3.

Ratio Analysis

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 Heads for Discussion
1. Why Ratio Analysis
2. Demystifying Ratios
3. Types of Ratio
1. Efficiency Analysis (Asset Utilization)
2. Profitability Analysis
3. Margin Analysis
4. Short Term: Liquidity Analysis
5. Long Term: Solvency Analysis
6. Profit Distribution Analysis
7. Investment Analysis: Equity Analysis
4. Du Pont Analysis
5. Availability of Financial Data: Annual Report
1. Balance Sheet
2. Profit/Loss Account
3. Cash Flow Statements
4. Cost Sheet
6. Database
1. Money Control.com
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2. CMIE’s Prowess
 1. Why Ratio Analysis?
• This helps in identifying the financial health of
the business organization.
• Comparison becomes easy and effective
– Against individual benchmark
– Industry average
– Market average
• Calculation of ratios is old, understanding and
interpretation is important

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 Main Use of Ratio Analysis
It is a health check-up, Financial Health Check-up.
There are mainly two set of people who are
interested to know the financial health of a
business organization…
• Before Extending Credit
– Short-term
– Long-term
• Investors who would like to buy
– Equity
– Debt
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 2. Demystifying the Ratios
Income/Sales
1. Asset Turnover
2. Profitability Ratios
Ratios

Asset Profit
3. Return Ratios

7. Market Value Profit

Financing
Ratios Distribution

4. Liquidity Ratios 6. Profit Distribution

5. Solvency Ratios Ratios
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 Purpose of Financial Ratios
1. Short-term Liquidity
2. Solvency (or Long-term Liquidity)
3. Return on Invested Capital
4. Asset Turnover
5. Operating performance and profitability
6. Profit Distribution
7. Market Valuation

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 3. Type of Ratios

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 3.1 Asset Utilization Ratios (1)
The other names which are used for these ratios
are
• Asset Management Ratios
• Activity Ratios
• Turnover Ratios

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 Important Asset Utilization Ratios
•

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 Interpretations

Ratio
Inventory TO Ratio Higher is better

Debtors TO Ratio Higher is better

Creditor TO Ratio Lower is better

Asset TO Ratio Higher is better

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 3.2 Profitability Ratios (2)
• Gross Margin Ratio
• Operating Profit Margin Ratio
• Net Profit Margin Ratio

Interpretation
Higher is better

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 3.3 Return Ratio (3)
• Return on Assets/Return on
Investments/Return on Capital Employed
• Return on Equity

Interpretation
Higher is better

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 3.4 Liquidity Ratios (4)
• Current Ratio
• Quick Ratio

Interpretation
Higher is better. Less than 1 does not mean that
company would become bankrupt but less than
1 is not advisable.

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 3.5 Solvency Ratios (5)
• Debt-equity Ratio

• Interest Coverage Ratio

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 Interpretations
DE Ratios
It is industry specific. Though, Ideal is 1-1.5. Less
than 1 is considered to be conservative and
more than 1.5 is considered to be risky. In
capital-intensive industries debt-ratio of 2 is also
found.
Interest Coverage Ratio
Higher is better. Lower limit is ideally 1.5. Below
1 is too risky.

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 3.6 Profit Distribution Ratio (6)
• Dividend Pay out Ratios

• Dividend Yield

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 Interpretations
Dividend Pay-out Ratio
Ideal is 30-60% but this is very subjective. Too
much as well as too little, both are not
advisable.

Dividend Yield
Between 3-7%

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 3.7 Market Value Ratios (7)
The Other Names
• Valuation Ratios
• Shareholders’ Ratios

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 Market Value Ratios
• EPS (Basic and Diluted)

• PE Ratio

• PB Ratio

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 Market Value Ratios
• PEG Ratio

• Dividend Yield

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 Market Value Ratios
• PEG Ratio

• Dividend Yield

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 Interpretation for Investments
Ratio
PE Lower is better (15-25 is
average) for investments
PB Lower is better
DY Higher is better (3-7% is
average)
PEG Less than one is better for
Investments

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 4. Du Pont Analysis
RoE is an important Return ratio. But sometimes it has
been observed that it may be misleading. Therefore,
Du Pont Corporation (USA) in year 1920 broke up RoE
into its component and presented this analysis which
is helpful in understanding the mystery of RoE better.

Note: Increasing of RoE may be good or may not be good and

DuPont helps in knowing this better that increase is good or not.

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 Du Pont Analysis
•

Equity multiplier=Asset/equity

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 5. Availability of financial data
1. Annual Report-Balance Sheet
2. Income Statement
3. Cash Flow Statement
4. Cost Sheet

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 6. Database
1. Money Control
2. Prowess

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