INTRODUCTION Finance is defined as the provision of money at the time when it is required. to achieve its targets.

Without adequate Every Enterprise, whether big, medium of small, needs finance to carryon its operations and In fact, finance is so indispensable to no enterprise can possibly Finance day that it is rightly said Finance is lifeblood of an enterprise. finance, accomplish its objectives. Finance may be defined as the

provision of money at the time when it is required. organization.

refers to the management of flows of money through an It concerns with the application of skills in the manipulation, use and control money.

INTRODUCTION OF RATIOS

RATIO ANALYSIS INTRODUCTION:Ratio Analysis is the process of establishing a significant relationship between the items of financial statements to provide a meaningful understanding of the performance and financial position of the firm.

Using the term Ratio in relation of financial statements analysis, it may properly mean An Accounting Ratio or Financial Ratio, defined as the mathematical relationship between two accounting figures, having mutual cause and effect relationship to produce a meaningful and useful ratio. Ratio is a simple mathematical expression between two items in a more meaningful way which help us to draw conclusions. MEANING OF RATIO:A ratio is a simple arithmetical expression of the relation of one number to another. It may be defined as the indicated quotient of two mathematical expressions. According to Accountants Handbook by Wixon, Kell and Bedford, a ratio is an expression of the quantitative relationship between two numbers. IMPORTANCE OF RATIO ANALYSIS: The importance of ratio analysis lies in the fact that it presents facts on a comparative basis and enables the drawing of inferences regarding the performance of a firm Ratio Analysis in relevant in assessing the performance of a firm in respect of the following points.

SIGNIFICANCE OF RATIO ANALYSIS: Ratios are significant in both the vertical and horizontal analysis. In vertical analysis, ratios help the analyst to form a judgment whether the performance of the firm at a given point of time is in good position or not use of ratios in horizontal analysis indicates whether the financial condition of the firm is improving or deteriorating and whether cost profitability of efficiency is showing an upward trend or downward trend. NATURE OF RATIO ANALYSIS:Ratio analysis is a technique of analysis and interpretation of financial statements. It is the process of establishing and interpreting various ratios for helping in making certain decisions. Ratios provide clues to the financial position of the concern. These are

the pointers or indicators of financial strength, soundness, position or weakness of an enterprise. One can draw conclusions about the exact financial positions of a concern with the help of ratios. Calculation of mere ratios does not serve any purpose, unless several appropriate ratios are analyzed and interpreted. The following are the four steps involved in the ratio analysis. Selection of relevant data from the financial statements depending upon the objective of the analysis Calculation of appropriate ratios from the above data Comparison of the calculated ratios with the ratios of the same firm in the past, or the ratios developed from the projected financial statement or the ratios of some other firms or the comparison with ratios of the industry to which the firm belongs

OBJECTIVES OF RATIO ANALYSIS: To measure the overall financial position of Avon organic private ltd To study the important aspects like liquidity, leverage, activity and profitability of the company To find out the operating efficiency of the company To suggest measres for improving the performance of the company in the light of the above

CLASSIFICATION OF RATIOS: Ratios may be classified in a number of ways keeping in view the particular purpose. Ratios indicating profitability are calculated on the basis of the profit and loss account; those indicating financial position are computed on the basis of the balance sheet and those which show operating efficiency or productivity or effective use of resources are calculated on the basis of figures in the profit and loss account and the balance sheet. This classification is rather crude and unsuitable to determine the

profitability and financial position of the business. To achieve this purpose effectively, ratios may be classified as: I. Profitability ratios II. Turnover ratios III. I. Financial ratios PROFITABILITY RATIOS Profitability ratios are of utmost importance for a concern. These ratios are calculated to enlighten the end results of business activities which is the sole criterion of the overall efficiency of a business concern. The following are the important profitability ratios: 1. Gross Profit Ratio: This ratio tells gross margin on trading and is calculated as under: Gross Profit Ratio = Gross Profit 100 Net Sales 2. Operating Ratio: This ratio indicates the proportion that the cost of sales bears to sales. Cost of sales includes direct cost of goods sold as well as other operating expenses, administration, selling and distribution expenses which have matching relationship with sales. It excludes income and expenses which have no bearing on production and sales, i.e., non-operating incomes and expenses as interest and dividend received on investment, interest paid on long-term loans and debentures, profit or loss on sale of fixed assets or long-term investments. It is calculated as follows: Operating Ratio = Cost of Goods Sold + Operating Expenses 100 Net Sales Here, Cost of Goods Sold = Opening Stock + Purchases + Direct Expenses + Manufacturing Expenses Closing Stock of Sales Gross Profit Operating Expenses = Administrative Expenses + Selling and Distribution Expenses Lower the ratio, the better it is. Higher the ratio, the less favourable it is because it would have a smaller margin of operating profit for the payment of dividends and the These are discussed one by one as follows:

creation of reserves. This ratio should be analysed further to throw light on the levels of efficiency prevailing in different elements of total cost. 3. Expenses Ratios: These are calculated to ascertain the relationship that exists between operating expenses and volume of sales. The following ratios will help in analysing operating ratio: (i) Material Consumed Ratio = Material Consumed 100 Net Sales (ii) Conversion Cost Ratio = Labour Expenses + Manufacturing Expenses 100 Net Sales (iii) Administrative Expenses Ratio = Administrative Expenses Ratio 100 Net Sales (iv) Selling and Distribution Expenses Ratio = Selling and Distribution Expenses 100 Net Sales The total of these four ratios will be equal to operating ratio.

4. Operating Profit Ratio: This ratio establishes the relationship between operating profit and sales and is calculated as follows: Operating Profit Ratio = Operating Profit 100 Net Sales Where Operating Profit = Net Profit + Non-operating Expenses Non-Operating Income (or)

= Gross Profit Operating Expenses Operating profit ratio can also be calculated with the help of operating ratio as follows: Operating Profit Ratio = 100 - Operating Ratio. This ratio indicates the portion remaining out of every rupee worth of sales after all operating costs and expenses have been met. Higher the ratio the better it is. 5. Net Profit Ratio: This ratio is very useful to the proprietors and prospective investors because it reveals the overall profitability of the concern. This is the ratio of net profit after taxes to net sales and is calculated as follows: Net Profit Ratio = Net Profit after Tax 100 Net Sales The ratio differs from the operating profit ratio in as much as it is calculated after deducting non-operating expenses, such as loss on sale of fixed assets etc., from operating profit and adding non-operating income like interest or dividends on investments, profit on sale of investments or fixed assets, etc., to such profit. Higher the ratio, the better it is because it gives idea of improved efficiency of the concern. 6. Return on Capital Employed (Overall Profitability Ratio): This ratio is an indicator of the earning capacity of the capital employed in the business. This ratio is calculated as follows: Return on Capital Employed = Operating Profit 100 Capital employed Here, Operating Profit = Profit before interest on long term borrowings and tax Capital Employed = Equity Share Capital + Preference Share Capital + Undistributed Profit + Reserves and Surplus + Long-term Liabilities Fictitious Assets Non-business Assets. Alternatively. Tangible Fixed and Intangible Assets + Current Assets Current Liabilities.

This ratio is considered to be the most important ratio because it reflects the overall efficiency with which capital is used. This ratio is a helpful tool for making capital budgeting decisions; a project yielding higher return is favoured. 7) Return on Shareholders Fund: When it is desired to work out the profitability of the company from the shareholders point of view, then it is calculated by the following formula: Return on Shareholders Fund = Net Profit after Interest and Tax 100 Shareholders Funds 8) Return on Equity Shareholders Fund: This ratio is a measure of the percentage of net profit to equity shareholders funds. The ratio is expressed as follows: Return on Equity Shareholders Fund = Net Profit after Tax, Interest and Preference Dividend Equity Shareholders Funds Here, Equity Shareholders Fund = Equity Share Capital + Capital Reserves + Revenue Reserves + Balance of Profit and Loss Account Fictitious Assets Non-business Assets 9) Return on Total Assets: This ratio is calculated to measure the profit after tax against the amount invested in total assets to ascertain whether assets are being utilized properly or not. It is calculated as under: Return on Total Assets = Net Profit after Tax 100 Total Assets 10) Earning per Share: This helps in determining the market price of equity shares of the company and in estimating the companys capacity to pay dividend to its equity shareholders. It is calculated as follows: Earning Per Share = Net Profit after Tax + Preference Dividend Number of Equity Shares

If there are both preference and equity share capitals, then out of net income first of all preference dividends should be deducted in order to find out the net income available for equity shareholders. The performance and prospects of the company are affected by earning per share. If earning per share increases, there is a possibility that the company may pay more dividend or issue bonus shares. In short the market price of the share of a company will be affected by all these factors. A comparison of earning per share of the company with another company will also help in deciding whether the equity capital is being effectively used or not. Though the earning per share is the most widely published data, yet it should be used cautiously as earning per share cannot represent the various financial operations of the business. Moreover, the financial data collected in respect of different companies may be affected by different practices followed by the companies relating to stock in trade, depreciation etc. This ultimately will affect the calculation of earning per share and that is why earning per share should be used with precaution while comparing the performance and prospects of two companies. 11) Price Earning Ratio: This ratio indicates the market value of every rupee earning in the firm and is compared with industry average. High ratio indicates the share is overvalued and low ratio shows that share is undervalued. It is computed by the following formula: Price Earning Ratio = Market price per equity share Earning per share 12) Payout Ratio: This is determined as follows: Payout Ratio = Dividend per equity share Earning per share Complementary of this ratio is retained Earning Ratio. It is calculated as follows: Retained Earning Ratio = Retained Earnings 100 Total Earnings

This ratio indicates as to what proportion of earning per share has been used for paying dividend and what has been retained for ploughing back. This ratio is very important from shareholders point of view as it tells him that if a company has used whole or substantially the whole of its earning for paying dividend and retained nothing for future growth and expansion purposes, then there will be very dim chances of capital appreciation in the price of shares of such company. In other words, an investor who is more interested in capital appreciation must look for a company having low payout ratio. 13) Dividend Yield Ratio: This is computed as under: Dividend Yield Ratio = Dividend per share
100

Market price per share This ratio is important for those investors who are interested in the dividend income. As the shareholder purchases the shares in the open market, so his yield (rate of return) is not equal to the dividend declared by the company. In fact, he calculates dividend per share by dividing the rate of dividend by paid-up value of share. Then he calculates yield by dividing dividend per share by the market price of share. II .TURNOVER RATIOS : These ratios are very important for a concern to judge how well facilities at the disposal of the concern are being used or to measure the effectiveness with which a concern uses its resources at its disposal. These ratios are usually calculated on the basis of sales or cost of sales and are expressed in integers rather than as a percentage. Such ratios should be calculated separately for each type of asset. Higher the turnover ratio, the better the profitability and use of capital or resources will be. The following are the important turnover ratios usually calculated by a concern.

(a) Sales to Capital Employed (or Capital Turnover) Ratio: This ratio shows the efficiency of capital employed in the business by computing how many times capital employed is turned-over in a stated period. The ratio is ascertained as follows. Sales___________________________

Capital Employed (i.e. Shareholders Fund + Long-term Liabilities) The higher the ratio, the greater are the profits. A low capital turnover ratio should be taken to mean that sufficient sales are not being made and profits are lower. (b) Sales to Fixed Assets (or Fixed Assets Turnover) Ratio: This ratio expresses the number of times fixed assets are being turnedover in a stated period. It is calculated as under: Sales_______________________ Net Fixed Assets (i.e., Fixed Assets less Depreciation) This ratio shows how well the fixed assets are being used in the business. The ratio is important in case of manufacturing concerns because sales are produced not only by use of current assets but also by amount invested in fixed assets. The higher is the ratio, the better is the performance. On the other hand, a low ratio indicates that fixed assets are not being efficiently utilised. (c) Sales to Working Capital (or Working Capital Turnover) Ratio: This ratio shows the number of times working capital is turned-over in a stated period. It is calculated as follows: Sales________________________ Net Working Capital (i.e., Current Assets Current Liabilities) The higher is the ratio, the lower is the investment in working capital and the greater are the profits. However, a very high turnover of working capital is a sign of overtrading and may put the concern into financial difficulties. On the other hand, a low working capital turnover ratio indicates that working capital is not efficiently utilised.

(d) Total Assets Turnover Ratio: This ratio is calculated by dividing the net sales by the value of total assets (i.e. Net Sales Total Assets). A high ratio is an indicator of over-trading of total assets while a low ratio reveals idle capacity. The traditional standard for the ratio is two times.

(e) Stock Turnover Ratio: This ratio, also known as inventory turnover ratio, establishes relationship between cost of goods sold during a given period and the average amount of inventory held during a given accounting period. This ratio reveals the number of times finished stock is turned over during a given accounting period. Higher the ratio, the better it is because it shows that finished stock is rapidly turned-over. On the other hand, a low stock turnover ratio is not desirable because it reveals the accumulation of obsolete stock, or the carrying of too much stock. This ratio is calculated as follows: Stock Turnover Ratio = Cost of Good Sold_________ Average Stock held during the period Where, Cost of Goods Sold = Opening Stock + Purchases + Manufacturing Expenses Closing Stock (or) Sales Gross profit. Average Stock = Opening Stock + Closing Stock 2 (f) Receivables (or Debtors) Turnover Ratio: This ratio measures the accounts receivables (trade debtors and bills receivables) in terms of number of days of credit sales during a particular period. This ratio is calculated as follows: Debtors Turnover Ratio = Net Credit Sales Average Debtors The collection period is calculated as under: Collection Period = 365________ Debtors Turnover Ratio (or) = Average Debtors No. of days in a period. Net Credit Sales

This ratio is a measure of the collectibility of accounts receivables and tells about how the credit policy of the company is being enforced. Suppose, a company allows 30 days credit to its customers and the ratio is 45; it is cause of anxiety to the management because debts are outstanding for a period of 45 days. Efforts should be made to make the collection machinery efficient so that the amount due from debtors may be realised in time. Higher the ratio, more the chances of bad debts and lower the ratio, less the chances of bad debts. Debtors Turnover Ratio = Credit Sales_ Average Debtors Collection Period = Days in a year____ Debtors Turnover Ratio (g) Creditors (or Accounts Payable) Turnover Ratio: This ratio gives the average credit period enjoyed from the creditors and is calculated as under: Credit Purchases____________ Average Accounts Payable (Creditors + B/P) A high ratio indicates that creditors are not paid in time while a low ratio gives an idea that the business is not taking full advantages of credit period allowed by the creditors. Sometimes it is also required to calculate the average payment period (or average age of payables or debt period enjoyed) to indicate the speed with which payments for credit purchases are made to creditors. It is calculated as

Average age of Payables = Months (or days) in a year Creditors Turnover Ratio II. FINANCIAL RATIOS

These ratios are calculated to judge the financial position of the concern from long term as well as short-term solvency point of view. These ratios can be divided into two broad categories: a) Liquidity Ratios b) Stability Ratios. a). Liquidity Ratios: These ratios are used to measure the firms ability to meet short term obligations. They compare short term obligations to short term (or current) resources available to meet these obligations. From these ratios, much insight can be obtained into the present cash solvency of the firm and the firms ability to remain solvent in the event of adversity. The important liquidity ratios are: (a) Current Ratio (or Working Capital Ratio): This is the most widely used ratio. It is the ratio of current assets to current liabilities. It shows a firms ability to cover its current liabilities with its current assets. It is expressed as follows: Current Ratio = Current Assets_ Current Liabilities Generally 2:1 is considered ideal for a concern i.e., current assets should be twice of the current liabilities. If the current assets are two times of the current liabilities, there will be no adverse effect on business operations when the payment of current liabilities is made. If the ratio is less than 2, difficulty may be experienced in the payment of current liabilities and day-to-day operations of the business may suffer. If the ratio is higher than 2, it is very comfortable for the creditors but, for the concern, it is indicator of idle funds and a lack of enthusiasm for work. All current assets cannot be treated as investments which are easily marketable and sold in case cash is required. For this purpose, the liquid ratio is worked out.

(b) Liquid (or Acid Test or Quick) Ratio: This is the ratio of liquid assets to liquid liabilities. It shows a firms ability to meet current liabilities with its most liquid (quick) assets. 1:1 ratios is considered ideal ratio for a concern because it is wise to keep the liquid assets at least equal to the liquid liabilities at all times. Liquid assets are those assets which are readily converted into cash and will include cash balances, bills receivable, sundry debtors and short-term investments. Inventories and prepaid expenses are not included in liquid assets because the emphasis is on the ready availability of cash in case of liquid assets. Liquid liabilities include all items of current liabilities except bank overdraft. This ratio is the acid test of a concerns financial soundness. It is calculated as under: Liquid Ratio = Liquid Assets_______ Current (or Liquid) Liabilities (c) Absolute Liquidity (or Super Quick) Ratio: Though receivables are generally more liquid than inventories, there may be debts having doubt regarding their real stability in time. So, to get idea about the absolute liquidity of a concern, both receivables and inventories are excluded from current assets and only absolute liquid assets, such as cash in hand, cash at bank and readily realizable securities are taken into consideration. Absolute liquidity ratio is calculated as follows: Cash in hand and at bank + Short-term marketable securities Current Liabilities The desirable norm for this ratio is 1:2, i.e., Re. 1 worth of absolute liquid assets are sufficient for Rs.2 worth of current liabilities. Even though the ratio gives a more meaningful measure of liquidity, it is not in much use because the idea of keeping a large cash balance or near cash items has long since been disproved. Cash balance yields no return and as such is barren. (d) Defensive Internal Ratio: It examines the firms liquidity position in terms of its ability to meet projected daily expenditure for operations. It is calculated as follows:

Defensive Internal Ratio =

Quick Assets_________ Projected daily cash requirements

Projected daily cash requirements are computed as follows: = Projected cash annual operating expenses No. of days in a year Projected cash operating expenses include cost of goods sold (excluding depreciation) and selling and administration expenses payable in cash. It measures the time period for which a firm can operate on the basis of present liquid assets without resorting to next years revenue. The higher the ratio, the better it is. (e) Ratio of Inventory to Working Capital: In order to ascertain that there is no overstocking, the ratio of inventory to working capital should be calculated. It is worked out as follows: = Inventory___ Working Capital Working Capital is the excess of current assets over current liabilities. Increase in volume of sales requires increase in size of inventory, but from a sound financial point of view, inventory should not exceed amount of working capital. The desirable ratio is 1:1. IV.STABILITY RATIOS: These ratios help in ascertaining the long term solvency of a firm which depends on firms adequate resources to meet its long term funds requirements, appropriate debt equity mix to raise long term funds and earnings to pay interest and instalment of long term loans in time (i.e., coverage ratios). The following ratios can be calculated for this purpose: (a) Fixed Assets Ratio:

This ratio explains whether the firm has raised adequate long term funds to meet its fixed assets requirements and is calculated as under: Fixed Assets_ Capital Employed This ratio gives an idea as to what part of the capital employed has been used in purchasing the fixed assets for the concern. If the ratio is less than one it is good for the concern. The ideal ratio is .67. (b) Ratio of Current Assets to Fixed Assets: This ratio is worked out as: Current Assets Fixed Assets This ratio will differ from industry to industry and, therefore, no standard can be laid down. A decrease in the ratio may mean that trading in slack or more mechanization has been put through. An increase in the ratio may reveal that inventories and debtors have unduly increased or fixed assets have been intensively used. An increase in the ratio, accompanied by increase in profit, indicates the business is expanding. (C)Debt Equity Ratio: This ratio is calculated to measure the relative proportions of outsiders funds and shareholders funds invested in the company. This ratio is determined to ascertain the soundness of long term financial policies of the company and is also known as external-internal equity ratio. It is calculated as follows: Debt Equity Ratio = (i) Long Term Debts Shareholders Funds (or) Long Term Debts______ (ii) Shareholders Funds + Long Term Debts

Whether a given debt to equity ratio shows a favourable or unfavourable financial position of the concern depends on the industry and the pattern of earning. A low ratio is generally viewed as favourable from long-term creditors point of view, because a large margin of protection provides safety for the creditors. The same low ratio may be taken as quite unsatisfactory by the shareholders because they find neglected opportunity for using low-cost outsiders funds to acquire fixed assets that could earn a high return. Keeping in view the interest of both (shareholders and long-term creditors), debt to equity ratio of 2:1 in case of (i) and 2:3 in case of (ii) is acceptable. (c) Proprietary Ratio: A variant of debt to equity ratio is the proprietary ratio which shows the relationship between shareholders funds and total tangible assets. This ratio is worked out as follows: Shareholders Funds Total Tangible Assets This ratio should be 1:3, i.e., one-third of the assets minus current liabilities should be acquired by shareholders funds and the other two-thirds of the assets should be financed by outsiders funds. It focuses the attention on the general financial strength of the business enterprise. (d) Capital Gearing Ratio: This ratio establishes the relationship between the fixed interest-bearing securities and equity shares of a company. It is calculated as follows: Fixed Interest bearing Securities Equity Shareholders Fund

BIBILOGRAPHY

3.RBI bankers journal 4.www.Investopedia.com 6.Financial managementKhan & Jain 7.Accounting for managementSharma & Shashi.K.Gupta.