T

A
R

S
I
S
Y
L
A
N
A
IO

CHAPTER OBJECTIVES

Ratio Analysis
Measure relationships between resources
and financial flows
Show ways in which firms situation
deviates from
Its own past
Other firms
The industry

Ratio Analysis
The study and
interpretation of the
relationships between
various financial variables,
by investors or lenders.

Ratio
Ratio Analysis
Analysis -- Significance
Significance
A single ratio by itself is not very meaningful.
The discussion of ratios will
include the following types of comparisons.

Ratio
Ratio Analysis
Analysis -- Purpose
Purpose

To identify aspects of a businesss

performance to aid decision making
Quantitative process may need to be
supplemented by qualitative factors to get
a complete picture
Standardize financial information for
comparisons

Ratio
Ratio Analysis
Analysis -- Significance
Significance
Provide the all-important early warning
indications that allow us to solve our business
problems before our business is destroyed by
those problems.
Enables the business owner/manager to spot
trends in a business

How a Ratio is expressed?

As Percentage - such as 25% or 50% . For
example if net profit is Rs.25,000/- and the sales is
Rs.1,00,000/- then the net profit can be said to be
25% of the sales.
As Proportion
- The above figures may be
expressed in terms of the relationship between net
profit to sales as 1 : 4.
As Pure Number /Times - The same can also be
expressed in an alternatively way such as the sale is
4 times of the net profit or profit is 1/4th of the sales.

Ratio Analysis

Ratio Analysis
1.
2.

3.
4.
5.

Liquidity the ability of the firm to pay its way

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

TERMS USED IN RATIO ANALYSIS

Current Assets
Quick Assets (Current Assets- Inventories- Prepaid
Expenses)
Absolute Liquid Assets (Cash, bank & short term
securities)
Working Capital
Receivables
Payables
Fixed Assets
Fictitious Assets
Intangible Assets

TERMS USED IN RATIO ANALYSIS

Capital Employed
Investments
Current Liabilities
Debt
Equity
Cost of Goods Sold
Cost of Sales
Long term funds
Long term loans

Classification of Ratios
Balance Sheet
Ratio

P&L Ratio or
Income/Revenue
Statement Ratio

Balance Sheet and

Profit & Loss
Ratio

Financial Ratio

Operating Ratio

Composite Ratio

Current Ratio
Quick Asset Ratio
Debt Equity Ratio

Gross Profit Ratio

Operating Ratio
Expense Ratio
Net profit Ratio
Stock Turnover Ratio

Fixed Asset Turnover

Ratio, Return on Total
Resources Ratio,
Return on Own Funds
Ratio, Earning per
Share Ratio, Debtors
Turnover Ratio,

Format of balance sheet for ratio analysis

LIABILITIES

ASSETS

NET WORTH/EQUITY/OWNED FUNDS

Share Capital/Partners Capital/Paid up Capital/
Owners Funds
Reserves ( General, Capital, Revaluation & Other
Reserves)
Credit Balance in P&L A/c

FIXED ASSETS : LAND & BUILDING, PLANT &

MACHINERIES
Original Value Less Depreciation
Net Value or Book Value or Written down value

LONG TERM LIABILITIES/BORROWED FUNDS :

Term Loans (Banks & Institutions)
Debentures/Bonds, Unsecured Loans, Fixed Deposits,
Other Long Term Liabilities

NON CURRENT ASSETS

Investments in quoted shares & securities
Old stocks or old/disputed book debts
Long 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 Sources of Funds
Long Term Liabilities & Short Term Liabilities are also called Outside
Liabilities
Current Assets are Short Term Use of Funds

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.
Investments in Govt. Securities to be treated current only if these
are marketable and due. Investments in other securities are to be
treated as 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.

Groups of Financial Ratios

Liquidity
Activity
Debt
Profitability

Liquidity

Analyzing Liquidity
Liquidity

refers to the solvency of the

firm's overall financial position, i.e. a
"liquid firm" is one that can easily meet
its short-term obligations as they come
due.
A second meaning includes the
concept of converting an asset into
cash with little or no loss in value.

1. Current Ratio : It is the relationship between the

current assets and current liabilities of a concern.
Current Ratio = Current Assets/Current Liabilities
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

Current Ratio

Ideal level? 2 : 1
The ideal Current Ratio preferred by Banks is 1.33 : 1
A ratio of 5 : 1 would imply the firm has Rs.5 of assets to cover
every Rs.1 in liabilities
A ratio of 0.75 : 1 would suggest the firm has only 75p in assets
available to cover every Rs.1 it owes
Too high Might suggest that too much of its assets are tied up
in unproductive activities too much stock, for example?
Too low - risk of not being able to pay your way

2. ACID TEST or QUICK RATIO or Liquid Ratio : It is the

ratio between Quick Current Assets and Current Liabilities.
Quick Current Assets : Cash/Bank Balances + Receivables upto 12
months + Quickly realizable securities such as Govt. Securities or
quickly marketable/quoted shares and Bank Fixed Deposits
Acid Test or Quick Ratio
Liabilities

= Quick Current Assets/Current

(Current assets stock-prepaid expenses) : liabilities

1.5:1 seen as ideal
The omission of stock gives an indication of the cash the firm has in relation to its
liabilities (what it owes)
A ratio of 3:1 therefore would suggest the firm has 3 times as much cash as it
owes very healthy!
A ratio of 0.5:1 would suggest the firm has twice as many liabilities as it has cash
to pay for those liabilities. This might put the firm under pressure but is not in
itself the end of the world!

3. ABSOLUTE LIQUIDITY TEST or Cash Ratio : It is the

ratio between Absolute liquid assets and Current Liabilities.
Quick Current Assets : Cash/Bank Balances + Quickly realizable
securities such as Govt. Securities or quickly marketable/quoted shares
and Bank Fixed Deposits
Absolute Liquidity Ratio = Absolute Liquid
Liabilities

Assets/Current

(Current assets stock-receivables) : liabilities

0.5:1 seen as ideal
The omission of stock and receivables gives an indication of the cash the firm
has in relation to its liabilities (what it owes)
A ratio of 3:1 therefore would suggest the firm has 6 times as much cash as it
owes very healthy!
A ratio of 0.2:1 would suggest the firm has five times as many liabilities as it has
ready cash to pay for those liabilities. This might put the firm under pressure but
is not in itself the end of the world!
4. NET WORKING CAPITAL : Current Assets Current Liabilities

Example :
Cash
Debtors
Inventories
Total Current Assets

50,000
1,00,000
1,50,000
3,00,000

Current Ratio = >

Quick Ratio
=>
Absolute Liquidity Ratio = >
Net Working Capital =>

Current Liabilities

3,00,000/1,00,000
1,50,000/1,00,000
50,000/1,00,000
300000-100000

1,00,000

= 3:1
= 1.5:1
= .5:1
= 200000

Analyzing Activity
Activity

is a more sophisticated
analysis of a firm's liquidity,
evaluating the speed with which
certain accounts are converted
into sales or cash; also
measures a firm's efficiency

Five Important Activity Measures

Inventory Turnover (IT)

Average Collection Period (ACP)

Average Payment Period (APP)

Fixed Asset Turnover (FAT)

IT =

Cost of Goods Sold

Average Inventory
Accounts Receivable

ACP =

Annual Sales/360
Accounts

Payable
APP=
Annual
Purchases/360
FAT =

Total Asset Turnover (TAT)

TAT =

Sales
Net Fixed Assets
Sales

STOCK/INVENTORY TURNOVER RATIO :

STR = COGS/ Average Stock

Average Conversion period =
Average Inventory or Stocks =

365/12/52
STR
(Opening Stock + Closing Stock)
-----------------------------------------

This ratio indicates the number of times the inventory is rotated during
the relevant accounting period

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

DEBTORS TURNOVER RATIO :

This is also called
Debtors Velocity or Average Collection Period or Period
of Credit given .
DTR = Net Credit Sales/ Average Receivables
Average Collection
365/52/12

period

(Debtors

Days)

DTR
This ratio tells about the time taken to collect money
from the debtors
ACP:

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

CREDITORS TURNOVER RATIO : This is also called

Creditors Velocity Ratio, which determines the creditor
payment period.
CTR = Net Credit Purchase/ Average Payables
Average Payment period (Creditors Days)
=
365/52/12
CTR
This ratio tells about the time available to make
payment to the creditors

APP:
Higher the better
Gives a measure of how long it takes the business to pay
its debts

ASSET TRUNOVER RATIO :

Net Sales/Tangible Assets
FIXED ASSET TURNOVER RATIO :
Net Sales /Fixed Assets
CURRENT ASSET TURNOVER
RATIO :
Net Sales / Current Assets

Asset Turnover
Asset Turnover = Sales turnover / assets
employed
Using assets to generate profit
Asset turnover x net profit margin = ROCE

Profitability

Key Financial Ratios

Profitability
Ratios
Profitability
ratios
measure the
overall performance of a firm and
its efficiency in managing assets,
liabilities, and equity.

Key Financial Ratios

Profitability Ratios

Profitability ratios include

gross profit margin

operating profit margin
net profit margin
cash flow margin
return on total assets (ROA) or return on investment
(ROI)
return on equity (ROE)
cash return on assets

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 persons salary

Profitability
Operating Profit Margin = Operating Profit /
Turnover x 100
Measures overall operating efficiency and incorporates
all of the expenses associated with ordinary business
activities

Profitability
Return on Capital Employed (ROCE) =
Profit / capital employed x 100
Be aware that there are different
interpretations of what capital employed
means see
[Link] for more
information!

Profitability Ratios
Overall Efficiency and Performance
Cash Flow Margin
Measures ability to translate sales into
cash
Cash flow from operating activities
Net sales

Profitability Ratios
Overall Efficiency and Performance
Return on Total Assets (ROA) or
Return on Investment (ROI)
Measures overall efficiency of firm in
managing investment in assets and
generating profits
Net earnings
Total assets

Profitability Ratios
Overall Efficiency and Performance
Return on Equity (ROE)
Measures rate of return on stockholders
investment
Net earnings
Stockholders equity

Profitability Ratios
Overall Efficiency and Performance
Cash Return on Assets
Measures firms ability to generate cash
from the utilization of its assets

Cash flow from operating activities

Total assets

Operating Ratio
Thais ratio establishes relationships between operating cost & net
sales. This ratio indicates the proportion that the cost of sales.
Cost of sale included direct cost of good sold & as well as other
operating expenses administration, selling & distribution expenses
Operating ratio = Cost of good sold + operating expenses X 100
Net sale
= Operating cost X 100
Net sale
Cost of good sold = opening stock + purchase + direct expenses
closing stock GP
Operating expenses = administrative expenses + selling &
distribution expenses

OBJECTIVE & SIGNIFICANCE

Operating ration is the test of the operational
efficiency of the business .it shows the
percentage of sales that is absorbed by the cost
of sales & operating expenses.
This ratio serves following objective

1. To determine whether the cost content has

increased or decreased in the figure of sales.
2. To determine which element of the cost has
gone up.

Example:
Cost of good sales
Operating expenses
Sales
Sales returns

6 lac
40,000
8,20,000
20,000

Operating Ratio = Cost of good sold + operating expenses X 100

Net Sales
= 6 lac + 40000 X 100
820000-20000
= 640000 X 100
800000
= 80%

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
Rs.1 of capital to generate 25p in profit
Partly a measure of efficiency in
organisation and use of capital

Key Financial Ratios

Leverage Ratios
Leverage ratios measure the extent of a
firms financing with debt relative to equity
and its ability to cover interest and other
fixed charges.

Key Financial Ratios

Leverage Ratios

Leverage ratios include

Debt ratio
Long-term debt to total capitalization
Debt to equity
Times interest earned
Fixed charge coverage
Cash flow adequacy

Analyzing Debt
Debt is a true "double-edged" sword as it
allows for the generation of profits with the
use of other people's (creditors) money, but
creates claims on earnings with a higher
priority than those of the firm's owners.
Financial Leverage is a term used to
describe the magnification of risk and return
resulting from the use of fixed-cost financing
such as debt and preferred stock.

SOLVENCY RATIOS
The term solvency implies ability of an
enterprise to meet its long-term indebtedness
and thus, solvency ratios convey an
enterprises ability to meet its long-term
obligations. Some important solvency ratios
are :

Debt-Equity Ratio,
Interest Coverage Ratio,
Debt to Total Funds Ratio,
Fixed Asset Ratio,

Debt Equity Ratio.

The debt-equity ratio is worked out to ascertain soundness of the
long-term financial policies of the firm.
The ratio ascertained as follows;
Debt-Equity Ratio = Debt (Long-Term Loans)
Equity (Shareholders Funds)

Dept equity ratio indicates the proportion between shareholders

funds and the long-term borrowed funds. A higher ratio indicates a
risky financial position while a lower ratio indicates safer financial
position.

Objective and Significance

This ratio is sufficient to assess the soundness
of long-term financial position. It also
indicates the extent to which the firm
depends upon outsiders for its existence

Ascertain Dept-Equity ratio;

Equity share capital
General reserve
10% debenture
Current liabilities
Preliminary expenses

2,00,000
1,60,000
1,50,000
1,00,000
10,000

Solution ;
Dept-equity Ratio =

Dept
Equity

Dept = debentures = Rs. 1,50,000

Equity= Equity Share Capital + General Reserve- preliminary Expenses
= 2,00,000+1,60,000-10,000
= 3,50,000
Dept-Equity ratio=
1,50,000
3,50,000
= 15:35= 3:7

Interest Coverage ratio:

when a business borrows money, the lender is
interested in finding out whether the business
would earn sufficient profit to pay periodically the
interest charge. A ratio which expresses this is
called Interest Coverage Ratio or Dept service
Ratio or fixed charges cover.
This ratio is determined by dividing profit before
interest by the interest charges
Interest Coverage Ratio =Net profit before interest and tax
Debentures

Interest on fixed (long-term) loans or

Objective and Significance :

This ratio indicates how many times the profit
covers fixed interest. It measures the margin
of safety for the lenders. The higher the
number, more secure the lender is in respect
of his periodical interest income.

Example:
The operating profit of Exe. Ltd. After charging interesr on
debentures and tax is Rs 1,00,000. The amount of interest is Rs
20,000 and the provision for tax has been made at Rs 40,000.
Calculate the interest coverage ratio.

Solution:
Interest Coverage Ratio = net profit before interest and tax
Interest charges
= 1,60,000
20,000

DEBT TO TOTAL FUNDS

RATIO
The Debt to Total Funds Ratio is a measure for long term
financial soundness.

Debt Total Funds Ratio =

Debt
Equity + Debt

Objective and Significance:

The main purpose of the ratio is to
determine the relative stock of outsiders and
shareholders.

Calculate Debt to Total Funds

Ratio:

9% Pref. Share Capital

Equity Share Capital
Reserves
10% Debentures
Loans From Industrial Finance corporation
Current liabilities

Debt to Total Funds Ratio =

=

10,00,000
20,00,000
10,00,000
30,00,000
20,00,000
8,00,000

Long-term loans
Shareholders funds + Long-term loans

30,00,000 + 20,00,000
10,00,000 + 20,00,000 + 10,00,000 + 30,00,000
+ 20,00,000
= Rs. 50,00,000 = 5 : 9 or 0.56.
Rs. 90,00,000

FIXED ASSETS RATIO

Fixed Assets Ratio
= Shareholders funds + Long-term loans
Net Fixed Assets
Objective and Significance.
This ratio indicates as to what extent
fixed assets are financed out of long-term
solvency.

Calculate Fixed Assets Ratio:

Share capital
Reserves
9% Debentures
Trade Creditors
Plant and Machinery
Land and Building
Furniture
Trade Debtors
Cash Balance
Bills Payable
Stock

2,00,000
50,000
2,00,000
75,000
2,00,000
2,00,000
50,000
60,000
40,000
24,000
80,000

Fixed Assets Ratio = Long-term Funds

Fixed Assets
= 2,00,000 + 50,000 + 2,00,000
2,00,000 + 2,00,000 + 50,000

= 4,50,000 = 1
4,50,000

RETURN ON EQUITY
Common shareholders are entittled to the residual
[Link] rate of divident is not fixed and earning may be
distributed to shareholders or retained in the business.
A ROE is calculated to se the profitability of owners
investment.
ROE indicates how well the firm has used the resources
of owners.
It is a most important relationship in financial analysis.
Formula:
ROE=

PAI
.
Net Worth Equity

Earning per share

It is a measure for calculating the profitability of
shareholders investment.
EPS is calculated as;EPS=PAT/NO. OF
OUTSTANDING SHARES
EPS shows the profitability of the firm on share
basis,it doest reflect how much is paid as
dividend and how much is retained in the
business? But as profitability index as it is
valuable.
The higher the EPS,the more attractive will be
the investment plan or vice-versa

Return on investment
The term investment refer to total asset or net asset.
the conventional approach of calculating ROI is to divide PAT by
investment,investment represents pool of funds,supplied by
shareholders and lenders,
while pat represents residue income of shareholders.
The formulae for calculating ROI is;
ROI=ROTA=EBIT(1-T)/ TA OR NA
Since taxes are not controllable by management and firms
opportunities far availing tax incentives differ,it may be more prudent
to use before tax measure of ROI,thus the before tax ratios are;
ROI=ROTA=EBIT/TA OR NA

Investment/Shareholders

Key Financial Ratios

Market Ratios
Market ratios measure returns to
stockholders and the value the
marketplace puts on a companys stock.
Market ratios include
earnings per common share
price-to-earnings
dividend payout
dividend yield

Market Ratios
Earnings per Common Share
Earnings per Common Share
Provides the investor with a common
denominator to gauge investment
returns
Net earnings
Average shares outstanding

Market Ratios
Price-to-Earnings
Price-to-Earnings
Relates earnings per common share to
the market price at which the stock
trades, expressing the multiple that the
stock market places on a firms earnings
Market price of common stock
Earnings per share

PEG Ratio
The market is usually more concerned
about the future than the present, it is
always looking for some way to figure out
what is going to happen in the companies
future.
PEG = (P/E) / (projected growth in
earnings)

 The lower the PEG number, the less you

pay for each unit of future earnings
growth. So even a stock with a high P/E,
but high projected earning growth may be
a good value.

You have a stock with a low P/E. Since the

stock has a low P/E, you start do wonder
why the stock has a low P/E. Is it that the
stock market does not like the stock? Or is
it that the stock market has overlooked a
stock that is actually fundamentally very
strong and of good value?

 If the PEG ratio is big (or close to the P/E

ratio), kind of stock that the stock market
thinks is of not much value.
On the other hand, if the PEG ratio is small
(or very small as compared to the P/E ratio,
kind of fundamentally strong stock that the
market has overlooked for some reason.

Market Ratios
Dividend Payout
Dividend Payout
Determined by the formula cash
dividends per share divided by earnings
per share
Dividends per share
Earnings per share

Market Ratios
Dividend Yield
Dividend Yield
Shows the relationship between cash
dividends and market price
Dividends per share
Market price of common stock

Analyzing the Data

There are five broad areas that would typically
constitute a fundamental analysis of financial
statements:

Background on the firm, industry, economy, and

outlook
Short-term liquidity
Operating efficiency
Capital structure and long-term solvency
Profitability

Background: Economy, Industry, and Firm

Economic developments and the actions of
competitors affect the ability of any business
enterprise to perform successfully.
It is necessary to evaluate the environment in
which the firm conducts business.
This process involves blending hard facts with
guess and estimates.

Short-Term Liquidity
Especially important to creditors, suppliers,
management, and others who are concerned
with the ability of a firm to meet near-term
demands for cash
Should include analysis of selected financial ratios
and a comparison with industry averages
Predicts the future ability of the firm to meet
prospective needs for cash

Operating Efficiency
Turnover ratios measure the operating
efficiency of a firm.
The efficiency in managing a companys
accounts receivable, inventory, and
accounts payable is discussed in the
short-term liquidity analysis.

Capital Structure and Long-Term Solvency

Analytical process includes an
evaluation of the amount and
proportion of debt in a firms capital
structure as well as the ability to
service debt.
Debt financing implies risk and
leverage.

Profitability
Analysis of how well the firm has
performed in terms of profitability,
beginning with the evaluation of
several key ratios

DuPont Framework
The DuPont framework was developed
internally at DuPont around 1920.
It provides a systematic approach to
identifying general factors causing ROE to
deviate from normal.
It establishes a framework for computing
financial ratios to yield more in-depth analysis
of a companys areas of strength and
weakness.

The number of dollarsThe number of

dollars of assets a
The number
in of
sales generated by
company is able to
pennies in profits
each dollar of assets
acquire using each
generated from
dollar invested by
each dollar of sales
stockholders

$180,000
$5,700,000

$5,700,000

$5,700,000
$2,278,000

$2,278,000

$2,278,000
$1,468,000

DuPont Framework

Colevilles ROE for 2011 is 12.3%. The ROE for 2010

would be calculated the same way.

Relating the Ratios

The Du Pont System
Helpful to complete the evaluation of a firm by
considering the interrelationship among the
individual ratios
Looks at how the various pieces of financial
measurement work together to produce an
overall return
Helps analyst see how the firms decisions
and activities over the course of an
accounting period interact to produce
overall return to shareholders

Relating the Ratios

The Du Pont System
The first three ratios reveal that return
on investment is a product of the net
profit margin and the total asset
turnover.
The second three ratios show how the
return on equity is the product of
return on investment and financial
leverage.

Relating the Ratios

The Du Pont System
By reviewing this series of relationships, the
analyst can identify strengths and
weaknesses as well as trace potential
causes of problems in the overall financial
condition and performance of the firm.
Analyst can evaluate changes in condition and
performance.
Evaluation can then focus on specific areas
contributing to changes.

Projections and
Pro Forma Statements
Pro forma financial statements are
projections based on a set of
assumptions regarding

future revenues
expenses
level of investment in assets
financing methods and costs
working capital management

Projections and
Pro Forma Statements
Pro forma financial statements are used
primarily for long-range planning and
long-term credit decisions.
Many firms have made up their own
definitions of pro forma statements,
which should not be confused with the
pro forma statement described above.

Summary of Analysis
Analysis of any firms financial statements
consists of a mixture of steps and pieces
that interrelate and affect each other.
No one part of the analysis should be
interpreted in isolation.
The last step of analysis is to integrate the
separate pieces into a whole, leading to
conclusions about the business enterprise.

EXERCISE 1
LIABILITES
Capital
Reserves

ASSETS
180 Net Fixed Assets
20 Inventories

Term Loan

300 Cash

Bank C/C

200 Receivables

Trade Creditors

50 Goodwill

Provisions

50
800

400
150
50
150
50
800

a.
b.
c.

What is the Net Worth : Capital + Reserve = 200

Tangible Net Worth is : Net Worth - Goodwill = 150
Outside Liabilities : TL + CC + Creditors + Provisions = 600

d.
e.
f.

Net Working Capital : C A - C L = 350 - 250 = 50

Current Ratio : C A / C L
= 350 / 300 = 1.17 : 1
Quick Ratio : Quick Assets / C L = 200/300 = 0.66 : 1

EXERCISE 2
LIABILITIES

2005-06

2006-07

2005-06

2006-07

730

750

30

30

Capital

300

350 Net Fixed

Assets

Reserves

140

160 Security Electricity

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

140

170

30

20

310

240

30

190

70 Finished Goods

Bills Payable

40

80 Cash

Expenses Payable

20

30 Receivables

Provisions

20

40 Loans/Advance
s

Goodwill
50
50
1. Tangible Net Worth for 1st Year : ( 300 + 140) - 50 = 390
Total
1600
1760
1600
1760
2. Current Ratio for 2nd Year : (170 + 20 + 240 + 2+ 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.

Sundry Creditors

100 Preliminary Expenses

Total

1400

1. Debt Equity Ratio will be : 600 / (200+100)

50
100
1400

= 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

Exercise 4.
LIABILITIES

ASSETS

Capital + Reserves

355

P & L Credit Balance

Net Fixed Assets

7 Cash

Loan From S F C

100 Receivables

265
1
125

Bank Overdraft

38 Stocks

Creditors

26 Prepaid Expenses

9 Intangible Assets

30

Provision of Tax
Proposed Dividend

15
550

Q. What is the Current Ratio ?

Q What is the Quick Ratio ?

128

550

Ans : (125 +128+1+30) / (38+26+9+15)

: 255/88 = 2.89 : 1

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.

contd

LIABILITIES
Capital + Reserves
P & L Credit Balance
Loan From S F C

ASSETS
355

Net Fixed Assets

265

7 Cash
100 Receivables

1
125

Bank Overdraft

38 Stocks

Creditors

26 Prepaid Expenses

9 Intangible Assets

30

Provision of Tax
Proposed Dividend

128

15
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
Capital + Reserves
P & L Credit Balance
Loan From S F C

ASSETS
355

Net Fixed Assets

7 Cash
100 Receivables

265
1
125

Bank Overdraft

38 Stocks

Creditors

26 Prepaid Expenses

9 Intangible Assets

30

Provision of Tax
Proposed Dividend

128

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 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
Exercise 8 : Suppose Current Ratio is 4 : 1. NWC is Rs.30,000/-. What
is the amount of Current Assets ?
Answer : 4 x - 1 x = 30,000
Therefore x = 10,000 i.e. Current Liabilities is Rs.10,000
Hence Current Assets would be 4x = 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

THANK YOU

11