managementaccountingunitii-230422135318-615cda36.ppt

RATIO ANALYSIS

2. WHATDOYOUMEANBYRATIOANALYSIS?
Aratioisamathematicalrelationshipbetweentwo
itemsexpressedinaquantitativeform.Ratioanalysis
involvestheprocessofcomputing,determiningand
presentingtherelationshipofitemsorgroupsofitems
inthefinancialstatements.

3. Steps in ratio analysis
SelectionofRelevantInformation:Thefirststepin
ratioanalysisistoselectrelevantinformationfrom
financialstatementsandcalculateappropriateratios
requiredfordecisionunderconsideration.
ComparisonofCalculatedRatios:Inordertoassess
therelativemeaningtheratioscalculatedare
comparedwiththepastratiosandindustryratios.
InterpretationandReporting:Thisisthefinalstep
whereinferencesaremadeandthereportiswritten.
Thereportrecommendsspecificactionandpresent
alternativeswithenablesthedecisionmaking.

4. STATETHEMODESOFEXPRESSIONOFRATIOS.
Ratiosmaybeexpressedinanyoneormoreofthe
followingways:
Inproportion:Inthistypeofexpressiontheamountsof
twoitemsareexpressedinacommondenominator.An
exampleofthisformofexpressionistherelationship
betweencurrentassetsandcurrentliabilitiesas2:1
InratesortimesofCoefficient:Inthistypeof
expression,aquotientobtainedbydividingoneitemby
anotheristakenasunitofexpression.E.g.costofsales
dividedbyaveragestock.
Inpercentage:Inthistypeofexpression,aquotient
obtainedbydividingonitembyanotherismultipliedby
onehundredtoshowtherelationshipintermsof
percentage.E.g.relationshipbetweennetprofitandsales.

5. ADVANTAGES OF RATIO ANALYSIS .
Managerial Control
Forecasting
Facilitates Communication
Measuring Efficiency
Facilitating Investment Decisions
Useful in Measuring Financial Solvency
Inter firm Comparisons

6. LIMITATIONS OF RATIO ANALYSIS
Practical Knowledge
Ratios are Means
Inter Relationship
Non Availability of Standards or Norms
Accuracy of Financial Information
Consistency in Preparation of Financial
Statements
Detachment from Financial Statements
Time Lag
Change in Price Level

7. CLASSIFICATION OF RATIOS
Solvency Ratios: Short term and long term solvency ratios.
E.g.: Current ratio, Debt equity ratio.
Profitability Ratios:E.g.: Gross profit ratio, Net profit ratio,
Operating profit ratio, Return on capital employed.
Turnover or Activity Ratio: E.g.: Stock turnover ratio,
Debtors turnover ratio, Creditors turnover ratio.
Capital Structure Ratio: E.g.: Capital gearing ratio.

8. CURRENT RATIO
Thisratioisalsocalled‘workingcapitalratio’.It
isusedtoassesstheshort-termfinancialpositionof
thebusinessconcern.Inotherwords,itisanindicator
ofthecompany’sabilitytomeetitsshort-term
obligations.Itmatchesthetotalcurrentassetsofthe
companyagainstitscurrentliabilities.Itiscalculated
onthebasisofthefollowingformula:

9. QUICK RATIO OR LIQUID RATIO
Thisratioisalsoknownasthe“acidtestratio”
or“thequickratio”or“thenearmoneyratio”.Itis
onlyavariationofcurrentratio.Likecurrentratio,it
measurestheabilityofthecompanytomeetitscurrent
obligations.Itexplainstherelationshipbetweenliquid
assetsandcurrentliabilities.Theformulafor
calculatingtheratiois:

10. Absoluteliquidityratio:Thisratioisalsocalled,‘cash
positionratio’or‘cashratio’or‘superquickratio’.This
ratioestablishesrelationshipbetweenabsoluteliquid
assetsandcurrentliabilities.Absoluteliquidassets
includecash,bankandimmediatelyrealizableassets
e.g.marketablesecurities.Thisratioiscomputedwith
thehelpofthefollowingformula