This document discusses ratio analysis and its advantages, limitations, and classifications. Ratio analysis is the process of determining relationships between financial statement items to evaluate aspects like liquidity, solvency, profitability, and capital structure. Key ratios discussed include current ratio, debt-to-equity ratio, return on equity, gross profit margin, and earnings per share. The document also provides ratio analyses for Reliance Industries for years 2014-2016, showing trends in ratios like return on equity, operating margin, and expenses as a percentage of net sales.

1. A ratiois simple arithmetical expressionof the relationshipof one numbertoanother.Itmaybe
definedasthe indicatedquotientof twomathematical expressions. AccordingtoAccountant’s
HandbookbyWixon,Kell andBedford,“aratiois an expression of the quantitative relationship
betweentwonumbers”.
Ratioanalysisisthe processof determiningandpresentingthe relationshipof itemsandgroupof
itemsinthe statements.AccordingtoBattyJ. ManagementAccounting“Ratiocanassist
managementin itsbasicfunctionsof forecasting,planningcoordination,control and
communication”.
It is helpful toknowaboutthe liquidity,solvency,capital structure andprofitabilityof an
organization.Itishelpful tool toaidinapplyingjudgement,otherwise complex situations.
ADVANTAGEOF RATIO ANALYSIS
1. Helpful inanalysisof Financial Statements.
2. Helpful incomparative Study.
3. Helpful inlocatingthe weakspotsof the business.
4. Helpful inForecasting.
5. Estimate aboutthe trendof the business.
6. Fixationof ideal Standards.
LIMITATIONS OF RATIO ANALYSIS
1. Comparisonnotpossibleif differentfirmsadoptdifferentaccountingpolicies.
2. Ratioanalysisbecomeslesseffective due toprice level changes.
3. Ratiomay be misleading inthe absence of absolute data.
4. Limiteduse of a single data.
5. Lack of properstandards.
CLASSIFICATION OFRATIO
(A) LiquidityRatio:-
It referstothe abilityof the firmtomeet itscurrent liabilities.The liquidityratio,therefore,are also
called‘Short-termSolvencyRatio’.These ratioare usedtoassessthe short-termfinancialpositionof
the concern.Theyindicate the firm’sabilitytomeetitscurrentobligationoutof currentresources.
Liquidityratioincludetworatio:-

2. a. CurrentRatio:- Thisratio explainsthe relationshipbetweencurrentassetsandcurrent
liabilitiesof abusiness.
b. QuickRatio:- Quickratio indicateswhetherthe firmisinapositiontopay itscurrent
liabilitieswithinamonthor immediately.
(B) Leverage or Capital Structure Ratio :-
Thisratio disclose the firm’sabilitytomeetthe interestcostsregularlyandLongtermindebtedness
at maturity.
These ratioinclude the followingratios:
a. DebtEquityRatio:- Thisratiocan be expressedintwoways:
FirstApproach:
DebtEquityRatio=Longterm Loans/Shareholder’sFundsorNetWorth
SecondApproach:
DebtEquityRatio=External Equities/internal Equities
b. Debtto Total FundsRatio : ThisRatio isa variationof the debtequityratio and givesthe same
indicationasthe debtequityratio.Inthe ratio,debtisexpressedinrelationtototal funds,i.e.,both
equityanddebt.
c. ProprietaryRatio:- Thisratioindicatesthe proportionof total fundsprovidebyownersor
shareholders.
d. FixedAssetstoProprietor’sFundRatio:- Thisratiois alsoknow as fixedassetstonetworthratio.
e.Capital GearingRatio:- Thisratioestablishesarelationshipbetweenequitycapital (includingall
reservesandundistributedprofits)andfixedcost bearingcapital.
f.InterestCoverage Ratio:- Thisratioisalsotermedas‘DebtService Ratio’.Thisratioiscalculatedas
follows:
InterestCoverage Ratio=NetProfitbefore charginginterestandtax / FixedInterestCharges
(C) Activity Ratio or Turnover Ratio :-
These ratioare calculatedonthe basesof ‘cost of sales’or sales,therefore,theseratioare also
calledas‘TurnoverRatio’. Turnoverindicatesthe speedornumberof timesthe capital employed
has beenrotatedinthe processof doing business.Higherturnoverratioindicatesthe betteruse of
capital or resourcesandin turnleadto higherprofitability.
It includesthe following:
a. Stock TurnoverRatio:- Thisratioindicatesthe relationshipbetweenthe costof goodsduringthe
yearand average stockkeptduringthat year.
b. DebtorsTurnoverRatio:- Thisratioindicatesthe relationshipbetweencreditsalesandaverage
debtorsduringthe year:

3. c. Average CollectionPeriod:- Thisratioindicatesthe time withinwhichthe amountiscollected
fromdebtorsand billsreceivables.
d. CreditorsTurnoverRatio:- Thisratioindicatesthe relationshipbetweencreditpurchasesand
average creditorsduringthe year.
d. Average PaymentPeriod:- Thisratioindicatesthe period whichisnormallytakenbythe firmto
make paymenttoits creditors.
d. FixedAssetsTurnoverRatio:- Thisratio revealshow efficientlythe fixedassetsare being
utilized.
e. WorkingCapital TurnoverRatio:- Thisratio revealshow efficientlyworkingcapital hasbeen
utilizedinmakingsales.
(D) ProfitabilityRatiosor Income Ratios:-
The main objectof everybusinessconcernistoearn profits.A businessmustbe able toearn
adequate profitsinrelationtothe riskandcapital invested init.The efficiencyandthe successof a
businesscanbe measuredwiththe helpof profitabilityratio.
Profitabilityratiocanbe determinedonthe basisof eithersalesorinvestmentintobusiness.
(A) ProfitabilityRatioBasedonSales:
a) Gross ProfitRatio: Thisratio showsthe relationshipbetweengrossprofitandsales.
b) NetProfitRatio:- Thisratio showsthe relationshipbetweennetprofitandsales.Itmaybe
calculatedbytwomethods:
(c) OperatingRatio:- Thisratiomeasuresthe proportionof anenterprisecostof salesandoperating
expensesincomparisontoitssales.
(d) ExpensesRatio:- These ratioindicate the relationshipbetweenexpensesandsales.Althoughthe
operatingratiorevealsthe ratioof total operatingexpensesin relationtosalesbutsome of the
expensesincludeinoperatingratiomaybe increasingwhile somemaybe decreasing.Hence,specific
expensesratioare computedbydividingeachtype of expense withthe netsalestoanalyse the
causesof variationineach type of expense.
(B) ProfitabilityRatioBasedonInvestmentinthe Business:-
These ratioreflectthe true capacityof the resourcesemployedinthe enterprise.Sometimesthe
profitabilityratiobasedonsalesare highwhereasprofitabilityratiobased oninvestmentare low.
Since the capital isemployedtoearnprofit,these ratiosare the real measure of the successof the
businessandmanagerial efficiency.

4. These ratiomay be calculatedintotwocategories:
I. Returnon Capital Employed:- Thisratioreflectsthe overall profitabilityof the business.Itis
calculatedbycomparingthe profitearnedandthe capital employedtoearnit.Thisratiois usuallyin
percentage andisalsoknownas ‘Rate of Return’or ‘YieldonCapital’.
II.Return on Shareholder’sFunds:- ReturnonCapital EmployedShowsthe overallprofitabilityof the
fundssuppliedbylongtermlendersandshareholderstakentogether.Whereas,Returnon
shareholdersfundsmeasuresonlythe profitabilityof the fundsinvestedby shareholders.
These are several measurestocalculate the returnonshareholder’sfunds:
(a) Returnon total Shareholder’sFunds:-Forcalculatingthisratio‘NetProfitafterInterestandTax’
isdividedbytotal shareholder’sfunds.
(b) Returnon Equity Shareholder’sFunds:-EquityShareholdersof acompanyare more interestedin
knowingthe earningcapacityof theirfundsinthe business.Assuch,thisratiomeasuresthe
profitabilityof the fundsbelongingtothe equityshareholder’s.
(c) EarningPerShare (E.P.S.) :- Thisratiomeasure the profitavailabletothe equityshareholderson
a per share basis.All profitleftafterpaymentof tax and preferencedividendare availabletoequity
shareholders.
(d) DividendPerShare (D.P.S.):- Profitsremainingafterpaymentof tax andpreference dividendare
available toequityshareholders.Butof these are notdistributedamongthemasdividend.Outof
these profitsisretainedinthe businessandthe remainingisdistributedamongequityshareholders
as dividend.D.P.S.isthe dividenddistributedtoequityshareholdersdividedbythe numberof equity
shares.
(e) DividendPayoutRatioorD.P.:- It measuresthe relationshipbetweenthe earningavailable to
equityshareholdersandthe dividenddistributedamongthem.
(f) Earningand DividendYield:- ThisratioiscloselyrelatedtoE.P.S.andD.P.S.While the E.P.S.and
D.P.S.are calculatedonthe basisof the book value of shares,thisratioiscalculatedonthe basisof
the marketvalue of share
(g) Price Earning (P.E.) Ratio:- Price earningratioisthe ratiobetweenmarketprice perequityshare
& earningspershare.The ratio iscalculatedtomake an estimate of appreciationinthe value of a
share of a company& is widelyusedbyinvestorstodecide whetherornot to buysharesina
particularcompany.

5. Key Ratios of Reliance Industries
The followingfiguresandratiohasbeenderivedfromfinancial StatementaspublishedbyReliance
IndustriesLtd.:-
Displayingunits INR
Thousands
INR
Thousands
INR
Thousands
Ratios
Y-2014 -
Cons.
Y-2015 -
Cons.
Y-2016 -
Cons.
Return on Equity (ROE) 11.35% 10.81% 11.31%
Annualised Return on Equity (ROE) 11.35% 10.81% 11.31%
Return on Sales (ROS) 5.17% 6.27% 9.95%
Gross ProfitMargin 16.31% 22.07% 32.57%
OperatingProfit (EBIT) Margin 7.48% 9.14% 14.09%
EBITDA Margin 10.06% 12.21% 18.76%
EBIT 3250,90,000 3431,20,000 3895,30,000
EBITDA 4371,00,000 4585,90,000 5186,90,000
Net Sales Revenue Trend 109.42% 86.41% 73.66%
Total Operating Revenue Trend 9.78% 5.55% 13.53%
Gross ProfitTrend 18.41% 16.92% 8.67%
EBITDA Trend 107.01% 104.92% 113.11%
OperatingIncome Trend 109.78% 105.55% 113.53%
Net Income Trend 107.87% 104.74% 116.93%
Shareholders' Equity Trend 9.68% 10.03% 11.69%
Salaries and Employee Benefits / Net sales 1.28% 1.67% 2.79%
Depreciation and Amortization / Net sales 2.58% 3.08% 4.67%
Interest paid / Net sales 0.88% 0.88% 1.30%
Income tax / Net sales 1.43% 1.99% 2.99%

6. Graphical Representation of Some Ratio