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(Session: 2009-2011)

INTRODUCTION

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RATIO ANALYSIS

Ratio analysis is one of the methods of analyzing financial statements. It implies the process
of computing, determining and presenting the relationship of items of financial statements. It
also involves the comparison and interpretation of ratio to use them for future projections.

Alexander Wall is considered the pioneer of ratio analysis. After pondering upon this for
quite some time he presented a detailed system of ratio analysis in1909. He explained that the
work of interpretation can be made easier by establishing qualitative relationship between the
facts given in the financial statements

MEANING OF RATIO

A ratio is a mathematical relationship between two related items expressed in quantitative


form. When this definition of ratio is explained with reference to the items shown in the
financial statements then it is called as Accounting ratio. Hence, an accounting ratio is
defined a quantitative relationship between two or more items of the financial statements
connected with each other.
This quantitative relationship that is ratio will be expressed in either of the following ways:

a) In Proportion: In this form the amount of two items are being expressed in a common
denominator. The example of this form of expression is the relationship between current
asset and current liabilities as 2:1.
b) In Rate or Times or Coefficient: In this form a quotient obtained by dividing one item
by another item is taken as unit of expression. The example of this form is sales divided
by stocks (say it comes 6); thus 6 times is the ratio between sales and stock. It is
important to note that when the ratio is expressed in this form, it is called as” Turnover”
and is written in “times”.
c) In Percentage: In this form a quotient obtained by dividing one item by another item is
multiplied by hundred and it becomes a percentage form of expression. For example, the
relationship between gross profit and sales as 25%, which is in percentage form.

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UTILITY OR OBJECTIVES OF RATIO

Accounting ratios are the true test of the profitability, efficiency and financial
Soundness of the company. These ratios have the following objectives:

1. Measurement of profitability: We can measure the profitability of the business by


calculating gross profit, net profit, expenses and other ratios. Profitability is the profit
earning capacity of the business.

2. Judging the operational efficiency of the management: The operational efficiency of the
business can be ascertained by calculating operating ratio. The operating ratio shows the
operational cost of the business.

3. Assessing the solvency of the business: we can ascertain whether the firm is solvent or
not by calculating solvency ratios. Solvency ratios show the relationship between liability
and assets.

4. Measuring Short and long term financial position of the company: We can know the
short term and long term position of the business by calculating various ratios. Current
and liquid ratios indicate short-term financial position, whereas debt-equity ratios fixed
asset ratios and proprietary ratios show long-term financial position.

5. Indicator of true efficiency: Financial statements is i.e. trading and profit and loss
account and balance sheet may indicate the amount of profit or the balance of different
accounts but the profitability can be known by analysis of financial statements i.e.
calculation of ratio shows the profit earning capacity of the business.

6. Facilitating comparative analysis of performance: Every promising company has to


compare its present performance with the previous performance and discover the plus and
minus points.

7. Helpful in budgeting & forecasting: Accounting ratios make the figures simple and
intelligible. They simplify, summarize and systematize the long monotonous figures.
Those who do not know accounting can easily understand the ratios. The importance of
the ratios lies in the fact that they provide relationship between different figures.

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SIGNIFICANCE OF RATIO ANALYSIS

The need or significance of ratio analysis arises due to the following facts:

1. Business facts shown in the financial statements do not carry any importance
individually. Their importance lies in the facts that they are inter-related. Hence, there is
need for conclusion to be drawn by their users.

2. Ratio Analysis as a tool for the interpretations of financial statements is also very
significant because ratio help the analyst to have a deep peep into the data neither
significant nor able to be compared. In fact, they are basically dumb. Ratio provides
power to speak. On account of the above facts plus the utility discussed earlier, the use of
ratio analysis has increased considerably.

IMPORTANCE OF RATIO ANALYSIS

1. It helps to understand the efficiency and performance of the company as a whole.

2. Its main purpose is to gain insights into the operating and financial problems confronting
the firm.

3. It helps to identify the trouble or potential trouble spots of the firm. This would impel the
management to investigate those areas more thoroughly.

4. It helps to pinpoint relationship that are not obvious from the financial statements.

5. It helps to highlight the factor responsible for the present state of financial affairs.

6. Ratio analysis helps the shareholders in evaluating the firm’s activities and policies that
affect the profitability, liquidity and ultimately the market price of the shares.

7. They help to examine the adequacy of funds, the solvency of the firm and its ability to
meet the financial obligations as when they become due.

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LIMITATION OF RATIO ANALYSIS

Accounting ratios are insignificant alone. These ratios become meaningful when they are
compared with the previous performance of the firm or with the performance of other firm.
The ratios though indicate profitability, efficiency and financial soundness, but they suffer
from some limitations. These limitations are as follows:

1. False result: Ratios are based upon financial statement. In case, financial statements are
incorrect or the data upon which ratios are based is incorrect, ratios calculated would also
be false and defective. The accounting system itself suffers from much inherent
weakness, so the ratio based upon it cannot be said to be always reliable.

2. Limited comparability: The ratios of one firm cannot always be compared with the
performance of other firm, if uniform accounting polices are not adopted by them. The
difference in the methods of calculation of stock or the method used to record
depreciation on assets will not provide identical data, so they cannot be compared.

3. Absence of standard uniformly accepted terminology: Different meanings are given to a


particular term. Such as some firm take profit before interest and after tax, others may
take profits before interest and tax. Bank overdraft is taken as current liability but some
firm may take it as non -current. The ratios can be comparable only when uniform
terminology is adopted by both the firms.

4. Price level changes affect ratios: The comparability of ratios suffers, if the prices of the
commodities in two year are not the same. Changes in price affect the cost of production,
sales and also the value of the assets. It means that the ratio will be meaningful for
comparison, if the prices do not change.

5. Ignoring qualitative factors: Ratio analysis is the quantitative measurement of the


performance of the business. It ignores the qualitative aspect of the firm, howsoever
important it may be. It shows that ratio is only one –sided approach to measure the
efficiency of the business.

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6. No single standard ratio: There is not a single standard ratio that can indicate the true
performance of the business at all time. Every firm has to work in different situation and
circumstances, so a particular ratio cannot be supported to be standard for everyone.
Strikes, lockouts, floods, wars etc materially affect the performance, so it cannot be
matched with the circumstances in normal days.

7. Misleading results in the absence of absolute data: In the absence of actual data the size
of the business cannot be known. If the gross profit of two firm is 25%, it may be just
possible that the profit of one is Rs2500 and sales I Rs10000 whereas the gross profit and
sales of other firm is Rs 500000 and sales Rs 2000000. Profitability of the two firms is
the same but the business is quite different.

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PRECAUTIONS TO BE TAKEN

Considering the various limitations in respect of ratio analysis following precautions should
be taken before using it as technique for interpretation of financial statements.

1. Ratios are computed on the basis of financial statements. If the statements are reliable,
then only the ratios computed there from will be meaningful. As such, before using the
ratio analysis, the reliability of the financial statements should be confirmed.

2. Ratios should be computed on the basis of inter-related figures which have a cause and
effect relationship. Computation of the ratios on the basis of irrelevant figures may even
lead to wrong conclusions.

3. It should always be remembered that ratios only show symptoms and the indications
given by the ratios can be interpreted correctly only after studying the realities behind the
financial statements.
Illustration: a higher current ratio should be treated as a good sign only after confirming the
fact that there are no non-moving or obsolete stocks or non-recoverable debtors.

4. If possible, the impact of inflationary conditions are changing price level should be taken
into account before computing the ratios. This may be done by using the technique of current
purchasing power or current cost accounting. Incase of inter-firm comparison of ratios,
following propositions should be kept in mind.

• The constituent units should be comparable in terms of size, age, nature of business,
degree of automation, etc.
• The constituent unit must be following similar accounting policies more particularly in
the areas of charging the depreciation and stock valuation.
• There should not be any holding back of any information or data by the constituent units.

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PROCEDURE (STAGES) FOR RATIO ANALYSIS

The following procedure is generally followed, while analyzing the financial statement
through ratio analysis:

1. Arrangement of data.
2. Classification of ratios.
3. Calculation of ratios and their interpretation.

Arrangement of data
Arrangement of data implies the representation of various items of annual accounts after
appropriate reshuffling in the form suitable for analysis and interpretation. No definite
procedure or step may be designed for arranging data; each case may involve different
procedure. However the item should be arranged in such a way that all items needed for
calculating a particular ratio are not only easily available but also are free from any
ambiguity.

Classification of ratios
Classifications of ratios depend upon the objectives for which they are calculated. It may also
depend upon the availability of data. Analysis of financial statement is made with a view to
ascertain the efficiency in financial soundness of the company; as such ratios can be
classified on the basis of profitability, turnover and financial capability. Several significant
structure ratios may be classified from various standpoints. Some of the possible
classification is mentioned below.
Financial ratios are generally classified into five categories. They are as follows:
1. Liquidity Ratio: These ratios reflect the firm’s ability to meet scheduled short time
obligations.
2. Profitability Ratios: These ratios reflect the profitability of the firm.
3. Activity Ratios: These ratios measure how well the various assets are managed.
4. Leverage Ratios: These ratios show how much of the debt has been used to finance the
various investments in different assets.
5. Market Value Ratios: These ratios reflect the market response to the performance of the
company based on the dividend and earning pattern of the concern.
The trend of these ratios tells the story of what has been happening in the firm in recent years.

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CLASSIFICATION OF RATIOS

Liquidity Profitability Activity/ Leverages Market


Value
Ratio Ratio Turnover Ratio Ratio Ratio

1. Current Ratio 1. Gross Profit 1. Inventory 1. Debt Liquidity 1. Price Earning


2. Acid Test Ratio Turnover Ratio Ratio Ratio
Ratio 2. Net Profit 2. Fixed Assets 2. Interest 2. Earning Per
Ratio Turnover Coverage Share
3. Operating Ratio Ratio 3. Earning Yield
Ratio 3. Total Assets 3. Capital Ratio
4. Return on Turnover Gearing 4. Dividend
Equity Ratio Ratio Yield Ratio
5. Return on 4. Creditor 4. Proprietary
Total Assets Turnover Ratio
6. Return on Ratio
Capital 5. Capital
Employed Turnover
Ratio

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CALCULATION & INTERPRETATION OF RATIOS

Test of Liquidity: Liquidity refers to a company‘s ability to meet its current financial
obligations as they arise and thereby remain solvent. Broadly speaking, liquidity is concerned
with the entire conversion cycle of stock into sales, debtors into cash and cash to creditors. If
business operations are successfully managed, stocks will be moving quickly through the
business, generating revenue, which improves the profitability and working capital thereby
maintaining liquidity. If liquidity is stretched, bankruptcy and liquidation would follow. If
creditors lose confidence in the company’s ability to pay, they will cease to extend credit,
thereby putting a further strain on what may already be a serious cash situation. Furthermore,
sales may be lost if the company’s liquidity position prevents the extension of credits to its
customers, and this can add impetus to a downhill slide.

LIQUIDITY RATIOS:

Liquidity ratios measure the extent to which the firm can meet its immediate obligation. They
also reflect the firm’s ability to meet financial contingencies that might arise.

1. Current Ratio: Current Asset


Current Liabilities

This indicates the company’s ability to meet current liabilities as they become due by using
its current assets. This ratio is of importance to suppliers of short term funds, i.e. the banker
and trade creditors. The proportion of each element of current assets is significant, as
company having a high percentage in cash is more liquid than one with a high percentage in
inventories, even though they both have the same current ratio. Each item within both current
assets and current liabilities has a separate significance that is lost in the overall ratio.
However the current ratio groups all current assets together on the assumption that all of them
can be converted into cash within a year.
Standard ratio is 2:1.
Even though, by definition, current assets can be converted into cash within a year, not all
current assets can be transformed into cash in short span of one year. Hence it is better to read

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the current ratio along with the acid test (quick) ratio which excludes the least liquid of the
current assets i.e. inventory. This ratio is described below:

2. Acid test (Quick Ratio): Quick Assets


Immediate Liabilities

Quick assets are defined as current assets net of stock. Whereas immediate liabilities are
current liabilities net of bank overdraft. This gives a more immediate measure of liquidity,
since the need to make sales is not relevant. The quick ratio provides a more conservative
view of liquidity by excluding the least liquid assets. The liquid assets to arrive at this ratio
normally cover the same current liabilities. However, it is possible to exclude bank overdraft
is a continuance finance facility provided by the bankers which need not be paid off
completely at any given time during the continuance of business operations.
Standard ratio is 1:1.

Test of profitability: Profitability ratios focus on the company’s effectiveness at generating


profit. They reflect the operating performance, its riskiness, and the effect of leverages.

PROFITABILITY RATIO:

1.Gross Profit Ratio: This ratio expresses the relationship between gross profit and Sales.
Gross profit is the difference between sales and the cost of good sold. Where, Cost of Goods
sold = Opening Stock + Purchases + Direct Expenses - closing stock.

Gross Profit is critical because it represents the amount of money remaining to pay operating
costs, financing costs, and taxes and to provide for profit. The gross profit margin is the
amount of each rupee of sales left over after paying the cost of goods sold.

Gross Profit Ratio = Gross Profit* 100


Sales
This ratio is an important indicator of profitability, showing the profit potential before
charging financial, administrative and selling expenses.

The gross profit margin is affected by Changes in sales volume.


• Changes in sales price.

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• Changes in the cost of production.
Normally higher ratio is always considered good and serves as an index of high profitability.

2 Net Profit Ratio: Net profit ratio relates net profit to the firm’s sales level, It
indicates what percent of every rupee of sales, the firm was able to convert into profit.
The net profit margin measures the profit that is available from each rupee of sales
after all expenses have been paid, including cost of goods sold, selling, general and
administrative expenses, depreciation, interest and taxes. The formula is as follows:

Net Profit Ratio = Net Profit (after taxes)*100


Sales

In order to calculate this ratio we require Net Profit which can be obtained
from Profit and Loss account by using this formula:

Net Profit = Gross Profit ( + ) Operating & Non operating Incomes


( - ) Operating & Non operating Incomes.

It is a yardstick, which measures the performance of the management. It is guiding ratio for
determining the dividend payout per share .It also determines the market price of the share.

3. Operating Ratio: This is the ratio, which shows the relationship between operating
cost and sales. The operating cost is expressed a percentage of sales. It reveals the amount of
sales required to cover the cost of goods sold plus operating expenses. This ratio is worked
out as follow:

Operating Ratio = Cost of Goods Sold + Operating expenses *100


Sales

Operating expense / incomes. It signifies the operational efficiency of the business. A lower
ratio is an indicative of higher efficiency and higher profitability. Higher This ratio is
complimentary of net profit ratio; subject to the existence of non-Profitability is not always
the indicator of higher operational efficiency; as it may be caused due to existence of non-

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operating incomes also. In such a case, operating ratio, as an index of operational efficiency,
helps to confirm to what extent the business operations have in fact been conducted
efficiently.
4. Return on Equity: Return on equity indicates what kind of rate of return was
earned on the book value of owners equity. The formula would be as follows:

Return on Equity = Net Profit (after taxes)*100


Equity

5. Return on total assets: Return on assets relates net profit to total tangible
assets. It measures how profitably the firm has used its assets.

Return on Assets = Net Profit (after taxes)*100


Total Assets

If the ratio is lower than the industry average, it would mean that the firm is not utilizing its
assets as profitably as many of its competitors. It show whether the investment in fixed assets
is in line with the sales volume; in other words
whether there is excessive investment or inadequate investment in assets. While the return on
assets ratio does crudely reflect how well the firm uses its assets. In total, there are some
difficulties associated with it. In case, a proportion of the total assets are fixed asset and since
book values and market values of fixed assets may be widely divergent, there may be
differences between some firms return on assets simply because of the degrees to which the
fixed assets have been depreciated.

6. Return on Capital Employed: It is a measure of profits as a return on Capital Employed.


It is the rate of net profit (after taxes) as a percentage of capital employed. Capital employed
consists of shareholders funds plus all the long-term loans including debentures. This ratio
indicates the effective use of capital. The ratio is calculated as follows in two different ways

Return on Capital employed = Net Profit (after taxes)*100


Capital Employed

Return on Capital Employed = NPAT + Interest on long term loan


Capital Employed

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It helps to judge whether the returns are adequate in comparison with the capital employed.
The returns generated must sufficiently cover the cost of fund employed. It helps to know
whether the capital has been effectively and gainfully used.
Test of efficiency (Activity Ratio): Activity ratio attempt to measure how
Efficiently the firm is managing its assets. These ratios are called turnover
ratios because they show how rapidly the assets are being converted or rather turned
over into sales. Generally speaking, high turnover ratios are usually are associated with good
asset management and low turnover ratios with poor asset management ratio. There are
several activity ratios, each is directed towards a specific type of asset management.

ACTIVITY/TURNOVER RATIO

1. Inventory turnover ratio: This ratio indicates how well a firm has used inventory to
generate the goods and services that are sold. The inventory turnover is the ratio of the
cost of goods sold to average inventory.

Inventory Turnover Ratio = Cost of goods sold


Average inventory

This measures the speed with which the stock is turned over, hence the efficiency of the
companies operations and whether capital is locked up unnecessarily in large stocks. This
may provide a vital warning signal. A variation is to show the average turnover period. In
terms of days, it can be expressed as follows:

Average turnover period (in days) = Average stock*360 days


Cost of goods sold

The above will then indicate the ‘shelf life’ of the inventory in terms of time period. This
ratio indicates the number of times stock is replenished in a year and resultantly how long on
an average it is held without any movement.

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2. Fixed Assets Turnover Ratio:

This ratio indicates the efficiency in the utilization of fixed assets. The fixed assets turnover
ratio is the sales turnover divided by the fixed assets. This ratio measures how effectively and
productively the firms has used its fixed assets. It indicates how many rupees of sales are
supported by one rupee of fixed assets. the formula is as follows:

Fixed Assets Turnover = Sales turnover


Fixed Assets

Generally speaking, higher than average fixed turnover ratio is indicative of


Better fixed asset management; whereas a lower fixed asset turnover ratio reflects poor fixed
asset management. However, since the book value of fixed assets may be considerably
different than the market value of these assets, the fixed assets turnover ratio may be
deceptively low or high. For example, a firm with a relatively old but serviceable plant where
it has been almost fully depreciated, will have a lower book value of fixed assets than a
similar concern with a new plant and therefore for similar sales levels the older plant will
tend to have a higher fixed assets turnover even though both firms may be utilizing their fixed
assets at about the same level of efficiency.

3. Total Assets Turnover Ratio:


It measures the overall efficiency and performance of the assets employed in business. Total
asset turnover ratio is defined as sales turnover divided by the total assets. It is measure of
firm’s total assets management. It indicates how many rupees of sales are supported by one
rupee of total tangible assets. The formula is as follows:

Total Assets Turnover Ratio = Sales Turnover


Total Asset

Generally speaking, high total assets turnover ratios are supposed to indicate successful assets
management whereas low total assets turnover ratios indicates

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Unsuccessful assets management. It indicates how productive the assets have been used.
However, since total assets turnover is a composite of all the firms tangible assets, both
current and fixed, all the problems associated with the inventory turnover, debtors turnover
ratio and fixed assets turnover ratios are inherent in the total assets turnover ratio.
4. Creditors Turnover Ratio: This ratio indicates the credit period enjoyed from the
creditors. The ratio is calculated as follows :

Creditors Turnover Ratio = Creditors *360 days (12 months)


Credit purchases

A higher turnover ratio may indicate inability to pay creditors on time. It may also mean that the
firm is taking advantage of longer credit from its creditors. A low turnover ratio indicates that
sufficient credit is not being enjoyed or the firm is not taking advantage of the credit facility
offered by the creditors; which may mean increase in working capital requirements and lower
profits.

5. Capital Turnover Ratio: It is the ratio of turnover to capital. It explains how many
times turnover is multiple to capital. It is calculated as follows :

Capital Turnover Ratio = Sales Turnover


Capital

Capital is normally taken as the shareholders funds. It indicates the frequency with which
sales are generated in relation to capital. In other words, it indicates the effective use of
capital.

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Test of Solvency (Leverages Ratio): Leverages ratio indicates the extent to which the firm
has financed its assets by borrowing. The use of debt financing increases the risk of the
firm. The leverage ratios reflect the financial risk posture of the firm. The more extensive
the use of debt, the higher would the firms leverage ratios and more risk present in the firm.
Some of the leverage ratios are explained below:

LEVERAGES RATIO

1. Debt Liquidity Ratio:


This ratio represents the proportion of external equity to internal equity in the capital
structure of the company. It indicates the proportion of the outsider’s money in comparison
with the owner’s stake. Generally, this is taken to be the ratio of the long-term debt to equity.
It can also be taken as the ratio of the total debt to equity. Total debt means both long term
and short term debts. There can be many version of the debt-equity ratio. However we are
restricting to the following two commonly used debt equity ratio:

• Debt Equity Ratio = Long term debt


Equity

• Debt Equity Ratio = Total Debt


Equity
This ratio brings about the safety cushion available to the loan creditors/ third party liability
against their money lent for materials supplied or services rendered on credit to the company.
This ratio indicates the capacity of the concerned to raise loans. It reflects the capital structure
of the firm; what percent of the firm’s capital is in equity and what percent is in debt. In other
words, it reflects the firms financial risk posture.

A high ratio means that the firm has liberally used debt (i.e. borrowings) to finance its assets;
whereas a low ratio means the firm has paid for its assets mainly through equity funds. Too
high ratio indicates excessive use of external funds and therefore exposure to risk. High
proportion of debt increases the risk of insolvency since the fixed burden of interest expenses
are to be paid for even in the periods of low profitability or losses. Too low ratio suggests that

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the management is not taking advantage of opportunities to maximize profits through external
borrowings.
Standard ratio is 2:1.
2. Times interest earned or Interest Coverage Ratio:
This ratio is the sum of the net earnings before taxes and interest charge divided by the
interest expenditure. The formula is as follows:

Interest coverage ratio = Net Earnings before taxes and interest


Interest Charges

It measures how aptly the firm can meet its interest obligations. It is on eof the debt service
ratios. It describes how well and how easily the firm can service its debts and meet its interest
obligations associated with the debt. It indicates how many times the interest charge is
covered by the funds available to meet such interest expenditure. In other words this enables
to measure the ratio of income available to pay interest to the amount of interest itself. The
greater the interest coverage ratio, the better is the ability of the firm to discharge its interest
expense.

3. Capital Gearing Ratio:


Short-term stability is not a sufficient condition for financial strength; stability must continue
and exist into the long term also. This hinges upon the attainment of satisfactory relationship
between the borrowed funds and internal sources of capital. The relationship between the
debt and equity defines a firm’s gearing. A highly geared company being one that has a high
proportion of debt capital. How highly geared a company will hinge critically on its profit
stability. Debt capital imposes a minimum required profit to cover interest payments and if thee
is nothing left after interest, the shareholders will not be rewarded. This ratio is worked out as
follows;

Capital Gearing = Fixed Interest Bearing Securities


Equity Capital

Fixed income bearing securities consists of all those securities where the return in the form of
dividend or interest is fixed and does not increase with increase in earnings i.e. preference
share capital, debentures and long term loans.

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4. Proprietary Ratio:
It is the ratio of the shareholders funds to total tangible assets. It indicates to what extent the
total tangible assets have been financed from shareholders funds. The ratio is calculated as
follows :

Proprietary Ratio = Shareholders Funds


Total Tangible Assets

A low proprietary ratio sends warning signal to the creditor and financiers indicating high
degree of risk in lending money. A high proprietary ratio is indicative of good borrowing
capacity.

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TEST FOR INVESTORS MARKET:

MARKET VALUE RATIO

1. Price Earning Ratio: This ratio highlights the relationship between the market price
of a share and the current earnings per share. The market value, on the other hand is
the value of equity as perceived by investors.

Price / Earning Ratio = Market Price


Earnings per share

The price / earnings ratio is widely used by investors as a general guideline in gauging share
values. Investors increase or decrease the price earnings ratio that they are willing to accept
for a share according to how they view its future prospects. Companies with ample
opportunities for growth generally have high price/earnings ratios, with the opposite being
true for companies with limited growth opportunities.

2. Earnings per share :


The shareholders invest their money with the expectation of getting dividends and capital
appreciation on the shares. Since the earnings form the basis for dividend payment as well as
basis for any future increase in the market price of shares, investors are always interested in
knowing the earnings per share. The competition of earning per share is made by dividing net
income remaining for ordinary shareholders by the number of ordinary shares issued.

Earnings per share = Net profit after taxes – preference dividends


Number of ordinary shares

It indicates the earnings (profits) available to the equity shareholders on per share basis.

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3. Earnings Yield Ratio = Earnings per share


Market price per share

This is the capitalization rate at which the stock market capitalizes the value of current
earnings. It is the reciprocal of the price earnings ratio. The yield is expressed in terms
of the market price of the share. It serves as a guiding ratio for the intended investors.

4. Dividend Yield Ratio = Dividend per Share


Market Price per Share

This ratio shows the prospective investors the effective return, which he can expect on his
proposed investment. This ratio reflects how the dividend income is related to the market
value of share. The rate of dividend is not the same as the effective rate of return. The
effective ratio of return may be higher lowering compared to the rate of dividend, depending
on the market value of share. Hence, it is one of the ratios, which guides the prospective
investor in deciding the investment.

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COMPANY PROFILE

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TAFE is a US$750 million tractor major incorporated in 1960 at Chennai in India, in


collaboration with Massey Ferguson (now owned by AGCO corporation, USA). TAFE
acquired the Eicher tractors business, its engine plant at Alwar and transmissions plant at
Parwanoo through a wholly owned subsidiary “TAFE Motors and Tractors Limited.

A member of the Amalgamations Group of Chennai, this company has four plants
involved in tractor manufacturing at Mandidheep (Bhopal), Kallidaipatti (Madurai),
Doddabalbur (Bangalore) and in Chennai.
Apart from being among the top five tractor manufacturers in the world, TAFE is also
involved in making diesel engines, gears, panel instruments, engineering plastics, hydraulic
pumps, plantations and passenger car distribution through other divisions and wholly owned
subsidiaries.

TAFE Motors and Tractors Limited has, apart from the tractor manufacturing plant at
Mandideep mentioned above, a Diesel Engine plant at Alwar, Rajasthan producing a range of
air cooled and water cooled diesel engines up to 80 HP with plans are on to increase the
product range up to 125 KVA. The Transmissions Division located at Parwanoo in Himachal

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Pradesh produces a range of transmission components both for captive use as well as for sale
to OE manufacturers.

TAFE Access Limited is a wholly owned subsidiary of TAFE involved in the


manufacture and marketing of farm implements, trailers and accessories, distribution of
passenger cars, manufacture of hydraulic pumps and panel instruments to discerning
customers both in India and overseas.
TAFE’s Engineering Plastics Division produces a range of components for the
consumer electronics, IT, white goods and automotive sector and has the distinction of being
awarded Toyota Quality Award.
TAFE’s Power Source Division produces a range of automotive batteries for both 2-
wheeler and 4-wheeler applications for sale through AMCO Batteries Ltd. As well as for sale
directly through a dedicated distribution channel under the brand name of “Speed”.
TAFE, first tractor company to be recognized for strong commitment to excel at CII
-EXIM Bank Award for Excellence.
The commendation to Tractors and Farm Equipment Limited (TAFE), for “Strong
commitment to excel on the journey towards excellence”, was announced at the 15th Quality
Summit conducted by the Confederation of Indian Industry (CII) held at the NIMHANS
auditorium in Bangalore recently. The commendation is based on an independent assessment
of the organization on the basis of specified criteria which include Leadership, Policy &
Strategies, Partnership & resources, Processes, Key results, People Results, Customer results
and Society results.

______________________________________________________________24
(Session: 2009-2011)

VISION –

“To achieve the distinction of the First Choice among the farming community of
India and a Growing Presence in International Markets through setting Leadership
standards of Performance and Customer Care in the Agricultural Machinery
Business.”

CORE VALUES -

Customer satisfaction: We may not be able to wipe the sweat from the customer's brow but
we can certainly put a smile on their face.

Quality in products and services: An uncompromising focus on quality not just in products
but in all that we do.

Human resources: We are not just individuals doing our respective jobs. We are partners in
progress. Our people matter.

Proactive response to change: We create value by anticipating, preparing and facing


changes in a world where the only thing that is permanent, is change itself.

Environment and society: While serving our company, we don't forget our commitment to
serve our society for everything that it has given us.

Trust & long term relationships with stake holders: We value relationships and we live it,
with our business associates.

Business ethics: Our strong foundation has been ethical practices and open and transparent
operations.

______________________________________________________________25
(Session: 2009-2011)

C H E N N A I

TAFE’s first plant which now houses


TAFE’s R & D and the total machining
operations of key tractor components.

K A L L A D I P A T T I

Most modern Tractor assembly plant at


Kalladipatti near Madurai set among verdant
fields and orchards.

D O D D A B A L P U R

Tractors assembly plant at


Doddaballapur near Bangalore.

______________________________________________________________26
(Session: 2009-2011)

M A N D I D E E P

The Eicher Tractor plant at


Mandidheep also houses Eicher R & D
facilities apart from a new line to manufacture
the Massey Ferguson range.

A L W A R

Alwar is in Rajasthan where the Eicher


diesel engines are made for captive
consumption at TAFE Motors and Tractors as
well as for supply to other original equipment
manufacturers in industrial, marine
construction equipment and generator sets applications. Capacity: 30,000 engines for
agricultural, industrial and Diesel Generator set applications.

P A R W A N O O

Parwanoo is in Himachal Pradesh


where transmission components, cam shafts
etc are made for captive consumption by
TMTL.

______________________________________________________________27
(Session: 2009-2011)

FACT SHEET

TAFE, Tractors And Farm Equipment, is a Chennai, India based tractor manufacturer, is a
unit of the Amalgamation Group. TAFE was established in 1961 to market and manufacturer
tractors under the license of Massey Ferguson. TAFE manufactures Simpson engines from
designs under license from the Perkins Company.

TAFE is one of the largest tractor manufacturers in India over 500 dealers and outlet in India
alone. TAFE is 24% owned by the AGCO Corporation of Duluth, Georgia, the owner of the
Massey Ferguson brand, and manufacturers’ tractors and components for AGCO for
exportation. TAFE is also active in exporting their own TAFE branded tractors.

TAFE has agreements with other companies to brand and market tractors under the TAFE
name to the USA. TAFE USA imports tractors from TAFE in India, as well as tractors
manufactured by LS Tractors in South Korea, (formerly LG Tractors), which are branded as
TAFE.

In June 2004, TAFE purchased Eicher motors Tractors and Engines business, along with the
Eicher brand name for tractors. This put them in the #2 position for market share of tractors
in India.

______________________________________________________________28
(Session: 2009-2011)

BUSINESS AREA

TAFE Limited is also involved in the following areas, apart from its core business of
manufacturing and marketing tractors.

TAFE has developed a range of matching trailers, implements and accessories


These are marketed through TAFE’s dealer network by a totally owned subsidiary, TAFE
access Limited (TAL).

TAFE through TAL is also involved in the marketing and distribution of lubricants and
greases for tractors through its dealer network.

TAFE is also involved in the packaged power industry through its Power Source Division.

TAFE has in-house facilities for the manufacture of Hydraulic pumps and Gears for tractors.
A related facility for the manufacture of panel instruments, not only for captive use but also
for the growing automobile industry in India is an integral part of the company.

TAFE has also diversified into Engineering plastics and Production of tools and dies for this
industry.

______________________________________________________________29
(Session: 2009-2011)

MARKETING NETWORK

TAFE has a network of more than 500 dealers, branches, service outlets as well as its own
sales officers and depots covering the entire width and breadth of India, TAFE is committed
to providing complete farming solutions to its customers and empowering them to work
towards increase farm productivity, prosperity and profits.

COMMUNITY SERVICE

TAFE’s factory at Sembium, stands in perfect harmony with nature. The Simpson Industrial
Estate, where the factory is located, also houses a serene bird sanctuary.

At Paddur Village, where TAFE’s Product Training Centre and “J” Farm are located , TAFE
has an ongoing Village Development Program which provides primary health services,
drinking water, Education and Vocational Training to the villagers from in and around
Paddur.

______________________________________________________________30
(Session: 2009-2011)

OBJECTIVES OF THE
STUDY

______________________________________________________________31
(Session: 2009-2011)

OBJECTIVES OF THE STUDY

o To calculate financial ratio of TAFE.


o To study the financial performance of the TAFE.
o To know the strength and weakness of the TAFE.
o To find out profitability position of the TAFE.
o To analyze the liquidity position of the TAFE.

______________________________________________________________32
(Session: 2009-2011)

RESEARCH
METHODOLOGY

______________________________________________________________33
(Session: 2009-2011)
RESEARCH METHODOLOGY

Research methodology is a way to systematically solve the research problem. It may


be understood as a science of studying how research is done scientifically.

Research methodology has many dimensions and research methods do constitute a


part of the research methodology.
It is necessary for the researcher to know not only the research methods but also
methodology.

In research methodology one studies the various steps that are generally adopted by
researcher in studying his research problem along with logic behind them. So it is necessary
for the researcher to design his methodology for his problem as the same may different from
problem to problem.

In research the scientist has to research decisions to evaluation before they are
implemented. Researcher has to specify very clearly and precisely what decision he selects
and why he selects them so that they cam be evaluated by others also.

Questions which are usually answered when one talk of research methodology
Concerning a research problems or study are:

o Why the research study has been undertaken


o How the research problem has been defined
o In what way the hypothesis has been formulated
o Why the hypothesis has been formulated
o What data have been collected
o What particular methods has been adopted and
o What particular techniques of analyzing data have been used.

______________________________________________________________34
(Session: 2009-2011)
RESEARCH DESIGN

A research design is the arrangement of conditions for collection and analysis of data
in a manner that aims to combine relevance to the research purpose with economy in
procedure.

In fact the research design is the conceptual structure within which the research is
conducted it constitute the blue print for the collection, measurement and analysis of data.
Decisions regarding what when where, how much, by what means concerning an inquiry or
research study constitute a research design.

Research design is needed because it facilitates the smoothing sailing of the various
research operations there by making research as efficient as possible yielding maximal
information with minimal expenditure
of effort, time and money.

Research design stands for advance planning of the methods to be adopted for
collecting the relevant data and the techniques to be used in there analysis keeping in view
the objective of the research and the availability of staff, time and money. The design helps
the researcher to organize his ideas in a form where by it will be possible for the researcher to
look for flaws and inadequacies. Preparation of the research design should be done with great
care as any error in it may upset the entire project. Research design in fact has a great bearing
on the reliability of the results. The firm foundation of the entire edifice of the research work.

______________________________________________________________35
(Session: 2009-2011)
TYPES OF STUDY

The study conducted is a conclusive descriptive statistical study. Conclusive because after
concluding the study, the researcher comes to a decision which is precise and rational. The
study is descriptive because it is in the descriptive study, that the data is collected for a
definite purpose and here the purpose is definite i.e. the data is collected, to find out the
effectiveness of the advertisement. The study is conclusive because after doing the study the
researcher comes to a conclusion regarding the position of the brand in the minds of
respondents of different age groups. The study is statistical because throughout the study all
the similar samples are selected and grouped together (similarity of ages thus forming a
group).

Thus, this conclusive descriptive statistical study is the best study for this purpose as
it provides the necessary information which is utilized to arrive at a concrete decision

______________________________________________________________36
(Session: 2009-2011)
TOOLS USED

It is essential to use a systematic research methodology for the assessment of a project


because without the use of a research methodology analysis of any company or organization
will not be possible.

It is worth a while to mention that I have used the following types of published data:-

• Balance Sheet
• Profit & Loss A/c
• Newspapers, Journals & Periodic
• Chairman’s Speech

______________________________________________________________37
(Session: 2009-2011)
LIMITATIONS OF THE STUDY

o Due to lack of time and resources I was not able to cover all the aspects but I have
tried to my best extent and covered each and every aspect related to the project.
o Financial management of any public sector TAFE is very vast to analyze.

______________________________________________________________38
(Session: 2009-2011)

FINANCIALS

______________________________________________________________39
(Session: 2009-2011)

(2004-05) - (2009-10)

YEAR NO. OF TRACTOR SOLD TURNOVER (In Mn. Rs.)

2004-05 9889.92 248905

2005-06 33848 14526.70

2006-07 66667 25744.31

2008-09 80134 31077.6

2009-10 78847 33973.3

______________________________________________________________40
(Session: 2009-2011)

DATA ANALYSIS
&
INTERPRETATION

______________________________________________________________41
(Session: 2009-2011)

CURRENT RATIO = CURRENT ASSETS / CURRENT LIABILITIES

Particulars 2010 2009 2008


Current Assets 6444.20 6257.60 4949.80
Current Liabilities 5993.20 5920.10 4501.80
Ratio 1.08 1.06 1.10

1.1

1.08

1.06

1.04
2010 2009 2008

Interpretation:
Current ratio indicates the short term financial soundness of the company. It judges whether current assets are
sufficient to meet the current liabilities. The company must be able to meet its current obligations out of the
current assets. Current ratio is increasing which is showing a sound financial position of the company.

______________________________________________________________42
(Session: 2009-2011)
INVENTORY TURNOVER RATIO = SALES/INVENTORY

Particular 2010 2009 2008


Sales 22188.30 19686.40 16493.80
Inventory 2103.80 1689.10 1612.30
Ratio 10.55 11.65 10.23

12

11.5

11
10.5

10

9.5
2010 2009 2008

Interpretation:
Inventory turnover ratio measures the velocity of conversion of stock into sales. Usually, a
high inventory turnover indicates efficient management of inventory because more frequently
the stocks are sold, the lesser amount of money is required to finance the inventory. The
inventory turnover ratio is decreasing which is not a good sign for the company.

WORKING CAPITAL TURNOVER RATIO

______________________________________________________________43
(Session: 2009-2011)
= SALES / WORKING CAPITAL

Particular 2010 2009 2008


Sales 22188.30 19686.40 16493.80
Working Capital 451.00 337.50 448.00
Ratio 49.20 58.33 36.82

60
50
40
30
20
10
0
2010 2009 2008

Interpretation:
Working capital turnover ratio is decreasing which shows that company’s liquidity position is
not strong.

FIXED ASSET TURNOVER RATIO = SALE / FIXED ASSETS

______________________________________________________________44
(Session: 2009-2011)
Particular 2010 2009 2008
Sales 22188.30 19686.40 16493.80
Fixed Assets 5815.20 5314.50 5003.90
ratio 3.82 3.70 3.30

3.8

3.6
3.4

3.2
3
2010 2009 2008

Interpretation:
Fixed assets are used in the business for producing goods to be sold. The effective utilization
of fixed assets will result in increased production and reduced cost. Fixed assets turnover
ratio is increasing which shows that fixed assets are efficiently utilized.

NET PROFIT RATIO = NET PROFIT / SALES

Particular 2010 2009 2010


Net Profit 640.60 609.70 453.10

______________________________________________________________45
(Session: 2009-2011)
Sales 22188.30 19686.40 16493.80
Ratio 0.03 0.03 0.03

0.03
0.025
0.02
0.015
0.01
0.005
0
2010 2009 2008

Interpretation:
Net Profit Margin of the company is constant for three consecutive years which is good sign
for the company.

______________________________________________________________46
(Session: 2009-2011)

OBSERVATIONS
AND
FINDINGS

OBSERVATIONS AND FINDINGS

• Current ratio indicates the short term financial soundness of the company. It judges whether current
assets are sufficient to the current liabilities. The company must be able to meet its current obligations

______________________________________________________________47
(Session: 2009-2011)
out of the current assets. Current Ratio is increasing which is showing a sound financial position of the
company.
• Inventory turnover ratio measures the velocity of conversion of stock into sales. Usually, a high
inventory turnover indicates efficient management of inventory because more frequently the stocks are
sold; the lesser amount money is decreasing which is not a good sign for the company.
• Working capital turnover ratio is decreasing which shows that company’s liquidity position is not
strong.
• Fixed assets are used in the business for producing goods to be sold. The effective utilization of fixed
assets will result in increased production and reduced cost. Fixed Assets Turnover Ratio is increasing
which shows that fixed assets are efficiently utilized.
• Net profit margin of the company is constant for three consecutive year which is good sign for the
company.

______________________________________________________________48
(Session: 2009-2011)

CONCLUTION
&
SUGGETIONS

CONCLUSION

Some of the major conclusions drawn are as follows:


• Current Ratio is increasing which is showing a sound financial position of the company.

______________________________________________________________49
(Session: 2009-2011)
• Inventory Turnover Ratio is decreasing which is not a good sign for the company.
• Liquidity position is not strong.
• Fixed Assets are efficiently utilized.
• Net Profit Margin of the company is constant for three consecutive years which is good sign for the
company.

SUGGETIONS
• TAFE should try to increase its proportions of fixed assets to net worth.
• The proportion of current assets is more, it should be reduced.
• TAFE should utilize its stock more efficiently.

______________________________________________________________50
(Session: 2009-2011)
• TAFE should pay attention proper and efficient utilization of working capital.
• TAFE must increase its return.
• It should also pay attention in increasing its net worth in comparisons to sales.
• TAFE must try and maintain a good fixed assets base.
• TAFE should increase its net profit margin, so that it can survive in adverse conditions also.
• TAFE should try to reduce their expenses particularly non operating expenses, so that the margin of
profit can be increased.

______________________________________________________________51
(Session: 2009-2011)

BIBBLIOGRAPHY

BIBBLIOGRAPHY

______________________________________________________________52
(Session: 2009-2011)
BOOKS:
• Sharma R.K. & Gupta Shashi k; “Management accounting principles and practice”. Eighth edition,
Kalyani Publisher’s, New Delhi.
• Bhalla V. K.; “Financial management and policy”. First Edition, Annual Publications, New Delhi.
• Maheshwari S.N.; “Management accounting and financial control”. Thirteenth Edition, Sultan chand &
sons, New Delhi (2002).
• Kothari C.R.; “Research methodology-methods & techniques”. Second Edition, Vishwa prakashan,
New Delhi (1990).
• Gupta Sunita; “Management of working capital”. First Edition, New Century Publications, New Delhi
(2003).
• Chandra Prasanna; “Financial Management”. TMH, 4th Edition, 1997, New Delhi.
• Gupta S.P.; “Management Accounting”. Sahitya Bhawan Publication, 2002
• Khan & Jain, “Financial Management”. MH, 3rd Edition, 1999.
• Pandey I.M.; “Financial Management” 7th Edition, Vikas Publishing House, New Delhi.

WEBSITES:
1. www.tafe.com

______________________________________________________________53
(Session: 2009-2011)

ANNEXURE

BALANCE SHEET

______________________________________________________________54
(Session: 2009-2011)
Liabilities March- 2010 March- 2009 March- 2008
Share Capital 280.90 280.90 280.90
Reserve & Surplus 4302.40 3852.80 4169.20
Net Worth(1) 4583.30 4133.70 4450.10
Secured Loans(2) 1432.30 1209.80 876.30
Unsecured Loans(3) 545.90 744.10 856.20
Total Liabilities (1+2+3) 6561.50 6087.60 3182.60
Assets
Fixed Assets
Gross Block 5815.20 5314.50 5003.90
(-) Depreciation 2765.70 2377.00 2051.70
Net Block (A) 3049.50 2937.50 2952.20
Capital Work in Progress (B) 193.30 85.00 72.50
Investments (C) 2867.70 2721.30 2689.00
Current Assets, Loans & Advs.
Inventories 2103.80 1689.10 1612.30
Sundry Debtors 1413.20 1893.80 1176.00
Cash & Bank 489.80 477.80 261.00
Loan & Advances 2437.40 2197.40 1900.50
(i) 6444.20 6257.60 4949.80
Current Liab. & Provs.
Current Liabilities 4296.90 4666.60 3487.70
Provisions 1696.30 1253.50 1014.10
(ii) 5993.20 5920.10 4501.80
Net Current Assets (i-ii) (D) 451.00 337.50 448.00
Misc. Expenses (E) 0.00 6.30 20.90
Total Assets (A+B+C+D+E) 6561.50 6087.60 6182.60

PROFIT & LOSS

Particulars March- 2010 March- 2009 March- 2008


Sales 22188.30 19686.40 16493.80
Other Income 180.80 187.50 170.30
Total Income 22369.10 19873.90 16664.10
Raw Material Cost 16299.70 14511.00 12391.80
Excise 3143.60 2695.50 2207.40
Other Expenses 1444.90 1223.10 1151.80
Operating Profit 1300.10 1256.80 742.80
Interest 177.70 138.30 165.10
Gross Profit 1122.40 1118.50 577.70
Depreciation 430.70 405.30 468.20
Profit Benefit Tax 866.20 886.10 258.50
Tax 225.60 276.40 -194.60
Net Profit 640.60 609.70 453.10

______________________________________________________________55
(Session: 2009-2011)
Other Non- Recurring Income -10.10 2.90 1715.70
Reported Profit 630.50 612.60 2168.80
Equity Dividend 140.50 814.70 112.40

______________________________________________________________56