Introduction

The aim of this Activity is to look at some financial data from some businesses and
to use ratio analysis to anlayse their performance and to assess the value of using
ratios in drawing conclusions about business performance.

One of the important aspects of ratio analysis is to know what ratio to use and what
the resulting figure tells you. Some ratios can be used on their own; others need to
be compared with previous years or other companies to make any sense. The most
important thing to remember is that a ratio is not used to demonstrate your
mathematical prowess (or lack of it as the case may be) but to provide you with
some information. All the ratios used are no more difficult that dividing one number
by another or doing a simple bit of multiplication.

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. Security analysts use financial ratios to
compare the strengths and weaknesses in various companies.[1] If shares in a
company are traded in a financial market, 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; these latter are also called multiples. Given any
ratio, one can take its reciprocal; if the ratio was above 1, the reciprocal will be
below 1, and conversely. The reciprocal expresses the same information, but may
be more understandable: for instance, the earnings yield can be compared with bond
yields, while the P/E ratio cannot be: for example, a P/E ratio of 20 corresponds to
an earnings yield of 5%.
Ratio Analysis
Financial ratio analysis is a fascinating topic to study because it can teach us so much about
accounts and businesses. When we use ratio analysis we can work out how profitable a business
is, we can tell if it has enough money to pay its bills and we can even tell whether its
shareholders should be happy!

Ratio analysis can also help us to check whether a business is doing better this year than it was
last year; and it can tell us if our business is doing better or worse than other businesses doing
and selling the same things.

In addition to ratio analysis being part of an accounting and business studies syllabus, it is a
very useful thing to know anyway!
The overall layout of this section is as follows: We will begin by asking the question, What do we want ratio analysis to
tell us? Then, what will we try to do with it? This is the most important question, funnily enough! The answer to that
question then means we need to make a list of all of the ratios we might use: we will list them and give the formula for
each of them.

Once we have discovered all of the ratios that we can use we need to know how to use them, who might use them and
what for and how will it help them to answer the question we asked at the beginning?

At this stage we will have an overall picture of what ratio analysis is, who uses it and the ratios they need to be able to use
it. All that's left to do then is to use the ratios; and we will do that step- by-step, one by one.

The term "accounting ratios" is used to describe significant relationship between figures shown
on a balance sheet, in a profit and loss account, in a budgetary control system or in any other
part of accounting organization. Accounting ratios thus shows the relationship between
accounting data.

Ratios can be found out by dividing one number by another number. Ratios show how one
number is related to another. It may be expressed in the form of co-efficient, percentage,
proportion, or rate. For example the current assets and current liabilities of a business on a
particular date are $200,000 and $100,000 respectively. The ratio of current assets and current
liabilities could be expressed as 2 (i.e. 200,000 / 100,000) or 200 percent or it can be expressed
as 2:1 i.e., the current assets are two times the current liabilities. Ratio sometimes is expressed
in the form of rate. For instance, the ratio between two numerical facts, usually over a period of
time, e.g. stock turnover is three times a year.
What do we want ratio analysis to tell us?
The key question in ratio analysis isn't only to get the right answer: for example, to be able to say that a
business's profit is 10% of turnover. We have to start working on ratio analysis with the following question in
our heads:

What are we trying to find out?

Isn't this just blether, won't the exam just ask me to tell them that profit is 10% of turnover? Well, yes, but then
they want to know that you are a good student who understands what it means to say that profit is 10% of
turnover.

We can use ratio analysis to try to tell us whether the business

1. is profitable
2. has enough money to pay its bills
3. could be paying its employees higher wages
4. is paying its share of tax
5. is using its assets efficiently
6. has a gearing problem
7. is a candidate for being bought by another company or investor

and more, once we have decided what we want to know then we can decide which ratios we need to use to
answer the question or solve the problem facing us.

There are ratios that will help us with question 1, but that wouldn't help us with question 2; and ratios that are
good for question 5 but not for question 4 - we'll see!
The Ratios

We can simply make a list of the ratios we can use here but it's much better to put them into different categories.
If we look at the questions in the previous section, we can see that we talked about profits, having enough cash,
efficiently using assets - we can put our ratios into categories that are designed exactly to help us to answer
these questions. The categories we want to use, section by section, are:

1. Profitability: has the business made a good profit compared to its turnover?
2. Return Ratios: compared to its assets and capital employed, has the business made a good profit?
3. Liquidity: does the business have enough money to pay its bills?
4. Asset Usage or Activity: how has the business used its fixed and current assets?
5. Gearing: does the company have a lot of debt or is it financed mainly by shares?
6. Investor or Shareholder

Not everyone needs to use all of the ratios we can put in these categories so the table that we present at the start
of each section is in two columns: basic and additional.

The basic ratios are those that everyone should use in these categories whenever we are asked a question about
them. We can use the additional ratios when we have to analyse a business in more detail or when we want to
show someone that we have really thought carefully about a problem.

Users of Accounting Information

Now we know the kinds of questions we need to ask and we know the ratios available to us, we need to know
who might ask all of these questions! This is an important issue because the person asking the question will
normally need to know something particular.

Of course, anyone can read and ask questions about the accounts of a business; but in the same way that we can
put the ratios into groups, we should put readers and users of accounts into convenient groups, too: let's look at
that now.

The list of categories of readers and users of accounts includes the following people and groups of people:

• Investors
• Lenders
• Managers of the organisation
• Employees
• Suppliers and other trade creditors
• Customers
• Governments and their agencies
• Public
• Financial analysts
• Environmental groups
• Researchers: both academic and professional
What do the Users of Accounts Need to Know?
The users of accounts that we have listed will want to know the sorts of things we can see in the table below:
this is not necessarily everything they will ever need to know, but it is a starting point for us to think about the
different needs and questions of different users.

Investors to help them determine whether they should buy shares in the business, hold on to the
shares they already own or sell the shares they already own. They also want to assess
the ability of the business to pay dividends.
Lenders to determine whether their loans and interest will be paid when due
Managers might need segmental and total information to see how they fit into the overall picture
Employees information about the stability and profitability of their employers to assess the ability
of the business to provide remuneration, retirement benefits and employment
opportunities
Suppliers and other businesses supplying goods and materials to other businesses will read their accounts to
trade creditors see that they don't have problems: after all, any supplier wants to know if his customers
are going to pay their bills!
Customers the continuance of a business, especially when they have a long term involvement with,
or are dependent on, the business
Governments and the allocation of resources and, therefore, the activities of business. To regulate the
their agencies activities of business, determine taxation policies and as the basis for national income
and similar statistics
Local community Financial statements may assist the public by providing information about the trends and
recent developments in the prosperity of the business and the range of its activities as
they affect their area
Financial analysts they need to know, for example, the accounting concepts employed for inventories,
depreciation, bad debts and so on
Environmental many organisations now publish reports specifically aimed at informing us about how
groups they are working to keep their environment clean.
Researchers researchers' demands cover a very wide range of lines of enquiry ranging from detailed
statistical analysis of the income statement and balance sheet data extending over many
years to the qualitative analysis of the wording of the statements
Which ratios will each of these groups be interested in?
On this page you should complete the table below (you can do this by printing it out). In the left hand column
there is a list of interest groups one by one. Your job is to complete the right hand column by giving two or
three examples of ratios they might be interested in.

When you've filled in the gaps you will appreciate that it gives us some ideas about the ratios that each of the
users we have identified would be interested in looking at.

Interest Group Ratios to watch

Investors Return on Capital Employed

Lenders Gearing ratios

Managers Profitability ratios

Employees Return on Capital Employed

Suppliers and other trade creditors Liquidity

Customers Profitability

Governments and their agencies Profitability

Local Community This could be a long and interesting list

Financial analysts Possibly all ratios

Environmental groups Expenditure on anti-pollution measures

Researchers Depends on the nature of their study

Advantages of Ratios Analysis:

Ratio analysis is an important and age-old technique of financial analysis. The

following are some of the advantages / Benefits of ratio analysis:

1. Simplifies financial statements: It simplifies the comprehension of financial

statements. Ratios tell the whole story of changes in the financial condition of
the business
2. Facilitates inter-firm comparison: It provides data for inter-firm comparison.
Ratios highlight the factors associated with with successful and unsuccessful
firm. They also reveal strong firms and weak firms, overvalued and
undervalued firms.
3. Helps in planning: It helps in planning and forecasting. Ratios can assist
management, in its basic functions of forecasting. Planning, co-ordination,
control and communications.
4. Makes inter-firm comparison possible: Ratios analysis also makes possible
comparison of the performance of different divisions of the firm. The ratios
are helpful in deciding about their efficiency or otherwise in the past and
likely performance in the future.
5. Help in investment decisions: It helps in investment decisions in the case of
investors and lending decisions in the case of bankers etc.
Limitations of Ratios Analysis:

The ratios analysis is one of the most powerful tools of financial management.
Though ratios are simple to calculate and easy to understand, they suffer from
serious limitations.

1. Limitations of financial statements: Ratios are based only on the information

which has been recorded in the financial statements. Financial statements
themselves are subject to several limitations. Thus ratios derived, there from,
are also subject to those limitations. For example, non-financial changes
though important for the business are not relevant by the financial statements.
Financial statements are affected to a very great extent by accounting
conventions and concepts. Personal judgment plays a great part in determining
the figures for financial statements.
2. Comparative study required: Ratios are useful in judging the efficiency of the
business only when they are compared with past results of the business.
However, such a comparison only provide glimpse of the past performance
and forecasts for future may not prove correct since several other factors like
market conditions, management policies, etc. may affect the future operations.
3. Ratios alone are not adequate: Ratios are only indicators, they cannot be taken
as final regarding good or bad financial position of the business. Other things
have also to be seen.
4. Problems of price level changes: A change in price level can affect the
validity of ratios calculated for different time periods. In such a case the ratio
analysis may not clearly indicate the trend in solvency and profitability of the
company. The financial statements, therefore, be adjusted keeping in view the
price level changes if a meaningful comparison is to be made through
accounting ratios.
5. Lack of adequate standard: No fixed standard can be laid down for ideal
ratios. There are no well accepted standards or rule of thumb for all ratios
which can be accepted as norm. It renders interpretation of the ratios difficult.
6. Limited use of single ratios: A single ratio, usually, does not convey much of
a sense. To make a better interpretation, a number of ratios have to be
calculated which is likely to confuse the analyst than help him in making any
good decision.
7. Personal bias: Ratios are only means of financial analysis and not an end in
itself. Ratios have to interpreted and different people may interpret the same
ratio in different way.
Liquidity Ratios
Working capital management is concerned with making sure we have exactly the right amount of money and
lines of credit available to the business at all times. In part 1 of our look at working capital management we will
look at the liquidity ratios. Cash is the life-blood of any business, no matter how large or small. If a business has
no cash and no way of getting any cash, it will have to close down. It's that simple! Following on from this we
can see that if a business has no idea of its liquidity and working capital position, it could be in serious trouble.

A liquidity ratio measures a company's ability to pay its bills. The denominator of a liquidity ratio is the
company's current liabilities, i.e., obligations that the company must meet soon, usually within one year. The numerator of
a liquidity ratio is part or all of current assets. Perhaps the most common liquidity ratio is the current ratio, or current
assets/current liabilities. Because current assets are expected to be converted to cash within one year, this liquidity ratio
includes assets and liabilities of equal longevity. The problem with the current ratio as a liquidity ratio is that inventories,
a current asset, may not be converted to cash for several months, while many current liabilities must be paid within 90
days. Thus a more conservative liquidity ratio is the acid test ratio -- (current assets - inventory)/current liabilities -- which
excludes relatively illiquid inventories. The most conservative liquidity ratio is the cash asset ratio or the cash ratio, which
includes only cash and cash equivalents (usually marketable securities) in the numerator. Finally, note that the liquidity
ratio sometimes means the cash ratio.

Liquidity ratios
There are four types of Liquidity Ratios.
Current Ratios
Acid Test Ratio
Cash Ratio
The Current Ratio
The current ratio is also known as the working capital ratio and is normally presented as a real ratio. That is,
the working capital ratio looks like this:

Current Assets: Current Liabilities = x: y eg 1.75: 1

Current ratio measures the company's ability to pay its short-term liabilities from short-term assets.

Current ratio = Current Assets / Current Liabilities

Current Ratio <= 1 Going bankrupt!

1< Current Ratio <= 2 May experience difficulties in facing short term
Commitments.
2< Current Ratio <= 5 Normal, depending on the industry
Standards for companies of similar size and activity.
5< Current Ratio Very little short term debt!

TISCO is our business of choice, so here is the information to help us work out its current ratio.

Consolidated Balance Sheet 31 March 2003 31 March 2004

Rupees Cr. Rupees Cr.
Total Current Assets 2487.43 2151.32

Creditors: Amounts falling due within one year 1917.49 2218.37

As we saw in the brief review of accounts section with Tisco's financial statements, the phrase current
liabilities is the same as Creditors: Amounts falling due within one year.

Current Ratio For TISCO

31 March 2003 Current Assets: Current Liabilities 2487.43: 1917.49 1.30: 1
31 March 2004 Current Assets: Current Liabilities 2151.32: 2218.37 0.97: 1
TISCO Current Ratio (For the year 08-09)
Work through the data for TISCO and calculate their current ratio for the two years for which you have data.

TISCO 31 March 2008 31 March 2009

Consolidated Balance Sheet
Rupees(Cr) Rupees(Cr)
Total Current Assets 3,613.70 5,707.05
Creditors: Amounts falling due within one year 3,855.26 6,039.86

Fill in this table and discuss what you find:

Current Ratio For TISCO

31 March 2008 Current Assets: Current Liabilities 3613.70: 3855.26 .94: 1
31 March 2009 Current Assets: Current Liabilities 5707.05: 6039.86 .944: 1

This additional information might help your analysis.

Current assets 2008 (Rs.cr) 2009 (Rs.cr)

Stock 2047.31 2868.28
Debtors due within one year 543.48 635.98
Stores And Spare Parts 557.67 612.19
Cash at bank and in hand 465.04 1590.60
Intrest accrued on investment 0.20 --
Total Current Assets 3613.70 5707.50
Creditors: Amounts falling due within one year 3855.26 6039.86
Net current assets (liabilities) -241.56 -332.36

TISCO has liquidated, or sold, many of its short-term investments. This business has grown at a very rapid rate
and has possibly used the cash from having sold its investments to finance that expansion. Overall, TISCO has
lost almost £10 billion of working capital as it has fallen from £5.8 billion to -£4.0. This has left TISCO in a
weak working capital position as its creditors are large but its cash and short-term assets balances are small by
comparison.
The Acid Test Ratio
The acid test ratio is also known as the liquid or the quick ratio. The idea behind this ratio is that stocks are
sometimes a problem because they can be difficult to sell or use. That is, even though a supermarket has
thousands of people walking through its doors every day, there are still items on its shelves that don't sell as
quickly as the supermarket would like. Similarly, there are some items that will sell very well.

Nevertheless, there are some businesses whose stocks will sell or be used slowly and if those businesses needed
to sell some of their stocks to try to cover an emergency, they would be disappointed. Engineering companies
can have their materials in stock for as much as 9 months to a year; a greengrocer should have his stocks for no
longer than 4 or 5 days - a good greengrocer anyway.

We'll look at the stock turnover ratio in detail later but here's the acid test ratio for the Carphone Warehouse.

Quick ratio = (Current Assets - inventory) / Current Liabilities

Quick Ratio <= 1 Dangerous Zone. Very low liquidity.

1 < Quick Ratio <= 2 May fail to meet short term commitments
2 < Quick Ratio <= 5 Normal, depending on the industry standards for
Companies of similar size and activity.
5 < Quick Ratio Very little short term debt!

Consolidated Balance Sheet 31 March 2003 31 March 2004

Rupees Cr. Rupees Cr.
Total Current Assets 2487.43 2151.32

Inventory 833.73 922.91

Total 1653.7 1228.41

Creditors: Amounts falling due within one year 1917.49 2218.37

As we saw in the brief review of accounts section with Tisco's financial statements, the phrase current
liabilities is the same as Creditors: Amounts falling due within one year.

Acid Ratio For TISCO

31 March 2003 Current Assets: Current Liabilities 1653.7: 1917.49 0.86: 1
31 March 2004 Current Assets: Current Liabilities 1228.41: 2218.37 0.55: 1
TISCO Acid Ratio (For the year 08-09)
Work through the data for TISCO and calculate their current ratio for the two years for which you have data.

TISCO 31 March 2008 31 March 2009

Consolidated Balance Sheet
Rupees(Cr) Rupees(Cr)
Total Current Assets 3,613.70 5,707.05
Inventory 2,047.31 2,868.28

Total 1566.39 2838.77

Creditors: Amounts falling due within one year 3,855.26 6,039.86

Fill in this table and discuss what you find:

Current Ratio For TISCO

31 March 2008 Current Assets-Inventory: Current Liabilities 1566.39: 3855.26 0.41: 1
31 March 2009 Current Assets-Inventory: Current Liabilities 2838.77: 6039.86 0.47: 1

This additional information might help your analysis.

Current assets 2008 (Rs.cr) 2009 (Rs.cr)

Stock 2047.31 2868.28
Debtors due within one year 543.48 635.98
Stores And Spare Parts 557.67 612.19
Cash at bank and in hand 465.04 1590.60
Intrest accrued on investment 0.20 --
Total Current Assets 3613.70 5707.50
Creditors: Amounts falling due within one year 3855.26 6039.86
Net current assets (liabilities) -241.56 -332.36
The fact that the differences between the current and acid test ratios are not too large tells us that the Carphone
Warehouse stocks are not that large either. The stocks are worth around £52 million in 2001; but since current
assets are £315 million, that's not a huge level of stock holdings.Additionally, the acid test ratio has increased
over the two year period, meaning that the Carphone Warehouse has a stronger liquidity position than it had
before. Normally that is a good thing.

Cash Ratio
The ratio of a company's total cash and cash equivalents to its current liabilities. The cash ratio is most commonly used as
a measure of company liquidity. It can therefore determine if, and how quickly, the company can repay its short-term
debt. A strong cash ratio is useful to creditors when deciding how much debt, if any, they would be willing to extend to
the asking party.

The cash ratio is generally a more conservative look at a company's ability to cover its liabilities than many
other liquidity ratios. This is due to the fact that inventory and accounts receivable are left out of the equation. Since these
two accounts are a large part of many companies, this ratio should not be used in determining company value, but simply
as one factor in determining liquidity.

The cash ratio is the most conservative liquidity ratio. It excludes all current assets except the most liquid: cash
and cash equivalents. The cash ratio is defined as follows:

Cash Ratio = Cash + Marketable Securities

Current Liabilities

The cash ratio is an indication of the firm's ability to pay off its current liabilities if for some reason immediate
payment were demanded.

Consolidated Balance Sheet 31 March 2003 31 March 2004

Rupees Cr. Rupees Cr.
Total Cash 373.12 250.74
Marketable Securities -- --

Total 373.12 250.74

Creditors: Amounts falling due within one year 1917.49 2218.37

As we saw in the brief review of accounts section with Tisco's financial statements, the phrase current
liabilities is the same as Creditors: Amounts falling due within one year.

Cash Ratio For TISCO

31 March 2003 Current Assets: Current Liabilities 373.12: 1917.49 0.19: 1
 31 March 2004 Current Assets: Current Liabilities 250.74: 2218.37 0.11: 1

Cash Ratio (For the year 08-09)

Work through the data for TISCO and calculate their current ratio for the two years for which you have data.

TISCO 31 March 2008 31 March 2009

Consolidated Balance Sheet
Rupees(Cr) Rupees(Cr)
Total Current Assets 465.04 1,590.60
Marketable Security -- --
Total 465.04 1590.60
Creditors: Amounts falling due within one year 3,855.26 6,039.86

Fill in this table and discuss what you find:

Current Ratio For TISCO

31 March 2008 Current Assets-Inventory: Current Liabilities 465.04: 3855.26 0.12: 1
31 March 2009 Current Assets-Inventory: Current Liabilities 1590.60: 6039.86 0.26: 1

This additional information might help your analysis.

Current assets 2008 (Rs.cr) 2009 (Rs.cr)

Stock 2047.31 2868.28
Debtors due within one year 543.48 635.98
Stores And Spare Parts 557.67 612.19
Cash at bank and in hand 465.04 1590.60
Intrest accrued on investment 0.20 --
Marketable Securities -- --
Total Current Assets 3613.70 5707.50
Creditors: Amounts falling due within one year 3855.26 6039.86

No such thing as an Ideal Ratio

It's time to say that whatever you've read about the ideal current ratio being 2:1 and the ideal acid test ratio
being 1: 1 forget it! This is a golden rule ...there's no such thing as an ideal current ratio or acid test ratio ... or
an ideal any other ratio for that matter.

We still need to know whether 0.98: 1 and 1.42: 1 are good results, though.

For the Carphone Warehouse, there has been a major turnaround between the two years as the ratio has
increased from 0.98: 1 to 1.42:1. Look at the accounting information above and you can see that whilst the
business has increased its sales by 59% over the two years, its stocks are almost unchanged; debtors have
increased by 80%, investments by 316% and cash by 166%.

As always, we have to point out that we only have two years' worth of data so any conclusions we can draw
have to be done cautiously.
PROFITABILITY RATIO

A company should earn profit to survive and grow over a long period of time. Profits are
essential, but it will be wrong to assume that every action initiated by the management of the
company should be aimed at maximizing profit, irrespective of concerns for customers,
employees, suppliers or social consequences. It is unfortunate that the word “profit” is looked
upon as a term of abuse since some firm always want to maximize profit at the cost of
employees, customers and society. Except such infrequent cases, it is a fact that sufficient profit
must be earned to sustain the operations of the business to be able to obtain funds from
investors for expansion & growth and to contribute towards the social over heads for the

welfare of the society.

Profit is the difference between revenue and expenses over a period of time (usually one year).
Profit is the ultimate ‘output’ of the company, and it will have no future if it fails to make
sufficient profits. The Profitability ratios are calculated to measure the operating efficiency of
the company. Besides management of the company, creditors and owners are also interested in
the profitability of the firm. Creditors want to get interest and repayment of the principal
regularly. Owners want to get a required rate of return on their investment. This is possible only
when the company earns enough profits.

Generally, two major types of profitability ratios are calculated:

a) Profitability in relation to sales

b) Profitability in relation to investments

How To Calculate Profit:

Profit can be measured in various ways.

A) Gross profit (GP) is the difference between the sales and the
manufacturing cost of the goods sold.

In India a number of companies define gross profit differenty.they defines it as

earnings profit before depreciation, interest and taxes(PBDIT or EBDIT).A number of
multinational companies call this profit or earning measure as earnings before
interest,taxes,depreciation ,and amortization or EBITDA.

The most common measure of profit is Profit after taxes (PAT) OR Net Income (NI),
which is the result of all factors on the firm’s earnings. Taxes are not controllable by
Management. To separate the influence of taxes, therefore, Profit before taxes (PBT) may
be computed. If the Firm profit has to be examined from the point of view of all investors
(Lenders & Owners), the appropriate measure of profit is Operating profit. Operating
profit is equivalent of earnings before interest and taxes (EBIT).

Gross Profit Margin- The first profitability ratio in relation to sales is the gross profit margin. It
is calculated by dividing the gross profit by sales

The Gross Profit Margin reflects the efficiency with which management produces each unit of
product. This ratio indicates the average spread between the cost of goods sold and the sales
revenue.
A high gross profit margin ratio is a sign of good management. A high gross profit margin
relative to the industry average implies that the firm is able to produce at relatively lower costs.
Across margin ratio may increase due to the various factors.

• Higher Sales price and the cost of goods sold remaining constant

• Lower costs of goods sold , sales price remaining constant

• A combination of variation in sales price and costs

A low gross profit margin may reflect high cost of goods sold due to the firm’s inabilkytu to
purchase raw materials at favorable term, inefficient utilization of plant and machinery or
overinvestment in plant and machinery resulting in higher cost of production
NET PROFIT MARGIN

Net profit is obtained when operating expenses, interest and taxes are subtracted from the gross
profit. The net profit margin ratio is measured by dividing profit after tax by sales:

Extract of the Profit and Loss Account for the year ended 31st March, 2004 and 31st March 2009

Particulars FY 2003-04 FY 2008-09

Sale of Products & Services (A) 11,920.96 26,843.73
Less- Excise Duty (B) 1,218.57 2,527.96
Net Sales (A-B) 10,702.39 24,315.77

Particulars FY 2003-04 FY 2008-09

Income 10842.90 24,624.04
Less-
7358.82 15,525.99
(i) Manufacturing and Other Expenses
(ii) Depreciation 625.11 973.40
(iii) Expenditure transferred to Capital &
151.84 343.65
Other Accounts
(iv) Net Finance Charges 122.17 1,152.69
(v) Exceptional Items (Expense)
Profit before Tax 2888.64 7,315.61
Less- Taxes 919.74 2,113.87
Profit after Tax 1746.22 5,201.74
FY 2003-04

= 16.3%

FY 2008-09

= 21.4%

We can conclude that the Company has improved its net profitability from 16.3% in FY 2003-
04 to 21.4% in FY 2008-09.

This information is useful to the shareholders, potential investors as well as Banks and
Financial institutions in analyzing the profitability of the Company.

Net profit margin ratio establishes a relationship between net profit and sales and indicates
management’s efficiency in manufacturing, administering and selling the products. This ratio is
the overall measure of the firm’s ability to turn each rupee sales into net profit. If the net profit
margin is inadequate, the firm will fail to achieve satisfactory returns on shareholders ‘funds.

This ratio indicates the firm’s capacity to withstand adverse economic conditions. A firm with
high net profit margin would be in advantageous position to survive in the face of falling selling
prices, rising cost of production or decling demand for the products. It would be really be
difficult for the low net margin firm to withstand these adversities.

An analyst will be able to interpret the firm’s profitability more meaningfully if he/she
evaluates both the ratio- Gross margin and net margin-jointly.for example if the gross margin
has increases over the year, but if the net profit has either remained constant or declined, or has
not increased has far as the gross margin, it implies that the operating expenses relative to sales
have been increasing. The increasing expenses should be identifies and controlled.
NET MARGIN BASED ON NOPAT:

The profit after-tax (PAT) excludes interest on borrowing. Interest is tax deductible, and
therefore the firm that pays more interest pays less tax. Tax saved on accounts of payment of
interest is called interest tax shield. Thus the conventional measures of net profit margin –PAT
to sales ratio-is affected by the firm’s financing policy.

Where T is the corporate tax rate.EBIT (1-T) is after tax operating profit, assuming the firm has
no debt

Taxes are not controlled by a firm, and also, one may not also know the marginal corporate tax
rate. Therefore the margin ratio may be calculated on before –tax basis

Particulars FY 2003-04 FY 2008-09

Income 10,842.90 24,624.04
Less-
7,358.82 15,525.99
(i)Manufacturing and Other Expenses
(ii) Depreciation 625.11 973.40
(iii) Expenditure transferred to Capital & Other
151.84 343.65
Accounts
Earnings before interest and Tax (EBIT) 2,707.13 7,781.00
Net Sales 10,702.39 24,315.77
FY 2003-04

= 25.3%

FY 2008-09

= 32%
OPERATING EXPENSE RATIO

The operating expense ratio explains the changes in the profit margin (EBIT to sales) ratio.
This ratio is computed by dividing operating expenses, i.e. cost of goods sold plus selling
expenses, general and administrative expenses by sales:

Particulars FY 2003-04 FY 2008-09

Manufacturing and Other Expenses 7,358.82 15,525.99
Less- Expenditure transferred to Capital & Other Accounts 625.11 973.40
Net Manufacturing and Other Expenses/Operating
6,733.71 14,552.59
Expenses
Net Sales 10,702.39 24,315.77
FY 2003-04

= 62.9%

FY 2008-09

= 59.8%

Operating Expense Ratio - This ratio shows the operating expenses of the Company in relation
to its sales.

From the above it can be seen that the Company has reduced its Operating expense from 62.9%
in FY 2003-04 to 59.8% in FY 2008-09. Lower the better
Leverages Ratios:
Ratios indicate the extent to which the firm has financed its assets by
borrowing.The use of debt financing increases posture of the the firm ,the more
extensive the use of debt ,the higher would be the firms leverages ratios and more
risk present in the firm. Some of the leverage ratios are explained below.

A] Debt equity ratio: It is the ratio of total outside liability to owners total fund. In
other words it’s the ratio of amount invested by outsiders to the amount invested by
the owners of business.
Interpretation: The D/E ratio is an important tool of financial analysis to appraise
the financial structure of firm. It has important implications from view point of
creditors, owners and firm itself. A high ratio shows a large share of financing by
the creditors of the firm, a low ratio implies a smaller claim of creditors. The D/E
ratio indicates the margin of safety to the creditors .if for instance the D/E ratio is
1:2 it implies that for every rupee of outside liability, the firm has 2 rupees of
owners capital or the stake of creditors is one half of the owners therefore a safety
margin of 66.67./. available to the creditors of the firm. The firm would be able to
meet the creditors claims even if the value of the assets declines by 66.67./.
conversely if the D/E ratio is 2:1 it implies low safety margin for the creditors. A
high debt equity ratio shows danger signal for the creditors. It means owners are
putting up relatively less money of their own. A high debt equity ratio has equally
serious implication from the firm’s point of view also.
Debt equity ratio: Total debt/equity
As per balance sheet and profit and loss a/c 31st march 2008 and 2009

Year Debt Equity Ratio Long Term Ratio

2008 1.08 1.07
2009 1.34 1.31

Analysis:
DE ratio and long term ratio has increased for both the years. Thus it is not showing
good performance of the company.

B] Interest coverage ratio:

This ratio is a sum of earnings before taxes and interest charged divided by interest
expenditure.
Formula: Ebit/interest
As per balance sheet and profit and loss A/c 2008 and 2009
Year Interest Coverage ratio
2008 8.35
2009 5.71

Analysis:
It actually means firm’s ability to meet its interest obligations. In this case we can
see that interest coverage ratio is deterioting, it means the firm’s ability is reducing.
Activity ratios (Efficiency Ratios):

Definition:

Stock Turn over ratio and Inventory Turn over ratio are the same. This ratio is a
relationship between the cost of goods sold during a particular period of time and
the cost of average inventory during a particular period. It is expressed in number of
times. Stock turn over ratio / Inventory turn over ratio indicates the number of time
the stock has been turned over during the period and evaluates the efficiency with
which a firm is able to manage its inventory. This ratio indicates whether
investment in stock is within proper limit or not.

Components of the Ratio:

The two elements of this ratio are Average inventory and cost of goods sold.

Average inventory is calculated by adding the stock in the beginning and at the and
of the period and dividing it by two.

i.e. (opening stock closing + stock)/2

In case of monthly balances of stock, all the monthly balances are added and the
total is divided by the number of months for which the average is calculated.

Generally, the cost of goods sold may not be known from the published financial
statements. In such circumstances, the inventory turnover ratio may be
calculated by dividing net sales by average inventory at cost. If average
inventory at cost is not known then inventory at selling price may be taken as
the denominator and where the opening inventory is also not known the closing
inventory figure may be taken as the average inventory.
Formula of Stock Turnover/Inventory Turnover Ratio:

The ratio is calculated by dividing the cost of goods sold by the amount of average
stock at cost.

Inventory Turnover Ratio = Average Inventory/COGS*360

Calculate inventory turnover ratio

Calculation:

Inventory Turnover Ratio (ITR) =

Inventory Turnover : Average Inventory/Sale of Products in days.

2003-04= 39 days

2008-09= 43 days

Significance of ITR:

Inventory turnover ratio measures the velocity of conversion of stock into sales.
Usually a high inventory turnover/stock velocity indicates efficient management
of inventory because more frequently the stocks are sold, the lesser amount of
money is required to finance the inventory.

A low inventory turnover ratio indicates an inefficient management of

inventory. A low inventory turnover implies over-investment in inventories, dull
business, poor quality of goods, stock accumulation, accumulation of obsolete and
slow moving goods and low profits as compared to total investment.

The inventory turnover ratio is also an index of profitability, where a high ratio
signifies more profit, a low ratio signifies low profit.
Working Capital Turnover Ratio:

Definition:

Working capital turnover ratio indicates the velocity of the utilization of net
working capital.

This ratio represents the number of times the working capital is turned over in the
course of year and is calculated as follows:

Formula of Working Capital Turnover Ratio:

Following formula is used to calculate working capital turnover ratio

Working Capital Turnover Ratio =

Cost of Sales / Net Working Capital

The components of ratio:

The two components of the ratio are cost of sales and the net working capital. If
the information about cost of sales is not available the figure of sales may be taken
as the numerator.
Calculate working capital turnover ratio

Calculation:

Working Capital Turnover Ratio = Cost of Sales / Net Working Capital

Significance:

The working capital turnover ratio measure the efficiency with which the working
capital is being used by a firm.

A high ratio indicates efficient utilization of working capital and a low ratio
indicates otherwise.

But a very high working capital turnover ratio may also mean lack of sufficient
working capital which is not a good situation.

Fixed Assets Turnover Ratio:

Definition:

Fixed assets turnover ratio is also known as sales to fixed assets ratio. This ratio
measures the efficiency and profit earning capacity of the concern.

Higher the ratio, greater is the intensive utilization of fixed assets. Lower ratio
means under-utilization of fixed assets. The ratio is calculated by using following
formula:

Formula of Fixed Assets Turnover Ratio:

Fixed assets turnover ratio turnover ratio is calculated by the following formula:

Fixed Assets Turnover Ratio = Cost of Sales / Net Fixed Assets