RATIO ANALYSIS Ratios are simply a means of highlighting in arithmetical terms the relationship between figures drawn from financial statements. Ratios.

RATIO ANALYSISRATIO ANALYSIS

Ratios are simply a means of Ratios are simply a means of highlighting in arithmetical terms the highlighting in arithmetical terms the relationship between figures drawn relationship between figures drawn from financial statements.from financial statements.

FORMS OF EXPRESSING FORMS OF EXPRESSING RATIOSRATIOS

►ProportionProportion►PercentagePercentage►QuotientQuotient

OBJECTIVES AND SIGNIFICANCE OBJECTIVES AND SIGNIFICANCE OF RATIO ANALYSIS.OF RATIO ANALYSIS.

► Helpful in Simplifying Financial data.Helpful in Simplifying Financial data.► Helpful in Determining Trends.Helpful in Determining Trends.► Helpful in Controlling.Helpful in Controlling.► Benefits to Other Parties Interested in the Benefits to Other Parties Interested in the

Business.Business.► Helpful in locating Weak Spots.Helpful in locating Weak Spots.► Helpful in Comparative Study.Helpful in Comparative Study.► Helpful in Measuring Operating efficiency.Helpful in Measuring Operating efficiency.► Overall ProfitabilityOverall Profitability

LIMITATION OF RATIO ANALYSISLIMITATION OF RATIO ANALYSIS

► Limited use of Single Ratio.Limited use of Single Ratio.► Wrong Ratios Based on Wrong Data.Wrong Ratios Based on Wrong Data.► Incorrect Comparison.Incorrect Comparison.► Different Meaning.Different Meaning.► Difficulty in Forecasting.Difficulty in Forecasting.► Lack of Qualitative Analysis.Lack of Qualitative Analysis.► Difficulty of Price Level Changes.Difficulty of Price Level Changes.► Lack of Proper Standards.Lack of Proper Standards.► Window Dressing.Window Dressing.

INTERPRETATION OF RATIOSINTERPRETATION OF RATIOS

► Interpretation of Individual Ratio.Interpretation of Individual Ratio.► Interpretation by referring to a group Interpretation by referring to a group

of Ratios.of Ratios.► Interpretation of Ratios by Trend.Interpretation of Ratios by Trend.► Interpretation by Inter-firm Interpretation by Inter-firm

Comparison.Comparison.

CLASSIFICATION OF RATIOSCLASSIFICATION OF RATIOS

►Classification According to Accounting Classification According to Accounting Statement.Statement.

►Classification on the Basis of Time.Classification on the Basis of Time.►Classification According to Importance.Classification According to Importance.►Classification According to the Classification According to the

Purpose.Purpose.

CLASSIFICATION ACCORDING TO CLASSIFICATION ACCORDING TO ACCOUNTING STATEMENT.ACCOUNTING STATEMENT.

►Profit and Loss Account Ratios.Profit and Loss Account Ratios.►Balance Sheet Ratios. Balance Sheet Ratios. ►Profit and Loss Account and Balance Profit and Loss Account and Balance

Sheet Ratios.Sheet Ratios.

CLASSIFICATION ON THE BASIS CLASSIFICATION ON THE BASIS OF TIME.OF TIME.

►Structural Ratios.Structural Ratios.►Trend RatioTrend Ratio

CLASSIFICATION ACCORDING TO CLASSIFICATION ACCORDING TO IMPORTANCEIMPORTANCE

►Primary Ratios.Primary Ratios.►Secondary Ratios.Secondary Ratios.

LIQUIDITY RATIOSLIQUIDITY RATIOS

►CURRENT RATIOCURRENT RATIO

Current AssetsCurrent Assets

Current Ratio = ----------------------Current Ratio = ----------------------

Current LiabilitiesCurrent Liabilities

► LIQUIDITY RATIO OR ACID TEST RATIO OR LIQUIDITY RATIO OR ACID TEST RATIO OR QUICK RATIO.QUICK RATIO.

Liquid AssetsLiquid AssetsLiquidity Ratio = ------------------------Liquidity Ratio = ------------------------

Current Liabilities.Current Liabilities.OrOrLiquid AssetsLiquid Assets

Liquidity Ratio = ------------------------Liquidity Ratio = ------------------------Liquid Liabilities.Liquid Liabilities.

►ABSOLUTE LIQUIDITY RATIOABSOLUTE LIQUIDITY RATIO

Cash+Bank+Cash+Bank+

Marketable Marketable SecuritiesSecurities

Absolute Liquidity Ratio = Absolute Liquidity Ratio = --------------------------------------------------------------

Current Liabilities.Current Liabilities.

► INVENTORY TURNOVER RATIOINVENTORY TURNOVER RATIO

Cost of Goods Cost of Goods SoldSold

Inventory Turnover = Inventory Turnover = --------------------------------------------------------

RatioRatio Average InventoryAverage Inventory

►DEBTORS TURNOVER RATIODEBTORS TURNOVER RATIO

Net Credit SalesNet Credit Sales

Debtors Turnover = -------------------------Debtors Turnover = -------------------------

RatioRatio Average Debtors.Average Debtors.

►CREDITORS TURNOVER RATIOCREDITORS TURNOVER RATIO

Net Credit PurchasesNet Credit PurchasesCreditors Turnover = ----------------------------Creditors Turnover = ----------------------------RatioRatio Average Creditors. Average Creditors.

Net Credit Purchases=Gross Credit Net Credit Purchases=Gross Credit Purchases-Purchases-

Purchase ReturnPurchase Return

► DEFENSIVE INTERVAL RATIODEFENSIVE INTERVAL RATIO

Quick AssetsQuick AssetsDefensive Interval=--------------------------------Defensive Interval=--------------------------------RatioRatio Projected Daily Cash Req.Projected Daily Cash Req.

Projected Cash Projected Cash

Operating ExpenditureOperating ExpenditureProjected Daily Cash=------------------------------------Projected Daily Cash=------------------------------------RequirementRequirement No. of Days in a year (365)No. of Days in a year (365)

PROFITABILITY RATIOSPROFITABILITY RATIOS

► Profitability Ratios Related to Sales :Profitability Ratios Related to Sales :a.a. Gross Profit RatioGross Profit Ratio

Gross ProfitGross ProfitGross Profit Ratio = ------------------ x 100Gross Profit Ratio = ------------------ x 100

Net Sales Net Sales

Net Sales = Gross Sales – Sales ReturnNet Sales = Gross Sales – Sales ReturnGross Profit = Net Sales – Cost of Goods soldGross Profit = Net Sales – Cost of Goods sold

b.b. Net Profit Ratio.Net Profit Ratio.

Net ProfitNet Profit

Net Profit Ratio = --------------------x 100Net Profit Ratio = --------------------x 100

Net Sales Net Sales

c.c. Operating Ratio.Operating Ratio.

Operating Costs.Operating Costs.

Operating Ratio = ------------------------ x Operating Ratio = ------------------------ x 100100

Net Sales Net Sales

EXPENSE RATIOSEXPENSE RATIOS

a.a. Direct Raw Material to Sales Ratio =Direct Raw Material to Sales Ratio =Direct Material Cost Direct Material Cost ------------------------- x 100------------------------- x 100Net SalesNet Sales

b.b. Cost of Goods sold to Sales Ratio =Cost of Goods sold to Sales Ratio =Cost of Goods Sold Cost of Goods Sold ------------------------- x 100------------------------- x 100Net SalesNet Sales

c.c. Direct Labour Cost of Sales Ratio.Direct Labour Cost of Sales Ratio.

Direct Labour CostDirect Labour Cost

= ------------------------- x 100= ------------------------- x 100

Net Sales Net Sales

d.d. Factory Expenses to Sales Ratio = x Factory Expenses to Sales Ratio = x 100100

e. Office and Administration Expenses to e. Office and Administration Expenses to

Sales Ratio Sales Ratio

Office and Administration ExpensesOffice and Administration Expenses

=------------------------------------------- x 100=------------------------------------------- x 100

Net SalesNet Sales

f.f. Selling Expenses to Sales Ratio = x Selling Expenses to Sales Ratio = x 100100

PROFITABILITY RATIOS BASED PROFITABILITY RATIOS BASED ON INVESTMENT.ON INVESTMENT.

► RETURN ON TOTAL ASSETS :RETURN ON TOTAL ASSETS :

Profit before Interest and TaxProfit before Interest and Tax = ------------------------------------- x 100= ------------------------------------- x 100

Total Assets.Total Assets.

Net Profit after TaxNet Profit after Tax = ------------------------ x 100= ------------------------ x 100

Total AssetsTotal Assets

Net Profit after Tax + InterestNet Profit after Tax + Interest = ----------------------------------------- = -----------------------------------------

Total Assets.Total Assets.

► RETURN ON NET CAPITAL EMPLOYED OR CAPITAL RETURN ON NET CAPITAL EMPLOYED OR CAPITAL EMPLOYED:EMPLOYED:

a. From Asset Side of Balance Sheet.a. From Asset Side of Balance Sheet.Capital Employed=Fixed Assets+Net Working Capital Employed=Fixed Assets+Net Working

Capital Capital ORORTotal Assets-Current Liabilities.Total Assets-Current Liabilities.

ORORb.b. From Liability Side of Balance SheetFrom Liability Side of Balance Sheet

Capital Employed=long-term Liabilities+Issue Capital Employed=long-term Liabilities+Issue Share Share Capital (Equity & Preference) + Capital (Equity & Preference) +

Reserve Reserve and and Surplus (Capital and Revenue)Surplus (Capital and Revenue)

Return on Capital Return on Capital Profit before Interest and Profit before Interest and TaxTax

Employed Employed = ----------------------------------- x = ----------------------------------- x 100100

Capital Employed.Capital Employed.

Advantage of the Concept of Advantage of the Concept of Return on Capital EmployedReturn on Capital Employed

► Helps the management in finding out with Helps the management in finding out with how much efficiency capital emplyed in how much efficiency capital emplyed in business is being used.business is being used.

► Compared with that of other firms of similar Compared with that of other firms of similar nature.nature.

► A comparative study of the profitability of A comparative study of the profitability of various departments.various departments.

► Proper decisions regarding capital Proper decisions regarding capital expenditure can be.expenditure can be.

► Facilities necessary changes in financial Facilities necessary changes in financial policies.policies.

► Reasonable and regular devidend.Reasonable and regular devidend.

Return on Shareholders Return on Shareholders FundsFunds

a.a. Return on Total Shareholders FundsReturn on Total Shareholders Funds

Net Profit after TaxNet Profit after Tax

= ---------------------------------- x 100= ---------------------------------- x 100

Total Shareholder’s EquityTotal Shareholder’s Equity

Total Shareholder’s Equity=Preference Share Total Shareholder’s Equity=Preference Share Capital+Ordinary Share Capital+Share Capital+Ordinary Share Capital+Share Premium+ Reserves and Surplus – Premium+ Reserves and Surplus – Accumulated Losses.Accumulated Losses.

b. Return on Equity Shareholder’s Funds.b. Return on Equity Shareholder’s Funds.

Net Profit after tax and Preference DividendNet Profit after tax and Preference Dividend

= ----------------------------------------------------- x 100= ----------------------------------------------------- x 100

Equity Shareholder’s FundsEquity Shareholder’s Funds

C.C. Earnings Per Share of EPSEarnings Per Share of EPS

Net Profit after Tax and Preference Net Profit after Tax and Preference DividendDividend

EPS= ------------------------------------------------------EPS= ------------------------------------------------------

Number of Equity SharesNumber of Equity Shares

d. d. Dividend Per Share or DPSDividend Per Share or DPS Profit distributed to Equity ShareholdersProfit distributed to Equity Shareholders

DPS = -----------------------------------------------DPS = -----------------------------------------------Number of Equity Shares.Number of Equity Shares.

e.e. Dividend-Payout Ratio or D/P Ratio:Dividend-Payout Ratio or D/P Ratio: Total Dividend paid to Equity Total Dividend paid to Equity

ShareholderShareholderD/P Ratio=---------------------------------------------------D/P Ratio=--------------------------------------------------- Total Net Profit belonging to Equity ShareholdersTotal Net Profit belonging to Equity Shareholders

ORORDPSDPS

D/P = ----------- x 100D/P = ----------- x 100EPSEPS

f. Dividend and Earning Yield :f. Dividend and Earning Yield :DPSDPS

Dividend Yield = ------------------------------Dividend Yield = ------------------------------ Market Value per ShareMarket Value per Share

EPSEPSEarning Yield = -------------------------------Earning Yield = -------------------------------

Market Value per ShareMarket Value per Shareg. g. Price Earning Ratio :Price Earning Ratio :

Market Price of the shareMarket Price of the shareP/E Ratio = ------------------------------------P/E Ratio = ------------------------------------

EPSEPS

TURNOVER RATIOSTURNOVER RATIOS

1.1. INVENTORY TURNOVER RATIO.INVENTORY TURNOVER RATIO.Net Sales Net Sales

Inventory Turnover Ratio=----------------------Inventory Turnover Ratio=---------------------- Average InventoryAverage Inventory

Cost to Raw Materials ConsumedCost to Raw Materials Consumed Raw Material Turnover=-----------------------------------------Raw Material Turnover=----------------------------------------- Ratio.Ratio. Average Stock of Raw Materials Average Stock of Raw Materials

Cost of Goods ManufacturedCost of Goods Manufactured Work in Progress = -----------------------------------------------Work in Progress = ----------------------------------------------- Turnover RatioTurnover Ratio Average Work-in-Progress Average Work-in-Progress

InventoryInventory

►Debtors Turnover Ratio and Average Debtors Turnover Ratio and Average Collection Period.Collection Period.