ratio analysis assignment (1)[1]

8/8/2019 Ratio Analysis Assignment (1)[1]

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RATIO ANALYSIS

Single most important technique of financial analysis in which quantities are converted into

ratios for meaningful comparisons, with past ratios and ratios of other firms in the same or different

industries. Ratio analysis determines trends and exposes strengths or weaknesses of a firm.

1. Liquidity Ratios:-Meaning:-

Liquidity ratio, expresses a company's ability to repay short-term creditors out of its total cash. The

liquidity ratio is the result of dividing the total cash by short-term borrowings.

These includes in liquidity ratios:

1. Current Ratio2. Acid test Ratio3. Sales to Working capital ratio4. Working capital ratio

(1) Current Ratio:-

Meaning:-

The current ratio is also known as the working capital ratio and is normally presented as a real

ratio. The current ratio is another test of a company's financial strength.

Formula:-


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Improvement:-

This ratio shows that company has how much assets to pay its current liabilities. This ratio

improves if current assets increase. If there are more current assets then company is a in beater

situation.

(2) Acid Test Ratio

The acid test ratio is also known as the liquid or the quick ratio. Ideally this figure should also be

above 1 for the firm to be comfortable. That would mean that they can meet all their liabilities

without having to sell any of their stock. This would make potential investors feel more

comfortable about their liquidity. If the figure is far below 1 they may begin to get worried about

the firm's ability to meet its debts. The primary difference between the current ratio and the quick

ratio is the quick ratio does not include inventory and prepaid expenses in the calculation.

Consequently, a business's quick ratio will be lower than its current ratio.

Cash + Marketable Securities + Accounts Receivable

Formula:-

Improvement:-

Ideally this figure should also be above 1 for the firm to be comfortable. This is calculate by

deducting stock from current assets. This ratio shows more pure financial situation of paying

current liabilities. It can be improve by enhancing cash. Accounts receivable, short term

investments.


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(3) Sales to working capital ratio:-

Meaning:-

It is exceedingly important to keep the amount of cash used by an organization at a minimum, so

that its financing needs are reduced. One of the best ways to determine changes in the overall

usage of cash over time is the sales to working capital ratio. This ratio shows the amount of cash

required to maintain a certain level of sales. To calculate the sales to working capital ratio,

compare annualized net sales to working capital, which is accounts receivable, plus inventory,

minus account payable.

Formula:-

Annualized Net Sales

(Accounts Receivable + Inventory Accounts Payable)

Improvement:-

Cash and short-term assets expected to be converted to cash within a year as a percentage of the

amount of annual sales. Because expansion requires capital on hand, the working capital ratio is

considered a prime indicator of a company's ability to expand its operations without taking on

additional debt.

(5) Working Capital Ratio:-

Meaning:-

A measure of both a company's efficiency and its short-term financial health.

Positive working capital means that the company is able to pay off its short-term

liabilities. Negative working capital means that a company currently is unable to meet its short-

term liabilities with its current assets (cash, accounts receivable and inventory).


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Formula:-

Improvement:-

Negative working capital means that a company currently is unable to meet its short-term

liabilities with its current assets (cash, accounts receivable and inventory). There should be more

current asset that would increase working capital and ultimately it would expand business.

2. LEVERAGE RATIO:-

Leverage ratios measure the degree of protection of suppliers of long term funds. A leverage ratio is

a comparison of a combination of a company's debt, equity, assets and interest payments to ascertain

its long-term solvency and ability to meet its financial obligations.

These include:

y Time interest earnedy Fixed charge coveragey Debt ratioy Debt/Equity Ratioy Debt to Tangible Net Worth Ratioy Current Worth/Net worth Ratioy Total capitalization Ratioy Fixed asset Ratio/Equity Ratioy Long term assets versus Long term Debty Debt coverage Ratio


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1. Time Interest Earned Ratio:-Meaning:-

A metric used to measure a company's ability to meet its debt obligations. It is calculated by

taking a company's earnings before interest and taxes (EBIT) and dividing it by the total interest

payable on bonds and other contractual debt. It is usually quoted as a ratio and indicates how

many times a company can cover its interest charges on a pretax basis. Failing to meet these

obligations could force a company into bankruptcy.

Also referred to as "interest coverage ratio" and "fixed-charged coverage".

Indicates a company's capacity to meet interest payments.

Formula:-

Time Interest Earned Ratio: Total Debt-

Total Equity

Improvement:-

A measure of a company's ability to service its debts.. Investors prefer publicly-traded companies to

have a middling times-interest-earned ratio. A low ratio indicates an inability to service debts, while

too high a ratio indicates a lack ofdebt that investors may find undesirable. This ratio should be high

and it can be improved by enhancing equity.

2. Fixed Charge Coverage Ratio:-Meaning:-

Fixed charge coverage ratio, explained, is a strong indicator of a companys future problems if

sales drop to any extent. It is especially important for a company who spends heavily on leases.

The lower the operation profit, the worse negative effects of fixed payments will become. For

example, a company will feel heavier burden of lease payments combined with interest expense

with declining sales.


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Formula:-

Times Interest Earned Ratio = (EBIT+ fixed charge) (total interest + fixed charge)

Improvement:-

It can be improved by increasing earnings of the company or by reducing the fixed charge on

assets and interest. It can be deteriorate by increasing interest and fixed charge on assets. It is

better as high

3. Debt Ratio:-Meaning:-

A ratio that indicates what proportion of debt a company has relative to its assets. The measure

gives an idea to the leverage of the company along with the potential risks the company faces in

terms of its debt-load.

Formula:-

Improvement:-

A debt ratio greater than 1 indicates that a company has more debt than assets; a debt ratio less

than 1 indicates that a company has more assets than debt. As higher this will go will be better

for the organization. This can be improved by increasing total assets.


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4. Debt to Tangible Net Worth Ratio:-Meaning:-

A measure of the physical worth of a company, which does not include any value derived from

intangible assets such as copyrights, patents and intellectual property.. Thus, it represents the

supposed liquidation proceeds a company would fetch if its operations were to cease

immediately and the firm was sold off.

Formula:-

Improvement:-

A debt ratio greater than 1 indicates that a company has more debt than assets; a debt ratio less

than 1 indicates that a company has more assets than debt. It should be higher and it can be

improved by increasing our total assets.

5. Debt to Equity Ratio:-

Meaning:-

Indicates the relationship between the external equities or outsiders funds and the internal

equities or shareholders funds. It is also known as external internal equity ratio. It is determined

to ascertain soundness of the long term financial policies of the company.

Formula:-

[Debt Equity Ratio = External Equities / Internal Equities]

Or

[Outsiders funds / Shareholders funds]


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Long term financial ratio it calculated as:

[Total Long Term Debts / Total Long Term Funds]

Or

[Total Long Term Debts / Shareholders Funds]

Improvement:-

The greater that a company's leverage is, the higher the ratio. Generally, companies with higher

ratios are thought to be more risky because they have more liabilities and less equity.

6. Current Worth/Net Worth Ratio:-

Meaning:-

It is the ratio of net profit to share holder's investment. It is the relationship between net profit (after

interest and tax) and share holder's/proprietor's fund. This ratio establishes the profitability from the

share holders' point of view. The ratio is generally calculated in percentage. This ratio is one of the

most important ratios used for measuring the overall efficiency of a firm.

Formula:-

Net profit (after interest and tax)/Share holder fund *100

Improvement:-

This ratio is of great importance to the present and prospective shareholders as well as the

management of the company. As the ratio reveals how well the resources of the firm are being used,

higher the ratio, better are the results. The inter firm comparison of this ratio determines whether the

investments in the firm are attractive or not as the investors would like to invest only where the

return is higher.


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7. Total Capitalization Ratio:-

Meaning:-

Capitalization ration measure the debt component of the company capital structure or

capitalization of long term debt liabilities and share holder equity to support company and

growth. Long-term debt is divided by the sum of long-term debt and shareholders' equity. This

ratio is considered to be one of the more meaningful of the "debt" ratios - it delivers the key

insight into a company's use of leverage.

8. Fixed Asset Ratio/Equity Ratio:-

Meaning:-

It is a variation to debt to equity ratio. It is also known as equity ratio or net worth to total

assets ratio. This ratio relates the shareholder's funds to total assets. Proprietary / Equity ratio

indicates the long-term or future solvency position of the business. Shareholder's funds

include equity share capital plus all reserves and surpluses items. Total assets include all

assets, including Goodwill.

Formula:-

Equity Ratio = Shareholders funds / Total Assets


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Improvement:-

Shareholders fund is a liability on a company. This ratio shows that how much assets we

have to pay shareholders funds. This ratio is good if its higher. It can be improved by

increasing total assets.

9. Debt Coverage Ratio:-

Meaning:-

Also known as the Debt Service Coverage Ratio (DSCR), the debt coverage ratio measures your

ability to pay the property's monthly mortgage payments from the cash generated from renting

the property. Bankers and lenders use this ratio as a guide to help them understand whether the

property will generate enough cash to pay rental expenses and whether you will have enough left

over to pay them back on the money you borrowed. The DCR is calculated by dividing the

property's annual net operating income (NOI) by a property's annual debt service. Annual debt

service is annual total of your mortgage payments (i.e. the principal and accrued interest, but not

your escrow payments.

Formula:-

Interest Coverage Ratio = Net Profit before Interest and Tax / Fixed Interest

Charges

Improvement:-

The ratio is used by lenders to evaluate loans on income-producing property.A ratio of 1.2 or

better will usually support the extension of credit.


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2. Gross Profit Margin:-Meaning:-

Gross profit ratio (GP ratio) is the ratio of gross profit to net sales expressed as a percentage. It

expresses the relationship between gross profit and sales. Gross profit ratio may be indicated to

what extent the selling prices of goods per unit may be reduced without incurring losses on

operations. It reflects efficiency with which a firm produces its products. As the gross profit is

found by deducting cost of goods sold from net sales, higher the gross profit better it is. There is

no standard GP ratio for evaluation. It may vary from business to business. However, the gross

profit earned should be sufficient to recover all operating expenses and to build up reserves after

paying all fixed interest charges and dividends.

Formula:

Gross Profit Ratio = (Gross profit / Net sales) 100

Improvement:-

We can improve this ratio by increasing our sales if our sales will increase ultimately our gross

profit will increase.

3. Return on Assets:-Meaning:-

An indicator of how profitable a company is relative to its total assets. ROA gives an idea as to

how efficient management is at using its assets to generate earnings. Calculated by dividing a

company's annual earnings by its total assets, ROA is displayed as a percentage.

Formula:


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Improvement:-

It can be improved by increasing all the multiplied values. It can be deteriorate by decreasing

profits and sales. It is as good as high

4. Operating income margin :-Meaning:-

A ratio used to measure a company's pricing strategy and operating efficiency.

Operating margin is a measurement of what proportion of a company's revenue is left over after

paying for variable costs of production such as wages, raw materials, etc. A healthy operating

margin is required for a company to be able to pay for its fixed costs, such as interest on debt.

Also known as "operating profit margin" or "net profit margin".

Formula:

5. Operating Asset turn over Ratio:-Meaning:-

The total asset turnover represents the amount of revenue generated by a company as a result of

its assets on hand. This equation is a basic formula for measuring how efficiently a company is

operating.

Formula:

Operating Asset Turnover= net sales/operating assets.

Improvement:-

The amount of money a company has on hand, or will have, in a given year. Working capital is

calculated by subtracting current liabilities from current assets.This is a good measure of the

short and medium-term financial health of a company, and may indicate by how much it can

expand its operations without resorting to borrowing or another capital raising tactic


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6. Return On operating Assets:-Meaning:-

An indicator of how profitable a company is relative to its total assets. ROA gives an idea as to

how efficient management is at using its assets to generate earnings. Calculated by dividing a

company's annual earnings by its total assets, ROA is displayed as a percentage. Sometimes this

is referred to as "return on investment

Formula:

Net Income + Interest Expense

Total Assets

Improvement:-

It can be improved by selling the assets fast. It can be deteriorate by retaining the assets for a

long time of period. It is better as moderate

7. Sales to Fixed Assets:-Meaning:-

The sales to fixed assets ratio is often called the asset turnover ratio.

A low sale to fixed assets ratio means inefficient utilization or obsolescence of fixed assets,

which may be caused by excess capacity or interruptions in the supply of raw materials.

Formula:

Sales revenue net fixed assets

Improvement:-

A measure of how efficiently a business generates sales from its investments. That is, it is the

ratio of the amount a company earns in sales to the average value of its fixed assets.Thus, if a

company has a high ratio, this means that its sales have kept pace with or exceeded the amount it

has invested in fixed assets, which is a positive sign for the company.


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8. Return on investment:-Meaning:-

A performance measure used to evaluate the efficiency of an investment or to compare the

efficiency of a number of different investments. To calculate ROI, the benefit (return) of an

investment is divided by the cost of the investment; the result is expressed as a percentage or a

ratio.

Formula:

The return on investment formula:

9. Return on total Equity:-Meaning:-

The amount of net income returned as a percentage of shareholders equity. Return on

equity measures a corporation's profitability by revealing how much profit a company

generates with the money shareholders have invested.

Formula:-

Improvement:-

ROE is useful for comparing the profitability of a company with that of other firms in the same

industry.


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4.Activity Ratios:-Activity ratio measure a firm ability to convert different accounts within their balance sheets into

cash or sales.

1. Account Receivable Turn over:-Meaning:-

An accounting measure used to quantify a firm's effectiveness in extending credit as well as

collecting debts. The receivables turnover ratio is an activity ratio, measuring how efficiently

a firm uses its assets.

Formula:

Improvement:-

It can be improved by receiving money from accounts receivable as many times as possible

in a financial year. It can be deteriorate by receiving money from accounts receivable late. It

is better as high in times.

2. Average collection Period:-Meaning:-

The Debtor or receivable turn over when calculated in terms of days is known as Average

Collection Period orDebtors Collection Period Ratio. The average collection period ratio

represents the average number of days for which a firm has to wait before its debtors are

converted into cash.

Formula:

[(Trade Debtors No. of Working Days) / Net Credit Sales]

Improvement:-

The average amount of time it takes for a business to collect on its accounts receivable.

Accounts receivable turnover is a way to determine how a business' credit risk compares to

that of its competitors. This is better if the collection period is high.


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3. Account payable turnover:-Meaning:-

A short-term liquidity measure used to quantify the rate at which a company pays off its

suppliers. Accounts payable turnover ratio is calculated by taking the total purchases made

from suppliers and dividing it by the average accounts payable amount during the same

period.

Formula:

Improvement:-

It can be improved by making late payments to vendors and keep retain that money for

business operations. It can be deteriorate by making early payments to vendors. It is better as

low as possible

4. Average Payment Period:-Meaning:-

A ratio showing how many times a company's inventory is sold and replaced over a period.

Formula:

Improvement:-It can be improved by making late payments to vendors after long period. It can be

deteriorate by making early payments to vendors in short time period. It is better as low in

number of days.


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5. Average age of Inventory:-Meaning:-

The Age of Inventory shows the number of days that inventory is held prior to being

sold. An increasing age of inventory ratio indicates a risk in the company's inability to sell

its products. Individual inventory items should be examined for obsolete or overstocked

items. A decreasing age of inventory may represent under-investment in inventory. The

Age of Inventory Ratio is also referred to as the Number ofDays Inventory, Days

Inventory or Inventory Holding Period.

Formula:

Age of Inventory = 365 days / inventory turnover ratio

Improvement:-

This ratio shows in how much time inventory is converting into sales. To improve this we

should change our inventory into sales as early as possible. Higher the turnover higher

suitable for the company.

6. Operating Cycle:-Meaning:-

The operating cycle is the number of days from cash to inventory to accounts receivable to

cash. The operating cycle reveals how long cash is tied up in receivables and inventory. A

long operating cycle means that less cash is available to meet short term obligations. The age

of inventory collection period, and Operating Cycle ratios are included in the financial

statement ratio analysis spreadsheets highlighted in the left column, which provide formulas,

definitions, calculation, charts and explanations of each ratio. The operating cycle is listed in

our efficiency ratio.

Formula:

Operating Cycle = age of inventory + collection period.

Improvement:-

The time between the purchase of an asset and its sale, or the sale of a product made from the

asset. Most companies desire short operating cycles because it creates cash flow to cover the


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company's liabilities. A long operating cycle often necessitates borrowing and thereby

reduces profitability.

7. Total Asset Turnover:-Meaning:-

The total asset turnover represents the amount of revenue generated by a company as a result

of its assets on hand. This equation is a basic formula for measuring how efficiently a

company is operating.

Formula:

Revenue

Total Assets

Improvement:-

Sales are listed on the firm's income statement and assets are listed on its balance sheet.

Also called asset turnover..It can be improved by generating more revenue from assets. Itcan be deteriorate by using fewer assets to generate revenues. It is better as high as possible


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5. Market Ratios:-Market ratios measure investor response to owing a companys stock and also the cost of

issuing stock.

1. Dividend per Share:-Meaning:-

The the sum of declared dividends for every ordinary share issued. Dividend per share (DPS)

is the total dividends paid out over an entire year (including interim dividends but not

including special dividends) divided by the number of outstanding ordinary shares issued.

Formula:

DPS can be calculated by using the following formula:

Improvement:-

It can be improved be increasing the total amount of dividend. It can be deteriorate by

increasing total number of outstanding shares. It is better as high, because it improve

investment also.

2. Earning Per Share:-

Meaning:-

The portion of a company's profit allocated to each outstanding share of common

stock. Earnings per share serve as an indicator of a company's profitability.

Formula:

Calculated as:


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Improvement:-

Diluted EPS expands on basic EPS by including the shares of convertibles or warrants

outstanding in the outstanding shares number. It can be improved by increasing net profit.

It can be deteriorate by increasing total number of ordinary shares. It is better as high,

because it generate funds for business

3. Price earning Ratio:-Meaning:-

A valuation ratio of a company's current share price compared to its per-share earnings.

Calculated as:

Improvement:-

It can be improved by increase in market value per share. It can be deteriorate by decrease

in market value of shares. It is good as high

4. Percentage of earning Retained:-Meaning:-

The percentage of net earnings not paid out as dividends, but retained by the company to be

reinvested in its core business or to pay debt. It is recorded under shareholders' equity on the

balance sheet. The formula calculates retained earnings by adding net income to (or

subtracting any net losses from) beginning retained earnings and subtracting any dividends

paid to shareholders:

Formula:


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5. Dividend payout :-Meaning:-

The percentage of earnings paid to shareholders in dividends.

Formula:Calculated as:

6. Dividend Yield:-Meaning:-

A financial ratio that shows how much a company pays out in dividends each year

relative to its share price. In the absence of any capital gains, the dividend yield is the

return on investment for a stock. Dividend yield is calculated as follows:

Formula:


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7. Book Value Per Share:-Meaning:-

Common stockholders' equity determined on a per-share basis. Book value per share iscalculated by subtracting liabilities and the par value of any outstanding preferred stock from

assets and dividing the remainder by the number of outstanding shares of stock. Also called

book, book value.

Formula:

Stockholders Equity - Preferred Stock

Average Outstanding Shares

Improvement:-

It can be improved by increasing shareholders equity. It can be deteriorate by decreasing

shareholders equity or increasing outstanding shares. It is better as high.

ratio analysis assignment (1)[1]

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