2. INTRODUCTION TO RATIO
ANALYSIS
A ratio is defined as a relationship between
two numbers of the same kind.
The ratio analysis is one of the most
useful and common methods of analyzing
financial statement.
Ratio enables the mass of data to
be summarized and simplified.
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3. IMPORTANCE OF RATIO
ANALYSIS
Ratio analysis of a firm’s financial statement is of
interest to a number of parties mainly:
Shareholders - interested with earning
capacity of the firm.
Creditors - interested in knowing the ability
of firm to meet financial obligation.
Financial Executives - concerned with
evolving analytical tools that will measure and
compare costs, efficiency liquidity and
profitability with a view to making intelligent
decisions.
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4. IMPORTANCE OF RATIO
ANALYSIS
Enables the banker or lender to arrive at the
following factors :
Liquidity position
Profitability
Solvency
Financial Stability
Quality of the Management
Safety & Security of the loans & advances to
be or already been provided
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5. How a Ratio is expressed?
As Percentage - such as 25% or 50% .
As Proportion – The figures may be
expressed in terms of the relationship as 1 :
4.
As Pure Number /Times - The same can
also be expressed in an alternatively way for
example the sale is 4 times of the net profit
or profit is 1/4th of the sales.
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7. ADVANTAGES OF RATIO
ANALYSIS
Aids to measure general efficiency.
Aids to measure financial liquidity and
solvency.
Aids in forecasting and planning.
Facilitates decision making.
Effective control and performance tool.
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8. LIMITATIONS OF RATIO
ANALYSIS
Limitations of recording: Ratio analysis is
based on financial statement, which
are themselves subject to limitations.
Changes in accounting procedure: Most
often firms for their valuation follow
different methods hence comparison will
be practically of no use.
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9. Lack of proper standard:
It is very difficult to ascertain the standard
ratio in order to make proper comparison.
Because ratios differ from firm to firm and
industry to industry.
Limited use of single ratio: A single ratio
will not be able to convey anything.
Too many ratios: Are likely to confuse
instead of revealing meaningful
conclusions.
Personal bias: Different people may
interpret the same ratio in different ways.
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12. CURRENT RATIO
The current ratio establishes the
relationship between the current assets and
the current liabilities. The ideal ratio is 2:1.
Current Assets
Current Ratio = -------------------------Current liabilities
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14. INTERPRETATION:
Here the current ratio seems to assure that the
company is in a position to pay off any short
term liabilities with liquid assets such as cash
and bank balances, inventory, accounts
receivables and short-term assets(can be
converted to cash).
This means that the company appears to be
doing well and liquidity has remained stable.
It can be seen that the current ratio has been
increased from 1.91 to 2.2.
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15. DEBT/EQUITY RATIO
This ratio is calculated to measure the
relative proportion of outsider’s funds
invested in the company.
Long term debt
Debt Equity Ratio = --------------------Shareholder’s fund
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17. INTERPRETATIONS
A Debt to Equity ratio of 3.49 means that debt
holders have a 3.49 times more claim on assets
than equity holders.
Thus this does not appear to be a healthy
situation for the company , which means they
cannot borrow more from banks.
The Debt to Equity ratio has increased from
3.33 to 3.49 and hence decreases the protection
of creditors.
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18. NET PROFITIBILITY
RATIO
This ratio establishes the relationship
between the amount of net profit or net
income and the amount of sales revenue.
Net Profit
Net Profit Ratio = ------------------- * 100%
Sales
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20. INTERPRETATIONS
This is a low margin of profit indicating a low margin of
safety, higher risk that a decline in sales will erase
profits and result in a net loss.
Different strategies and product mix should be used to
get higher profit margin.
Net profit margin is mostly used to compare a
companies results overtime.
In this case net profit margin has negligibly increased
from 2.51 to 2.58.
To compare Net profit margin between companies in
the same industry might have little meaning as we can’t
say which is more efficient or less efficient.
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21. GROSS PROFITIBILITY
RATIO
This ratio establishes the relationship
between gross profit on sales and net sales
in terms of percentage indicating the
percentage of gross profit earned on sales.
Gross Profit
Gross Profit Ratio = ------------------- * 100%
Sales
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23. INTERPRETATIONS
In this case the Gross Profit Ratio does not
seem to be good enough and hence
indicates reduced efficiency in production
of the unit.
Gross profit has decreased from 7.43 to
6.06.
Gross profit margin can be used to compare
a company with its competitors.
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24. INVENTORY TURNOVER
RATIO
Inventory turnover ratio which is also called
stock turnover ratio or stock velocity
establishes the relationship between
the cost of goods sold during a given period
and the average of the costs of opening and
closing stocks.
Cost of goods sold
Stock Turnover Ratio : ------------------------Inventory holdings
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26. INTERPRETATIONS
This ratio can reflect both on the quality of the
inventory and the efficiency of management.
Typically, the higher the turnover rate, the
greater the likelihood that profits would be
larger and less working capital bound up in
inventory.
In this case the turnover rate is low and
indicates more working capital being bound up
in inventory.
The inventory turnover ratio has decreased
from 15.89 to 14.26.
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27. DEBTORS TURNOVER
RATIO
Debtor turnover ratio, also known as
receivables turnover ratio or debtors
velocity establishes the relationship
between the net credit sales of the year and
the average receivable
Net Sales
Debtors Turnover Ratio = --------------------Debtors
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29. INTERPRETATIONS
In this case debtor turnover ratio is good
which indicates that we are collecting
money fast.
Here debtor turn over ratio has increased
from 19.82 to 21.31.
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30. CREDITORS TURNOVER
RATIO
This ratio, also known as payable turnover
ratio establishes the relationship between
the net credit purchases and the average
trade creditors.
Net Purchases
Creditors Turnover Ratio = ------------------Creditors
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32. INTERPRETATIONS
In this case , there is a low turnover which means
that it takes longer for the company to pay off its
creditors.
The ratio has fallen from 0.12 to 0.089, it means the
company is now taking longer to repay creditors.
This may be the result of low sales, or other issues.
A continued drop may be a cause for concern as it
suggests the company cannot control its debt and
may be at risk of bankruptcy.
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33. RETURN ON CAPITAL
EMPLOYED(ROCE)
A ratio that indicates the efficiency and
profitability of a company's capital
investments.
Calculated as:
PROFIT BEFORE
INTEREST AND TAX
ROCE = ________________
CAPITAL EMPLOYED
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35. INTERPRETATIONS
The company has been utilising the capital
invested in a favourable manner with
returns increasing as compared to the
previous financial year.
The ROCE has increased from 19.82 to
21.43.
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36. The current position of the company when
assessed on the basis of current ratio and
ROCE appears to be healthy though
negligibly.
It should be noted that the Debtors
turnover ratio is high, thus indicating that
the company is promptly receiving its debts
back.
On the basis of profitability, inventory
turnover ratio and creditors turnover
ratio, the company does not appear to be
performing at a satisfactory level.
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37. CONCLUSION &
RECOMMENDATION
Considering the above mentioned points it is
advisable that the management should
change its strategies in terms of better
utilization of current assets to pay back its
creditors on time, rework its pricing policies
in order to avoid pressure on profit margins.
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