Ratio Analysis

B.V.Raghunandan,SVS College,

Bantwal-KarnatakaIndia

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

C. Activity Ratios

D. Profitability Ratios

E. Shareholders' Ratios

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 = bilitiesCurrentLiaetsCurrentAss

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 =

litiesQuickLiabisQuickAsset

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

lkingCapitaAverageWorNetSales

B. Solvency Ratios

• 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

Types of Solvency Ratios

1) Interest Coverage Ratio

2) Debt Ratio3) Debt-Equity Ratio4) Capital Gearing

Ratio5) Proprietary Ratio

1.Interest Coverage Ratio

TermDebtLongInterestonTaxInterestofitBefore

&Pr

2. Debt Ratio (Debt to Total Funds ratio)

rsFundsShareholdeLTDebtLTDebt

3) Debt-Equity Ratio

rsFundsShareholdebtLongTermDe

4) Capital Gearing Ratio

ndeholdersFuEquitySharcuritieseBearingSeFixedIncom

5) Proprietary Ratio

sTotalAssetrsFundsShareholde

C] Activity Ratios

1) Inventory Turnover Ratio2) Debtors Turnover Ratio3) Average Collection Period4) Fixed Assets Turnover Ratio5) Total Assets Turnover Ratio6) Capital Turnover Ratio

1) Inventory Turnover Ratio

ckAverageStosSoldCostofGood

ckAverageStosSoldCostofGood

2) Debtor Turnover Ratio

torsAverageDebsCreditSale

3) Average Collection Period

overRatioDebtorTurnmonthsaYearday )(12/)sin(365

4) Fixed Assets Turnover Ratio

setsNetFixedAsNetSales

5) Total Assets Turnover Ratio

sTotalAssetNetSales

6) Capital Turnover Ratio

TermFundsLongNetSales

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 XsTotalAssetaxofitAfterT

4) Return on Equity

100'

Pr XFundsrsShareholdeaxofitAfterT

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

uitySharesNumberofEqaxofitAfterTPr

2) PE Ratio

ShareEarningpereiceperSharMar Prker

3) Dividend Yield Ratio

100Pr

XeiceperSharMarket

rShareDividendpe

4) Dividend Pay-out Ratio

100XShareEarningperrShareDividendpe

THANK YOU