R C F,Prashant V V

Presentation on Presentation on Ratio, Fund Flow Ratio, Fund Flow

Statement, Statement, Cash Flow Statement Cash Flow Statement

Subject:- Financial account Subject:- Financial account Subject cod:- 104Subject cod:- 104Submitted to:- Prof. Keshave Kulkarni Submitted to:- Prof. Keshave Kulkarni

Submitted By:-Submitted By:-Prashant. v .v Prashant. v .v

Financial Ratio AnalysisFinancial Ratio Analysis

Meaning of RatioMeaning of Ratio

‘ ‘A ratio is defined as A ratio is defined as thethe indicated quotient of two indicated quotient of two mathematical expressions and also mathematical expressions and also as the expression of relationship as the expression of relationship between two or more things’between two or more things’

Users of Financial Users of Financial AnalysisAnalysis

• Trade creditorsTrade creditors• Suppliers of long term debtSuppliers of long term debt• InvestorsInvestors• ManagementManagement

Types of RatiosTypes of Ratios

• Liquidity ratiosLiquidity ratios• Leverage ratiosLeverage ratios• Activity ratios Activity ratios • Profitability ratiosProfitability ratios

Liquidity RatioLiquidity Ratio

It is not an exaggeration but a fact It is not an exaggeration but a fact that liquidity is very essential for that liquidity is very essential for

very survival of organization . Hence very survival of organization . Hence there is a need for evaluating the there is a need for evaluating the

liquidity position to find out whether liquidity position to find out whether the company is capable of paying all the company is capable of paying all

its current obligations its current obligations

1. Liquidity ratios1. Liquidity ratios

The ratios which are commonly used The ratios which are commonly used for this purpose are _for this purpose are _

• Current ratioCurrent ratio• Quick ratioQuick ratio• Cash ratioCash ratio• Interval measureInterval measure

Current RatioCurrent Ratio

As the working capital is equivalent to As the working capital is equivalent to the difference between current asset the difference between current asset

and current liabilities, or as the and current liabilities, or as the working capital is the excess of working capital is the excess of

current asset over current liabilities current asset over current liabilities this ratio is also called working this ratio is also called working

capital ratio. capital ratio.

Current RatioCurrent Ratio

Current ratio = Current ratio = Total current assetsTotal current assets

Total current liabilitiesTotal current liabilities

Current assets include- cash, cash at Current assets include- cash, cash at bank, debtors,B.R. bank, debtors,B.R. inventories,marketable inventories,marketable securities,prepaid expenses etcsecurities,prepaid expenses etc … …

Current ratio(contd)Current ratio(contd)

• Current liabilities include- S’ Current liabilities include- S’ creditors, bills payables, outstanding creditors, bills payables, outstanding expenses,short term bank expenses,short term bank loan,income tax liabilities,long term loan,income tax liabilities,long term loan repayable during the current loan repayable during the current year.year.

Current ratioCurrent ratio

• Interpretation of the current ratio(2:1)Interpretation of the current ratio(2:1)1.1. It represents It represents margin of safetymargin of safety2.2. It is a test of It is a test of quantityquantity and not and not qualityquality3.3. Should not be too Should not be too lowlow or or highhigh4.4. Should be evaluated in in the light of Should be evaluated in in the light of

other factors (cash budget, cash and other factors (cash budget, cash and fund flow statements, turnover ratio fund flow statements, turnover ratio etc)etc)

5.5. It is a crude and quick method It is a crude and quick method

Quick RatioQuick Ratio

It is also called Liquid Ratio, Acid-test It is also called Liquid Ratio, Acid-test Ratio, Nearer money RatioRatio, Nearer money Ratio

Quick Ratio Quick Ratio

Quick ratio =Quick ratio = Current assets – Current assets – InventoriesInventories

Current liabilitiesCurrent liabilities

Quick ratioQuick ratio

• Interpretation of quick Interpretation of quick ratio(1:1)ratio(1:1)

1.1. Establishes the relationship Establishes the relationship between more liquid current assets between more liquid current assets and the total current liabilitiesand the total current liabilities

2.2. Quality of debtors should be Quality of debtors should be consideredconsidered

Cash RatioCash Ratio

It is also called Absolute Liquidity It is also called Absolute Liquidity Ratio or Ratio or

Super-Quick RatioSuper-Quick Ratio

Cash Ratio = Cash Ratio = Cash + Marketable Cash + Marketable securitiessecurities

Current liabilitiesCurrent liabilities

Interval MeasureInterval Measure

Interval Measure = Interval Measure = Current assets- Current assets- InventoryInventory

Average daily operating Average daily operating expensesexpenses

2 .Leverage Ratio 2 .Leverage Ratio (Capital Structure Ratio)(Capital Structure Ratio)

• They help to judge the long term financial They help to judge the long term financial position of the firm.position of the firm.

• These ratio indicate the mix of funds provided These ratio indicate the mix of funds provided by owner and lender.by owner and lender.

• In order to assess the long term financial In order to assess the long term financial soundness soundness

• It is necessary to find out whether the It is necessary to find out whether the organization is able to meet its long term organization is able to meet its long term financial commitments whenever they financial commitments whenever they become due and whether the organization is become due and whether the organization is able to maintain or increase the market value able to maintain or increase the market value of its shares. of its shares.

Leverage RatioLeverage Ratio• In simple it is very much essential to fiind In simple it is very much essential to fiind

out whether the company is capable of :out whether the company is capable of :

Paying back the principal amt soon after Paying back the principal amt soon after the stipulated period as per the agreement.the stipulated period as per the agreement. Paying the int on principal amt promptly Paying the int on principal amt promptly

and periodically as per the tem and and periodically as per the tem and conditions to which the company has conditions to which the company has

agreed at the time of raising capital. agreed at the time of raising capital.

Implication of Debt / Implication of Debt / EquityEquity

• Debt is more risky as compared to Debt is more risky as compared to equity.equity.

• However use of debt is advantageous to However use of debt is advantageous to share holders, in two waysshare holders, in two ways(a) Control with limited stake.(a) Control with limited stake.(b) Trading on equity.(b) Trading on equity.

• High debt burden will make firm difficult High debt burden will make firm difficult to further lone.to further lone.

• Owner funds is treated as margin of Owner funds is treated as margin of safety.safety.

Debt ratioDebt ratio

• It is used to analyse the long term It is used to analyse the long term solvency of a firm.solvency of a firm.

• It indicates the proportion of interest It indicates the proportion of interest bearing debt in the Capital bearing debt in the Capital Structure.Structure.

Debt Equity RatioDebt Equity Ratio

• Debt Equity Ratio = Debt Equity Ratio = Total DebtTotal Debt

net worthnet worth

Capital Employed to Net Capital Employed to Net Worth RatioWorth Ratio

CE to NW Ratio = CE to NW Ratio = Capital EmployedCapital Employed

Net WorthNet Worth

Other Debt RatioOther Debt Ratio

Total Debt Ratio = Total Debt Ratio = Total LiabilityTotal Liability

Total Assets Total Assets

Implication of Debt RatioImplication of Debt Ratio

High Debt Ratio indicates the followingHigh Debt Ratio indicates the following• Claim of creditors is greater than Claim of creditors is greater than

ownersowners• It leads to inflexibility in firms operation It leads to inflexibility in firms operation

due to interferencedue to interference• Further borrowing of funds becomes Further borrowing of funds becomes

difficultdifficult• The company will suffer during the The company will suffer during the

period of low profitperiod of low profit

Implication of Debt Ratio Implication of Debt Ratio (Contd.)(Contd.)

A low Debt Ratio indicates the A low Debt Ratio indicates the following.following.

1.1. Greater claim of owners than Greater claim of owners than creditors.creditors.

2.2. Creditors find it a safe situation.Creditors find it a safe situation.

3.3. From shareholders’ view there is From shareholders’ view there is still scope for trading on equity. still scope for trading on equity.

Treatment of Preference Treatment of Preference share capital ?share capital ?

• Interest Coverage RatioInterest Coverage Ratio

When the organization asks for loan, When the organization asks for loan, the lender wishes to know whether the lender wishes to know whether the organization is capable of earning the organization is capable of earning adequate amount of profit to pay the adequate amount of profit to pay the int periodicallyint periodically

The int coverage ratio also The int coverage ratio also known as known as Debt service Ratio Debt service Ratio oror Fixed charges Coverage RatioFixed charges Coverage Ratio

Interest Coverage RatioInterest Coverage Ratio

Interest coverage ratio=Net profit Interest coverage ratio=Net profit before int before int & & income tax income tax *100*100

Fixed Interest chargesFixed Interest charges

Implication of interest Implication of interest coverage ratiocoverage ratio

• It shows the number of times interest It shows the number of times interest charges are covered by the funds charges are covered by the funds available for their paymentavailable for their payment

• In other words it indicates the extent to In other words it indicates the extent to which a fall in the EBIT is tolerablewhich a fall in the EBIT is tolerable

• A high ratio is a safe indication to the A high ratio is a safe indication to the creditors however reflects unused debt creditors however reflects unused debt capacity.capacity.

• A low ratio is a danger signal indicating A low ratio is a danger signal indicating excessive debt and interest burden excessive debt and interest burden

Dividend Coverage RatioDividend Coverage Ratio

Dividend coverage ratio =Dividend coverage ratio = Net profit Net profit after int&after int& tax but tax but before Dividend before Dividend Preference dividendPreference dividend

Implication of dividend coverage ratioImplication of dividend coverage ratio• It reveals the margin of safety to the It reveals the margin of safety to the

preference shareholders.preference shareholders.• The higher the ratio, the better it is to The higher the ratio, the better it is to

the preference shareholdersthe preference shareholders

3.Activity Ratio3.Activity Ratio

• Funds of creditors and owners are Funds of creditors and owners are invested in various assets to invested in various assets to generate sales.generate sales.

• The efficient management of these The efficient management of these assets leads to larger sale.assets leads to larger sale.

• Activity ratio will indicate the Activity ratio will indicate the efficiency with which the assets are efficiency with which the assets are being used.being used.

• It indicates the speed with which the It indicates the speed with which the assets are converted into salesassets are converted into sales

Activity or Turnover Activity or Turnover RatioRatio

The important ratios used for this The important ratios used for this purpose are_purpose are_

1.1. Stock Turnover or Inventory Ratio.Stock Turnover or Inventory Ratio.

2.2. Debtor’s Turnover Ratio.Debtor’s Turnover Ratio.

3.3. Creditors Turnover Ratio.Creditors Turnover Ratio.

4.4. Fixed Asset turnover Ratio.Fixed Asset turnover Ratio.

Inventory Turnover ratioInventory Turnover ratio

Inventory turnover = Inventory turnover = Cost of goods Cost of goods soldsold

Average inventoryAverage inventory

oror

= = SalesSales

InventoryInventory

Average Collection Average Collection periodperiod

Average collection = Average collection = 365 or 12 . 365 or 12 .

Period Debtor TOPeriod Debtor TO

Implication of Debtors Implication of Debtors TO ratioTO ratio

• It shows how quickly the receivables It shows how quickly the receivables and debtors are converted into cashand debtors are converted into cash

• It is thus a test of liquidity of the It is thus a test of liquidity of the debtors of the firmdebtors of the firm

• The average collection period shows The average collection period shows the number of days for which the the number of days for which the debt is outstanding.debt is outstanding.

Implication of Debtors Implication of Debtors TO Ratio(contd)TO Ratio(contd)

• A long collection period implies a A long collection period implies a very liberal and inefficient credit and very liberal and inefficient credit and collection performance.collection performance.

• Which in turn means delay in cash Which in turn means delay in cash collection and there by effects the collection and there by effects the liquidity position of the firm.liquidity position of the firm.

• A long collection period also A long collection period also increases the chances of bad debts increases the chances of bad debts

Implication of Debtors Implication of Debtors TO ratio(contd)TO ratio(contd)

• A low a collection period is also not A low a collection period is also not favorable.favorable.

• It indicates very restrictive credit It indicates very restrictive credit and collection policy and collection policy

• Due to the fear of bad debt the firm Due to the fear of bad debt the firm sells only to customers who are sells only to customers who are financially sound and there by looses financially sound and there by looses the potentials of higher credit sales. the potentials of higher credit sales.

Implication of Debtors Implication of Debtors TO ratio(contd)TO ratio(contd)

• The average collection period should be The average collection period should be compared against the firm’s credit terms, compared against the firm’s credit terms, to judge the credit and collection to judge the credit and collection efficiency.efficiency.

• In addition to the above comparison the In addition to the above comparison the average collection period should also be average collection period should also be compared with that of the industry compared with that of the industry average.average.

• The above comparison helps to find out The above comparison helps to find out as to whether the firm is too liberal or as to whether the firm is too liberal or too restrictive in its credit policy. too restrictive in its credit policy.

Assets Turnover RatioAssets Turnover Ratio

It establishes the relationship between It establishes the relationship between the the assetsassets and the and the salessales of the firm. of the firm. It includes the following It includes the following

1.1. Net assets turnover ratioNet assets turnover ratio2.2. Total assets turnover ratioTotal assets turnover ratio3.3. Fixed assets turnover ratio Fixed assets turnover ratio 4.4. Current assets turnover ratioCurrent assets turnover ratio5.5. Working capital turnover ratioWorking capital turnover ratio

Formula for the assets Formula for the assets turnover ratioturnover ratio

Assets turnover ratio =Assets turnover ratio = Net Sales Net Sales Revenue Revenue . .

concerned asset concerned asset (Fixed Asset) (Fixed Asset)

Fund Flow StatementFund Flow Statement

The most widely accepted view of The most widely accepted view of ‘fund’ is one relating to ‘working ‘fund’ is one relating to ‘working capital’ where in ‘fund is used to capital’ where in ‘fund is used to

denote the working capital which is denote the working capital which is the difference between current asset the difference between current asset and current liabilities. As the current and current liabilities. As the current

asset comprise of cash also , cash is asset comprise of cash also , cash is part of the ‘fund’ in this background part of the ‘fund’ in this background

Definition of Fund Flow Definition of Fund Flow StatementStatement

By Almand Coleman as:-By Almand Coleman as:-

A statement summarizing the significant A statement summarizing the significant financial changes which have occurred financial changes which have occurred between the beginning and end of company’s between the beginning and end of company’s accounting period .accounting period .

By Smith and Brown :-By Smith and Brown :-

A fund flow statement is prepared in summary A fund flow statement is prepared in summary form to indicate changes accruing in terms of form to indicate changes accruing in terms of financial condition between different balance financial condition between different balance sheet dates.sheet dates.

By Robert Anthony:-By Robert Anthony:-

Describes the sources from which Describes the sources from which additional funds were derived and additional funds were derived and the use to which these fund put the use to which these fund put

Limitations of Fund Flow Limitations of Fund Flow StatementStatement

Fund Flow Statement is being criticized as one Fund Flow Statement is being criticized as one which re-arranges the financial data extracted which re-arranges the financial data extracted

from the financial Statement.from the financial Statement.The Fund Flow Statement is also being The Fund Flow Statement is also being

criticized as not furnishing anything new criticized as not furnishing anything new and /or original over and above the and /or original over and above the conventional Financial Statement.conventional Financial Statement.

The Fund Flow Statement is also based on the The Fund Flow Statement is also based on the historical data as it bases its preparation on historical data as it bases its preparation on

the conventional Financial statements.the conventional Financial statements.Some of the transactions affecting only the Some of the transactions affecting only the

Non-current items are sometimes, not Non-current items are sometimes, not considered while preparing the Fund Flow considered while preparing the Fund Flow

Statement. Statement.

Cash Flow StatementCash Flow Statement

Cash flow statement should show the Cash flow statement should show the movement of cash during the period movement of cash during the period under 3 different heads.under 3 different heads.

(a)(a) Operating ActivityOperating Activity(b)(b) Investing Activity Investing Activity (c)(c) Financing ActivityFinancing Activity• Cash flow statement may be presented Cash flow statement may be presented

using either Direct of Indirect method.using either Direct of Indirect method.• Listed companies have to present under Listed companies have to present under

indirect method only.indirect method only.

• ““Cash is king”Cash is king”• Statement of cash flows for listed Statement of cash flows for listed

companies is mendotory.companies is mendotory.

Purpose and uses of the Purpose and uses of the statment of cash flow statment of cash flow

• Purpose :-Purpose :-To provide relevant information about the To provide relevant information about the

cash receipts and payments of an cash receipts and payments of an enterpriseenterprise

• Uses :-Uses :-Asses an enterprisesAsses an enterprises LiquidityLiquidity Financial flexibilityFinancial flexibility ProfitabilityProfitability Risk Risk Provide feedback about previous assesment.Provide feedback about previous assesment.

Cash flows from operating Cash flows from operating activities activities

Cash flow from Investing Cash flow from Investing Activities Activities

Cash flow from Financing Cash flow from Financing ActivitiesActivities

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