Ratio-analysisRatio-analysis means the process of computing, determining and presenting the relationship of related items and groups of items of the financial statements. They provide in a summarized and concise form of fairly good idea about the financial position of a unit. They are important tools for financial 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

Meaning of Ratio Analysis

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

Purpose/Importance/Advantages

Based on Historical Data No Standard Interpretation Ignoring Qualitative Aspects Difference in Accounting Methods make

comparison difficult

Limitations of Ratio Analysis

1) Liquidity Ratios

2) Profitability Ratios

3) Solvency Ratios

4) Activity Ratios

5) Shareholders' Ratios

Classification of Ratios

LIABILITIES ASSETS

NET WORTH/EQUITY/OWNED FUNDSShare Capital/Partner’s Capital/Paid up Capital/ Owners FundsReserves ( General, Capital, Revaluation & Other Reserves) Credit Balance in P&L A/c

FIXED ASSETS : LAND & BUILDING, PLANT & MACHINERIES Original Value Less DepreciationNet Value or Book Value or Written down value

LONG TERM LIABILITIES/BORROWED FUNDS : Term Loans (Banks & Institutions)Debentures/Bonds, Unsecured Loans, Fixed Deposits, Other Long Term Liabilities

NON CURRENT ASSETSInvestments in quoted shares & securitiesOld stocks or old/disputed book debtsLong Term Security DepositsOther Misc. assets which are not current or fixed in nature

CURRENT LIABILTIESBank Working Capital Limits such as /Bills/Export CreditSundry /Trade Creditors/Creditors/Bills Payable, Short duration loans or depositsExpenses payable & provisions against various items

CURRENT ASSETS : Cash & Bank Balance, Marketable/quoted Govt. or other securities, Book Debts/Sundry Debtors, Bills Receivables, Stocks & inventory (RM,SIP,FG) Stores & Spares, Advance Payment of Taxes, Prepaid expenses, Loans and Advances recoverable within 12 months

INTANGIBLE ASSETSPatent, Goodwill, Debit balance in P&L A/c, Preliminary or Preoperative expenses

Format of balance sheet for ratio analysis

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.

Liquidity Ratios

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

Current Ratio

Measurement of Current 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 indicator of cash management

Acid Test Ratio/Quick Ratio/Liquid Asset Ratio

Measurement of Acid Test Ratio

It is the ratio between cash and current liabilities

Means Availability of cash for meeting current liabilities.

Cash Ratio= Cash in hand + cash at bank Current Liabilities

Cash Ratio

These ratio shows short term financial soundness of the company.

The Financial position is supposed to very sound, if the current ratio is more than 2:1.

Higher ratio shows the better capacity of the business to meet its current obligation.

Significance of Liquidity Ratio

1) Net Profit Ratio 2) Gross Profit Ratio 3) Return on Total Assets 4) Return on Equity

Profitability Ratio

Net Profit Ratio