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Ratio
A ratio is simply an arithmetical expression of the relationship of one number to another. According to Accountants Handbook by Wixon, Kell and Bedford, a ratio is an expression of the quantitative relationship between two numbers. For example, if the current assets of a firm on a given date are Rs. 5,00,000 and the current liabilities are Rs. 2,50,000, then the ratio of C.A to C.L will work out to be: 5,00,000 or 2:1 or 2 2,50,000
Uses contd..
Helps in Control - Appraise the performance of the company, make predictions for future performance and assist in future planning Eliminate the effects of the scale and size of different companies or different years of the same company so comparison can be provided.
Classification of ratios..
Ratios can be broadly classified into four groups mainly : Liquidity Ratios Activity Ratios Profitability Ratios Capital Structure / Leverage Ratios
Liquidity ratios
Analyze the short term financial position The business ability to pay i.e. meeting short term commitments(liabilities) out of short term resources(assets) Also known as Solvency Ratios It is of two types:
Current ratio Quick ratio / Acid test ratio/ Liquid ratio
Current Ratio
It is calculated by dividing current assets by current liabilities Conventionally a current ratio of 2:1 is considered satisfactory
Higher ratios are indicative of efficient management and low ratios are indicative of under utilization of resources and presence of idle capacity
Profitability ratios
These ratios measure the operating efficiency of the firm and its ability to ensure adequate returns to its shareholders Profitability ratios can be divided in two parts:
In relation to sales In relation to investments
In relation to investments
Return on assets Return on capital employed Return on shareholders equity Earnings per share Dividend per share Price earning ratio
Return on assets(ROA)
It measures the profitability of the total funds of a firm Total assets exclude fictitious assets
Return on assets = net profit after taxes plus interest / total assets * 100
Return on shareholders equity = net profits after taxes /total shareholders equity *100
Earnings per share = net profit after tax preference dividend/number of equity shares
Dividend per share = dividend paid to ordinary shareholders /number of equity shares
Proprietary ratio
It indicates the general financial strength of the firm and long term solvency of the business