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Ratio Analysis 1

This document discusses ratio analysis and different types of ratios used to analyze a company's financial health and performance. It defines ratio analysis as the quotient of two mathematical expressions that shows the relationship between two or more things. It then lists four main types of ratios: liquidity ratios, long-term solvency ratios, activity ratios, and profitability ratios. It focuses on liquidity ratios, which measure a company's ability to pay off short-term debts, and provides examples of current ratio, quick ratio, cash ratio, basic defense interval ratio, and net working capital ratio. It then works through an example calculation of these key liquidity ratios.

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Srabon Barua
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58 views2 pages

Ratio Analysis 1

This document discusses ratio analysis and different types of ratios used to analyze a company's financial health and performance. It defines ratio analysis as the quotient of two mathematical expressions that shows the relationship between two or more things. It then lists four main types of ratios: liquidity ratios, long-term solvency ratios, activity ratios, and profitability ratios. It focuses on liquidity ratios, which measure a company's ability to pay off short-term debts, and provides examples of current ratio, quick ratio, cash ratio, basic defense interval ratio, and net working capital ratio. It then works through an example calculation of these key liquidity ratios.

Uploaded by

Srabon Barua
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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What is Ratio Analysis?

The indicated quotient of two mathematical expressions and the relationship between two or
more things.
Types of Ratios –
1. Liquidity Ratios
2. Long Term Solvency Ratios
3. Activity Ratios
4. Profitability Ratios
1. Liquidity Ratios –
Liquidity is how fast you can convert your assets in to cash or cash equivalents. Also known as
Short Term Solvency Ratio.
a) Current Ratio: Does your business have enough current assets (CA) to meet the current
liabilities (CL) of your business?
Current Ratio = CA / CL
Standard: 2:1
b) Quick Ratio or Acid Test Ratio: measures the available amount of CAs which can be
liquidated early than the other assets.
Quick Ratio = QA / QL or QA / CL (if Bank OD is not given)
Quick Assets – Current Assets – Inventory – Prepaid Expenses
Quick Liabilities = Current Liabilities – Bank Overdraft
Standard: 1:1 or 1.33:1
c) Cash Ratio or Absolute Liquidity Ratio:
CR or ALR = (Cash and Bank Balances + Short Term Marketable Securities / Quick Liabilities)
Or,
(Cash and Bank Balances + Short Term Marketable Securities / Current Liabilities)
Standard: 1:1
d) Basic Defense Interval or Interval Measures Ratio
(Cash & bank balances + Net Receivables + Short Term marketable Securities) / (Operating
Expenses / No of Days)
Or,
(Current Assets – Prepaid Expenses – Inventory) / Daily Operating Expenses
Daily Operating Expenses = [(COGS + Selling and Admin Expenses + Other Op Expenses) –
Depreciation and Other Non-Cash Expenses] / 360 days
e) Net Working Capital Ratio
Working Capital = Current Assets and Current liabilities
Ratio = (CA – CL) / CL
Example:
Inventories - ₹40,000, Debtors - ₹50,000; Bills Receivables - ₹65,000; Cash Balances - ₹15000;
Bank Balances - ₹55,000; Prepaid Expenses - ₹20,000, Sundry Creditors - ₹75,000; Bills
Payable - ₹15,000; Outstanding Expenses - ₹10,000
Calculate Current Ratio; Quick Ratio, Absolute Cash Ratio, Gross Working Capital and Net
Working Capital.
Ans:
Current Ratio = CA / CL = (40,000 + 50,000 + 65,000 + 15,000 + 55,000 + 20,000) / (75,000 +
15000 + 10000) = 245000/100000 = 2.45:1
Interpretation: The Current Ratio is 2.45:1 which is favourable from the industry point of view.
Quick Ratio = (CA – Inventories – Prepaid Expenses) / (CL – Bank Overdraft)
= (245000 – 40,000 – 20,000) / (100000 – 0) = 185000 / 100000 = 1.85:1
Interpretation: The Quick Ratio is 1.85:1 which is favourable from the industry point of view.
Absolute Cash Ratio = (15000 + 55000) / 100000 = 0.70:1
Interpretation: the ACR is unfavourable, so, the company will face cash crunch in time of paying
off the current liabilities.
Gross Working Capital = Total Current Assets = ₹2,45,000
Net Working Capital = CA – CL = 245000 – 100000 = ₹145000
Net Working Capital Ratio = 145000 / 100000 = 1.45:1
Interpretation: The Net Working Capital is positive as well as the net working capital ratio shows
that there is enough current assets available to meet up current liabilities.

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