RATIO ANALY SIS

Sumitted by navdep kaur

3/25/12

CONTENTS
Meaning Objectives of ration analysis Users of ratio analysis Classification of ratio analysis
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1. liquidity ratio 2. activity ratio 3. solvency ratio 4. profitability ratio

Meaning
A ratio is simple arithmetic expression of

relationship of one number to another . It provides the quantitative information. It may be defined as the indicated quotient of two mathematical expression.

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For example, if the current assets of a firm on

a given date is 500000 and current liabilities are 250000 and then current ratio will be current assets to current liability will work out to be 500000/250000=2 ratios. these can be expressed as percentage by simply multiplying the ratio by 100. 2*100=200% or say current assets are 200%of current liabilities.

Such type of ratios are called pure and simple

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Objective of ratio analysis

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Users of ratio analysis

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Managerial uses
Helps in decision making Helps in financial forecasting and planning Helps to communicate the financial strength Helps in coordination with better

communication
Helps in control Budgetary control, standard costing, analysis

and interpretation of statements

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SHAREHOLDERS AND INVESTORS

To know the financial position Security of investment Rate of return in the form of dividend and

interest

CREDITORS

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Employees
To know the the profitability of concern to

request for increase wages.

Government------To know overall strength of concern To make policies taxation

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limitation

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Classification of ratio
Traditional classification Functional classification

Income stateme nt b/s ratio Composit e mixed ratio

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Liquidity ratio Activity ratio Solvency ratio Profitability

Liquidity ratio Current ratio Quick liquid ratio Activity ratio Invento ry turnove r Inventor ratio y turnover period
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Absolute ratio

Debtors receivabl e Turnover Average ratio collectio n period

Credito rs payabl e Averag Turnov e er ratio payme nt period

Working capital ratio

Liquidity ratios
Current ratio-------relationship between

current assists and current liabilities . it is also known as working capital ratio rule of thumb for this ratio is

Current assets/current liability Current assets--------cash in hand + cash at

bank+ marketable security + short term investments +b/r+ sundry debtors + inventory +WIP + prepaid expenses
Current liability------o/s exp + b/p+s.

creditors + short term advances + income tax 3/25/12 payable + bank overdraft + dividend payable

Quick/liquid ratio
It is more realistic than current ratio as

prepaid expenses and inventory are not easily convertible. it presents liquid assets which are easily convertible into cash whenever they become due. also known as acid test ratio.

Quick ratio=quick assets/current liability Quick assets-------current assets-inventories-

prepaid expenses

Rule of thumb for this ratio is 1:1

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Absolute liquid ratio

Rule of thumb for this ratio is 0.5:1 Liquid assets---current assets-inventoryOr Quick assets-advances-trade debtors

prepaid expenses-advances-taxable debtor

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Activity ratio
These also known as current assets

movement ratio/efficiency/assets management/turnover ratios. these ratio indicate the speed with which assets are converted into sales efficiency will be better

As fast as the process of cycle will be its

cas h debt ors
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Raw Workin mat g erial capital Finish cycle work in ed

INVENTORY TURNOVER RATIO

IT INDICATES THE NO. OF TIMES THE STOCK

HAS BEEN TURN OVER DURING THE PERIOD AND EVALUATED EFFICIENCY WITH A FIRM IS ABLE TO MANAGE ITS INVENTORY. net sales/average inventory or inventory at the end[in times]

Inventory turnover=cost of goods sold or

Net sales=total sales-sales return Cost of good sold=op. stock +purchases-

closing stock
Or net sales-gross profit
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Inventory turnover period

sales year/ inventory turnover

It is period in which stock is converted into Inventory turnover =months or days in a

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Debtor receivable turnover

firm

It indicates the velocity of debt collection of Debtor turnover ratio=net creditors annual

sale/average trade debtors or trade debtors

Average debtors=[op. stock+ bills receivable]

+ [closing debtors+ bills receivable]/2

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Average collection period

It represent the average number of days for

which a firm has to wait before its receivable are converted into cash. year/debtor collection period

Average collection period=no. of days in a

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Creditors/payable ratio..average payment period of days for which It indicates the velocity of credit payment of average number
a firm firm. can delay payments.
Creditor payment period =net credit Average payments =no. of days in a

year/creditors turnover ratio purchaser net purchase/average trade creditors or trade creditors
Average creditors= opening +closing

creditors/2

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Average payment period

It indicates average number of days for which

a firm can delay payments.

Average payments =no. of days in a

year/creditors turnover ratio

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Working capital turnover ratio

It indicates the number of items the working

capital is turned over in the course of year. sales/average working capital

Working capital turnover=cost of Average working capital=opening +closing

capital

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Particular

Trading profit and loss account

Particular

amount 192000

amount 240000

To purchase a/c To gross profit c/d

By sales a/c By closing stock

60000

12000

252000
To operating exp ---selling exp
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252000
By gross profit b/d

60000

Balance sheet
Liabilities

amt.

Assets

amt.

Equity share capital @10 each share

Goodwill

24000
Fixed assets

40000
Capital reserve

56000

8000
Profit and loss a/c

Current assets --stock Debtors Investment

16000

12000 12000 4000

Sec. Loan mortgage

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Current ratio
Current assets /current liabilities Current

=40000/24000=1.66:1

assets=stock+debtors+investment+cash =12000+12000+4000+12000=40000

Current liabilities=creditors+bank

o/d+taxation

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=16000+4000+4000=24000

Liquid ratio
liquid assets/current liabilities

28000/24000=1.17:1 40000-12000=28000

Liquid assets=current assets- inventory

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Absolute ratio
Absolute liquid ratio/current liabilities

16000/24000=0.66:1

Absolute liquid ratio=current assets-stock-

debtors

=40000-12000-12000=16000

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Activity ratios
Inventory turnover ratio=cogs/inventory at

the end times

=180000/1200=15

Cogs=sales-gross profit=24000060000=180000 a year/inventory turnover ratio=365/15=24 days

Inventory turnover period=number of days in

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Creditor turnover ratio=net purchase or net

credit purchase/trade creditors at the end =192000/16000=12 times

Average payment period=number of days in a

year/creditor turnover ratio=365/12=30.40 or 30 days or net sales/working capital at the end=240000/16000=15 times

Working capital turnover ratio=cost of sales

working capital=current assets current 3/25/12 liabilities

Solvency ratios
The term solvency refers to the ability of a

concern to meet its long term liabilties.long term solvency ratio indicates a firms ability to meet the fixed interest and cost and repayment scheduled association with its long term borrowings.

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Debt equity ratio

It is calculated to measure the relative claims

of outsiders and owners against the firm assets . A ratio of 1:1 may be usually consider to be satisfactory

Debt equity ratio=debt/equity Debt=long term debt + current liabilities Shareholder fund=e.s capital + p.s. capital +

reserves + dividend equalization fund+ p/l a/c

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Debt ratio
Long term fund raised from outsiders are

linked with total long term funds available in business

Debt ratio=long term debt/total capitalization Total capitalization=e.s capital+p.s. capital +

reserves+ other undistributed profits+ long term debts

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Proprietary ratio
Equity ratio represent the relationship of

owners fund to total assets, higher the ratio in total capital of company better is the long term solvency position of company. outsiders/total assets

Proprietary ratio=total liability to Total liability = e.s capital + p.s capital

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Ratio of fixed assets to net worth

fixed assets and shareholder funds depreciation] shareholder fund

This ratio establish the relationship between Fixed assets to net worth=fixed assets[after If the ration is less then 100% it implies that

owner are mere then fixed assets and a part of working capital id provided by the shareholders. if it is more then 100% it means owners funds are not sufficient to finance the fixed assets and firm has to depend upon outsiders to finance the fixes assets 3/25/12

Fixed assets ratio

It is the relationship between fixe assets and

long term funds

Fixed assets ratio=fixed assets after dep.

/total long term funds

Long term funds=shareholders fund+long

term liability

If the ratio is. 100< then fixed assets are met out of working

capital partly

3/25/12 100>long term funds are used as working

Ratio of current assets to proprietary funds

It indicates the extent to which proprietors

funds are invested in current assets

it is =current assets/shareholders fund*100

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Profitability ratios
The primary concern of business undertaking

is to earn profits. Profits are useful measures of overall efficiency and measure of control to owners, a measure of worth to their investment to the creditors, the margin of safetyto employ a source of fringe benefits, to govt. for tax, to country profits are index of economic progress. these ratios are.

General profitability Overall profitability

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General profitability ratios

profit to sales

Gross profit ratio=This the relation of gross

=gp/sales*100 or =sales cogs/net sales*100

Operating profit ratiothis is the percentage

of net sales that is consumed by operating cost. =operating cost/net sales*100 or

=cogs +operating expenses/net 3/25/12 sales*100

Expense ratio
It is the relation between various expenses to

net sales.

=particular expense/net sales*100

Net profit ratioit establish a relationship

between net profit after taxes and sales . This ratio is the overall measure of firms profitability.

= net profit after taxes/net sales*100

Cash profit ratio---the net profit f the firm is

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effected by the amount of dep. Charged. Further dep being non cash exp, it is better to

Overall profitable ratio

Return on shareholders investment or net

worth

=net profit after interest and tax/shareholder fund =net profit after tax-preference dividend/paid up equity share capital/paid up equity share capital

Return on equity capital

Equity per share

3/25/12 =net profit after tax-preference

Return on gross capital employed

=adjusted net profit/gross capital employed*100 assets

Gross capital employed=fixed assets +current Return on net capital employed

=adjusted net profit/net capital employed*100 liability

Net capital employed=fixed asstes+current

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Market test ratio

Dividend yield ratio

share

=dividend per share/market value per

Price earning ratio

share

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=market per equity share/earning per

Earning yield ratio

=earning per share/market per share

Market value or book value ratio

Particular

Trading profit and loss account

Particular

amount 192000

amount 240000

To purchase a/c To gross profit c/d

By sales a/c By closing stock

60000

12000

252000
To operating exp ---selling exp
3/25/12 18000

252000
By gross profit b/d

60000

Balance sheet
Liabilities

amt.

Assets

amt.

Equity share capital @10 each share

Goodwill

24000
Fixed assets

40000
Capital reserve

56000

8000
Profit and loss a/c

Current assets --stock Debtors Investment

16000

12000 12000 4000

Sec. Loan mortgage

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Solvay ratios
Debt equity ratio=debt equity=56000/64000 Debt =long term debt+current

=.875:1

liability=32000+24000 =56000

Equity fund=e. s. capital+profit and loss

account

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=40000+8000+16000=64000

Debt ratio=long term debt/total

Proprietary ratio
Proprietary ratio=shareholder fund/total assets =64000/120000=.53 :1 Solvay ratio=total liability to outsiders/total assets =56000/120000=.47:1 Total liability to outsiders=e.s capital+profit and loss account =40000+16000=56000 Ratio of fixed assets to net worth=fixed assets after dep./shareholder fund*100
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=80000/64000*100=125%

Fixed assets ratio

Fixed assets after dep/total long term

fund*100

Current assets/shareholder

fund=40000/64000*100

=62.5

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Profitability ratio
Gross profit ratio=gross profit/net sales*100

=26000/240000*100=10.83%
Net profit ratio

=net profit/net sales*100

=16000/240000*100=6.67%
Return on shareholders investment=net

profit/shareholder fund*100

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=16000/64000*100=25%

Return on e.s capital=net profit-preference

Earning per share

Net profit- preference dividend/ number of

shares

=16000/4000=4

Operating ratio=operating cost/net

sales*100=93.33%
Operating expenses=selling and distribution

expenses+adminsration expenses

=18000+26000=44000

Operating expenses=cogs + operating

3/25/12 expenses=180000+44000=224000

Expenses ratio
Selling and distribution expenses ratio=selling

expenses/net sales*100

=1800/240000*100=7.5%

Administration and management expense

ratio/net sales*100=26000/240000*100=10.83%

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