RATIO ANALYSIS

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 RATIO ANALYSIS

Ratio-analysis means the process of

computing, determining and presenting the
relationship of related items and groups of
items of the financial statements. They
provide in a summarized and concise form
of fairly good idea about the financial
position of a unit. They are important tools
for financial analysis.
RATIO ANALYSIS
It’s a tool which enables the banker or lender to arrive
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 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.
CLASSIFICATION OF RATIOS
Balance Sheet P&L Ratio or Balance Sheet and
Ratio Income/Revenue Profit & Loss
Statement Ratio Ratio

Financial Ratio Operating Ratio Composite Ratio

Current Ratio Gross Profit Ratio Fixed Asset Turnover
Quick Asset Ratio Operating Ratio Ratio, Return on Total
Proprietary Ratio Expense Ratio Resources Ratio,
Debt Equity Ratio Net profit Ratio Return on Own Funds
Stock Turnover Ratio Ratio, Earning per
Share Ratio, Debtors’
Turnover Ratio,
 FORMAT OF BALANCE SHEET FOR RATIO ANALYSIS
LIABILITIES ASSETS
NET WORTH/EQUITY/OWNED FUNDS FIXED ASSETS : LAND & BUILDING, PLANT
Share Capital/Partner’s Capital/Paid up Capital/ & MACHINERIES
Owners Funds Original Value Less Depreciation
Reserves ( General, Capital, Revaluation & Other Net Value or Book Value or Written down value
Reserves)
Credit Balance in P&L A/c
LONG TERM LIABILITIES/BORROWED NON CURRENT ASSETS
FUNDS : Term Loans (Banks & Institutions) Investments in quoted shares & securities
Debentures/Bonds, Unsecured Loans, Fixed Old stocks or old/disputed book debts
Deposits, Other Long Term Liabilities Long Term Security Deposits
Other Misc. assets which are not current or fixed in
nature
CURRENT LIABILTIES CURRENT ASSETS : Cash & Bank Balance,
Bank Working Capital Limits such as Marketable/quoted Govt. or other securities, Book
CC/OD/Bills/Export Credit Debts/Sundry Debtors, Bills Receivables, Stocks &
Sundry /Trade Creditors/Creditors/Bills Payable, inventory (RM,SIP,FG) Stores & Spares, Advance
Short duration loans or deposits Payment of Taxes, Prepaid expenses, Loans and
Expenses payable & provisions against various Advances recoverable within 12 months
items
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.
If there is profit it shall become part of Net Worth under the head
Reserves 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 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
The ideal Current Ratio preferred by Banks is 1.33 : 1
(In general 2:1)
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/quoted shares and
Bank Fixed Deposits

Acid Test or Quick Ratio = Quick Assets/Current Liabilities

Quick assets = Current assets – (inventory +prepaid expenses)

Example :
Cash 50,000
Debtors 1,00,000
Inventories 1,50,000 Current Liabilities 1,00,000
Total Current Assets 3,00,000

Current Ratio = > 3,00,000/1,00,000 = 3:1

Quick Ratio => 1,50,000/1,00,000 = 1.5 : 1
4. DEBT EQUITY RATIO : It is the relationship between borrower’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 Lacs

Free Reserves & Surplus = Rs. 300 Lacs
Long 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 which
Tangible Assets are financed by Owner’s Fund.
Proprietary Ratio = (Tangible Net Worth/Total Tangible Assets) x
100
The ratio will be 100% when there is no Borrowing for purchasing of
Assets.

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

Sales we can arrive at the Gross Profit Ratio which indicates the
manufacturing 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 is rotated
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 and
forms 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
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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)