Ratios - Study ppt.

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RATIO ANALYSIS

Very Useful Material



Ratio-analysis means the process of computing, determining and presenting the

relationship of related items and groups of

items of the financial statements. Theyprovide in a summarized and concise form

of fairly good idea about the financial

position of a unit. They are important toolsfor financial analysis.

RATIO ANALYSIS



RATIO ANALYSIS

It’s a tool which enables the banker or lender toarrive at the following factors :

Liquidity position

Profitability Solvency

Financial Stability

Quality of the Management Safety & Security of the loans & advances to be

or already been provided



HOW A RATIO IS EXPRESSED?

As Percentage - such as 25% or 50% . For example if net profit is Rs.25,000/- and the sales isRs.1,00,000/- then the net profit can be said to be25% of the sales.

As Proportion - The above figures may beexpressed in terms of the relationship between netprofit to sales as 1 : 4.

As Pure Number /Times - The same can also beexpressed in an alternatively way such as the saleis 4 times of the net profit or profit is 1/4th of thesales.



CLASSIFICATION OF RATIOS

Balance Sheet

Ratio

P&L Ratio or

Income/RevenueStatement Ratio

Balance Sheet

and Profit & LossRatio

Financial Ratio Operating Ratio Composite Ratio

Current RatioQuick Asset Ratio

Proprietary Ratio

Debt Equity Ratio

Gross Profit RatioOperating Ratio

Expense Ratio

Net profit Ratio

Stock Turnover Ratio

Fixed AssetTurnover Ratio,

Return on Total

Resources Ratio,

Return on Own

Funds Ratio,

Earning per Share

Ratio, Debtors’

Turnover Ratio,



FORMAT OF BALANCE SHEET FOR RATIO ANALYSISLIABILITIES ASSETS

NET WORTH/EQUITY/OWNED FUNDS

Share Capital/Partner’s Capital/Paid up

Capital/ Owners FundsReserves ( General, Capital, Revaluation &

Other Reserves)

Credit Balance in P&L A/c

FIXED ASSETS : LAND & BUILDING, PLANT

& MACHINERIES

Original Value Less DepreciationNet Value or Book Value or Written down value

LONG TERM LIABILITIES/BORROWED

FUNDS : Term Loans (Banks & Institutions)

Debentures/Bonds, Unsecured Loans, FixedDeposits, Other Long Term Liabilities

NON CURRENT ASSETS

Investments in quoted shares & securities

Old stocks or old/disputed book debtsLong Term Security Deposits

Other Misc. assets which are not current or

fixed in nature

CURRENT LIABILTIES

Bank Working Capital Limits such as

CC/OD/Bills/Export Credit

Sundry /Trade Creditors/Creditors/Bills

Payable, Short duration loans or deposits

Expenses payable & provisions against various

items

CURRENT ASSETS : Cash & Bank Balance,

Marketable/quoted Govt. or other securities,

Book Debts/Sundry Debtors, Bills Receivables,

Stocks & inventory (RM,SIP,FG) Stores &

Spares, Advance Payment of Taxes, Prepaid

expenses, Loans and Advances recoverable

within 12 months

INTANGIBLE ASSETS

Patent, Goodwill, Debit balance in P&L A/c,

Preliminary or Preoperative expenses



SOME IMPORTANT NOTES

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 Sou rces of

Funds

Long Term Liabilities & Short Term Liabilities are also called



SOME IMPORTANT NOTES

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 headReserves 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.



1. Current Ratio : It is the relationship between the

current assets and current liabilities of a concern.

Current Ratio = Current Assets/Current Liabi l i t ies

If the Current Assets and Current Liabilities of a concern

are Rs.4,00,000 and Rs.2,00,000 respectively, then the

Current Ratio will be : Rs.4,00,000/Rs.2,00,000 = 2 : 1

The ideal Current Ratio preferred by Banks is

1.33 : 1

2. Net Working Capital : This is worked out as surplus of

Long Term Sources over Long Tern Uses, alternatively it

is the difference of Current Assets and Current

Liabilities.

NWC = Current Assets – Current Liabilities



Current Assets : Raw Material, Stores, Spares, Work-in Progress. Finished

Goods, Debtors, Bills Receivables, Cash.

Current Liabilities : Sundry Creditors, Installments of Term Loan, DPG etc.

payable within one year and other liabilities payable within one year.

This ratio must be at least 1.33 : 1 to ensure minimum margin of 25% of current

assets as margin from long term sources.

Current Ratio measures short term liquidity of the concern and its ability to

meet its short term obligations within a time span of a year.

It shows the liquidity position of the enterprise and its ability to meet current

obligations in time.

Higher ratio may be good from the point of view of creditors. In the long run

very high current ratio may affect profitability ( e.g. high inventory carrying cost) Shows the liquidity at a particular point of time. The position can change

immediately after that date. So trend of the current ratio over the years to be

analyzed.

Current Ratio is to be studied with the changes of NWC. It is also necessary to

look at this ratio along with the Debt-Equity ratio.



3. ACID TEST or QUICK RATIO : It is the ratio between Quick Current Assets and Current Liabilities. The should be at least equal to 1.

Quick Current Assets : Cash/Bank Balances + Receivables upto 6 months +Quickly realizable securities such as Govt. Securities or quickly marketable/quotedshares and Bank Fixed Deposits

Acid Test or Quick Ratio = Quick Current Assets/Current Liabilities

Example :Cash 50,000Debtors 1,00,000Inventories 1,50,000 Current Liabilities 1,00,000

Total Current Assets 3,00,000

Current Ratio = > 3,00,000/1,00,000 = 3 : 1Quick Ratio = > 1,50,000/1,00,000 = 1.5 : 1



4. DEBT EQUITY RATIO : It is the relationship betweenborrower’s fund (Debt) and Owner’s Capital (Equity).

Long Term Outside Liabilities / Tangible Net Worth

Liabilities of Long Term Nature

Total of Capital and Reserves & Surplus Less Intangible Assets

For instance, if the Firm is having the following :

Capital = Rs. 200 LacsFree Reserves & Surplus = Rs. 300 LacsLong Term Loans/Liabilities = Rs. 800 Lacs

Debt Equity Ratio will be => 800/500 i.e. 1.6 : 1



5. PROPRIETARY RATIO : This ratio indicates the extent to whichTangible Assets are financed by Owner’s Fund.Proprietary Ratio = (Tangible Net Worth/Total Tangible

Assets) x 100The ratio will be 100% when there is no Borrowing for purchasingof Assets.

6. GROSS PROFIT RATIO : By comparing Gross Profit percentage to

Net Sales we can arrive at the Gross Profit Ratio which indicates themanufacturing efficiency as well as the pricing policy of the concern.

Gross Profit Ratio = (Gross Profit / Net Sales ) x 100

Alternatively , since Gross Profit is equal to Sales minus Cost of Goods Sold, it can also be interpreted as below :

Gross Profit Ratio = [ (Sales – Cost of goods sold)/ Net Sales]x 100

A higher Gross Profit Ratio indicates efficiency in production of the unit.



7. OPERATING PROFIT RATIO :

It is expressed as => (Operating Profit / Net Sales ) x 100

Higher the ratio indicates operational efficiency

8. NET PROFIT RATIO :

It is expressed as => ( Net Profit / Net Sales ) x 100

It measures overall profitability.



9. STOCK/INVENTORY TURNOVER RATIO :

(Average Inventory/Sales) x 365 for days

(Average Inventory/Sales) x 52 for weeks

(Average Inventory/Sales) x 12 for months

Average Inventory or Stocks = (Opening Stock + Closing Stock)

-----------------------------------------

2

. This ratio indicates the number of times the inventory isrotated during the relevant accounting period



10. DEBTORS TURNOVER RATIO : This is also called Debtors

Velocity or Average Collection Period or Period of Credit given .

(Average Debtors/Sales ) x 365 for days(52 for weeks & 12 for months)

11. ASSET TRUNOVER RATIO : Net Sales/Tangible Assets

12. FIXED ASSET TURNOVER RATIO : Net Sales /Fixed Assets

13. CURRENT ASSET TURNOVER RATIO : Net Sales / Current Assets

14. CREDITORS TURNOVER RATIO : This is also called Creditors

Velocity Ratio, which determines the creditor payment period.

(Average Creditors/Purchases)x365 for days

(52 for weeks & 12 for months)



15. RETRUN ON ASSETS : Net Profit after Taxes/Total Assets

16. RETRUN ON CAPITAL EMPLOYED :

( Net Profit before Interest & Tax / Average Capital Employed) x 100

Average Capital Employed is the average of the equity share

capital and long term funds provided by the owners and the

creditors of the firm at the beginning and end of the accounting

period.



Composite Ratio

17. RETRUN ON EQUITY CAPITAL (ROE) :

Net Profit after Taxes / Tangible Net Worth

18. EARNING PER SHARE : EPS indicates the quantum of net profit

of the year that would be ranking for dividend for each share of

the company being held by the equity share holders.

Net profit after Taxes and Preference Dividend/ No. of Equity

Shares

19. PRICE EARNING RATIO : PE Ratio indicates the number of times

the Earning Per Share is covered by its market price.

Market Price Per Equity Share/Earning Per Share



20. DEBT SERVICE COVERAGE RATIO : This ratio is one of the most

important one which indicates the ability of an enterprise to

meet its liabilities by way of payment of installments of Term

Loans and Interest thereon from out of the cash accruals andforms the basis for fixation of the repayment schedule in

respect of the Term Loans raised for a project. (The Ideal DSCR

Ratio is considered to be 2 )

PAT + Depr. + Annual Interest on Long Term Loans & Liabilities

---------------------------------------------------------------------------------

Annual interest on Long Term Loans & Liabilities + Annual

Installments payable on Long Term Loans & Liabilities

( Where PAT is Profit after Tax and Depr. is Depreciation)

EXERCISE 1



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 - 250 = 50e. 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



EXERCISE 2

LIABILITIES 2005-06 2006-07 2005-06 2006-07

Capital 300 350 Net Fixed Assets 730 750

Reserves 140 160Security Electricity

30 30Bank 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 1Loan 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







550 550

Q . What is the Proprietary Ratio ? Ans : (T NW / Tangible Assets) x 100

[ (362 - 30 ) / (550 – 30)] x 100

(332 / 520) x 100 = 64%

Q . What is the Net Working Capital ?

Ans : C. A - C L. = 255 - 88 = 167

Q . If Net Sales is Rs.15 Lac, then What would be the Stock Turnover

Ratio in Times ? Ans : Net Sales / Average Inventories/Stock

1500 / 128 = 12 times approximately

Exercise 4. contd…



LIABILITIES ASSETS







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) /SalesTherefore 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 = 30,000Therefore 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 amountof 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. A firm sold its stocks in CASH, in order to meet its liquidity

needs. Which of the following Ratio would be affected by this?

1. Debt Equity Ratio

2. Current Ratio3. Debt Service Coverage Ratio

4. Quick Ratio

EXERCISE 13. A company is found to be carrying a high DEBT EQUITY

Ratio. To improve this, a bank may suggest the company to :

1. Raise long term interest free loans from friends and relatives

2. Raise long term loans from Institutions

3. Increase the Equity by way of Bonus Issue

4. Issue Rights share to existing share holders.

EXERCISE 14. Which of the following is a fictitious Asset?

1. Goodwill

2. Preliminary Expenses

3. Pre-operative expenses

4. Book Debts which have become doubtful of recovery



EXERCISE 15. Under which of the following methods of depreciation on

Fixed Assets, the annual amount of depreciation decreases?

1. Written Down Value method

2. Straight Line method3. Annuity method

4. Insurance policy method

EXERCISE 16 Debt Service Coverage Ratio (DSCR) shows :

1. Excess of current assets over current liabilities

2. Number of times the value of fixed assets covers the amount of loan

3. Number of times the company’s earnings cover the payment of

interest and repayment of principal of long term debt

4. Effective utilisation of assets

EXERCISE 17. Which of the following is not considered a Quick Asset?

1. Cash and Bank balances

2. Bank Fixed Deposits

3. Current Book Debts

4. Loans and Advances



Exercise 18. 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 125Cost 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



Questions on Fund Flow Statement

Q . Fund Flow Statement is prepared from the Balance sheet :

1. Of three balance sheets

2. Of a single year

3. Of two consecutive years

4. None of the above.

Q. Why this Fund Flow Statement is studied for ?

1. It indicates the quantum of finance required

2. It is the indicator of utilisation of Bank funds by the concern

3. It shows the money available for repayment of loan

4. It will indicate the provisions against various expenses

Q . In a Fund Flow Statement , the assets are represented by ?

1. Application of Funds

2. Sources of Funds

3. Surplus of sources over application

4. Deficit of sources over application



Q . In Fund Flow Statements the Liabilities are represented by ?

1. Sources of Funds

2. Use of Funds

3. Deficit of sources over application4. All of the above.

Q . When the long term sources are more than long term uses, in the

fund flow statement, it would suggest ?

1. Increase in Current Liabilities2. Decrease in Working Capital

3. Increase in NWC

4. Decrease in NWC

Q . When the long term uses in a fund flow statement are more than the

long term sources, then it would mean ?

1. Reduction in the NWC

2. Reduction in the Working Capital Gap

3. Reduction in Working Capital

4. All of the above



EQUITY MULTIPLIER ------------ 2.5

Equity ratio = 1 / equity multiplier = 1 / 2.5 = 0.4 x 100% = 40%

Debt ratio = 100% - equity ratio

Debt ratio = 100% - 40% = 60%

EQUITY MULTIPLIER --------- 2.4

Therefore Equity Ratio = 1/EM

Equity Ratio = 1/2.4 = 0.42

MEMORIZE this formula:

Debt Ratio + Equity Ratio = 1

Therefore Debt Ratio = 1 - Equity Ratio = 1 - 0.42 = 0.58 OR

58%



EQUITY MULTIPLIER ----- 2.5

Equity multiplier =Total assets/common stockholder equity =TA/(TA-DC) ,where DC = debt capital.

Then

==> TA = 2.5(TA) - 2.5(DC)==> 2.5(DC) = 1.5(TA)

==>Debt Ratio = 3/5 OR 0.60 OR 60%

Ratios - Study ppt.

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