Ratio Analysis.pptxRatio Analysis.pptxRatio Analysis.pptx

Ratio Analysis.pptx

1. RATIO ANALYSIS Presented By: Rachna Anand

2. RATIO ANALYSIS Ratio Analysis is a form of Financial Statement Analysis that is used to obtain a quick indication of a firm's financial performance in several key areas. “Ratio Analysis is a study of relationship among the various financial factors in a business.” Ratio- It is a simple arithmetical expression of the relationship of one number to another. It can be expressed in:- In Proportion-e.g.(2:1) In Rate or Times- e.g. (6 times) In Percentage- e.g.20%

3. OBJECTIVE Measuring the Profitability Judging the Operational Efficiency of Business Assessing the Solvency of the Business Measuring the Short and Long-term Financial position of the company Facilitating comparative Analysis of the Performance

4. TYPES OF RATIOS The ratios can be classified into the following four broad categories Liquidity Ratios Solvency /Leverage Ratios Turnover or Activity Ratios Profitability Ratios

5. Liquidity Ratios

6. CURRENT RATIO Where , Current Assets = stock + sundry debtors + cash and bank + Receivables + marketable securities + prepaid expenses And, Current Liabilities = Creditors + Short Term Loans + Overdraft+ Outstanding Exps . + Prov. For tax + Unclaimed dividend The most common measure of short-term liquidity is also known as the working capital ratio because net working capital is the difference between current assets and current liabilities Idea l 2 : 1 QUICK RATIO The Quick ratio is sometimes called the “acid” test ratio and is one of the best measures of liquidity. Quick Ratio = Quick Assets Current Liabilities Ideal 1 : 1 Where, Quick Assets = Current Assets − Inventories & prepaid expenses And Current Liabilities = As discussed in the current ratio ABSOLUTE LIQUIDITY RATIO The absolute liquidity ratio measures the absolute liquidity of the business. This ratio only considers the absolute liquidity available to the firm. Absolute Liquidity Ration = Cash+ Marketable Securities Current Liabilities Ideal 0.5 : 1 Where, Marketable Securities = These are financial instruments that can be easily converted to cash such as government bonds, common stock or certificates of deposit. Current Ratio = Current Assets Current Liabilities

7. SOLVENCY /LEVERAGE RATIOS Solvency/leverage ratio may be defined as those ratios which measure the long term stability and structures of the firm. Debt Equity Ratio Proprietary Ratio Capital Gearing Ratio Interest Coverage Ratio

8. This ratio reflects the long-term financial position of a firm and is calculated in the form of a relationship between external equities or outsider funds and internal equities or shareholders funds. DEBT EQUITY RATIO Debt Equity Ratio = Long-term& short-term debt Shareholder’s Fund Ideal 1 : 1 Long-term Debts = Debentures + Loans + lease loans Shareholder’s fund = Eq. share capital + Pref. share capital + Reserve & surplus- Fictitious Assets

9. This ratio indicates the relationship between proprietor’s fund and the total assets . Proprietary Ratio = Shareholder ' s fund Total Assets Shareholders fund = Eq. share capital + Pref. Share capital + reserve and surplus – Fictitious Asset PROPRIETARY RATIO Ideal 1 : 3

10. This ratio establishes the relationship between equity share capital including reserves and surplus to preference share capital and other fixed interest-bearing loans. CAPITAL GEARING RATIO Equity share capital+ Reserve & Surplus Capital Gearing Ratio = Preference share capital + long–term debt bearing fixed interest Long-term debt = Debentures + Long Term Loan

11. INTEREST COVERAGE RATIO This ratio measures the debt-servicing capacity of a firm so far as fixed interest on long-term debt is concerned. Interest Coverage Ratio = Net profit before Interest and Taxes Interest on Long-term debt The standard ratio is 6 or 7 times. The higher the ratio the better it is. Lower the ratio, the management may face difficulties in raising loans in the future.

12. These ratios are employed to evaluate the efficiency with which the firms manages and utilizes its assets . For this reason, they are often called ‘Asset management ratios ’. Stock Turnover Ratio Debtor Turnover Ratio Creditor Turnover Ratio Working Capital Turnover Ratio TURNOVER OR ACTIVITY RATIOS

13. This ratio is also known as inventory turnover ratio. This rati o measures the speed with which the stock of goods is converted into sales. It indicates whether stock has efficiently been used or not. The higher the ratio, the better it is. A higher ratio indicates that more sales are done with less investment in stock. Stock Turnover Ratio = Cost of goods sold /Sales Average Stock or Inventory Cost of Goods Sold = Sales – Gross Profit Average Inventory = (Opening Stock + Closing Stock) / 2 Average holding period= 365/stock turnover ratio STOCK TURNOVER RATIO

14. This ratio is also known as Receivables Turnover Ratio. It establishes relationship between net credit sales and average trade debtors of the year. This ratio measures how efficiently receivables are managed in the business. It indicates how quickly the amount is realised from them. Net Credit Sales Debtor Turnover Ratio = DEBTOR TURNOVER RATIO Net Credit Sales = Sales ― Cash sales― Sales Return Accounts Receivable = Sundry Debtors+ Bills Receivables Average collection period = 365days/Debtor turnover ratio Average Accounts Receivable

15. This ratio indicates the number of times the payables rotates in a year or the velocity with which the payment for credit purchases are made to creditors. Higher credit turnover ratio indicates that firm pays its creditors quickly which increases its creditworthiness. Net Credit Purchase Average Accounts Payable Creditor Turnover Ratio = Net Credit Purchases = Total Purchases ― Cash Purchases ― Purchases Return Accounts Payable = Sundry creditors+ Bills Payable Average payment period =365 days/Creditor Turnover Ratio CREDITOR TURNOVER RATIO

16. This ratio indicates the velocity of the utilization of net working capital. In other words it indicates the number of times the Working capital is converted into sales. Working Capital Ratio = Net Working Capital Net Working Capital = Current Assets ― Current Liabilities WORKING CAPITAL TURNOVER RATIO Net Sales or Cost of Goods Sold

17. The profitability ratios measure the profitability or the operational efficiency of the firm. They are some of the most closely watched and widely quoted ratios. Profitability Ratio based on Sales : Gross Profit Ratio Net Profit Ratio Profitability Ratios based on Investment : Return on Assets Return on Equity Return on Investment/Capital Employed PROFITABILITY RATIOS

18. It is also known as ‘Gross Profit Margin’. This ratio establishes relationship of gross profit to net sales of the firm. This ratio indic ates the margin on sales. T he higher the ratio,better it is. Gross Profit Ratio = Gro s s Pr o fit Net Sales GROSS PROFIT RATIO x 100 Net Sales = Total Sales ― Sales Return Gross Profit = Sales ― Cost of Goods Sold

19. It measures the overall profitability of the business. The greater the ratio, the more profitable the business will be. A high ratio indicates that the business can survive even in case of rising costs or decreasing selling price of the goods. Net Profit Ratio = Net profit after tax X 100 Sales NET PROFIT RATIO / PROFIT MARGIN Net Profit = Gross Profit - Indirect Expenses

20. Profitability Ratios based on Investment Return on Equity = (Net profit for the financial year/total equity) × 100 Return on Assets = (Net profit for the financial year/total assets) × 100 Earnings per share= (Equity earnings/Number of outstanding equity shares) Return on Capital Employed/ ROI = EBIT/capital employed x 100 (capital employed = Equity + long - term & short - term debt) Assets turnover ratio = Sales/ Total Assets

21. Capital Market Standing Ratios: These ratios relate market price of a company’s share to the company’s earnings and dividends. Price to earnings ratio (P/E ratio) (Market price per share/ Earnings per share (EPS)) Price to book value ratio (P/B ratio) (Market price per share/ Book value per share) Dividend Yield (Dividend per share/Market price per share)*100 Dividend payout ratio (Equity dividends/Net profit) Dividend per share (Earnings per share x Dividend payout ratio