Ratio analysis
- 1. FINANCIAL ANALYSIS & PLANNING RATIO ANALYSIS NAYAN PARMAR A.M.U-MALAPPURAM nayanparmaramu144@gmail.com
- 2. Ratio Analysis is a form of Financial Statement Analysis that is used to obtain a quick indication of a firm's financial performance in several key areas. Lets see how it is calculated and what the objective of this calculation is ? a. Calculation basis A relationship expressed in mathematical terms Between two individual figures or group of figures Connect with each other in some logical manner Selected from financial statements of the concern RATIO ANALYSIS
- 3. Objective for financial ratios is that all the stakeholders (owners, investors, lenders, employees etc.) can draw conclusion about the Performance(present, past and future) Strength & weaknesses of a firm Can take decisions in relation to firm OBJECTIVE:
- 4. The ratios can be classified into the following four broad categories : i. Liquidity Ratios ii. Capital Structure/Leverage Ratios iii. Turnover or Activity Ratios iv. Profitability Ratios TYPES OF RATIOS
- 5. These are those ratios which are computed to evaluate the capacity of the entity to meet its short term liabilities. Commonly used liquidity ratios are : a. Current Ratio b. Quick Ratio c. Absolute Liquidity Ratio LIQUIDITY RATIOS
- 6. Most common measure of short-term liquidity also known as the working capital ratio because net working capital is the difference between current assets and current liabilities Where, Current Assets = stock + sundry debtors + cash and bank + Receivables + Disposable investments + Loan & Adv. Current Liabilities = Creditors + Short Term Loans + Overdraft + Outstanding Exps. + Prov. For tax + Unclaimed dividend CURRENT RATIO Current Ratio = Current Assets Current Liabilities Ideal 2 : 1
- 7. The Quick ratio is sometimes called as the “acid” test ratio and is one of the best measure of liquidity. Quick Ratio = Quick Assets Current Liabilities Where, Quick Assets = Current Assets − Inventories Current Liabilities = As discussed in current ratio QUICK RATIOS Ideal 1 : 1
- 8. The absolute liquidity ratio measures the absolute liquidity of the business. This ratio only considers the absolute liquidity available with the firm. Absolute Liquidity Ratio = Cash + Marketable Securities Current Liabilities Where, Marketable Securities = These are financial instruments that can be easily converted to cash such as government bonds, common stock or certificates of deposit. ABSOLUTE LIQUIDITY RATIO Ideal 0.5 : 1
- 9. Capital structure/leverage ratio may be defined as those ratios which measure the long term stability and structures of the firm. a. Debt Equity Ratio b. Proprietary Ratio c. Capital Gearing Ratio d. Fixed Asset Ratio CAPITAL STRUCTURES/LEVERAGE RATIOS
- 10. This ratio reflects the long-term financial position of a firm and is calculated in the form of relationship between external equities or outsider funds and internal equities or shareholders fund. Debt-Equity Ratio = Debt Equity Where, Debt = Debentures + Loans + Other long term liabilities Equity = Eq. share capital + Pref. share capital + Reserve & surplus DEBT EQUITY RATIO Ideal 2 : 1
- 11. This ratio indicates the relationship between proprietor’s fund and total assets Proprietary Ratio = Shareholder′s fund Total Assets Where, Shareholders fund = Eq. share capital + Pref. Share capital + reserve and surplus – (Loss + Fictitious Asset) PROPRIETARY RATIO Ideal 1 : 3
- 12. This ratio establishes the relationship between fixed cost bearing capital. Capital Gearing Ratio = Eq. share capital+Reserve & surplus pref.capital+Int. Bearing Finance Where, Interest Bearing Finance = Debentures + Long Term Loan CAPITAL GEARING RATIO
- 13. This ratio specifically measures how able a company is to generate net sales from fixed-asset investments, namely property, plant and equipment, net of depreciation. Fixed Asset Ratio = Net Fixed Asset Shareholders fund+Long Term Liability Where, Net Fixed Asset = Total Fixed Asset – Depreciation FIXED ASSETS RATIO Ideal >1
- 14. These ratios are employed to evaluate the efficiency with which the firms manages and utilizes its asset. For this reason, they are often called as ‘Asset management ratio’. a. Stock Turnover Ratio b. Debtor Turnover Ratio c. Creditor Turnover Ratio d. Working Capital Turnover Ratio TURNOVER OR ACTIVITY RATIOS
- 15. This ratio is also known as inventory turnover ratio. This ratio establishes relationship between cost of goods sold during a given a period and the average amount of inventory carried during that period. Stock Turnover Ratio = Cost of goods sold Average Stock or Inventory Where, Cost of Goods Sold = Sales – Gross Profit Average Inventory = (Opening Stock + Closing Stock)/2 STOCK TURNOVER RATIO
- 16. This ratio is also known as Receivables Turnover Ratio. It establishes relationship between net credit sales and average debtors of the year. Debtor Turnover Ratio = Net Credit Sales Average Debtors Where, Net Credit Sales = Sales ― Cash ― Sales Return Average Debtors = Opening Debtors +Closing Debtors 2 DEBTOR TURNOVER RATIO
- 17. This ratio indicates the number of times the payables rotates in a year or the velocity with which the payment for credit purchases are made to creditors. Creditor Turnover Ratio = Net Credit Purchase Average Creditors Where, Net Credit Purchases = Total Purchases ― Cash Purchases ― Purchases Return CREDITOR TURNOVER RATIO
- 18. This ratio indicates the velocity of the utilization of net working capital. In other words it indicates the number of times the Working capital is rotated in coarse of a year. Working Capital Ratio = Cost of Goods Sold Working Capital Where, Working Capital = Current Assets ― Current Liabilities WORKING CAPITAL TURNOVER RATIO
- 19. The profitability ratios measures the profitability or the operational efficiency of the firm. They are some of the most closely watched and widely quoted ratios. a. General profitability Ratio : I. Gross Profit Ratio II. Net Profit Ratio III. Operating Profit Ratio PROFITABILITY RATIOS
- 20. b. Overall Profitability Ratios : I. Return on Equity II. Return on Capital Employed III. Return on Proprietor Fund PROFITABILITY RATIOS
- 21. It is also called as ‘Gross Profit Margin’. This ratio establishes relationship of gross profit to net sales of the firm. This ratio is a indicator to the adequacy of selling price and efficiency of trading activities. Gross Profit Ratio = Gross Profit x 100 Net Sales Where, Net Sales = Total Sales ― Sales Return Gross Profit = Sales ― Cost of Good Sold GROSS PROFIT RATIO
- 22. It measures overall profitability of the business. Net Profit Ratio finds the proportion of revenue that finds its way into profits. Net Profit Ratio = Net Profit X 100 Sales Where, Net Profit is derived by deducting admin. Exps, selling Exps, finance charges, etc from Gross Profit NET PROFIT RATIO
- 23. Operating Profit measures the percentage of each sales in rupees that remains after the payment of all cost and expenses except for Interest and Taxes. Operating Profit Ratio = Operating Profit X 100 Sales Where, Operating Profit = Earning before interest and taxes. OPERATING PROFIT RATIO
- 24. Return on Equity measures the profitability of equity funds invested in the firm. This ratio reveals how profitability of the owner’s fund has been utilized by the firm. R.O.E = Net profit Equity Shareholder′s Funds X 100 Where, Shareholder’s Funds = Equity Capital + Reserves and surplus – Accumulated Losses. RETURN ON EQUITY
- 25. It is the most important ratio of all. It is the percentage of return on funds invested in the business by it’s owner’s. R.O.C.E = Net Profit Capital employed X 100 Where, Capital Employed = Total Assets – Current Liabilities. RETURN ON CAPITAL EMPLOYED
- 26. This ratio is also known as return on net worth and it determines the earning capacity related to owner’s capital. R.O.P.F = Net Profit Shareholders Fund X 100 Where, Shareholders Fund = Equity Share Capital + Preference Share Capital + Reserves and Surplus – Accumulated Loss and Fictitious Assets. RETURN ON PROPRIETOR FUND
- 27. Diversified product lines. Financial data are badly distorted by inflation. Seasonal factors may also influence financial data. To give a good shape to the popularly used financial ratio. Differences in accounting policies and accounting period. It is very difficult to generalize weather a particular ratio is good or bad. LIMITATION OF RATIO ANALYSIS