Financial Matters - Ratio Analysis

RATIO ANALYSIS

A ratio is a simple mathematical expression. It is a number expressed in terms of another number, expressing the quantitative relationship between two.

Ratio analysis is the technique of interpretation of financial statements with the help of meaningful ratios. They help us to draw certain conclusions with related facts is the basis of ratio analysis.

CLASSIFICATION OF RATIOS:

1. Traditional Classification: Balance sheet ratios, P&L a/c ratios and mixed ratios.

2. Functional classification: liquidity ratios, profitability ratios and earning ratios.

3. Importance ratios: primary & secondary ratios. Primary- ROCE, secondary- operating profit ratio.

4. Basis of point of time: Structural & Trend analysis.

5. Basis of usage: for management, creditors and shareholders.

6. Basis of nature of ratios: leverage, liquidity and turnover ratios.

Outsiders Fund (L.T. Liabilities): Debentures + Bank Loan + Creditors + proposed dividend + provision for tax + mortgage.

Shareholders Fund: Equity Share capital + preference share capital + Reserves – Fictitious Assets.

Quick Assets: Current Assets – (stock + prepaid expenses).

Quick Liabilities: current liabilities – Bank Overdraft.

Absolute Liquid assets: cash in hand, cash at bank, short term or temporary investment.

Net worth: Eq. Share capital + pref. Share capital + reserves – fictitious assets.

Total Assets: Fixed assets + current assets (excluding fictitious assets).

Funds bearing fixed interest and dividend: Debentures + term loans + pref. Share capital.

Eq. shareholders fund: Eq. Share capital + reserves – fictitious assets.

Capital Employed: Eq. Share capital + pref. Share capital + reserves + L. T. liabilities – fictitious assets.

Cost of goods sold: sales – gross profit. (Op. stock + purchases + man. Expenses – clo. stock.).

Average stock: (opening stock + closing stock) / 2.

Working capital: current assets – current liabilities.

Net fixed assets: gross fixed assets – depreciation.

Gross profit: net sales – cost of goods sold.

Net sales: Total sales – sales returns.

Operating cost: C.G.S. + Admin. Exp. + S&D expenses (operating cost excludes financial expenses and abnormal losses).

1. Liquidity or Short term solvency Ratios.

Ø Current ratio

Ø Working capital ratio.

Ø Quick ratio.

Ø Liquid ratio

Ø Absolute liquid ratio.

Ø Basic defensive interval ratio.

Ø Solvency ratio.

2. Leverage or capital structure ratios.

Ø Debt & Equity ratio

Ø Capital gearing ratio

Ø Fixed asset ratio

Ø Interest coverage ratio or Debt service ratio.

Ø Dividend coverage ratio

Ø Debt coverage ratio.

3. Activity ratios or turnover ratios.

Ø Inventory or stock turnover ratio.

Ø Debtors turnover ratio.

Ø Creditors turnover ratio.

Ø Working capital turnover ratio.

Ø Fixed assets turnover ratio.

Ø Total assets turnover ratio.

4. Profitability ratios.

A). General profitability ratios.

Ø Gross profit ratio.

Ø Net profit ratio.

Ø Operating ratio.

Ø Operating profit ratio.

Ø Expenses ratio.

B). Overall profitability ratios.

Ø Return on capital employed ratio.

Ø Return on proprietary ratio.

Ø Return on net worth.

Ø Return on equity capital.

Ø Return on asset ratio.

Ø Earning per share.

Ø Dividend per share.

Ø Dividend pay out ratio.

Ø Price earning ratio( P/E ratio).

Ø Earnings yield (1 / P/E ratio).

Ø Dividend yield ratio.

Ø Book value.

Current ratio = current assets

Current liabilities

Quick ratio = Quick assets

Quick liabilities

Equity debt ratio = Debt

Equity

Debt coverage ratio = Return available for debt service

Interest + loan installments of current year

Interest coverage ratio = EBIT

Interest

Price earning ratio( P/E ratio) = Market price per share

Earnings per share

Dividend yield ratio = Dividend per share

Market price per share

Operating leverage = Contribution

EBIT

Finance leverage = EBIT

EBT

Total leverage = Operating leverage x finance leverage

E.P.S. = Earnings available to equity share holders

No of shares outstanding

WORKING CAPITAL

For running day-to-day activities of a business, some capital is required which is called working capital. It is necessary to operate day- to- day transactions of an enterprise. Like purchase of raw material and payment of salaries, wages,…..etc,.

Working capital is difference between current assets and current liabilities.

Working capital cycle / operating cycle:

There is a complete cycle from cash to cash. Operating cycle is the time duration required to convert cash in to cash.

Ø Conversion of cash in to raw material.

Ø Conversion of raw material in to work in progress.

Ø Conversion of work in progress in to finished stock.

Ø Conversion of finished goods in to debtors.

Ø Conversion of debtors in to cash.

Operating cycle = No. of days in a year.

Operating cycle period.