RATIO ANALYSIS

INTRODUCTION

The Financial Analyst needs certain yardstick to evaluate the efficiency and performance of

business units. The most frequently used yardstick is Ratio Analysis. It is a tool, which studies

the numerical or quantitative relationship between two variables or items, which are related. This

is because no useful purposes will be served if ratios are calculated between two figures, which

are not at all related to each other. It is difficult to compare any data unless simplified. The ratios

are simplification of huge mass of data and are easy to compare.

Ratios Analysis may be expressed in any of the three ways:

Rate.

Proportion and

Percentage.

The different types of ratios are as follows:-

Solvency or Financial Ratios :

It is used to find out the short term and long term financial position of the concern. The

norm varies as per the ratio.

Turnover Ratios :

It measures the effectiveness of the business. Higher is the better.

Profitability Ratios :

Profitability ratios are prepared to find out the overall efficiency of the business. The

higher the ratio better is the company’s position.

SOLVENCY OR FINANCIAL RATIOS

Solvency or financial ratios include all ratios which express financial position of the

concern.

SHORT TERM SOLVENCY RATIOS OR LIQUIDITY RATIOS

Current Ratio :-

The ratio of current assets to current liabilities is called Current Ratio. It indicates the

ability of a concern to meet its current obligations as and when they are due for payment.

It may be expressed as:

Current Ratio: Current Assets

Current Liabilities

Years 2007-08 2008-09 2009-10

Current Assets (Rs.) 4487710 4900817 4426769

Current Liabilities

(Rs.)

1441833 3416993 2747739

2.97:1 1.43:1 1.61:1

Significance:

The ideal ratio is 2:1. High current ratio indicates dependence on long term sources of

raising fund. Lesser ratio indicates inadequate current assets to meet current liabilities.

Liquid Ratio:-

This ratio is also called ‘Quick’ or ‘Acid test ratio’. It is calculated by comparing the

quick assets with current liabilities. It may be expressed as:

Liquid Ratio = Liquid Assets

Current Liabilities

Year 2007-08 2008-09 2009-10

Liquid Assets (Rs.) 4402845 4814166 4338756

Current Liabilities (Rs.) 1481833 3416993 2747739

2.97 1.41 1.58

3.11

1.431.61

0

0.5

1

1.5

2

2.5

3

3.5

2007-08 2008-09 2009-2010

Current Ratio

Significance:

The ideal ratio is 1:1. Comparison of quick ratio with current ratio indicates the inventory

hold ups.

2.97

1.411.58

0.00

0.50

1.00

1.50

2.00

2.50

3.00

3.50

2007-08 2008-09 2009-10

Liquid Ratio

Absolute Ratio :

It is modified form of Liquid Ratio. The relationship of absolute liquid assets to

liquid liabilities is known as Absolute liquid ratio. This ratio is also called as

Super Quick ratio. This is calculated as :

Liquid ratio = Absolute Liquid assets

Liquid liabilities

Years 2007-08 2008-09 2009-10

Absolute liquid

Assets (Rs.)

4487710 4900817 4426769

Liquid liabilities (Rs.) 3005877 3416993 2747739

1.49 1.43 1.61

Significance :

The quick ratio/acid test ratio is very useful in measuring the liquidity position of a firm. It

measures the firm's capacity to pay off current obligations immediately and is more rigorous

test of liquidity than the current ratio. A standard of 0.5:1 absolute liquidity ratio is

considered an acceptable norm. As a convention, generally, a quick ratio of "one to one"

(1:1) is considered to be satisfactory.

SOLVENCY RATIOS

Debt Equity Ratio:-

A measure of a company's financial leverage. Debt/equity ratio is equal to

long- term debt divided by common shareholders' equity. The data from the

prior fiscal year is used in the calculation.

It is the relationship between borrower’s fund (Debt) and Owner’s Capital

(equity).

1.49

1.43

1.61

1.30

1.35

1.40

1.45

1.50

1.55

1.60

1.65

2007-08 2008-09 2009-2010

Asolute Liquid Ratio

Asolute Liquid Ratio

YEARS

RUPEES

IN

CRORES

Debt Equity Ratio : Long term debts

Shareholders Fund

Year 2007-08 2008-09 2009-10

Long term debts (Rs.) 103835 38255 38255

Shareholders Funds (Rs.) 818412 1038071 1696183

0.13 0.04 0.02

Significance:

It is important to realize that if the ratio is greater than 1, the majority of assets are financed

through debt. If it is smaller than 1, assets are primarily financed through equity.

0.13

0.04

0.02

0

0.02

0.04

0.06

0.08

0.1

0.12

0.14

2007-08 2008-09 2009-2010

Fixed Assets Ratio

YEARS

RUPEES

IN

CRORES

Proprietary Ratio:-

This ratio expresses the relationship between the proprietor’s funds and the total tangible

assets. It may be expressed as:

Proprietary ratio: Shareholder’s funds

Total tangible asset

S

i

significance:

This ratio shows the general soundness of the company. A high ratio

indicates safety to the creditors and a low ratio shows greater risk to the creditors.

Years 2007-08 2008-09 2009-10

Shareholder’s funds

(Rs.)

818412 1038071 1696183

Total tangible assets

(Rs.)

1925865 1854487 1854487

0.42 0.56 0.86

TURNOVER RATIOS(Activity Ratios)

These ratios are also called ‘performance ratios’ or ‘activity ratios’. These ratios highlight

the operational efficiency of the business concern.

Operating Profit Ratio:-

Operating net profit ratio is calculated by dividing the operating net

profit by sales. This ratio helps in determining the ability of the

management in running the business.

Operating Profit Ratio = Operating Profit x 100

Sales

0

0.2

0.4

0.6

0.8

1

1.2

1.4

1.6

1.8

2

2006-07 2007-08 2008-09

Proprietary ratio

Years 2007-08 2008-09 2009-10

Operating Profit (Rs.) 525331 490192 1032741

Sales (Rs.) 13185718 8746585 13506451

3.98 5.60 7.65

Significance:

This ratio indicates whether Investment in Inventories is efficiently used or not. Higher

ratio indicates brisk sales. Lower ratio indicates blocking of funds in Inventory.

Fixed assets turnover ratio:-

This ratio determines efficiency of utilization of fixed assets and profitability of a

business concern.

Fixed Assets Turnover Ratio: Sales/Cost of Sales

0

1

2

3

4

5

6

7

8

9

2007-08 2008-09 2009-10

Operating Profit Ratio

Net fixed assets

Years 2007-08 2008-09 2009-10

Sales (Rs.) 13815718 8746585 13506451

Net fixed assets

(Rs.)

444032 370663 299346

31.11 23.60 45.12

Significance:

Higher the ratio more is the efficiency in utilization of fixed assets. A lower ratio is the

indication of under utilization of fixed assets.

Capital turnover ratio:-

0

0.05

0.1

0.15

0.2

0.25

0.3

0.35

2006-07 2007-08 2008-09

Fixed assets turnover ratio

Fixed assets turnover

ratio

Managerial efficiency is also calculated by establishing the relationship between Cost of

Sales/Sales with the amount of Capital invested in the business. It may be expressed as

follows:

Capital Turnover Ratio: Sales

Capital employed

Years 2007-08 2008-09 2009-10

Sales (Rs.) 13815718 8746585 13506451

Capital employed

(Rs.)

818412 1038071 1696183

16.88 8.43 7.96

Significance:

Higher ratio indicates higher efficiency and lower ratio indicates ineffective usage of

Capital.

PROFITABILITY RATIOS

Ability to make maximum profit from optimum utilization of resources by a business

concern is termed as ‘profitability’. Profitability depends on sales, costs and utilization of

resources. The following are the various ratios used to analyze profitability.

Gross profit ratio:-

This ratio is also known as Gross margin/Trading Margin ratio. Gross profit ratio

indicates the difference between sales and direct costs. Gross profit ratio explains the

relationship between gross profit and net sales.

Gross Profit Ratio: Gross Profit x 100

Net Sales

Years 2007-08 2008-09 2009-10

0

0.05

0.1

0.15

0.2

0.25

0.3

2006-07 2007-08 2008-09

Capital turnover ratio

Gross profit (Rs.) 3026701 1502741 6265422

Net sales (Rs.) 13818218 8476585 13506451

21.90 17.18 46.39

Significance:

Higher ratio indicates higher profitability. Lower ratio indicates lesser profitability.

0

10

20

30

40

50

60

70

80

90

2006-07 2007-08 2008-09

Gross profit ratio

Net profit ratio:-

This ratio is also called net profit to sales ratio. It is a measure of management’s

efficiency in operating the business successfully from the owner’s point of view. It

indicates the return on shareholder’s investments.

Net Profit Ratio: Net Profit after tax x 100

Net sales

Years 2007-08 2008-09 2009-10

Net profit after tax

(Rs.)

413157 384373 950450

Net sales (Rs.) 13815718 8746585 13506451

2.99 4.39 7.04

Significance:

Higher the ratio better is the operational efficiency of the business concern.

0

1

2

3

4

5

6

7

8

2007-082008-09

2009-10

2.99

4.39

7.04