Ratio Analysis

Ratio Analysis is an effective tool of analysis of financial statements. Following selected

ratios are calculated to have in-depth analysis and interpretation of vital areas of accounting and
finance, like- profitability, current obligation, solvency, efficiency and risk. Under each of these
five categories six different ratios are calculated.
(I) Ratios to measure profitability: Profit earning is essential for the survival of all banks.
Profits are a measure of creditworthiness or worth of investment for owners, source of
fringe benefits for employees and a measure of tax-paying capacity for Government. With
the help of following profitability ratios, the profitability of the bank is tested in the present
study.
1. Net worth ratio or Return on Shareholder’s funds– This ratio measures the returns available
to the shareholders on the capital invested by them in the enterprise. As this ratio reveals
how well the capital of a firm is being used, so higher ratio is considered as better.
NPAT
NWR= ×100
TC (wherein, NPAT=Net Profit after tax, TC=Total shareholder’s
funds)
2. Return on Capital Employed– The term ‘capital employed’ refers to total investments
made in fixed and current assets. As this ratio measures how well the institution is using its
assets in generating income, so higher ratio is considered better.
NPAT
ROCE= ×100
TA (wherein, NPAT=Net Profit after tax, TA=Total Assets)
3. Profit Margin– This ratio reveals that how much amount is available to the owners of an
enterprise out of total income earned. It also follows the principal ‘higher the ratio, better it
is.’
NP
PM= ×100
TI (wherein, NP=Net Profit, TI=Total Income)
4. Asset Utilization – It reflects the ability of a bank to generate revenues through its assets.
Higher the ratio better it is.
TI
AU= ×100
TA (wherein, TI=Total Income, TA=Total Assets)
5. Net Interest Margin– It is a measure of the net interest return on income producing assets.
It shows the management’s ability to control the spread between interest revenue and
interest costs. Net interest margin is the difference between total interest income and total
interest expenses. It reflects the core income (income from lending operations) of the bank.
IM
NIM= ×100
TA (wherein, IM=Interest Margin, TA=Total Assets)
6. Capital Turnover– It reflects the relationship between sales (loans and advances in case of
bank) and total assets (fixed assets plus current assets). It also signifies the volume of
business earned on the invested capital or the effectiveness with which a firm utilizes its
resources or the capital employed. Higher the ratio, better it is.
S
CT= ×100
TA (wherein, S=Sales or Loans and Advances, TA=Total Assets)
(II) Ratios to measure current obligation: The short term obligations are met by realizing
amount from current, floating or circulating assets. The current assets should either be
liquid or near liquidity. Liquidity refers to the ability of a concern to meet its current
obligations as and when these become due.
1. Cash-Assets ratio– This ratio reflects the liquidity level against the asset base of the bank.
The higher the ratio, the higher the liquidity of the asset portfolio, however, this may lead
to low profitability.
C
CAR= ×100
TA (wherein, C=Cash, TA=Total Assets)
2. Cash-Deposit ratio– It reflects the liquidity and payment capacity of the bank. Higher the
ratio better is the liquidity position of the bank.
C
CDR= ×100
TD (wherein, C=Cash, TD=Total Deposit)
3. Cash-Demand ratio– The higher the ratio, higher is the liquidity of the bank. Hence, the
probability that the bank defaults on its payment obligations is low.
C
CDD= ×100
DD (wherein, C=Cash, DD=Demand Deposits)
4. Demand-Time ratio– The higher this ratio, the more the need for liquidity for the bank is.
 DD
DTR= ×100
TD (wherein, DD=Demand Deposit, TD=Time Deposits)
5. Demand-Assets ratio– The higher the ratio, the more is the need to invest in liquid assets
for the bank.
DD
DAR= ×100
TA (wherein, DD=Demand Deposit, TA=Total Assets)
6. Working funds to Assets ratio– The higher the ratio better is the situation of working funds
in the company.
NWC
WFAR= ×100
TA (wherein, NWC=Net Working Capital, TA=Total Assets)
(III) Ratios to measure solvency: The term ‘solvency’ refers to the ability of an institution to
meet its long term obligations. Long term indebtedness of a firm includes debenture
holders, financial institutions providing medium and long-term loans and other creditors.
The long term creditors of firm are primarily interested in knowing the firm’s ability to pay
regularly interest on long-term borrowings, repayment of the principal amount at the
maturity and the security of their loans. Thus, solvency ratios indicate a firm’s ability to
meet the fixed interest costs and repayment schedules associated with its long term
borrowings.
1. Debt-Equity Ratio– Also known as external-internal ratio is calculated to measure the
relative claims of outsiders and the owners (shareholders) funds. Outsiders’ funds include
all debts, loans or borrowings and shareholders’ funds include share capital plus reserves
plus retained earnings. Generally, low ratio (debt being low in comparison to shareholders’
funds) is considered as favorable from the long term creditors’ point of view because a
high proportion of owner funds provide a larger margin of safety to them. A high ratio may
not be considered by the creditors because it gives a lesser margin of safety to them at the
time of liquidation of the firm.
OF
DER= ×100
SF (wherein, OF=Outsiders Funds, SF=Shareholders funds)
2. Cash-Debt Ratio– This ratio reflects the availability of cash in comparison to total
borrowings of the concern. Higher ratio signifies better capability of the company to pay
 for interest and principal amount of borrowings, but at the same time there may be
blockage of funds in cash.
C
CBR= ×100
TB ( wherein, C=Cash, TA=Total Borrowings)
3. Outside Liabilities to Total Assets– It measures the relative availability of the assets to pay
outside liabilities. Lower the ratio better is the long term solvency of the company.
TB
OLTA= ×100
TA (wherein, TB=Total Borrowings, TA=Total Assets)
4. Fixed Assets to Total Net worth ratio– The ratio establishes the relationship between fixed
assets and shareholder’s funds (share capital plus reserves plus retained earnings). It
signifies that to what extent shareholders’ funds are sunk into fixed assets. Generally, 60-
65% is considered to be satisfactory. It means rests of the funds are invested in current
assets.
FA
FATC= ×100
TC (wherein, FA=Fixed Assets, TC=Total Capital)
5. Interest coverage ratio or debt service ratio– It indicates the number of times interest is
covered by the profits available to pay the interest charges. Long term creditors are
interested in knowing the ability of the company to pay interest on their long term
borrowing. Higher the ratios, safer are the long term creditors and increase the
creditworthiness of a bank.
PBIT
ICR= ×100
TIE (wherein, PBIT=Profit before Interest and Taxes, TIE=Total
Interest Expenditures)
6. Capital Gearing Ratio– The term ‘capital gearing’ is used to describe the relationship
between equity share capital including reserves to preference share capital plus other fixed
interest bearing loans. If fixed interest bearing loans exceed the owners’ funds, the
company is said to be highly geared. Capital gearing ratio is very important leverage ratio.
Gearing should be kept in such a way that the company is able to maintain a steady rate of
dividend. High gearing ratio is not good for a new company or a company in which future
earnings are uncertain.
 OF
CGR= ×100
TB (wherein, OF=Owner’s Funds, TB=Total Long Term Borrowings)
(IV) Ratios to measure efficiency: The efficiency ratios are calculated to measure the
effectiveness with which funds are utilized in the business, how well the institution
controls expenses relative to producing revenues, and how productive employees are in
terms of generating income, managing assets and handling operations.
1. Operating Efficiency Ratio– It signifies the amount of non-interest expenses relative to
total assets of a bank. Total operating expenses are calculated by deducting net profit,
interest expenditure and provisions from total earnings. Lower the ratio more efficient the
bank is.
TOE
OER= ×100
TA (wherein, TOE=Total Operating Expenses, TA=Total Assets)
2. Cost of funds– The lower the ratio, the lower is the cost of funds for a bank.
TIE
COF= ×100
TB (wherein, TIE=Total Interest Expenses, TB=Total Borrowings)
3. Interest to income ratio– It reflects the share of interest income in the total income of the
bank. Higher ratio means the income from lending operations is higher but non-interest
income (from fee-based and other services) is lesser in the bank.
II
IIR= ×100
TI (wherein, II=Interest Income, TI=Total Income)
4. Overhead Efficiency (Burden) ratio– It reflects the efficiency of an institution to pay non-
interest expenditure out of non-interest income. Higher ratio means lesser is the burden on
interest income and the bank is earning more through fee based services.
NII
OE= ×100
NIE (wherein, NII=Non Interest Income, NIE=Non Interest Expenses)
5. Income productivity per employee– It shows the efficiency of the employees and
management to earn income. Higher ratio is the indicator of better efficiency.
NIAT
IPPE= ×100
TE (wherein, NIAT=Net Income after Tax, TE=Total Employees)
6. Business per employee– Total business of a bank includes the sum of deposits and credit,
therefore, the higher ratio indicates higher level of efficiency in generating business for the
bank.
TB
BPE= ×100
TE (wherein, TB=Total Business, TE=Total Employees)
(V) Ratios to measure risk: Financial institutions face many risks including losses on loans and
losses on investments. Financial managers must limit these risks in order to avoid failure of
the institution (bankruptcy).
1. Equity Assets Ratio– It reflects how many assets can default before the equity is eroded.
The higher the ratio, the lesser is the risk for a bank.
TE
EAR= ×100
TA (wherein, TE=Total Equity, TA=Total Assets)
2. Equity Multiplier– Equity multiplier is a measure of financial leverage for a bank. When
returns are positive, a higher leverage works to the bank’s advantage by boosting the return
on equity but when returns are negative, fall in return on equity is higher.
TA
EM= ×100
TE (wherein, TA=Total Assets, TE=Total Equity)
3. GNPA to Sales– It shows the amount of effective sales by a bank. Higher ratio leads to
higher risk of loss to the bank due to non-realization of the sales.
GNPA
GNPS= ×100
S (wherein, GNPA=Gross Non Performing Assets, S=Sales)
4. GNPA to Asset Ratio– It reflects the asset quality by calculating the amount of non-
performing assets in the total asset base of the bank. Lower the ratio, better it is.
GNPA
GNPAR= ×100
TA (wherein, GNPA=Gross Non Performing Assets, TA=Total
Assets)
5. GNPA to Equity Ratio– It reflects the improper utilization of the shareholders’ funds and
improper realization of revenues from sales. Higher ratio leads to higher risk.
GNPA
GNPE= ×100
TE (wherein, GNPA=Gross Non Performing Assets, TE=Total
Equity)
6. NNPA to Sales– It shows the relationship of Net NPA (GNPA minus Provisions) to the
total loans and advances made by the bank. Higher ratio is the signal of danger to bank.
NNPA
NNPS= ×100
S (wherein, NNPA=Net Non Performing Assets, S=Sales)