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Financial Statements Analysis is an analysis which critically examines the relationship between
various elements of the Financial Statements. It focuses on the evaluation of past operations as
revealed by the analysis of basic statements. It is a process of scanning Financial Statements for
evaluating the relationship between the items as disclosed in these. It is an important means of
assessing past performance and forecasting and planning future performance. The analysis
simplifies, summarizes and systematizes the monotonous figures.
MEANING OF RATIO ANALYSIS
Analysis of Financial Statements with the help of Ratio is termed as Ratio Analysis. Ratio
Analysis is a widely used tool of Financial Analysis. It can be used to compare the risk and
return relationships of firms of different sizes. It is defined as the systematic use of ratio to
interpret the Financial Statements so that the strengths and weaknesses of a firm as well as its
historical performance and current financial condition can be determined.
4.3 OBJECTIVES OF RATIO ANALYSIS
Following are the important objectives of Ratio Analysis
1) To provide the necessary basis for Inter-period and Inter-firm Comparison.
2) To help in providing a part of information needed in the process of decision-making.
3) To focus on facts on a comparative basis and facilitate drawing of conclusions relating to the
performance of a firm.
4) To evaluate the performance of a firm in determining the important aspects of a business
such as liquidity, solvency, operational efficiency, overall profitability capital gearing, etc.
5) To throw light on the degree of efficiency in the management and the effectiveness in the
utilization of its assets.
6) To provide the way for effective control of the enterprise in the matter of achieving the
physical and monetary targets.
7) To help management in discharging its basic functions like forecasting, planning, coordination, communication, control, etc.
8) To promote co-ordination among the departments and the staff by the study of performance
and efficiency of each department.
9) To point out the financial condition of business whether it is strong, questionable, or poor
and enables the management to take necessary steps.
10) To act as an index of the efficiency of an enterprise.
4.4 CLASSIFICATION OF RATIOS
Accounting Ratios may be classified as under
Traditional Ratios
Functional Ratios
Traditional Ratios
Traditional Accounting Ratios are classified on the basis of the origin of the figures used in the
accounting ratios, i.e. on the basis of the Financial Statements from which ratios are derived. The
following ratios are usually included in this type of classification.
Balance Sheet Ratios or Financial Ratios
Ratios calculated from the different items as appearing in the Balance Sheet of a concern
are called Balance Sheet Ratios, e.g. Current Ratio, Liquid Ratio, Proprietary Ratio, Debt-equity
Ratio, and so on.
Profit & Loss Account Ratios or Operating Ratios
Ratios calculated from the different items as appearing in the Profit & Loss Account of a
concern are called Profit & Loss Account Ratios or operating Ratio, e.g. Gross Profit Ratio, Net
Profit Ratio, Operating Ratio.
Mixed Ratios or Composite Ratios
Ratios calculated, taking some items as appearing in the Balance Sheet and taking some
items as appearing in Profit & Loss Account, are called Mixed Ratios or Composite Ratios, e.g.
Return on Net Worth, Return on Investment (ROI), Capital Turnover Ratio, etc.
FUNCTIONAL RATIOS
The other way of classifying the ratios in on the basis of functions they perform, what they
indicate, symptoms or characteristics, namely, liquidity, profitability, financial stability and
turnover relationship, etc. This classification assumes greater significance because it distinctly
the different aspects of business performance and helps the various users of Financial Statements
to take guard of their interest. For instance, short-term creditors are interested to evaluate the
liquidity position by analyzing the liquidity ratios, while long-term creditors and investors are
interested in the solvency and profitability position of the organization and as such they study the
solvency and profitability ratios. The following ratios are included in this classification.
1) Liquidity Ratios
2) Leverage Ratios
3) Profitability Ratios
4) Activity/Efficiency Ratios
Liquidity Ratios
Liquidity Ratios are those ratios which are computed to evaluate the capacity of the
company to pay off its short-term liabilities. These ratios indicate the short-term financial
position of the company by relating short-term resources with short-term obligations. These
ratios are basically used by the short-term creditors, viz. suppliers, bankers, lenders, employees
and all others who are interested in the recovery of money due to them. Short-term creditors
focus their attention on the liquidity of the company.
The most common ratios which indicate the extent of liquidity or lack of it are as follows:
Current Ratio
This ratio is also called Working Capital Ratio. It is used to assess the short-term financial
position of the business concern. In other words, it is a measure of the companys short-term
solvency, i.e. its ability to meet its short-term obligations. It matches the total current assets of
the company against its current liabilities.
As a measure of short-term solvency, it indicates the rupees of current assets available for
each rupee of current liability. Apparently, the higher the current ratio, the more protected are the
short-term creditors and vice -versa. Conventionally, a current ratio of 2:1 (current assets twice
of current liabilities) is satisfactory. The Formula for computation of current ratio is given
below:
Current Assets
Where,
Current Assets
Current Assets
Current Liablities
Prepaid Expenses.
Current Liabilities = Creditors + Bills Payable + Bank Overdraft + Provision for Taxation
2005-06
CURRENT
CURRENT
CURRENT
ASSETS
LIABILITIES
RATIO
34,534.03
12,434.02
2.78
2006-07
19,612.14
7,816.77
2.51
2007-08
27,933.61
18,900.97
1.48
2008-09
23,712.52
9,292.14
2.55
2009-10
18,690.25
9,453.41
1.98
2010-11
29,196.75
10,345.30
2.82
CURRENT RATIO
3
2.5
2
1.5
RATIOS 0.51
0
YEARS
Although KSFC has better short-term solvency position, a higher current ratio of more
than 2:1 may be regarded as an inefficient working capital management. Therefore, it should
have a reasonable current ratio.
Super Quick Ratio:
This ratio is also called, Cash Position Ratio or Cash Ratio or Absolute Liquidity
Ratio. This ratio establishes the relationship between super quick assets and current liabilities. It
may be used by banks and financial institutions who are very much interested in lending shortterm loans to companies for a period of not more than three months. Generally, an absolute liquid
ratio of 0.5:1 is considered as an ideal ratio. This ratio is computed with the help of the following
formula.
Super-Quick Ratio
Where,
Super Quick Assets = Cash in Hand + Cash at Bank + Marketable Securities
TABLE 4.2 Showing Super Quick Ratio of KSFC:
(Rs. In Lakhs)
YEAR
SUPER QUICK
CURRENT
SUPER QUICK
ASSETS
LIABILITIES
RATIO
2005-06
11,563.87
12,434.02
0.93
2006-07
4,871.07
7,816.77
0.62
2007-08
4,995.99
18,900.97
0.26
2008-09
6,498.37
9,292.14
0.7
2009-10
6,979.35
9,453.41
0.74
2010-11
3,651.58
10,345.30
0.35
YEARS
relationship between borrowed funds and owners capital. These ratios are computed from the
Balance Sheet and reflect the relative / stake of owners and creditors in financing the assets of
the firm. In other words, such ratios reflect the safety margin to the long-term creditors. The
second category of such ratios is based on the Income Statement and shows the number of times
the fixed obligations are covered by earnings before interest and taxes. In other words, they
indicate the extent to which a fall in operating profits is tolerable in that the ability to repay
would not be adversely affected.
Following are some important leverage ratios
Debt to Equity Ratio
The relationship between borrowed funds and owners capital is a popular measure of the
long-term financial solvency of a firm. This relationship is shown by the Debt-Equity Ratio. This
ratio indicates the relative proportions of debt and equity in financing the assets of a firm. It
reveals the extent to which debt financing has been used in the business. It discloses to the
creditors the extent of their in interest being covered by the net worth by the company. It can be
computed by using the following formula.
'
Debt-Equity Ratio
Where,
Total Debt Debentures + Term Loans + Loans on Mortgage + Loans from Financial
= Institutions + Other Long-Term Loans + Redeemable Preference Share
Capital + All Current Liabilities.
Shareholders Funds Equity Share Capital + Irredeemable Preference Share Capital +
= Capital Reserves + Retained Earnings + Any Earmarked Surplus
Like Provision for Contingencies etc. Fictitious Assets
(Goodwill, Preliminary Expenses).
TABLE 4.3 Showing Debt-Equity Ratio of KSFC
(Rs. In Lakhs)
YEAR
TOTAL
SHAREHOLDERS
DEBT-EQUITY
DEBT
' FUNDS
RATIO
2005-06
1,90,155.54
12,892.55
14.75
2006-07
1,73,719.56
12,892.55
13.47
2007-08
1,75,960.85
33,108.24
5.31
2008-09
1,72,155.17
58,054.77
2.97
2009-10
1,76,040.01
70,732.82
2.49
2010-11
1,96,015.74
72,588.68
2.7
DEBT-EQUITY RATIO
20
15
10
RATIOS
5
0
YEARS
Total Debt
Total Tangible assets
Where,
Total Tangible Assets = Total Assets (Goodwill + Preliminary Expenses +
Accumulated Losses)
TABLE 4.4 Showing Debt-Total Tangible Assets Ratio Of KSFC
(Rs. In Lakhs)
YEAR
TOTAL
TOTAL TANGIBLE
DEBT-TOTAL
DEBT
ASSETS
TANGIBLE ASSETS
RATIO
2005-06
1,90,155.54
1,42,720.56
1.33
2006-07
1,73,719.56
1,26,520.87
1.37
2007-08
1,75,960.85
1,55,194.58
1.13
2008-09
1,72,155.17
1,72,351.35
0.99
2009-10
1,76,040.01
1,89,210.39
0.93
2010-11
1,96,015.74
2,13,229.12
0.92
YEARS
Analysis and Interpretation It is observed from the table and the chart that the Debt to Total
Tangible Assets Ratios of KSFC revealed a declining trend during the study period except during
2006-07. The ratio was 1.33 in 2005-06 which signifies that 1.33 rupees of debt is covered by
one rupee of tangible assets. This is undesirable from the point of creditors/lenders as there is no
sufficient margin of safety available to them. There was a slight increase in the ratio in 2006-07.
However, the mid and lower part of the study period revealed an altogether downward trend in
the ratio values. This is a welcome change as the margin of safety available to the
creditors/lenders has increased over the years.
On the whole, there have been desirable changes in the ratio values from the perspective of
creditors/lenders. However, the debt holders are still at high risk because of low margin of safety.
Proprietary Ratio
This ratio is called Equity Ratio or Owners Fund Ratio or Shareholders Equity Ratio. This
ratio points out the relationship between the shareholders funds and total tangible assets. In other
words, it indicates the proportion of total assets financed by owners. The formula for this ratio
may be written as follows:
'
Proprietary Ratio
Shareholder s Funds
100
Total Tangible Assets
TOTAL TANGIBLE
PROPRIETARY
FUNDS
ASSETS
RATIO (%)
2005-06
12,892.55
1,42,720.56
2006-07
12,892.55
1,26,520.87
10.2
2007-08
33,108.24
1,55,194.58
21.3
2008-09
58,054.77
1,72,351.35
33.7
2009-10
70,732.82
1,89,210.39
37.4
2010-11
72,588.68
2,13,229.12
34
YEAR
PROPRIETARY RATIO
40
30
20
RATIOS 10
0
YEARS
Analysis and Interpretation
The Proprietary Ratios of KSFC over a period of six years are presented in tabular and
graphical form. The Proprietary Ratio of KSFC was 9% in 2005-06 which indicates that
shareholders funds form only 9% of total tangible assets employed in the business. From
creditors point of view, it is alarming for them because it indicates more of creditors funds and
less of shareholders funds in the total tangible assets of the company.
A marginal increase in Proprietary Ratio was registered in the next year. A significant
rise in Proprietary Ratio was seen from 9% in 2005-06 to 37.4 % in 2009-10. This rise was partly
due to increase in the amount of reserves and surplus and the issue of additional share capital The
rise in the ratio implies corresponding increase in the security to the creditors as more
shareholders funds are available as safety of margin. Thereafter, the ratio declined to 34%.
The analysis of these figures reveals that there has been appreciable improvement in the
Proprietary Ratio of KSFC during the period of study. However, creditors are still exposed to
more risk. Usually, a Proprietary Ratio of 50% is regarded as safe.
Fixed Assets to Proprietors Funds Ratio
This is also known as Fixed Assets to Net Worth Ratio. It establishes the relationship
between fixed assets and shareholders funds. The main object of calculating this ratio is to
ascertain the percentage of owners funds invested in fixed assets. This is an indicator of the
efficiency of the management regarding formulation of financial planning. It can be calculated as
follows:
Fixed Assets to Proprietors funds Ratio
Where,
Assets
100
Shareholder s ' Funds
FIXED
SHAREHOLDERS'
ASSETS
FUNDS
2005-06
821.85
12,892.55
6.37
2006-07
748.21
12,892.55
5.80
2007-08
6155.17
33,108.24
18.59
2008-09
6094.41
58,054.77
10.50
2009-10
6011.58
70,732.82
8.50
2010-11
5280.52
72,588.68
7.27
5.00
0.00
YEARS
A ratio of 6.37% implies that 6.37% of shareholders funds are sunk into the fixed assets
which constitute the revenue earning capacity of a business. There was a dip in the ratio in the
next year. This was mainly due to the decrease in the value of fixed assets. The Ratio increased
to 18.59 in 2007-08 which was the highest during the study period. In the last three years, the
value of fixed value decreased as a result of which there was also a decline in the ratio.
On the whole, the Corporation has used very less amount of shareholders funds in
making investment in the fixed assets especially in the latter part of the study period.
Capital Gearing Ratio
This ratio is also known as Capital Structure Ratio or Leverage Ratio. It is used to analyze
capital structure of the company. It establishes the relationship between fixed interest, dividend
bearing securities and equity shareholders funds. It is an indicator of the degree of risk involved
in the total capital employed in the business. It can be calculated as follows:
Interest Dividend bearing Funds
Capital Gearing Ratio =
Equity Shareholder s ' Funds
Where,
Fixed Interest and Dividend bearing Funds = Preference Share Capital + Debentures +
Long-Term Loans
Equity Shareholders Funds = Equity Share Capital + Reserves and Surplus {Goodwill
+ Preliminary Expenses + Profit and Loss A/c (Dr.)}.
TABLE 4.7 Showing Capital Gearing Ratio of KSFC
(Rs. in Lakhs)
YEAR
EQUITY
CAPITAL
SHAREHOLDERS' FUNDS
GEARING
RATIO
2005-06
1,77,726.52
12,892.55
13.79
2006-07
1,66,147.79
12,892.55
12.89
2007-08
1,57,059.88
33,108.24
4.74
2008-09
1,62,872.03
58,054.77
2.81
2009-10
1,66,586.60
70,732.82
2.36
2010-11
1,85,670.44
72,588.68
2.56
RATIOS
16
14
12
10
8
6
4
2
0
YEARS
Where,
EBIT or PBIT = Earnings or Profits before Interest and Taxes
TABLE 4.8 Showing Interest Coverage Ratio of KSFC
(Rs. in Lakhs)
YEAR
EBIT
FIXED INTREST
INTEREST
CHARGES
COVERAGE RATIO
2005-06
17,676.17
16,780.62
1.05
2006-07
15,886.75
14110.66
1.13
2007-08
20,453.21
13,634.01
1.50
2008-09
13,127.48
16,667.20
0.79
2009-10
15,246.00
13,706.49
1.11
2010-11
17,729.21
14,391.03
1.23
RATIOS
1.60
1.40
1.20
1.00
0.80
0.60
0.40
0.20
0.00
YEARS
charges. It does not provide a sufficient margin of safety to the debt holders because even a slight
decline in its earnings would hamper KSFCs ability to offer assured payment of interest to the
lenders.
The further analysis of the figures reveals that Interest Coverage Ratio remained at or below
1.50:1. The highest ratio was 1.50:1 which occurred in 2007-08 and the lowest was 0.79:1 which
occurred in 2008-09. This was the year when KSFC incurred loss. On the whole, it can be said
that earnings available to the lenders are not sufficient. Usually a coverage of six to seven times
is desirable from lenders point of view.
PROFITABILITY RATIOS
Profit is the difference between revenue and expenditure over a period of time. It refers to
the absolute quantum of profits, whereas profitability refers to the ability to earn profits.
Profitability ratios are the ratios which are computed to evaluate the performance and efficiency
of the business concern. Profitability Ratios are used by the management, owners, creditors and
employees. Equity shareholders employ these ratios because they are very much interested in
knowing capital appreciation of their investment and dividend per share. Management employs
profitability ratios to assess the operational performance of the business concern. They are used
by the creditors to ascertain the margin of safety available to them. Profitability ratios are the test
of wages and fringe benefits to the employees. Following are the important profitability ratios:
Return on Assets (ROA)
Here, the profitability ratio is measured in terms of the relationship of between net
profits and assets. The ROA may also be called profit to assets ratio. It is calculated to measure
the productivity of total assets. It is calculated using the following formula:
Return on Assets =
The term fictitious assets include preliminary expenses, deferred revenue expenditure, discount
on issue of shares and debentures, debit balance of Profit and Loss Account and other losses
shown on the assets side of the Balance Sheet.
TABLE 4.9 Showing Return on Assets of KSFC
(Rs. in Lakhs)
YEAR
TOTAL TANGIBLE
RETURN ON
ASSETS
ASSETS
2005-06
526.17
1,42,720.56
0.36
2006-07
1295.37
1,26,520.87
1.02
2007-08
6216.74
1,55,194.58
4.01
2008-09
-3984.09
1,72,351.35
(-2.31)
2009-10
296.15
1,89,210.39
0.15
2010-11
2187.14
2,13,229.12
1.03
YEARS
The analysis of the ratio values reveals that the income generated by the tangible
assets has been very modest during the study period. In other words, the investment made in
tangible assets is not justified by the amount of income generated.
Return on Investment
Return on Investment is also known as Return on Capital Employed or Overall
Profitability Ratio. It is calculated by establishing the relationship between the operating profit
earned and capital employed. It is an indicator of the earning capacity of the capital invested in
the business. It shows efficiency of the business as a whole. This ratio is calculated by using the
following formula:
Return on Investment =
Operating Profits
100
Capital Employed
Where,
Capital Employed = Equity Share Capital + Preference Share Capital + Reserves and
Surplus + Debentures and Long-Term Loans (Fictitious Assets +
Intangible Assets + Investments outside the Business).
(Or)
Capital Employed = Proprietors Funds + long-Term Loans.
TABLE 4.10 Showing Return on Investment of KSFC
(Rs. in Lakhs)
YEAR
EBIT
CAPITAL
RETURN ON
EMPLOYED
INVESTMENT
2005-06
17,676.17
1,29,971.29
13.6
2006-07
15,886.75
1,18,579.19
13.4
2007-08
20,453.21
1,20,922.45
16.91
2008-09
13,127.48
1,27,783.65
10.27
2009-10
15,246.00
1,26,877.61
12.02
2010-11
17,729.21
1,56,272.35
11.35
RETURN ON INVESTMENT
20
15
10
RATIOS
5
0
YEARS
ORDINARY
RETURN ON
INTEREST AND
SHAREHOLDERS'
SHAREHOLDERS'
TAX
EQUITY
EQUITY
2005-06
526.17
12,892.55
0.041
2006-07
1295.37
12,892.55
0.100
2007-08
6216.74
33,108.24
0.188
2008-09
-3984.09
58,054.77
-0.069
2009-10
296.15
70,732.82
0.004
2010-11
2187.14
72,588.68
0.030
EPS =
EAIT
NO. OF ORDINARY
EARNINGS PER
SHARES OUTSTANDING
SHARE
2005-06
526.17
97,84,550
0.0000538
2006-07
1,295.37
97,84,550
0.0001324
2007-08
6,216.74
97,84,550
0.0006354
2008-09
-3917.39
1,23,05,060
-0.0003184
2009-10
296.15
5,09,05,750
0.0000058
2010-11
2187.14
6,19,05,750
0.0000353
The Earnings per Share values of the KSFC for the study period are depicted in the above table
and chart. It can be observed from the above table and chart that the Corporation is not
maintaining the EPS uniformly and at a higher level during the study period. This is mainly due
to negative or low income generated in certain years. The Corporation is not able to generate
even one rupee per share. The income generated is not justifying the contribution made by the
shareholders. On the whole, the EPS of the Corporation is not considered to be satisfactory.
4.4.2.4 Activity/Efficiency Ratios
Activity ratios make use of purchases and sales while calculating various ratios. But, KSFC is
neither a trading company nor a manufacturing company. Hence, the question of purchases and
sales does not arise in the case of KSFC. Therefore, the activity/efficiency ratios cannot be
calculated for KSFC.