Ratio analysis
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This document discusses various types of financial ratios used to analyze the financial statements of a business unit. It defines ratio analysis as comparing two components of a balance sheet, profit and loss statement, or trading account to understand trends. The main types of ratios covered are: 1) Profitability ratios like gross profit margin and net profit margin, which indicate earnings levels. 2) Return ratios like return on assets and return on equity, which measure earnings power and returns to investors. 3) Liquidity ratios like current ratio and quick ratio, which analyze a company's ability to meet short-term obligations. 4) Turnover ratios which relate trading figures to balance sheet items to understand stock holding periods
Ratio analysis
- 1. By A R Mankodi Faculty- NIIT IFBI (PGDB) Director-Karnavati Coop Bank Secretary-Bankers’ Club Ex CEO- Guj State Coop Union Ex DGM- A D C Bank, Ahmedabad AMCO Bank,Ahmedabad 1 E mail: armankodi@hotmail.com Mobile 9227282003
- 2. Q 1 What is ration analysis? It is a way of comparing two components of balance sheet/profit loss account or trading account It helps understanding health, culture and trends of a unit. This comparison is in form of ratio and shown as percentage. They are relationships, which are expressed in quantitative terms between figures. They show relationships, how figures are connected with each other in some manner 2 A R Mankodi,Faculty Banking Diploma
- 3. Q 2 Can decision is based only on these ratios? No. They are indicative only and point at a certain direction. It just helps formulating decision. Q 3 How many types of ratios of financial statements of unit are there? Profitability Ratio Return ratio Liquidity ratio Turnover ratio Financial structure ratio (1) Debt (2) Coverage 3 A R Mankodi, Faculty Banking Diploma
- 4. Q 4 What do you know of profitability ratio? What does each indicate? Gross profit*100/Sales: This will indicate GP versus sale in percentage form. This suggests margin earned on sale. EBDITA*100/Sales: It is Earning Before Depreciation, Interest, Tax, Adjustments versus sale % This indicates generation of net profit after all administrative and fixes costs. This indicates how much is administrative and sale cost on total sale. Higher the ratio more the sale/admn cost. Not a favorable condition Net profit*100/Sales: This expresses in percentage from the net margin available out of total sale. If the sale is huge but this ratio is poor when the above ratio is high, the unit is said to be having bad administration or poor net margin. It may be because of higher burden of interest cost; burden due to cost of commission to agents or sales done at lower prices or may be force sale. Also Indicates quality of product or demand in market in case of producing unit. It can indicate availability of profit for repayment of loan This can be viewed as repaying capacity too. 4 A R Mankodi, Faculty Banking Diploma
- 5. Q 5 What is return ratios? How do you interpret it? Return ratios are as follows Return = Profit After Tax (PAT) + Depreciation + interest This will suggest actual cash inflow or available cash for repayment. It may suggest actual profit or creation of value on assets. Return on Assets (ROA)/Return on Capital Employed (ROCE): As per following formula ROA / ROAC = PBDT/Total Assets Total assets include investments, fix or tangible assets and current assets. This will suggest earning power of unit. It will also suggest how far the capital/reserves are used to create meaningful or productive assets. This may capture diversification trends too. It shows utilization of funds employed. It is a very useful ratio. Return on equity: Following formula will find this Return on equity = PBDIT/Net worth In case of a company, per share earning power can be known. Investors understand availability of returns to them from this ratio. 5 A R Mankodi, Faculty Banking Diploma
- 6. Q 6 What is liquidity ratio and what does it indicate? This ratio analyses the availability of actual cash in the hands of the company to meet its expenses and commitments. It can be viewed as cycle of realization of debtors’ payment. This is very useful ratio. Many a times the business may be good, other parameters like sale etc can be good, but the unit always run short of cash. This is bad health of unit. Current Ratio: This liquidity group ratio. It is calculated as follows Current Ratio=Current Assets/Current Liability. This decides working capital of unit. It means availability of funds to finance operation cycle of unit. For cash credit/OD or working capital finance this provides useful information. Quick Ratio/Acid test: This is also liquidity group ration. Quick Ratio= (Current Assets-Stock)/Current Liability This indicates realisability of working capital from debtors/investment. 6 A R Mankodi,Faculty Banking Diploma
- 7. Q 7 What is turnover Ratio? How do you calculate this? What to find out from this? This is useful in finding out turnover of stock, holding period of finished goods, requirement of raw material, credit period, debtors’ period in production unit. These are important ratios in industrial finance. Raw material consumption days= Stock of RM/yearly consumption*365 Processing RM days = SIP/cost of production*365 Finished goods holding period= FG/cost of sale*365 Credit sale days= Debtors/sales*365 Credit purchase days= Creditors/purchase*365 Stock Turnover= Cost of sale/Average stock (Op stock + Close stock)/2 Figures are available in trading account and balance sheet. This relates trading with balance sheet status. 7 A R Mankodi,Faculty Banking Diploma
- 8. Q 8 How do we know stake of owner and liability on capital? This ratio indicates borrowing against capital. This can suggest availability of margin money with unit and also long term debt. This ration is generally known as Debt/Equity ratio Long term debt/equity Total outside liability/equity. Higher the ratio higher the borrowed funds. May be there is more burden of interest and less profitability. Generally 1:2 or 2.5 are considered good. It also indicates vulnerability to capital in case of interest rate raise or downturn of business. 8 A R Mankodi,Faculty Banking Diploma
- 9. Q 9 What are important ratios for term loan processing? This ratio is known as Debt Service Coverage Ratio. (DSCR) It indicates profitability available to service debt, meaning installments. Interest coverage Ration can be calculated by ICR DSCR=PBDITA/EMI Or GP/EMI ICR= PBDTIA/interest Or GP/interest If this is positive up to installments or interest it suggests enough repaying capacity. 9 A R Mankodi,Faculty Banking Diploma
- 10. Q 10 How market ratios are calculated of listed company? What they suggest? Earnings Per Share (EPS) = PAT/No of shares. Price to Earnings Ratio (PE Ratio) =Market price of share/EPS Dividend Yield=Dividend/Market price These give important information to market inventors. 10 ARMankodi,FacultyBankingDiploma
- 11. Q 11 What is trend analysis? How is it useful? This is historical study of 3 or more year’s financials of unit. Analyzing can indicate YOY progress or financial health of unit. Generally it is done by charts or graphs. Following comparison is useful Profitability Turnover Return Fund Flow A base year is selected and each item of that year is taken as 100%. Others are compared in relative percentage to base year. Before finalizing a borrower proposal trend also should be checked. 11 A R Mankodi,Faculty Banking Diploma
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