FINANCIAL RATIO
ANALYSIS
Financial Statements
•Balance Sheet
•Income Statement
•Cashflow Statement
•Statement of Retained Earnings
RATIO - MEANING
• Relationship or Proportion that one amount bears to another, the
first number being the ‘Numerator’ & the later ‘Denominator’
OR
• Relationship b/w two figures expressed Mathematically
Advantages/Importance/
Significance
- Ratio Analysis
• Analytical Tool for measuring performance.
• Ratios makes Comparison Easy.
• Inter firm Comparison possible.
• Ascertainment of Short term Liquidity & Long term Solvency
position possible.
• Analysis about the STRENGTHS & WEAKNESSES of the firm’s
operations.
• Analyze Past Performance & make further projections.
TYPES OF RATIOS
LIQUIDITY
CAPITAL STRUCTURE OR LEVERAGE
TURNOVER/ACTIVITY/PERFORMANCE
PROFITABILITY
MARKET INDICATORS
LIQUIDITY
CURRENT RATIO
QUICK/ ACID TEST RATIO
ABSOLUTE LIQUID/SUPER QUICK RATIO
STOCK TO WORKING CAPITAL RATIO
INVENTORY TURNOVER RATIO
ACCOUNTS RECEIVABLE TURNOVER RATIO
CURRENT RATIO
CURRENT ASSETS, LOANS & ADVANCES
CURRENT LIABILTIES & PROVISIONS
QUICK/ACID TEST RATIO
CURRENT ASSETS, LOANS & ADVANCES-
INVENTORIES
CURRENT LIABILTIES & PROVISIONS- BANK O/D
Current Ratio
• Looks at the ratio between Current Assets and Current
Liabilities
• Current Ratio = Current Assets : Current Liabilities
• Ideal level? – 1.5 : 1
• A ratio of 5 : 1 would imply the firm has ₹ 5 of assets to
cover every ₹ 1 in liabilities
• A ratio of 0.75 : 1 would suggest the firm has only 75p in
assets available to cover every ₹ 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
Acid Test
• Also referred to as the ‘Quick ratio’
• (Current assets – stock) : liabilities
• 1:1 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!
ABSOLUTE LIQUID/SUPER QUICK RATIO
ABSOLUTE LIQUID ASSETS*
CURRENT LIABILTIES
* Cash in hand + Cash at Bank
STOCK TO WORKING CAPITAL RATIO
Inventory or Stock** x 100
Working Capital
** (opening stock + closing stock)
2
From the given Balance Sheet calculate Current , Liquid,
Absolute Liquid & Stock to Working Capital ratios.
Balance Sheet
LIABILTY Rs. ASSETS Rs.
Share Capital 2,00,000 Fixed Assets 1,60,000
Reserves 80,000 Current Assets:
CURRENT LIABILITIES: Stock 1,20,000
Creditors 80,000 Debtors 60,000
Bills Payable 40,000 Short term Investments 40,000
Cash 20,000
4,00,000 4,00,000
• Current Ratio= 2,40,000 = 2: 1
1,20,000
• Quick Ratio = 2,40,000 – 1,20,000 = 1: 1
1,20,000
• Absolute Ratio = 20,000 = 0.167
1,20,000
• Stock to Working Capital
= 1,20,000 x 100 = 100%
1,20,000
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
Notes:
• 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
• Assets other than Current Assets are Long Term Use of Funds