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Ratio analysis total formulas with ideal ratios (1)
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Transcript of Ratio analysis total formulas with ideal ratios (1)
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Ratio Analysis
G.Krishna
Assoc.Profesor
ICBM-School of Business Excellence
Hyderabad
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Meaning of Ratio Analysis
• It is an analysis of strength and weakness of an organisation by establishing the quantitative relation among the items of Balance Sheet or Income Statement of such an organisation
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Purpose/Importance/Advantages
• Analysis of financial Position• Simplification of Accounting Figures• Assessment of Operational Efficiency• Determining Trends in the long-run• Identification of Strength & Weakness• Taking Remedial Measures• Comparison of Performance
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Limitations of Ratio Analysis
• Based on Historical Data• Change in Real Value of Monetary Unit• No Standard Interpretation• Ignoring Qualitative Aspects• Difference in Accounting Methods make
comparison difficult• Ambiguity in Terms Used
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Classification of Ratios
A. Liquidity Ratios-
B. Solvency Ratios- Leverage
C. Activity Ratios- Turnover
D. Profitability Ratios-
E. Shareholders' Ratios
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Classification of Ratios
What is Liquidity ?
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Classification of Ratios
-Ability to convert as asset to cash quickly
-Assets that can be easily bought & sold without loss.
It is an ratio to know short term solvency of the company
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A. Liquidity Ratios
• Used to study the ability of the organisation in meeting short-term payments or obligations
• Includes:
1) Current Ratio,
2) Acid Test Ratio and
3) Working Capital Turnover Ratio
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1) Current Ratio
• Relation between current assets and current liabilities
• Long Term Sources Financing the Current assets give a stable base for the liquidity of the organisation
• Normally , the ratio should not be less than 2 i.e., the current assets should be double the size of current liabilities
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Measurement of Current Ratio
Current Ratio =
Ideal Ratio : 2:1
bilitiesCurrentLia
etsCurrentAss
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2) Acid Test Ratio/Quick Ratio
• It is the ratio between quick assets and quick liabilities
• Quick assets include current assets except inventory and pre-paid expenses
• Quick liabilities include current liabilities other than bank overdraft
• A 1:1 ratio is healthy• Healthy indicator of cash management
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Measurement of Acid Test Ratio
Acid Test Ratio =
Ideal Ratio; 1:1
litiesQuickLiabi
sQuickAsset
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3) Working Capital Turn-over Ratio
• Shows the efficiency of usage of working capital
• Relation between Sales and Working Capital
• Determination of number of times the working capital is turned over to achieve the maximum profit
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Measurement of Working Capital Turnover Ratio
Higher the ratio is Ideal
lkingCapitaAverageWor
NetSales
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B. Solvency Ratios/Leverage
• Measure long-term liquidity ratio• Reflect the ability of the firm to pay interest
and repayment of loans at due dates on the long-term loans taken
• Avoidance of over-borrowing (over-leverage)
• Avoidance of bankruptcy by maintaining healthy solvency ratios
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What is Leverage ?
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The amount of debt used to finance a firm’s assets
A firm with significantly more debt than equity is considered
to be highly leveraged
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Types of Solvency/ Leverage Ratios
1) Interest Coverage Ratio
2) Debt Ratio
3) Debt-Equity Ratio
4) Capital Gearing Ratio
5) Proprietary Ratio
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1.Interest Coverage Ratio6 is Ideal
TermDebtLongIntereston
TaxInterestofitBefore
&Pr
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2. Debt Ratio (Debt to Total Funds ratio)
rsFundsShareholdeLTDebt
LTDebt
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3) Debt-Equity Ratio
rsFundsShareholde
btLongTermDe
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4) Capital Gearing Ratio
ndeholdersFuEquityShar
curitieseBearingSeFixedIncom
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5) Proprietary RatioNet worth/Total Assets
sTotalAsset
rsFundsShareholde
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C] Activity Ratios/Turnover
1) Inventory Turnover Ratio
2) Debtors Turnover Ratio
3) Average Collection Period
4) Fixed Assets Turnover Ratio
5) Total Assets Turnover Ratio
6) Capital Turnover Ratio
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1) Inventory Turnover Ratio8 is Ideal
ckAverageSto
sSoldCostofGood
ckAverageSto
sSoldCostofGood
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2) Debtor Turnover Ratio
Higher Ratio – or 10-12
torsAverageDeb
sCreditSale
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3) Average Collection Period
overRatioDebtorTurn
monthsaYearday )(12/)sin(365
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4) Fixed Assets Turnover RatioHigher the Ratio is Ideal
setsNetFixedAs
NetSales
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5) Total Assets Turnover Ratio
sTotalAsset
NetSales
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6) Capital Turnover Ratio
TermFundsLong
NetSales
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D] Profitability Ratios
1) Net Profit Ratio
2) Gross Profit Ratio
3) Return on Total Assets
4) Return on Equity
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1) Net Profit Ratio
100Pr
XNetSales
axofitAfterT
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2) Gross Profit Ratio
100Pr
XSales
ofitGross
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3) Return on Total Assets
100Pr
XsTotalAsset
axofitAfterT
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4) Return on Equity
100'
PrX
FundsrsShareholde
axofitAfterT
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E) Shareholders‘ Ratio
1) Earning per Share (EPS)
2) Price-Earning Ratio (PE Ratio)
3) Dividend Yield Ratio
4) Dividend Pay-out Ratio
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1) Earning per Share
uitySharesNumberofEq
axofitAfterTPr
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2) PE Ratio
ShareEarningper
eiceperSharMar Prker
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3) Dividend Yield Ratio
100Pr
XeiceperSharMarket
rShareDividendpe
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4) Dividend Pay-out Ratio
100XShareEarningper
rShareDividendpe
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THANK YOU