MEGHNAD SAHA

INSTITUTE
OF TECHNOLOGY

Project report

A STUDY ON RATIO ANALYSIS

Presented BY
[Link] UDDIN
BACHELOR OF BUSINESS ADMINISTRATION
(HONS)
 ACKNOWLEDGEMENT

I am very pleased to express my deep

sense of gratitude to Mr. PARASAR BENARJEE
for his consistent encouragement. I shall forever
cherish my association with him for exuberant
encouragement, perennial approachability, absolute
freedom of thought and action I have enjoyed during
the course of the project.

I am also thankful to Mr. B. Vimal

kumar, Finance faculty of MEGHNAD SAHA
INSTITUTE OF TECHNOLOGY for his support
and suggestions during the project.
PREFACE
INTRODUCTION
 OBJECTIVES

Standardize financial information for

comparisons
Evaluate current operations
Compare performance with past
performance
Compare performance against other firms or
industry standards
Study the efficiency of operations
Study the risk of operations
METHODOLOGY
Meaning of Ratio:- A ratio is simple arithmetical
expression of the relationship of one number
to another. It may be defined as the indicated
quotient of two mathematical expressions.
According to Accountant’s Handbook by
Wixom, Kell and Bedford, “a ratio is an
expression of the quantitative relationship
between Two numbers”.

For example if there are 40 teachers

in a college of 1000 students, we can say that teachers-
students ratio in the college is 40:1000 i.e. 1:25.

Ratio Analysis:- Ratio analysis is the process of

determining and presenting the relationship
of items and group of items in the statements.
According to Batty J. Management Accounting
“Ratio can assist management in its basic
functions of forecasting, planning
coordination, control and communication”.

It is helpful to know about the liquidity,

solvency, capital structure and profitability of
an organization. It is helpful tool to aid in
applying judgment, otherwise complex
situations.
 IMPORTANCE OF RATIO ANALYSIS

Aid to measure general efficiency

Aid to measure financial solvency

Aid in forecasting and planning

Facilitate decision making

Aid in corrective action

Aid in intra-firm comparison

Act as a good communication

Evaluation of efficiency

Effective tool
 CLASSIFICATIONS OF RATIOS
The use of ratio analysis is not confined to
financial manager only. There are different parties interested in the ratio
analysis for knowing the financial position of a firm for different
purposes. Various accounting ratios can be classified as follows:-

1. Traditional Classification

2. Functional Classification

3. Significance ratios

RATIOS

Classification according to Classification according to

source Different economic aspect of
Firm’s operation

1. Balance sheet ratios. 1. Liquidity or short term

Solvency ratios.
2. Profit & loss account ratios 2. Long term solvency ratios
3. Composite or mixed ratios 3. Efficiency or turnover
ratios
4. Profitability ratios
 CLASSIFICATION OF RATIO

Ratio may be classified into the four categories as follows:-

1. Liquidity ratio

2. Leverage ratio

3. Activity ratio

4. Profitability ratio

1. Liquidity ratio
Liquidity refers to the ability of a concern to meet its current
Obligations as & when there becomes due. The short term obligations of a
Firm can be met only when there are sufficient liquid assets. The short term
Obligations are met by realizing amounts from current, floating (or)
Circulating assets the current assets should either be calculated liquid (or)
Near liquidity. They should be convertible into cash for paying obligations of
Short term nature. The sufficiency (or) insufficiency of current assets should be
assessed by comparing them with short-term current liabilities. If current assets can
pay off current liabilities, then liquidity position will be
Satisfactory.
To measure the liquidity of a firm the following ratios can be
Calculated
Current ratio
Quick (or) Acid-test (or) Liquid ratio
Absolute liquid ratio (or) Cash position ratio
 (a) CURRENT RATIO:-

Current ratio may be defined as the relationship

between current assets and current liabilities. This ratio also
known as Working capital ratio is a measure of general liquidity
and is most widely used to make the analysis of a short-term
financial position (or) liquidity of a firm.

Current assets

Current ratio =

Current liabilities

Components of current ratio

CURRENT ASSETS CURRENT LIABILITIES

Cash in hand Outstanding or accrued expenses
Cash at bank Bank over draft
Bills receivable Bills payable
Inventories Short-term advances
Work-in-progress Sundry creditors
Marketable securities Dividend payable
Short-term investments Income-tax payable
Sundry debtors
Prepaid expenses
 (b) QUICK RATIO
Quick ratio is a test of liquidity than the current ratio.
The term liquidity refers to the ability of a firm to pay its short-
term obligations as & when they become due. Quick ratio may
be defined as the relationship between quick or liquid assets and
current liabilities. An asset is said to be liquid if it is converted
into cash within a short period without loss of value.

Quick or liquid assets

Quick ratio =

Current liabilities

Components of quick or liquid ratio

QUICK ASSETS CURRENT LIABILITIES

Cash in hand Outstanding or accrued expenses

Cash at bank Bank over draft
Bills receivable Bills payable
Sundry debtors Short-term advances
Marketable securities Sundry creditors
Temporary investments Dividend payable
Income tax payable

(c) ABSOLUTE LIQUID RATIO

 Although receivable, debtors and bills receivable are
generally more liquid than inventories, yet there may be doubts
regarding their realization into cash immediately or in time.
Hence, absolute liquid ratio should also be calculated together
with current ratio and quick ratio so as to exclude even
receivables from the current assets and find out the absolute
liquid assets.

Absolute liquid assets

Absolute liquid ratio =

Current liabilities

Components of Absolute Liquid Ratio

ABSOLUTE LIQUID ASSETS CURRENT LIABILITIES

Cash in hand Outstanding or accrued expenses
Cash at bank Bank over draft
Interest on Fixed Deposit Bills payable
Short-term advances
Sundry creditors
Dividend payable
Income tax payable
 2. LEVERAGE RATIOS

The leverage or solvency ratio refers to the ability of a

concern to meet its long term obligations. Accordingly, long
term solvency ratios indicate firm’s ability to meet the fixed
interest and costs and repayment schedules associated with its
long term borrowings. The following ratio serves the purpose of
determining the solvency of the concern.
Proprietory ratio

(a) PROPRIETORY RATIO

A variant to the debt-equity ratio is the proprietory ratio
which is also known as equity ratio. This ratio establishes
relationship between share holder’s funds to total assets of the
firm.

Shareholders fund

Proprietory ratio =

Total assets

SHARE HOLDERS FUND TOTAL ASSETS

Share Capital Fixed Assets
Reserves & Surplus Current Assets
Cash in hand & at bank
Bills receivable
Inventories
Marketable securities
Short-term investments
Sundry debtors
 Prepaid Expenses

3. ACTIVITY RATIOS

Funds are invested in various assets in business to make

sales and earn profits. The efficiency with which assets are
managed directly affect the volume of sales. Activity ratios
measure the efficiency (or) effectiveness with which a firm
manages its resources (or) assets. These ratios are also called
“Turn over ratios” because they indicate the speed with which
assets are converted or turned over into sales.

Working capital turnover ratio

Fixed assets turnover ratio

Capital turnover ratio

Current assets to fixed assets ratio

 (a) WORKING CAPITAL TURNOVER RATIO

Working capital of a concern is directly related to sales.

Working capital = Current assets - Current liabilities

It indicates the velocity of the utilization of net

working capital. This indicates the no. of times the working
capital is turned over in the course of a year. A higher ratio
indicates efficient utilization of working capital and a lower
ratio indicates inefficient utilization.
Working capital turnover ratio=cost of goods
Sold/working capital.

Components of Working Capital

CURRENT ASSETS CURRENT LIABILITIES

Cash in hand Outstanding or accrued expenses
Cash at bank Bank over draft
Bills receivable Bills payable
Inventories Short-term advances
Work-in-progress Sundry creditors
Marketable securities Dividend payable
Short-term investments Income-tax payable
Sundry debtors
Prepaid expenses
 (b) FIXED ASSETS TURNOVER RATIO

It is also known as sales to fixed assets ratio. This ratio

measures the efficiency and profit earning capacity of the firm.
Higher the ratio, greater is the intensive utilization of fixed
assets. Lower ratio means under-utilization of fixed assets.

Cost of Sales

Fixed assets turnover ratio =

Net fixed assets

Cost of Sales = Income from Services

Net Fixed Assets = Fixed Assets - Depreciation

 (c) CAPITAL TURNOVER RATIOS

Sometimes the efficiency and effectiveness of the

operations are judged by comparing the cost of sales or sales
with amount of capital invested in the business and not with
assets held in the business, though in both cases the same result
is expected. Capital invested in the business maybe classified as
long-term and short-term capital or as fixed capital and working
capital or Owned Capital and Loaned Capital. All Capital
Turnovers are calculated to study the uses of various types of
capital.

Cost of goods sold

Capital turnover ratio =

Capital employed

Cost of Goods Sold = Income from Services

Capital Employed = Capital + Reserves & Surplus

(d) CURRENT ASSETS TO FIXED ASSETS RATIO
 This ratio differs from industry to industry. The increase
in the ratio means that trading is slack or mechanization has
been used. A decline in the ratio means that debtors and stocks
are increased too much or fixed assets are more intensively used.
If current assets increase with the corresponding increase in
profit, it will show that the business is expanding.

Current Assets

Current Assets to Fixed Assets Ratio =

Fixed Assets

Component of Current Assets to Fixed Assets Ratio

CURRENT ASSETS FIXED ASSETS

Cash in hand Machinery

Cash at bank Buildings
Bills receivable Plant
Inventories Vehicles
Work-in-progress
Sundry debtors
Prepaid expenses
Short-term investments
4. PROFITABILITY RATIOS
 The primary objectives of business undertaking
are to earn profits. Because profit is the engine, that drives the
business enterprise.

Net profit ratio

Return on total assets

Reserves and surplus to capital ratio

Earnings per share

Operating profit ratio

Price – earnings ratio

Return on investments
The linkage of various profitability and turnover ratio can be
graphically presented.

ROI
Operating profit

Capital Employed

Margin Ratio Turnover ratio

Operating profit Sales
Sales Capital Employed

Operating ratio Net profit ratio fixed assets turnover Working capital

Turn over

Cost of goods sold Profit

Sales Sales Sales Sales

Working Capital

Sales Sales Sales

Stock Debtors Creditors

(a) NET PROFIT RATIO

Net profit ratio establishes a relationship between

net profit (after tax) and sales and indicates the efficiency of the
management in manufacturing, selling administrative and other
activities of the firm.

Net profit after tax

Net profit ratio =

Net sales

Net sales

Net Profit after Tax = Net Profit (–) Depreciation (–) Interest (–) Income Tax

Net Sales = Income from Services

It also indicates the firm’s capacity to face adverse economic

Conditions such as price competitors, low demand etc. Obviously higher the ratio,
the better is the profitability.
(b) RETURN ON TOTAL ASSETS

Profitability can be measured in terms of

relationship between net profit and assets. This ratio is also
known as profit-to-assets ratio. It measures the profitability of
investments. The overall profitability can be
Known.

Net profit

Return on assets =

Total assets

Net Profit = Earnings before Interest and Tax

Total Assets = Fixed Assets + Current Assets

(c) RESERVES AND SURPLUS TO CAPITAL RATIO
It reveals the policy pursued by the company with
regard to growth shares. A very high ratio indicates a
conservative dividend policy and increased plugging back to
profit. Higher the ratio better will be the
Position.

Reserves& surplus

Reserves & surplus to capital =

Capital

(d) EARNINGS PER SHARE

Earnings per share is a small verification of
return of equity and is calculated by dividing the net profits
earned by the company and those profits after taxes and
preference dividend by total no. of equity shares.

Net profit after tax

Earnings per share =

Number of Equity shares

(e) OPERATING PROFIT RATIO

 Operating ratio establishes the relationship between
cost of goods sold and other operating expenses on the one hand
and the sales on the other.

Operating cost

Operation ratio =

Net sales
However 75 to 85% may be considered to be a good ratio
in case of a manufacturing under taking.

Operating profit ratio is calculated by dividing operating profit

by sales.

Operating profit = Net sales - Operating cost

Operating profit

Operating profit ratio =

Sales
 (f) PRICE - EARNING RATIO

Price earnings ratio is the ratio between market

price per equity share and earnings per share. The ratio is
calculated to make an estimate of appreciation in the value of a
share of a company and is widely used by
Investors to decide whether (or) not to buy shares in a particular
company.

Generally, higher the price-earnings ratio, the

better it is. If the price earnings ratio falls, the management
should look into the causes that have resulted into the fall of the
ratio.

Market Price per Share

Price – Earning Ratio =

Earnings per Share

Capital + Reserves & Surplus

Market Price per Share =

Number of Equity Shares

Earnings before Interest and Tax

(g) RETURN ON INVESTMENTS
Earnings per Share =

Number of Equity Shares

 Return on share holder’s investment, popularly
known as Return on investments (or) return on share holders or
proprietor’s funds is the relationship between net profit (after
interest and tax) and the proprietor’s funds.

Net profit (after interest and tax)

Return on shareholder’s investment =

Shareholder’s funds

The ratio is generally calculated as percentages by

multiplying the above with 100.