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**RATIO ANALYSIS R K MOHANTY FACULTY MEMBER, SIR SPBT COLLEGE,**

CENTRAL BANK OF INDIA, MUMBAI

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**WHY FINANCIAL ANALYSIS**

Lenders’ need it for carrying out the following Technical Appraisal Commercial Appraisal Financial Appraisal Economic Appraisal Management Appraisal

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Ratio Analysis It’s a tool which enables the banker or lender to arrive at the following factors : Liquidity position Profitability Solvency Financial Stability Quality of the Management Safety & Security of the loans & advances to be or already been provided

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**How a Ratio is expressed?**

As Percentage - such as 25% or 50% . For example if net profit is Rs.25,000/- and the sales is Rs.1,00,000/- then the net profit can be said to be 25% of the sales. As Proportion - The above figures may be expressed in terms of the relationship between net profit to sales as 1 : 4. As Pure Number /Times - The same can also be expressed in an alternatively way such as the sale is 4 times of the net profit or profit is 1/4th of the sales.

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**Classification of Ratios**

Balance Sheet Ratio P&L Ratio or Income/Revenue Statement Ratio Balance Sheet and Profit & Loss Ratio Financial Ratio Operating Ratio Composite Ratio Current Ratio Quick Asset Ratio Proprietary Ratio Debt Equity Ratio Gross Profit Ratio Expense Ratio Net profit Ratio Stock Turnover Ratio Fixed Asset Turnover Ratio, Return on Total Resources Ratio, Return on Own Funds Ratio, Earning per Share Ratio, Debtors’ Turnover Ratio,

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**Format of balance sheet for ratio analysis**

LIABILITIES ASSETS NET WORTH/EQUITY/OWNED FUNDS Share Capital/Partner’s Capital/Paid up Capital/ Owners Funds Reserves ( General, Capital, Revaluation & Other Reserves) Credit Balance in P&L A/c FIXED ASSETS : LAND & BUILDING, PLANT & MACHINERIES Original Value Less Depreciation Net Value or Book Value or Written down value LONG TERM LIABILITIES/BORROWED FUNDS : Term Loans (Banks & Institutions) Debentures/Bonds, Unsecured Loans, Fixed Deposits, Other Long Term Liabilities NON CURRENT ASSETS Investments in quoted shares & securities Old stocks or old/disputed book debts Long Term Security Deposits Other Misc. assets which are not current or fixed in nature CURRENT LIABILTIES Bank Working Capital Limits such as CC/OD/Bills/Export Credit Sundry /Trade Creditors/Creditors/Bills Payable, Short duration loans or deposits Expenses payable & provisions against various items CURRENT ASSETS : Cash & Bank Balance, Marketable/quoted Govt. or other securities, Book Debts/Sundry Debtors, Bills Receivables, Stocks & inventory (RM,SIP,FG) Stores & Spares, Advance Payment of Taxes, Prepaid expenses, Loans and Advances recoverable within 12 months INTANGIBLE ASSETS Patent, Goodwill, Debit balance in P&L A/c, Preliminary or Preoperative expenses

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Some important notes Liabilities have Credit balance and Assets have Debit balance Current Liabilities are those which have either become due for payment or shall fall due for payment within 12 months from the date of Balance Sheet Current Assets are those which undergo change in their shape/form within 12 months. These are also called Working Capital or Gross Working Capital Net Worth & Long Term Liabilities are also called Long Term Sources of Funds Current Liabilities are known as Short Term Sources of Funds Long Term Liabilities & Short Term Liabilities are also called Outside Liabilities Current Assets are Short Term Use of Funds

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Some important notes Assets other than Current Assets are Long Term Use of Funds Installments of Term Loan Payable in 12 months are to be taken as Current Liability only for Calculation of Current Ratio & Quick Ratio. If there is profit it shall become part of Net Worth under the head Reserves and if there is loss it will become part of Intangible Assets Investments in Govt. Securities to be treated current only if these are marketable and due. Investments in other securities are to be treated Current if they are quoted. Investments in allied/associate/sister units or firms to be treated as Non-current. Bonus Shares as issued by capitalization of General reserves and as such do not affect the Net Worth. With Rights Issue, change takes place in Net Worth and Current Ratio.

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Current Ratio : It is the relationship between the current assets and current liabilities of a concern. Current Ratio = Current Assets/Current Liabilities If the Current Assets and Current Liabilities of a concern are Rs.4,00,000 and Rs.2,00,000 respectively, then the Current Ratio will be : Rs.4,00,000/Rs.2,00,000 = 2 : 1 The ideal Current Ratio preferred by Banks is : 1 Net Working Capital : This is worked out as surplus of Long Term Sources over Long Tern Uses, alternatively it is the difference of Current Assets and Current Liabilities. NWC = Current Assets – Current Liabilities

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**Current Ratio = > 3,00,000/1,00,000 = 3 : 1 **

3. ACID TEST or QUICK RATIO : It is the ratio between Quick Current Assets and Current Liabilities. Quick Current Assets : Cash/Bank Balances + Receivables upto 6 months + Quickly realizable securities such as Govt. Securities or quickly marketable/quoted shares and Bank Fixed Deposits Acid Test or Quick Ratio = Quick Current Assets/Current Liabilities Example : Cash ,000 Debtors ,00,000 Inventories ,50, Current Liabilities 1,00,000 Total Current Assets 3,00,000 Current Ratio = > ,00,000/1,00, = 3 : 1 Quick Ratio = > ,50,000/1,00, = 1.5 : 1

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DEBT EQUITY RATIO : It is the relationship between borrower’s fund (Debt) and Owner’s Capital (Equity). Long Term Outside Liabilities / Tangible Net Worth Liabilities of Long Term Nature Total of Capital and Reserves & Surplus Less Intangible Assets For instance, if the Firm is having the following : Capital = Rs. 200 Lacs Free Reserves & Surplus = Rs. 300 Lacs Long Term Loans/Liabilities = Rs. 800 Lacs Debt Equity Ratio will be => 800/500 i.e. 1.6 : 1

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**Proprietary Ratio = (Tangible Net Worth/Total Tangible Assets) x 100 **

5. PROPRIETARY RATIO : This ratio indicates the extent to which Tangible Assets are financed by Owner’s Fund. Proprietary Ratio = (Tangible Net Worth/Total Tangible Assets) x 100 The ratio will be 100% when there is no Borrowing for purchasing of Assets. 6. GROSS PROFIT RATIO : By comparing Gross Profit percentage to Net Sales we can arrive at the Gross Profit Ratio which indicates the manufacturing efficiency as well as the pricing policy of the concern. Gross Profit Ratio = (Gross Profit / Net Sales ) x 100 Alternatively , since Gross Profit is equal to Sales minus Cost of Goods Sold, it can also be interpreted as below : Gross Profit Ratio = [ (Sales – Cost of goods sold)/ Net Sales] x 100 A higher Gross Profit Ratio indicates efficiency in production of the unit.

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**7. OPERATING PROFIT RATIO :**

It is expressed as => (Operating Profit / Net Sales ) x 100 Higher the ratio indicates operational efficiency NET PROFIT RATIO : It is expressed as => ( Net Profit / Net Sales ) x 100 It measures overall profitability.

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**2 (Average Inventory/Sales) x 52 for weeks**

9. STOCK/INVENTORY TURNOVER RATIO : (Average Inventory/Sales) x for days (Average Inventory/Sales) x for weeks (Average Inventory/Sales) x for months Average Inventory or Stocks = (Opening Stock + Closing Stock) 2 . This ratio indicates the number of times the inventory is rotated during the relevant accounting period

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10. DEBTORS TURNOVER RATIO : This is also called Debtors Velocity or Average Collection Period or Period of Credit given . (Average Debtors/Sales ) x 365 for days (52 for weeks & 12 for months) 11. ASSET TRUNOVER RATIO : Net Sales/Tangible Assets 12. FIXED ASSET TURNOVER RATIO : Net Sales /Fixed Assets 13. CURRENT ASSET TURNOVER RATIO : Net Sales / Current Assets 14. CREDITORS TURNOVER RATIO : This is also called Creditors Velocity Ratio, which determines the creditor payment period. (Average Creditors/Purchases)x365 for days

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**15. RETRUN ON ASSETS : Net Profit after Taxes/Total Assets**

16. RETRUN ON CAPITAL EMPLOYED : ( Net Profit before Interest & Tax / Average Capital Employed) x 100 Average Capital Employed is the average of the equity share capital and long term funds provided by the owners and the creditors of the firm at the beginning and end of the accounting period.

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Composite Ratio 17. RETRUN ON EQUITY CAPITAL (ROE) : Net Profit after Taxes / Tangible Net Worth EARNING PER SHARE : EPS indicates the quantum of net profit of the year that would be ranking for dividend for each share of the company being held by the equity share holders. Net profit after Taxes and Preference Dividend/ No. of Equity Shares 19. PRICE EARNING RATIO : PE Ratio indicates the number of times the Earning Per Share is covered by its market price. Market Price Per Equity Share/Earning Per Share

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20. DEBT SERVICE COVERAGE RATIO : This ratio is one of the most important one which indicates the ability of an enterprise to meet its liabilities by way of payment of installments of Term Loans and Interest thereon from out of the cash accruals and forms the basis for fixation of the repayment schedule in respect of the Term Loans raised for a project. (The Ideal DSCR Ratio is considered to be 2 ) PAT + Depr. + Annual Interest on Long Term Loans & Liabilities Annual interest on Long Term Loans & Liabilities + Annual Installments payable on Long Term Loans & Liabilities ( Where PAT is Profit after Tax and Depr. is Depreciation)

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**What is the Net Worth : Capital + Reserve = 200 **

EXERCISE 1 LIABILITES ASSETS Capital 180 Net Fixed Assets 400 Reserves 20 Inventories 150 Term Loan 300 Cash 50 Bank C/C 200 Receivables Trade Creditors Goodwill Provisions 800 What is the Net Worth : Capital + Reserve = 200 Tangible Net Worth is : Net Worth - Goodwill = 150 Outside Liabilities : TL + CC + Creditors + Provisions = 600 Net Working Capital : C A - C L = = 50 Current Ratio : C A / C L = / 300 = : 1 Quick Ratio : Quick Assets / C L = 200/300 = : 1

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**1. Tangible Net Worth for 1st Year : ( 300 + 140) - 50 = 390**

EXERCISE 2 LIABILITIES Capital 300 350 Net Fixed Assets 730 750 Reserves 140 160 Security Electricity 30 Bank Term Loan 320 280 Investments 110 Bank CC (Hyp) 490 580 Raw Materials 150 170 Unsec. Long T L S I P 20 Creditors (RM) 120 70 Finished Goods Bills Payable 40 80 Cash Expenses Payable Receivables 310 240 Provisions Loans/Advances 190 Goodwill 50 Total 1600 1760 1. Tangible Net Worth for 1st Year : ( ) = 390 2. Current Ratio for 2nd Year : ( ) / ( ) 820 /800 = 3. Debt Equity Ratio for 1st Year : / 390 = 1.21

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Exercise 3. LIABIITIES ASSETS Equity Capital 200 Net Fixed Assets 800 Preference Capital 100 Inventory 300 Term Loan 600 Receivables 150 Bank CC (Hyp) 400 Investment In Govt. Secu. 50 Sundry Creditors Preliminary Expenses Total 1400 1. Debt Equity Ratio will be : / ( ) = 2 : 1 2. Tangible Net Worth : Only equity Capital i.e. = 200 3. Total Outside Liabilities / Total Tangible Net Worth : ( ) / 200 = 11 : 2 4. Current Ratio will be : ( ) / ( ) = 1 : 1

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Exercise 4. LIABILITIES ASSETS Capital + Reserves 355 Net Fixed Assets 265 P & L Credit Balance 7 Cash 1 Loan From S F C 100 Receivables 125 Bank Overdraft 38 Stocks 128 Creditors 26 Prepaid Expenses Provision of Tax 9 Intangible Assets 30 Proposed Dividend 15 550 What is the Current Ratio ? Ans : ( ) / ( ) : 255/88 = : 1 Q What is the Quick Ratio ? Ans : (125+1)/ 88 = : 11 Q. What is the Debt Equity Ratio ? Ans : LTL / Tangible NW = 100 / ( 362 – 30) = / 332 = : 1

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Exercise contd… LIABILITIES ASSETS Capital + Reserves 355 Net Fixed Assets 265 P & L Credit Balance 7 Cash 1 Loan From S F C 100 Receivables 125 Bank Overdraft 38 Stocks 128 Creditors 26 Prepaid Expenses Provision of Tax 9 Intangible Assets 30 Proposed Dividend 15 550 Q . What is the Proprietary Ratio ? Ans : (T NW / Tangible Assets) x 100 [ ( ) / (550 – 30)] x 100 (332 / 520) x 100 = 64% Q . What is the Net Working Capital ? Ans : C. A - C L. = = 167 Q . If Net Sales is Rs.15 Lac, then What would be the Stock Turnover Ratio in Times ? Ans : Net Sales / Average Inventories/Stock 1500 / 128 = 12 times approximately

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Exercise contd… LIABILITIES ASSETS Capital + Reserves 355 Net Fixed Assets 265 P & L Credit Balance 7 Cash 1 Loan From S F C 100 Receivables 125 Bank Overdraft 38 Stocks 128 Creditors 26 Prepaid Expenses Provision of Tax 9 Intangible Assets 30 Proposed Dividend 15 550 What is the Debtors Velocity Ratio ? If the sales are Rs. 15 Lac. Ans : ( Average Debtors / Net Sales) x 12 = (125 / 1500) x 12 = 1 month Q. What is the Creditors Velocity Ratio if Purchases are Rs.10.5 Lac ? Ans : (Average Creditors / Purchases ) x = (26 / 1050) x 12 = 0.3 months

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**Exercise 5. : Profit to sales is 2% and amount of profit is say Rs**

Exercise 5. : Profit to sales is 2% and amount of profit is say Rs.5 Lac. Then What is the amount of Sales ? Answer : Net Profit Ratio = (Net Profit / Sales ) x 100 = (5 x100) /Sales Therefore Sales = /2 = Rs.250 Lac Exercise 6. A Company has Net Worth of Rs.5 Lac, Term Liabilities of Rs.10 Lac. Fixed Assets worth RS.16 Lac and Current Assets are Rs.25 Lac. There is no intangible Assets or other Non Current Assets. Calculate its Net Working Capital. Answer Total Assets = = Rs. 41 Lac Total Liabilities = NW + LTL + CL = CL = 41 Lac Current Liabilities = 41 – 15 = 26 Lac Therefore Net Working Capital = C. A – C.L = 25 – 26 = (- )1 Lac

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**Exercise 7 : Current Ratio of a concern is 1 : 1**

Exercise 7 : Current Ratio of a concern is 1 : 1. What will be the Net Working Capital ? Answer : It suggest that the Current Assets is equal to Current Liabilities hence the NWC would be NIL Exercise 8 : Suppose Current Ratio is 4 : 1. NWC is Rs.30,000/-. What is the amount of Current Assets ? Answer : 4 x - 1 x = 30,000 Therefore x = 10,000 i.e. Current Liabilities is Rs.10,000 Hence Current Assets would be 4x = 4 x 10,000 = Rs.40,000/- Exercise 9. The amount of Term Loan installment is Rs.10000/ per month, monthly average interest on TL is Rs.5000/-. If the amount of Depreciation is Rs.30,000/- p.a. and PAT is Rs.2,70,000/-. What would be the DSCR ? DSCR = (PAT + Depr + Annual Intt.) / Annual Intt + Annual Installment = ( ) / = / = 2

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**Exercise 10 : Total Liabilities of a firm is Rs**

Exercise 10 : Total Liabilities of a firm is Rs.100 Lac and Current Ratio is 1.5 : 1. If Fixed Assets and Other Non Current Assets are to the tune of Rs. 70 Lac and Debt Equity Ratio being 3 : 1. What would be the Long Term Liabilities? Ans : We can easily arrive at the amount of Current Asset being Rs. 30 Lac i.e. ( Rs. 100 L - Rs. 70 L ). If the Current Ratio is 1.5 : 1, then Current Liabilities works out to be Rs. 20 Lac. That means the aggregate of Net Worth and Long Term Liabilities would be Rs. 80 Lacs. If the Debt Equity Ratio is 3 : 1 then Debt works out to be Rs. 60 Lacs and equity Rs. 20 Lacs. Therefore the Long Term Liabilities would be Rs.60 Lac. Exercise 11 : Current Ratio is say 1.2 : 1 . Total of balance sheet being Rs.22 Lac. The amount of Fixed Assets + Non Current Assets is Rs. 10 Lac. What would be the Current Liabilities? Ans : When Total Assets is Rs.22 Lac then Current Assets would be 22 – 10 i.e Rs. 12 Lac. Thus we can easily arrive at the Current Liabilities figure which should be Rs. 10 Lac

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**Questions on Fund Flow Statement**

Q . Fund Flow Statement is prepared from the Balance sheet : Of three balance sheets Of a single year Of two consecutive years None of the above. Q. Why this Fund Flow Statement is studied for ? It indicates the quantum of finance required It is the indicator of utilisation of Bank funds by the concern It shows the money available for repayment of loan It will indicate the provisions against various expenses Q . In a Fund Flow Statement , the assets are represented by ? Application of Funds Sources of Funds Surplus of sources over application Deficit of sources over application

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**Q . In Fund Flow Statements the Liabilities are represented by ?**

Sources of Funds Use of Funds Deficit of sources over application All of the above. Q . When the long term sources are more than long term uses, in the fund flow statement, it would suggest ? Increase in Current Liabilities Decrease in Working Capital Increase in NWC Q . When the long term uses in a fund flow statement are more than the long term sources, the n it would mean ? Reduction in the NWC Reduction in the Working Capital Gap Reduction in Working Capital All of the above

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**Q. How many broader categories are there for the Sources of funds, in the Fund Flow Statement ?**

Only One, Source of Funds Two, Long Term and Short Term Sources Three , Long, Medium and Short term sources None of the above. Which of following item is not an application of funds in the

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