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# Ratio analysis

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# Ratio analysis

Ratio Analysis concepts

Ratio Analysis concepts

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### Ratio analysis

1. 1. RATIO ANALYSIS
2. 2. What are Financial Statements: 1. Balance Sheet/Position statement 2. Profit and Loss Account/income Statement 3. Statement of Retained Earnings/Profit and Loss Appropriation Account 4. Cash Flow Statement
3. 3. Methods of Analyzing Financial Statements 1. Comparative Statements 2. Common Size Statements 3. Ratio Analysis 4. Cash Flow Statement
4. 4. Ratio Analysis • A comparative study of the relationship between various factors of statements. • It shows the profitability, liquidity, solvency. • It helps for forecasting. • It is helpful for interfirm comparison and intrafirm comparison. • These are useful for both internal as well as external stakeholders.
5. 5. Classification of Ratios • 1. Profitability Ratio: It reflects the relationship between profit and sales, assets or capital employed. It judges the efficiency of the business. • 2.Turnover ratio/ Activity Ratio: It measures the effectiveness of the usage of capital or assets employed in the business. • 3. Financial Ratio/solvency Ratio: It judges the solvency in short term and long term of the company. • 4. Market Test ratios: It tells the market value of the company/ shares.
6. 6. Profitability Ratio 1. Return on Investment: How much company is earning on its investment. ROI= (Net Operating Profit*100)/ Capital employed Notes: • Operating profit is EBIT. • Non business income should not be included. • Capital includes share capital, reserve and surplus, long term loans – non operating assets and fictitious assets. • It can be net fixed assets + working capital • ROI= (operating profit/sales) * (sales/capital) • ROI= net profit ratio * turnover ratio
7. 7. Numerical 1 • Q. Suppose a company has the following items on the liabilities side and it shows fictitious asset of Rs. 1,00,000 on the assets side: 13% Preference capital 10,00,000 Equity capital 30,00,000 Reserves 26,00,000 Loans @15% 30,00,000 Current liabilities 15,00,000 Its profit after paying tax @ 50% is Rs. 14,00,000. Calculate ROI?
8. 8. SOLUTION • PBIT= PAT+ TAX+INTEREST ON LOAN • = 14,00,000+ 14,00,000 + 4,50,000 • = 32,50,000 • Capital employed = 10,00,000+ 30,00,000+ 26,00,000+30,00,000-1,00,000= 95,00,000 • ROI= (32,50,000/95,00,000)*100= 34.21%
9. 9. Profitability ratios • Return on shareholders’ funds/ return on net worth: • = (PAT*100)/shareholders' funds • Capital should be after deducting long term loans. • It would reflect profitability for the shareholders. Return on assets: • It shows whether assets are being properly utilized or not. • = PAT*100/ Total assets • Gross profit ratio/gross margin: • Gross profit is profit before admin, selling and financing expenses. • =Gross profit*100/sales • This ratio should be enough high to cover other costs and for proper returns to owners.
10. 10. • Net profit ratio: • = operating profit *100/sales • Net profit= gross profit- admin charges- selling & distribution charges. • Non operating incomes and expenses are ignored. • It shows the expenses for admin and selling are less or high.
11. 11. Activity ratio/ turnover ratio • It shows the effectiveness of the resources employed in business. • 1) capital turnover ratio: • = net sales/ capital employed • Higher the ratio greater the profit. • 2) total assets turnover ratio: • = net sales/ total assets • It can be divided in following parts: • 2.a.)Fixed assets turnover ratio: • = net sales/ FA • FA should be taken after depreciation.
12. 12. • Working capital turnover ratio: • = net sales/ working capital • Stock /inventory turnover ratio: • = COGS/ avg. inventory • =sale/avg inventory • Debtors turnover ratio: • = net sales/average debtors • Debtor collection period: • = (Months or days I a year)/ debtors turnover
13. 13. • Q. From the following information calculate Debtors turnover ratio and avg collection period: • Total debtors opening balance 2,00,000 • Cash sales 1,50,000 • Credit sales 10,00,000 • Cash collected 7,80,000 • Sales return 60,000 • Bad debts 40,000 • Discount allowed 20,000 • Provision for bad debts 20,000 • No of days in a year 360
14. 14. • Creditors’ turnover ratio: • = credit purchase/avg creditors • Debt payment period: • =( Months or days in a year)/ creditors turnover
15. 15. Financial ratios/ solvency ratios 1. Liquidity ratio: short term solvency ratio In short term firm should be able to meet all its short term obligations. a. Current ratio= current assets/ current liabilities 2:1 is an ideal ratio. If it is too high it is not a good sign it will effect the profitability. b. Quick ratio/ liquid ratio= quick assets/ current liabilities Quick assets = current assets – inventory – prepaid expenses 1:1 is an ideal ratio.
16. 16. • 2. Long term solvency ratio: • 2.a. debt-equity ratio: • External-internal equity ratio • Debt include debentures, Long term loan from FIs. • Equity means preference, equity share capital, reserves less loss and fictitious assets as preliminary expenses. • = Debt/ Equity • In India 2:1 is ideal. • It means a company can take debt twice of equity or it can finance 2/3 portion from debt. • 2.b. Debt service coverage ratio: • Fixed charges cover/ interest cover ratio. • It covers the debt servicing capacity of the company. • = PBT/ Interest charges • Ideal ration is 6-7.
17. 17. • 2.c.Capital gearing ratio: • Proportion of fixed interest or dividend bearing funds and non fixed interest or dividend bearing funds in total capital. • = fixed interest bearing funds/ equity shares funds
18. 18. Market test ratios • These are used for the companies whose shares are trading in the market. • Following ratios reflect the market value of shares: • 1. EPS/ earning per share • EPS= net profit/ no of equity shares • Net profit should be calculated after preference shares’ dividend. • It should consider all operating , non operating income and expenses. • High EPS, high share price, vice versa.
19. 19. • 2. Price Earning ratio/ PE Ratio: it establishes the relation between market price and earning of a share. = MP of a equity share/ EPS It helps to decide whether the share is undervalued or overvalued. 3. Pay out ratio: It shows what is available as earning per share and what is actually paid as dividend out of earnings. It shows the dividend policy of a company. = DPS/EPS 4. Dividend yield ratio: It shows the return shareholders are getting on market price of the shares. = DPS/ MPS * 100
20. 20. • From the following information, calculate ( i) Net Assets Turnover (ii) Fixed Assets Turnover and (iii ) Working Capital Turnover Ratios iv) debt- equity ratio v) debtors turnover ratio vi) creditors turnover ratio : • Preference Shares Capital 4,00,000 Plant and Machinery 8,00,000 • Equity Share Capital 6,00,000 Land and Building 5,00,000 • General Reserve 1,00,000 Motor Car 2,00,000 • Profit and Loss Account 3,00,000 Furniture 1,00,000 • 15% Debentures 2,00,000 Stock 1,80,000 • 14% Loan 2,00,000 Debtors 1,10,000 • Creditors 1,40,000 Bank 80,000 • Bills Payable 50,000 Cash 30,000 • Outstanding Expenses 10,000 • Sales for the year 2005 were Rs. 30,00,000.
21. 21. • Solution • Sales = Rs. 30,00,000 • Capital Employed = Share Capital + Reserves and Surplus + Long-term Debt (or Net Assets) • = (Rs.4,00,000 + Rs.6,00,000) + (Rs.1,00,000 + Rs.3,00,000) + (Rs.2,00,000 + Rs.2,00,000) = Rs. 18,00,000 • Fixed Assets = Rs.8,00,000 + Rs.5,00,000 + Rs.2,00,000 + Rs.1,00,000 = Rs. 16,00,000 • Working Capital = Current Assets – Current Liabilities = Rs.4,00,000 – Rs.2,00,000 = Rs. 2,00,000 • Net Assets Turnover Ratio = Rs.30,00,000/Rs.18,00,000 = 1.67 times • Fixed Assets Turnover Ratio = Rs.30,00,000/Rs.16,00,000 = • 1.88 times • Working Capital Turnover = Rs.30,00,000/Rs.2,00,000 = 15 • times.