ratio analysis
TRANSCRIPT
What are Financial
Statements:
1. Balance Sheet/Position statement
2. Profit and Loss Account/income Statement
3. Statement of Retained Earnings/Profit and Loss
Appropriation Account
4. Cash Flow Statement
Methods of Analyzing
Financial Statements
1. Comparative Statements
2. Common Size Statements
3. Ratio Analysis
4. Cash Flow Statement
Ratio Analysis
• A comparative study of the relationship between various
factors of statements.
• It shows the profitability, liquidity, solvency.
• It helps for forecasting.
• It is helpful for interfirm comparison and intrafirm
comparison.
• These are useful for both internal as well as external
stakeholders.
Classification of Ratios
• 1. Profitability Ratio: It reflects the relationship between
profit and sales, assets or capital employed. It judges the
efficiency of the business.
• 2.Turnover ratio/ Activity Ratio: It measures the
effectiveness of the usage of capital or assets employed in
the business.
• 3. Financial Ratio/solvency Ratio: It judges the
solvency in short term and long term of the company.
• 4. Market Test ratios: It tells the market value of the
company/ shares.
Profitability Ratio1. Return on Investment:
How much company is earning on its investment.
ROI= (Net Operating Profit*100)/ Capital employed
Notes:
• Operating profit is EBIT.
• Non business income should not be included.
• Capital includes share capital, reserve and surplus, long
term loans – non operating assets and fictitious assets.
• It can be net fixed assets + working capital
• ROI= (operating profit/sales) * (sales/capital)
• ROI= net profit ratio * turnover ratio
Numerical 1
• Q. Suppose a company has the following items on the
liabilities side and it shows fictitious asset of Rs. 1,00,000
on the assets side:
13% Preference capital 10,00,000
Equity capital 30,00,000
Reserves 26,00,000
Loans @15% 30,00,000
Current liabilities 15,00,000
Its profit after paying tax @ 50% is Rs. 14,00,000.
Calculate ROI?
SOLUTION
• PBIT= PAT+ TAX+INTEREST ON LOAN
• = 14,00,000+ 14,00,000 + 4,50,000
• = 32,50,000
• Capital employed = 10,00,000+ 30,00,000+
26,00,000+30,00,000-1,00,000= 95,00,000
• ROI= (32,50,000/95,00,000)*100= 34.21%
Profitability ratios
• Return on shareholders’ funds/ return on net worth:
• = (PAT*100)/shareholders' funds
• Capital should be after deducting long term loans.
• It would reflect profitability for the shareholders.
Return on assets:
• It shows whether assets are being properly utilized or not.
• = PAT*100/ Total assets
• Gross profit ratio/gross margin:
• Gross profit is profit before admin, selling and financing expenses.
• =Gross profit*100/sales
• This ratio should be enough high to cover other costs and for proper returns to owners.
• Net profit ratio:
• = operating profit *100/sales
• Net profit= gross profit- admin charges- selling &
distribution charges.
• Non operating incomes and expenses are ignored.
• It shows the expenses for admin and selling are less or
high.
Activity ratio/ turnover ratio• It shows the effectiveness of the resources employed in
business.
• 1) capital turnover ratio:
• = net sales/ capital employed
• Higher the ratio greater the profit.
• 2) total assets turnover ratio:
• = net sales/ total assets
• It can be divided in following parts:
• 2.a.)Fixed assets turnover ratio:
• = net sales/ FA
• FA should be taken after depreciation.
• Working capital turnover ratio:
• = net sales/ working capital
• Stock /inventory turnover ratio:
• = COGS/ avg. inventory
• =sale/avg inventory
• Debtors turnover ratio:
• = net sales/average debtors
• Debtor collection period:
• = (Months or days I a year)/ debtors turnover
• Q. From the following information calculate Debtors
turnover ratio and avg collection period:
• Total debtors opening balance 2,00,000
• Cash sales 1,50,000
• Credit sales 10,00,000
• Cash collected 7,80,000
• Sales return 60,000
• Bad debts 40,000
• Discount allowed 20,000
• Provision for bad debts 20,000
• No of days in a year 360
• Creditors’ turnover ratio:
• = credit purchase/avg creditors
• Debt payment period:
• =( Months or days in a year)/ creditors turnover
Financial ratios/ solvency ratios1. Liquidity ratio: short term solvency ratio
In short term firm should be able to meet all its short term
obligations.
a. Current ratio= current assets/ current liabilities
2:1 is an ideal ratio.
If it is too high it is not a good sign it will effect the
profitability.
b. Quick ratio/ liquid ratio= quick assets/ current
liabilities
Quick assets = current assets – inventory – prepaid
expenses
1:1 is an ideal ratio.
• 2. Long term solvency ratio:
• 2.a. debt-equity ratio:
• External-internal equity ratio
• Debt include debentures, Long term loan from FIs.
• Equity means preference, equity share capital, reserves less loss and fictitious assets as preliminary expenses.
• = Debt/ Equity
• In India 2:1 is ideal.
• It means a company can take debt twice of equity or it can finance 2/3 portion from debt.
• 2.b. Debt service coverage ratio:
• Fixed charges cover/ interest cover ratio.
• It covers the debt servicing capacity of the company.
• = PBT/ Interest charges
• Ideal ration is 6-7.
• 2.c.Capital gearing ratio:
• Proportion of fixed interest or dividend bearing funds and
non fixed interest or dividend bearing funds in total
capital.
• = fixed interest bearing funds/ equity shares funds
Market test ratios
• These are used for the companies whose shares are
trading in the market.
• Following ratios reflect the market value of shares:
• 1. EPS/ earning per share
• EPS= net profit/ no of equity shares
• Net profit should be calculated after preference shares’
dividend.
• It should consider all operating , non operating income
and expenses.
• High EPS, high share price, vice versa.
• 2. Price Earning ratio/ PE Ratio:
it establishes the relation between market price and earning of a share.
= MP of a equity share/ EPS
It helps to decide whether the share is undervalued or overvalued.
3. Pay out ratio:
It shows what is available as earning per share and what is actually paid as dividend out of earnings.
It shows the dividend policy of a company.
= DPS/EPS
4. Dividend yield ratio:
It shows the return shareholders are getting on market price of the shares.
= DPS/ MPS * 100
• From the following information, calculate ( i) Net Assets Turnover (ii) Fixed Assets Turnover and (iii ) Working Capital Turnover Ratios iv) debt- equity ratio v) debtors turnover ratio vi) creditors turnover ratio :
• Preference Shares Capital 4,00,000 Plant and Machinery 8,00,000
• Equity Share Capital 6,00,000 Land and Building 5,00,000
• General Reserve 1,00,000 Motor Car 2,00,000
• Profit and Loss Account 3,00,000 Furniture 1,00,000
• 15% Debentures 2,00,000 Stock 1,80,000
• 14% Loan 2,00,000 Debtors 1,10,000
• Creditors 1,40,000 Bank 80,000
• Bills Payable 50,000 Cash 30,000
• Outstanding Expenses 10,000
• Sales for the year 2005 were Rs. 30,00,000.
• Solution
• Sales = Rs. 30,00,000
• Capital Employed = Share Capital + Reserves and Surplus + Long-term Debt (or Net Assets)
• = (Rs.4,00,000 + Rs.6,00,000) + (Rs.1,00,000 + Rs.3,00,000) + (Rs.2,00,000 + Rs.2,00,000) = Rs. 18,00,000
• Fixed Assets = Rs.8,00,000 + Rs.5,00,000 + Rs.2,00,000 + Rs.1,00,000 = Rs. 16,00,000
• Working Capital = Current Assets – Current Liabilities = Rs.4,00,000 – Rs.2,00,000 = Rs. 2,00,000
• Net Assets Turnover Ratio = Rs.30,00,000/Rs.18,00,000 = 1.67 times
• Fixed Assets Turnover Ratio = Rs.30,00,000/Rs.16,00,000 =
• 1.88 times
• Working Capital Turnover = Rs.30,00,000/Rs.2,00,000 = 15
• times.