CLASSIFICATION OF RATIOS

Several ratios can be grouped into various classes, according to the activity or
function they perform. There are several groups of persons- creditors,
investors+-, lenders, management and public, interested in interpretation of the
financial statements. Each group identifies those ratios, relevant to its
requirements. They wish to interpret ratios, for those purposes they are interested
in, to take appropriate decisions to serve their own individual interests. In view
of the diverse requirements of the various users of the ratios, the ratios can be
classified into four categories:

1. Liquidity Ratios: They measure the firm’s ability to meet current

obligations.
2. Activity Ratios: They reflect the firm’s efficiency in utilizing the assets.
3. Leverage Ratios: These ratios show the proportion of debt and equity in
financing the firm’s assets.
4. Profitability Ratios: These ratios measure overall performance and
effectiveness of the firm.
LIQUIDITY RATIOS

Liquidity ratios measure the firm’s ability to meet current obligations, as and
when they fall due. A firm should ensure that it does not suffer from lack of
liquidity and does not have excess liquidity. In the absence of adequate liquidity,
the firm would not be able to pay creditors on the due date. If the firm maintains
more liquidity, it will not experience any difficulty in making payments.
However, more liquidity is bad, as idle assets earn nothing, while there is cost
for the funds. The firm’s funds will be, unnecessarily, tied up in liquid assets.
Both inadequate and excess liquidity are not desirable. It is necessary for the firm
to strike a proper balance between high liquidity and lack of liquidity. These
ratios are termed as „working capital ratio‟ or „short term solvency ratio‟.
Liquidity ratios are highly useful tocreditors and commercial banks that provide
short-term credit. The liquidity ratios are classified as under:

Current Ratio

Liquidity Ratios Quick Ratio

Absolute Liquidity Ratio

(i) Current Ratio

Current ratio is defined as the relationship between current assets and current
liabilities. It refers to the measurement of the firm‟s ability to meet its short- term
obligations. It establishes the relationship between the current assets and the
current liabilities. It is calculated as follows:

Current assets normally mean such assets which are converted into cash within
a year’s time or during the normal operating cycle of the business. It usually
includes cash in hand and at bank, debtors (less provision for bad and doubtful
debts), inventories - raw materials, work-in-progress and finished goods, prepaid
expenses, bills receivable, marketable securities, etc. Current liabilities represent
the liabilities which are payable within a year’s time during the normal
operating cycle of the business. It includes sundry creditors, bills payable,
outstanding expenses, bank overdraft, etc.

Interpretation:

The current ratio is used to find out the ability of the business to pay-off its short-
term obligations. The current ratio of 2:1 is reckoned as an ideal ratio. This ratio
should be neither too high nor too low. A very high current ratio is also not
desirable since it means inefficient use of working capital. It may be due to the
piling up of obsolete inventory, excessive cash, large amount of debtors due to
inefficient collection policy, etc. On the other hand, a low ratio indicates inability
of the company to meet adequately its short-term obligations.

(ii) Liquid Ratio (Quick Ratio) (Acid Test Ratio)

Liquid ratio establishes the relationship between liquid assets and current
liabilities. Liquid assets are those that can be converted into cash, quickly,
without loss of value. Cash and balance in current account with bank are the most
liquid assets. Other assets that are considered, relatively, liquid are debtors, bills
receivable and marketable securities. Inventories and prepaid expenses are
excluded from this category. Inventories are considered less liquid as they
require time for realizing into cash and have a tendency to fluctuate, in value, at
the time of realization. Prepaid expenses cannot be recovered in cash, normally,
hence they are excluded.

Liquid Assets = Current Assets –Inventory -Prepaid Expenses

Interpretation:

It helps to assess the ability of the company to meet its obligation without waiting
for much time to liquidate its assets. Ideal Quick/Liquid Ratio is 1:1. Thus, an
organization must have quick assets equivalent to 100% of its current liabilities.
However, the result of quick ratio should be interpreted carefully keeping in view
the composition of liquid assets.

(iii) Absolute Liquidity Ratio (Super-Quick Ratio) (Cash Ratio)

This ratio establishes the relationship between the absolute liquid assets and
current liabilities. Absolute liquid assets usually constitute of cash in hand and
at bank and marketable securities. Cash is the most liquid asset. Although debtors
and bills receivable are, generally, better realisable than inventories, still, there
are doubts regarding their realisation, more so, in time. So, they are not
considered, immediately, available for making payments and so excluded for the
calculation of cash ratio. It is the most vigorous test of the firm‟s liquidity
position. However, this ratio is hardly used in practice. It may be expressed as
follows.

Interpretation:

Cash ratio of 1:2 is considered acceptable. It means Rs. 1 liquid assets are
considered adequate to pay Rs. 2 of current liabilities as all the creditors are not
expected to demand cash, at the same time, and cash may be realised, at least
something, from debtors and inventories too. More so, sanctioned working
capital limits of the bank are not always, fully, utilised and the balance drawing
power is available to the firm for immediate withdrawal of cash.
EFFICIENCY OR TURNOVER RATIOS

Activity Ratio is also called turnover ratios or asset utilization ratio or efficiency
ratios. It is concerned with measuring the efficiency with which asset is managed.
It refers to the speed and rapidity with which assets are converted into sales. The
greater is the rate of turnover or conversion, the more efficient is the utilization
or management of the asset. These ratios are usually calculated with reference to
sales/cost of goods sold and are expressed in terms of rate or times. Activity
Ratio may be calculated for all the assets, however, some of the important
activity ratios are as follows:

Inventory Turnover Ratio

Efficiency Ratios Debtors‟ Turnover Ratio

Creditors‟ Turnover Ratio

Other Turnover Ratio

(i) Inventory Turnover Ratio

The Institute of Chartered Accountants of India defines inventories in

Accounting Standard 2 as follows: “Inventories are assets held for sale in the
ordinary course of business, in the process of production for such sale; or in the
form of materials or supplies to be consumed in the production process or in the
rendering of services.”

This ratio is also called as „Stock Velocity Ratio‟ and establishes the relationship
between the cost of goods sold during a given period and the average inventory
held during the year by firm. It is calculated as follows:
Cost of Goods Sold = Opening Stock + Purchases - Closing Stock

(Or)

= Net Sales - Gross Profit

Sometimes, it is difficult to calculate cost of goods sold on the basis of available

information. In such a case, net sale are used in place of cost of goods sold. It
may be computed on the following basis:

Average age of Inventory Period

The concept of Inventory Turnover Ratio can be extended to find out the number
of days of inventory holding as follows:

Where, 360/365 is taken as number of days in a year.

Interpretation:

It measures the liquidity of the inventory. It indicates the velocity with which the
goods move, thus serves as a yardstick of efficient inventory management. The
lower this ratio, the better it is. A lower inventory ratio indicates quick sales. But
a low turnover ratio should be analyzed carefully as it may result in lower
investment in inventory and frequent stock outs. A high ratio is an indicator of
slow moving, obsolete or poor quality goods which the company may not be able
to sell.
(ii) Debtors’ Turnover Ratio

It is also known as the Receivables Turnover Ratio or „Receivables Velocity

Ratio‟. It establishes the relationship between net credit sales of the year andthe
average debtors. It indicates how well receivables are turning into cash. It refers
to the speed with which receivables are converted into cash, thus important for
analyzing the liquidity position of the firm. This ratio may be calculated using
the following formula:

The term receivables here include both the trade debtors and bills receivable.

Average Accounts Receivable =

In case information about credit sale and average debtors is not available, this
ratio may be calculated on the basis of total sales and closing balance of
receivables.

Average Collection Period

The other important ratio related to Debtor’s Turnover Ratio is the Average
Collection Period. It states the average debt collection period. It is useful because
it indicates the average period of credit extended by the firm and the
effectiveness of credit and collection policy of the firm. A low Average
Collection Period implies the shorter time lag between credit sales and cash
collection. It may be calculated by any of the following methods:
(Or)

Interpretation:

In absolute terms, high debtors ratio and low collection period is an indicator of
highly liquid accounts receivable. A shorter collection period implies prompt
payment by debtors and restrictive credit policy. On the other hand, low' debtors‟
turnover ratio and longer collection period implies liberal credit andcollection
policy. As such, credit policy should be neither too liberal nor too restrictive. A
restrictive credit policy can affect sales adversely and thus reduce profits. The
efficiency of firms‟ credit and collection policy can be evaluated by comparing
it with the average of the industry. There is no ideal collection period of debtors.
It depends upon the peculiar characteristics of the industry, business and the
firm.

(iii) Creditors’ Turnover Ratio

It establishes the relationship between the net credit purchases and the average
trade creditors. It is also known as „Creditors' Velocity Ratio‟. It indicates the
speed with which the payments for credit purchases are made to the trade
creditors. It is computed as follows:

The term Accounts Payable includes both Trade Creditors and Bills Payable.
Average Payment Period or Credit Period

This ratio is supported by another ratio, viz., „Average Payment Period‟ which
may be calculated by any of the following methods:

(Or)

Interpretation:

A low „Creditors' turnover ratio‟ or „Larger Average Payment Period‟ implies

liberal credit terms granted by the supplier. But excessive „large average
payment period' means an unusual delay in the payment to the suppliers and thus
affects adversely the credit reputation of the firm. On the other hand, a higher
„creditors turnover ratio' or a „shorter credit period' implies that the creditors are
being paid promptly which enhances the credit worthiness of the company.
However, shorter credit period also means that the company is not taking full
advantage of the credit facilities granted by the suppliers. Therefore, it should be
neither too high nor too low. As far as possible, the company should try to
maintain the Average Payment Period in line with the credit terms of the supplier.

(iv) Other Turnover Ratios

(a) Working Capital Turnover Ratio

It is an indication of the velocity or efficiency in the utilization of the working

capital during the year. The working capital here means the net working capital
which is equal to the total current assets less total current liabilities. It is
calculated as follows:
The higher the working capital turnover ratio, the lower is the investment in the
working capital and greater is the contribution to sales. However, high working
capital turnover ratio also implies a risky proposition for the firm and low net
working capital in relation to the sales volume.

(b) Fixed Assets Turnover Ratio

It indicates the efficiency of the fixed assets towards contribution to sales. It

helps to assess whether the investment in fixed assets is justified or not. It is
calculated as follows:

Higher fixed assets turnover ratio indicates the higher efficiency in the
utilization of the fixed assets.

(c) Total Assets Turnover Ratio

It measures the efficiency in the use of total assets. This ratio is calculated as
follows:

LEVERAGE RATIOS (FINANCIAL RATIOS) (LONG-TERM

SOLVENCY RATIOS)

These ratios are used to assess the long-term solvency of the business. The short-
term creditors are interested in short-term solvency of the business. Liquidity of
the firm can be ascertained and understood with the help of Liquidity Ratios. The
long-term solvency of the business can be judged by using Leverage
(i) Capital Gearing Ratio

Capital Gearing Ratio refers to the relationship between the fixed income bearing
capital and variable income bearing capital. The fixed interest bearing capital
includes the funds provided by the debenture holders and preference
shareholders. The variable income bearing capital includes the funds provided
by equity shareholders. It includes the equity share capital and other reserves. It
can be calculated as follows:

The numerator of the above equation includes both the debt and the preference
share capital. The denominator of the above equation includes equity share
capital and other reserves meant for equity shareholders.

Interpretation:

In case, the amount of fixed interest or dividend bearing funds is more than the
equity shareholders' funds, the capital structure is said to be highly geared. On
the other hand, the capital structure is said to be low geared, if reverse is the case.
If both the components are equal, the capital structure is said to be evenly geared.
There is another implication of capital gearing ratio. It indicates the additional
residual benefits accruing to the equity shareholders' funds. It is due to the fact
that the company earns a certain rate of return on the capital employed, but is
required to pay only a fixed return against loans and preference share capital.
(ii) Debt Equity Ratio

The debt-equity (D/E) ratio is another tool of financial analysis. The debt equity-
ratio reflects the relative contribution of creditors and owners of business in the
capital structure of the firm. It is also called „External-Internal Equity‟ Ratio. It
is computed as follows:

External Equities = Debentures + Long-term loans + Short-term Creditors

(Creditors, Bill Payable, Outstanding Expenses, Provision for Income tax,
Proposed Dividend etc.)

(Or)

External Equities = Long-Term Debts + Current Liabilities

Internal Equities/Shareholders‟ Funds = Equity Share Capital + Preference

Share Capital + Capital Reserves + Revenue Reserves.

Interpretation:

Debt Equity Ratio indicates the extent to which debt financing has been used in
business. This ratio shows the level of dependence on the outsiders. As a general
rule, there should be a mix of debt and equity. The owners want to conduct
business, with maximum outsiders‟ funds to take less risk for their investment.
At the same time, they want to maximise their earnings, at the cost and risk of
outsiders‟ funds. The outsiders (lenders and creditors) want theowners‟ share, on
a higher side in the business and assume lower risk, with more safety to their
funds.

Total debt to net worth of 1:1 is considered satisfactory, as a thumb rule. In some
businesses, a high ratio 2:1 or even more may be considered satisfactory, say, for
example in the case of contractor‟s business. It all depends upon the
financial policy of the firm, risk bearing profile and nature of business. Generally
speaking, the long-term creditors welcome a low ratio as owners‟ funds provide
the necessary cushion to them, in the event of liquidation. A high debt-equity
ratio may be unfavourable as the firm may not be able to raise further borrowing,
without paying higher interest, and accepting stringent conditions. This situation
creates undue pressures and unfavourable conditions to the firm from the
creditors.

(iii) Total Debt Ratio

Total Debt Ratio compares the total debts (long-term as well as short-term) with
total assets.

Total Debts = Long Term Debts + Current liabilities

Interpretation:

This ratio depicts the proportion of total assets, financed by total liabilities. A
higher ratio is a threat to the solvency of the firm. A lower ratio is an indication
that the firm may be missing the available opportunities to improve profitability.
What is required a balanced proportion of debt and equity so as to take care of
the interests of lenders, the shareholders and the firm, as a whole.

(iv) Proprietary Ratio

It is also known as Net Worth to Total Assets Ratio or Capital Ratio Itestablishes
the relationship between shareholders' funds and total assets of business. Its main
purpose is to find out how much funds have been provided by shareholders for
investment in assets of the business.
Proprietors‟ Funds/Shareholders‟ Funds = Ordinary Share Capital + Preference
Share Capital + Reserves and surplus.

Total Assets = Fixed Assets + Current Assets (excluding fictitious assets)

Interpretation:

This ratio is quite significant for the creditors of business. With the help of this
ratio, it can be ascertained in what proportion owners have provided funds for
investment in assets of business. The higher the ratio, the more profitable it is for
the creditors and the lesser is the dependence on external funds. If the ratio is
low, the creditors can be suspicious about the repayment of their debt which
indicates greater risk to the creditors. The higher the ratio, the better it is. A ratio
below 50% may be quite alarming for the creditors. The greater the percentage
financing provided by shareholders equity, the larger is the cushion of protection
for the firm‟s creditors.

(v) Fixed Assets to Proprietors’ Funds Ratio

This ratio establishes relationship between fixed assets and proprietors funds.
The main objective of this ratio is to find out in what proportion owners funds
are invested in fixed assets.

Fixed Assets here means net fixed assets, i.e., after charging depreciation
proprietors‟ funds are the same as internal equities in the debt equity ratio.

Interpretation:

The higher proportion of proprietors‟ funds to fixed assets is a measure of long-

term financial soundness of business. However, the lower the ratio, the better it
is for the long term solvency of business because proprietors funds will be
available for working capital needs also. For industrial units, the standard is
usually 65%. If the ratio is more than one, it means that a part of fixed assets has
been financed from debt capital.

(vi) Current Assets to Proprietors’ Funds Ratio

This ratio establishes relationship between current assets and proprietor‟s

funds. The main objective of this ratio is to find out in what proportion
proprietors fund has been invested in current assets. It is calculated as follows:

(vii) Interest Coverage Ratio

It is also known as „Debt Service Ratio‟ or „Fixed Charges Cover‟. It

establishes the relationship between the amount of net profit before deduction of
interest and tax, and the fixed interest charges. Interest Coverage Ratio may be
calculated as follows:

Interpretation:

This ratio indicates the extent to which earnings can fall, without causing any
embarrassment to the firm, regarding the payment of interest charges. The higher
the ratio, better it is both for the firm and lenders. For the firm, the probability of
default in payment of interest is reduced and for the lenders, the firm is
considered to be less risky. However, too high a ratio indicates the firm is very
conservative in not using the debt to its best advantage of the shareholders. On
the other hand, a lower coverage ratio indicates the excessive use of debt.
(viii) Dividend Coverage Ratio

This ratio measures the margin of safety available to preference shareholders

with regard to the payment of dividend. Though the payment of preference
dividend is not compulsory, it is assumed that the payment of such dividend is
payable only out of profit after taxes, thus it is calculated as follows:

The higher is the ratio the greater is the security for the presence shareholders.

4.4.1. PROFITABILITY RATIOS

The profitability ratios measure the profitability or the operational efficiency of

the firm. A lack of profit may arise due to poor sales, lack of control over the
expenses. Both the shareholders (owners) and the management are interested in
measuring the operational efficiency or profitability of the firm. Even the
prospective investors and creditors of the firm look at the profitability prospects
of the firm. The profitability ratios are the relative measurement which can be
determined on the basis of either sales or investment.

(i) Profitability Ratios Related to Sales

These ratios are calculated on the basis of sale. If a firm does not earn adequate
profit on sales, it will be difficult for the firm to pay operating expenses and the
owners will not able to get reasonable return on their investments. The following
ratios fall in this category:

(a) Gross Profit Ratio

(b) Net Profit Ratio
(c) Operating Profit Ratio
(d) Operating Expenses Ratio
(e) Expenses Ratio
(a) Gross Profit Ratio

It is also called the average mark up ratio. This ratio establishes the relationship
between the gross profit of the firm and net sales. It is generally expressed in
terms of percentage of gross profit earned on sales. It is calculated as follows:

Gross Profit = Net Sales - Cost of Goods Sold

Cost of Goods Sold = Opening Stock + Net Purchases + Direct Expenses –

Closing Stock

Net Sales = Sales – Sales Return

Net Purchases = Purchases – Purchase Return

Interpretation:

The Gross Profit Ratio measures the per rupee gross profit earned on every 1
rupee of sales. It indicates the efficiency with which the firm purchases/produces
the goods. The improvement in gross profit ratio over the previous years may be
due to improved efficiency of the firm in manufacturing or trading activities
which may result from increase in the selling price or decrease in the cost price
or reduction in raw material consumption per unit, etc. The deterioration in gross
profit ratio over the previous years may be due to the decline in the efficiency
of the firm in manufacturing or trading activities which may be due to decrease
in the selling price per unit of goods sold or increase in the cost price or increase
in the raw material consumption per unit or increase in the direct expenses, etc.
The amount of gross profit earned by the firm should be adequate to cover
operating and non operating expenses and to provide for reasonable return for
the shareholders.
 (b) Net Profit Ratio

The net profit ratio establishes the relationship between the net profit (after tax)
of the firm and net sales. Net profit is obtained, after deducting operating
expenses, interest and taxes from gross profit and is calculated as follows:

The net profit can also be calculated from operating profit as follows:

Net Profit = Operating Profit + Non Operating Income - Non Operating

Expenses.

Interpretation:

It is a meaningful tool to judge the profitability of the firm when this ratio is
studied along with the Gross Profit Ratio and Operating Profit Ratio. Net Profit
ratio indicates the overall efficiency of the management in manufacturing,
administering and selling the products. Net profit has a direct relationship with
the return on investment. If net profit is high, with no change in investment,
return on investment would be high. If there is fall in profits, return on investment
would also go down.

(c) Operating Ratio

This ratio establishes the relationship between the aggregate of cost of goods sold
and other operating expenses on the one hand and the sales revenue on the other
hand. Other operating expenses comprise of administrative overheads, selling
and distribution overheads. Financial charges such as interest, provision for
taxation, etc are excluded from operating expenses. It is calculated as follows:
Interpretation:

It is a yardstick for measurement of the operating efficiency of the firm. A higher

operating expense ratio is not favorable since it will leave a small amount of
income to meet non-operating expenses. It should be low enough to generate a
reasonable return for the shareholders. The comparison of operating ratio with
that of the past or average of the industry will indicate whether the operating cost
component is reasonable or not in relation to sales. The reasons for the variation
in the operating expense ratio should be carefully analyzed which may be due to
external uncontrollable factors, internal factor or management policies of the
firm etc.

(d) Operating Profit Ratio

This ratio measures the relationship between the operating profit and net sales.
The operating profit is also termed as the earnings before interest and taxes. The
operating profit refers to the profit generated by the firm from operating
activities. It is calculated as follows:

Net Operating Profit = Net Sales- Operating Cost

Operating Cost = Cost of Goods Sold + Operating Expenses

(Or)

Net Operating Profit =Net Profit (After taxes) + Non-Operating Expenses -

Non-operating Income
Non-operating Expenses relates to financial charges such as unexpected interest
payments, loss on sale of fixed assets or on account of contingencies, tax liability,
etc. Non-operating income relates to dividend, interest received on long-term
investment, profit on sale of goods, etc.

Interpretation:

This Ratio determines the efficiency of the firm in the management of the
business. There are no standard norms for the evaluation of this ratio. However,
the comparison of the OP Ratio with that of the past and/or industry averages
provides an indication about the operating management and conditions of the
business.

(e) Expense Ratios

The operating ratio can be calculated separately for each element of operating
cost, viz
(ii) Profitability Ratios Related to Investment

A financial analyst is interested to measure the profitability of the firm with

reference to assets employed by the firm. The larger the assets employed, the
greater should be the profits and vice versa. The following are the four important
ratios identified on the basis of linking of the profitability via- a-via the assets
employed by the firm.

(a) Return on Assets

(b) Return on Capital Employed or Return on Investment
(c) Return on Shareholders‟ Funds
(d) Return on Equity Shareholders‟ Funds

(a) Return on Assets (ROA)

It measures the profitability of the firm in relation to assets employed by the firm.
It is computed to know how much the profit is generated by the firm per rupees
of assets used. As net profit and net assets have several meanings, there are
a number of approaches to compute the ROA. Usually, the following approaches
are used:

Interpretation:

It measures the overall efficiency of the management in generating profits from

the use of assets. The increase in the size of the firm should be accompanied with
the increase in the ROA; only then the employment of more assets is justified.
The ROA of the firm should be compared with the industry average to judge the
operating efficiency of the firm with respect to the assets employed.
(b) Return on Investment

It is also known as „Return on Capital Employed‟ or „Rate of Return‟. It is

calculated on the basis of the following formula:

(Or)

The amount of capital employed has been defined differently by different

authors. However, the following approach is the most popular and acceptable
one.

Capital Employed = Net Fixed Assets + Working Capital

= Net Fixed Assets + (Current Assets - Current Liabilities)

(Or)

= Equity Share Capital + Preference Share Capital + Reserves and

Surplus + Long Term Loans - (Fictitious Assets + Non Operating
Assets)

(c) Return on Shareholders’ Funds

It is also called „Return on Net worth Ratio‟ or „Return on Proprietors‟ Funds‟. It

determines the profitability of the company from the perspective of
shareholders. It is computed as follows:
(d) Return on Equity Shareholder’s Funds

This ratio determines the profitability of the firm from the perspective of equity
shareholders. It is calculated after taking into account the amount of dividend
payable to preference shareholders. It is computed as follows:

Return on Equity Shareholder's Funds =

Where, Equity Shareholder's Funds = Equity Share Capital + Revenue Surplus

+ Capital Reserves – Accumulated Loses if any

(iii) Profitability Ratios from the Point of View of Owners of the Business

The profitability of the firm from the point of view of owners of the business
can be assessed from the following ratios:

a) Earnings Per Share

b) Dividend Per Share
c) Payout Ratio
d) Price Earnings Ratio
e) Earnings and Dividend Yield Ratio

(a) Earnings Per Share

The profitability of the shareholder‟s investment can be assessed by calculating

the earnings per share. EPS is determined by the following formula:

The number of equity shares should be adjusted for bonus or rights issue, if any
made during the year.
Interpretation:

The comparison of the EPS of the firm with that of the industry average and the
earnings per share of other firms helps in assessing the profitability of the firm
on per share basis. It helps in determining the market value of the share and the
capacity of the company to pay dividend to its equity shareholders.

(b) Dividend Per Share

The profit which is left after paying off taxes and preference dividend belongs to
equity shareholders. But the earnings which they really receive are the amount
of dividends distributed to them. The amount of earnings distributed to equity
shareholders per share is known as dividend per share and is calculated as
follows:

(C) Dividend Payout Ratio

Dividend Payout Ratio refers to the proportion of the earnings which has been
distributed to the shareholders as dividend. The company does not distribute all
of its earnings to equity shareholder The earnings not distributed are retained
back in the business and meant to be invested for the future growth prospects of
the firm.

(d) Price Earnings Ratio

It measures the relationship between the market price of an equity share and the
earning per share and is calculated as follows:
The PE Ratio indicates the expectation of equity investors about
the earnings or performance of the firm. It is widely used by
security analysts to find out whether the equity share of the
company is undervalued or overvalued.

(e) Earnings and Dividend Yield Ratio

The yield is defined as the rate of return on the amount invested

in the business. In order to find out the yield of an equity share,
the earnings per share and Dividend Per Share should be
compared with the market price per share. That is as follows:

The Earnings Yield is the inverse of Price Earnings Ratio. It is

also known as Earnings Price Ratio. The dividend yield and the
earnings yield ratio evaluate the return of the shareholders in
relation to the market price of shares.