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Statement Analysis

508)

Submitted To:

Letter of Submission

To

Md. Ataur Rahman

Lecturer.

Department of RMBA Program,

University Information Technology & Sciences,

Khulshi, Chittagong.

Dear Sir,

This is the most excellent time when I have the overwhelming experience of submitting

the term paper on “Financial Statement Analysis” as a requirement of RMBA Program.

This report has been attempted to focus practical use Ratio Analysis which is powerful

tools in Financial Management.

The preparation of this term paper enables me to a great extent to complement out

theoretical knowledge with practical analysis. I have tired to prepare this term paper with

best of my skill to make it as sound to go through the accompanying term paper &

evaluate it how far I have been successful in the endeavor.

I would like to express my profound gratitude for your kind and conscious guidance in

preparing my term paper in the given time. I sincerely believe that you will find this

study very interesting, informative and enlightening.

Yours sincerely,

A. F. M. Nahid Parvez.

SOB, UITS, Chittagong.

Acknowledgement

With profound regard we gratefully acknowledge our respected course teacher Mr.

Ataur Rahman Lecturer, School of Business Studies for his generous help and day to

day suggestion preparing the term paper.

We like to give thanks especially to our rest of teacher, friends, class mate and many

individuals for their enthusiastic encouragements and helps during the preparation of this

Term Paper by sharing ideas regarding this subject and for their assistance in typing and

proof reading this manuscript.

RATIO ANALYSIS

It refers to the systematic use of ratios to interpret the financial statements in terms of the

operating performance and financial position of a firm. It involves comparison for a

meaningful interpretation of the financial statements.

In view of the needs of various uses of ratios the ratios, which can be calculated from the

accounting data are classified into the following broad categories

A. Liquidity Ratio

B. Turnover Ratio

C. Leverage ratios

D. Profitability ratios

A. LIQUIDITY RATIO

It measures the ability of the firm to meet its short-term obligations, that is capacity of the

firm to pay its current liabilities as and when they fall due. Thus these ratios reflect the

short-term financial solvency of a firm. A firm should ensure that it does not suffer from

lack of liquidity. The failure to meet obligations on due time may result in bad credit

image, loss of creditors confidence, and even in legal proceedings against the firm on the

other hand very high degree of liquidity is also not desirable since it would imply that

funds are idle and earn nothing. So therefore it is necessary to strike a proper balance

between liquidity and lack of liquidity.

The various ratios that explains about the liquidity of the firm are

1. Current Ratio

2. Acid Test Ratio / quick ratio

1. CURRENT RATIO

The current ratio measures the short-term solvency of the firm. It establishes the

relationship between current assets and current liabilities. It is calculated by dividing

current assets by current liabilities.

Current Liabilities

Current assets include cash and bank balances, marketable securities, inventory, and

debtors, excluding provisions for bad debts and doubtful debtors, bills receivables and

prepaid expenses. Current liabilities includes sundry creditors, bills payable, short- term

loans, income-tax liability, accrued expenses and dividends payable.

2. ACID TEST RATIO / QUICK RATIO

It has been an important indicator of the firm’s liquidity position and is used as a

complementary ratio to the current ratio. It establishes the relationship between quick

assets and current liabilities. It is calculated by dividing quick assets by the current

liabilities.

Current liabilities

Quick assets are those current assets, which can be converted into cash immediately or

within reasonable short time without a loss of value. These include cash and bank

balances, sundry debtors, bill’s receivables and short-term marketable securities.

B. TURNOVER RATIO

Turnover ratios are also known as activity ratios or efficiency ratios with which a firm

manages its current assets. The following turnover ratios can be calculated to judge the

effectiveness of asset use.

1. Inventory Turnover Ratio

2. Average Collection Period

3. Fixed Assets Turnover

4. Total Assets Turnover

This ratio indicates the number of times the inventory has been converted into sales

during the period. Thus it evaluates the efficiency of the firm in managing its inventory.

It is calculated by dividing the cost of goods sold by average inventory.

Inventory

The average inventory is simple average of the opening and closing balances of

inventory. (Opening + Closing balances / 2). In certain circumstances opening balance

of the inventory may not be known then closing balance of inventory may be considered

as average inventory

This indicates the Average collection period of Receivable of any company.

Average Collection Period = Receivable

Sales per day

This ratio is calculated by dividing sales by net fixed assets.

Net Fixed Assets

Net fixed assets represent the cost of fixed assets minus depreciation.

4. TOTAL ASSET TURNOVER

This ratio shows the firms ability to generate sales from all financial resources committed

to total assets. It is calculated by dividing sales by total assets.

Total Assets

The solvency or leverage ratios throws light on the long term solvency of a firm

reflecting it’s ability to assure the long term creditors with regard to periodic payment of

interest during the period and loan repayment of principal on maturity or in

predetermined instalments at due dates. There are thus two aspects of the long-term

solvency of a firm.

b. Regular payment of the interest.

The ratio is based on the relationship between borrowed funds and owner’s capital it is

computed from the balance sheet, the second type are calculated from the profit and loss

a/c. The various solvency ratios are

2. Debt to total capital ratio

3. Times Interest Earned

Debt equity ratio shows the relative claims of creditors (Outsiders) and owners (Interest)

against the assets of the firm. Thus this ratio indicates the relative proportions of debt

and equity in financing the firm’s assets. It can be calculated by dividing outsider funds

(Debt) by shareholder funds (Equity)

Shareholder Funds or Equity

The outsider fund includes long-term debts as well as current liabilities. The

shareholder funds include equity share capital, preference share capital, reserves and

surplus including accumulated profits. However fictitious assets like accumulated

deferred expenses etc should be deducted from the total of these items to shareholder

funds. The shareholder funds so calculated are known as net worth of the business.

Debt to total capital ratio = Total Debts

Total Assets

This ratio establishes the relationship between companies Net Operation Income against

Interest Expenses.

Net Worth

PROFITABILITY RATIOS

The profitability ratio of the firm can be measured by calculating various profitability

ratios. General two groups of profitability ratios are calculated.

a. Profitability in relation to sales.

b. Profitability in relation to investments.

Profitability Ratio

1. Gross profit margin or ratio

2. Return on Assets

3. Return on Equity

It measures the relationship between net profit and sales of a firm. It indicates

management’s efficiency in manufacturing, administrating, and selling the products. It is

calculated by dividing net profit after tax by sales.

Net Sales

2. RETURN ON ASSETS

It is calculated by dividing Earnings after Interest & Tax by the Total Assets employed.

Return on Assets = Net Income

Total Assets

3. RETURN ON EQUITY

It is calculated by dividing Earnings after Interest & Tax by the Total Assets employed.

Return on Equity = Net Income

Equity

MARKET RATIOS

IT measure the profit available to the equity shareholders on a per share basis. It is

computed by dividing earnings available to the equity shareholders by the total number of

equity share outstanding

Earnings per share = Net Income

No of shares outstanding

The dividends paid to the shareholders on a per share basis in dividend per share. Thus

dividend per share is the earnings distributed to the ordinary shareholders divided by the

number of ordinary shares outstanding.

No. of shares outstanding

While the earnings per share and dividend per share are based on the book value per

share, the yield is expressed in terms of market value per share. The dividend yield may

be defined as the relation of dividend per share to the market value per ordinary share and

the earning ratio as the ratio of earnings per share to the market value of ordinary share.

Market value of ordinary share

DIVIDEND PAYOUT

It calculate by dividing Dividend Per share by Earning Per Share (EPS).

EPS

The reciprocal of the earnings yield is called price earnings ratio. It is calculated by

dividing the market price of the share by the earnings per share.

Earnings per share

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