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CHAPTER NO- 1
INTRODUCTION

Ratio analysis is an important tool for analyzing financial statement. The

data given in financial statements either balance sheet or profit and loss
account in absolute form is silent or dump and are unable to say anything.
Ratios are relative from financial data and very useful tool to check upon
the efficiency of a firm. Some ratios indicate the trend or progress or
downfall of the business firm.

Definition of 'Ratio Analysis'

A tool used by individuals to conduct a quantitative analysis of information in a
company's financial statements. Ratios are calculated from current year numbers and are then
compared to previous years, other companies, the industry, or even the economy to judge the
performance of the company. Ratio analysis is predominately used by proponents of
fundamental analysis.
There are many ratios that can be calculated from the financial statements pertaining
to a company's performance, activity, financing and liquidity. Some common ratios include
the price-earnings ratio, debt-equity ratio, earnings per share, asset turnover and working
capital.

Ratio analysis is based on different ratios which are calculated from the accounting
data contained in the financial statements. Different ratios are used for different problems.

MEANING OF RATIO:
A financial ratio (or accounting ratio) is a relative magnitude of two selected numerical
values taken from an enterprise's financial statements. Often used in accounting, there are
many standard ratios used to try to evaluate the overall financial condition of a corporation or
other organization. Financial ratios may be used by managers within a firm, by current and
potential shareholders (owners) of a firm, and by a firm's creditors. Financial analysts use
financial ratios to compare the strengths and weaknesses in various companies. [1] If shares in
a company are traded in a financial, the market price of the shares is used in certain financial
ratios.
Ratios can be expressed as a decimal value, such as 0.10, or given as an
equivalent percent value, such as 10%. Some ratios are usually quoted as percentages,
especially ratios that are usually or always less than 1, such as earnings yield, while others are
usually quoted as decimal numbers, especially ratios that are usually more than 1, such as P/E
ratio
1. The ratio refers to the numerical relationship between two variables
2. The relationship between two figures can be established on the basis, of some logical
methods, which is called ratio.
3. Ratio is an assessment of one number in relation to the other.
1. MODE OF EXPRESSION: This is quantitative relationship may be expressed in
either of the following ways Rate, Proportion and Percentage.

NATURE OF RATIO ANALYSIS:

In financial analysis, ratio is used as an index of yardstick for evaluating the financial
position and performance of the firm. It is a technique of analysis and interpretation of
financial statements. Ratio analysis helps in making decisions as it helps establishing
relationship between various ratios and interpret thereon. Ratio analysis helps analysts to
make quantitative judgment about the financial position and performance of the firm. Ratio
analysis involves following steps:
1. Relevant data selection from the financial statements related to the objectives of the
analysis.
2. Calculation of required ratios from the data and presenting them either in pure ratio
form or in percentage.
3. Comparison of derived different ratios with:

i. The ratio of the same concern over a period of years to know upward or downward trend or
static position to help in estimating the future, or
ii. The ratios of another firm in same line, or
iii. The ratios of projected financial statements, or
iv. The ratios of industry average, or

v. The ratios between the departments of the same concern assessing either the financial
position or the profitability or both.

IMPORTANCE OR OBJECTIVES OF RATIO ANALYSIS:

With this, we can analyze business's financial position. We also check company's short term
and long term solvency with ratio analysis. Following are the main advantages of ratio
analysis.

1. Aid to measure General efficiency

2. Aid in comparison of financial data
3. Financial forecasting
4. Aid in planning
5. Facilitate decision making
6. To test profitability
7. To test solvency positions
8. Aid in Intra firm comparison
9. Taking investment decision
10. Effective tool for management
11. Act as a good communication
12. To achieve desired co-ordination

Helpful in Decision Making

All our financial statements are made for providing information. But this information is not
helpful for decision making because financial statements provide only raw information.
When we calculate different ratios in ratio analysis, at that time, we get useful information.

Helpful in Communication
Ratio analyses are more important from communication point of view. Suppose, we have to
appoint new sales agents for our company, at that time, we can communicate them by using
our company's sales and profit related ratios. There is no need of hi-tech for understanding
the meaning of any specific ratio. For example, our gross profit in 2010 is 26.6% and in 2011,
it is 28.55%. By just telling this ratio, we can understand whether our company is growing or
falling.

Helpful in Co-ordination
No company has all the strength points. Company's financial results show some strength
points and some weak points. Ratio analysis can create co-ordination between strength points
and weak points.

Helps in Control
Ratio analysis can also use for controlling our business. We can easily create the standard of
each financial item of our balance sheet and profit and loss account. On this basis, we can
also calculate standard ratios. By comparing standard ratios with actual accounting ratios, we
can find variance. This variance may be favorable and unfavorable. On this basis, we can
control our business from financial point of view.

LIMITATIONS OF RATIO ANALYSIS:

1. A single ratio in itself is not important or has limited value because trend is more
2.
3.
4.
5.
6.

significant in the analysis

A simple ratio would not be able to convey anything
Lack of proper standard
Differences in definitions
Effect of personal opinion
Ratios may make the comparative study complicated and misleading an account of

changes in price level.

7. Ratio analysis is one of the many techniques of analysis and interpretation
8. Ratio become meaningless if detached from the details from which they are derived.
9. Ratios are computed on the basis of past data. past is not an indicator of future
10. Ratio analysis is not a substitute for sound judgment.

LIMITED USE OF SINGLE RATIO

Sometime, we cannot compare our ratios with others. For example, we have started new
business and our financial results are not still normal. At that time, our profitability ratio
will have limited use because there is not any past data of profitability ratios.

LACK OF ADEQUATE STANDARDS

We could not make standards of all ratios. For example, we cannot tell what is rule of
them of our net profit ratio because there are lots of factors affect it. In the lack of
adequate standards of ratios, we cannot give exact comment on the basis of ratio analysis.

INHERENT LIMITATION OF FINANCIAL ACCOUNTING

Ratio analysis is just like simplification of financial accounting data. But there are lots of
limitations of financial accounting. All these limitation will be absorbed by ratios. This is
the one of the important limitation of ratio. I can say if base is not good, everything will
be wrong. If there is small portion of poison in milk, its effect will be in everything what
you will make.

PERSONAL BIAS
This is reality, I saw many CAs who waste their time to optimize different ratios by
changing the project financial statements figures for making attractive projects. All these
activities are done for getting loan. So, this will make the drawback of ratio analysis.

CHANGES OF ACCOUNTING PROCEDURES

If accounting procedures will change; our accounting ratio will be changed. At that time,
we cannot compare our current year ratios with our past year ratios. For example, in past
year, we had used LIFO but current year; we are using FIFO for inventory valuation. Due
to this, figures of closing stock will be different. On this basis, if we have calculated
current ratio, it will not be comparable with past current ratio.

RATIOS ARE NOT SUBSTITUTE OF FINANCIAL STATEMENTS

Ratio analysis is important part of financial statements analysis. It can never become a
substitute of financial statements. We just use it with cash flow analysis, fund flow
analysis and other analysis.

WRONG INTERPRETATION
For explaining the effect on company's position with ratios, there is big need of
experience. Wrong interpretation will be helpful for wrong decisions. So, it is limitation
of ratio analysis that it does not explain all the facts, it has to explain. For a new accounts
manager, it may be difficult.

INTERESTED PARTIES OF RATIOS:

Ratio analysis of firms financial statement is of interest to a number of parties, mainly
management, creditors, share holders and investors etc. Parties interested and application of
different ratios in short, are given below:
Parties interested

Application of Ratio

To use

Operating Ratio
Return on capital employed
Stock turnover ratio
Debtors turnover ratio
Solvency Ratio

PROFITABILITY

1 Management

a
b
c
d
e

2 Creditors, Money
lenders and Investors

a Current ratio
b Solvency ratio
c Creditors turnover ratio

LIQUIDITY
OR
SOLVENCY

d Fixed asset ratio

e Asset cover
f Interest cover or Debt service ratio
3 Share holders,
Creditors, Employees,
Government

a
b
c
d
e
f
g

Return on share holders fund

Capital gearing ratio
Dividend cover ratio
Yield rate ratio
Proprietary ratio
Dividend rate ratio
Assets cover of share

1. Profitability ratios:

Gross profit ratio

Net profit ratio
Expense ratio
Operating profit ratio
Return on capital

CAPITAL
STRUCTURE

3. Activity ratios:
Stock turnover
Working capital turnover
Fixed asset turnover
Capital turnover

ACCOUNTING RATIOS:
employed ratio

4. Liquidity ratios:
There 2.
are Earning
several ratios
ratios:which can be computed in a firm for various purposes. In view of the
Current ratio
Dividend ratio
Acid
Test
requirements of the various users of ratios we may classify
them
intoratio
the following five
Earning per share
Debt Equity ratio
Price earning ratio
important categories :-)
Long Term Debt Equity
Pay out ratio
Earning power ratio
Ratio
5. Leverage ratio:

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LIQUIDITY RATIO
1. CURRENT RATIO :
The current ratio is used to evaluate the liquidity, or ability to meet short term debt. High
current ratio are needed for companies that have difficulty borrowing on short term
notice. The generally acceptable current ratio is 2:1. The minimum acceptable current
ratio is 1:1.
Current Ratio = Current Assets/Current Liabilities.
2. Acid Test Ratio :
A stringent test that indicates whether a firm has enough short-term assets to cover its
immediate liabilities without selling inventory. The acid-test ratio is far more strenuous

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than the working capital ratio, primarily because the working capital ratio allows for the
inclusion of inventory assets.
Acid Test Ratio = Current Assets Stock Prepaid Expenses/ Current Liabilities
Bank Overdraft.
3. Debt Equity Ratio :The debt to equity ratio is a financial, liquidity ratio that compares a company's total debt
to total equity. The debt to equity ratio shows the percentage of company financing that
comes from creditors and investors. A higher debt to equity ratio indicates that more
creditor financing (bank loans) is used than investor financing (shareholders).
Debt Equity Ratio = Total Liabilities/Total Equity.
4. Long Term Debt Equity Ratio:LONG-TERM DEBT TO EQUITY expresses the relationship between long-term capital
contributions of creditors as related to that contributed by owners (investors). As opposed
to DEBT TO EQUITY, Long-Term Debt to Equity expresses the degree of protection
provided by the owners for the long-term creditors.
Long Term Debt Equity Ratio = Long Term Liabilities/ Stockholders Equity.

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LIQUIDITY ANALYSIS OF SELECTED INDIAN COMPANIES

1. CURRENT RATIO OF 10 COMPANIES FOR THE YEAR 2013-14

Current Ratio = Current Assets

Current Liabilities
(---- in Rs. Cr. -----)

Tata Motors
Ambuja
Cement

Bajaj auto
Company

= 9,681
16,043

=0.61 : 1

=4,811
3,778

=1.27 : 1

= 4,048
5,082

=0.80 : 1

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Maruti
Suzuki

=7,006
7,872

=0.88: 1

Tech
Mahindra

= 10,347
4,913

=2.11 : 1

Hero
Motocorp.

=2,912
4,497

=0.65 : 1

ACC Ltd

= 3,585
4,436

=0.81 : 1

Shree
Cement

= 2,132
1,539

=1.38 : 1

Bajaj
Finance

= 24,370
4,677

=5.22 : 1

Tata Steel

= 13,604
23,766

=0.57 : 1

COMMENTS :-

Current ratio reflects short term financial position of the company. The standard
current ratio is 2:1. The Current ratio of Bajaj Finance (5.22) is better of all
other companies. The position of current assets of Bajaj Finance is satisfactory

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as compare to above companies to meet the current obligation out of its current
assets.

2. QUICK RATIO OF 10 COMPANIES FOR THE YEAR 2013-14

Liquid Ratio /
Quick Ratio /
Acid Test Ratio

Tata Motors
Ambuja
Cement

Bajaj auto
Company

= Liquid Assets or Quick Assets

Current Liabilities
(---- in Rs. Cr. -----)

= 5,817
16,043

=0.36 : 1

=3,922
3,778

=1.04: 1

= 3,409
5,082

=0.67 : 1

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Maruti
Suzuki

=5,300
7,873

=0.67: 1

Tech
Mahindra

= 10,347
4,913

=2.11 : 1

Hero
Motocorp.

=2,243
4,497

=0.49 : 1

ACC Ltd

= 2,329
4,439

=0.53: 1

Shree
Cement

= 1,323
1,539

=0.86 : 1

Bajaj
Finance

= 24,370
4,677

=5.22 : 1

Tata Steel

= 7,596
23,766

=0.32 : 1

COMMENTS:Liquid ratio is designed to indicate the liquid financial position of an enterprise. The
purpose of liquid ratio is to measures the immediate solvency of the business and indicates
the availability of liquid cash to meet its immediate commitment. Thus the liquidity of
Bajaj Finance (5.22) is more than other companies.

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3. DEBT EQUITY RATIO OF 10 COMPANIES FOR THE YEAR 2013-14

Debt Equity Ratio

= Total Liabilities
Total Equity
(---- in Rs. Cr. -----)

Tata Motors

= 14,515
19,153

=0.76 : 1

= 0019
10,104

=0.03: 1

Bajaj auto
Company

= 0057
9609

=0.05: 1

Maruti
Suzuki

= 1,685
20,978

=0.08: 1

Ambuja
Cement

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Tech
Mahindra

= 0005
9,820

=0.01 : 1

Hero
Motocorp.

=0000
5,599

=0.00 : 1

ACC Ltd

= 0000
8,235

=0.00: 1

Shree
Cement

= 1,078
4,711

Bajaj
Finance

= 15,951
3,991

=4.00 : 1

Tata Steel

= 26,127
61,148

=0.43: 1

=0.23 : 1

COMMENTS:-

Leverage ratio indicating the relative proportion of shareholders'

equity and debt used to finance a company's assets. A low debt to
equity ratio indicates lower risk, because debt holders have less
claims on the company's assets. A debt to equity ratio of 5 means
that debt holders have a 5 times more claim on

assets than

equity holders. A high debt to equity ratio usually means that a

company has been aggressive in financing growth with debt and

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often results in volatile earnings. Thus the Debt Equity Ratio of Bajaj Finance
(4.00) is more than other companies.

1. LONG TERM DEBT EQUITY RATIO OF 10 COMPANIES FOR THE YEAR

2013-14

Long Term Debt Equity Ratio

= Long Term Liabilities

Stockholders Equity

(---- in Rs. Cr. -----)

Tata Motors

= 14,515
19,153

=0.76 : 1

= 0019
10,104

=0.03: 1

Bajaj auto
Company

= 0057
9609

=0.05: 1

Maruti

= 1,685

=0.08: 1

Ambuja
Cement

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Suzuki

20,978

Tech
Mahindra

= 0005
9,820

=0.01 : 1

Hero
Motocorp.

=0000
5,599

=0.00 : 1

ACC Ltd

= 0000
8,235

=0.00: 1

Shree
Cement

= 1,078
4,711

Bajaj
Finance

= 15,951
3,991

=4.00 : 1

Tata Steel

= 26,127
61,148

=0.43: 1

=0.23 : 1