Ratio Analysis

Financial Statements Analysis
© Tata McGraw-Hill Publishing Company Limited, Management Accounting 6-1

FINANCIAL STATEMENTS
ANALYSIS
Ratio Analysis
Common Size Statements
Importance and Limitations of

Ratio Analysis
© Tata McGraw-Hill Publishing Company Limited, Management 6-2
Accounting
Ratio Analysis
Ratio analysis is a widely used tool of financial analysis. It is

defined as the systematic use of ratio to interpret the
financial statements so that the strengths and
weaknesses of a firm as well as its historical
performance and current financial
condition can be determined.

Accounting
Basis of Comparison
1) Trend Analysis involves comparison of a firm over a period
of time, that is, present ratios are compared with past
ratios for the same firm. It indicates the direction of
change in the performance – improvement, deterioration
or constancy – over the years.
2) Interfirm Comparison involves comparing the ratios of a

firm with those of others in the same lines of business or
for the industry as a whole. It reflects the firm’s
performance in relation to its competitors.
3) Comparison with standards or industry average.

Accounting
Types of Ratios
Liquidity
LiquidityRatios
Ratios Capital
CapitalStructure
StructureRatios
Ratios
Profitability
ProfitabilityRatios
Ratios Efficiency
Efficiencyratios
ratios
Integrated
Integrated Growth
GrowthRatios
Ratios
Analysis
AnalysisRatios
Ratios
Accounting
Net Working Capital
Net working capital is a measure of liquidity calculated by
subtracting current liabilities from current assets.
Table 1: Net Working Capital

Particulars Company A Company B
Total current assets Rs 1,80,000 Rs 30,000
Total current liabilities 1,20,000 10,000
NWC 60,000 20,000
Table 2: Change in Net Working Capital

Particulars Company A Company B
Current assets Rs 1,00,000 Rs 2,00,000
Current liabilities 25,000 1,00,000
NWC 75,000 1,00,000

Accounting
Liquidity Ratios
Liquidity ratios measure the ability

of a firm to meet its short-term
obligations

Accounting
Current Ratio
Current Ratio is a measure of liquidity calculated dividing
the current assets by the current liabilities
Current Assets
Current Ratio =
Current Liabilities
Particulars Firm A Firm B

Current Assets Rs 1,80,000 Rs 30,000
Current Liabilities Rs 1,20,000 Rs 10,000
Current Ratio = 3:2 (1.5:1) 3:1

Accounting
Acid-Test Ratio
The quick or acid test ratio takes into consideration
the differences in the liquidity of the
components of current assets
Quick Assets
Acid-test Ratio =
Current Liabilities
Quick Assets = Current assets – Stock –

Pre-paid expenses
Accounting
Example 1: Acid-Test Ratio
Cash Rs 2,000
Debtors 2,000
Inventory 12,000
Total current assets 16,000
Total current liabilities 8,000
(1) Current Ratio 2:1
(2) Acid-test Ratio 0.5 : 1
6-
© Tata McGraw-Hill Publishing Company Limited, Management 10
Accounting
Supplementary Ratios for
Liquidity
Inventory
Inventory Turnover
Turnover Debtors
Debtors Turnover
Turnover Ratio
Ratio
Ratio
Ratio
Creditors
Creditors Turnover
Turnover Ratio
Ratio
6-
Accounting
Inventory Turnover Ratio
The ratio indicates how fast inventory is sold. A high ratio is good
from the viewpoint of liquidity and vice versa. A low ratio
would signify that inventory does not sell fast and stays
on the shelf or in the warehouse for a long time.
Cost of goods sold

Inventory turnover ratio =
Average inventory
The cost of goods sold means sales minus gross profit.
The average inventory refers to the simple average of the opening

and closing inventory.
6-
Accounting
Example 2: Inventory Turnover Ratio
A firm has sold goods worth Rs 3,00,000 with a gross profit margin of
20 per cent. The stock at the beginning and the end of the year
was Rs 35,000 and Rs 45,000 respectively. What is the
inventory turnover ratio?
(Rs 3,00,000 – Rs 60,000)

Inventory 6 (times per
= =
turnover ratio (Rs 35,000 + Rs 45,000) ÷ 2 year)
12 months
Inventory
= = 2 months
holding period Inventory turnover ratio, (6)
6-
Accounting
Debtors Turnover Ratio
The ratio measures how rapidly receivables are collected. A high
ratio is indicative of shorter time-lag between credit sales and
cash collection. A low ratio shows that debts are not
being collected rapidly.
Net credit sales

Debtors turnover ratio =
Average debtors
Net credit sales consist of gross credit sales minus

returns, if any, from customers.
Average debtors is the simple average of debtors (including

bills receivable) at the beginning and at the end of year.
6-
Accounting
Example 3: Debtors Turnover Ratio
A firm has made credit sales of Rs 2,40,000 during the year. The
outstanding amount of debtors at the beginning and at the end
of the year respectively was Rs 27,500 and Rs 32,500.
Determine the debtors turnover ratio.
Rs 2,40,000
Debtors 8 (times per
= =
turnover ratio (Rs 27,500 + Rs 32,500) ÷ 2 year)
12 Months
Debtors collection 1.5
= =
period Debtors turnover ratio, (8) Months
6-
Accounting
Creditors Turnover Ratio
A low turnover ratio reflects liberal credit terms granted by
suppliers, while a high ratio shows that accounts are to be settled
rapidly. The creditors turnover ratio is an important tool of
analysis as a firm can reduce its requirement of current assets by
relying on supplier’s credit.
Net credit purchases

Creditors turnover
=
ratio Average creditors
Net credit purchases = Gross credit purchases - Returns to
suppliers.
Average creditors = Average of creditors (including bills payable)

outstanding at the beginning and at the end of the year.
6-
Accounting
Example 4: Creditors Turnover Ratio
The firm in previous Examples has made credit purchases of Rs

1,80,000. The amount payable to the creditors at the beginning
and at the end of the year is Rs 42,500 and Rs 47,500
respectively. Find out the creditors turnover ratio.
(Rs 1,80,000)
Creditors 4 (times
= =
turnover ratio (Rs 42,500 Rs 47,500) ÷ 2 per year)
12 months
Creditor’s
= = 3 months
payment period Creditors turnover ratio, (4)
6-
Accounting
The summing up of the three turnover ratios (known as a cash
cycle) has a bearing on the liquidity of a firm. The cash cycle
captures
the interrelationship of sales, collections from debtors
and payment to creditors.
The combined effect of the three turnover ratios
is summarised below:
Inventory holding period 2 months
Add: Debtor’s collection period + 1.5 months
Less: Creditor’s payment period – 3 months
0.5 months
As a rule, the shorter is the cash cycle, the better are the liquidity
ratios as measured above and vice versa.
6-
Accounting
DEFENSIVE INTERVAL RATIO
Defensive interval ratio is the ratio between quick

assets and projected daily cash requirement.
Liquid assets
Defensive-
=
interval ratio Projected daily cash requirement
Projected cash operating expenditure

Projected daily
=
cash requirement Number of days in a year (365)
© Tata McGraw-Hill Publishing Company Limited, Management Accounting 6 - 19

Example 5: Defensive Interval Ratio
The projected cash operating expenditure of a firm from the next

year is Rs 1,82,500. It has liquid current assets
amounting to Rs 40,000. Determine the
defensive-interval ratio.
Rs 1,82,500
Projected daily cash requirement = = Rs 500
365
Rs 40,000
Defensive-interval ratio = = 80 days
Rs 500
6-
Accounting
Cash-flow From Operations Ratio
Cash-flow from operation ratio measures liquidity of a

firm by comparing actual cash flows from operations
(in lieu of current and potential cash inflows from
current assets such as inventory and debtors)
with current liability.
Cash-flow from operations

Cash-flow from
=
operations ratio Current liabilities
6-
Accounting
Leverage Capital Structure Ratio
There are two aspects of the long-term solvency of a firm:
(i) Ability to repay the principal when due, and
(ii) Regular payment of the interest .
Capital structure or leverage ratios throw light on the
long-term solvency of a firm.
Accordingly, there are two different types of leverage ratios.

First type: These ratios are Second type: These ratios are
computed from the balance computed from the Income
sheet Statement
(a) Debt-equity ratio (a) Interest coverage ratio
(b) Debt-assets ratio (b) Dividend coverage ratio
(c) Equity-assets ratio
6-
Accounting
I. Debt-equity ratio
Debt-equity ratio measures the ratio of long-term or total
debt to shareholders equity.
Long-term Debt + Short

Debt-equity ratio measures theDebt
Total ratio of long-term
term debt + Other Current
Debt-equity ratio to=shareholders equity
or total de3bt Liabilities = Total external
Shareholders’ equity Obligations
If the D/E ratio is high, the owners are putting up relatively less
money of their own. It is danger signal for the lenders and
creditors. If the project should fail financially, the
creditors would lose heavily.
A low D/E ratio has just the opposite implications. To the creditors,
a relatively high stake of the owners implies sufficient safety
margin and substantial protection against
shrinkage in assets.
For the company also, the servicing of debt is less
burdensome and consequently its credit standing
is not adversely affected, its operational flexibility
is not jeopardised and it will be able to
raise additional funds.
The disadvantage of low debt-equity ratio is that

the shareholders of the firm are deprived
of the benefits of trading on equity
or leverage.
6-
Accounting
Trading on Equity
Trading on equity (leverage) is the use of borrowed funds in
expectation of higher return to equity-holders.
Trading on Equity (Amount in Rs thousand)

Particular A B C D
(a) Total assets 1,000 1,000 1,000 1,000
Financing pattern:
Equity capital 1,000 800 600 200
15% Debt — 200 400 800
(b)Operating profit (EBIT) 300 300 300 300
Less: Interest — 30 60 120
Earnings before taxes 300 270 240 180
Less: Taxes (0.35) 105 94.5 84 63
Earnings after taxes 195 175.5 156 117
Return on equity (per cent) 19.5 21.9 26 58.5
6-
Accounting
II. Debt to Total Capital
The relationship between creditors’ funds and
owner’s capital can also be expressed using
Debt to total capital ratio.
Total debt
Debt to total capital ratio =
Permanent capital
Permanent Capital = Shareholders’ equity +

Long-term debt.
6-
Accounting
III. Debt to total assets ratio
Total debt
Debt to total assets ratio =
Total assets
Proprietary Ratio
Proprietary ratio indicates the extent to which assets
are financed by owners funds.
Proprietary funds
Proprietary ratio = X 100
Total assets
Capital Gearing Ratio

Capital gearing ratio is used to know the relationship between equity
funds (net worth) and fixed income bearing funds (Preference
shares, debentures and other borrowed funds.
6-
Accounting
Coverage Ratio
Interest Coverage Ratio
Interest Coverage Ratio measures the firm’s ability to make
contractual interest payments.
EBIT (Earning before interest and taxes)

Interest coverage ratio =
Interest
Dividend Coverage Ratio

Dividend Coverage Ratio measures the firm’s ability to pay dividend on
preference share which carry a stated rate of return.
EAT (Earning after taxes)

Dividend coverage ratio =
Preference dividend
6-
Accounting
Total fixed charge coverage ratio
Total fixed charge coverage ratio measures the firm’s ability to meet all fixed
payment obligations.
Total fixed charge EBIT + Lease Payment

coverage ratio = Interest + Lease payments + (Preference dividend +
Instalment of Principal)/(1-t)
Total Cashflow Coverage Ratio

However, coverage ratios mentioned above, suffer from one major
limitation, that is, they relate the firm’s ability to meet its various
financial obligations to its earnings. Accordingly, it would be
more appropriate to relate cash resources of a firm to its
various fixed financial obligations.
EBIT + Lease Payments + Depreciation + Non-cash expenses

Total cashflow
=
coverage ratio (Principal repayment) (Preference dividend)
Lease payment +
+
+ Interest (1– t) (1 - t)

Debt Service Coverage Ratio
Debt-service coverage ratio (DSCR) is considered a more
comprehensive and apt measure to compute debt
service capacity of a business firm.
n
∑ EATt + Interestt
+ Depreciationt + OAt
t=1
DSCR = n
∑ Instalmentt
t=1
DEBT SERVICE CAPACITY

Debt service capacity is the ability of a firm to make the
contractual payments required on a scheduled
basis over the life of the debt. 6-
Accounting
Example 6: Debt-Service Coverage Ratio
Agro Industries Ltd has submitted the following projections. You are
required to work out yearly debt service coverage ratio (DSCR)
and the average DSCR.
(Figures in Rs lakh)
Year Net profit for the Interest on term loan Repayment of term
year during the year loan in the year
1 21.67 19.14 10.70
2 34.77 17.64 18.00
3 36.01 15.12 18.00
4 19.20 12.60 18.00
5 18.61 10.08 18.00
6 18.40 7.56 18.00
7 18.33 5.04 18.00
8 16.41 Nil 18.00
The net profit has been arrived after charging depreciation of Rs 17.68 lakh
every year. 6-
Accounting
Solution
Table 3: Determination of Debt Service Coverage Ratio
(Amount in lakh of rupees)
Ye Net Depreciation Interest Cash Principal Debt DSCR [col. 5
ar profit available instalment obligation ÷ col. 7
(col. (col. 4 + col. 6) (No. of times)]
2+3+4)
1 2 3 4 5 6 7 8
1 21.67 17.68 19.14 58.49 10.70 29.84 1.96
2 34.77 17.68 17.64 70.09 18.00 35.64 1.97
3 36.01 17.68 15.12 68.81 18.00 33.12 2.08
4 19.20 17.68 12.60 49.48 18.00 30.60 1.62
5 18.61 17.68 10.08 46.37 18.00 28.08 1.65
6 18.40 17.68 7.56 43.64 18.00 25.56 1.71
7 18.33 17.68 5.04 41.05 18.00 23.04 1.78
8 16.41 17.68 Nil 34.09 18.00 18.00 1.89
Average DSCR (DSCR ÷ 8) 1.83

6-
Accounting
Profitability Ratio
Profitability ratios can be computed either from
sales or investment.
Profitability Ratios Profitability Ratios

Related to Sales Related to Investments
(i) Profit Margin (i) Return on Investments
(ii) Expenses Ratio (ii) Return on Shareholders’

Equity
6-
Accounting
Profit Margin
Gross Profit Margin
Gross profit margin measures the percentage of each sales

rupee remaining after the firm has paid for its goods.
Gross profit margin = Gross Profit

X 100
Sales
6-
Accounting
Net Profit Margin
Net profit margin measures the percentage of each sales rupee
remaining after all costs and expense including interest
and taxes have been deducted.
Net profit margin can be computed in three ways
Earning before interest and taxes

i. Operating Profit Ratio =
Net sales
Earnings before taxes

ii. Pre-tax Profit Ratio =
Net sales
Earning after interest and taxes

iii. Net Profit Ratio = Net sales
6-
Accounting
Example 7: From the following information of a firm,
determine (i) Gross profit margin and (ii) Net profit
margin.
1. Sales Rs 2,00,000
2. Cost of goods sold 1,00,000
3. Other operating expenses 50,000
Rs 1,00,000
(1) Gross profit margin = = 50 per cent
Rs 2,00,000
Rs 50,000
(2) Net profit margin = = 25 per cent
Rs 2,00,000
6-
Accounting
Expenses Ratio
Cost of goods sold
i. Cost of goods sold = X 100
Net sales
Administrative exp. + Selling exp.
ii. Operating expenses = X 100
Net sales
Administrative expenses
iii. Administrative expenses = X 100
Net sales
Selling expenses
iv. Selling expenses ratio = X 100
Net sales
Cost of goods sold + Operating expenses
v. Operating ratio = X 100
Net sales
Financial expenses
vi. Financial expenses = X 100
Net sales
6-
Accounting
Return on Investment
Return on Investments measures the overall effectiveness of
management in generating profits with
its available assets.
i. Return on Assets (ROA)

EAT + (Interest – Tax advantage on interest)
ROA =
Average total assets
ii. Return on Capital Employed (ROCE)

EAT + (Interest – Tax advantage on interest)
ROCE =
Average total capital employed
6-
Accounting
Return on Shareholders’ Equity
Return on shareholders equity measures the return on the
owners (both preference and equity shareholders )
investment in the firm.
Return on total shareholders’ equity =

Net profit after taxes
X 100
Average total shareholders’ equity
Return on ordinary shareholders’ equity (Net worth) =

Net profit after taxes – Preference dividend
X 100
Average ordinary shareholders’ equity
6-
Accounting
Efficiency Ratio
Activity ratios measure the speed with which various
accounts/assets are converted into sales or cash.
Inventory turnover measures the efficiency of various types of
inventories.
i. Inventory Turnover measuresCost

the of goods sold of
activity/liquidity
Inventory Turnover Ratio =
Average
inventory of a firm; the speed with whichinventory
inventory is sold
i. Inventory Turnover measuresCost

theof raw materials used
activity/liquidity of
Raw materials turnover =
inventory of a firm; the speed with which
Average inventoryinventory
raw material is sold
i. Inventory Turnover measures Cost of goods manufactured

the activity/liquidity of
Work-in-progress turnover =
inventory of a firm; the speed with which
Average inventory isinventory
work-in-progress sold 6 -
Accounting
Debtors Turnover Ratio
Liquidity of a firm’s receivables can be examined
in two ways.
i. Debtors
Inventoryturnover
Turnover Credit sales
i. = measures the activity/liquidity of inventory
of a firm; the speedAverage
with which
debtors
inventory
+ Average
is sold
bills receivable (B/R)
Months (days) in a year

2. Average collection period =
Debtors turnover
i. Inventory Months (days)

Turnover in a year
measures the (x) (Average Debtors
activity/liquidity of + Average
inventory of (B/R)
a
Alternatively =
firm; the speed with which inventory Total
is credit
sold sales
Ageing Schedule enables analysis to identify

slow paying debtors.
Assets Turnover Ratio
Assets turnover indicates the efficiency with which firm
uses all its assets to generate sales.
i. Inventory Turnover measures Cost

the of goods sold of inventory
activity/liquidity
i. Total assets turnover =
of a firm; the speed with which
Average
inventory
total
is assets
sold
Cost of goods sold
ii. Fixed assets turnover =
Average fixed assets
Cost of goods sold
i. Inventory Turnover
iii. Capital turnover = measures the activity/liquidity of inventory
of a firm; the speed with whichAverage
inventorycapital employed
is sold
Cost of goods sold
iv. Current assets turnover =
Average current assets
i. Inventory Turnover measures Cost

the of goods sold of inventory
activity/liquidity
v. Working capital turnover =
of a firm; the speed with which Net working
inventory is capital
sold
6-
Accounting
1) Return on shareholders’ equity = EAT/Average total shareholders’ equity.
2) Return on equity funds = (EAT – Preference dividend)/Average ordinary

shareholders’ equity (net worth).
3) Earnings per share (EPS) = Net profit available to equity shareholders’

(EAT – Dp)/Number of equity shares outstanding (N).
4) Dividends per share (DPS) = Dividend paid to ordinary

shareholders/Number of ordinary shares outstanding (N).
5) Earnings yield = EPS/Market price per share.
6) Dividend Yield = DPS/Market price per share.
7) Dividend payment/payout (D/P) ratio = DPS/EPS.
8) Price-earnings (P/E) ratio = Market price of a share/EPS.
9) Book value per share = Ordinary shareholders’ equity/Number of equity

shares outstanding.
Integrated Analysis Ratio
Integrated ratios provide better insight about financial and
economic analysis of a firm.
(1) Rate of return on assets (ROA) can be decomposed in to

(i) Net profit margin (EAT/Sales)
(ii) Assets turnover (Sales/Total assets)
(2) Return on Equity (ROE) can be decomposed in to
(i) (EAT/Sales) x (Sales/Assets) x (Assets/Equity)
(ii) (EAT/EBT) x (EBT/EBIT) x (EBIT/Sales) x (Sales/Assets) x
(Assets/Equity)
6-
Accounting
Rate of Return on Assets
EAT as percentage of Assets

sales turnover
EAT Divided by Sales Sales Divided by Total Assets
Fixed assets Plus Current assets

Gross profit = Sales less
cost of goods sold Alternatively
Minus Shareholder equity

Expenses: Selling Plus
Administrative Interest
Long-term borrowed
Minus funds
Income-tax Plus
Current liabilities
6-
Accounting
Return on Assets
Earning Power
Earning power is the overall profitability of a firm; is computed
by multiplying net profit margin and
assets turnover.
Earning power = Net profit margin × Assets turnover

Where, Net profit margin = Earning after taxes/Sales
Asset turnover = Sales/Total assets
i. Inventory Earning
Turnover after taxes
measures the Sales of inventory
activity/liquidity EAT
Earning Power = x x
of a firm; the speed withSales
which inventoryTotal
is sold
Assets Total assets
6-
Accounting
EXAMPLE: 8
Assume that there are two firms, A and B, each having total assets
amounting to Rs 4,00,000, and average net profits after
taxes of 10 per cent, that is, Rs 40,000, each.
Firm A has sales of Rs 4,00,000, whereas the sales of firm B aggregate Rs

40,00,000. Determine the ROA of firms A and B. Table 4 shows
the ROA based on two components.
Table 4: Return on Assets (ROA) of Firms A and B

1. Net sales Rs 4,00,000 Rs 40,00,000
2. Net profit 40,000 40,000
3. Total assets 4,00,000 4,00,000
4. Profit margin (2 ÷ 1) (per cent) 10 1
5. Assets turnover (1 ÷ 3) (times) 1 10
6. ROA ratio (4 × 5) (per cent) 10 10
6-
Accounting
Return on Equity (ROE)
ROE is the product of the following three ratios: Net profit ratio (x)
Assets turnover (x) Financial leverage/Equity multiplier
Three-component model of ROE can be broadened further to

consider the effect of interest and tax payments.
EAT Turnover measures EBIT Net Profit

EBT the activity/liquidity
i. Inventory x x = of
Earnings
inventory before taxes
of a firm; Sales
EBITwith which
the speed inventorySales
is sold
As a result of three sub-parts of net profit ratio, the ROE
is composed of the following 5 components.
EAT EBT EBIT Sales Assets

x x x x
EBT EBIT Sales Assets Equity6 -
Accounting
A 5-way break-up of ROE enables the management of a firm to analyse the effect of interest
payments and tax payments separately from operating profitability. To illustrate further assume 8
per cent interest rate, 35 per cent tax rate and other operating expense of Rs 3,22,462 (Firm A) and
Rs 39,26,462 (Firm B) for the facts contained in Example 8. Table 5 shows the ROE (based on the
5 components) of Firms A and B.
Table 5: ROE (Five-way Basis) of Firms A and B

Net sales Rs 4,00,000 Rs 40,00,000
Less: Operating expenses 3,22,462 39,26,462
Earnings before interest and taxes (EBIT) 77,538 73,538
Less: Interest (8%) 16,000 12,000
Earnings before taxes (EBT) 61,538 61,538
Less: Taxes (35%) 21,538 21,538
Earnings after taxes (EAT) 40,000 40,000
Total assets 4,00,000 4,00,000
Debt 2,00,000 2,50,000
Equity 2,00,000 1,50,000
EAT/EBT (times) 0.65 0.65
EBT/EBIT (times) 0.79 0.84
EBIT/Sales (per cent) 19.4 1.84
Sales/Assets (times) 1 10
Assets/Equity (times) 2 1.6
ROE (per cent) 20 16
6-
Accounting
Common Size Statements
Preparation of common-size financial statements is an extension
of ratio analysis. These statements convert absolute sums into
more easily understood percentages of some base amount. It is
sales in the case of income statement and totals of assets and
liabilities in the case of the balance sheet.
Limitations
Ratio analysis in view of its several limitations should be
considered only as a tool for analysis rather than as an end in
itself. The reliability and significance attached to ratios will largely
hinge upon the quality of data on which they are based. They are
as good or as bad as the data itself. Nevertheless, they are an
important tool of financial analysis.
6-
Accounting

Ratio Analysis

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Ratio Analysis

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Financial Statements Analysis

© Tata McGraw-Hill Publishing Company Limited, Management Accounting 6-1

Common Size Statements

Importance and Limitations of

Ratio analysis is a widely used tool of financial analysis. It is

© Tata McGraw-Hill Publishing Company Limited, Management 6-3

2) Interfirm Comparison involves comparing the ratios of a

3) Comparison with standards or industry average.

Table 1: Net Working Capital

Table 2: Change in Net Working Capital

© Tata McGraw-Hill Publishing Company Limited, Management 6-6

Liquidity ratios measure the ability

© Tata McGraw-Hill Publishing Company Limited, Management 6-7

Particulars Firm A Firm B

© Tata McGraw-Hill Publishing Company Limited, Management 6-8

Quick Assets = Current assets – Stock –

Cost of goods sold

The cost of goods sold means sales minus gross profit.

The average inventory refers to the simple average of the opening

(Rs 3,00,000 – Rs 60,000)

Net credit sales

Net credit sales consist of gross credit sales minus

Average debtors is the simple average of debtors (including

Net credit purchases

Average creditors = Average of creditors (including bills payable)

The firm in previous Examples has made credit purchases of Rs

Defensive interval ratio is the ratio between quick

Projected cash operating expenditure

© Tata McGraw-Hill Publishing Company Limited, Management Accounting 6 - 19

The projected cash operating expenditure of a firm from the next

Cash-flow from operation ratio measures liquidity of a

Cash-flow from operations

Accordingly, there are two different types of leverage ratios.

Long-term Debt + Short

The disadvantage of low debt-equity ratio is that

Trading on Equity (Amount in Rs thousand)

Permanent Capital = Shareholders’ equity +

Capital Gearing Ratio

EBIT (Earning before interest and taxes)

Dividend Coverage Ratio

EAT (Earning after taxes)

Total fixed charge EBIT + Lease Payment

Total Cashflow Coverage Ratio

EBIT + Lease Payments + Depreciation + Non-cash expenses

© Tata McGraw-Hill Publishing Company Limited, Management Accounting 6 - 29

DEBT SERVICE CAPACITY

Average DSCR (DSCR ÷ 8) 1.83

Profitability Ratios Profitability Ratios

(ii) Expenses Ratio (ii) Return on Shareholders’

Gross Profit Margin

Gross profit margin measures the percentage of each sales

Gross profit margin = Gross Profit

Net profit margin can be computed in three ways

Earning before interest and taxes

Earnings before taxes

Earning after interest and taxes

i. Return on Assets (ROA)

ii. Return on Capital Employed (ROCE)

Return on total shareholders’ equity =

Return on ordinary shareholders’ equity (Net worth) =

i. Inventory Turnover measuresCost

i. Inventory Turnover measuresCost