presentation4

1. RATIO ANALYSIS
Meaning of Ratio Analysis
Ratio Analysis is defined as the
systematic use of ratio to interpret
financial statements so that strengths
and weaknesses of a firm as well as
its historical performance and
current financial condition can be
determined.

2. Importance or significance of Ratio
Analysis
• 1) Liquidity position
• 2) Long term solvency
• 3) Operating efficiency
• 4) Overall profitability
• 5) Inter-firm comparison
• 6) Trend analysis

3. Limitations of the Ratio Analysis
• 1) Difficulty in comparison
• 2) Impact of inflation
• 3) Conceptual diversity

4. Types of ratios
Liquidity
ratios
A) Current Ratio
B) Quick Ratio
C) Cash Ratio
Profitability
ratios
a) Gross profit ratio (GP ratio)
b) Operating ratio
c) Net profit ratio (NP ratio)
d) Return on investment (ROI)
e) Return on capital employed ratio
f) Earnings per share (EPS) ratio
g) Dividend payout ratio
h) Dividend yield ratio
i) Price earnings ratios (P/E ratio)
j)The net worth ratio
Turnover
ratios
a) Inventory Turnover Ratio
b) Debtors Turnover Ratio
c) Creditor turnover ratio
d) Working Capital Turnover Ratio
e) Fixed assets turnover ratio
f) Capital Employed
Solvency
ratios
A) Debt-to-Equity Ratio
B) The proprietary ratio
C) Capital gearing ratio
D) 'Debt-Service Coverage Ratio -
DSCR'
E) Overall profitability ratio

5. Liquidity Ratios
Liquidity represents one's ability to pay its current
obligations or short-term debts within a period
less than one year. Liquidity ratios, therefore,
measures a company's liquidity position. The
ratios are important from the viewpoint of its
creditors as well as management. The liquidity
position of the company can be measured
mainly by using two liquidity ratios such as
follows.
A) Current Ratio
B) Quick Ratio
C) Cash Ratio

6. A. Current Ratio
Current ratio is also known as short-term solvency ratio or working capital ratio.
Current ratio is used to assess the short-term financial position of the business. In
other words, it is an indicator of the firm's ability to meet its short-term obligations.
Current ratio is calculated by using following formula:
Current ratio = Current assets/Current liabilities
Sr.
no
Current assets Current liabilities
1 Cash in hand Sundry
creditors(accounts
payable)
2 Cash at bank Bills payable
3 Sundry debtors Outstanding expenses
4 Bills receivables Income tax payable
5 Marketable securities Short term advances
6 Other Short term investments Unpaid or unclaimed
dividend
7 Inventories:
(a)Stock of raw materials
Bank overdraft

7. B. Quick Ratio
Quick ratio is also known as liquid ratio or acid test
ratio. However, although it is used to test the
short-term solvency or liquidity position of the
firm, Liquid assets are cash and other assets
which are either equivalent to cash or convertible
into cash within a very short period of time.
The following formula is used to calculate quick
ratio:
Quick Ratio = Liquid assets/Current Liabilities
Liquid assets = Total current assets - stock-
prepaid expenses

8. C) Cash ratio
• It the most conservative liquidity ratio. It excludes
all current assets except the most liquid: cash and
cash equivalents. The cash ratio is defined as
follows:
• Cash Ratio = Cash + Marketable
Securities/Current Liabilities
The cash ratio is an indication of the firm's ability to
pay off its current liabilities if for some reason
immediate payment were demanded.

9. 2)Profitability Ratios
• Profitability ratios measure a company’s ability to generate
earnings relative to sales, assets and equity. These ratios assess the
ability of a company to generate earnings, profits and cash flows
relative to relative to some metric, often the amount of money
invested. They highlight how effectively the profitability of a
company is being managed.
Following are the types of profitability ratios
• a) Gross profit ratio (GP ratio)
• b) Operating ratio
• c) Net profit ratio (NP ratio)
• d) Return on investment (ROI)
• e) Return on capital employed ratio
• f) Earnings per share (EPS) ratio
• g) Dividend payout ratio
• h) Dividend yield ratio
• i) Price earnings ratios (P/E ratio)
• j)The net worth ratio

10. a)Gross profit ratio (GP ratio)
It is a profitability ratio that shows the
relationship between gross profit and total net
sales revenue. It is a popular tool to evaluate
the operational performance of the business.
Formula:
profit ratio: Gross profit *100
net sales

11. b) Operating ratio
It is computed to measure the relationship between
total operating expenses and sales
Formula:
Operating ratio=operating cost *100
net sales
net sales=sales-sales return(or)inwards
Operating ratio=cost of goods sold +administrative
expenses + selling and distribution expenses

12. C) Net profit ratio (NP ratio)
It is a popular profitability ratio that shows
relationship between net profit after tax and
net sales.
• Formula:
Net profit ratio= net profit after tax *100
net sales

13. d) Return on investment (ROI)
It is performance measure used to evaluate the
efficiency of investment. It compares the
magnitude and timing of gains from
investment directly to the magnitude and
timing of investment costs.
Formula
• Return on Investment = Net profit after
interest and tax / shareholders funds or
investments *100

14. e) Return on capital
employed ratio
• It measures the success of a business in
generating satisfactory profit on capital
invested.
• Return on capital employed =net profit after
tax/gross capital employed *100
• gross capital employed =fixed asset+current
assets

15. f) Earnings per share (EPS) ratio
• The earnings per share ratio (EPS ratio)
measures the amount of a company's net
income that is theoretically available for
payment to the share holders.
• Earnings per share (EPS) ratio=net profit after
tax and preference dividend /number of
share*100

16. g) Dividend payout ratio (or
payout ratio)
• it is the ratio of dividend per share divided by
earnings per share. It is a measure of how
much earnings a company is paying out to its
shareholders as compared to how much it is
retaining for reinvestment.
Formula
Dividend Payout Ratio =
Dividend per Share/Earnings per Share*100

17. h) Dividend yield ratio
• The dividend yield ratio shows the amount of
dividends that a company pays to its investors
in comparison to the market price of its stock.
• Dividend yield ratio =dividends per share
/Market value per share*100

18. i) Price earnings ratios (P/E ratio)
• it measures how many times the earnings per
share (EPS) have been covered by current
market price of an ordinary share.
• Price earnings ratios=market price per equity
share/earnings per share

19. J) The net worth ratio
• It states the return that shareholders could
receive on their investment in a company, if all
of the profit earned were to be passed
through directly to them.
• Net worth ratio=net profit after
taxes/shareholders net worth *100
• Shareholders net worth=total tangible net
worth
• Total tangible net worth =shareholders
fund+profits earned in business

20. 3) Turnover ratios
• Meaning: Turnover ratios are also known as activity or efficiency
ratios. The total funds raised by the company are invested in
acquiring various assets for its operations. The assets are acquired
to generate the sales revenue and the position of profit depends
upon the value of sales. Turnover ratios establish the relationship of
sales with various assets. Turnover ratios are as follows:
• a) Inventory Turnover Ratio
• b) Debtors Turnover Ratio
• c)creditor turnover ratio
• d) Working Capital Turnover Ratio
• e) Fixed assets turnover ratio
• f) Capital Employed Turnover Ratio

21. a) Inventory Turnover Ratio
Inventory turnover ratio is also known as stock turnover ratio.
Inventory turnover ratio shows the relationship between the cost of
good sold and the average inventory. This ratio measures
how frequently the company's inventory turned into sales.
formula.
Inventory turnover ratio = Cost of good sold/Average stock = ...........
times.
In the absence of the cost of good sold and average stock, the
following formula can be used to calculate inventory turnover ratio.
Inventory turnover ratio = Sales/Closing Inventory = .......... times.
* Cost Of Goods Sold = Opening stock+ Purchases+Carriage
inward+Direct wages and expenses- Closing Stock
* Cost of Goods Sold =Sales - Gross profit
* Average stock = (Opening stock + closing stock)/2

22. b) Debtors Turnover Ratio
Debtors turnover ratio is also called receivable
turnover ratio. This ratio establishes the
relationship between net credit sales and average
debtors for the year. Debtors turnover ratio
shows how quickly the credit sales of the
company have been converted into cash
Debtors Turnover Ratio = Net credit sales/Average
account receivable
* the term account receivable includes 'trade
debtors and bills receivable'.

23. c) creditors 's turnover ratio
It is a reflection of how quickly a company pays its
creditors. This is also known as a payable turnover
ratio. Low turnover means it takes longer for a
company to pay off creditors, while high turnover
reflects rapid processing of credit accounts. Changes in
the creditor's turnover ratio can provide information
about a company's financial circumstances.
formula
Creditor or Payable Turnover Ratio
= Net Credit Annual Purchase / Average Trade Creditors

24. d) Working Capital Turnover Ratio
• The working capital turnover ratio measures
how well a company is utilizing its working to
support a given level of sales
• Net sales
working capital(Beginning working capital +
Ending working capital) / 2

25. e) Fixed assets turnover ratio
• Fixed assets turnover ratio indicates how
efficiently the fixed assets are used. It
measures the efficiency with which the firm
has been using its fixed assets to generate
sales.
• Fixed Assets Turnover Ratio = Sales/ Net fixed
assets.
•

26. f) Capital Employed Turnover
Ratio
• It shows how efficiently capital employed in
the company has been utilized in generating
sales revenue.
• Capital Employed Turnover Ratio =
Sales/Capital employed

27. 4)Solvency ratios
Solvency ratio is one of the various ratios used
to measure the ability of a company to meet
its long term debts.
Following are solvency ratios
• A) Debt-to-Equity Ratio
• B) The proprietary ratio
• C) Capital gearing ratio

28. A) Debt-to-Equity Ratio
Debt-to-Equity ratio is the ratio of total liabilities of
a business to its shareholders' equity. It is a
leverage ratio and it measures the degree to
which the assets of the business are financed by
the debts and the shareholders' equity of a
business.
• Formula
Debt-to-equity ratio is calculated using the
following formula:
Debt-to-Equity Ratio = Total Liabilities
Shareholders' Equity

29. B) The proprietary ratio
It is also known as net worth ratio or equity ratio
is used to evaluate the soundness of the
capital structure of a company.
The proprietary ratio =stockholders equity
/total asset*100

30. C) Capital gearing ratio
The term "capital gearing" or "leverage"
normally refers to the proportion of
relationship between equity share capital
including reserves and surpluses to preference
share capital and other fixed interest bearing
funds or loans.
Capital gearing ratio= equity share capital/fixed
interest bearing funds

31. D) 'Debt-Service
Coverage Ratio - DSCR'
• The debt service coverage ratio (DSCR),
also known as "debt coverage ratio," (DCR)
is the ratio of cash available for debt
servicing to interest, principal and lease
payments.
• 'Debt-Service Coverage Ratio =net profit
before interest and tax/fixed interest
charges

32. E) Overall profitability ratio
Objective: - The objective of computing this
ratio is to find out how efficiently the long
term funds supplied by the creditors and the
shareholders have been used.
• Formula:-
Overall profitability Ratio = net profit/total
asset
•