Ratio Analysis Part 1 - Overview

Paper 3B: Financial Management Chapter 3 Unit I

CA B. Hari Gopal B.com, PGDBA, FCA, FCMA, DISA(ICAI), PMP (PMI, USA),
EPBM (IIMC), MCT

Learning Objectives
1. Concept of Ratio Analysis
2. Classification of Ratios
3. Application of Ratio Analysis
4. Limitations of Financial Ratios

Introduction to Ratio Analysis

Introduction
Basis
Objective
Purpose

Ratio Analysis - Introduction

1. Basis for financial analysis, planning and
decision making is financial statements - that is
Balance Sheet and Profit and Loss account
2. However, the above statement does not
disclose all the necessary and relevant
information required for planning and decision
making
3. Ratio analysis is an analytical tool in the hands
of the Finance Manager to analyze the data
depicted in the financial statement

Ratio Analysis - Basis

1. A relationship expressed in mathematical terms

2. Between two individual figures or group of figures

3. Connected with each other in some logical manner

4. And selected from financial statements of the concern

Ratio Analysis - Objective

Objective of financial ratios is that all
stakeholders can draw conclusions about the

1. Performance
2. Strengths and
weaknesses of the firm
3. And take decisions
in relation to the firm

Ratio Analysis - Purpose

To identify aspects of a businesss performance to aid

decision making

Quantitative process may need to be supplemented

by qualitative factors to get a complete picture

Classification of ratios
Statement based classification
Functional Classification

Ratio - Classification

Statement Based

Functional

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Statement Based Classification

Balance Sheet Current Ratio
Debt Equity Ratio
Ratios
Profit and Loss Gross Profit Ratio
account Ratios Net Profit Ratio
Combined
Ratios

Debtors Turnover Ratio

Inventory Turnover Ratio

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Functional Classification
Liquidity Ratios

Current Ratio
Quick Ratio

Capital Structure
Ratios

Equity Ratio
Debt Equity Ratio

Coverage Ratios

Debt Service Coverage Ratio

Interest Coverage Ratio

Activity Ratios
Profitability Ratios

Capital Turnover Ratio

Inventory Turnover Ratio
Return on Equity Ratio
Price Earning Ratio

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Liquidity Ratios

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Liquidity Ratios
Current Ratio
Quick Ratio
Cash Ratio / Absolute Liquidity Ratio
Basic Defense Interval
Net Working Capital Ratio

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Capital Structure Ratios

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Capital Structure Ratios

Equity Ratio
Debt Ratio
Debt Equity Ratio

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Coverage Ratios

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Coverage Ratios
Debt Service Coverage Ratio
Interest Coverage Ratio
Preference Dividend Coverage Ratio
Capital Gearing Ratio
Fixed Assets Long Term Funds Ratio
Proprietary Ratio

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Activity Ratios

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Activity Ratios

Capital Turnover Ratio

Fixed Assets Turnover Ratio
Working Capital Turnover Ratio

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Activity Ratios Working Capital

Ratios
Inventory Turnover Ratio

Debtors Turnover Ratio

Creditors Turnover Ratio

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Profitability Ratios

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Profitability ratios
From Owners point of view
Based on assets / investments
Based on sales
Based on Capital Market information

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Profitability ratios from Owners

point of view
Return on Equity
Earnings Per Share
Dividend Per Share
Price Earning Ratio

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Return on Equity DuPont Model

Dupont Model

Net Profit Margin

Asset Turnover

Equity Multiplier

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Profitability ratios based on

Assets / Investment

Return on Capital Employed (ROCE) /

Return on Investment (ROI)

Return on Assets
2

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Profitability ratios based on Sales

Gross Profit Ratio

Operating Profit Ratio

Net Profit Ratio

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Profitability ratios based on

Capital Market Info
Price Earning Ratio

Yield Ratio

Market Value / Book Value per share

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Performance Evaluation

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Financial ratios for Performance Evaluation

1. Liquidity Position
2. Long Term Solvency
3. Operating Efficiency
4. Overall Profitability
5. Inter-firm comparison
6. Financial Ratios for Budgeting

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Limitations of Ratios

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Limitations of Financial ratios

Diversified product lines

Financial data are badly distorted by

Inflation

Seasonal factors

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Lesson Summary
1. We have learnt the meaning, objective and purpose of
ratio analysis
2. We had seen the classification of ratios and discussed
the ratios under various groupings
3. We had reviewed how the financial ratios helps in
performance analysis
4. Finally we went through the limitations of ratio analysis

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What Next

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Follow the below Presentations

Ratio Analysis Part 2 - Liquidity Ratios
Ratio Analysis Part 3 Leverage Ratios
Ratio Analysis Part 4 - Activity Ratios
Ratio Analysis Part 5 - Profitability Ratios

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Thank You