ratio analysis of financial statment

1. BY-krishan gopal saini

2. Ratio Analysis
• Ratio analysis is referred to as the study or analysis of the line items
present in the financial statements of the company. It can be used to check
various factors of a business such as profitability, liquidity, solvency and
efficiency of the company or the business.
• Ratio analysis is mainly performed by external analysts as financial
statements are the primary source of information for external analysts.
• The analysts very much rely on the current and past financial statements in
order to obtain important data for analyzing financial performance of the
company. The data or information thus obtained during the analysis is
helpful in determining whether the financial position of a company is
improving or deteriorating.

4. Types of Ratio Analysis
1. Liquidity Ratios
• Liquidity ratios measure a company's ability to pay off its short-term debts
as they become due, using the company's current or quick assets. Liquidity
ratios include the current ratio, quick ratio, and working capital ratio.
2. Solvency Ratios
• Also called financial leverage ratios, solvency ratios compare a company's
debt levels with its assets, equity, and earnings, to evaluate the likelihood
of a company staying afloat over the long haul, by paying off its long-term
debt as well as the interest on its debt. Examples of solvency ratios include:
debt-equity ratios, debt-assets ratios, and interest coverage ratios.

5. Types of Ratio Analysis
3. Profitability Ratios
• These ratios convey how well a company can generate profits from its
operations. Profit margin, return on assets, return on equity, return
on capital employed, and gross margin ratios are all examples
of profitability ratios.
4. Efficiency Ratios
• Also called activity ratios, efficiency ratios evaluate how efficiently a
company uses its assets and liabilities to generate sales and maximize
profits. Key efficiency ratios include: turnover ratio, inventory
turnover, and days' sales in inventory.

6. Types of Ratio Analysis
5. Profitability ratios
• The purpose of profitability ratios is to determine the ability of a
company to earn profits when compared to their expenses. A better
profitability ratio shown by a business as compared to its previous
accounting period shows that business is performing well.
• The profitability ratio can also be used to compare the financial
performance of a similar firm, i.e it can be used for analysing
competitor performance.
• Some of the most used profitability ratios are return on capital
employed, gross profit ratio, net profit ratio, etc.

7. Solvency Ratio
• Also called financial leverage ratios, solvency ratio compare a
company's debt levels with its assets, equity, and earnings, to
evaluate the likelihood of a company staying afloat over the long haul,
by paying off its long-term debt as well as the interest on its debt.
Examples of solvency ratios include: debt-equity ratios, debt-assets
ratios, and interest coverage ratios.

8. Types of Solvency Ratios
Debt to equity
ratio
Debt Ratio
Proprietary Ratio
or Equity Ratio
Interest Coverage
Ratio

9. Types of Solvency Ratios
1. Debt to equity ratio
The debt-to-equity ratio (D/E ratio) shows how much debt a
company has compared to its assets. It is found by dividing a
company's total debt by total shareholder equity. A higher D/E
ratio means the company may have a harder time covering its
liabilities.

10. Types of Solvency Ratios
2. Debt Ratio
The debt ratio is defined as the ratio of total debt to total
assets, expressed as a decimal or percentage. It can be
interpreted as the proportion of a company's assets that are
financed by debt.

11. Types of Solvency Ratios
3. Proprietary Ratio or Equity Ratio
• Proprietary ratios is also known as equity ratio. It establishes a relationship
between the proprietors funds and the net assets or capital.
• It is expressed as
• Equity Ratio = Shareholder’s funds / Capital or Shareholder’s funds / Total
Assets

12. Types of Solvency Ratios
4. Interest Coverage Ratio
• The interest coverage ratio is a debt and profitability ratio used to
determine how easily a company can pay interest on its outstanding
debt. The interest coverage ratio is calculated by dividing a company's
earnings before interest and taxes (EBIT) by its interest expense
during a given period.

13. Profitability Ratios
Profitability Ratios
• Profitability ratios are a type of accounting ratio that helps in determining the
financial performance of business at the end of an accounting period.
Profitability ratios show how well a company is able to make profits from its
operations.

14. Types of Profitability Ratios
1.Gross Profit Ratio
1.Operating Ratio
1.Operating Profit Ratio
1.Net Profit Ratio
Return on Investment (ROI)
1.Return on Net Worth
1.Earnings per share
1.Book Value per share
1.Dividend Pay-out Ratio
1.Price Earning Ratio

15. Types of Profitability Ratios
Gross Profit Ratio
• Gross Profit Ratio is a profitability ratio that measures the relationship
between the gross profit and net sales revenue. When it is expressed
as a percentage, it is also known as the Gross Profit Margin.
• Formula for Gross Profit ratio is
• Gross Profit Ratio = (Gross Profit/Net Revenue of Operations) × 100
• Net revenue from operation =net sales =sales – returns
• Gross profit =sales –cost of sales

16. Types of Profitability Ratios
Operating Ratio
• Operation ratio is calculated to determine the cost of operation in
relation to the revenue earned from the operations.
• The formula for operating ratio is as follows
• Operating Ratio = (Cost of Revenue from Operations +
Operating Expenses)/
• Net Revenue from Operations ×100

17. Types of Profitability Ratios
Operating Profit Ratio
• Operating profit ratio is a type of profitability ratio that is used for determining
the operating profit and net revenue generated from the operations. It is
expressed as a percentage.
• The formula for calculating operating profit ratio is:
• Operating Profit Ratio = Operating Profit/ Revenue from Operations × 100
• Or Operating Profit Ratio = 100 – Operating ratio

18. Types of Profitability Ratios
Net Profit Ratio
• Net profit ratio is an important profitability ratio that shows the relationship
between net sales and net profit after tax. When expressed as percentage, it
is known as net profit margin.
• Formula for net profit ratio is
• Net Profit Ratio = Net Profit after tax ÷ Net sales
• Or
• Net Profit Ratio = Net profit/Revenue from Operations × 100

19. Types of Profitability Ratios
Return on Capital Employed (ROCE) or Return on Investment (ROI)
• Return on capital employed (ROCE) or Return on Investment is a profitability ratio
that measures how well a company is able to generate profits from its capital. It is an
important ratio that is mostly used by investors while screening for companies to
invest.
• The formula for calculating Return on Capital Employed is :
• ROCE or ROI = EBIT ÷ Capital Employed × 100
• Where EBIT = Earnings before interest and taxes or Profit before interest and taxes
• Capital Employed = Total Assets – Current Liabilities

20. Types of Profitability Ratios
Return on Net Worth
• This is also known as Return on Shareholders funds and is used for determining
whether the investment done by the shareholders are able to generate profitable
returns or not.
• It should always be higher than the return on investment which otherwise would
indicate that the company funds are not utilised properly.
• The formula for Return on Net Worth is calculated as :
• Return on Shareholders’ Fund = Profit after Tax / Shareholders’ Funds × 100
• Or Return on Net Worth = Profit after Tax / Shareholders’ Funds × 100

21. Types of Profitability Ratios
Earnings Per Share (EPS)
• Earnings per share or EPS is a profitability ratio that measures the extent to
which a company earns profit. It is calculated by dividing the net profit earned
by outstanding shares.
• The formula for calculating EPS is:
• Earnings per share = Net Profit ÷ Total no. of shares outstanding

22. Types of Profitability Ratios
Book Value Per Share
• Book value per share is referred to as the equity that is available to the
common shareholders divided by the number of outstanding shares
• Equity can be calculated by:
• Equity funds = Shareholders funds – Preference share capital
• The formula for calculating book value per share is:
• Book Value per Share = (Shareholders’ Equity – Preferred Equity) / Total
Outstanding Common Shares.

23. Types of Profitability Ratios
Dividend Payout Ratio
• Dividend payout ratio calculates the amount paid to shareholders as dividends
in relation to the amount of net income generated by the business.
• It can be calculated as follows:
• Dividend Payout Ratio (DPR) : Dividends per share / Earnings per share

24. Types of Profitability Ratios
Price Earning Ratio
• This is also known as P/E Ratio. It establishes a relationship between the
stock (share) price of a company and the earnings per share. It is very helpful
for investors as they will be more interested in knowing the profitability of the
shares of the company and how much profitable it will be in future.
• P/E ratio is calculated as follows:
• P/E Ratio = Market value per share ÷ Earnings per share
• It shows if the company’s stock is overvalued or undervalued.

25. Activity ratios
• Activity ratios are used to determine the efficiency of the organization in
utilizing its assets for generating cash and revenue. It is used to check the
level of investment made on an asset and the revenue that it is generating.
For this reason, the activity ratio is also known as the efficiency ratio or the
more popular turnover ratio.
• The role of activity ratio or turnover ratio is in the evaluation of the efficiency of
a business by careful analysis of the inventories, fixed assets and accounts
receivables.

26. Types of Activity Ratios
1.Stock Turnover ratio or Inventory Turnover Ratio
1.Debtors Turnover ratio or Accounts Receivable Turnover Ratio
1.Creditors Turnover ratio or Accounts Payable Turnover Ratio
1.Working Capital turnover ratio.
1.Investment Turnover Ratio

27. Types of Activity Ratios
Stock Turnover Ratio
• This is one of the most important turnover ratios which highlights the
relationship between the inventory or stock in the business and cost of the
goods sold. It shows how fast the inventory gets cleared in an accounting
period or in other words, the number of times the inventory or the stock gets
sold or consumed. For this reason, it is also known as the inventory turnover
ratio.
• A high stock turnover ratio is indicative of fast moving goods in a company while a low
stock turnover ratio indicates that goods are not getting sold and are being stored at
warehouses for an extended period of time.
• Formulas:
• Quick ratio =COGS/Average stock
• COGS =SALES –gross profit
• Average stock =(opening stock +closing stock)/2

28. Types of Activity Ratios
Debtor Turnover Ratio
• This ratio is an important indicator of a company which shows how well a company is
able to provide credit facilities to its customers and at the same time is also able to
recover the due amount within the payment period.
• It is also known as accounts receivable turnover ratio as the payments for credit sales
that will be received in the future are known as accounts receivables.
• Formula:
• Debtors turnover ratio =credits sale/ average or
• Debtor turnover ratio =credit sales /debtors =bills receivable
• And with a slight modification, we also derive the average collection period. This will
indicate the average payment period in the number of Days/ weeks /months .we only
have to modify the ratio a little ,and remember this will be expressed as a function of
time (days ,weeks months etc)
• Average collection period =(number of days /weeks/months)/(Debtors t/o ratio)

29. Types of Activity Ratios
Creditors Turnover Ratio
• Creditors turnover ratio is a measure of the capability of the company to pay off the amount for
credit purchases successfully in an accounting period.
• It shows the number of times the account payables are cleared by the company in an accounting
period. For this reason, it is also known as the Accounts payable turnover ratio.
• formula:
• Creditors turnover ratio = credit purchases/average creditors or
• Creditors turnover ratio = credit purchase /(creditors = bill payable)
• Average creditors =(opening creditor+ closing creditors)/2
• Now using the same ratio we can be also calculate the average payment period in the
number of Days/ weeks /months .we only have to modify the ratio a little ,and
remember this will be expressed as a function of time (days ,weeks months etc)
• Average payment period =(number of days /weeks/months)/(creditors t/o ratio)

30. Types of Activity Ratios
Working Capital Turnover Ratio
• This ratio is helpful in determining the effectiveness with which a company is able to
utilize its working capital for generating sales of its goods.
• Working capital turnover ratio= total sales /working capital
• Working capital = current assets – current liabilities
Investment Turnover Ratio or Net Asset Turnover Ratio
• Investment Turnover Ratio is related to the sales taking place in the business and
the net assets or the capital employed. It determines the ability of the business to
generate sales revenue by the use of net assets of the business. The ratio is
calculated using the following formula
• Investment Turnover Ratio = Net Sales/ Capital Employed

31. Liquidity Ratio
• Liquidity ratios are an important class of financial metrics used to
determine a debtor's ability to pay off current debt obligations
without raising external capital. Common liquidity ratios include the
quick ratio, current ratio, and days sales outstanding

32. Types of Liquidity Ratio
1.Current
Ratio or
Working
Capital Ratio
1.Quick Ratio
also known as
Acid Test Ratio
1.Cash Ratio
also known
Cash Asset
Ratio or
Absolute
Liquidity Ratio
1.Net Working
Capital Ratio

33. Types of Liquidity Ratio
1. Current Ratio:
• The current ratio is used to compare the current assets with current liabilities
of the business.
• Formula to calculate Current Ratio:
• Current ratio = Current Assets / Current Liabilities
2. Quick or liquid Ratio
• The Quick or liquid Ratio is used to compare the Liquid assets with current
liabilities of the business.
• Formula to calculate Quick or liquid Ratio :
• Quick Ratio = (Cash + Marketable securities + Accounts receivable) / Current
liabilities
• or current ratio=current Assets/ Liquid ratio

34. Types of Liquidity Ratio
3. Absolute liquid or cash Ratio:
• Cash ratio is a measure of a company’s liquidity in which it is measured
whether the company has the ability to clear off debts only using the liquid
assets (cash and cash equivalents such as marketable securities). It is used
by creditors for determining the relative ease with which a company can clear
short term liabilities.
• It is calculated by dividing the cash and cash equivalents by current liabilities.
• Cash ratio = Cash and equivalent / Current liabilities

35. Types of Liquidity Ratio
4.Net Working Capital Ratio
• The net working capital ratio is used to determine whether a company has
sufficient cash or funds to continue its operations. It is calculated by
subtracting the current liabilities from the current assets.
• Net Working Capital Ratio = Current Assets – Current Liabilities

36. Liquidity Ratio Formula

37. Example of Liquidity Ratios
Balance Sheet as on 31st March 2020
Particulars
Note
No.
31, March 2020
I. Equity and Liabilities
(3) Current Liabilities
(a) Sundry Creditors 75,000
(b) Bills payables 15,000
(c) Outstanding Expenses 5,000
(d) Bank Overdraft 55,000
Total Current Liabilities 1,50,000
II. Assets
(2) Current Assets
(a) Cash in hand 10,000
(b) Cash at Bank 40,000
(c) Inventories 1,35,000
(d) Trade Receivables 75,000
(e) Marketable security 25,000
(f) Prepaid Expenses 15,000
Total Current Assets 3,00,000
Total Assets

38. The solution of Liquidity Ratios
• 1. Calculation of Current Ratio:
• Current Ratio = Current Assets
Current Liabilities
=Cash in hand + Cash at Bank + Inventories + Trade Receivables + Marketable security + Prepaid Expenses
Sundry Creditors + Bills payables + Outstanding Expenses + Bank Overdraft
= 10,000 + 40,000 + 1,35,000 + 75,000 + 25,000 + 15,000
75,000 + 15,000 + 5,000 + 55,000
= 3,00,000
1,50,000
Current Ratio = 2 : 1

39. • 2. Calculation of Liquid Ratio:
• Liquid Ratio = Liquid Assets
Current Liabilities
= Cash in hand + Cash at Bank + Trade Receivables + Marketable security
Sundry Creditors + Bills payables + Outstanding Expenses + Bank Overdraft
= 10,000 + 40,000 + 75,000 + 25,000
75,000 + 15,000 + 5,000 + 55,000
= 1,50,000
1,50,000
• Liquid Ratio = 1 : 1

40. • . Calculation of Absolute Liquid or cash Ratio:
• Absolute Liquid or cash Ratio = Absolute Liquid or cash Assets
Current Liabilities
= Cash in hand + Cash at Bank + Marketable security
Sundry Creditors + Bills payables + Outstanding Expenses + Bank Overdraft
= 10,000 + 40,000 + 25,000
75,000 + 15,000 + 5,000 + 55,000
•
= 75,000
1,50,000
Absolute Liquid or cash Ratio = 0.5 : 1