III B.

COM CA - PERSONAL FINANCE

UNIT - I Formulae for TVM Calculations:

TIME VALUE OF MONEY (TVM) 1. Future Value (FV):

The Time Value of Money (TVM) is a fundamental financial concept FV=PV×(1+r)t

that states money today is worth more than the same amount in the future
due to its earning potential. This principle is based on the idea that money Where:
can grow over time if invested or saved.
o FV = Future Value
Reasons for TVM: o PV = Present Value
o r = Interest rate (as a decimal)
1. Inflation – The value of money decreases over time as prices of o t = Number of periods
goods and services rise. 2. Present Value (PV):
2. Investment Opportunities – Money can be invested to generate
returns (interest, dividends, or capital appreciation). PV=FV(1+r)t
3. Risk and Uncertainty – Future money carries uncertainty due to
risks like inflation, market changes, or unforeseen events. This helps determine how much money today is equivalent to a
future amount.
Components of TVM:
3. Compound Interest Formula:
1. Present Value (PV) – The current worth of a future sum of money,
discounted at a specific rate. FV=PV×(1+rn)n×t
2. Future Value (FV) – The value of money after a certain period,
considering interest or investment growth. Where:
3. Interest Rate (r) – The rate at which money grows over time (also
called the discount rate or return rate). o n = Number of times interest is compounded per year.
4. Time Period (t) – The duration for which money is invested or
borrowed. Example of TVM Application:
5. Compounding Frequency – The number of times interest is
calculated and added to the principal (e.g., annually, quarterly, If you invest $1,000 today at an annual interest rate of 5%, after 5 years, it
monthly). will grow to:

FV=1000×(1+0.05)5=1276.28

This means your money increases in value over time due to compounding.

1
III B.COM CA - PERSONAL FINANCE
PERSONAL FINANCIAL PLANNING • Ensures money is allocated wisely for necessities, savings, and
investments.
Personal financial planning refers to the process of managing your
finances to achieve financial stability and future goals. It involves setting 2. Achieving Financial Goals
financial objectives, budgeting, saving, investing, managing debt, and
planning for retirement and emergencies. • Supports short-term goals (buying a car, vacation), medium-term
goals (home purchase, higher education), and long-term goals
Components of Personal Financial Planning: (retirement, wealth creation).

1. Goal Setting – Defining short-term, medium-term, and long-term 3. Preparing for Emergencies
financial goals (e.g., buying a house, saving for retirement).
2. Budgeting – Tracking income and expenses to ensure spending • Builds an emergency fund to handle unexpected expenses like
aligns with financial goals. medical emergencies, job loss, or urgent repairs.
3. Saving & Investing – Setting aside money for emergencies,
retirement, and wealth-building through investments. 4. Reducing Debt Burden
4. Debt Management – Handling loans, credit cards, and other debts
responsibly. • Helps avoid excessive borrowing and manage debt repayments
5. Insurance Planning – Protecting yourself and your assets through efficiently.
health, life, and property insurance. • Prevents financial stress due to high-interest loans or credit card
6. Tax Planning – Minimizing tax liabilities through legal strategies. debt.
7. Retirement Planning – Preparing financially for life after work.
8. Estate Planning – Ensuring assets are distributed as desired after 5. Ensuring a Comfortable Retirement
passing.
• Helps save enough money for a secure and independent retirement.
Effective financial planning helps individuals achieve financial security, • Ensures financial stability in old age without relying on others.
avoid unnecessary financial stress, and build wealth over time.
6. Wealth Creation and Investment
Need for Personal Financial Planning
• Encourages investment in assets that grow wealth over time (stocks,
Personal financial planning is essential for managing money wisely and mutual funds, real estate, etc.).
securing one’s financial future. Here are the key reasons why it is necessary: • Helps money work efficiently through strategic financial decisions.

1. Managing Income and Expenses 7. Tax Efficiency

• Helps track earnings and spending effectively. • Aids in proper tax planning to minimize liabilities and maximize
savings.
2
III B.COM CA - PERSONAL FINANCE
• Ensures the use of legal tax-saving investment options. • Provides a structured approach to meeting short-term, medium-
term, and long-term financial objectives.
8. Protecting Against Financial Risks
3. Effective Budgeting and Expense Control
• Ensures appropriate insurance coverage (health, life, property) to
protect against unforeseen risks. • Helps track and control spending to avoid unnecessary expenses.
• Reduces the financial impact of accidents, illness, or loss of income. • Ensures that savings and investments are prioritized over impulsive
spending.
9. Avoiding Financial Stress
4. Debt Management
• Creates a clear financial roadmap, reducing uncertainty and anxiety
about money. • Helps in avoiding excessive debt and managing loan repayments
• Provides confidence in handling finances wisely. efficiently.
• Reduces financial stress caused by high-interest loans and credit card
10. Enhancing Quality of Life debt.

• Ensures financial independence and better decision-making. 5. Emergency Preparedness

• Provides the freedom to enjoy life without constant financial worries.
• Encourages building an emergency fund to handle unexpected
Importance of Personal Financial Planning situations like medical expenses, job loss, or urgent repairs.
• Prevents reliance on loans during financial crises.
Personal financial planning is crucial for achieving financial security,
managing money wisely, and ensuring a stable future. Below are the key 6. Wealth Creation and Growth
reasons why it is important:
• Encourages investing in assets that generate long-term returns
1. Financial Stability and Security (stocks, mutual funds, real estate, etc.).
• Helps individuals grow their wealth and build financial
• Helps individuals manage their income and expenses effectively. independence.
• Ensures sufficient funds for daily needs, emergencies, and future
goals. 7. Retirement Planning

2. Goal Achievement • Ensures that individuals have enough savings and investments to
sustain a comfortable lifestyle after retirement.
• Enables people to set and achieve financial goals such as buying a • Prevents dependency on others in old age.
home, funding education, or retiring comfortably.

3
III B.COM CA - PERSONAL FINANCE
8. Tax Efficiency 4. Compare Interest Rates - Obtain rate information from multiple
financial services firms to get the best value for your money.
• Helps in effective tax planning to minimize tax liabilities. 5. Don't Borrow What You Can't Repay - Be a responsible borrower
• Encourages smart investment decisions that offer tax benefits. who repays as promised, showing that you are worthy of getting
credit in the future. Before you borrow, compare your total payment
9. Protection Against Financial Risks obligations with income that you will have available to make these
payments.
• Ensures proper insurance coverage (health, life, property) to protect 6. Budget Your Money - Create an annual budget to identify expected
against unexpected financial losses. income and expenses. Including savings. This will serve as a guide
• Provides financial security to family members in case of emergencies. to help you live within your income.
7. Money Doubles By “The Rule of 72" - To determine how long it will
10. Peace of Mind and Reduced Stress take your money to double, divide the interest rate into 72. For
example, an account earning 6% interest will double in twelve years
• Having a well-structured financial plan reduces money-related (72 divided by 6 equals 12).
worries. 8. High Returns Equal High Risks - Recognize that no one will pay
• Provides confidence in managing finances effectively and achieving you high interest rates on a sure thing. In most cases, the higher the
financial freedom. interest rate offered, the higher the risk of losing some, or all, of the
money you invest. Diversification is the best hedge against
Principles of Personal Finance investment risk.
9. Don't Expect Something for Nothing - Be leery of advertisements,
To achieve financial stability and long-term success, individuals sales people, or other sources of financial offers promising anything
should follow key principles of personal finance. These principles help in free or guaranteed investment returns. Like non financial
managing money effectively and securing financial well-being. opportunities, “if it sounds too good to be true, it probably is.”
10. Map Your Financial Future - Take time to list your financial goals,
Twelve Principles of Personal Financial Literacy with a specific time deadline and dollar cost, and develop a realistic
plan for achieving them.
1. Know Your Take-Home (Net) Pay - Before committing to significant 11. Your Credit Past Is Your Credit Future - Be aware that credit
expenditures, estimate how much income is likely to be available to bureaus maintain credit reports, which record borrowers' histories of
you after all mandatory deductions. repaying loans. Negative information in credit reports can affect
2. Pay Yourself First - Before paying bills and other financial your ability to borrow at a later point.
obligations, set aside an affordable amount each month in accounts 12. Stay Insured - Purchase insurance to avoid being wiped out by a
designated for long-range goals and unexpected emergencies. financial loss, such as an illness or accident. An insurance plan
3. Start Saving Young - Recognize that your total savings are should be part of every personal financial plan.
determined both by the interest you earn on savings and the time
period over which you save.

4
III B.COM CA - PERSONAL FINANCE
FINANCIAL PLANNING PROCESS • A wedding or property purchase
• Emergency funds to cover for household catastrophes
The correct investment strategy and sound financial advice will • Family Funds reserve in case something happens with your job or you
determine how you live today and in the future. There are six stages to • Is your retirement just around the corner?
develop a financial plan and to carry out personal money management.
From beginning to end, a certified financial planner professional guides you This step serves as a foundation for developing your plan and gives you a
through the financial planning process - keeping in view your current good reference point to achieve your short as well as long term financial
financial situation and economic background. goals.

1) Identify your Financial Situation 2) Determine Financial Goals

The first stage of the financial planning process constitutes assessment on Experts say when you have identified your goals; you’re most likely to
what is happening in your life right now and how you can change your achieve them. Highlighting the financial goals serves as an important aspect
financial situation. The key areas to reflect are: of financial planning. Subjected to what phase in life you have reached, these
goals could be:
Household budgeting –This is an important area as after calculating the
monthly costs spent at home, you’d be able to figure out how much you are • Get married and initiate a family
left with to save or invest. • Purchase or pay off a property
• Ensure your children get a good education
Family commitments and Living Expenses – Are you single or married? Do • Make your reserves and investments tax proficient
you have children? What are their living and lifestyle expenses? • Get retirement with enough income on hands to enjoy life ahead

Tax Standing and Strategies – How do you manage taxes? Are you living The sole purpose of this step is to differentiate your needs from your
or working abroad? wants. Apart from these, the goals or objectives may range from spending
your entire income into developing a long lasting investment program for
Current investments or saving reserves – How much savings or debts you future financial security. However, you must select which goals you need to
have right now? pursue.

Other Financial obligations – These may involve some miscellaneous costs 3) Identify Alternatives for Investment
you might be planning ahead for future such as:
After a thorough understanding of your financial needs has been taken and
all the appropriate financial goals have been cemented down, next thing is
5
III B.COM CA - PERSONAL FINANCE
the investment alternatives or specific recommendations from your financial Risk Evaluation
planner. While evaluating the options you might end up having uncertain ideas. For
instance, choosing your career over studies involves risk. How can you
By taking a good look at your short, medium and long term goals, an
ensure if it’s rewarding in your future?
integrated investment strategy would be developed based on your set
Other financial decisions involve a comparatively low degree of risk such as
requirements. Furthermore the objectives would be looked upon again and
saving your money in a savings account or purchasing some object of great
it will be analyzed how far you are down the road to achieving your short
value with it. The option of losing that object is low in such scenarios.
and long term financial goals. Taking in account your timeframe, cash flow,
risk tolerance, current insurance coverage, tax strategies and investment Thus while making financial decisions; finding out risks and evaluating
goals, a range of ideas and financial planning alternatives would be them is tricky. You need to collect data based on your experience and the
presented in order to determine which one suits you the best. This will help experiences of others as well. Decision-making process will require you to
you produce more actual and satisfying decisions. frequently update your knowledge politically, economically and socially so
you can make informed decisions.
4) Evaluate Alternatives

The proposed recommendations are then further assessed. This is your 5) Put Together a Financial Plan and Implement
chance to discuss the alternatives face-to-face and take necessary actions Once you are content with the recommendations and feel good to proceed,
bearing in mind your current situation, financial standings and personal the implementation of the plan would be carried out. This step of financial
interests. If you have any concerns regarding your financial planner’s planning process can be considered as an action plan where you will pick
recommendations, those can be altered and revised. Alternatives can be ways to achieve your short, immediate or long term goals. Often taken as
closed down based on the decisions you make. For instance: the toughest step for some people, but makes a huge difference in the long
run!
The idea to carry on your education attests you cannot do a full time job.
The key thing to consider here is to carry it out as early as you can. The
Decision making thus stands as an ongoing process which works side by
longer it’s left unattended, the longer it will take you to grow your wealth –
side with your personal and financial situation so lost opportunities as a
ultimately a great shortfall in your savings when you retire.
result of your decision making should always be kept in mind while
analyzing the alternatives. 6) Review, Re-evaluate and Monitor The Plan

Financial planning is an on-going and dynamic process and it’s unlikely that
your financial condition will remain same throughout your life. You need to
assess your financial decisions periodically as changed personal, economic

6
III B.COM CA - PERSONAL FINANCE
and social factors will require you to alter your decisions to fit into your new 4. Inflation and Cost of Living
situation.
• Rising inflation reduces purchasing power and affects savings.
• Higher cost of living requires careful financial planning to maintain
As you progress through the different phases of your life, you financial lifestyle.
needs will be reflected and financial process will serve as a tool to let you
adjust to these changes. Monitoring your plans will help you prioritize your 5. Investment Decisions and Risk Tolerance
decisions and make necessary adjustments that will bring your financial
• Different people have different risk appetites (conservative,
needs and goals in line with your current life situation.
moderate, aggressive).
• Choosing the right investment options (stocks, bonds, real estate)
FACTORS INFLUENCING PERSONAL FINANCIAL PLANNING depends on financial goals and risk capacity.

Personal financial planning is influenced by various factors that 6. Debt and Liabilities
impact income, expenses, savings, and investments. Understanding these
factors helps in making informed financial decisions and achieving financial • High debt levels (credit card, loans) impact financial stability.
goals. • Proper debt management strategies help reduce financial stress and
improve cash flow.
1. Income Level
7. Economic Conditions
• Higher income provides more opportunities for savings,
investments, and luxury spending. • Economic downturns, recessions, and market fluctuations affect
• Lower income may require strict budgeting and prioritization of income and investment returns.
essential expenses. • Diversification and emergency funds help manage financial
uncertainties.
2. Expenses and Spending Habits
8. Taxation Policies
• High expenses reduce the ability to save and invest.
• Proper budgeting helps control unnecessary spending and increase • Income tax, property tax, and capital gains tax impact financial
savings. planning.
• Tax-saving investments (e.g., retirement plans, tax-exempt bonds)
3. Financial Goals help reduce liabilities.

• Short-term goals (e.g., buying a car, vacation).

• Medium-term goals (e.g., home purchase, education).
• Long-term goals (e.g., retirement, wealth accumulation).

7
III B.COM CA - PERSONAL FINANCE
9. Insurance and Risk Management Financial Statements

• Health, life, property, and auto insurance protect against unexpected 1. Income Statement (Profit & Loss Statement)
financial losses. o Shows revenue, expenses, and profits over a period.
• Proper coverage ensures financial security for individuals and o Key metrics: Gross Profit, Operating Profit, Net Profit,
families. Earnings per Share (EPS).
2. Balance Sheet
10. Life Stage and Family Responsibilities o Displays assets, liabilities, and shareholders' equity at a
specific point in time.
• Young professionals focus on career growth and wealth o Key metrics: Current Ratio, Debt-to-Equity Ratio, Return on
accumulation. Assets (ROA).
• Married individuals and parents need to plan for family expenses, 3. Cash Flow Statement
education, and homeownership. o Tracks cash inflows and outflows from operations, investing,
• Retirees focus on maintaining savings and managing medical and financing activities.
expenses. o Key metrics: Operating Cash Flow, Free Cash Flow (FCF).

11. Government Policies and Regulations Methods of Financial Statement Analysis

• Changes in financial laws, tax rules, and social security policies 1. Horizontal Analysis
impact financial planning. o Compares financial data over multiple periods to identify
• Staying updated helps in making informed financial decisions. trends.
2. Vertical Analysis
12. Financial Literacy and Awareness o Expresses each line item as a percentage of a base figure (e.g.,
revenue for income statement, total assets for balance sheet).
• Knowledge of financial concepts, budgeting, and investment options 3. Ratio Analysis
affects decision-making. o Evaluates financial performance using key ratios:
• Higher financial literacy leads to better money management and ▪ Liquidity Ratios: Current Ratio, Quick Ratio.
wealth growth. ▪ Profitability Ratios: Net Profit Margin, Return on
Equity (ROE).
FINANCIAL STATEMENT ANALYSIS ▪ Efficiency Ratios: Inventory Turnover, Accounts
Receivable Turnover.
Financial statement analysis is the process of examining a company’s ▪ Solvency Ratios: Debt-to-Equity, Interest Coverage
financial statements to evaluate its financial performance and make Ratio.
informed business decisions. It involves reviewing financial data to assess 4. Trend Analysis
profitability, liquidity, efficiency, and solvency. o Examines patterns in financial data over time to predict
future performance.
8
III B.COM CA - PERSONAL FINANCE
5. Comparative Analysis (Benchmarking) 3. Asset Analysis
o Compares company performance against industry peers or
competitors. • Liquid Assets (Cash, Bank Accounts) – Should cover 3-6 months of
expenses.
Importance of Financial Statement Analysis • Investments (Stocks, Bonds, Retirement Accounts) – Check for
diversification.
• Helps investors assess company performance. • Fixed Assets (Real Estate, Vehicles, Businesses) – Consider
• Aids managers in strategic decision-making. depreciation and market value.
• Enables creditors to evaluate creditworthiness.
• Identifies strengths, weaknesses, and potential risks. 4. Liability Analysis

• Short-Term Liabilities (Credit Card Debt, Personal Loans) – Should

be minimized.
Personal financial statement analysis involves evaluating an individual's • Long-Term Liabilities (Mortgage, Student Loans, Car Loans) –
financial position by reviewing their assets, liabilities, income, and Ensure manageable debt-to-income ratio.
expenses. It helps in assessing net worth, cash flow, financial health, and
future planning. Here's how you can analyze it effectively: 5. Income & Expense Analysis

1. Understanding the Personal Financial Statement • Income Sources (Salary, Business, Investments, Passive Income) –
Diversification is key.
A personal financial statement typically consists of: • Expenses (Fixed & Variable) – Identify areas to cut costs.
• Savings Rate – Aim to save at least 20% of income.
• Balance Sheet (Net Worth Statement) – Lists assets and liabilities to
determine net worth. 6. Financial Planning & Improvement
• Income Statement (Cash Flow Statement) – Tracks income sources
and expenses to measure financial performance. • Increase Income – Side hustles, investments, salary negotiations.
• Reduce Liabilities – Pay off high-interest debt first.
2. Analyzing Net Worth • Optimize Expenses – Budget and track spending.
• Grow Investments – Diversify portfolio and maximize retirement
Formula: accounts.

Net Worth=Total Assets−Total Liabilities

• Positive Net Worth: Indicates financial stability.

• Negative Net Worth: Means liabilities exceed assets, signaling
potential financial trouble.
9
III B.COM CA - PERSONAL FINANCE
Income and Expenses Statement Analysis o Travel
o Miscellaneous spending
The income and expense statement (also called a cash flow statement) helps • Savings & Investments (Money set aside for the future)
assess your financial health by showing how much money you earn and o Retirement contributions (401k, IRA)
spend over a specific period. Proper analysis can reveal spending habits, o Emergency fund
savings potential, and areas for financial improvement. o Stock market investments
o Real estate investments

1. Structure of an Income and Expense Statement

2. Key Metrics for Analysis
The statement consists of two main sections:
A. Net Income Calculation
A. Income Section (Money Coming In)
Net Income=Total Income−Total Expenses
Includes:
• Positive Net Income: You are saving money.
• Primary Income – Salary, wages, business income. • Negative Net Income: You are spending more than you earn (needs
• Passive Income – Rental income, dividends, royalties. adjustment).
• Other Income – Bonuses, tax refunds, side hustle earnings.
B. Expense-to-Income Ratio
B. Expense Section (Money Going Out)
Expense Ratio=(Total Expenses/Total Income)×100
Divided into:
• Should ideally be below 80% (leaving at least 20% for savings and
• Fixed Expenses (Essential and recurring) investments).
o Rent/Mortgage
o Insurance (health, car, home) C. Savings Rate
o Loan payments (car, student, personal)
o Utilities (electricity, water, internet) Savings Rate=(Total Savings/Total Income)×100
o Subscriptions (gym, streaming)
• Variable Expenses (Change based on lifestyle) • Aim for 20% or more of income saved.
o Groceries
o Entertainment D. Fixed vs. Variable Expense Ratio
o Dining out
o Shopping Fixed Expense Ratio=(Fixed Expenses/Total Expenses)×100

10
III B.COM CA - PERSONAL FINANCE
• High fixed costs can reduce financial flexibility. o Cryptocurrency
3. Fixed Assets (Long-term tangible assets)
Variable Expense Ratio=(Variable Expenses/Total Expenses)×100 o Primary residence
o Vehicles
• A high variable ratio suggests potential savings opportunities. o Jewelry, collectibles, valuable assets

E. Debt-to-Income (DTI) Ratio B. Liabilities (What You Owe)

DTI Ratio=(Total Monthly Debt Payments/Total Monthly Income)×100 Divided into:

• Should be below 36% for financial stability. 1. Short-Term Liabilities (Due within 12 months)
o Credit card debt
Balance Sheet Analysis for Personal Finance o Personal loans
o Unpaid bills
A personal balance sheet (also called a net worth statement) gives a 2. Long-Term Liabilities (Due over multiple years)
snapshot of your financial position at a specific time. It shows what you own o Mortgage loan
(assets) and what you owe (liabilities) to determine your net worth. o Car loan
o Student loan
o Business loan

1. Structure of a Personal Balance Sheet C. Net Worth Calculation

A balance sheet consists of three main sections: Net Worth=Total Assets−Total Liabilities

A. Assets (What You Own) • Positive Net Worth = Financial stability.

• Negative Net Worth = More liabilities than assets; may require
Divided into: financial adjustments.

1. Liquid Assets (Easily convertible to cash)

o Cash on hand 2. Key Ratios for Balance Sheet Analysis
o Checking & savings accounts
o Money market accounts A. Liquidity Ratio (Measures financial flexibility)
2. Investments (Wealth-building assets)
o Stocks, bonds, mutual funds Liquidity Ratio=Liquid Assets/Monthly Expenses
o Retirement accounts (401k, IRA)
o Real estate investments
11
III B.COM CA - PERSONAL FINANCE
• Should be 3-6 months to cover emergencies.

B. Debt-to-Asset Ratio (Measures financial leverage) 1. Components of a Budget

Debt-to-Asset Ratio=Total Liabilities/Total Assets×100 A budget consists of three main sections:

• Below 50% is ideal; the lower, the better. A. Income (Money Coming In)

C. Net Worth Growth Rate (Tracks financial progress) • Salary/wages

• Side hustle earnings
Net Worth Growth Rate=Current Net Worth−Previous Net Worth/Previou • Investment income (dividends, rental income)
• Passive income (royalties, online businesses)
s Net Worth×100
B. Expenses (Money Going Out)
• Should be positive over time.
Divided into:
D. Investment-to-Net Worth Ratio (Shows wealth-building efficiency)
1. Fixed Expenses (Necessary and consistent)
Investment Ratio=Total Investments/Net Worth×100
o Rent/mortgage
o Utilities (electricity, water, internet)
• A higher percentage indicates better financial growth. o Loan payments (car, student loans, credit card minimums)
o Insurance (health, auto, life)
2. Variable Expenses (Fluctuate monthly)
3. Identifying Financial Issues o Groceries
o Entertainment & dining out
• Low Liquidity → Increase emergency savings. o Shopping
• High Debt-to-Asset Ratio → Reduce debt aggressively. o Travel & vacations
• Declining Net Worth → Increase income and invest wisely. o Miscellaneous personal spending
• Low Investment Ratio → Prioritize long-term wealth-building. 3. Savings & Investments (Future-focused spending)
o Emergency fund contributions
Budgeting Analysis: How to Evaluate and Optimize Your Budget o Retirement savings (401k, IRA)
o Investment accounts (stocks, mutual funds, real estate)
A budgeting analysis helps track income and expenses, ensuring you spend o Debt repayment (above minimum payments)
wisely, save efficiently, and achieve financial goals. It reveals spending
habits, savings potential, and areas for cost-cutting.

12
III B.COM CA - PERSONAL FINANCE
RATIO ANALYSIS o Measures profitability from core operations before interest
and taxes.
Ratio analysis is a technique used to evaluate a company’s financial health • Net Profit Margin = Net Profit / Revenue
by analyzing relationships between different financial statement items. It o Indicates the percentage of revenue that remains as profit
helps assess profitability, liquidity, efficiency, and solvency. after all expenses.
• Return on Assets (ROA) = Net Income / Total Assets
o Measures how efficiently a company uses assets to generate
profit.
Types of Financial Ratios • Return on Equity (ROE) = Net Income / Shareholders' Equity
o Evaluates profitability relative to shareholders’ investment.
1. Liquidity Ratios (Measures Short-Term Financial Stability)

These ratios determine a company’s ability to meet short-term obligations.

3. Efficiency Ratios (Activity Ratios) (Measures Operational
• Current Ratio = Current Assets / Current Liabilities Effectiveness)
o Measures short-term financial health.
o A ratio above 1 indicates the company can cover its short- These ratios assess how well a company uses its assets and liabilities.
term debts.
• Quick Ratio (Acid-Test Ratio) = (Current Assets - Inventory) / Current • Inventory Turnover Ratio = Cost of Goods Sold / Average Inventory
Liabilities o Measures how frequently inventory is sold and replaced.
o Excludes inventory, focusing on the most liquid assets. o A high ratio indicates efficient inventory management.
o A higher ratio suggests strong liquidity. • Accounts Receivable Turnover = Net Credit Sales / Average Accounts
• Cash Ratio = Cash & Cash Equivalents / Current Liabilities Receivable
o Evaluates the company's ability to pay short-term debts using o Indicates how quickly the company collects payments from
only cash and cash equivalents. customers.
• Asset Turnover Ratio = Revenue / Average Total Assets
o Measures how efficiently a company utilizes assets to
generate revenue.
2. Profitability Ratios (Measures Earnings Performance)

These ratios assess a company’s ability to generate profit relative to revenue,

assets, or equity. 4. Solvency Ratios (Financial Leverage Ratios) (Measures Long-Term
Stability)
• Gross Profit Margin = (Revenue - Cost of Goods Sold) / Revenue
o Shows how efficiently a company produces and sells goods. These ratios determine a company’s ability to meet long-term financial
• Operating Profit Margin = Operating Income / Revenue obligations.
13
III B.COM CA - PERSONAL FINANCE
• Debt-to-Equity Ratio (D/E) = Total Debt / Shareholders’ Equity
o Assesses financial leverage and risk.
o A high ratio means the company relies more on debt than
equity.
• Interest Coverage Ratio = Earnings Before Interest & Taxes (EBIT) /
Interest Expense
o Measures a company’s ability to cover interest payments.
• Debt Ratio = Total Liabilities / Total Assets
o Shows the proportion of assets financed by debt.

5. Market Valuation Ratios (Used by Investors)

These ratios help investors assess stock performance and value.

• Earnings Per Share (EPS) = Net Income / Total Outstanding Shares

o Represents the profit per share of stock.
• Price-to-Earnings Ratio (P/E) = Market Price per Share / Earnings per
Share
o Indicates how much investors are willing to pay for each
dollar of earnings.
• Dividend Yield = Annual Dividends per Share / Market Price per Share
o Shows the return on investment from dividends.

Importance of Ratio Analysis

Helps Investors: Assesses profitability and risk before investing.

Aids Management: Improves decision-making and operational efficiency.
Supports Creditors: Evaluates a company’s ability to repay loans.
Identifies Strengths & Weaknesses: Highlights financial strengths and
potential risks.

14