4.Ratio Analysis

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RATIO ANAYLSIS

Ratios are defined as, Relationships expressed in quantitative fear, between

figures which have cause and effect relationships, or which are connected

with each other in some manner or the other".

Ratio analysis is an age old technique of financial analysis. It is the process

of determining and presenting the relationships of items and group of items

in the financial statements. "The information provided by the financial

statements in absolute form is historical and static, conveying ray little

meaning to the users. Accounting ratios are designed to show how one

number is related to another and the meaning of such relationship. A ratio is

worked out by dividing one number with another.

ADVANTAGES OF RATIO ANALYSIS

The following are the advantages of ratio analysis:

FORECASTINGRatios reveal trends in cost, sales, projects and other inter related facts,

which will be helpful in forecasting future events

MANAGERIAL CONTROLRatio can be used as instrument of control regarding sales costs and profit.

FACILITATES COMMUNICATIONRatios facilitate the communication function of management as ratios

convey the information relating to the present and future quickly, forcefully

and clearly


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MEASURING EFFICIENCYRatios help to know operation efficiency by comparison of present ratios

with those of the past working and also with other firm in the industry

FACILITING INSTRUMENT DECISIONRatios help in computing return on investment, this helps in exercising

effective decision regarding profitable avenues of investment.

USEFUL IN MEASURING FINANCIAL SOLVENCYThis ratio indicates the liquidity position of the company and the proportion

of borrowed funds to local resources which reveal the short term and long

term solvency position of a firm.

INTER FIRM COMPARISIONSThe technique of inter firm comparison can be carried out successfully

only with the help of ratio analysis.

CLASSIFICATIONRatios are classified in several ways Different approaches are used for

classifying ratios. Ratios are used for the purpose of assessing profitability,

activity or operating efficiency and financial position of a concern. Based onthe purpose, the ratios are classified as

1. Profitability ratios,

2. Turn over ratios,

3. Financial ratios or solvency ratios.

PROFITABLITY RATIOProfitability is an indication of the efficiency with which the operations of

the business are carried on. Profit making is the main objective of the

business. Aim of every business concern is to earn maximum profits in

absolute terms. Owners are interested to know the profitability as it indicates

the return which the can get on their investments. Ability to make maximum

profit from optimum utilization of resources by a business concern is termed

as profitability.


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GROSS PROFIT RATIOThis ratio expresses relationship between gross profit and net sales.

SIGNIFICANCEThe gross profit ratio indicates the extend to which selling prices of goods

per unit may decline without resulting in losses on operations of a firm. It

reflects the efficiency with which a firm produces its products. Yet the gross

profit ratio is one of the very important ratios for measuring profitability of

the firm.

FORMULAGross profit *100

Net sales

CALCULATIONS

Year 2009-2010 2010-2011 2011-2012

Gross

Profit( Rs in

millions)

Net sales ( Rs

in millions )

Gross Profit

Ratio

INTERPRETATION

RETURN ON SHAREHOLDERS FUNDSThis ratio signifies the return on shareholders funds .This ratio establishes

the profit from the shareholders point of view


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SIGNIFICANCEThis ratio is an effect to measure the profitability of the business. This is an

index to know whether the main objective of the business (i.e.) realization of

satisfactory net income is achieved.

FormulaNet profit after interest and tax * 100

Shareholders funds

CALCULATIONS

Year 2009-2010 2010-2011 2011-2012

Net profitafter interest

and tax( Rs in millions )

Shareholders

funds( Rs in millions )

Return onShareholders

Funds

INTERPRETATION

TURNOVER RATIOS:The ratio indicates the efficiency with which the capital employed is rotated

in the business. The overall profitability of the business depends on two

factors 1.the rate on return on capital employed 2. Turnover .higher the rate

of rotation, the greater will be profitability.

FIXED ASSET TURNOVER RATIO


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This Ratio indicates the extend to which the investments in fixed assets

contribute towards sales.

FORMULA

Net SalesFixed asset (net)

SIGNIFICANCEFixed asset turnover ratio indicates the contribution of investments in fixed

asset towards sales. If compared with the previous perios , it indicates

whether the investment in fixed asset has been judicious or not

CALCULATIONS

Year 2009-2010 2010-2011 2011-2012

Net sales( Rs in millions)

Fixed Asset( Rs in millions)

Fixed Asset

Turnover

Ratio

INTERPRETATION

WORKING CAPITAL TURNOVER RATIO

This ratio indicates whether or not working capital has been effectively

utilized in making sales.

SIGNIFICANCEWorking capital turnover ratio indicates the velocity of the utilization of net

working capital. The ratio measures the efficiency with which the working

capital is been used by a firm. This ratio can at best be used by making

comparative and trend analysis for different firms in the same industry and

for various periods.


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FORMULA

Net sales

Working capital

CALCULATIONS

Year 2009-2010 2010-2011 2011-2012

Net sales(Rs in millions)

Working

Capital

(Rs in millions)Working

Capital

Turnover

Ratio

INTERPRETATION

SOLVENCY RATIOSSolvency or financial ratio includes all ratios which express financial

position of the concern. The financial ratio is also called as balance sheet

ratio.

Financial position may concern differently to different persons interested in

the business concern. The financial ratios are also analyzed to find judicious

use of funds. The significant financial ratio is classified as short term

solvency ratio and long term solvency ratio.

CURRENT RATIO


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The ratio of current asset to current liabilities is called as current ratio. In

order to measure the short term liquidity or solvency of a concern, the

comparison of current asset to current liability is applicable.

SIGNIFICANCECurrent ratio indicates the ability of a concern to meet its current obligation

as and when they are due for payment. A very high current ratio does not

indicate efficiency since it means less efficient use of funds. A high current

ratio also indicates dependence on long term source of raising funds. Long

term funds are more expensive than current liabilities .A ratio less than 2

indicate inadequate current liabilities

FORMULACurrent ratio = Current asset

Current liabilities

IDEAL RATIO is 2: 1

CALCULATIONS

Year 2009-2010 2010-2011 2011-2012

Current assets

(Rs in millions)

Current

Liabilities( Rs in millions )

Current Ratio

INTERPRETATION


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PROPRIETORY RATIOIt is a variant of debt-equity ratio. It establishes relationship between the

proprietors or shareholders funds and the total tangible assets.

SIGNIFICANCEThis ratio focuses the attention on the general financial strength of the

business enterprise. The ratio is of particular importance to the creditors who

can find out the proportion of shareholders funds in the total assets

employed in the business. A high proprietary ratio will indicate a relatively

little danger to the creditors a low proprietary ratio indicates greater risk to

the creditors. A ratio below 50% maybe alarming for the creditors since they

may have to loose heavily in the event of companys liquidation on account

of heavy losses.

FORMULA

Shareholders Funds

Total tangible assets

CALCULATIONS

Year 2009-2010 2010-2011 2011-2012

Shareholders

funds(Rs in millions)

Total tangible

assets(Rs in millions)

ProprietaryRatio

INTERPRETATION


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CONCLUSION

From the analysis of the ratios it is found that short term solvency position

of the company is not satisfactory .The Proprietary ratio reveals that the

shareholders funds have not been effectively utilized. From the turnover

ratios it is found that Working Capital ratio has been effectively utilized

towards making sales

4.Ratio Analysis

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