RATIO ANALYSIS

R K MOHANTY
FACULTY MEMBER, SIR SPBT COLLEGE,
CENTRAL BANK OF INDIA, MUMBAI

WHY FINANCIAL ANALYSIS

Lenders need it for carrying out the following
Technical Appraisal
Commercial Appraisal
Financial Appraisal
Economic Appraisal
Management Appraisal

RATIO ANALYSIS
Its a tool which enables the banker or lender to
arrive at the following factors :
Liquidity position
Profitability
Solvency
Financial Stability
Quality of the Management
Safety & Security of the loans & advances to be
or already been provided

HOW A RATIO IS EXPRESSED?

As Percentage - such as 25% or 50% . For

example if net profit is Rs.25,000/- and the sales is
Rs.1,00,000/- then the net profit can be said to be
25% of the sales.
As Proportion
- The above figures may be
expressed in terms of the relationship between net
profit to sales as 1 : 4.
As Pure Number /Times - The same can also be
expressed in an alternatively way such as the sale
is 4 times of the net profit or profit is 1/4th of the
sales.

CLASSIFICATION OF RATIOS
Balance Sheet
Ratio

P&L Ratio or
Income/Revenue
Statement Ratio

Balance Sheet
and Profit & Loss
Ratio

Financial Ratio

Operating Ratio

Composite Ratio

Current Ratio
Quick Asset Ratio
Proprietary Ratio
Debt Equity Ratio

Gross Profit Ratio

Operating Ratio
Expense Ratio
Net profit Ratio
Stock Turnover Ratio

Fixed Asset
Turnover Ratio,
Return on Total
Resources Ratio,
Return on Own
Funds Ratio,
Earning per Share
Ratio, Debtors
Turnover Ratio,

FORMAT OF BALANCE SHEET FOR RATIO ANALYSIS

LIABILITIES

ASSETS

NET WORTH/EQUITY/OWNED FUNDS

Share Capital/Partners
Capital/Paid up
Capital/ Owners Funds
Reserves ( General, Capital, Revaluation &
Other Reserves)
Credit Balance in P&L A/c

FIXED ASSETS : LAND & BUILDING, PLANT

& MACHINERIES
Original Value Less Depreciation
Net Value or Book Value or Written down value

LONG
TERM
LIABILITIES/BORROWED
FUNDS : Term Loans (Banks & Institutions)
Debentures/Bonds, Unsecured Loans, Fixed
Deposits, Other Long Term Liabilities

NON CURRENT ASSETS

Investments in quoted shares & securities
Old stocks or old/disputed book debts
Long Term Security Deposits
Other Misc. assets which are not current or
fixed in nature

CURRENT LIABILTIES
Bank Working
Capital Limits such as
CC/OD/Bills/Export Credit
Sundry
/Trade
Creditors/Creditors/Bills
Payable, Short duration loans or deposits
Expenses payable & provisions against various
items

CURRENT ASSETS : Cash & Bank Balance,

Marketable/quoted Govt. or other securities,
Book Debts/Sundry Debtors, Bills Receivables,
Stocks & inventory (RM,SIP,FG) Stores &
Spares, Advance Payment of Taxes, Prepaid
expenses, Loans and Advances recoverable
within 12 months
INTANGIBLE ASSETS
Patent, Goodwill, Debit balance in P&L A/c,
Preliminary or Preoperative expenses

SOME IMPORTANT NOTES

Liabilities have Credit balance and Assets have Debit

balance
Current Liabilities are those which have either become due
for payment or shall fall due for payment within 12 months
from the date of Balance Sheet
Current Assets are those which undergo change in their
shape/form within 12 months. These are also called
Working Capital or Gross Working Capital
Net Worth & Long Term Liabilities are also called Long
Term Sources of Funds
Current Liabilities are known as Short Term Sources of
Funds
Long Term Liabilities & Short Term Liabilities are also called

SOME IMPORTANT NOTES

Assets other than Current Assets are Long Term Use of Funds
Installments of Term Loan Payable in 12 months are to be taken
as Current Liability only for Calculation of Current Ratio & Quick
Ratio.
If there is profit it shall become part of Net Worth under the head
Reserves and if there is loss it will become part of Intangible
Assets
Investments in Govt. Securities to be treated current only if these
are marketable and due. Investments in other securities are to be
treated Current if they are quoted. Investments in
allied/associate/sister units or firms to be treated as Non-current.
Bonus Shares as issued by capitalization of General reserves
and as such do not affect the Net Worth. With Rights Issue,
change takes place in Net Worth and Current Ratio.

1.

Current Ratio : It is the relationship between the

current assets and current liabilities of a concern.
Current Ratio = Current Assets/Current Liabilities
If the Current Assets and Current Liabilities of a concern
are Rs.4,00,000 and Rs.2,00,000 respectively, then the
Current Ratio will be : Rs.4,00,000/Rs.2,00,000 = 2 : 1
The ideal Current Ratio preferred by Banks is
1.33 : 1

2.

Net Working Capital : This is worked out as surplus of

Long Term Sources over Long Tern Uses, alternatively it
is the difference of Current Assets and Current
Liabilities.
NWC = Current Assets Current Liabilities

3. ACID TEST or QUICK RATIO : It is the ratio between Quick Current

Assets and Current Liabilities.
Quick Current Assets : Cash/Bank Balances + Receivables upto 6 months +
Quickly realizable securities such as Govt. Securities or quickly marketable/quoted
shares and Bank Fixed Deposits
Acid Test or Quick Ratio = Quick Current Assets/Current Liabilities

Example :
Cash
50,000
Debtors
1,00,000
Inventories
1,50,000
Total Current Assets 3,00,000

Current Ratio = >

Quick Ratio
=>

Current Liabilities 1,00,000

3,00,000/1,00,000
1,50,000/1,00,000

= 3:1
= 1.5 : 1

4. DEBT EQUITY RATIO : It is the relationship between

borrowers fund (Debt) and Owners Capital (Equity).
Long Term Outside Liabilities / Tangible Net Worth

Liabilities of Long Term Nature

Total of Capital and Reserves & Surplus Less Intangible Assets
For instance, if the Firm is having the following :
Capital
= Rs. 200 Lacs
Free Reserves & Surplus
= Rs. 300 Lacs
Long Term Loans/Liabilities = Rs. 800 Lacs
Debt Equity Ratio will be => 800/500 i.e. 1.6 : 1

5. PROPRIETARY RATIO : This ratio indicates the extent to which

Tangible Assets are financed by Owners Fund.
Proprietary Ratio = (Tangible Net Worth/Total Tangible
Assets) x 100
The ratio will be 100% when there is no Borrowing for purchasing
of Assets.
6. GROSS PROFIT RATIO : By comparing Gross Profit percentage to
Net Sales we can arrive at the Gross Profit Ratio which indicates the
manufacturing efficiency as well as the pricing policy of the concern.

Gross Profit Ratio = (Gross Profit / Net Sales ) x 100

Alternatively , since Gross Profit is equal to Sales minus Cost of
Goods Sold, it can also be interpreted as below :

Gross Profit Ratio = [ (Sales Cost of goods sold)/ Net Sales]

x 100
A higher Gross Profit Ratio indicates efficiency in production of the unit.

7. OPERATING PROFIT RATIO :

It is expressed as =>

(Operating Profit / Net Sales ) x 100

Higher the ratio indicates operational efficiency

8. NET PROFIT RATIO :

It is expressed as =>

( Net Profit / Net Sales ) x 100

It measures overall profitability.

9. STOCK/INVENTORY TURNOVER RATIO :

(Average Inventory/Sales) x 365 for days

(Average Inventory/Sales) x 52 for weeks
(Average Inventory/Sales) x 12 for months

Average Inventory or Stocks = (Opening Stock + Closing Stock)

-----------------------------------------

2
. This ratio indicates the number of times the inventory is
rotated during the relevant accounting period

10. DEBTORS TURNOVER RATIO : This is also called Debtors

Velocity or Average Collection Period or Period of Credit given .
(Average Debtors/Sales ) x 365 for days
(52 for weeks & 12 for months)
11. ASSET TRUNOVER RATIO :

Net Sales/Tangible Assets

12. FIXED ASSET TURNOVER RATIO :

Net Sales /Fixed Assets

13. CURRENT ASSET TURNOVER RATIO : Net Sales / Current Assets

14. CREDITORS TURNOVER RATIO : This is also called Creditors
Velocity Ratio, which determines the creditor payment period.
(Average Creditors/Purchases)x365 for days
(52 for weeks & 12 for months)

15. RETRUN ON ASSETS :

Net Profit after Taxes/Total Assets

16. RETRUN ON CAPITAL EMPLOYED :

( Net Profit before Interest & Tax / Average Capital Employed) x 100

Average Capital Employed is the average of the equity share

capital and long term funds provided by the owners and the
creditors of the firm at the beginning and end of the accounting
period.

Composite Ratio
17. RETRUN ON EQUITY CAPITAL (ROE) :
Net Profit after Taxes / Tangible Net Worth
18. EARNING PER SHARE : EPS indicates the quantum of net profit
of the year that would be ranking for dividend for each share of
the company being held by the equity share holders.
Net profit after Taxes and Preference Dividend/ No. of Equity
Shares

19. PRICE EARNING RATIO : PE Ratio indicates the number of times

the Earning Per Share is covered by its market price.
Market Price Per Equity Share/Earning Per Share

20. DEBT SERVICE COVERAGE RATIO : This ratio is one of the most
important one which indicates the ability of an enterprise to
meet its liabilities by way of payment of installments of Term
Loans and Interest thereon from out of the cash accruals and
forms the basis for fixation of the repayment schedule in
respect of the Term Loans raised for a project. (The Ideal DSCR
Ratio is considered to be 2 )
PAT + Depr. + Annual Interest on Long Term Loans & Liabilities
--------------------------------------------------------------------------------Annual interest on Long Term Loans & Liabilities + Annual
Installments payable on Long Term Loans & Liabilities
( Where PAT is Profit after Tax and Depr. is Depreciation)

EXERCISE 1
LIABILITES
Capital
Reserves

ASSETS
180 Net Fixed Assets
20 Inventories

Term Loan

300 Cash

Bank C/C

200 Receivables

Trade Creditors

50 Goodwill

Provisions

50
800

a.
b.
c.
d.
e.
f.

400
150

50
150
50
800

What is the Net Worth : Capital + Reserve = 200

Tangible Net Worth is : Net Worth - Goodwill = 150
Outside Liabilities : TL + CC + Creditors + Provisions = 600
Net Working Capital : C A - C L = 350 - 250 = 50
Current Ratio : C A / C L
= 350 / 300 = 1.17 : 1
Quick Ratio : Quick Assets / C L = 200/300 = 0.66 : 1

EXERCISE 2
LIABILITIES

2005-06

2006-07

2005-06

2006-07

Capital

300

350 Net Fixed Assets

730

750

Reserves

140

160 Security Electricity

30

30

Bank Term Loan

320

280 Investments

110

110

Bank CC (Hyp)

490

580 Raw Materials

150

170

Unsec. Long T L

150

170 S I P

20

30

Creditors (RM)

120

140

170

30

20

310

240

30

190

50

50

1600

1760

70 Finished Goods

Bills Payable

40

80 Cash

Expenses Payable

20

30 Receivables

Provisions

20

40 Loans/Advances
Goodwill

Total

1600

1760

1. Tangible Net Worth for 1st Year : ( 300 + 140) - 50 = 390

2. Current Ratio for 2nd Year : (170 + 20 + 240 + 2+ 190 ) / (580+70+80+70)
820 /800 = 1.02
3. Debt Equity Ratio for 1st Year : 320+150 / 390 = 1.21

Exercise 3.
LIABIITIES

ASSETS

Equity Capital

200 Net Fixed Assets

800

Preference Capital

100 Inventory

300

Term Loan

600 Receivables

150

Bank CC (Hyp)

400 Investment In Govt. Secu.

Sundry Creditors

100 Preliminary Expenses

Total

1400

1. Debt Equity Ratio will be : 600 / (200+100)

50
100
1400

= 2:1

2. Tangible Net Worth : Only equity Capital i.e. = 200

3. Total Outside Liabilities / Total Tangible Net Worth : (600+400+100) / 200
= 11 : 2
4. Current Ratio will be : (300 + 150 + 50 ) / (400 + 100 ) = 1 : 1

Exercise 4.
LIABILITIES

ASSETS

Capital + Reserves

355

P & L Credit Balance

Net Fixed Assets

7 Cash

Loan From S F C

100 Receivables

265
1
125

Bank Overdraft

38 Stocks

Creditors

26 Prepaid Expenses

9 Intangible Assets

30

Provision of Tax
Proposed Dividend

15

550
Q. What is the Current Ratio ?

Q What is the Quick Ratio ?

128

550

Ans : (125 +128+1+30) / (38+26+9+15)

: 255/88 = 2.89 : 1

Ans : (125+1)/ 88 = 1.43 : 11

Q. What is the Debt Equity Ratio ?

Ans : LTL / Tangible NW

= 100 / ( 362 30)
= 100 / 332 = 0.30 : 1

Exercise 4.

contd

LIABILITIES
Capital + Reserves
P & L Credit Balance
Loan From S F C

ASSETS
355

Net Fixed Assets

265

7 Cash
100 Receivables

1
125

Bank Overdraft

38 Stocks

Creditors

26 Prepaid Expenses

9 Intangible Assets

30

Provision of Tax
Proposed Dividend

128

15

550

550

Q . What is the Proprietary Ratio ? Ans : (T NW / Tangible Assets) x 100

[ (362 - 30 ) / (550 30)] x 100
(332 / 520) x 100 = 64%
Q . What is the Net Working Capital ?
Ans : C. A - C L. = 255 - 88 = 167
Q . If Net Sales is Rs.15 Lac, then What would be the Stock Turnover
Ratio in Times ? Ans : Net Sales / Average Inventories/Stock
1500 / 128 = 12 times approximately

Exercise 4.

contd

LIABILITIES
Capital + Reserves

P & L Credit Balance

Loan From S F C

ASSETS
355

Net Fixed Assets

7 Cash
100 Receivables

265

1
125

Bank Overdraft

38 Stocks

Creditors

26 Prepaid Expenses

9 Intangible Assets

30

Provision of Tax
Proposed Dividend

128

15
550

550

Q. What is the Debtors Velocity Ratio ? If the sales are Rs. 15 Lac.
Ans : ( Average Debtors / Net Sales) x 12 = (125 / 1500) x 12
= 1 month
Q. What is the Creditors Velocity Ratio if Purchases are Rs.10.5 Lac ?
Ans : (Average Creditors / Purchases ) x 12 = (26 / 1050) x 12 = 0.3 months

Exercise 5. : Profit to sales is 2% and amount of profit is say

Rs.5 Lac. Then What is the amount of Sales ?
Answer : Net Profit Ratio = (Net Profit / Sales ) x 100
2
= (5 x100) /Sales
Therefore Sales = 500/2 = Rs.250 Lac
Exercise 6. A Company has Net Worth of Rs.5 Lac, Term
Liabilities of Rs.10 Lac. Fixed Assets worth RS.16 Lac and
Current Assets are Rs.25 Lac. There is no intangible Assets
or other Non Current Assets. Calculate its Net Working
Capital.
Answer
Total Assets
= 16 + 25 = Rs. 41 Lac
Total Liabilities = NW + LTL + CL = 5 + 10+ CL = 41 Lac
Current Liabilities = 41 15 = 26 Lac
Therefore Net Working Capital = C. A C.L
= 25 26 = (- )1 Lac

Exercise 7 : Current Ratio of a concern is 1 : 1. What will be the Net

Working Capital ?
Answer : It suggest that the Current Assets is equal to Current Liabilities
hence the NWC would be NIL
Exercise 8 : Suppose Current Ratio is 4 : 1. NWC is Rs.30,000/-. What
is the amount of Current Assets ?
Answer : 4 x - 1 x = 30,000
Therefore x = 10,000 i.e. Current Liabilities is Rs.10,000
Hence Current Assets would be 4x = 4 x 10,000 = Rs.40,000/-

Exercise 9. The amount of Term Loan installment is Rs.10000/ per

month, monthly average interest on TL is Rs.5000/-. If the amount
of Depreciation is Rs.30,000/- p.a. and PAT is Rs.2,70,000/-. What
would be the DSCR ?
DSCR = (PAT + Depr + Annual Intt.) / Annual Intt + Annual Installment
= (270000 + 30000 + 60000 ) / 60000 + 120000
= 360000 / 180000 = 2

Exercise 10 : Total Liabilities of a firm is Rs.100 Lac and Current Ratio

is 1.5 : 1. If Fixed Assets and Other Non Current Assets are to the tune
of Rs. 70 Lac and Debt Equity Ratio being 3 : 1. What would be the Long
Term Liabilities?
Ans : We can easily arrive at the amount of Current Asset being Rs. 30 Lac
i.e. ( Rs. 100 L - Rs. 70 L ). If the Current Ratio is 1.5 : 1, then Current
Liabilities works out to be Rs. 20 Lac. That means the aggregate of Net
Worth and Long Term Liabilities would be Rs. 80 Lacs. If the Debt Equity
Ratio is 3 : 1 then Debt works out to be Rs. 60 Lacs and equity Rs. 20 Lacs.
Therefore the Long Term Liabilities would be Rs.60 Lac.

Exercise 11 : Current Ratio is say 1.2 : 1 . Total of balance sheet being

Rs.22 Lac. The amount of Fixed Assets + Non Current Assets is Rs. 10
Lac. What would be the Current Liabilities?

Ans : When Total Assets is Rs.22 Lac then Current Assets would be 22 10
i.e Rs. 12 Lac. Thus we can easily arrive at the Current Liabilities figure
which should be Rs. 10 Lac

Questions on Fund Flow Statement

Q . Fund Flow Statement is prepared from the Balance sheet :
1.
2.
3.
4.

Of three balance sheets

Of a single year
Of two consecutive years
None of the above.

Q. Why this Fund Flow Statement is studied for ?

1.
2.
3.
4.

It indicates the quantum of finance required

It is the indicator of utilisation of Bank funds by the concern
It shows the money available for repayment of loan
It will indicate the provisions against various expenses

Q . In a Fund Flow Statement , the assets are represented by ?

1.
2.
3.
4.

Application of Funds
Sources of Funds
Surplus of sources over application
Deficit of sources over application

Q . In Fund Flow Statements the Liabilities are represented by ?

1.
2.
3.
4.

Sources of Funds
Use of Funds
Deficit of sources over application
All of the above.

Q . When the long term sources are more than long term uses, in the
fund flow statement, it would suggest ?
1.
2.
3.
4.

Increase in Current Liabilities

Decrease in Working Capital
Increase in NWC
Increase in NWC

Q . When the long term uses in a fund flow statement are more than the
long term sources, the n it would mean ?
1.
2.
3.
4.

Reduction in the NWC

Reduction in the Working Capital Gap
Reduction in Working Capital
All of the above

Q. How many broader categories are there for the Sources of funds, in
the Fund Flow Statement ?
1.
2.
3.
4.

Only One, Source of Funds

Two, Long Term and Short Term Sources
Three , Long, Medium and Short term sources
None of the above.

Q. Which of following item is not an application of funds in the