ratio analysis total formulas with ideal ratios (1)
TRANSCRIPT
Ratio Analysis
G.Krishna
Assoc.Profesor
ICBM-School of Business Excellence
Hyderabad
Meaning of Ratio Analysis
• It is an analysis of strength and weakness of an organisation by establishing the quantitative relation among the items of Balance Sheet or Income Statement of such an organisation
Purpose/Importance/Advantages
• Analysis of financial Position• Simplification of Accounting Figures• Assessment of Operational Efficiency• Determining Trends in the long-run• Identification of Strength & Weakness• Taking Remedial Measures• Comparison of Performance
Limitations of Ratio Analysis
• Based on Historical Data• Change in Real Value of Monetary Unit• No Standard Interpretation• Ignoring Qualitative Aspects• Difference in Accounting Methods make
comparison difficult• Ambiguity in Terms Used
Classification of Ratios
A. Liquidity Ratios-
B. Solvency Ratios- Leverage
C. Activity Ratios- Turnover
D. Profitability Ratios-
E. Shareholders' Ratios
Classification of Ratios
What is Liquidity ?
Classification of Ratios
-Ability to convert as asset to cash quickly
-Assets that can be easily bought & sold without loss.
It is an ratio to know short term solvency of the company
A. Liquidity Ratios
• Used to study the ability of the organisation in meeting short-term payments or obligations
• Includes:
1) Current Ratio,
2) Acid Test Ratio and
3) Working Capital Turnover Ratio
1) Current Ratio
• Relation between current assets and current liabilities
• Long Term Sources Financing the Current assets give a stable base for the liquidity of the organisation
• Normally , the ratio should not be less than 2 i.e., the current assets should be double the size of current liabilities
Measurement of Current Ratio
Current Ratio =
Ideal Ratio : 2:1
bilitiesCurrentLia
etsCurrentAss
2) Acid Test Ratio/Quick Ratio
• It is the ratio between quick assets and quick liabilities
• Quick assets include current assets except inventory and pre-paid expenses
• Quick liabilities include current liabilities other than bank overdraft
• A 1:1 ratio is healthy• Healthy indicator of cash management
Measurement of Acid Test Ratio
Acid Test Ratio =
Ideal Ratio; 1:1
litiesQuickLiabi
sQuickAsset
3) Working Capital Turn-over Ratio
• Shows the efficiency of usage of working capital
• Relation between Sales and Working Capital
• Determination of number of times the working capital is turned over to achieve the maximum profit
Measurement of Working Capital Turnover Ratio
Higher the ratio is Ideal
lkingCapitaAverageWor
NetSales
B. Solvency Ratios/Leverage
• Measure long-term liquidity ratio• Reflect the ability of the firm to pay interest
and repayment of loans at due dates on the long-term loans taken
• Avoidance of over-borrowing (over-leverage)
• Avoidance of bankruptcy by maintaining healthy solvency ratios
What is Leverage ?
The amount of debt used to finance a firm’s assets
A firm with significantly more debt than equity is considered
to be highly leveraged
Types of Solvency/ Leverage Ratios
1) Interest Coverage Ratio
2) Debt Ratio
3) Debt-Equity Ratio
4) Capital Gearing Ratio
5) Proprietary Ratio
1.Interest Coverage Ratio6 is Ideal
TermDebtLongIntereston
TaxInterestofitBefore
&Pr
2. Debt Ratio (Debt to Total Funds ratio)
rsFundsShareholdeLTDebt
LTDebt
3) Debt-Equity Ratio
rsFundsShareholde
btLongTermDe
4) Capital Gearing Ratio
ndeholdersFuEquityShar
curitieseBearingSeFixedIncom
5) Proprietary RatioNet worth/Total Assets
sTotalAsset
rsFundsShareholde
C] Activity Ratios/Turnover
1) Inventory Turnover Ratio
2) Debtors Turnover Ratio
3) Average Collection Period
4) Fixed Assets Turnover Ratio
5) Total Assets Turnover Ratio
6) Capital Turnover Ratio
1) Inventory Turnover Ratio8 is Ideal
ckAverageSto
sSoldCostofGood
ckAverageSto
sSoldCostofGood
2) Debtor Turnover Ratio
Higher Ratio – or 10-12
torsAverageDeb
sCreditSale
3) Average Collection Period
overRatioDebtorTurn
monthsaYearday )(12/)sin(365
4) Fixed Assets Turnover RatioHigher the Ratio is Ideal
setsNetFixedAs
NetSales
5) Total Assets Turnover Ratio
sTotalAsset
NetSales
6) Capital Turnover Ratio
TermFundsLong
NetSales
D] Profitability Ratios
1) Net Profit Ratio
2) Gross Profit Ratio
3) Return on Total Assets
4) Return on Equity
1) Net Profit Ratio
100Pr
XNetSales
axofitAfterT
2) Gross Profit Ratio
100Pr
XSales
ofitGross
3) Return on Total Assets
100Pr
XsTotalAsset
axofitAfterT
4) Return on Equity
100'
PrX
FundsrsShareholde
axofitAfterT
E) Shareholders‘ Ratio
1) Earning per Share (EPS)
2) Price-Earning Ratio (PE Ratio)
3) Dividend Yield Ratio
4) Dividend Pay-out Ratio
1) Earning per Share
uitySharesNumberofEq
axofitAfterTPr
2) PE Ratio
ShareEarningper
eiceperSharMar Prker
3) Dividend Yield Ratio
100Pr
XeiceperSharMarket
rShareDividendpe
4) Dividend Pay-out Ratio
100XShareEarningper
rShareDividendpe
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