Ratio Analysis

Formulas

1) Financial ratios

S.no Ratio Formula Ideal ratio Comments

1 Current ratio Current assetsCurrent liabilities

2:1/1.33:1 Indicates firm’s commitment to meet financial obligations.Avery heavy ratio is not desirable as it indicates less efficient use of funds

2 Quick ratio Quick assetsCurrent liabilities

1:1 This ratio also indicates short term solvency of a firm

3 Debt –Equity ratios long term debtequity

1:2 Indicates long term solvencyHigher ratio is riskier for the creditors

4 Proprietary ratio Shareholders’ fundsTotal tangible assets

Variant of debt-equity ratioShows the extent of shareholders funds in the total assets employed in the businessHigher ratio indicates relatively little danger to creditors and vice versa

Notes

1) Current assets are those assets which can be converted into cash within a period of one year or normal operating cycle of the business whichever is longer

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Examples : Cash in hand, cash at bank ,stock, debtors, bills receivable, prepaid expenses

2) Current liabilities are those liabilities payable within an year or operating cycle

3) Quick assets = current assets – (stock+prepaid expenses)4) Quick ratio is also known as the acid test ratio or liquidity ratio5) Tangible assets are those assets which have physical existence6) Long term debt /external funds/external equities =debentures+termloans7) Share holders’ funds/internal funds/proprietary funds/owners funds=equity

share capital+preference share capital+reserves+profit and loss account-fictitious assets

2) Profitability ratios

S.no Ratio Formula Ideal ratio comments

1 Gross Profit Ratio

G ross profit X 100Net sales

Higher the ratio better it is

This ratio expresses the relationship between gross profit and net sales

Gross profit should be adequate to cover operating expenses

2 Net Profit ratio Net profit X100Net sales

Higher the ratio, better it is

This ratio expresses the relationship between net profit and Net sales

3 Net operating profit ratio

(Net operating profit/net sales)X100

Higher ratio is better

Helps in determining the efficiency with which the affairs of the business being managed

4 Operating Ratio Operating cost X100 Ratio This ratio is a test of

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net sales should be low

operating efficiency with which the business is being carried

5 Fixed charges cover

PBITInterest

6 -7 times for an industrial concern

Important from lender’s point of view

It indicates whether the business would earn sufficient profits to pay periodically the interest charges

6 Debt Service coverage ratio

PBIT/interest+(principal)/1-taxrate

Indicates ability of the company to repay principal

7 Overall profitability ratio/Return on investment/return on capital employed

Operating profitCapital employed X100

Higher ratio is better

Indicates the percentage return on capital employed in the business

8 Return on share holders’ funds Profit after tax(PAT)

Share holders funds X100

Higher ratio is better

Indicates the percentage return on share holders’ funds

9 Return on Equity share holders Funds

PAT-pref.dividend X100Eq.shareholders funds

Higher ratio is better

Indicates the percentage return on equity shareholders funds

10 Price Earnings Ratio

Market price per shareEarnings per share

Higher ratio is better

Indicates the number of times the earning per share is covered by the market price

Helps the investor in deciding whether to buy or not to buy the shares

11 Earnings per PAT – pref.dividend Higher ratio Helps in estimating

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share No of Equity shares is better company’s capacity to pay dividend to the shareholders

Notes

1) Calculation of Gross profit

Gross profit = Sales- Cost of goods sold

Cost of goods sold (COGS) = opening stock +purchases+ all direct expenses –closing stock

2) Operating profit = Gross profit-operating expenses

Operating expenses= COGS +administration expenses +selling and distribution expenses

Note: does not include financial charges like interest and provision for tax

3) Capital employed= sum total of all the long term funds employed in the business

C E= Equity share capital+ preference share capital+ reserves+ profit and loss account+ long term loans-fictitious assets

Shareholder’s funds= Equity share capital +preference share capital +reserves +profit and loss account-fictitious assets

Equity share holder’s funds= equity share capital + reserves+ profit and loss account-fictitious assets

3) Turnover ratios

S.no Ratio Formula Ideal ratio comments

1 Fixed assets turn over ratios

Net salesFixed Assets

Higher ratio is

Indicates the extent to which investment in

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better fixed assets contribute towards sales

2 Working capital turnover ratio

Net salesWorking capital

Higher ratio is better

This ratio indicates whether or not working capital has been effectively utilized in making sales

3 Debtors turnover ratio(DTR)/debtors velocity

Net credit salesAverage debtors

Higher ratio is better

Average debtors=(opening debtors+opening bills receivable+closing debtors+closing bills receivable)/2

4 Debt collection period Months in a yearDTR

Lower ratio is better

Indicates the extent to which debts have been collected in time

5 Creditors Turnover ratio(creditors velocity)(CTR)

Credit purchasesAverage creditors

Higher ratio is better

Indicates the speed with which the payments for the credit purchases are made

Average creditors= opening creditors+bills receivable+closing creditors+closing bills payable

6 Credit payment period Months in a yearCTR

Low ratio is better

Indicates the promptness with which the payments are made to the creditors

7 Stock turnover ratio Cost of goods soldAverage Stock

Higher ratio is better

Indicates whether investment in stock is efficiently used or not

Average stock= (opening stock+closing stock)/2

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Note : please do refer these links

http://www.zenwealth.com/BusinessFinanceOnline/RA/RatioCalc.html

www.capitaline.com

Exercise

1) From the following information calculate current ratio and quick ratio

Cash in hand - Rs 2000

Bank overdraft - Rs 40000

Cash at Bank - Rs 10000

Bills receivable – Rs 30000

Creditors –Rs 60000

Outstanding expenses-Rs 7000

Proposed dividend- Rs10000

Debtors-Rs 70000

Stock –Rs 40000

Provision for taxation –Rs20000

2) From the following details calculate current ratio and liquidity ratio

Current assets ,loans and advances

Rs Rs

Stock in trade 77500debtors 46800

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Cash in hand 6300Loans and advances 13700Prepaid expenses 700 145000Current liabilitiesSundry creditors 23000Interest accrued 1900

Bills payable 7560Dividend warrants issued but not encashed

390

Provision for taxation 10150 43000

3) Calculate the following ratios from the balance sheet given below1) Current ratio2) Quick ratio3) Inventory turnover ratio4) Average collection period assuming 360 days in a year5) Debt- Equity ratio6) Gross profit ratio7) Fixed assets turnover ratio8) Proprietary ratio

liabilities Rs Assets RsShare capital 200000 Goodwill 1,20,000Reserves and Surpluses

58000 Plant and machinery

1,50,000

debentures 1,00,000 stock 80000creditors 40,000 debtors 45,000Bills payable 20,000 cash 17000Other current liabilities

2000 Misc.Current assets

8000

4,20,000 4,20,000

Sales - Rs 400000

Gross profit – Rs 1,60,000

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4) Following is the Profit and Loss Account of Vector Limited for the year ended March 31, 2008 and the Balance Sheet as on that date.

Profit and Loss Account for the year ended March 31, 2008

Details Value in Rs Value in Rs

Sales 30,00,000

Less: Cost of Goods Sold 25,80,000

Gross Profit 4,20,000

Less Operating Expenses

Selling Expenses 22,000

Administrative Expenses 40,000

Rent of Office 28,000

Depreciation 1,00,000 1,90,000

Earnings before Interest and Tax 2,30,000

Less: Interest Expense

Interest on Bank Overdraft 3,000

Interest on Debentures 42,000 45,000

Operating Profit before tax 1,85,000

Add. Interest on Investment 15,000

Total Profit before tax 2,00,000

Taxes [ 50%] 1,00,000

Net Profit after taxes 1,00,000

Balance Sheet as on March 31, 2008

Details Value in Rs

Sources

Equity Share Capital 5,00,000

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Reserve and Surplus 4,00,000

7% Preference Share Capital 1,00,000

6% Mortgage Debentures 7,00,000

Current Liabilities

Sundry Creditors 60,000

Bills Payable 1,00,000

Outstanding Expenses 10,000

Provision Taxation 1,30,000

Total 20,00,000

Application

Fixed Assets [ Net of Depreciation] 13,00,000

Current Assets

Inventory 3,00,000

Sundry Debtors 2,00,000

Marketable Securities 1,50,000

Cash 50,000

Total 20,00,000

Calculate the following financial ratios and interpret the same [

Return on Investment Debt Collection Period Debt Equity Ratio Current Ratio Inventory Turnover Ratio Fixed assets turnover ratio Proprietary ratio Return on share holders’

funds Return on equity

shareholders funds Gross profit ratio Net profit ratio Operating ratio

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5) Calculate earnings per share from the following dataNet profit before tax = Rs 100000Tax rate= 50%10% preference capital (Rs.10 each) = Rs 100000Equity share capital (Rs 10 per share) = Rs 100000

6) The following are the balance sheets of Robert Limited for the year 2005 and 2006

liabilities 2005 2006 assets 2005 2006Share capital

100000 100000 Fixed assets

200000 250000

General reserve

50000 50000 stock 40000 60000

Profit & loss A/c

50000 100000 debtors 30000 40000

8% debentures

50000 80000 cash 20000 30000

Sundry creditors

40000 50000 Prepaid expenses

10000 20000

Proposed dividend

10000 20000

300000 400000 300000 400000

Calculate the following ratiosa) Current ratiob) Acid-Test ratioc) Debt-equity ratiod) Fixed assets-shareholders ratioe) Proprietary ratio

7) The current ratio is 2.5, liquid ratio 1.5 and working capital is Rs.100000.find current assets, current liabilities and stock.

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8) The average stock is Rs.80000 and the opening stock is 10000 less than the closing stock. Find opening and closing stock.

9) It is given that the long term debt to equity ratio is 2:3 and the equity amount is Rs 50000.compute the value of long term debt

10) The following financial data is given:

Sales for the year = Rs 200000

Stock – Rs 100000

Credit sales = Rs 150000

Debtors= Rs 75000

Total assets = Rs300000

Share capital(10000 shares of 10 each) = Rs 100000

Net profit = Rs 50000

Market price per share is Rs 12.from the above information calculate and give your opinion on each ratio

a) Stock turnover ratiob) Debtors turnover ratioc) Debt collection periodd) Price-earnings ratioe) Earnings per share

11) Gross profit ratio is 20% .gross profit is Rs 50000.calculate sales12) Given below is the trading and profit and loss account

Opening stock 120000 Cash sales 120000Cash purchases 60000 Credit sales 480000Credit purchases 320000 Closing stock 80000Gross profit 180000

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Total 680000 Total 680000General expenses 40000 By gross profit 180000depreciation 20000Income tax 30000Net profit 90000

180000 180000

Balance Sheet

Share capital 300000 Fixed assets 170000General reserve 60000 stock 80000Profit and loss account

110000 investments 100000

creditors 80000 debtors 160000Bills payable 20000 cash 60000

570000 570000

Compute:

a) Current ratiob) Acid test ratioc) Debt-equity ratiod) Proprietary ratioe) Stock turnover ratiof) Creditors turnover ratiog) Debtors turnover ratioh) Debt collection periodi) Credit payment periodj) Gross profit ratiok) Net profit ratiol) Return on share holders funds

13) Below is the summarized balance sheet and profit and loss account of hero limited for the year ended 31/3/08

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(in lakhs)

liabilities Rs Assets RsShare capital(Rs 10 each)

4 Fixed assets 11

reserves 3 Liquid assets 3overdraft 4 Other current

assets5

Current liabilities 819 19

Profit and Loss account

(in lakhs)

To opening capital 2 By sales less returns

28

purchases 22 Closing stock 3expenses 3

Net profit 431 31

Calculate all the key ratios and comment on the financial position of the company

14) The following is the information of a textile company. Complete the proforma balance sheet if the sales are 3200000

Sales to networth - 2.3 times

Current debt to networth – 42%

Total debt-networth – 75%

Current ratio – 2.9 times

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Netsales to inventory – 4.7 times

Average collection period-64 days

Fixed assets to networth – 53.2%

Proforma Balance Sheet

Networth

Long term debt

Current debt

?

?

?

Fixed assets

Cash

Stock

Sundry debtors

?

?

?

?

? ?

15) From the following particulars calculate current assets current liabilities and stock

Sales 1200000

GP ratio 25%

Current ratio 1.75

Quick ratio 1.25

Stock turnover ratio 9 times

16) With the help of following details prepare balance sheet of the firm concerned:

Working capital 75000

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Reserves and surpluses 100000Bank overdraft 60000Current ratio 1.75Liquid ratio 1.15Fixed assets-proprietary funds 0.75Long term liabilities NIL

17) With the help of following ratios regarding sujith films, draw a balance sheet of the company for the year 2007:

Current ratio 2.5

Liquidity ratio 1.5

Net working capital Rs 300000

Stock turnover ratio(cost of sales/cl stock) 6 times

Gross profit ratio 20%

Fixed assets turnover ratio(on cost of sales) 2 times

Debt collection period 2 months

Fixed assets to shareholders net worth 0.80

Reserve and surplus to capital 0.50

18) The following are the ratios extracted from the balance sheet of a firm

Current ratio -2.5

Working capital – 300000

Liquid ratio – 1.5

Stock turnover ratio – 6

Gross profit as a percentage of sales 20%

debt collection period – 2 months

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share capital – Rs 500000

reserves and surpluses- 250000

fixed assets turnover -2

19) From the following information prepare a balance sheet

Current ratio – 2.5

Liquid ratio- 1.5

Proprietary ratio (fixed assets/proprietary funds) 0.75

Working capital – Rs 60000

Reserves and surpluses –Rs 40000

Bank overdraft- Rs 10000

There is no long term or fictitious assets

20)

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