Académique Documents
Professionnel Documents
Culture Documents
RATIO ANALYSIS
By Shilpa Arora
Assistant Professor
IITM
RATIO ANALYSIS
Quick assets
Quick ratio=
Current liabilities
Proprietary funds
Proprietary ratio=
Total assets
Current liabilities
Current liabilities to net worth ratio=
Net worth
Ideal ratio:1:3
This ratio indicates the relative contribution of short term
creditors and owners to the capital of an enterprise. If
the ratio is high, it means it is difficult to obtain long term
funds by the business.
Capital Gearing Ratio
It expresses the relationship between equity capital and
fixed interest bearing securities and fixed dividend
bearing shares.
Fixed interest bearing securities + fixed dividend
bearing shares
CGR=
Equity shareholders funds
Components of fixed Components of equity
interest bearing securities shareholders funds
Debentures Equity share capital
Long-term loans Accumulated reserves &
Long-term fixed deposits profits
Less losses and fictitious
assets
Interpretation Of Capital Gearing
Ratio
When fixed interest bearing securities and fixed
dividend bearing shares are higher than equity
shareholders funds, the company is said to be ‘highly
geared’.
Where the fixed interest hearing securities and fixed
dividend bearing shares share equal to equity share
capital it is said to be ‘evenly geared’.
When the fixed interest bearing securities and fixed
dividend bearing shares are lower than equity share
capital it is said to be ‘low geared’.
If capital gearing is high, further raising of long term
loans may be difficult and issue of equity shares may
be attractive and vice-versa
Fixed Assets Ratio
It establishes the relationship between fixed assets and
capital employed
Fixed assets
Fixed assets ratio=
Capital employed
Where, capital employed=Shareholder’s funds+ Long-term Debt
Ideal ratio: 0.67:1
This ratio enables to know how fixed assets are financed
i.e. by use of short term funds or by long term funds.
This ratio should not be more than 1.
Fixed Charges cover or Debt
Service Ratio
This ratio is determined by dividing net profit by fixed
interest charges.
Net profit before interest
and tax
Debt service ratio=
Fixed interest charges
Ideal ratio: 6 or 7 times; if the ratio is high it means
there is higher margin of safety for the long term lenders
and as such it is not difficult for the business to obtain
further long term funds and vice-versa.
This ratio indicates the financial ability of the enterprise
to meet interest payment out of current earnings
Dividend Cover Ratio
It is the ratio between disposable profit and dividend.
Disposable profit refers to profit left over after paying
interest on long term borrowing and income tax.
Net profit after interest and tax
Dividend cover ratio=
Dividend declared
This ratio indicates the ability of the business to maintain
the dividend on shares in future. If this ratio is higher is
indicates that there is sufficient amount of retained profit.
Even if there is slight decrease in profit in the future it
will not affect payment of dividend in future
III. Activity Ratio
Activity ratios indicate the performance of an
organisation.
This indicate the effective utilization of the
various assets of the organisation.
Most of the ratio falling under this category is
based on turnover and hence these ratios are
called as turnover ratios.
Important Ratios In Activity Ratio
Stock turnover ratio.
Debtors turnover ratio.
Creditors turnover ratio.
Wording capital turnover ratio.
Fixed assets turnover ratio.
Current assets turnover ratio.
Total assets turnover ratio.
Sales to networth ratio.
Stock Turnover Ratio
This ratio establishes the relationship between the cost
of goods sold during a given period and the average
sock holding during that period. It tells us as to how
many times stock has turned over (sold) during the
period. Indicates operational and marketing efficiency.
Helps in evaluating inventory policy to avoid over
stocking.
Cost of goods sold
Inventory turnover ratio=
Average stock
Cost of goods sold= sales-gross profit
= opening stock + purchases +Direct
expenses – closing stock
Opening stock + Closing stock
Average stock=
2
Interpretation Of Stock Turnover
Ratio
Ideal ratio: 8 times; A low inventory turnover may
reflect dull business, over investment in inventory,
accumulation of stock and excessive quantities of
certain inventory items in relation to immediate
requirements.
A high ratio may not be accompanied by a relatively
high net income as, profits may be sacrificed in
obtaining a large sales volume (unless accompanied
by a larger total gross profit). It may indicate under
investment in inventories. But generally, a high stock
turnover ratio means that the concern is efficient and
hence it sells its goods quickly.
Debtor Turnover Ratio
This ratio explains the relationship of net credit sales of
a firm to its book debts indicating the rate at which cash
is generated by turnover of receivables or debtors.
The purpose of this ratio is to measure the liquidity of the
receivables or to find out the period over which
receivables remain uncollected.
Net credit sales
Debtor turnover ratio=
Average receivables
Average receivables=Average Debtors+ Average B/R
Average Collection Period
The average collection period represents the average
number of days for which a firm has to wait before its
receivables are converted into cash
COGS
Working capital turnover ratio=
Average working capital
Net sales
Fixed assets turnover ratio=
Fixed assets
Net sales
Total assets turnover ratio=
Total assets
Net profit
Return on total recourses = X 100
Total assets
Dividend Yield Ratio
It refers to the percentage or ratio of dividend paid per
share to the market price per share. This ratio throws
light on the effective rate of return on investment, which
potential investors may hope to earn.
LIABILITES ASSETS
Capital 180 Net Fixed Assets 400
Reserves 20 Inventories 150
Term Loan 300 Cash 50
Bank C/C 200 Receivables 150
Trade Creditors 50 Goodwill 50
Provisions 50
800 800
Goodwill 50 50
Total 1600 1760 1600 1760