Presentation on theme: "Ratio Analysis Ratio Analysis: A ‘Ratio: is defined as an arithmetical/quantitative/numerical relationship between two numbers. Ratio analysis is a very."— Presentation transcript:
1 Ratio AnalysisRatio Analysis: A ‘Ratio: is defined as an arithmetical/quantitative/numerical relationship between two numbers. Ratio analysis is a very important and age old technique of financial analysis.
2 Ratio Analysis1 Uses of Ratio Analysis: There are various uses of Ratio analysis, some of which are as follows:1. It helps in managerial decision making2. It helps in financial forecasting and planning3. It helps in communicating the financial strength of a concern4. It helps in control5. It is an essential part of budgetary control and Standard costing6. It helps an investor/prospective investor in decision making7. It provides information to the creditors about the solvency of the firm8. It helps the employees by providing information about the profitability of the concern9. It helps the government in policy making by providing financial information about the industry/firm etc10. It facilitates inter-firm; intra-firm; and firm-industry comparison
3 Ratio Analysis RESERVES & SURPLUSES Capital reserves Capital redemption reserveShare premium accountProposed additions to reservesP & L account balance etc.
4 Ratio Analysis LIST OF CURRENT ASSETS: Cash in hand Cash at bank Bills receivable or notes receivableBook debts or sundry debtors or receivables or accounts receivablesStock or raw material, work-in-progress or finished goodsMarketable securitiesAdvance payments ( prepaid expenses etc)Stores & spare partsPreliminary expenses etc
5 Ratio Analysis LIST OF CURRENT LIABILITIES Trade creditors or accounts payableBills payable or notes payableOutstanding accruals or expensesShort term loansBank overdraftProvision for taxes/ contingencies/ insurance etcUnclaimed dividendsAdvance payments & un expired discounts etc
6 Ratio Analysis LIST OF FIXED ASSETS Land & buildings Plant & machinery Furniture & fixturesLease hold landPatents or trade marksCopy rights, formulas, license etcGood willLoose tools
7 Ratio Analysis LIST OF LONG TERM LIABILITIES Loan on mortgage Debentures or bondsBank loanLoans from financial institutes etcCAPITALPreference share capitalEquity share capital
8 Ratio Analysis1. Liquidity Ratios (Short Term Solvency Ratios): These Ratios measure the ability of the firm to meet its current obligations. They indicate whether the firm has sufficient liquid resources to meet its short term liabilities. The various liquidity ratios are :-(i) Current Ratio: This Ratio measures the ability of the firm to pay debts in the short termCurrent Ratio = Current Assets (Ideal Ratio is 2:1)Current Liabilities
9 Ratio Analysis(ii) Quick / Liquid / Acid-Test Ratio: This Ratio measures the short term debt paying ability of the firmQuick / Liquid /Acid Test Ratio = Quick Assets (Ideal Raito = 1:1)Current LiabilitiesAbsolute Liquid Ratio / Cash position Ratio =Cash in hand & at Bank + Short term Marketable securities(Ideal Ratio = 0.75:1, or even 0.50:1)
10 Ratio Analysis(iv) Debtor’s Turnover Ratio: This Ratio is a measure of quality of Debtors and of the effectiveness of the collection efforts.Debtor’s Turnover Ratio = Debtors + Bills Receivable X No. of working daysCredit sales in a year(v) Average Debt Collection Period: This Ratio measures the time taken to collect from DebtorsAverage Debt Collection Period = Average DebtorsNet Sales / 360 days(vi) Stock / Inventory Turnover Ratio: This Ratio measures the time taken to turn inventory into sales.Stock / Inventory Turnover Ratio = Cost of Goods soldAverage stock(Where Average Stock = Opening stock + Closing Stock )2
11 Ratio Analysis2. Solvency Ratios (Long Term): These Ratios measure the long term financial condition of the firm. Bankers and creditors are most interested in liquidity. But shareholders, debenture holders and financial institutions are concerned with the long-term financial prospects. The various Solvency Ratios are:(i) Debt-Equity Ratio: This Ratio measures the relationship between borrowed Capital to own Capital. There are many variations to this Ratio. But, the most popular ones’ are : Debt (or) Outsider’s funds (Ideal Ratio = 1:1)Equity Share holders’ funds(ii) Proprietary Ratio: Share holders’ FundsTotal Assets
12 Ratio Analysis iii) Assets to Proprietary Ratios: (a) Fixed Assets to Proprietor’s Fund Ratio =Fixed Assets after Depreciation (Ideal Ratio = 60% to 65) Shareholders’ Funds(b) Current Assets to Proprietor’s Fund Ratio = Current AssetsShareholders’ Funds(iv) Interest Coverage Ratio : This Ratio measures the ability of the firm in meeting its interest charges and thus gives the measure of protection to creditors for payment of interest. Interest coverage ratio less than 2.0 suggest a risky situationInterest Coverage Ratio = Profit before interest and TaxesInterest Expense
13 Ratio Analysis3. Profitability Ratios: These Ratios measure the profitability of a firm’s business operations. They may be related to sales (ex- Gross Profit Ratio) or investments (ex – Return on Assets or Return on Capital Employed)(i) Gross Profit Ratio = Gross Profit X 100Sales(ii) Net Profit Ratio = Net Profit X 100Sales Operating Ratio = Cost of Goods Sold + Operating Expenses X 100
14 Ratio Analysis(iv) Return on Capital Employed (ROCE) : This Ratio measures the overall profitability and efficiency of the business.ROCE = Net Profit + Interest + Taxes X 100Average Capital EmployedWhere Capital Employed = Fixed Assets + Current Assets – Current Liabilities (or) Shareholders’ Funds + Long Term Liabilities.(v) Profit Margin : This Ratio gives the amount of Net Profit earned by each rupee of revenue.Profit Margin = Profit after TaxNet Sales
15 Ratio AnalysisAsset Turnover: This Ratio measures the efficiency with which Assets are utilizedAsset Turnover = Net SalesAverage Total AssetsReturn on Assets (ROA): This Ratio measures the profitability from a given level of investmentReturn on Assets (ROA) = Profit after Tax
16 Ratio AnalysisReturn on Equity (ROE) : This Ratio measures the profitability on Shareholders’ Funds.Return on Equity (ROE) = Profit after TaxAverage Shareholders’ EquityEarnings Per Share (EPS) : This Ratio measures the earnings on each equity shareEarnings Per Share (EPS) = Profit after TaxNo of Equity Shares
17 Ratio Analysis4. Activity Ratios: These Ratios indicate the number of times stock is replaced during a year. A high Ratio indicates quick movement of stock and vice-versa. i.e, Activity Ratios measure the efficiency of asset management. The efficient utilization of assets would be reflected by the speed with which they are converted into sales.(i) Stock / Inventory Turnover Ratio = Cost of Goods soldAverage stock(Where Average Stock = Opening stock + Closing Stock )2(ii) Debtor’s Turnover Ratio = Debtors + Bills Receivable X No. of working daysCredit sales in a yearThis Ratio shows the speed with which Debtors / Accounts Receivable are collected.
18 Ratio Analysis(iii) Creditor’s Turnover Ratio : This Ratio shows the no. of days taken by the firms to pay its creditors.Creditor’s Turnover Ratio = Creditors + Bill Payable X No of working days in aCredit Purchases year(iv) Fixed Assets Turnover Ratio: This Ratio indicates the sales generated by every rupee invested in Fixed AssetsFixed Assets Turnover Ratio = SalesNet Fixed Assets
19 Ratio Analysis6. Capital Market Ratios : These Ratios are usually related to the Stock Market and are highly useful to the investors / potential investors.Price Earnings Ratio (P/E Ratio): This Ratio measures the amount investors are willing to pay for a rupee of earnings.Price Earnings Ratio (P/E Ratio) = Market Price per share (MPS)Earnings per Share (EPS)Dividend Yield : This Ratio measures the current return to investorsDividend Yield = Dividend per Share (DPS)Market Price per share (MPS)