RATIO

ANALYSIS

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AFTAB.MULLA

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DEFINATION

WHAT DO YOU MEAN BY RATION ANALYSIS

ADVANTAGES & USES

LIMITATIONS

BIBLOGRAPHY

DEFINATION

According to Myers, “Ratio analysis of financial statements is a study of relationship among various financial factors in a business as disclosed by a single set of statements and a study of trend of these factors as shown in a series of statements.”

WHAT DO YOU MEAN BY RATIO ANALYSIS

A TOOL USED BY INDIVIDUAL TO CONDUCT A QUANTITATIVE ANALYSIS OF INFORMATION

ONE OF THE TECHNIQUE OF FINANCIAL ANALYSIS TO EVALUATE THE FINANCIAL CONDITION AND PERFORMANCE OF A BUSINESS CONCERN

THE COMPARISION OF ONE FIGURE TO OTHER RELEVANT FIGURE OR FIGURES

ADVANTAGES & USESTO WORKOUT THE PROFITABILITY

TO WORK THE SOLVENCY

HELPFUL IN ANALYSIS OF FINANCIAL STATEMENT

HELPFUL IN COMPARATIVE ANALYSIS OF THE PERFORMANCE

TO SIMPLIFY THE ACCOUNTING INFORMATION

TO WORKOUT THE OPERATING EFFICIENCY

TO WORKOUT SHORT-TERM FINANCIAL POSITION

HELPFUL FOR FORECASTING PURPOSES

LIMITATIONS

LIMITED COMPARABILITY

FALSE RESULTSEFFECT OF PRICE LEVEL CHANGESQUALITATIVE FACTORS ARE IGNOREDEFFECT OF WINDOW-DRESSINGCOSTLY TECHNIQUEMISLEADING RESULTSABSENCE OF STANDARD UNVERSITY ACCEPTED TERMINOLOGY

CURRENT RATIO

Current assets are those which are usually converted into cash or consumed with in short period (say one year). Current liabilities are required to be paid in short period (say one year).

Formula of Current Ratio:

Current ratio = Current assets / current liabilities

QUICK RATIO

Quick ratio is also known as liquid ratio or acid test ratio. Current ratio provides a rough idea of the liquidity of a firm so subsequently a second testing device was developed named as acid test ratio or quick ratio. It establishes relationship between liquid assets and current liabilities. In many businesses a significant proportion of current assets may comprise of inventory. Inventory, by nature, cannot be converted into ready cash abruptly. The term liquid assets does not include inventory.

Formula of Quick ratio

Quick ratio = Liquid (quick) assets / Current

Liabilities

*The term liquid or quick assets includes all the current assets minus inventory at prepaid expenses.

Ratio of net credit sales to average trade debtors is called debtors turnover ratio. It is also known as receivables turnover ratio. This ratio is expressed in times. Accounts receivables is the term which includes trade debtors and bills receivables. It is a component of current assets and as such has direct influence on working capital position (liquidity) of the business. Perhaps, no business can afford to make cash sales only thus extending credit to the customers is a necessary evil. But care must be taken to collect book debts quickly and within the period of credit allowed. Otherwise chances of debts becoming bad and unrealizable will increase. How effective or efficient is the credit collection? To provide answer debtors turnover ratio or receivable turnover ratio is calculated.

DEBTOR’S TURNOVER RATIO

FORMULA OF DEBTOR’S

TURNOVER RATIO

Receivables turnover ratio = Annual net credit sales /

Average accounts receivables

*Where accounts receivables = Trade debtors + Bills receivables

Gross profit ratio is the ratio of gross profit to net sales i.e. sales less sales returns. The ratio thus reflects the margin of profit that a concern is able to earn on its trading and manufacturing activity. It is the most commonly calculated ratio. It is employed for inter-firm and inter-firm comparison of trading results.

GROSS PROFIT RATIO

Formula of gross profit ratio

Gross profit = Gross profit / (Net sales × 100)

*Where Gross profit = Net sales - Cost of goods sold

*Cost of goods sold = Opening stock + Net purchases + Direct expenses - Closing stock

*Net sales = Sales - Returns inwards

The operating ratio is determined by comparing the cost of the goods sold and other operating expenses with net sales.

OPERATING RATIO

Formula for Operating Ratio

Operating Ratio = [(Cost of goods sold + Operating expenses / Net sates)] × 100 OR Net sales - Gross profit

*Here cost of goods sold = Operating stock + Net purchases + Manufacturing expenses - Closing stock

*Operating expenses = Office and administrative expenses + Selling and distribution expenses

NET PROFIT RATIO

Net profit ratio (NP ratio) expresses the relationship between net profit after taxes and sales. This ratio is a measure of the overall profitability net profit is arrived at after taking into account both the operating and non-operating items of incomes and expenses. The ratio indicates what portion of the net sales is left for the owners after all expenses have been met.

Formula of Net Profit RatioNet Profit Ratio =

(Net profit after tax / Net sales) × 100

*It is expressed in percentage. Higher the net profit ratio, higher is the profitability of the business.

OPERATING RATIOThe total revenue expenditure may be sub-divided into two categories with fixed and variable. In the case of a fixed expense, the ratio will fall with increase in sales and for a variable expense, the ratio in proportion to sales shall nearly remain the same. Expense ratios are calculated to ascertain the relationship that exists between operating expenses and volume of sales. Expense ratios are calculated by dividing each item of expense or group of expenses with the net sales so analyze the cause of variation of the operating ratio. It indicates the portion of sales which is consumed by various operating expenses.

Ratio of material used to sales

(Direct material cost / Net sales) × 100

Ratio of labor to sales

(Direct labor cost / Net sales) × 100

Ratio of factory overheads to

sales

(Factory expenses / Net sales) × 100

Ratio of office and administration

expenses to sales

(Office and administration

expenses / Net sales) × 100

Ratio of selling and distribution

expenses to sales

(Selling and distribution expenses /

Net sales) × 100

CONTINUE..

*These ratios are expressed in terms of percentage. The total of the above ratios will be equal to the operating ratio.

DEBT EQUITY RATIO

The relationship between borrowed funds and internal owner's funds is measured by Debt-Equity ratio. This ratio is also known as debt to net worth ratio. The total revenue expenditure may be sub-divided into two categories with fixed and variable. In the case of a fixed expense, the ratio will fall with increase in sales and for a variable expense, the ratio in proportion to sales shall nearly remain the same. Expense ratios are calculated to ascertain the relationship that exists between operating expenses and volume of sales. Expense ratios are calculated by dividing each item of expense or group of expenses with the net sales so analyze the cause of variation of the operating ratio. It indicates the portion of sales which is consumed by various operating expenses.

Formula of Debt Equity Ratio

Debt Equity Ratio = DEBT/DEBT+EQUITY

PROPRIETORY RATIO

Proprietary ratio (also known as Equity Ratio or Net worth to total assets or shareholder equity to total equity). Establishes relationship between proprietor's funds to total resources of the unit. Where proprietor's funds refer to Equity share capital and Reserves, surpluses and Tot resources refer to total assets.

Formula of Proprietary Ratio

Proprietary Ratio = Proprietor's funds /

Total assets

*This relationship highlights the fact as to what is the proportion of Proprietors and outsiders in financing the total business

PRICE-TO-BOOK RATIO

A ratio used to compare a stock's market value to its book value. It is calculated by dividing the current closing price of the stock by the latest quarter's book value per share.                                                                                         A lower P/B ratio could mean that the stock is undervalued. However, it could also mean that something is fundamentally wrong with the company. As with most ratios, be aware that this varies  by industry. This ratio also gives some idea of whether you're paying too much for what would be left if the company went bankrupt immediately.

FORMULA OF P/B RATIOP/B RATIO =

STOCK PRICES/TOTAL ASSETS – INTANGIBLE ASSETS & LIABILITIES

*Also known as the “Price-Equity Ratio” 

PRICE-EARNING RATIOA valuation ratio of a company's current share price compared to its per-share earnings. In general, a high P/E suggests that investors are expecting higher earnings growth in the future compared to companies with a lower P/E. However, the P/E ratio doesn't tell us the whole story by itself. It's usually more useful to compare the P/E ratios of one company to other companies in the same industry, to the market in general or against the company's own historical P/E. It would not be useful for investors using the P/E ratio as a basis for their investment to compare the P/E of a technology company (high P/E) to a utility company (low P/E) as each industry has much different growth prospects.

FORMULA OF P/E RATIO

P/E RATIO = MARKET VALUE PER SHARE/ EARNINGS PER SHARE (EPS)

*Also known as “Price Multiple" or “Earnings Multiple"

FIXED-ASSET TURNOVER RATIO

A financial ratio of net sales to fixed assets. The fixed-asset turnover ratio measures a company's ability to generate net sales from fixed-asset investments - specifically property, plant and equipment (PP&E) - net of depreciation. A higher fixed-asset turnover ratio shows that the company has been more effective in using the investment in fixed assets to generate revenues. This ratio is often used as a measure in manufacturing industries, where major purchases are made for PP&E to help increase output. When companies make these large purchases, prudent investors watch this ratio in following years to see how effective the investment in the fixed assets was.

FORMULA OF FIXED-ASSET

TURNOVER RATIO

FIXED-ASSET TURNOVER = NET PROPERTY, PLAN,

EQUIPMENT

INTEREST COVERAGE RATIO

A ratio used to determine how easily a company can pay interest on outstanding debt. The interest coverage ratio is calculated by dividing a company's earnings before interest and taxes (EBIT) of one period by the company's interest expenses of the same period. The lower the ratio, the more the company is burdened by debt expense. When a company's interest coverage ratio is 1.5 or lower, its ability to meet interest expenses may be questionable. An interest coverage ratio below 1 indicates the company is not generating sufficient revenues to satisfy interest expenses.

FORMULA OF INTEREST

COVERAGE RATIO

INTEREST COVERAGE RATIO = EBIT/INTEREST EXPENSE

DEBT RATIO

A ratio that indicates what proportion of debt a company has relative to its assets. The measure gives an idea to the leverage of the company along with the potential risks the company faces in terms of its debt-load. A debt ratio of greater than 1 indicates that a company has more debt than assets, meanwhile, a debt ratio of less than 1 indicates that a company has more assets than debt. Used in conjunction with other measures of financial health, the debt ratio can help investors determine a company's level of risk.

FORMULA OF DEBT RATIO

DEBT RATIO = TOTAL DEBT/TOTAL ASSETS

PROFIT MARGIN RATIO

Indicates what portion of sales contribute to the income of a company.

FORMULA OF PROFIT MARGIN RATIO

PROFIT MARGIN RATIO = NET INCOME/REVENUE

*This ratio is not useful for companies losing money, since they have no profit.

*A low profit margin can indicate pricing strategy and/or the impact competition has on margins.

RETURN ON ASSET

An indicator of how profitable a company is relative to its total assets. ROA gives an idea as to how efficient management is at using its assets to generate earnings. Calculated by dividing a company's annual earnings by its total assets, ROA is displayed as a percentage. Sometimes this is referred to as "return on investment". ROA tells you what earnings were generated from invested capital (assets). ROA for public companies can vary substantially and will be highly dependent on the industry. This is why when using ROA as a comparative measure, it is best to compare it against a company's previous ROA numbers or the ROA of a similar company.  

FORMULA OF RETURN ON ASSET (ROA)

RETURN ON ASSET = NET INCOME/TOTAL ASSET

RETURN ON EQUITY

The amount of net income returned as a percentage of shareholders equity. Return on equity measures a corporation's profitability by revealing how much profit a company generates with the money shareholders have invested. The ROE is useful for comparing the profitability of a company to that of other firms in the same industry.

FORMULA OF RETURN ON EQUITY (ROE)

ROE = NET INCOME/SHAREHOLDER’S EQUITY

*ROE is expressed as a percentage.

*Also known as "return on net worth" (RONW).

RETURNS ON CAPITAL EMPLOYED

A ratio that indicates the efficiency and profitability of a company's capital investments. ROCE should always be higher than the rate at which the company borrows, otherwise any increase in borrowing will reduce shareholders' earnings.A variation of this ratio is return on average capital employed (ROACE), which takes the average of opening and closing capital employed for the time period.

RETURN ON CAPITAL EMPLOYES (ROCE)

ROCE = EBIT/TOTAL ASSETS-CURRENT LIABILITIES

EFFECTIVE TAX RATE

The rate a taxpayer would be taxed at if taxing was done at a constant rate, instead of progressively. This is the net rate a taxpayer pays if you include all forms of taxes.

FORMULA OF EFFECTIVE TAX RATE

EFFECTIVE TAX RATE (%) = INCOME TAX

EXPENSES/PRETAX INCOME

BIBLOGRAPHY

www.google.com

Wikipedia

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