Professional Documents
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MEANING
The term ‘ratio’ refers to the numerical or
quantitative relationship between two
items/ variables.
Thus a ‘ratio’ is a simple arithmetical
expression of the relationship of one
number to another and is obtained by
dividing the former by the later.
When this ratio is expressed with
reference to the items shown in financial
statement, then it is called ‘accounting
ratio’.
The ratio is calculated by dividing
one item of the relationship by the
other. The dividing number is known
as the base or base number. The
other number is expressed in relation
to this base number. In ratio analysis
base is always taken as 1 or 100 &
the other number is expressed in its
comparison.
For example:
If sales are four times the average
stock then in terms of ratio we
express it as 4:1 & not 1:0.25.
EXPRESSION OF RATIO
Pure Ratio:
In this, the relationship between two items
is expressed in proportionate form. In other
words, the relationship between two figures
is expressed in a common denominator.
For example – if current assets & current
liabilities of an enterprise are Rs.20,000 &
Rs.10,000. The pure ratio between current
assets & current liabilities will be
20,000 = 2:1
10,000
Rate or So Many Times /
Ratio as Turnover:
In this, rate is calculated between
two numerical variables. In other
words, a ratio is calculated between
two numerical facts for which one
item is divided by another and the
quotient so obtained is taken as unit
of expression. When the ratio is
expressed in this form, it is called as
‘turnover’ and is written in ‘times’.
For example – sales for the year are
Rs.80,000 and fixed assets are
Rs.20,000; it indicates that sales are
4 (80,000/20,000) times of fixed
assets.
Ratio as Percentage:
In this form, the relationship between
two items is expressed in the form of a
part of 100. In other words, a quotient
obtained by dividing one item by
another is multiplied by 100 and thus it
become the percentage form of
expression.
For example – if gross profit is Rs.30,000
and sales is Rs.1,00,000, we can say
that ratio of gross profit to sales is 30%
(30,000/1,00,000 x 100)
OBJECTIVES, UTILITY or ROLE
OF RATIO ANALYSIS
Helping in Financial Statement Analysis
Helping in Financial Forecasting
Helping in Co-ordination
Helping in Control
Helping in Communication
Helping in Efficiency Appraisal
Helping in Financial Strength Appraisal
Trend Analysis
LIMITATIONS RATIO ANALYSIS
Limited use of a Single Ratio
Lack of Qualitative Analysis of the Problem
Effect of Inherent limitations of Accounting
Arithmetical Window Dressing
Future Estimates on the Basis of the Past
Background is Overhead
Different Accounting Procedures
Contd…
No Allowance for Price Level Changes
Lack of Proper Standards
Calculating Ratios between Unrelated
items
Effect of Personal Ability and Bias of
Analyst
PRECAUTIONS IN RATIO
ANALYSIS
Nature of Data
Dispatch
Presentation
Reliability
Determination of proper Standards
Revision and Alteration
Price Level Changes
Cost-Benefit
Contd…
Comparison
Use of Other methods
Proper Record
STEPS FOR RATIO ANALYSIS
Arrangement of Data
Calculation of appropriate ratios from
the above data.
Comparison of the calculated ratios
with the predetermined standards or
norms set for the purpose.
Interpretation of Ratios
INTERPRETATION OF RATIOS
On the basis of the single ratio
On the basis of group of related ratios
On the basis of historical trends
On the basis of projected ratios (or
future expectations)
On the basis of inter-firm comparison
On the basis of similar firms
On the basis of common sense
Classification of Ratios
Statement-wise Classification Classification accor- Functional
Classification by Users ding to importance Classification
2
Return on Net Worth/Shareholder’s Funds/
Shareholders Investment/Proprietors’ Funds/
Equity : This ratio measures the profitability
of a concern in relation to total investments
made by the shareholders or proprietors in the
business.
The excess of total assets over total outside
liabilities of an enterprise is known as
shareholders’ funds or proprietors’ funds or
net worth.
Return on Net Worth = Net Profit (PAIT) x 100
Shareholder’s fund
Return on Equity Shareholder’s Fund :-
It examines profitability from the perspective of
the equity investors by relating profits
available for the equity shareholders with the
book value of the equity investment. The
return from the point of view of equity
shareholders may be calculated by comparing
the net profit less preference dividend with
their total contribution in the firm.
Return on Equity Shareholder’s Fund =
Net Profit after Tax – Preference Dividend x 100
Equity Shareholder’s Funds
*Equity Shareholder’s Funds = Share Capital+Reserves Credit balance of P/l