PGDM 2009-11 Ratio Analysis

Ratio Analysis is a study of relationship among various financial factors in a business. Ratio Analysis is a technique of analysing the financial statements by computing Ratios. A Ratio is an arithmetical expression of relationship between two related or interdependent items. Expression of Ratio 1. Pure 2. Percentage 3. Time 4. Fraction Users of Ratio Analysis 1. Shareholders/Owners 2. Managers 3. Creditors/Lenders 4. Potential Investors 5. Analysts Ratios computed for different users are compared with 1. Past Year(s) Data 2. Nearest Competitor 3. Industry Leader 4. Industry averages Types of Ratios 1. Return on Investment Ratio 2. Activity/Turnover Ratio 3. Liquidity Ratio 4. Solvency Ratio 5. Capital Market Ratio 6. Profitability Ratio

Caution (What analysts must ensure in calculating, using and interpreting Ratio)
1. 2. 3. 4. Look for any difference in Industry group, Accounting Policies, Size & Nature. Look for any change in Price Level. Similarity in defining various terms in financial statements and Ratio. Reliance on past to predict future.

Why Ratios Return on Investment Ratio 1. Return on Assets Useful for those divisional heads who have no control over the financing pattern of assets they have. The financing pattern (debt and equity) is decided by the top management of the Organisation. 2. Return on Invested Capital Useful for those shareholders, Bankers and Financial Institutions who have provided the funds to the Organisation for a longer period (more than 5 years). 3. Return on Net Worth Useful for present and potential shareholders and also for the management of the Organisation as an important indicator of Wealth Creation for shareholder. Activity/Turnover Ratio 1. Total Asset Turnover Ratio Useful for managers. Indicates how much sales is being generated on Total Assets of Business or how effectively total assets have been put to use by the Organisation.The other variant of this ratio is Fixed Assets Turnover Ratio. 2. Invested Capital Turnover Ratio Useful for Long Term Fund Providers. Indicates the level of sales generated by using Long term Funds. 3. Net worth Turnover Ratio - Useful for Share capital providers. Indicates how much sales is being generated by using shareholders funds. 4. Average Collection Period (ACP) Useful for Managers and Working Capital Funds providers. Indicates the period, company takes to collect money from its debtors. 5. Inventory Turnover Ratio - Useful for Managers and Working Capital Funds providers. Indicates the velocity with which Inventory moves or how quickly a company is able to convert its inventory into cash or cash equivalents. 6. Working Capital Turnover Ratio - Useful for Managers and Working Capital Funds providers. Indicates how much sales company is able to make on working capital. 7. Days Inventory Useful for managers. Indicates the no of days for which the company has the inventory in hand. 8. Average Credit Period Useful for managers so that they can compare Average Credit period with Average Collection Period. Indicates the no of days ,within which company pays off to its creditors for goods. Liquidity Ratio 1. Current Ratio Useful for Managers and working capital fund providers. Measures the companys liquidity and also the margin of safety ,the company has in order to meet any emergency arising out of uneven flows of funds through current assets and current liabilities account. 2. Acid Test Ratio Useful for Managers and working capital fund providers. A better indicator of immediate liquidity position of the Organisation. Companies having similar Current Ratio are analysed on Acid Test Ratio as it gives better picture of liquidity position of the Organisation.

Solvency Ratio 1. Debt Equity Ratio Useful for Lenders, Shareholders and potential shareholders. Indicates the Organisations reliance on own funds or debt funds. Higher debt is cause of concern for Organisation. 2. Debt to Total Invested Capital Useful for Lenders, Shareholders and potential shareholders. Indicates the proportion of debt in total Long Term Funds available with the Organisation. 3. Interest Coverage Ratio Useful for Lenders and Managers. Indicates the safety net available to the Organisation for the payment of Interest Charges. Capital Market Ratio 1. Earning Per Share Useful for Shareholders. Indicates the amount of profit available for equity shareholders after paying off all expenses. 2. Book value to Market value Useful for Shareholders. Indicates whether share is properly priced, under priced or overpriced. 3. Dividend Payout Useful for Shareholders. Indicates how much dividend is paying out by the Organisation. 4. Price Earning Ratio Useful for shareholders. Expresses the market price as a certain multiple of earning per share. Profitability Ratio 1. 2. 3. 4. Gross profit Ratio Net Profit Ratio Operating Profit Ratio Expenses to Sales Ratio

Profitability ratios are useful for all the parties interested in Financial Statements. These ratios indicate the different types of profits being generated by the Organisation.The Expenses to sales ratio is significant in finding out the portion of different expenses in the total expenditures.

Ratio Computation
Return on Assets (ROA) = Profit after Tax + Interest (1-T) Total Assets Total Assets = Fixed Assets + Current Assets + Investments

Return on Invested Capital (ROIC) =

Profit After Tax + Interest (1-T) _____ Long Term Liabilities + Shareholders Fund

Long Term Liability = Loan Funds Shareholders Funds = Equity/Preference Share Capital + Reserve & Surplus

Return on Net Worth (RONW) = Profit after Preference Share Dividend Net Worth Net Worth = Equity Share capital + Reserve & Surplus Misc Expenses not written off

Total Asset Turnover Ratio = Sales Revenue (Net of returns & Excise) Total Assets

Invested Capital Turnover Ratio = Sales Revenue (Net of returns &Excise)_____ Long Term Liabilities + Shareholders Fund

Average Collection Period =

Debtors*365 Sales Debtors = (Debtors + Receivables)

Inventory Turnover Ratio = Cost of Goods Sold Inventory Cost of Goods Sold = Material consumed + Stock Adjustments + Manufacturing Expenses Inventory = Closing inventory

Working Capital Turnover Ratio = _Sales Revenue___ Working Capital Working Capital = Current Assets Current Liabilities Days Inventory = 365/Inventory Turnover Ratio

Average Credit Period = Creditors*365 Purchases Creditors = (Creditors + Payables)

Current Ratio = Current Assets/Current Liabilities Acid Test Ratio = Current Assets (Inventory + Prepaid Expenses)/Current Liability

Debt Equity Ratio = Long Term Liability/Shareholders Funds

Debt to Total Invested Capital =

Long Term Liability______________ Long Term Liabilities + Shareholders Fund

Interest Coverage Ratio = Earnings before Interest & Tax / Total Interest Charges Earnings Per Share = PAT Preference Share Dividend No of Equity Share outstanding Cash Realisation = Cash Generated by Operations Net Income This Ratio is useful for Managers and Lenders. It indicates how close net income is of being realised in cash. Higher the ratio better is the quality of earning.

Book Value to Market Value = Book Value/Market Value

Dividend Payout Ratio = Dividend/Profit after Tax

Price Earning Ratio = Market Price/EPS

Gross Profit Ratio = ______Gross Profit*100_____ Sales net of returns & Excise Gross Profit = Sales Cost of Goods Sold

Net Profit Ratio = ______Net Profit*100______ Sales net of returns & Excise

Operating Profit Ratio =___Operating Profit*100_____ Sales net of returns & Excise