Time Value of Money (TVM)?

The time value of money (TVM) is the concept that a sum of money is worth more now than the same sum will be at a
future date due to its earnings potential in the interim. The time value of money is a core principle of finance. A sum of
money in the hand has greater value than the same sum to be paid in the future. The time value of money is also referred
to as the present discounted value.

 The time value of money means that a sum of money is worth more now than the same sum of money in the
future.
 The principle of the time value of money means that it can grow only through investing so a delayed investment
is a lost opportunity.
 The formula for computing the time value of money considers the amount of money, its future value, the
amount it can earn, and the time frame.
 For savings accounts, the number of compounding periods is an important determinant as well.
 Inflation has a negative impact on the time value of money because your purchasing power decreases as prices
rise.

Time Value of Money Formula

The most fundamental formula for the time value of money takes into account the following: the future value of money,
the present value of money, the interest rate, the number of compounding periods per year, and the number of years.

Based on these variables, the formula for TVM is:

FV=PV(1+i/n)n × t

FV=Future value of money

PV=Present value of money

i=Interest raten=Number of compounding periods per year

t=Number of years
1) From the following information calculate the net present value of the two projects and
suggest which of the two projects should be accepted assuming a discount rate of 10%.

(Because all the investment is to be made in the first year only, the present value is the same as the cost of the initial
investment)
Present value of all cash inflows            34728
Less present value of initial investment    30000

(Because all the investment is to be made in the first year only, the present value is the same as the cost of the initial
investment)

Net present values = 4728

We find that net present value of Project Y is higher than that the net present value of Project X and hence it is suggested
that project Y should be selected.

2. Calculate present value of the following cash flows assuming a discount rate of 10%

Total present value of cash flow = 23604

3. If the cash flows are not equivalent, how the payback period is to be calculated? The
cost of the project  is Rs.1,00,000. The annual earnings of the project are as follows
     The ultimate aim of determining the cumulative cash inflows to find out how many number of years taken by the firm to
recover the initial investment. The next step under this method is to determine the cumulative cash flows

The uncollected portion of the investment is Rs,10,000. This Rs.10,000 is collected from the 4th year Net income / cash
inflows of the enterprise. During the 4th year the total earnings amounted Rs.20,000 but the amount required to recover
is only Rs.10,000. For earning Rs.20,000 one full year is required but the amount required to collect it back is amounted
Rs.10,000. How many months the firm may require to collect Rs.10,000 out of the entire earnings Rs.20,000.

        Payback period consists of two different components

   Payback period for the major portion of the investment collection in full course - E.g.: 3 years

   Payback period for the left /uncollected portion of the investment

   For the second category 0.5 years

   = 10000/20000 = 0.5 years

Total payback period= 3 Years +.5 year = 3.5 years

4. Calculate the payback period for a project which requires a cash outlay of Rs.20,000
and generates cash inflows of Rs 4,000 Rs.8,000 Rs. 6,000 and Rs. 4,000 in the first,
second, third, and fourth year respectively
 First step is to identify the nature of the cash inflows The cash inflows are not equivalent/constant

 
 Net present value method(NPV) 
Illustration
5. Calculate the NPV of 2 projects and suggest which of 2 projects should be
accepted assuming a discount rate 10%

NPV = PV cash of inflow - PV of cash outflows = 24224 - 20000 NPV = 4224

 
Project Y

NPV = PV of cash inflow  - PV of cash outflows

NPV = 34724 – 30000       

NPV = 4724    

5. A company is considering investment in a project that cost Rs. 2 lakh the

project that cost Rs. 2 lakh the project has an expected life of 5 years and
zero solvage (scrap) value. The company uses straight line method of
depreciation (40,000),Tax Rate is 40%

You are require to calculate the Net present value @ 10 % and advice the company

 
Solution
 

NPV = PV of cash inflow – PV of cash outflow 

= 251724 – 200000

=       51724
https://www.brainkart.com/article/Financial-Management---Tutorial-Problems-and-Worked-out-Problems_7194/

UNIT 4

Financial Statement

1. Balance Sheet

A balance sheet is a financial document or statement that provides a complete overview of a firm’s assets, liabilities, and
shareholders’ equity for a particular period. Preparing this document helps people understand the current capital structure
of a firm. In addition, the clear information from the balance sheet lets investors decide whether to spend on the
company’s assets.
 The balance sheet is one of the financial statements through which a company presents the shareholders’ equity,
liabilities, and assets at a particular time.
 It is based on an accounting equation stating that the total liabilities and the owner’s capital equal the company’s
total assets.
 The most common format companies use to present data on the balance sheet is horizontal or T-shaped and
vertical.
 The data presented in this financial statement helps investors decide whether to trust the firms for further
investment. It also lets lenders check if the firms can repay if the required loans are approved.

Balance Sheet Explained

A balance sheet keeps the details of the assets and liabilities and presents the company’s financial details in a proper
format. The details in statements help firms understand their financial progress and accordingly make business decisions to
improve and excel in the future. Plus, the companies can check their finances and frame strategies with respect to the
available resources. 

The investors who invest in the firms consider these sheets as an important credential as they reflect the company’s
economic position. The statement helps them decide whether it would be fruitful to continue investing in the venture or
they should withdraw the backing. In short, these financial documents intend to guide investors and help them make
better and more informed investment decisions.

The recorded asset, liability, and equity details let the information readers find out multiple ratios to check where the firm
stands in the market. For example, investors and lenders can easily calculate the debt-to-equity ratio using the information,
making them aware of what the firms own and how much they are liable to repay.

Components of a Balance Sheet

Assets
Accounts within this segment are listed from top to bottom in order of their  liquidity. This is the ease with which they can
be converted into cash. They are divided into current assets, which can be converted to cash in one year or less; and non-
current or long-term assets, which cannot.
Here is the general order of accounts within current assets:
  Cash and cash equivalents are the most liquid assets and can include Treasury bills and short-term certificates
of deposit, as well as hard currency.
 Marketable securities are equity and debt securities for which there is a liquid market.
 Accounts receivable (AR) refer to money that customers owe the company. This may include an allowance for
doubtful accounts as some customers may not pay what they owe.
 Inventory refers to any goods available for sale, valued at the lower of the cost or market price.
 Prepaid expenses represent the value that has already been paid for, such as insurance, advertising contracts,
or rent.

Long-term assets include the following:

 Long-term investments are securities that will not or cannot be liquidated in the next year.
 Fixed assets include land, machinery, equipment, buildings, and other durable, generally capital-intensive
assets.
 Intangible assets include non-physical (but still valuable) assets such as intellectual property and goodwill.
These assets are generally only listed on the balance sheet if they are acquired, rather than developed in-house.
Their value may thus be wildly understated (by not including a globally recognized logo, for example) or just as
wildly overstated.

Liabilities
A liability is any money that a company owes to outside parties, from bills it has to pay to suppliers to interest
on bonds issued to creditors to rent, utilities and salaries. Current liabilities are due within one year and are listed in
order of their due date. Long-term liabilities, on the other hand, are due at any point after one year.

Current liabilities accounts might include:

 Current portion of long-term debt is the portion of a long-term debt due within the next 12 months. For
example, if a company has a 10 years left on a loan to pay for its warehouse, 1 year is a current liability and 9
years is a long-term liability.
 Interest payable is accumulated interest owed, often due as part of a past-due obligation such as late
remittance on property taxes.
 Wages payable is salaries, wages, and benefits to employees, often for the most recent pay period.
 Customer prepayment is money received by a customer before the service has been provided or product
delivered. The company has an obligation to (a) provide that good or service or (b) return the customer's
money.
 Dividends payable is dividends that have been authorized for payment but have not yet been issued.
 Earned and unearned premiums is similar to prepayments in that a company has received money upfront, has
not yet executed on their portion of an agreement, and must return unearned cash if they fail to execute.
 Accounts payable is often the most common current liability. Accounts payable is debt obligations on invoices
processed as part of the operation of a business that are often due within 30 days of receipt.

Long-term liabilities can include:

 Long-term debt includes any interest and principal on bonds issued

 Pension fund liability refers to the money a company is required to pay into its employees' retirement accounts
 Deferred tax liability is the amount of taxes that accrued but will not be paid for another year. Besides timing,
this figure reconciles differences between requirements for financial reporting and the way tax is assessed, such
as depreciation calculations.

Some liabilities are considered off the balance sheet, meaning they do not appear on the balance sheet.

Shareholder Equity

Shareholders’ Equity (Net Assets): - Total assets- Total Liability

Shareholder equity is the money attributable to the owners of a business or its shareholders. It is also known as net
assets since it is equivalent to the total assets of a company minus its liabilities or the debt it owes to non-shareholders.
Retained earnings are the net earnings a company either reinvests in the business or uses to pay off debt. The remaining
amount is distributed to shareholders in the form of dividends.

Treasury stock is the stock a company has repurchased. It can be sold at a later date to raise cash or reserved to repel
a hostile takeover.

Some companies issue preferred stock, which will be listed separately from common stock under this section. Preferred
stock is assigned an arbitrary par value (as is common stock, in some cases) that has no bearing on the market value of
the shares. The common stock and preferred stock accounts are calculated by multiplying the par value by the number of
shares issued.

Additional paid-in capital or capital surplus represents the amount shareholders have invested in excess of the common
or preferred stock accounts, which are based on par value rather than market price. Shareholder equity is not directly
related to a company's market capitalization. The latter is based on the current price of a stock, while paid-in capital is
the sum of the equity that has been purchased at any price.

2. Income Statement

The income statement examples summarize all the revenues and expenses over the period to ascertain the company’s profit
or loss. The example includes an income statement prepared by a company, XYZ Ltd. Every half-yearly to present the
company’s different revenues and expenses during the period of half-year to present a financial picture of the company.

 The profit and loss (P&L) statement is a financial statement that summarizes the revenues, costs, and expenses
incurred during a specified period.
 The P&L statement is one of three financial statements that every public company issues quarterly and
annually, along with the balance sheet and the cash flow statement.
 When used together, the P&L statement, balance sheet, and cash flow statement provide an in-depth look at a
company’s overall financial performance.
 Statements are prepared using the cash method or accrual method of accounting.
 It is important to compare P&L statements from different accounting periods, as any changes over time become
more meaningful than the numbers themselves.

Types of Profit and Loss (P&L) Statements

As noted above, a P&L statement may be prepared in one of two ways. These are the cash method and the accrual
method.

Cash method

The cash method, which is also called the cash accounting method, is only used when cash goes in and out of the
business. This is a very simple method that only accounts for cash received or paid. A business records  transactions as
revenue whenever cash is received and as liabilities whenever cash is used to pay any bills or liabilities. This method is
commonly used by smaller companies as well as people who want to manage their personal finances.3

Accrual method

The accrual accounting method records revenue as it is earned. This means that a company using the accrual method
accounts for money that it expects to receive in the future. For instance, a company that delivers a product or service to
its customer records the revenue on its P&L statement, even though it hasn’t yet received payment. Similarly, liabilities
are accounted for even when the company hasn’t yet paid for any expenses.4

The income statement examples feature one of the three fundamental financial statements that aim at calculating net
income from the organization’s operations. Generally Accepted Accounting Principle (GAAP) and International Financial
Reporting Standards (IFRS) are the two major financial reporting methods based on which credentials, like balance sheet
and income statement examples, are prepared. In addition, the income statement states the financial health of the
organization.
 Major parameters included in and showcased in the comprehensive income statement examples are :

 Revenue: The revenue of the company is the income from all sources.

 Expenses: Costs incurred by a company like the cost of goods sold, and operating expenses come under this.
 Gains/Losses: These are non-operating investment-related activities.

Examples – GAAP

GAAP classifies the statement as single-step and multi-step, and hence both single-step and multi-step income statement
examples are listed below:

Example #1 – Single-Step Income Statement

In this, the classification of all expenses is mentioned under this head. Then they are deducted from the total income to get
net income before tax. Both small and large companies use such a format.

There is no implication that one type of revenue or expense item has priority over another. All are treated equally.

 Revenues: All income and revenues are totaled.

 Expenses: All expenses are totaled.
 Net Income: Net income is derived from subtracting Expenses from Income. It is also referred to as “the bottom line.”

Example #2 – Multi-Step Income Statement

The multi-step income statement format comprises a gross profit section where the cost of sales is deducted from sales,
followed by income and expenses to reach an income before tax.
Compared to a single-step income statement, multi-step income statement examples are more complex.

It also provides a more detailed overview of the company’s financial position.

The sections of a multi-step income statement include:

 Sales: This section includes total sales, the cost of goods sold, and the difference between the two, gross profit.
 Operating Expenses: These are the expenses that are directly related to the Operations of the company, like selling,
general, and administrative expenses.
 Operating Income: It is the income earned from operating activities. It is derived from the difference between gross profit
and total operating expenses.
 Non-Operating Income or Expenses: Non-operating activities like investments involve expenses, revenue, gain, or loss.
Such an entity comes under this category.
 Net Income: Any resulting profit or loss calculated as the difference between total income and total expenses is called net
income.

Assuming the number of outstanding shares to be six lakhs;

Explanation

Suppose XYZ is a US-based company, and a multiple-step income statement is followed here. We can see that all entities
are assembled in different categories based on their characteristics.

 Gross profit is derived by subtracting COGS from Sales.

 Selling and administration are operating expenses and are shown separately.

The difference between gross profit and operating expenses give operating income.
The same follows for non-operating expenses and income.

IFRS

Most companies follow IFRS the world for financial reporting.

The IFRS requires the following items in the income statement :

 revenue
 finance cost
 The share of post-tax results of associates and joint ventures
 after-tax gain or loss.
 profit or loss for the period

Under IFRS, a company that shows operating results should include all the items of irregular or unusual nature.
Example #1

Explanation

Suppose PQR is a UK-based company that follows IFRS for reporting. Then, in the above example, we can see that apart
from normal entities, all the activities that are unusual and continuous are also taken into count.

Profit from joint ventures and an associate are also considered.

So, IFRS is a more comprehensive and informative type of reporting income statement.

Cash flow statement (CFS)

The cash flow statement (CFS), is a financial statement that summarizes the movement of cash and cash equivalents
(CCE) that come in and go out of a company. The CFS measures how well a company manages its cash position, meaning
how well the company generates cash to pay its debt obligations and fund its operating expenses. As one of the three
main financial statements, the CFS complements the balance sheet and the income statement.

 A cash flow statement summarizes the amount of cash and cash equivalents entering and leaving a company.  
 The CFS highlights a company's cash management, including how well it generates cash. 
 This financial statement complements the balance sheet and the income statement. 
 The main components of the CFS are cash from three areas: Operating activities, investing activities, and
financing activities.
 The two methods of calculating cash flow are the direct method and the indirect method.

Structure of the Cash Flow Statement

The main components of the cash flow statement are:

1. Cash flow from operating activities

2. Cash flow from investing activities
 3. Cash flow from financing activities
4. Disclosure of non-cash activities, which is sometimes included when prepared under generally accepted
accounting principles (GAAP).1

Cash from Operating Activities

The operating activities on the CFS include any sources and uses of cash from business activities. In other words,
it reflects how much cash is generated from a company’s products or services.

These operating activities might include:

 Receipts from sales of goods and services

 Interest payments
 Income tax payments
 Payments made to suppliers of goods and services used in production
 Salary and wage payments to employees
 Rent payments
 Any other type of operating expenses

In the case of a trading portfolio or an investment company, receipts from the sale of loans, debt, or  equity instruments
are also included because it is a business activity.

Changes made in cash, accounts receivable, depreciation, inventory, and accounts payable are generally reflected in cash
from operations.

Cash from Investing Activities

Investing activities include any sources and uses of cash from a company’s investments. Purchases or sales of assets,
loans made to vendors or received from customers, or any payments related to mergers and acquisitions (M&A) are
included in this category. In short, changes in equipment, assets, or investments relate to cash from investing.

Changes in cash from investing are usually considered cash-out items because cash is used to buy new equipment,
buildings, or short-term assets such as marketable securities. But when a company divests an asset, the transaction is
considered cash-in for calculating cash from investing.

Cash from Financing Activities

Cash from financing activities includes the sources of cash from investors and banks, as well as the way cash is paid to
shareholders. This includes any dividends, payments for stock repurchases, and repayment of debt principal (loans) that
are made by the company.

Changes in cash from financing are cash-in when capital is raised and cash-out when dividends are paid. Thus, if a
company issues a bond to the public, the company receives cash financing. However, when interest is paid
to bondholders, the company is reducing its cash. And remember, although interest is a cash-out expense, it is reported
as an operating activity—not a financing activity.

How Cash Flow Is Calculated

There are two methods of calculating cash flow: the direct method and the indirect method.

Direct Cash Flow Method

The direct method adds up all of the cash payments and receipts, including cash paid to suppliers, cash receipts from
customers, and cash paid out in salaries. This method of CFS is easier for very small businesses that use the  cash
basis accounting method.

These figures can also be calculated by using the beginning and ending balances of a variety of asset and  liability accounts
and examining the net decrease or increase in the accounts. It is presented in a straightforward manner.
Most companies use the accrual basis accounting method. In these cases, revenue is recognized when it is earned rather
than when it is received. This causes a disconnect between net income and actual cash flow because not all transactions in
net income on the income statement involve actual cash items. Therefore, certain items must be reevaluated when
calculating cash flow from operations.

Indirect Cash Flow Method

With the indirect method, cash flow is calculated by adjusting net income by adding or subtracting differences resulting
from non-cash transactions. Non-cash items show up in the changes to a company’s assets and liabilities on the balance
sheet from one period to the next. Therefore, the accountant will identify any increases and decreases to asset and
liability accounts that need to be added back to or removed from the net income figure, in order to identify an accurate
cash inflow or outflow.

Changes in accounts receivable (AR) on the balance sheet from one accounting period to the next must be reflected in
cash flow:

 If AR decreases, more cash may have entered the company from customers paying off their credit accounts—
the amount by which AR has decreased is then added to net earnings.
 An increase in AR must be deducted from net earnings because, although the amounts represented in AR are in
revenue, they are not cash.

What about changes in a company's inventory? Here's how they are accounted for on the CFS:

 An increase in inventory signals that a company spent more money on raw materials. Using cash means the
increase in the inventory's value is deducted from net earnings.
 A decrease in inventory would be added to net earnings. Credit purchases are reflected by an increase in
accounts payable on the balance sheet, and the amount of the increase from one year to the next is added to
net earnings.

The same logic holds true for taxes payable, salaries, and prepaid insurance. If something has been paid off, then the
difference in the value owed from one year to the next has to be subtracted from net income. If there is an amount that
is still owed, then any differences will have to be added to net earnings.

Limitations of the Cash Flow Statement

Negative cash flow should not automatically raise a red flag without further analysis. Poor cash flow is sometimes the
result of a company’s decision to expand its business at a certain point in time, which would be a good thing for the
future.

Analyzing changes in cash flow from one period to the next gives the investor a better idea of how the company is
performing, and whether a company may be on the brink of bankruptcy or success. The CFS should also be considered in
unison with the other two financial statements (see below).

The indirect cash flow method allows for a reconciliation between two other financial statements: the income statement
and balance sheet.

Cash Flow Statement vs. Income Statement vs. Balance Sheet

The cash flow statement measures the performance of a company over a period of time. But it is not as easily
manipulated by the timing of non-cash transactions. As noted above, the CFS can be derived from the  income
statement and the balance sheet. Net earnings from the income statement are the figure from which the information on
the CFS is deduced. But they only factor into determining the operating activities section of the CFS. As such, net earnings
have nothing to do with the investing or financial activities sections of the CFS.

The income statement includes depreciation expense, which doesn't actually have an associated cash outflow. It is simply
an allocation of the cost of an asset over its useful life. A company has some leeway to choose its  depreciation method,
which modifies the depreciation expense reported on the income statement. The CFS, on the other hand, is a measure of
true inflows and outflows that cannot be as easily manipulated.

As for the balance sheet, the net cash flow reported on the CFS should equal the net change in the various line items
reported on the balance sheet. This excludes cash and cash equivalents and non-cash accounts, such as accumulated
depreciation and accumulated amortization. For example, if you calculate cash flow for 2019, make sure you use
2018 and 2019 balance sheets.

Ratio Analysis

Liquidity Ratio Analysis

The first type of financial ratio analysis is the liquidity ratio. It aims to determine a business’s ability to meet its financial
obligations during the short term and maintain its short-term debt-paying ability. One can calculate the liquidity ratio in
multiple ways. They are as follows: –

#1 – Current Ratio

The current ratio is a working capital ratio or banker’s ratio. The current ratio expresses the relationship between current
assets to current liabilities.

Formula = Current Assets / Current Liabilities

One can compare a company’s current ratio with the past current ratio; this will help to determine if the current ratio is
high or low at this period in time.
The ratio of 1 is ideal; if current assets are twice a current liability. No issue will be in repaying liability. However, if the
ratio is less than 2, repayment of liability will be difficult and affect the work.

#2 – Acid Test Ratios/ Quick Ratio

Generally, one can use the current ratio to evaluate an enterprise’s short-term solvency or liquidity position. Still, it is
often desirable to know a firm’s more immediate status or instant debt-paying ability than that indicated by the current
ratio for this acid test financial ratio. That is because it relates the most liquid assets to current liabilities.
Acid Test Formula = (Current Assets -Inventory)/ (Current Liability)

One can write the quick ratio as: –

Quick Ratio Formula = Quick Assets / Current Liabilities

Or

Quick Ratio Formula = Quick Assets / Quick Liabilities

Turnover Ratio Analysis

The second type of financial ratio analysis is the turnover ratio. The turnover ratio is also known as the activity ratio. This
ratio indicates the efficiency with which an enterprise’s resources utilize. Again, the financial ratio can be calculated
separately for each asset type.
The following are financial ratios commonly calculated:-

1 – Inventory Turnover Ratio

This financial ratio measures the relative inventory size and influences the cash available to pay liabilities.

Inventory Turnover Ratio Formula = Cost of Goods Sold / Average Inventory

2 – Debtors or Receivable Turnover Ratio

The receivable turnover ratio shows how often the receivable turns into cash.

Receivable Turnover Ratio Formula = Net Credit Sales / Average Accounts Receivable

3 – Capital Turnover Ratio

The capital turnover ratio measures the effectiveness with which a firm uses its financial resources.
Capital Turnover Ratio Formula = Net Sales (Cost of Goods Sold) / Capital Employed

4 – Asset Turnover Ratio

This financial ratio reveals the number of times the net tangible assets turns over during a year. The higher the ratio better
it is.
Asset Turnover Ratio Formula = Turnover / Net Tangible Assets

5 – Net Working Capital Turnover Ratio

This financial ratio indicates whether or not working capital has been utilized effectively in sales.  Net Working
Capital signifies the excess of current assets over current liabilities.
Net Working Capital Turnover Ratio Formula = Net Sales / Net Working Capital
6 – Cash Conversion Cycle

The Cash Conversion Cycle is the total time taken by the firm to convert its cash outflows into cash inflows (returns).
Cash Conversion Cycle Formula = Receivable Days + Inventory Days – Payable Days

Operating Profitability Ratio Analysis

The third type of financial ratio analysis is the operating profitability ratio. The profitability ratio helps to measure a
company’s profitability through this efficiency of business activity. The following are the important profitability ratios:-
1 – Earning Margin

It is the ratio of net income to turnover expressed in percentage. It refers to the final net profit used.

Earning Margin formula = Net Income / Turnover * 100

2 – Return on Capital Employed or Return On the Investment

This financial ratio measures profitability concerning the total capital employed in a business enterprise.

Return on Investment formula = Profit Before Interest and Tax / Total Capital Employed

3 – Return On Equity

Return on equity derives by dividing net income by shareholder’s equity. It provides a return that management realizes
from the shareholder’s equity.
Return on Equity Formula = Profit After Taxation – Preference Dividends / Ordinary Shareholder’s Fund * 100

4 – Earnings Per Share

EPS derives by dividing the company’s profit by the total number of shares outstanding. It means profit or net earnings.
Earnings Per Share Formula = Earnings After Taxation – Preference Dividends / Number of Ordinary Shares

Before investing, the investor uses all the above ratios to maximize profit and analyze risk. He can easily compare and
predict a company’s future growth through ratios. It also simplifies the financial statement.
Business Risk Ratios

The fourth type of financial ratio analysis is the business risk ratio. Here, we measure how sensitive the company’s earnings
are concerning its fixed costs and the assumed debt on the balance sheet.

Financial Risk Ratio Analysis

The fifth type of financial ratio is the financial risk ratio. Here, we measure how leveraged the company is and placed
concerning its debt repayment capacity.

1 – Debt Equity Ratio

Debt Equity Formula = Long Term Debts / Shareholder’s Fund

It helps to measure the extent of equity to repay debt. One may use it for long-term calculations.
 2 – Interest Coverage Ratio Analysis

This financial ratio signifies the ability of the firm to pay interest on the assumed debt.

Interest Coverage Formula = EBITDA / Interest Expense

 Higher interest coverage ratios imply the greater ability of the firm to pay off its interests.
 If interest coverage is less than 1, then EBITDA is insufficient to pay off interest, implying finding other ways to arrange
funds.

Stability Ratios

The sixth type of financial ratio analysis is the stability ratio. It is used with a long-term vision and to check the company’s
stability in the long run. One can calculate this type of ratio analysis in multiple ways. They are as follows: –

1 – Fixed Asset Ratio

This ratio one may use to know whether the company is having good fun or not to meet the long-term business
requirement.

Fixed Asset Ratio Formula = Fixed Assets / Capital Employed

The ideal ratio is 0.67. If the ratio is less than 1, one can use it to purchase fixed assets.

2 – Ratio to Current Assets to Fixed Assets

Ratio to Current Assets to Fixed Assets = Current Assets / Fixed Assets

IIf the ratio increases, profit increases and reflects the business expansion. If the ratio decreases, trading is loose.

3 – Proprietary Ratio

The proprietary ratio is the ratio of shareholder funds to total tangible assets; it discusses a company’s financial strength.
Ideally, the ratio should be 1:3.
Proprietary Ratio Formula = Shareholder Fund / Total Tangible Assets

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