Financial Analysis Through Ratios

Ratio Analysis

Need of ratio analysis

Much of the financial information is mentioned in the Financial Statements of a company,but sometimes an absolute figures conveys no meaning.a figure may become more meaningful if it is compared with some other informative figure. Also the figure mentioned in financial statements may not give the qualitative information. For analyzing and interpretation of financial statements Ratio Analysis is used.

Importance of Ratio Analysis

As the absolute figure do not convey any meaning unless they are compared eith each other. Various ratios can be obtained from financial ratio by grouping and regrouping of figure in order to draw fruitful meanings. The importance of ratio analysis are mentioned.

i. Ratio analysis states the financial position of the firm. It helps insurance companies,bank other financial institution s for assessing the firm before sanctioning loan to them.

ii. Financial ratios are also useful for investors for finding the profitability of the firm.iii. The financial ratios of organization may be compared with the ratio of previous year of

the same organization to find the exact growth of firm.this comparison is called intra- firm comparison.

iv. The ratio of one organizations are compared with other organization of similar industry.this is called as inter-firm comparision.

v. Ratio analysis helps in setting future plans and forecasting of the firm.vi. Ratios reflects the actual asset and liability so the weaknesses of the firm can be point out

and remedial steps can be taken to overcome this situation.vii. Ratios indicates the efficiency of the firm.

viii. Ratios reflects the ability of the firm to meet the financial obligations.

Classification of Ratios

Following types of financial ratios are particularly important to managerial control.i. Liquidity ratios.

ii. Activity ratios/ Asset management ratios.iii. Debt management ratios/Leverage ratios.iv. Profitability ratios.

Liquidity Ratios

Liquidity ratios can be classified into two types.

1.Current Ratio.

2.Quick Ratio.

Current Ratio

Current Assets

Current Ratio= ------------------------------

Current Liability

Quick Ratio

Quick Assets

Quick Ratio= -------------------------

Current Liabilities

Where ,

Quick Assets=Current Assets-(stock+ prepaid Expenses)

Activity Ratio

Activity ratio is calssified as.

1.Inventory Turnover Ratio.

2.Debtors Turnover Ratio.

Inventory Turnover Ratio

Cost of goods sold

Inventory Turnover Ratio= -------------------------

Average inventory

Where,

Cost of goods=sales - gross profit

Opening Inventory + Closing Inventory

Average Inventory=------------------------------------------------------

2

365 days

Inventory holding period= ------------------------------------

Inventory Turnover Ratio

Debtor’s Turnover Ratio

Credit Sales

Debtor’s turnover ratio= --------------------

Average debtor’s

Where ,

Credit sales refers to goods sold on credit,

Credit sales=Gross credit sales-returns.

Debtors at the beginning of year + Debtors at the end of year

Average debtor= ---------------------------------------------------------------------------

2

Capital Structure Ratios

Capital structure ratios are classified as

1.Debt-equity ratio

2.Inerest coverage ratio

Debt-equity Ratio

Debt

Debt-equity Ratio= -------------

Equity

Interest Coverage Ratio

Net Profit before interest and taxes

Interest Coverage Ratio =------------------------------------------------------

Interest

Profitability Ratios

Profitability ratio measures profitability of the firm. if provides information as following

-Quantum of profit.

-Rate of return.

-Earning for each share.

-Amount for each divided.

Various types of profitability ratios are1.Gross profit ratio.2.Net profit ratio.3.Price/Earning ratio(P/E ratio).4.Earning per share(EPS).

Gross Profit Ratio

Gross Profit

Gross Profit Ratio= ------------------ x100

Sales

Where ,

Gross Profit = Sale - cost of goods sold.

Net Profit Ratio

Net profit after taxes

Net Profit Ratio = --------------------------- x100

Net sales

Earnings Per Share(EPS)

Net profit after taxes

EPS = ------------------------------------

Number of shares out standings

Price /Earning Ratio(P/E ratio)

Price /Earning ratio is given by- Market value per share

P/E ratio = --------------------------------------- EPS

Limitations of Ratio Analysis

1.Accounting ratios are retrospective.

2.Accounting methods,policies and procedures are not common.

3.Inflationary tendencies cannot be highlighted.

4.Concept of ratios are not the same.

5.Ratios by itself has no utility.

6.Factors weakening ratio analysis.

Problems

1.Two companies ABC Limited and XYZ Limited have approached ICICI Bank for a loan sanction of Rs. 50,000 for working capital purpose.

ABC LIMITED (Rs.) XYZ LIMITED (Rs.)Net sales 9,10,000 7,50,000Gross profit 3,82,000 2,92,500Interest paid 20,000 8,200Income Tax 75,000 5,000Profit after Tax 82,000 56,200Inventories 90,000 65,200Debtors 70,000 56,000Cash 6,000 18,000Current liabilities 1,82,000 1,16,000Long term liability 1,60,000 1,30,000Shareholders equity 1,80,000 1,40,000

2. From the following extract of a balance sheet of airline company calculate the debt equity ratio and interest coverage ratio. Given that the debt equity ratio is in the range of 10:1,how do u interpret this ratio?50,000,10% preference shares of Ra.100 each 2,00,000 equity shares of Rs.10 each 10%,3,00,000 debentures of Rs.100 each Net profit during the year was Rs.10,00,000.

3.Selected financial information about Siri Traders Limited is given below:

2001 2002Sales

Cost of goods sold

Debtors

Inventories

Cash

Other current assets

Current liabilities

6,00,000

5,70,000

72,000

1,14,000

15,000

40,000

1,60,000

4,30,000

3,25,000

30,000

55,000

8,000

27,000

1,10,000 Compute the current ratio, quick ratio, debt collection period and inventory turnover ratios for

the above two years and comment on the results.

4.The following are the extracts from the financial statements of Blue and Red Ltd. As on 31st March 2001 and 2002 respectively.

31st March 2001 (Rs.)

31st March 2002 (Rs.)

Stock

Debtors

Bills receivables

Cash in hand

Bills payable

Bank overdraft

9% debentures

Sales for the year

10,000

20,000

10,000

18,000

15,000

----

5,00,000

3,50,000

25,000

20,000

5,000

15,000

20,000

2,000

5,00,000

3,00,000

Gross profit 70,000 50,000 Compute for both the years the following.

a) Current ratio.b) Liquidity ratio.c) Stock turnover ratio. Also interpret the results.

5. The summarized balance sheet of Alpha Ltd,as on 31st March 2000,2001 and 2002 is given below.

As on March 31st

2000 2001 (Rs.in lakhs) 2002 (Rs. In lakhs)Liabilities:Paid up capitalBorrowing long term

i. Bonds ii. Others

Current liabilities

194

6828152----595

194

9734354---688

194

12437999---796

Assets:Gross BlockLess depreciation

Net BlockCurrent AssetsProfit and LossAccount

35569----

286143166

35695----

261199228

361122-----

239234323

Total 595 688 796From the above compute the following as on 31st March 2000 and 2002:

a) Debt to Equity Ratiob) Current Ratio and comment on the results.

6. Following is the Profit and Loss Account and Balance Sheet of Jai Hind Ltd. Calculate the following ratios.

a) Gross Profit Ratio b) Current Ratio c) Liquidity ratio.

Profit and Loss Account

Dr. Cr.

Liabilities Rs. Assets Rs.To Opening stock of finished goods

To opening shock of raw materials

To Purchase of raw materials

To manufacturing Expenses

To administration Expenses

To selling and distribution expenses

To Loss on sale of plant

To Interest on debentures

To Net profit

1,00,000

50,000

3,00,000

1,00,000

50,000

50,000

55,000

10,000

3,85,00011,00,000

By sales

By closing stock of raw materials

By closing stock of finished goodsBy Profit or sale of shares

8,00,000

1,50,000

1,00,000

50,000

11,00,000Balance sheet

Liabilities Rs. Assets Rs.Share Capital:

Equity share capital

Preference share capital

Reserves

Debentures

Sundry creditors

Bills paable

100000

100000

100000

200000

100000

50000650000

Fixed Assets:

Stock of raw materials

Stock of finished goods

Sundry debtors

Bank balance

250000

150000

100000

100000

50000

650000