Analysis of

Financial Ratios
CV.Alexander
DGM &FM

Version: College of Agricultural Banking, RBI, PUNE 1

 Definition

• The relationship between two accounting figures

expressed mathematically is known as financial
ratio

Date: College of Agricultural Banking, RBI, PUNE 2

 Introduction

• What is the purpose of analysis of financial ratios

– It is for a meaningful study of information in the
financial statements

– Ascertaining overall financial position of a business

organisation

– Interpretation of key information in the financial

statements

Date: College of Agricultural Banking, RBI, PUNE 3

 Objective

• The objectives:

– Assess credit risk profile of the borrower

– Stipulation of terms and conditions

– Assess utilization of credit facility

– Establish sound well defined credit granting criteria

– Ensure safety of bank funds

Date: College of Agricultural Banking, RBI, PUNE 4

 Factors that banks consider

• Credit worthiness of the borrower

• Integrity/reputation
• Credit risk profile
• Sensitivity to economic and market developments
• Liquidity
• Solvency
• Profitability of business
• Resource efficiency

Date: College of Agricultural Banking, RBI, PUNE 5

 Financial Analysis

• Trends in the financial planning

• Analysis of projected financial statements

Date: College of Agricultural Banking, RBI, PUNE 6

 Assets & Liabililities
(Rs.crore)
Liabilitiesm Assets
Year 3 Year 2 Year 1 Category Category Year 1 Year 2 Year 3

2652 2308 2249 Current Current 2868 2867 3088

Liabilities Assets

(436) (559) (619) Net Working

Capital

039 3688 3279 Deferred Net Fixed 5394 5527 6300

Liability Assets

4065 3974 3742 Net Worth Misc. 840 1298 1071

Assets
Intangible 168 278 297
Assets

10756 9970 9270 Total Total 9270 9970 10756

Date: College of Agricultural Banking, RBI, PUNE 7

 Measures of Liquidity

• Net Working Capital

• Current Ratio
• Quick Ratio
• Net Working Capital/Net Assets
• Net Working Capital/Current Assets

Date: College of Agricultural Banking, RBI, PUNE 8

 Net Working Capital

• Gross Working Capital ( GWC)

• is the investment required to be made by the
borrower in Current Assets
• How
• From own contributions
• From creditors, borrowings
• Other short term resources

Date: College of Agricultural Banking, RBI, PUNE 9

 Gross Working Capital

• Gross Working Capital

• How funded
• From own resources and other long term sources
• Short fall if any from short term resources

Date: College of Agricultural Banking, RBI, PUNE 10

 Short Term Resources

• Short term resources constitute what are known

as ‘ Current Liabilities’
• Current Liabilities should be lower than Current
Assets
• Excess o0f Current Assets over Current Liabilities
is Net Working Capital

• Contribution from long term resources applied to

financing of Current Assets ( excess of Current
Assets) is owner’s stake or margin money

Date: College of Agricultural Banking, RBI, PUNE 11

 Financing of Current Assets
(National Steel Corporation)

• 1.Current Assets = Current Liabilities + NWC or

• 3088 = 2652 + 436

• 2. NWC = Current Assets – Current Liabilities or

• 436 = 3088 – 2652
• 3. Current Assets = Current Liabilities +
Contribution from Long Term Liabilities
• 3088 = 2249 +[(8104-7668)] =2652+436
• (i.e.NWC = 3088)

Date: College of Agricultural Banking, RBI, PUNE 12

 Concept of NWC

• NWC represents the surplus long term funds

applied towards financing of Current Assets
• Current assets are financed from two sources

– Surplus from Long Term Liabilities

– Current Liabilities

Difference between Current assets and Current Liabilities

should always be positive

Date: College of Agricultural Banking, RBI, PUNE 13

 NWC

• Negative Net Working Capital

• What is the Implication
• Business has applied part of surplus Current
Liabilities towards meeting shortfall in Long Term
resources

Date: College of Agricultural Banking, RBI, PUNE 14

 NWC

• Positive NWC means

i.Borrower has brought in his
contribution

ii.Any fall in value of Current Assets will

be cushioned by borrower’s stake

iii.Loss in sale of Current Assets will not

affect Short term creditors

Date: College of Agricultural Banking, RBI, PUNE 15

 NWC

• Net Working Capital ( NWC ) is a measure of

liquidity

• Sources for NWC

Long Term Liabilities net of Long Term Assets
( LTLs including Net Worth less LTAs which includes
Fixed Assets, miscellaneous assets and
intangibles. Another measure of liquidity is the
Current Ratio)

Date: College of Agricultural Banking, RBI, PUNE 16

 Current Ratio

• Current Ratio:
Current Assets/ Current Liabilities

If Net Working Capital is to be of positive value

the Current Ratio must be higher than 1.

Ideally for calculating MPBF Current Ratio should be

1.33: 1

Date: College of Agricultural Banking, RBI, PUNE 17

 Liquidity Ratios
Year 1 Year 2 Year 3

1. Current Assets 2868 2867 3088

2.Quick Assets 1792 1846 1040
3.Current Liabilities 2249 2308 2652
4.NWC (1-3) 619 559 436
5.Current Ratio 1.28 1.24 1.16
6.Quick Ratio 0.80 0.80 0.77
7.Net Sales 5635 5526 6104
8 NWC/Net Sales (%) 10.98 10.12 7.14
9NWC/Current Assets(%) 21.58 19.50 14.12

Date: College of Agricultural Banking, RBI, PUNE 18

 Quick Ratio

• From the ‘gone concern’ approach inventory is

the least liquid of Current Assets

• Quick Ratio or Acid Test Ratio = Current Assets-

Inventory/Current Liabilities

• Norm the QR should not be less than 1.

• 1:1 is satisfactory

Date: College of Agricultural Banking, RBI, PUNE 19

 NWC/Net Sales

• This percentage should be around 8-12 %

• NWC is lower:

• Business is growing too fast without

building an adequate cushion in the form of NWC

• It indicates symptom of overtrading and

• Undue reliance on borrowed short term funds

Date: College of Agricultural Banking, RBI, PUNE 20

 Falling NWC/Net Sales

• Indicative of overtrading and serious liquidity

problems

• It needs to be investigated

Date: College of Agricultural Banking, RBI, PUNE 21

 NWC/Current Assets
• This measures contribution of Long Term funds
towards financing Current Assets

• Method of Lending
• 1st Method Amt. 2nd Method Amt.
Current Assets 370 25 (LTS) 370
Less CLs -150 278
WCG 220 -150
25% -55
MPBF 165 128
CR 1.17 CR 1.33

Date: College of Agricultural Banking, RBI, PUNE 22

 Debt Equity Ratio

• DER = TLT Liabilitie/TNW

• Low ratio has a better leverage for borrowing

• Not more than 1.5 for providing finance by banks

Date: College of Agricultural Banking, RBI, PUNE 23

 DSCR

• DSCR =( Net profit +Depcn+ Annual amount of

int.on LTLs)/Interest + principal

• Indicative of funds available for servicing long

term debt

• DSCR = 6+4+2/6 = 12/6= 2

• This is comfortable
• Should not be less than 1.5:1 while considering
projects

Date: College of Agricultural Banking, RBI, PUNE 24

 Return on Assets

• RoA = PBIT/Total Assets

• To measure profitability and efficiency

• Higher the ratio, the more efficient is the firm in
using resources

Date: College of Agricultural Banking, RBI, PUNE 25

 Gross Profit Margin

• The surplus of sales over cost of goods sold

• Gross profit Margin= (Sales minus Cost of goods

sold )x 100/Sales

• A higher ratio indicates better managerial

efficiency and profitability

Date: College of Agricultural Banking, RBI, PUNE 26

 Interest Coverage Ratio

• ICR = PBDIT/Annual Int.Obligation

• To find out whether business generates sufficient

profit to service interest payment
• Interest Coverage Ratio of 3 is reasonable and
below 2 is considered risk prone

Date: College of Agricultural Banking, RBI, PUNE 27


– Ratio analysis is used as a
major tool for financial
analysis
– For a meaningful study of
information contained in the
financial statements
– Ascertaining the overall
financial position of a
Business Organization
– Ratios are calculated from the
past financial statements
– Ratios could also be worked
out based on the projected
financial statements of the
same firm
Date: College of Agricultural Banking, RBI, PUNE
Summary
• Easiest way of evaluating the
performance of a firm is by
comparing past and present
ratios
• Used to judge operational
efficiency, financial health,
solvency or soundness
• To find out the liquidity
position
• Major categories of ratios
9 Liquidity ratios
9 Leverage or solvency ratios
9 Activity Ratios
9 Profitability Ratios
28
 • ANY ????

• THANK YOU

Date: College of Agricultural Banking, RBI, PUNE 29