
Income statement for the year ended 31st DecemberSales 40, 00,000Less: Cogs 30, 80,000Gross profit 9, 20,000Less: op. exp 6, 80,000Net profit before tax 2, 40,000Less; tax 50% 1, 20,000PAT 1, 20,000 Sundry debtors & stock at the beginning of the year were Rs 3, 00,000 & Rs 4,00,000 respectively.CalculateCR, LR, STR, DTR, GP, NP, Operating profit ratio, EPS, ROCE, Market value if P/E ratio is 10 times.
Illustration 14From the following information draw balance sheet of Ravi Ltd as on 31st march 2008.Current ratio 2:1Liquid ratio 1:1Return on capital employed 10%Fixed assets turnover ratio 5:8Closing stock was 12.5% of salesOwners equity to fixed assets 8:15Debtor’s turnover 1 monthDebt equity ratio 5:4
For the current year Ravi ltd made profit of Rs 1, 00,000 after paying interest of Rs 1, 20,000. Tax paid during the year Rs 1, 00,000. Bank balance at the end Rs 1, 00,000.
Illustration 15From the following information prepare balance sheet of Shri Mohan.Current ratio 2Working capital Rs 4, 00,000Net worth + Deb to current ratio 3:2Fixed assets to turnover 1:3Cash sales / Credit sales 1:2Creditor’s velocity 2 monthsStock velocity 2 monthsDebtors’ velocity 3 monthsNet profit 10% of turnoverReserves 2.5% of turnoverDebenture / Share capital 1:2GP ratio 25%