INTRODUCTION

A Ratio Analysis studied that there are various methods or techniques used in analyzing financial statements. Such as comparative statements, trend analysis, common size statement schedule of changes in working capital, fund flow and cash flow analysis, cost volume profit analysis and ratio analysis. The ratio analysis is one of the most powerful tools of financial analysis. It is the process of establishing and interpreting various ratios (quantitative relationship between figures and groups of figure).It is with the help of ratios that the financial statement can ne analyses more clearly and decision made from such analysis. Ratio analysis is the process of determining and presenting the relationship of items and group of items in the statements. According to Batty J. Management Accounting Ratio can assist management in its basic functions of forecasting, planning coordination, control and communication A ratio is simple arithmetical expression of the relationship of one number to another. It may be defined as the indicated quotient of two mathematical expressions. It is helpful to know about the liquidity, solvency, capital structure and profitability of an organization. It is helpful tool to aid in applying judgment, otherwise complex situations. The ratio analysis helps in analysis of financial statement. Ratio analysis is a technique of analysis and interpreting of financial statement. It is the process of establishing various ratios for helping in making certain decisions. Ratio analysis helps in comparative study. The comparative analyses are financial statement of the financial position at different period. The ratio analysis study the two or more items

DEFINITION
Acc. to Accountants Handbook by wixon, Kell and Bedford,Ratuo is an expression of the quantitative relationship between two numbers.

RATIO ANALYSIS
Meaning of Ratio: A ratio is simple arithmetical expression of the relationship of one number to another. It may be defined as the indicated quotient of two mathematical expressions. According to Accountants Handbook by Wixon, Kell and Bedford, a ratio is an expression of the quantitative relationship between two numbers. Ratio Analysis: Ratio analysis is the process of determining and presenting the relationship of items and group of items in the statements. According to Batty J. Management Accounting Ratio can assist management in its basic functions of forecasting, planning coordination, control and communication. It is helpful to know about the liquidity, solvency, capital structure and profitability of an organization. It is helpful tool to aid in applying judgement, otherwise complex situations. Ratio may be expressed in the following three ways: 1. Pure Ratio or Simple Ratio :- It is expressed by the simple division of one number by another. For example , if the current assets of a business are Rs. 200000 and its current liabilities are Rs. 100000, the ratio of Current assets to current liabilities will be 2:1. 2. Rate or So Many Times :- In this type , it is calculated how many times a figure is, in comparison to another figure. For example , if a firms credit sales during the year are Rs. 200000 and its debtors at the end of the year are Rs. 40000 , its Debtors Turnover Ratio is 200000/40000 = 5 times. It shows that the credit sales are 5 times in comparison to debtors.

3.

Percentage :- In this type, the relation between two figures is expressed in hundredth. For example, if a firms capital is Rs.1000000 and its profit is Rs.200000 the ratio of profit capital, in term of percentage, is 200000/1000000*100 = 20%

ADVANTAGE OF RATIO ANALYSIS

1. Helpful in analysis of Financial Statements:- The ratio analysis helps in analysis of financial statement. Ratio analysis is a technique of analysis and interpreting of financial statement. It is the process of establishing various ratios for helping in making certain decisions. 2. Helpful in comparative study:- Ratio analysis helps in comparative study. The comparative analysis are financial statement of the financial position at different period. The ratio analysis study the two or more items . 3. Helpful in locating the weak spots of the business:-A ratio is a simple arithmetical expression of the relationship of one number to another. Ratio analysis even helps in making effective control of the business. Standard ratio can be based upon the Performa financial statement and variances or deviations. The weaknesses or otherwise ,if any, come to the knowledge of the management which helps in effective control of the business. 4. Helpful in forecasting:-The ratio analysis is of much help in financial forecasting and planning. Planning is looking ahead and the ratios calculated for a number of years work as a guide for the future. Meaningful conclusions can be drawn for future from these ratios. 5. Estimate about the trend of the business:- The financial statement may be analyzed by computing trends of series of information. This method determines the direction upwards and downwards and involves the computation of the

percentage relationship that each statement item bears to the same item in base year. 6. Effective control: - Ratio analysis helps in making effective control of the business. Some ratios help in the business making effective control. 7 Study of financial soundness:-The ratio analysis study of the financial soundness of the financial .The ratio analysis helps in the business to know the financial strength of the business .Some ratios helps in the business to maintain the financial position of the business.

LIMITATION OF RATIO ANALYSIS

Comparison not possible if different firms adopt different accounting policies: Change in accounting procedure by a firm often makes ratio analysis

misleading e.g.:- change in the valuation of methods of inventories ,from FIFO to LIFO increases the cost of sales and reduces considerably the value of closing stocks which makes stock turnover ratio turnover ratio to be lucrative and an unfavorable gross profit ratio. Ratio analysis less effective due to price level changes: While making ratio analysis ,no consideration is made to changes in price levels and this makes the interpretation of ratios invalid. Ratio analysis may be misleading in the absence of absolute data: There are no well accepted standards or rules of thumb for all ratios which can be accepted as norms .It renders interpretation of the ratios difficult. Limited use of a single data: A single ratios ,usually does not convey much of a sense .To make a better interpretation a number of ratios have to be calculated which is likely to confuse the analyst than help him in making any meaningful conclusion.

Lack of proper standard: There are no well accepted standards of rules of thumb for all ratios which can be accepted as norms. It renders interpretation of the ratio difficult. False accounting data gives false ratio: Like financial statements, ratios also suffer from the inherent weakness of accounting records such as their historical nature. Ratio alone are not adequate for proper conclusion: Ratio analysis provides only clues to analysts and not final conclusion. These ratio have to be interpreted by these experts and there are no standard rules for interpretation. Effect of personal ability and bias of the analyst: Ratio are only means of financial analysis and not an end in itself .Ratios have to be interpreted and different people may interpret the same ratio. Unfavorable: Not only industries differ in their nature but also the firms of the similar business widely differ in their size and accounting procedures ,etc.It makes comparison of ratios difficult and misleading .Moreover ,comparison are made difficult due to differences in definition of various financial terms used in the ratio analysis. Ratios no substitutes: Ratio analysis is merely a tool of financial statements .Hence, ratios become useless from the statement from which they are computed. Window Dressing: Financial statements can easily be window dressed to present better picture of its financial and profitability position to outsiders .Hence one has to be very careful in making a decision from ratios calculated from such financial statements. But it may be very difficult for an outsider to know about the window dressing made by a firm.

CLASSIFICATION OF RATIO
A. Liquidity Ratio a. b. c. Current Ratio Quick Ratio or Acid Test Ratio Absolute Liquid ratio

B. Leverage or Capital Structure Ratio a. b. c. d. e. f. Debt Equity Ratio Debt to Total Fund Ratio Proprietary Ratio Fixed Assets to Proprietors Fund Ratio Capital Gearing Ratio Interest Coverage Ratio

C. Activity Ratio or Turnover Ratio a. b. c. d. e. f. g. Stock Turnover Ratio Debtors or Receivables Turnover Ratio Average Collection Period Creditors or Payables Turnover Ratio Average Payment Period Fixed Assets Turnover Ratio Working Capital Turnover Ratio

D. Profitability Ratio or Income Ratio (a) Profitability Ratio based on Sales: i. ii. iii. iv. Gross Profit Ratio Net Profit Ratio Operating Ratio Expenses Ratio

(a) Profitability Ratio Based on Investment: i. Return on Capital Employed

F. Return on Shareholders Funds: a. Return on Total Shareholders Funds b. Return on Equity Shareholders Funds c. Earning Per Share d. Dividend Per Share e. Dividend Payout Ratio f. Earning and Dividend Yield g. Price Earnings Ratio

LIQUIDITY RATIO
(A) Liquidity Ratio:- It refers to the ability of the firm to meet its current liabilities. The liquidity ratio, therefore, are also called Short-term Solvency Ratio. These ratio are used to assess the short-term financial position of the concern. They indicate the firms ability to meet its current obligation out of current resources.

In the words of Saloman J. Flink, Liquidity is the ability of the firms to meet its current obligations as they fall due. Liquidity ratio include three ratio :a. b. c. Current Ratio Quick Ratio or Acid Test Ratio Absolute Liquid Ratio

CURRENT RATIO: This ratio explains the relationship between current assets and current liabilities of a business. Current Assets: Current assets includes those assets which can be converted into cash with in a years time. Current Assets = Cash in Hand + Cash at Bank + B/R + Short Term Investment + Debtors(Debtors Provision) + Stock(Stock of Finished Goods + Stock of Raw Material + Work in Progress) + Prepaid Expenses. Current Liabilities:- Current liabilities include those liabilities which are repayable in a years time. Current Liabilities = Bank Overdraft + B/P + Creditors + Provision for Taxation + Proposed Dividend + Unclaimed Dividends + Outstanding Expenses + Loans Payable within a Year. Example: On December 31, 2010 Company B had total asset of $150,000, equity of $75,000, non-current assets of $50,000 and non-current liabilities of $50,000. Calculate the current ratio. Solution To calculate current ratio, we need to calculate current assets and current liabilities first:
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Current Assets = Total Asset Non-Current Assets = $150,000 $50,000 = $100,000 Total Liabilities = Total Assets Total Equity = $150,000 $75,000 = $75,000 Current Liabilities = $75,000 $50,000 = $25,000 Current Ratio = $100,000 $25,000 = 4.00 Example: On December 31, 2009 Company A had current assets of $100,000 and current liabilities of $50,000. Calculate its current ratio. Solution Current ratio = $100,000 $50,000 = 2.00 Significance:- According to accounting principles, a current ratio of 2:1 is supposed to be an ideal ratio. It means that current assets of a business should, at least , be twice of its current liabilities. The higher ratio indicates the better liquidity position, the firm will be able to pay its current liabilities more easily. If the ratio is less than 2:1, it indicate lack of liquidity and shortage of working capital. The biggest drawback of the current ratio is that it is susceptible to window dressing. This ratio can be improved by an equal decrease in both current assets and current liabilities. QUICK RATIO:- Quick ratio indicates whether the firm is in a position to pay its current liabilities with in a month or immediately. Liquid Assets means those assets, which will yield cash very shortly. Liquid Assets = Current Assets Stock Prepaid Expenses Example: A company has following assets and liabilities at the year ended December 31, 2009:
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Cash $34,390 Marketable Securities Accounts Receivable Prepaid Insurance Total Current Assets Total Current Liabilities 12,000 56,200 9,000 111,590 73,780

Calculate quick ratio (acid test ratio). Solution Quick ratio = ( 34,390 + 12,000 + 56,200 ) / 73,780 = 102,590 / 73,780 = 1.39 OR Quick ratio = ( 111,590 9,000 ) / 73,780 = 102,590 / 73,780 = 1.39 Significance:An ideal quick ratio is said to be 1:1. If it is more, it is

considered to be better. This ratio is a better test of short-term financial position of the company. Absolute liquid ratio:-Although receivables, debtors and bills receivable are generally more liquid than inventories, yet there may be doubts regarding their realization into cash immediately or in time. Hence some authorities are of the opinion that the absolute liquid ratio should also be calculated together with current ratio and acid test ratio so as to exclude receivables from the current asset and find out the absolute liquid assets. Absolute liquid ratio = Absolute liquid asset Current liabilities Absolute liquid asset = Cash+bank+Short-term securities

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Significance Absolute liquid asset include cash in hand and at bank and marketable securities or temporary investment. The acceptable norm for this ratio is 50%or 0.5:1i.e.Re.1worth absolute liquid asset are considered adequate to pay Rs.2 worth current liabilities in time as all creditors are not expected to demand cash at the same time and then cash may also be realized from debtors and inventories. EXAMPLE From the following balance sheet calculate absolute liquid ratio: Liabilities Share capital Reserves Bank overdraft Sundry creditors Bills payable Outstanding expenses $ 5,00,000 1,90,000 1,00,000 1,40,000 50,000 10,000 Assets Goodwill Plant & machinery Trade investments Marketable securities Bills receivable Cash Bank Inventories 9,90,000 Solution: Absolute liquid assets Absolute liquid ratio = Absolute liquid assets/Current liabilities Absolute liquid assets are marketable securities, cash and bank. Thus $1,50,000 + $45,000 + $30,000 = $2,25,000 Current liabilities are bank overdraft, sundry creditors, bills payable and creditors for outstanding expenses. = 1,00,000 + 1,40,000 + 50,000 + 10,000 = $3,00,000. Absolute liquid ratio = 2,25,000 / 3,00,000 = 0.75
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$ 50,000 4,00,000 2,00,000 1,50,000 40,000 45,000 30,000 75,000 9,90,000

The absolute liquid ratio in this case is 0.75 which is better as compared to rule of thumb standard which is 0.50.

LEVERAGE OR CAPITAL STRUCTURE RATIO

(B) Leverage or Capital Structure Ratio :- This ratio disclose the firms ability to meet the interest costs regularly and Long term indebtedness at maturity. These ratio include the following ratios : a. Debt Equity Ratio:- This ratio can be expressed in two ways: First Approach: According to this approach, this ratio expresses the relationship between long term debts and shareholders fund. Formula: Debt Equity Ratio=Long term Loans/Shareholders Funds or Net Worth Long Term Loans:- These refer to long term liabilities which mature after one year. These include Debentures, Mortgage Loan, Bank Loan, Loan from Financial institutions and Public Deposits etc. Shareholders Funds :- These include Equity Share Capital, Preference Share Capital, Share Premium, General Reserve, Capital Reserve, Other Reserve and Credit Balance of Profit & Loss Account. Second Approach: According to this approach the ratio is calculated as follows:Formula: Debt Equity Ratio=External Equities/internal Equities Debt equity ratio is calculated for using second approach.
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Significance :- This Ratio is calculated to assess the ability of the firm to meet its long term liabilities. Generally, debt equity ratio of is considered safe. If the debt equity ratio is more than that, it shows a rather risky financial position from the long-term point of view, as it indicates that more and more funds invested in the business are provided by long-term lenders. The lower this ratio, the better it is for long-term lenders because they are more secure in that case. Lower than 2:1 debt equity ratio provides sufficient protection to long-term lenders. Example:Calculate debt-to-equity ratio of a business which has total liabilities of $3,423,000 and shareholders' equity of $5,493,000. Solution Debt-to-Equity Ratio = $3,423,000 / $5,493,000 = 0.62 DEBT TO TOTAL FUNDS RATIO : This Ratio is a variation of the debt equity ratio and gives the same indication as the debt equity ratio. In the ratio, debt is expressed in relation to total funds, i.e., both equity and debt. Formula: Debt to Total Funds Ratio = Long-term Loans/Shareholders funds + Long-term Loans Significance :- Generally, debt to total funds ratio of 0.67:1 (or 67%) is considered satisfactory. In other words, the proportion of long term loans should not be more than 67% of total funds.

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A higher ratio indicates a burden of payment of large amount of interest charges periodically and the repayment of large amount of loans at maturity. Payment of interest may become difficult if profit is reduced. Hence, good concerns keep the debt to total funds ratio below 67%. The lower ratio is better from the longterm solvency point of view. Example: ABC Company has applied for a loan. The lender of the loan requests you to compute the debt to equity ratio as a part of the long-term solvency test of the company. The Liabilities and Stockholders Equity section of the balance sheet of ABC company is given below: Liabilities and Stockholders Equity Current liabilities: Accounts payable Accrued payables Short-term notes payable Total current liabilities Long-term liabilities: 6% Bonds payable Total liabilities Stockholders equity: 3,750 7,250 2,900 450 150 3,500

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Preferred stock, $100, 6% Common stock, $12 par Additional paid-in capital Total paid in capital Retained earnings Total stockholders equity Total liabilities and stockholders equity

1,000 3,000 500 4,500 4,000 8,500 15,750

Solution:

= 7,250 / 8,500 = 0.85 The debt to equity ratio of ABC company is 0.85 or 0.85 : 1. It means the creditors of ABC company provide 85 cents of assets for each $1 of assets provided by stockholders c. Proprietary Ratio:- This ratio indicates the proportion of total funds provide by owners or shareholders. Formula: Proprietary Ratio = Shareholders Funds/Shareholders Funds + Long term loans
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Significance :- This ratio should be 33% or more than that. In other words, the proportion of shareholders funds to total funds should be 33% or more. A higher proprietary ratio is generally treated an indicator of sound financial position from long-term point of view, because it means that the firm is less dependent on external sources of finance. If the ratio is low it indicates that long-term loans are less secured and they face the risk of losing their money. Fixed Assets to Proprietors Fund Ratio:- This ratio is also know as fixed assets to net worth ratio. Formula: Fixed Asset to Proprietors Fund Ratio = Fixed Assets/Proprietors Funds (i.e., Net Worth) Significance The ratio indicates the extent to which proprietors (Shareholders) funds are sunk into fixed assets. Normally , the purchase of fixed assets should be financed by proprietors funds. If this ratio is less than 100%, it would mean that proprietors fund are more than fixed assets and a part of working c apital is provided by the proprietors. This will indicate the long-term financial soundness of business. Capital Gearing Ratio:- This ratio establishes a relationship between equity capital (including all reserves and undistributed profits) and fixed cost bearing capital. Formula: Capital Gearing Ratio = Equity Share Capital+ Reserves + P&L Balance/ Fixed cost Bearing Capital
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Whereas, Fixed Cost Bearing Capital = Preference Share Capital + Debentures + Long Term Loan Significance:- If the amount of fixed cost bearing capital is more than the equity share capital including reserves an undistributed profits), it will be called high capital gearing and if it is less, it will be called low capital gearing. The high gearing will be beneficial to equity shareholders when the rate of interest/dividend payable on fixed cost bearing capital is lower than the rate of return on investment in business. Thus, the main objective of using fixed cost bearing capital is to maximize the profits available to equity shareholders. Example: The following information have been taken from the balance sheet of PQR limited: 2011 Common stockholders equity 2012

3,500,000 2,800,000

Preferred stock 9%

1,400,000 1,800,000

Bonds payable 6%

1,600,000 1,400,000

We can compute the capital gearing ratio for the years 2011 and 2012 from the above information as follows:
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For the year 2011: Capital gearing ratio = 3,500,000 / 3,000,000 = 7: 6 (Low geared) For the year 2012: Capital gearing ratio = 2,800,000 / 3,200,000 = 7: 8 (Highly geared) The company has a low geared capital structure in 2011 and highly geared capital structure in 2012. Notice that the gearing is inverse ratio to the common stockholders equity. Less common

Highly geared

>>> stockholders equity More common >>> stockholders equity

Low geared

f. Interest Coverage Ratio:- This ratio is also termed as Debt Service Ratio. This ratio is calculated as follows: Formula: Interest Coverage Ratio = Net Profit before charging interest and tax / Fixed Interest Charges Significance: - This ratio indicates how many times the interest charges are covered by the profits available to pay interest charges. This ratio measures the margin of safety for long-term lenders.
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This higher the ratio, more secure the lenders is in respect of payment of interest regularly. If profit just equals interest, it is an unsafe position for the lender as well as for the company also, as nothing will be left for shareholders. An interest coverage ratio of 6 or 7 times is considered appropriate. Example ABC PLC has the following financial results for the year ended 31st December 2012: $m Sales Cost of sales Gross Profit General and administration Finance cost (Note 1) Profit before tax Taxation Profit after tax 200 110 90 (20) (30) 40 (10) 30

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Note 1: Finance Cost Finance cost comprises the following expenses: $m Bank Charges Unwinding of discount on provisions Interest cost on short term and long term borrowings 5 5

20

30

Interest Coverage may be calculated as follows: Profit before interest & tax Interest Coverage = Interest expense = 20* 40 + 30 = 3 times

*Interest cost used in calculating interest coverage includes only the interest expense incurred on loans and other financing arrangements but does not include accounting expense recognized in respect of unwinding of discount on the recalculation of present value of provisions.

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ACTIVITY RATIO OR TURNOVER RATIO

(C) Activity Ratio or Turnover Ratio :- These ratio are calculated on the bases of cost of sales or sales, therefore, these ratio are also called as Turnover Ratio. Turnover indicates the speed or number of times the capital employed has been rotated in the process of doing business. Higher turnover ratio indicates the better use of capital or resources and in turn leads to higher profitability. It includes the following : Stock Turnover Ratio:- This ratio indicates the relationship between the cost of goods during the year and average stock kept during that year. Formula: Stock Turnover Ratio = Cost of Goods Sold / Average Stock Here, Cost of goods sold = Net Sales Gross Profit Average Stock = Opening Stock + Closing Stock/2 Significance:- This ratio indicates whether stock has been used or not. It shows the speed with which the stock is rotated into sales or the number of times the stock is turned into sales during the year. The higher the ratio, the better it is, since it indicates that stock is selling quickly. In a business where stock turnover ratio is high, goods can be sold at a low margin of profit and even than the profitability may be quite high. Example : Cost of goods sold of a retail business during a year was $84,270 and its inventory at the beginning and at the ending of the year was $9,865 and $11,650 respectively. Calculate the inventory turnover ratio of the business from the given information. Solution
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Average Inventory = ($9,865 + $11,650) 2 = $10,757.5 Inventory Turnover = $84,270 $10,757.5 7.83 b. Debtors Turnover Ratio :- This ratio indicates the relationship between credit sales and average debtors during the year : Formula: Debtor Turnover Ratio = Net Credit Sales / Average Debtors + Average B/R While calculating this ratio, provision for bad and doubtful debts is not deducted from the debtors, so that it may not give a false impression that debtors are collected quickly. Significance :- This ratio indicates the speed with which the amount is collected from debtors. The higher the ratio, the better it is, since it indicates that amount from debtors is being collected more quickly. The more quickly the debtors pay, the less the risk from bad- debts, and so the lower the expenses of collection and increase in the liquidity of the firm. By comparing the debtors turnover ratio of the current year with the previous year, it may be assessed whether the sales policy of the management is efficient or not. Example : Net credit sales of Company A during the year ended June 30, 2010 were $644,790. Its accounts receivable at July 1, 2009 and June 30, 2010 were $43,300 and $51,730 respectively. Calculate the receivables turnover ratio. Solution Average Accounts Receivable = ($43,300 + $51,730) 2 = $47,515 Receivables Turnover Ratio = $644,790 $47,515 = 13.57
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c. Average Collection Period :- This ratio indicates the time with in which the amount is collected from debtors and bills receivables. Formula: Average Collection Period = Debtors + Bills Receivable / Credit Sales per day Here, Credit Sales per day = Net Credit Sales of the year / 365 Second Formula:Average Collection Period = Average Debtors *365 / Net Credit Sales Average collection period can also be calculated on the bases of Debtors Turnover Ratio. The formula will be: Average Collection Period = 12 months or 365 days / Debtors Turnover Ratio Significance :- This ratio shows the time in which the customers are paying for credit sales. A higher debt collection period is thus, an indicates of the inefficiency and negligence on the part of management. On the other hand, if there is decrease in debt collection period, it indicates prompt payment by debtors which reduces the chance of bad debts. Example Following data have been extracted from the books of accounts of PQR Ltd. $ Total sales Cash sales Sales returns 200,000 77,000 24,000

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Accounts receivables (closing) Notes receivables (closing)

8,000 3,000

Compute average collection period for PQR Ltd. Solution

360* /9** 40 days On average, the PQR limited have to wait for 40 days before the receivables are collected. *Assumed number of working days in a year.

**Receivables turnover ratio has been calculated as follows: Net credit sales / Receivables + Notes receivables 99,000 / 8,000 + 3,000 99,000 /11,000 = 9 times d. Creditors Turnover Ratio :- This ratio indicates the relationship between credit purchases and average creditors during the year . Formula:Creditors Turnover Ratio = Net credit Purchases / Average Creditors + Average B/P Note :- If the amount of credit purchase is not given in the question, the ratio may be calculated on the bases of total purchase.

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Significance :- This ratio indicates the speed with which the amount is being paid to creditors. The higher the ratio, the better it is, since it will indicate that the creditors are being paid more quickly which increases the credit worthiness of the firm. EXAMPLE P&G is a trading company. The company has a good relation with vendors. All the purchases are made on credit. The following data has been extracted from the financial statements for the year 2012 and 2011:

Purchases during 2012

$ 220,000

Purchases returns during 2012

20,000

Accounts payable on 31 December, 2011

40,000

Accounts payable on 31 December, 2012

20,000

Notes payable on 31 December, 2011

8,000

Notes payable on 31 December, 2012

12,000

Required: Compute accounts payable turnover ratio (creditors velocity). Solution:

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= $200,000* / $40,000** = 5 times It means, on average, P&G Company pays its creditors 5 times in a year. * 220,000 20,000

** [(40,000 + 8,000) + (20,000 + 12,000)] / 2 d. Average Payment Period :- This ratio indicates the period which is normally taken by the firm to make payment to its creditors. Formula:Average Payment Period = Creditors + B/P/ Credit Purchase per day This ratio may also be calculated as follows: Average Payment Period = 12 months or 365 days / Creditors Turnover Ratio Significance: - The lower the ratio, the better it is, because a shorter payment period implies that the creditors are being paid rapidly. Example: Metro trading company makes most of its purchases on credit. The extracted data for the year 2012 is given below: Total purchases Cash purchases Purchases returns Accounts payable at the start of the year $ 600,000 150,000 30,000

65,000

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Accounts payable at the end of the year Notes payable at the start of the year Notes payable at the end of the year

40,000

20,000

15,000

Required: Calculate average payment period from the above data. Solution: When complete information about credit purchases and opening and closing balances of accounts payable is given, the proper method to compute average payment period is to compute accounts payable turnover ratio first and then divide the number of working days in a year by accounts payable turnover ratio.

= $420,000* / $70,000** = 6 times Average payment period = 360 days /6 times 60 days d. Fixed Assets Turnover Ratio :- This ratio reveals how efficiently the fixed assets are being utilized. Formula:Fixed Assets Turnover Ratio = Cost of Goods Sold/ Net Fixed Assets

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Here, Net Fixed Assets = Fixed Assets Depreciation Significance:- This ratio is particular importance in manufacturing concerns where the investment in fixed asset is quit high. Compared with the previous year, if there is increase in this ratio, it will indicate that there is better utilization of fixed assets. If there is a fall in this ratio, it will show that fixed assets have not been used as efficiently, as they had been used in the previous year. Example: ABC Company has gross fixed assets of $5,000,000 and accumulated depreciation of $2,000,000. Sales over the last 12 months totaled $9,000,000. The calculation of ABC's fixed asset turnover ratio is: $9,000,000 Net sales $5,000,000 Gross fixed assets - $2,000,000 Accumulated depreciation = 3.0 Turnover per year e. Working Capital Turnover Ratio :- This ratio reveals how efficiently working capital has been utilized in making sales. Formula :Working Capital Turnover Ratio = Cost of Goods Sold / Working Capital Here, Cost of Goods Sold = Opening Stock + Purchases + Carriage + Wages + Other Direct Expenses - Closing Stock Working Capital = Current Assets Current Liabilities Significance :- This ratio is of particular importance in non-manufacturing concerns where current assets play a major role in generating sales. It shows the number of times working capital has been rotated in producing sales.

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A high working capital turnover ratio shows efficient use of working capital and quick turnover of current assets like stock and debtors. A low working capital turnover ratio indicates under-utilisation of working capital Example: ABC Company has $12,000,000 of net sales over the past twelve months, and average working capital during that period of $2,000,000. The calculation of its working capital turnover ratio is: $12,000,000 Net sales $2,000,000 Average working capital = 6.0 Working capital turnover ratio Profitability Ratios or Income Ratios (D) Profitability Ratios or Income Ratios:- The main object of every business concern is to earn profits. A business must be able to earn adequate profits in relation to the risk and capital invested in it. The efficiency and the success of a business can be measured with the help of profitability ratio. Profitability ratios are calculated to provide answers to the following questions: i. ii. iii. iv. v. Is the firm earning adequate profits? What is the rate of gross profit and net profit on sales? What is the rate of return on capital employed in the firm? What is the rate of return on proprietors (shareholders) funds? What is the earning per share?

Profitability ratio can be determined on the basis of either sales or investment into business.
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(A)

Profitability Ratio Based on Sales :

a) Gross Profit Ratio : This ratio shows the relationship between gross profit and sales. Formula : Gross Profit Ratio = Gross Profit / Net Sales *100 Here, Net Sales = Sales Sales Return Significance:- This ratio measures the margin of profit available on sales. The higher the gross profit ratio, the better it is. No ideal standard is fixed for this ratio, but the gross profit ratio should be adequate enough not only to cover the operating expenses but also to provide for deprecation, interest on loans, dividends and creation of reserves. Example: The following data relates to a small trading company. Compute the gross profit ratio (GP ratio) of the company. Gross sales Sales returns Opening stock Purchases Purchases returns Closing stock $ 1,000,000 90,000 200,000 590,000

70,000

45,000

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Solution: With the help of above information, we can compute the gross profit ratio as follows:

= (235,000 / 910,000) = 0.2582 or 25.82% The GP ratio is 25.82%. It means the company may reduce the selling price of its products by 25.82% without incurring any loss. *Computation of gross profit: Sales Less sales returns Net sales Less cost of goods sold: Opening inventory Purchases 590,000 Purchases 70,000 520,000 returns Available for sale 720,000 200,000 1,000,000 90,000 910,000

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Less closing inventory Gross profit

45,000

675,000

235,000

b) Net Profit Ratio:- This ratio shows the relationship between net profit and sales. It may be calculated by two methods: Formula: Net Profit Ratio = Net Profit / Net sales *100 Operating Net Profit = Operating Net Profit / Net Sales *100 Here, Operating Net Profit = Gross Profit Operating Expenses such as Office and Administrative Expenses, Selling and Distribution Expenses, Discount, Bad Debts, Interest on short-term debts etc. Significance :- This ratio measures the rate of net profit earned on sales. It helps in determining the overall efficiency of the business operations. An increase in the ratio over the previous year shows improvement in the overall efficiency and profitability of the business. Example: Sales Returns inwards Gross profit 210,000

10,000

80,000

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Administrative expenses Selling expenses Interest investment Loss on on

15,000

15,000

10,000

account of fire Income tax

6,000

5,000

Net profit ratio would be computed as follows:

= ($45,000* / 200,000**) = 0.225 or 22.5% *Computation of net operating profit after tax: Gross profit Less operating expenses: 15,000 Administrative 80,000

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expenses Selling expenses Net operating profit tax Less tax Net operating profit after tax income before 50,000

15,000 30,000

5,000

45,000

(c) Operating Ratio:- This ratio measures the proportion of an enterprise cost of sales and operating expenses in comparison to its sales. Formula: Operating Ratio = Cost of Goods Sold + Operating Expenses/ Net Sales *100 Where, Cost of Goods Sold = Opening Stock + Purchases + Carriage + Wages + Other Direct Expenses - Closing Stock Operating Expenses = Office and Administration Exp. + Selling and Distribution Exp. + Discount + Bad Debts + Interest on Short- term loans. Operating Ratio and Operating Net Profit Ratio are inter-related. Total of both these ratios will be 100. Significance:- Operating Ratio is a measurement of the efficiency and profitability of the business enterprise. The ratio indicates the extent of sales that is absorbed by the cost of goods sold and operating expenses. Lower the operating ratio is better, because it will leave higher margin of profit on sales.
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Example: The selected data from the records of Good Luck limited is given below: $ Net sales Cost of goods sold 200,000 120,000

Administrative expenses

20,000

Selling expense Interest charges

20,000 10,000

Required: Compute operating ratio for Good Luck limited from the above data. Solution:

= (160,000* / 200,000) 100 = 80% The operating profit ratio is 80%. It means 80% of the sales revenue would be used to cover cost of goods sold and operating expenses of Good Luck limited. *Computation of operating cost: Cost of goods sold + Administrative expenses + Selling expenses = $120,000 + $20,000 + $20,000 = $160,000

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(d) Expenses Ratio:- These ratio indicate the relationship between expenses and sales. Although the operating ratio reveals the ratio of total operating expenses in relation to sales but some of the expenses include in operating ratio may be increasing while some may be decreasing. Hence, specific expenses ratio are computed by dividing each type of expense with the net sales to analyse the causes of variation in each type of expense. The ratio may be calculated as : (a) Material Consumed Ratio = Material Consumed/Net Sales*100 (b) Direct Labour cost Ratio = Direct labour cost / Net sales*100 (c) Factory Expenses Ratio = Factory Expenses / Net Sales *100 (a), (b) and (c) mentioned above will be jointly called cost of goods sold ratio. It may be calculated as: Cost of Goods Sold Ratio = Cost of Goods Sold / Net Sales*100 (d) Office and Administrative Expenses Ratio = Office and Administrative Exp./ Net Sales*100 (e) Selling Expenses Ratio = Selling Expenses / Net Sales *100 (f) Non- Operating Expenses Ratio = Non-Operating Exp./Net sales*100 Significance:- Various expenses ratio when compared with the same ratios of the previous year give a very important indication whether these expenses in relation to sales are increasing, decreasing or remain stationary. If the expenses ratio is lower, the profitability will be greater and if the expenses ratio is higher, the profitability will be lower.

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Example: Administrative expenses are $2,500, selling expenses are $3,200 and sales are $25,00,000. Calculate expense ratio. Calculation: Administrative expenses ratio = (2,500 / 25,00,000) 100 = 0.1% Selling expense ratio = (3,200 / 25,00,000) 100 = 0.128% (B) Profitability Ratio Based on Investment in the Business:These ratio reflect the true capacity of the resources employed in the enterprise. Sometimes the profitability ratio based on sales are high whereas profitability ratio based on investment are low. Since the capital is employed to earn profit, these ratios are the real measure of the success of the business and managerial efficiency. These ratio may be calculated into two categories: I. Return on Capital Employed II. Return on Shareholders funds I. Return on Capital Employed :- This ratio reflects the overall profitability

of the business. It is calculated by comparing the profit earned and the capital employed to earn it. This ratio is usually in percentage and is also known as Rate of Return or Yield on Capital. Formula:
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Return on Capital Employed = Profit before interest, tax and dividends/ Capital Employed *100 Where, Capital Employed = Equity Share Capital + Preference Share Capital + All Reserves + P&L Balance +Long-Term Loans- Fictitious Assets (Such as Preliminary Expenses OR etc.) Non-Operating Assets like Investment made outside the business. Capital Employed = Fixed Assets + Working Capital Examples The average stockholders' equity and average capital employed of a company during the accounting year ended December 31, 20X2 were $348,000 and $120,000 respectively. The net profit during the period was $49,000. Calculate return on capital employed of the company. Solution Return on Capital Employed = 49,000 (348,000 + 120,000) = 10.5% Advantages of Return on Capital Employed: Since profit is the overall objective of a business enterprise, this ratio is a barometer of the overall performance of the enterprise. It measures how efficiently the capital employed in the business is being used. Even the performance of two dissimilar firms may be compared with the help of this ratio. The ratio can be used to judge the borrowing policy of the enterprise. This ratio helps in taking decisions regarding capital investment in new projects. The new projects will be commenced only if the rate of return on capital employed in such projects is expected to be more than the rate of borrowing.
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 This ratio helps in affecting the necessary changes in the financial policies of the firm. Lenders like bankers and financial institution will be determine whether the enterprise is viable for giving credit or extending loans or not. With the help of this ratio, shareholders can also find out whether they will receive regular and higher dividend or not. II. Return on Shareholders Funds :Return on Capital Employed Shows the overall profitability of the funds supplied by long term lenders and shareholders taken together. Whereas, Return on shareholders funds measures only the profitability of the funds invested by shareholders. These are several measures to calculate the return on shareholders funds: (a) Return on total Shareholders Funds :For calculating this ratio Net Profit after Interest and Tax is divided by total shareholders funds. Formula: Return on Total Shareholders Funds = Net Profit after Interest and Tax / Total Shareholders Funds Where, Total Shareholders Funds = Equity Share Capital + Preference Share Capital + All Reserves + P&L A/c Balance Fictitious Assets Significance:- This ratio reveals how profitably the proprietors funds have been utilized by the firm. A comparison of this ratio with that of similar firms will throw light on the relative profitability and strength of the firm.

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(b) Return on Equity Shareholders Funds:Equity Shareholders of a company are more interested in knowing the earning capacity of their funds in the business. As such, this ratio measures the profitability of the funds belonging to the equity shareholders. Formula: Return on Equity Shareholders Funds = Net Profit (after int., t ax & preference dividend) / Equity Shareholders Funds *100 RATIO ANALYSIS Where, Equity Shareholders Funds = Equity Share Capital + All Reserves + P&L A/c Balance Fictitious Assets Significance:- This ratio measures how efficiently the equity sha reholders funds are being used in the business. It is a true measure of the efficiency of the management since it shows what the earning capacity of the equity shareholders funds. If the ratio is high, it is better, because in such a case equity shareholders may be given a higher dividend. Example : Company A earned net income of $1,722,000 during the year ending march 31, 2011. The shareholders' equity on April 30, 2010 and March 31, 2011 was $14,587,000 and $16,332,000 respectively. Calculate its return on equity for the year ending March 31, 2011. Solution Average Shareholders' Equity = ( $14,587,000 + $16,332,000 ) / 2 = $15,459,500 Return On Equity = $1,722,000 / $15,459,500 0.11 or 11%
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Example : Total assets and total liabilities of Company B on Jan 1, 2010 were $2,342,000 and $1,383,000. During the year ended December 31, 2011 it made a net profit of $242,000 and its shareholders' equity increased by $302,000. Calculate ROE of Company B. Solution Step 1: Beginning Shareholders' Equity = $2,342,000 $1,383,000 = $959,000 Step 2: Ending Shareholders' Equity = $959,000 + $302,000 = $1,261,000 Step 3: Average Shareholders' Equity = ( $959,000 + $1,261,000 ) / 2 = $1,110,000 Step 4: Return On Equity = $242,000 / $1,110,000 0.22 or 22% (c) Earning Per Share (E.P.S.) :- This ratio measure the profit available to the equity shareholders on a per share basis. All profit left after payment of tax and preference dividends are available to equity shareholders. Formula: Earnings Per Share = Net Profit Dividend on Preference Shares / No. of Equity Shares Significance:- This ratio helpful in the determining of the market price of the equity share of the company. The ratio is also helpful in estimating the capacity of the company to declare dividends on equity shares. Example Following data has been extracted from the financial statements of Peter Electronics Limited. You are required to compute the earnings per share ratio of the company for the year 2012.
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Data taken from income statement: Net income Preferred dividend 1,500,000 180,000 Income available for common

stockholders

1,320,000

Data taken from balance sheet: 2012 Preferred stock 6% 2011

3,000,000 3,000,000

Common stock Par value $15 2,376,000 2,376,000 Solution: From the above data, we can compute the earnings per share (EPS) ratio as follows:

= $1,320,000/ 158,400* shares = $8.33 per share *Average number of + shares outstanding during 2012: /2

[($2,376,000/$15)

($2,376,000/$15)]

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[158,400 158,400

158,400]

/2

(d) Dividend Per Share (D.P.S.):- Profits remaining after payment of tax and preference dividend are available to equity shareholders. But of these are not distributed among them as dividend. Out of these profits is retained in the business and the remaining is distributed among equity shareholders as dividend. D.P.S. is the dividend distributed to equity shareholders divided by the number of equity shares. Formula: D.P.S. = Dividend paid to Equity Shareholders / No. of Equity Shares *100 (e) Dividend Payout Ratio or D.P. :- It measures the relationship between the earning available to equity shareholders and the dividend distributed among them. Formula: D.P. = Dividend paid to Equity Shareholders/ Total Net Profit belonging to Equity Shareholders*100 OR D.P. = D.P.S. / E.P.S. *100 (f) Earning and Dividend Yield :- This ratio is closely related to E.P.S. and D.P.S. While the E.P.S. and D.P.S. are calculated on the basis of the book value of shares, this ratio is calculated on the basis of the market value of share (g) Price Earning (P.E.) Ratio:- Price earning ratio is the ratio between market price per equity share & earnings per share. The ratio is calculated to make an estimate .
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Significance :- This ratio shows how much is to be invested in the market in this companys shares to get each rupee of earning on its shares. This ratio is used to measure whether the market price of a share is high or low. EXAMPLE A share of T Ltd. has current market price of $20 and it's EPS for current period is reported as $2. It's EPS for next period is expected as $2.5, expected payout ratio is 40%, required rate of return is 12% and growth rate is 6%. Find the trailing P/E, leading P/E and justified P/E. Solution Trailing P/E = current share price/current year EPS = $20/$2 = 10 Leading P/E = current share price/next year EPS = $20/$2.5 = 8 Justified P/E = payout ratio/(required rate of return growth rate) = 40%/(12% 6%) = 40%/6% = 6.67 Reciprocal of P/E ratio is called earnings yield (which is EPS/price). Ratio analysis at NSL

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EXECUTIVE SUMMARY
Ratio Analysis is one of the techniques of financial analysis where ratios are used as a yardstick for evaluating the financial condition and performance of a firm. Analysis and interpretation of various accounting ratios gives a better understanding of financial condition and performance of firm. Trend ratios indicate the direction of change in the performance improvement, deterioration or constancy- over the year.

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OBJECTIVES OF THE STUDY:

1.To help the management in its planning and forecasting activities.2.To evaluate operational efficiency, liquidity, and solvency of NSL.3.To help the management in having effective control over the activities of

differentdepartments.4.To compare the previous five years and present year performance of the company.5.To give suggestion and recommendation based on the study. For the study Nirani sugars Ltd , is considered. The ratio analysis is done using the Incomestatements and Balance Sheets of the company between 2005 to

2009.Data Interpretation on trend ratio analysis is carried out at NSL at Kulali cross Tq:Mudhol Dist: Bagalkot Karnataka State. For study, of five years is considered and compared its performance over the period of five years. For result analysis and MS ExcelSoftware package are used. From the analysis, I am able to indicate following finding of thefirm1.Fro m the current ratio it is found that the ratio is not satisfactory because the %increase in current assets is less than the % increase in current liabilities during the year 2005-2009.The highest ratio recorded is 3.04 in 2005 and the lowest ratio recorded is 0.42 in the year 2007.And less than the standard ratio.2.From the gross profit ratio it is found that the ratio is satisfactory during the last three years from 2007 to 2009. The highest ratio recorded in the year 2008 is 21.65and the lowest ratio recorded is 0.11 in the year 2005.3.From the operating profit ratio it is found that the ratio is highly satisfactory during the considered financial years.

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INTRODUCTION
Ratio analysis is a technique of analyzing the financial statement of industrial concerns. Now a day this technique is sophisticated and is commonly used in business concerns. Ratio analysis is not an end but it is only means of better understanding of financial strength and weakness of a firm. Ratio analysis is one of the most powerful tools of financial analysis which helps in analyzing and interpreting the health of the firm. Ratios are proved as the basic instrument in the control process and act as back bone in schemes of the business forecast. With the help of ratio we can determine 1.The ability of the firm to meet its current obligation. 2.The limit or extent to which the firm has used its borrowed funds. 3. The efficiency with which the firm is utilizing in generating sales revenue. The operating efficiency and performance of the company. Classification of Ratios Ratios can be classified into different categories depending upon the basis of classification.

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SUGGESTION
1.The co mpan y ma y i mprove its current ratio by decreasing the current liabilities because in the year 2008-09 current assets are decreased and it may also improve its quick ratio .2.The company may decrease its total debt as there is increase in total debt the year 2008-09. The company may increase its investment in current assets. 3.Long terms solvency of the compan y has to be improved by limiting a mount invested by outsiders to the amount invested by the owner of the company . This can be achieved by purchasing the shares gradually. 4.The proper man age ment of the inventory can i mpr ove liquidity position and efficiency of the company. Balance is also increased for the above said years this is due to companys revised policy in debt collection. It is also observed that the current ratio is not so satisfactory which creates chunks in the current assets in the form of sundry debtors and inventory.

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INTERPRETATION The table shows that the total debt ratio of NSL had increase in the year 2005 and2006 from 0.61 to 0.62 and had fluctuation to 0.52 in the year 2007 and further Increased to 0.82 in the 2008 and 0.93 in the year 2009. The company had increase In the total debt by 3.27% and 0.23% in net worth and in the year 2009 the debt Was increased by 11.02%and 0.188% in net worth. Debt equity ratio measures ultimate Solvency of the company. It provides a margin of safety to creditors ,thus when the ratio is Smaller the creditors are more secured . An appropriate debt equity ratio is 0.33.A ratio Higher than this is an indication of risky financial policy.

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CONCLUSION Ratio analysis is a simple arithmetical expression of the relationship of one number to another .It may be defined as the indicated quotient of two mathematical expression .A Financial ratio is the relationship between two accounting figure expressed

mathematically ratio can also be expressed as percentage by simply multiplying the ratio Ratio analysis is a technique of analysis and interpretation of financial statement.It is a process of establishing and interpreting various ratios for helping in making certain decisions.

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BIBLIOGRAPHY 1. WIKIPEDIA 2. GOOGLE SEARCH 3.WWW.ALL PROJECT.COM 4. WWW.RATIO ANALYSIS PROJECT.COM 5.WWW.BOOK PUBLISHER .COM 6.RATIO WORDWIDE

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