RATIO ANALYSIS

BY:-SAGAR.V.MORADIYA
 What is ratio analysis?
• Tool of financial analysis.
• Compare the risk and return relationships.
• It is a systematic use of ratios to interpret/assess
the performance and status of the firm.
• Interpret financial statements so the strength
and weakness as well as historical performance
and current financial condition can be
determined.
  Basis of comparison
 ratio make the related information
comparable. a single figure by itself has no
meaning, but when expressed in terms of
related figure, it yields significant inferences.
Thus, ratios are relative figures reflecting the
relationship between related variables.
 Three types of comparisons are generally
involved: namely, (1)trend analysis (2)inter
firm comparison (3) comparison with
standards or industry average.
 ◙ Trend analysis
 it involve evaluation of financial performance over a
period of time using financial ratio analysis.
 Present ratios are compared with past ratios for the
same firm.

For
example:-
year Gross profit sales Gross profit
ratio
2007 25000/- Rs.300000 8.33%
2008 48000/- Rs.450000 10.67%
  Inter firm comparison
• Comparison of the ratios of a firm with those of
others in the same line of business.
• For example:-
Year (2007) ABC STEEL LTD. XYZ STEEL LTD.

gross profit 6.89% 7%

net profit 4.2% 4%

• Interpretation:- the profit of ABC steel ltd is better

than xyz steel ltd but here xyz steel ltd has
opportunity to increase profit but reducing costs.
۞ Comparison with standard
or plan
 In this method the ratios will 30
be compare with the standard 25
measurement or plan. 20
15
 For example:- suppose, the 10
standard rate of net profit of 5

oil and gas industry is 20%. if 0

net profit
any firm make profit more
than 20% is better for that Abcltd standard Xyz ltd

firm and if less than it then

they have to focus to reach
up to average 20% profit of
industry. 25

 Comparison of what they 20

15
have decide while planning 10
and now we where. 5
0
net profit

Abc ltd planned xyz ltd

  types of ratios
 ratios can be classified into six broad
groups:-
1. Liquidity ratios.
2. Capital structure/leverage ratios.
3. Profitability ratios.
4. Activity/efficiency ratios.
5. Integrated analysis of ratios
6. Growth ratios.
 Liquidity ratio
Ratio Formula Location Explanation

Current Ratio (:) Current Asset B.S. Asset portion it indicate the firm’s ability to
Current Liabilities B.S. Liability portion meet its short term
obligation.(2:1)
For example.
A B
=18000/12000 30000/10000

=1.5:1 =3:1

Good very good

Quick Test (:) Quick Asset (C.A-inventory) B.S. Asset portion it indicate the firm’s instant
Current Liabilities B.S. Liability portion debt paying ability.(1:1)

For example:-
A B
= 4000/8000 =12000/6000

= 0.5:1 = 2:1

Not satisfactory appreciate

Ratio Formula Location Explanation

Inventory to Net WorkingInventory B.S. Asset portion To indicate the cushion

Capital (:) (Current Assets – Current Liabilities) B.S. Liability & Asset portion of excess current
assets over current
For example:- liabilities may be
threatened by
= 30000/(300000-100000) unfavorable changes
in inventory
= 0.15:1 (good)

Cash Ratio (:) Cash + Cash Equivalents B.S. Cur. Asset To indicate how many
Current Liabilities B.S. Liability portion current obligations
can be met with
For example. cash or cash
equivalents
= 50000+20000/140000

= 0.5:1 (50%)
 Profitability ratio
Ratio Formula Location Explanation

Net Profit Margin (%) Net profit After Taxes Income Statement Indicates the net profit after
Net Sales Income Statement tax in compare to net sales.

For example:-
= 500000/3000000
= 16.67%

Gross Profit Margin (%) Sales – Cost of Goods Sold Income Statement Indicates the profit available
Net Sales Income Statement for non-manufacturing
overhead
For example:-
=30000/400000
=7.5%

Return On Investment (%) Net Profit After taxes Income Statement Indicates the efficiency that
Total Assets Balance sheet management uses the
companies assets
For example:-
=25000/300000
= 8.33%
Return On Equity (%) Net Profit After taxes Income Statement Indicates the how
Shareholder’s Equity Balance sheet profitably the owners’
(preference & equity share capital+ordinary+ fund have been
share premium+ reserve and surplus) utilized by the firm.

For example:-

=39000/200000
=19.5%

Earnings per Share ($) Earning available to equity share holders (Income Statement-B.S) Indicates the profit
(equity) Number of equity shares. B.S. (sometimes) available to the equity
shareholders on a per
For example:- share basis.

= 25000/5000
= RS.5
 Activity ratio
Ratio Formula Location Explanation

Inventory Turnover (times) Net Sales Income Statement measures the

Closing Inventory Balance sheet activity/liquidity of
inventory of a firm; the
For example:- speed with which
= 20000/5000 inventory is sold.
= 4 times

Net Working Capital Turnover (:) Net Sales Income Statement assess effectively the Net
Net Working Capital Balance sheet (CA-CL) Working Capital is used to
generate sales
For example:-
=20000/40000
=0.5:1

Asset Turnover (:) Sales Income Statement the efficiency with which
Total Assets Balance sheet the firm uses all its assets
to generate sales.
For example:-
=27500/19250
=1.43:1
Receivable (debtors) Turnover Annual Credit Sales Work sheet or Sub. The average amount of
(days) Average debtors + average bills Ledgers time needed to collect
receivables Balance Sheet accounts receivables.

For example:-

=1200000/(140000+160000)/2
=8 times

Average debt Collection Period Accounts Receivable Balance Sheet It indicates the gap of
(days) Sales for Year/365 Income Statement days to collect the debt.
Or
12 months / debtors ratio.

For example:-
= 12/8
= 1.5 months

Creditor (payables) turnover ratio Credit purchase Work sheet & sub.Average amount of time
(days) (Creditors + bills payables)2 ledger needed to pay account
Balance Sheet payables.
For example:-

= 50000/(9000+11000)/2
= 5 times

Accounts Payable Period
Accounts Payable
Purchases for year/365
For example:-
=12/5times (2.4months)
Balance Sheet It indicates the period gap
Work sheet &/or Sub. to pay money to creditors
Ledgers for credit purchase.
 Leverage ratio
Ratio Formula Location Explanation

Debt to Asset Ratio (%) Total Debt Balance Sheet it indicate the portion assets
Total assets Balance Sheet which company have to meet the
total debt.
For example:-
=20000/22000
= 0.91:1 (good)

Proprietary ratio Proprietor's fund Balance Sheet it indicates the extent to which
Total assets Balance Sheet assets are financed by owners
funds.
For example:-
= 50000/200000
= 25% (neither high nor low)

Long term debt to CapitalL –T debt Balance Sheet It indicates the what portion
Structure ratio (%) Permanent capital Balance Sheet permanent capital of a firm
consists of long term debt.
For example:-
= 200000/500000
= 40%
Time Interest Earned EBIT Income Statement Indicates the
(interest coverage ratio) Interest Charges Income Statement ability of the
company to
For example:- meet its annual
=270000/27000(.09*300000) interest
= 10 times payment.

Coverage of Fixed Charges EBIT+ Lease payment Income Statement Assess the
Interest + lease payments + Income Statement company’s
( preference dividend +installment of principal) / ability to meet
(1-t) all of its fixed
expenses.
for example:-
= 50000+20000/1000+20000+(25000)/(1-.35)
= 1.18 times

Dividend coverage ratio EAT Income statement It measures the

Preference dividend Balance Sheet ability of a firm to
pay dividend on
For example:- preference shares
= 50000/10000 which carry a stated
= 5 times ( higher-better) rate of return
 Other ratios
Ratio Formula Location Explanation

Price/Earnings Ratio Market price per Share Stock Market Reports Assess the amount
Earnings per share Income Statement investors are willing
to pay for each
For example:- rupee of earnings
= 40/3.04
= 13.2 times

Dividend Payout Ratio (%) Annual dividends per Share Income Statement Indicates the
Annual Earnings per Share Income Statement percentage of profit
that is paid out as
For example:- dividends
= 4/11
= 36.37%

Dividend Yield on CommonAnnual dividends per Share Income Statement Indicates the
Stock Current Market price per share Stock Market dividend rate of
(%) return to common
For example:- shareholders at the
= 4/40 current market price
= 10%
Ϋ Importance and limitation of
ratio analysis
₪ advantages ₪ disadvantages
• Liquidity position. • Difficulty in
• Long term solvency. comparison.
• Operating efficiency. • Impact of inflation.
• Overall profitability.
• Inter-firm comparison. • Conceptual
diversity.
• Trend analysis.
 Thank : you
For your feedback kindly mail
to onintex2012@gmail.com
Sagar_moradiya@yahoo.com