Documenti di Didattica
Documenti di Professioni
Documenti di Cultura
RATIO ANALYSIS
INTRODUCTION
A Ratio is defined as the indicated quotient of two mathematical expressions and as the relationship between two or more things. It is a powerful analytical tool useful for measuring performance of an organization. It helps the management to analyze the past performance of the firm and to make further projections.
DEFINITION
According to Kennedy and Macmillan, "The relationship of one item to another expressed in simple mathematical form is known as ratio. According to J. Batty, The term accounting ratio is used to describe significant relationships which exist between figures shown in a balance sheet, in a profit and loss account, in a budgetary control system or in any other part of the accounting organization.
CLASSIFICATION OF RATIOS
The ratio analysis is made of Six broad categories are as follows:
1. Liquidity Ratios
2. Leverage Ratios
4. Profitability Ratios
1. LIQUIDITY RATIOS
It is also known as Short-term Solvency Ratios. It measures the company's liquidity & its ability to meet its near-term obligations, and it is a major measure of financial health. It establishes a relationship between cash and other current assets to current obligations, which provides a quick measure of liquidity. Also it refers to the ability to pay in cash, the obligations that are due.
It measures the solvency of the firm in the short term. A current ratio of 2:1 indicates a highly solvent position. And 1.33:1 is considered by banks.
Illustration 1::
2. LEVERAGE RATIO ::
It is also known as Long Term Solvency Ratios. These ratios indicate the long term financial prospects of the companys. The long term stability of the firm may be considered as dependent upon its ability to meet its all liabilities.
Capital Gearing Ratio = Fixed Interest Bearing Funds Equity Shareholders Funds
The fixed interest bearing funds include debentures, long-term loans and preference share capital. The equity shareholders funds include equity share capital, reserves and surplus.
Fixed assets represents the gross fixed assets minus depreciation. Long term funds include share capital, reserves and surplus & long term loans.
Proprietary Ratio =
Net Worth = Equity share capital + Preference share capital + Reserves Fictitious assets Total Assets = Fixed assets + Current assets Fictitious assets
The interest coverage ratio shows how many times interest charges are covered by funds or (current profits) that are available for the payment of interest. An interest cover of 2 times is considered reasonable by financial institutions.
DSCR = Profit after Taxes + Depreciation + Interest on loan Interest on loan + Loan repayment in a year
It indicates whether the business is earning sufficient profits to pay not only the interest charges, but also the installments due of the principal amount. This ratio enables the lender to take the correct view of borrowers repayment capacity.
2) Equity Dividend Cover = Net Profit after Tax Preference Dividend Equity Dividend
Illustration 2 ::
Illustration 3 ::
Illustration 4 ::
The following Asset management ratios are calculated for analysis :1) Inventory Turnover Ratio = Cost of Goods Sold Average Inventory Note :: Average Inventory = or Sales Average Inventory
The following Asset management ratios are calculated for analysis :3) Debtors Turnover Ratio = Credit Sales Average Debtors 4) Debtors Collection Period (in days) = Average Debtors Credit Sales 5) Bad Debts to Sales Ratio = Bad Debts Sales 100
365
The following Asset management ratios are calculated for analysis :6) Creditors Turnover Ratio = Credit Purchases Average Creditors 7) Creditors Payment Period (in days) = Average Creditors Credit Purchases 8) Fixed Assets Turnover Ratio = Sales Fixed Assets
365
The following Asset management ratios are calculated for analysis :9) Total Assets Turnover Ratio = Sales Total Assets 10) Working Capital Turnover Ratio = Sales Working Capital 11) Sales to Capital Employed Ratio = Sales Capital Employed
Illustration 5 ::
4. PROFITABILITY RATIOS ::
There ratios show the combined effects of liquidity, asset management on the results of the companys. It helps in assessing the adequacy of profits earned by the company & also to discover whether profitability is increasing or declining. These are measured with the reference to sales, capital employed, total assets employed, shareholders funds etc.
The major Profitability ratios or rates are as follows :1) Gross Profit Margin = Gross Profit 100 Sales Note:: Gross Profit = Sales Cost of Goods Sold 2) Net Profit Margin = Net Profit before Interest & Tax Sales 3) Cash Profit Ratio = Cash Profit Sales 100 100
The major Profitability ratios or rates are as follows :4) Return on Total Assets = Net Profit after Tax Total Assets 100
5) Return on Shareholders Funds or Return on Net Worth = Net Profit after Interest & Tax Net Worth Note :: Net Worth = Equity Capital + Reserves & Surplus 100
Illustration 6 ::
6) Return on Capital Employed (ROCE) or Return on Investment (ROI) = Net Profit before Interest & Tax 100 Capital Employed
Illustration 7 ::
5. OPERATING RATIOS ::
The ratios of all operating expenses (i.e. materials used, labor, factory overheads, administration and selling expenses) to sales is the operating ratio. A comparison of the operating ratio would indicate whether the cost content is high or low in the figure of sales. The three major components are :: material, labour and overheads.
The classification of Cost ratios are as follows :1) Material Cost Ratio = Material Consumed Sales 2) Labor Cost Ratio = Labor Cost Sales 100 100
The classification of Cost ratios are as follows :4) Administrative Expenses Ratio = Administrative Expenses Sales 5) Selling & Distribution ExpensesRatio = Selling & Distribution Expenses Sales 100
100
100
Illustration 8 ::
Illustration 9 ::
The remaining Market based ratios are as follows :3) Dividend Payout Ratio = Dividend per Share Earnings per Share 4) Dividend Yield Ratio = Dividend per Share Market Price 100
5) Book Value = Equity Capital + Reserves Profit &Loss A/c Debit Balance Total Number of Equity Share
The remaining Market based ratios are as follows :6) Price Earnings Ratio (P/E Ratio) = Current Market Price of Equity Share Earnings per Share
7) Market Price to Book Value Ratio (P/BV Ratio) = Market Price per Share Book Value per Share
Illustration 10 ::
Illustration 11 ::
Illustration 12 ::