Financial Management

Ratio Analysis

Padmaja Buzruk

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 Agenda

’ © at is Financial Statement?
’ Parties interested in t e analysis of financial
statements.
’ Tools of Analysis and Interpretation of
Financial Statement.
’ Ratio Analysis of Financial Statements
’ Classification of Ratios.

—
mnderstanding Financial Statement
’ Financial Statement Business Transaction

M ënd Product of a financial

accounting system
ëntry
’ Importance of Financial
Statement
Books of Prime entry
M Portrait of t e financial
performance of a company
Books of Secondary entry - Ledger

’ ë amples of Financial
Statement Trial Balance

M Income statement or Profit

and loss account
Financial statements
M Balance S eet

]
 Financial statements ± ë ample 1
’ Profit and Loss Account

Particulars Rs. Particulars Rs.

To Opening stock 99,500 By Sales 9,50,000
To Purc ases 5,45,000 By Closing stock 1,50,000
To Carriage inward 15,500
To Gross Profit 4,40,000
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To Operating e penses 2,00,000 By Gross Profit 4,40,000
To Non operating e penses 40,000 By Non operating 60,000
income
To Net Profit 2,60,000








Financial statements ± ë ample 2
’ Balance S eet
Liabilities Rs. Asset Rs.
Capital (ë
uity s ares of 2,00,000 Land and Building 1,50,000
Rs.10 eac

Reserves 2,00,000 Plant and Mac inery 1,80,000
Profit and Loss account 60,000 Stock 50,000
Ot er current liabilities 90,000 Debtors 45,000
Bills payable 40,000 Cas and Bank 60,000
Bills receivable 1,05,000
 



 

Do you understand t e financial stability of an organization easily from above

figures? And can you compare it wit ot er organization in t e same industry?


 Parties interested in analysis of
Financial Statements
’ S are olders and prospective investors
’ S ort term creditors
’ Long term creditors
’ Management
’ Ot ers

Note: Analysis And Interpretation - Study t e financial statements and arrive at t e conclusion.

Œ
Tools of analysis and interpretation
of financial statements
’ Comparative financial statements
M Preparation of Profit and Loss a/c and Balance S eet for two or more years

’ Common size statements

M Financial figures are converted into percentages to some common base. ëac
statement is reduced to 100 and eac individual item is stated as percentage of total
100. In common size statement analysis condensed and compact figures are available
and relative importance of eac item can be known at a glance.

’ Trend analysis
M A year is taken as base year and eac item in t at year is taken as 100. Percentage
of t e same item for year under study is calculated. As large amounts are reduced to
percentages, management finds it easy to compare and know t e trends and t eir
directions.

’ Funds flow analysis

M A statement w ic indicates various means by w ic t e funds ave been obtained
during a certain period and t e ways to w ic t ese funds ave been used during t at
period. ³funds´ means working capital ie. ë cess of current assets over current
liabilities

’ Ratio analysis
D
Ratio Analysis and it's Importance

’ Ratio Analysis is t e process of determining and

interpreting numerical relations ip between two
figures taken from t e financial statements.
M To measure general efficiency
M To measure financial solvency
M To elp in forecasting, planning and decision making
M To elp in inter firm comparison

Investopedia definition - A tool used by individuals to conduct a
uantitative analysis of information in a

company's financial statements. Ratios are calculated from current year numbers and are t en compared to previous
years, ot er companies, t e industry, or even t e economy to judge t e performance of t e company. Ratio analysis is
predominately used by proponents of fundamental analysis.


 Classification of Ratios
Ô
   
 Ô
 

   
  

  

`

  

  
  
Current Ratio Gross Profit Ratio Fi ed Asset Turnover Ratio

Quick Asset Ratio or Operating Ratio Return on s are olders

Acid Test Ratio
ë pense Ratio Fund Ratio
Proprietary/Net wort
Ratio Net profit Ratio ëarning per S are Ratio

Debt ë
uity Ratio Stock Turnover Ratio Debtors¶ Turnover Ratio

Capital Gearing Ratio Return on capital employed

Ô
 ow is Ratio e pressed?

’ ?   -
M Suc as 25% or 50% . For e ample if net profit is
Rs.25,000/- and t e sales are Rs.1,00,000/- t en t e net
profit can be said to be 25% of t e sales.
’ ? 
 
M T e above figures may be e pressed in terms of t e
relations ip between net profit to sales as 1 : 4.
’ ?   
 
M T e same can also be e pressed as, t e sale is 4 times
of t e net profit or profit is 1/4t of t e sales.

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 Calculation of Ratios
Liabilities Rs. Asset Rs.
Capital (ë
uity s ares of Rs.10 eac
2,00,000 Land and Building 1,50,000
Reserves 2,00,000 Plant and Mac inery 1,80,000
Profit and Loss account 60,000 Stock 50,000
Ot er current liabilities 90,000 Debtors 45,000
Bills payable 40,000 Cas and Bank 60,000
Bills receivable 1,05,000

 



 




x


’ x 
 It is an inde of firms financial stability. x



X

M Ideal ratio is 2:1.

= c
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?
 
 Li
uid assets can be converted into cas {
 
’ X
{
 { 
 
immediately.
—
 
X X
— 

M Ideal ratio is 1:1.
 

×
 

’ 
  
 ig ratio indicates ig financial X

 
X
strengt . 
 
X X 
  
M Standard ratio is 1:3.
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 Calculation of Ratios
Particulars Rs. Particulars Rs. ’ G

To Opening stock 99,500 By Sales 9,50,000 
 ig
Gross Profit
To Purc ases 5,45,000 By Closing stock 1,50,000
Ratio is better,
To Carriage inward 15,500 it s ows ig
margin for
To Gross Profit 4,40,000
covering
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e penses, ot er
t an cost of
To Operating e penses 2,00,000 By Gross Profit 4,40,000 goods sold.
To Non operating e penses 40,000 By Non operating income 60,000 G


X
Xc
To Net Profit 2,60,000  



X X
Xc











 

x
  

X 
 

X
’ ½ 
 
 ig er t e ratio
lower is t e margin of operating profit.




Xc X
u



 
 It reveals overall profitability of t e X XXc
’ 

organisation. ig er t e ratio, better is t e efficiency. X

 
X
Xc

 

c—
c]
 Calculation of Ratios

’ Current Ratio x



x



X ’ It is an inde of firms
—
 
financial stability. Ideal ratio
X —
X
   is 2:1.

{
 
’ Acid Test Ratio X
{
 { 
 
X
’ Li
uid assets can be
converted into cas
X
—
 

 
X
— 
immediately. Ideal ratio is
1:1.

’ Proprietary Ratio X
×
 


 
X


 
’ ig ratio indicates ig
X X 
   financial strengt . Standard
ratio is 1:3.

c
 Calculation of Ratios

’ Gross Profit Ratio G  

X


X
Xc ’ ig Gross Profit Ratio is
X



X
Xc

better, it s ows ig margin
 
for covering e penses, ot er
t an cost of goods sold.
’ Net Profit Ratio X
u   
 


X
Xc ’ It reveals overall profitability
of t e organisation. ig er

 
X
 
X
Xc
 t e ratio, better is t e
efficiency.
’ Operating Ratio X
Xx
  

X    

X



X
Xc

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