Financial Analysis Through Ratios

Financial Analysis Through Ratios
Ratio Analysis
Need of ratio analysis
Much of the financial information is mentioned in the Financial Statements of a company,but
sometimes an absolute figures conveys no meaning.a figure may become more meaningful if it is
compared with some other informative figure. Also the figure mentioned in financial statements
may not give the qualitative information. For analyzing and interpretation of financial
statements Ratio Analysis is used.
Importance of Ratio Analysis
i.
ii.
iii.
iv.
v.
vi.
vii.
viii.
As the absolute figure do not convey any meaning unless they are compared eith each
other. Various ratios can be obtained from financial ratio by grouping and regrouping of
figure in order to draw fruitful meanings. The importance of ratio analysis are mentioned.
Ratio analysis states the financial position of the firm. It helps insurance companies,bank
other financial institution s for assessing the firm before sanctioning loan to them.
Financial ratios are also useful for investors for finding the profitability of the firm.
The financial ratios of organization may be compared with the ratio of previous year of
the same organization to find the exact growth of firm.this comparison is called intrafirm comparison.
The ratio of one organizations are compared with other organization of similar
industry.this is called as inter-firm comparision.
Ratio analysis helps in setting future plans and forecasting of the firm.
Ratios reflects the actual asset and liability so the weaknesses of the firm can be point out
and remedial steps can be taken to overcome this situation.
Ratios indicates the efficiency of the firm.
Ratios reflects the ability of the firm to meet the financial obligations.
Classification of Ratios
Following types of financial ratios are particularly important to managerial control.

i.
Liquidity ratios.
ii.
Activity ratios/ Asset management ratios.
iii.
Debt management ratios/Leverage ratios.
iv. Profitability ratios.
Liquidity Ratios
Liquidity ratios can be classified into two types.

1.Current Ratio.
2.Quick Ratio.
Current Ratio
Current Assets
Current Ratio= -----------------------------Current Liability
Quick Ratio
Quick Assets
Quick Ratio= ------------------------Current Liabilities
Where ,
Quick Assets=Current Assets-(stock+ prepaid Expenses)
Activity Ratio
Activity ratio is calssified as.
1.Inventory Turnover Ratio.
2.Debtors Turnover Ratio.
Inventory Turnover Ratio
Cost of goods sold
Inventory Turnover Ratio= ------------------------Average inventory
Where,
Cost of goods=sales - gross profit
Opening Inventory + Closing Inventory
Average Inventory=-----------------------------------------------------2
365 days
Inventory holding period= -----------------------------------Inventory Turnover Ratio
Debtors Turnover Ratio
Credit Sales
Debtors turnover ratio= -------------------Average debtors
Where ,
Credit sales refers to goods sold on credit,
Credit sales=Gross credit sales-returns.
Debtors at the beginning of year + Debtors at the end of year
Average debtor= --------------------------------------------------------------------------2
Capital Structure Ratios
Capital structure ratios are classified as
1.Debt-equity ratio
2.Inerest coverage ratio
Debt-equity Ratio
Debt
Debt-equity Ratio= ------------Equity
Interest Coverage Ratio
Net Profit before interest and taxes

Interest Coverage Ratio =-----------------------------------------------------Interest
Profitability Ratios
Profitability ratio measures profitability of the firm. if provides information as following

-Quantum of profit.
-Rate of return.
-Earning for each share.
-Amount for each divided.
Various types of profitability ratios are

1.Gross profit ratio.
2.Net profit ratio.
3.Price/Earning ratio(P/E ratio).
4.Earning per share(EPS).
Gross Profit Ratio

Gross Profit
Gross Profit Ratio= ------------------ x100
Sales
Where ,
Gross Profit = Sale - cost of goods sold.
Net Profit Ratio
Net profit after taxes
Net Profit Ratio =
--------------------------Net sales
Earnings Per Share(EPS)
x100
Net profit after taxes

EPS = -----------------------------------Number of shares out standings
Price /Earning Ratio(P/E ratio)
Price /Earning ratio is given byMarket value per share

P/E ratio = --------------------------------------EPS
Limitations of Ratio Analysis

1.Accounting ratios are retrospective.
2.Accounting methods,policies and procedures are not common.
3.Inflationary tendencies cannot be highlighted.
4.Concept of ratios are not the same.
5.Ratios by itself has no utility.
6.Factors weakening ratio analysis.
Problems
1.Two companies ABC Limited and XYZ Limited have approached ICICI Bank for a loan
sanction of Rs. 50,000 for working capital purpose.
Net sales
Gross profit
Interest paid
Income Tax
Profit after Tax
Inventories
Debtors
Cash
Current liabilities
Long term liability
Shareholders equity
ABC LIMITED (Rs.)

9,10,000
3,82,000
20,000
75,000
82,000
90,000
70,000
6,000
1,82,000
1,60,000
1,80,000
XYZ LIMITED (Rs.)

7,50,000
2,92,500
8,200
5,000
56,200
65,200
56,000
18,000
1,16,000
1,30,000
1,40,000
2. From the
following
extract of a
balance sheet of
airline company
calculate the
debt equity
ratio and
interest
coverage ratio. Given that the debt equity ratio is in the range of 10:1,how do u interpret this
ratio?50,000,10% preference shares of Ra.100 each 2,00,000 equity shares of Rs.10 each
10%,3,00,000 debentures of Rs.100 each Net profit during the year was Rs.10,00,000.
3.Selected financial information about Siri Traders Limited is given below:
Sales
2001
6,00,000
2002
4,30,000
Cost of goods sold
5,70,000
3,25,000
Debtors
72,000
30,000
Inventories
1,14,000
55,000
Cash
15,000
8,000
Other current assets
40,000
27,000
Current liabilities
1,60,000
1,10,000
Compute the current ratio, quick ratio, debt collection period and inventory turnover ratios for
the above two years and comment on the results.
4.The following are the extracts from the financial statements of Blue and Red Ltd. As on 31st
March 2001 and 2002 respectively.
Stock
31st March 2001

(Rs.)
10,000
31st March 2002

(Rs.)
25,000
Debtors
20,000
20,000
Bills receivables
10,000
5,000
Cash in hand
18,000
15,000
Bills payable
15,000
20,000
Bank overdraft
----
2,000
9% debentures
5,00,000
5,00,000
Sales for the year
3,50,000
3,00,000
Gross profit
70,000
Compute for both the years the following.
50,000
a) Current ratio.
b) Liquidity ratio.
c) Stock turnover ratio. Also interpret the results.
5. The summarized balance sheet of Alpha Ltd,as on 31st March 2000,2001 and 2002 is given
below.
As on March 31st
2000
Liabilities:
Paid up capital
Borrowing long term
i.
Bonds
ii.
Others
Current liabilities
Assets:
Gross Block
Less depreciation
2001 (Rs.in lakhs)
2002 (Rs. In lakhs)
194
194
194
68
281
52
---595
97
343
54
--688
124
379
99
--796
355
69
----
356
95
----
361
122
-----
Net Block
286
261
239
Current Assets
143
199
234
Profit and Loss
166
228
323
Account
Total
595
688
796
st
From the above compute the following as on 31 March 2000 and 2002:
a) Debt to Equity Ratio
b) Current Ratio and comment on the results.
6. Following is the Profit and Loss Account and Balance Sheet of Jai Hind Ltd. Calculate the
following ratios.
a) Gross Profit Ratio
b) Current Ratio
c) Liquidity ratio.
Profit and Loss Account

Dr.
Cr.
Balance sheet
Liabilities
Share Capital:
Rs.
Assets
Fixed Assets:
Rs.
250000
Equity share capital
100000
Stock of raw materials
150000
Preference share capital
100000
Stock of finished goods
100000
Reserves
100000
Sundry debtors
100000
Debentures
200000
Bank balance
50000
Sundry creditors
100000
Bills paable
50000
650000
650000

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Financial Analysis Through Ratios

Importance of Ratio Analysis

Following types of financial ratios are particularly important to managerial control.

Liquidity ratios can be classified into two types.

Opening Inventory + Closing Inventory

Interest Coverage Ratio

Net Profit before interest and taxes

Profitability ratio measures profitability of the firm. if provides information as following

Various types of profitability ratios are

Gross Profit Ratio

Earnings Per Share(EPS)

Net profit after taxes

Price /Earning ratio is given byMarket value per share

Limitations of Ratio Analysis

ABC LIMITED (Rs.)

XYZ LIMITED (Rs.)

Cost of goods sold

Other current assets

31st March 2001

31st March 2002

Sales for the year

2001 (Rs.in lakhs)

2002 (Rs. In lakhs)

Profit and Loss Account

Equity share capital

Stock of raw materials

Preference share capital

Stock of finished goods

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