9 and 10 Financial Analysis.ppt

3R’s of credit analysis
 1. Returns from the proposed investment
 2.Repayment capacity the investment
generates
 3. Risk- bearing ability of the borrower
 The 3Rs of credit are sound indicators of credit
worthiness of the borrowers.

• The “5 Cs of Credit” is a common phrase used
to describe the five major factors used to
determine a potential borrower’s
creditworthiness.
• The 5 Cs of Credit refer to Character, Capacity,
Collateral, Capital, and Conditions.
• Financial institutions use credit ratings to
quantify and decide whether an applicant is
eligible for credit and to determine the interest
rates and credit limits for existing borrowers.

7PS OF CREDIT, REPAYMENT PLANS
1) Principle of Productive Purpose,
2) Principle of Personality,
3) Principle of Productivity,
4) Principle of Phased disbursement,
5) Principle of Proper utilization,
6) Principle of repayment,
7) Principle of protection

• Financial Statements
• Balance Sheet Ratios
• Income Statement and Income/Balance
Sheet Ratios
• Trend Analysis
• Common-Size and Index Analysis
Financial Statement Analysis

Where can one find financial statements?

• Trade Creditor – Focus on the
liquidity of the firm.
• Bondholder – Focus on the long-
term cash flow of the firm.
• Shareholder– Focus on the
profitability and long-term health of
the firm.
Examples of External Uses
of Statement Analysis

• Plan – Focus on assessing the current
financial position and evaluating
potential firm opportunities.
• Control – Focus on return on investment
for various assets and asset efficiency.
• Understand – Focus on understanding
how supplier of funds analyze the firm.
Examples of Internal Uses
of Statement Analysis

Income Statement
• A summary of a firm’s revenues and
expenses over a specified period, ending
with net income or loss for the period.
Balance Sheet
• A summary of a firm’s financial position on
a given date that shows total assets = total
liabilities + owners’ equity.
Primary Types of
Financial Statements

a. How the firm stands on
a specific date.
b. What BW owned.
c. Amounts owed by
customers.
d. Future expense items
already paid.
e. Cash/likely convertible
to cash within 1 year.
f. Original amount paid.
g. Acc. deductions for
wear and tear.
Cash ₹ 90
Acct. Rec.c 394
Inventories 696
Prepaid Exp d 5
Accum Tax Prepay 10
Current Assetse ₹1,195
Fixed Assets (@Cost)f 1030
Less: Acc. Depr. g (329)
Net Fix. Assets ₹ 701
Investment, LT 50
Other Assets, LT 223
Total Assetsb ₹2,169
Basket World Balance Sheet (thousands) Dec. 31, 2007a
Basket World’ Balance
Sheet (Asset Side)

a. Note Assets =
Liabilities + Equity.
b. What BW owed and
ownership position.
c. Owed to supplier for
goods and services.
d. Unpaid wages,
salaries, etc.
e. Debts payable < 1 year.
f. Debts payable > 1 year.
g. Original investment.
h. Earnings reinvested.
Notes Payable ₹ 290
Acct. Payablec 94
Accrued Taxes d 16
Other Accrued Liab. d 100
Current Liab. e ₹ 500
Long-Term Debt f 530
Shareholders’ Equity
Com. Stock (₹10 par) g 200
Add Pd in Capital g 729
Retained Earnings h 210
Total Equity ₹1,139
Total Liab/Equitya,b ₹2,169
Basket World Balance Sheet (thousands) Dec. 31, 2007
Basket World’ Balance
Sheet (Liability Side)

a. Measures profitability
over a time period.
b. Received, or receivable,
from customers.
c. Sales comm., adv.,
office’ salaries, etc.
d. Operating income.
e. Cost of borrowed funds.
f. Taxable income.
g. Amount earned for
shareholder
Net Sales ₹ 2,211
Cost of Goods Sold b 1,599
Gross Profit ₹ 612
SG&A Expenses c 402
EBITd ₹ 210
Interest Expensee 59
EBT f ₹ 151
Income Taxes 60
EATg ₹ 91
Cash Dividends 38
Increase in Reserve ₹
53
Basket World Statement of Earnings (in thousands) for
Year Ending December 31, 2007a
Basket World’ Income Statement

Analytical Tools Used
Sources and Uses Statement
Statement of Cash Flows
Cash Budgets
1. Analysis of the funds
needs of the firm.
Trend/Seasonal Component
How much funding will be
required in the future?
Is there a seasonal
component?
Framework for Financial Analysis

Health of a Firm
Financial Ratios
1. Individually
2. Over time
3. In combination
4. In comparison
needs of the firm.
2. Analysis of the financial
condition and profitability
of the firm.

Examples:
Volatility in sales
Volatility in costs
Proximity to break-even
point
needs of the firm.
of the firm.
3. Analysis of the business
risk of the firm.
Business risk relates to
the risk inherent in the
operations of the firm.

A Financial
Manager
must
consider all
three jointly
when
determining
the
financing
needs of the
firm.
Determining
the
financing
needs of
the firm.
needs of the firm.
of the firm.
risk of the firm.

Negotiations
with
supplier of
capital.
Determining
the
financing
needs of
the firm.
needs of the firm.
of the firm.
risk of the firm.

Types of
Comparisons
Internal
Comparisons
External
Comparisons
A Financial Ratio is
an index that relates
two accounting
numbers and is
obtained by dividing
one number by the
other.
Use of Financial Ratios

Examples:
Risk Management
Association
Dun & Bradstreet
Almanac of
Business and
Industrial
Financial Ratios
This involves
comparing the ratios
of one firm with those
of similar firms or with
industry averages.
Similarity is important
as one should
compare “apples to
apples.”
External Comparisons and
Sources of Industry Ratios

Before looking at the ratios there are a number of
cautionary points concerning their use that need to be
identified :
a. The dates and duration of the financial statements
being compared should be the same. If not, the effects
of seasonality may cause erroneous conclusions to be
drawn.
b. The accounts to be compared should have been
prepared on the same bases. Different treatment of
stocks or depreciations or asset valuations will distort
the results.
c. In order to judge the overall performance of the firm a
group of ratios, as opposed to just one or two should
be used. In order to identify trends at least three years
of ratios are normally required.

• 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

• 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.

Ratio Analysis
1. Liquidity – the ability of the firm to pay its way
2. Investment/shareholders – information to enable decisions to be made on the
extent of the risk and the earning potential of a business investment
3. Gearing – information on the relationship between the exposure of the business
to loans as opposed to share capital
4. Profitability – how effective the firm is at generating profits given sales and or
its capital assets
5. Financial – the rate at which the company sells its stock and the efficiency with
which it uses its assets

Current
Current Assets
Current Liabilities
For Basket World
December 31, 2007
Shows a firm’s
ability to cover its
current liabilities
with its current
assets.
Balance Sheet Ratios
Liquidity Ratios
₹1,195
₹500
= 2.39
Liquidity Ratios

BW Industry
2.39 2.15
2.26 2.09
1.91 2.01
Year
2007
2006
2005
Current Ratio
Ratio is stronger than the industry average.
Liquidity Ratio
Comparisons

Acid-Test (Quick)
Current Assets - Inv
Current Liabilities
For Basket World
December 31, 2007
Shows a firm’s
ability to meet
current liabilities
with its most liquid
assets.
Liquidity Ratios
₹1,195 – ₹696
₹500
= 1.00
Liquidity Ratios

BW Industry
1.00 1.25
1.04 1.23
1.11 1.25
Year
2007
2006
2005
Acid-Test Ratio
Ratio is weaker than the industry average.
Liquidity Ratio
Comparisons

• Strong current ratio and weak acid-test
ratio indicates a potential problem in the
inventories account.
• Note that this industry has a relatively
high level of inventories.
Ratio BW Industry
Current 2.39 2.15
Acid-Test 1.00 1.25
Summary of the Liquidity
Ratio Comparisons

Trend Analysis of Current Ratio
1.5
1.7
1.9
2.1
2.3
2.5
2005 2006 2007
Analysis Year
Ratio
Value
BW
Industry
Current Ratio – Trend
Analysis Comparison

Trend Analysis of Acid-Test Ratio
0.5
0.8
1.0
1.3
1.5
2005 2006 2007
Analysis Year
Ratio
Value
BW
Industry
Acid-Test Ratio – Trend
Analysis Comparison

• The current ratio for the industry has
been rising slowly at the same time the
acid-test ratio has been relatively stable.
• This indicates that inventories are a
significant problem for BW.
• The current ratio for BW has been rising
at the same time the acid-test ratio has
been declining.
Summary of the Liquidity
Trend Analyses

Gearing
Gearing Ratio = Long term loans / Capital
employed x 100
The higher the ratio the more the business is
exposed to interest rate fluctuations and to
having to pay back interest and loans before
being able to re-invest earnings

Debt-to-Equity
Total Debt
Shareholde’ Equity
For Basket World
December 31, 2007
Shows the extent to
which the firm is
financed by debt.
Financial Leverage
Ratios
₹1,030
₹1,139
= 0.90
Financial Leverage Ratios

BW Industry
0.90 0.90
0.88 0.90
0.81 0.89
Year
2007
2006
2005
Debt-to-Equity Ratio
BW has average debt utilization
relative to the industry average.
Financial Leverage
Ratio Comparisons

Debt-to-Total-Assets
Total Debt
Total Assets
For Basket World
December 31, 2007
Shows the percentage
of the firm’s assets
that are supported by
debt financing.
Financial Leverage
Ratios
₹1,030
₹2,169
= 0.47

BW Industry
0.47 0.47
0.47 0.47
0.45 0.47
Year
2007
2006
2005
Debt-to-Total-Asset Ratio
BW has average debt utilization
Financial Leverage
Ratio Comparisons

Total Capitalization
Total Debt
Total Capitalization
For Basket World
December 31, 2007
Shows the relative
importance of long-term
debt to the long-term
financing of the firm.
Financial Leverage
Ratios
₹1,030
₹1,669
= 0.62
(i.e., LT-Debt + Equity)

BW Industry
0.62 0.60
0.62 0.61
0.67 0.62
Year
2007
2006
2005
Total Capitalization Ratio
BW has average long-term debt utilization
Financial Leverage
Ratio Comparisons

Interest Coverage
EBIT
Interest Charges
For Basket World
December 31, 2007
Indicates a firm’s
ability to cover
interest charges.
Income Statement
Ratios
Coverage Ratios
₹210
₹59
= 3.56
Coverage Ratios

BW Industry
3.56 5.19
4.35 5.02
10.30 4.66
Year
2007
2006
2005
Interest Coverage Ratio
BW has below average interest coverage
Coverage
Ratio Comparisons

Trend Analysis of Interest Coverage Ratio
3.0
5.0
7.0
9.0
11.0
2005 2006 2007
Analysis Year
Ratio
Value
BW
Industry
Coverage Ratio – Trend
Analysis Comparison

• This indicates that low earnings (EBIT)
may be a potential problem for BW.
• Note - we know that debt levels are in
line with the industry averages.
• The interest coverage ratio for BW has
been falling since 2005. It has been
below industry averages for the past
two years.
Summary of the Coverage
Trend Analysis

Receivable Turnover
Annual Net Credit Sales
Receivables
For Basket World
December 31, 2007
Indicates quality of
receivables and how
successful the firm is in
its collections.
Income Statement/
Balance Sheet
Ratios
Activity Ratios
₹2,211
₹394
= 5.61
(Assume all sales are credit sales.)
Activity Ratios

Avg Collection Period
Days in the Year
Receivable Turnover
For Basket World
December 31, 2007
Average number of days
that receivables are
outstanding.
(or RT in days)
Income Statement/
Balance Sheet
Ratios
Activity Ratios
365
5.61
= 65 days
Activity Ratios

BW Industry
65.0 65.7
71.1 66.3
83.6 69.2
Year
2007
2006
2005
Average Collection Period
BW has improved the average collection
period to that of the industry average.
Activity
Ratio Comparisons

Payable Turnover (PT)
Annual Credit Purchases
Accounts Payable
For Basket World
December 31, 2007
Indicates the
promptness of payment
to supplier by the firm.
Income Statement/
Balance Sheet
Ratios
Activity Ratios
₹1551
₹94
= 16.5
(Assume annual credit
purchases = ₹1,551.)
Activity Ratios

PT in Days
Days in the Year
Payable Turnover
For Basket World
December 31, 2007
Average number of days
that payables are
outstanding.
Income Statement/
Balance Sheet
Ratios
Activity Ratios
365
16.5
= 22.1 days
Activity Ratios

BW Industry
22.1 46.7
25.4 51.1
43.5 48.5
Year
2007
2006
2005
Payable Turnover in Days
BW has improved the PT in Days.
Is this good?
Activity
Ratio Comparisons

Inventory Turnover
Cost of Goods Sold
Inventory
For Basket World
December 31, 2007
Indicates the
effectiveness of the
inventory management
practices of the firm.
Income Statement/
Balance Sheet
Ratios
Activity Ratios
₹1,599
₹696
= 2.30
Activity Ratios

BW Industry
2.30 3.45
2.44 3.76
2.64 3.69
Year
2007
2006
2005
Inventory Turnover Ratio
BW has a very poor inventory turnover ratio.
Activity
Ratio Comparisons

Trend Analysis of Inventory Turnover Ratio
2.0
2.5
3.0
3.5
4.0
2005 2006 2007
Analysis Year
Ratio
Value
BW
Industry
Inventory Turnover Ratio –
Trend Analysis Comparison

Total Asset Turnover
Net Sales
Total Assets
For Basket World
December 31, 2007
Indicates the overall
effectiveness of the firm
in utilizing its assets to
generate sales.
Income Statement/
Balance Sheet
Ratios
Activity Ratios
₹2,211
₹2,169
= 1.02
Activity Ratios

BW Industry
1.02 1.17
1.03 1.14
1.01 1.13
Year
2007
2006
2005
Total Asset Turnover Ratio
BW has a weak total asset turnover ratio.
Why is this ratio considered weak?
Activity
Ratio Comparisons

Asset Turnover
 Asset Turnover = Sales turnover / assets
employed
 Using assets to generate profit
 Asset turnover x net profit margin = ROCE
Return on capital employed (ROCE)

Stock Turnover
 Stock turnover = Cost of goods sold / stock expressed as
times per year
 The rate at which a company’s stock is turned over
 A high stock turnover might mean increased efficiency?
 But: dependent on the type of business – supermarkets
might have high stock turnover ratios whereas a shop
selling high value musical instruments might have low
stock turnover ratio
 Low stock turnover could mean poor customer
satisfaction if people are not buying the goods (Marks
and Spencer?)

Debtor Days
 Debtor Days = Debtors / sales turnover x 365
 Shorter the better
 Gives a measure of how long it takes the
business to recover debts
 Can be skewed by the degree of credit facility a
firm offers

Profitability
 Profitability measures look at how much profit the firm
generates from sales or from its capital assets
 Different measures of profit – gross and net
 Gross profit – effectively total revenue (turnover) – variable
costs (cost of sales)
 Net Profit – effectively total revenue (turnover) – variable costs
and fixed costs (overheads)

Profitability
 Gross Profit Margin = Gross profit / turnover x 100
 The higher the better
 Enables the firm to assess the impact of its sales and
how much it cost to generate (produce) those sales
 A gross profit margin of 45% means that for every 1 of
sales, the firm makes 45p in gross profit

Profitability
 Net Profit Margin = Net Profit / Turnover x 100
 Net profit takes into account the fixed costs
involved in production – the overheads
 Keeping control over fixed costs is important –
could be easy to overlook for example the
amount of waste - paper, stationery, lighting,
heating, water, etc.
 e.g. – leaving a photocopier on overnight uses enough
electricity to make 5,300 A4 copies. (1,934,500 per year)
 1 ream = 500 copies. 1 ream = 5.00 (on average)
 Total cost therefore = 19,345 per year – or 1 person’s salary

Profitability
Return on Capital Employed (ROCE) = Profit
/ capital employed x 100

Profitability
The higher the better
Shows how effective the firm is in using its
capital to generate profit
A ROCE of 25% means that it uses every 1 of
capital to generate 25p in profit
Partly a measure of efficiency in
organisation and use of capital

Gross Profit Margin
Gross Profit
Net Sales
For Basket World
December 31, 2007
Indicates the efficiency
of operations and firm
pricing policies.
Income Statement/
Balance Sheet
Ratios
Profitability Ratios
₹612
₹2,211
= 0.277

BW Industry
27.7% 31.1%
28.7 30.8
31.3 27.6
Year
2007
2006
2005
Gross Profit Margin
BW has a weak Gross Profit Margin.
Profitability
Ratio Comparisons

Trend Analysis of Gross Profit Margin
25.0
27.5
30.0
32.5
35.0
2005 2006 2007
Analysis Year
Ratio
Value
(%)
BW
Industry
Gross Profit Margin –

Net Profit Margin
Net Profit after Taxes
Net Sales
For Basket World
December 31, 2007
Indicates the firm’s
profitability after taking
account of all expenses
and income taxes.
Income Statement/
Balance Sheet
Ratios
₹91
₹2,211
= 0.041

BW Industry
4.1% 8.2%
4.9 8.1
9.0 7.6
Year
2007
2006
2005
Net Profit Margin
BW has a poor Net Profit Margin.
Profitability
Ratio Comparisons

Trend Analysis of Net Profit Margin
4
5
6
7
8
9
10
2005 2006 2007
Analysis Year
Ratio
Value
(%)
BW
Industry
Net Profit Margin –

Return on Investment
Total Assets
For Basket World
December 31, 2007
Indicates the
profitability on the
assets of the firm (after
all expenses and taxes).
Income Statement/
Balance Sheet
Ratios
₹91
₹2,160
= 0.042

BW Industry
4.2% 9.6%
5.0 9.1
9.1 10.8
Year
2007
2006
2005
Return on Investment
BW has a poor Return on Investment.
Profitability
Ratio Comparisons

Investment/Shareholders
 Earnings per share – profit after tax / number of shares
 Price earnings ratio – market price / earnings per share
– the higher the better generally for company.
Comparison with other firms helps to identify value
placed on the market of the business.
 EV / EBITDA Ratio - Enterprise Value / EBITDA ratio -
the higher the better generally for company . It
measures the operational performance of the firm.
 Dividend yield – ordinary share dividend / market price
x 100 – higher the better. Relates the return on the
investment to the share price.

Trend Analysis of Return on Investment
4
6
8
10
12
2005 2006 2007
Analysis Year
Ratio
Value
(%)
BW
Industry
Return on Investment –

Return on Equity
Shareholder’ Equity
For Basket World
December 31, 2007
Indicates the profitability
to the shareholde of the
firm (after all expenses
and taxes).
Income Statement/
Balance Sheet
Ratios
₹91
₹1,139
= 0.08

BW Industry
8.0% 18.0%
9.4 17.2
16.6 20.4
Year
2007
2006
2005
Return on Equity
BW has a poor Return on Equity.
Profitability
Ratio Comparisons

Trend Analysis of Return on Equity
7.0
10.5
14.0
17.5
21.0
2005 2006 2007
Analysis Year
Ratio
Value
(%)
BW
Industry
Return on Equity –

ROI2007 = 0.041 × 1.02 = 0.042 or 4.2%
ROIIndustry = 0.082 × 1.17 = 0.096 or 9.6%
(Note: values are rounded)
ROI = Net profit margin ×
Total asset turnover
Earning Power = Sales profitability ×
Asset efficiency
Return on Investment and
the Du Pont Approach

ROE2007 = 0.041 × 1.02 × 1.90 = 0.080
ROEIndustry = 0.082 × 1.17 × 1.88 = 0.180
(Note: values are rounded)
Return On Equity = Net profit margin X
Total asset turnover X
Equity Multiplier
Equity Multiplier =
Total Assets
Shareholde’ Equity
Return on Equity and
the Du Pont Approach

• The profitability ratios for BW have ALL
been falling since 2005. Each has been
below the industry averages for the past
three years.
• This indicates that COGS and
administrative costs may both be too
high and a potential problem for BW.
• Note, this result is consistent with the low
interest coverage ratio.
Summary of the Profitability
Trend Analyses

• Inventories are too high.
• May be paying off creditor
(accounts payable) too soon.
• COGS may be too high.
• Selling, general, and
administrative costs may be too
high.
Summary of Ratio Analyses

An analysis of percentage
financial statements where all
balance sheet items are divided
by total assets and all income
statement items are divided by
net sales or revenues.
Common-Size Analysis

Common-Size Analysis
Common-size financial statements present all
items in percentage terms.
Balance sheet items are presented as
percentages of assets,
income statement items are presented as
percentages of sales

comparative statement
comparative statement, the base year values
are compared with the current year

Basis of Difference Comparative Common Size
Meaning
The comparative statements are that statement which shows the
comparison between the component of the financial statement of the
business for the period of more the two years
The Common-Size statement is that statement which shows the
percentage to a common base of all accounts of the financial
statement of the business for the period of more than two years.
Base of Comparison
In this, the value of the basis year compared with the value of
the current year.
In this, the value of the current year compared with the current
year.
Number of Years required Minimum Financial Statements of two years are required. The financial Statement of One year is required.
Results expressed in The results are expressed in the pictorial as well as percentage form. The results are expressed in the percentage form.
Type of Comparision included It included both types of Intra and inter-firm comparison. It included only inter-firm comparison.
Helps in It helps in the decision making for the management for future planning. It helps the stakeholder in the decision of the investment.
Useful in
It is useful to compare the current year results with the prevision
year.
It is useful to compare the current year results with its competitors’
results.

An analysis of percentage financial
statements where all balance sheet
or income statement figures for a
base year equal 100.0 (percent) and
subsequent financial statement
items are expressed as percentages
of their values in the base year.
Index Analyses

Summary of Financial Ratios
Ratios help to:
Evaluate performance
Structure analysis
Show the connection between
activities and performance
Benchmark with
Past for the company
Industry

Limitations of Ratio Analysis
A firm’s industry category is often
difficult to identify
Published industry averages are
only guidelines
Accounting practices differ across
firms
Sometimes difficult to interpret
deviations in ratios
Industry ratios may not be desirable
targets
Seasonality affects ratios

LIABILITES ASSETS
Capital 180 Net Fixed Assets 400
Reserves 20 Inventories 150
Term Loan 300 Cash 50
Bank C/C 200 Receivables 150
Trade Creditors 50 Goodwill 50
Provisions 50
800 800
EXERCISE 1
a. What is the Net Worth : Capital + Reserve = 200
b. Tangible Net Worth is : Net Worth - Goodwill = 150
c. Outside Liabilities : TL + CC + Creditors + Provisions =
600
d. Net Working Capital : C A - C L = 350 - 300 = 50
e. Current Ratio : C A / C L = 350 / 300 = 1.17 : 1
f. Quick Ratio : Quick Assets / C L = 200/300 = 0.66 : 1

EXERCISE 2
LIABILITIES 2005-06 2006-07 ASSETS 2005-
06
2006-
07
Capital 300 350 Net Fixed Assets 730 750
Reserves 140 160 Security
Electricity
30 30
Bank Term Loan 320 280 Investments 110 110
Bank CC (Hyp) 490 580 Raw Materials 150 170
Unsec. Long T L 150 170 S I P 20 30
Creditors (RM) 120 70 Finished Goods 140 170
Bills Payable 40 80 Cash 30 20
Expenses Payable 20 30 Receivables 310 240
Provisions 20 40 Loans/Advances 30 190
Goodwill 50 50
Total 1600 1760 1600 1760
1. Tangible Net Worth for 1st Year : ( 300 + 140) - 50 = 390
2. Current Ratio for 2nd Year : (170 + 30 +170+20+ 240 + 190 ) /
(580+70+80+70)
820 /800 = 1.02
3. Debt Equity Ratio for 1st Year : 320+150 / 390 = 1.21

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 100 Preliminary Expenses 100
Total 1400 1400
1. Debt Equity Ratio will be : 600 / (200+100) = 2 : 1
2. Tangible Net Worth : Only equity Capital i.e. = 200
3. Total Outside Liabilities / Total Tangible Net Worth : (600+400+100) /
200
= 11 : 2
4. Current Ratio will be : (300 + 150 + 50 ) / (400 + 100 ) = 1 : 1

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 1
Provision of Tax 9 Intangible Assets 30
Proposed Dividend 15
550 550
Q. What is the Current Ratio ? Ans : (1+125 +128+1) / (38+26+9+15)
: 255/88 = 2.89 : 1
Q What is the Quick Ratio ? Ans : (125+1)/ 88 = 1.43 : 11
Q. What is the Debt Equity Ratio ? Ans : LTL / Tangible NW
= 100 / ( 362 – 30)
= 100 / 332 = 0.30 : 1
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 1
Provision of Tax 9 Intangible Assets 30
Proposed Dividend 15
550 550
Q. 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 12 = (26 / 1050) x 12 = 0.3
months
Exercise 4. contd…

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
2 = (5 x100) /Sales
Therefore Sales = 500/2 = 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 = 16 + 25 = Rs. 41 Lac
Total Liabilities = NW + LTL + CL = 5 + 10+ CL = 41 Lac
Current Liabilities = 41 – 15 = 26 Lac
Therefore Net Working Capital = C. A – C.L
= 25 – 26 = (- )1 Lac

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 ( since NWC = C.A - C.L )
Exercise 8 : Suppose Current Ratio is 4 : 1. NWC is Rs.30,000/-. What
is the amount of Current Assets ?
Answer : 4a - 1a = 30,000
Therefore a = 10,000 i.e. Current Liabilities is Rs.10,000
Hence Current Assets would be 4a = 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
= (270000 + 30000 + 60000 ) / 60000 + 120000
= 360000 / 180000 = 2

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

Exercise 12. From the following financial statement calculate (i) Current
Ratio (ii) Acid test Ratio (iii) Inventory Turnover (iv) Average Debt Collection
Period (v) Average Creditors’ payment period.
C.Assets
Sales 1500 Inventories 125
Cost of sales 1000 Debtors 250
Gross profit 500 Cash 225
C. Liabilities
Trade Creditors
200
(i) Current Ratio : 600/200 = 3 : 1
(ii)Acid Test Ratio : Debtors+Cash /Trade creditors = 475/200 = 2.4 : 1
(iii) Inventory Turnover Ratio : Cost of sales / Inventories = 1000/125 = 8
times
(iv) Average Debt collection period : (Debtors/sales) x 365 = (250/1500)x365
= 61 days
(v)Average Creditors’ payment period : (Trade Creditors/Cost of sales) x 365
(200/100) x 365 = 73 days

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