BHAVANS COLLEGE

A PROJECT REPORT ON

RATIO ANALYSIS
SUBMITTED BY
GROUP-5

T.Y.B.M.S. SEMESTER V

Submitted To Prof. Vikram Dala

Academic Year 2010 2011

RATIO ANALYSIS
Ratio-analysis is a concept or technique, which is as old as accounting concept. Financial analysis is a scientific tool. It has assumed important role as a tool for appraising the real worth of an enterprise, its performance during a period of time and its pit falls. Financial analysis is a vital apparatus for the interpretation of financial statements. It also helps to find out any cross-sectional and time series linkages between various ratios. Unlike in the past when security was considered to be sufficient consideration for banks and financial institutions to grant loans and advances, nowadays the entire lending is need-based and the emphasis is on the financial viability of a proposal and not only on security alone. Further, all business decision contains an element of risk. The risk is more in the case of decisions relating to credits. Ratio analysis and other quantitative techniques facilitate assessment of this risk. Ratio-analysis means the process of computing, determining, and presenting the relationship of related items and groups of items of the financial statements. They provide in a summarized and concise form of fairly good idea about the financial position of a unit. They are important tools for financial analysis.

RELEVANCE OF RATIO ANALYSIS

When it comes to investing, analyzing financial statement information (also known as quantitative analysis), is one of, if not the most important element in the fundamental analysis process. At the same time, the massive amount of numbers in a company's financial statements can be bewildering and intimidating to many investors. However, through financial ratio analysis, you will be able to work with these numbers in an organized fashion. Ratio-analysis means the process of computing, determining, and presenting the relationship of related items and groups of items of the financial statements. They provide in a summarized and concise form of fairly good idea about the financial position of a unit. They are important tools for financial analysis. On account of above fact plus the utility discussed earlier, the use of ratioanalysis has increased considerably. It is now being used as a device to diagnose the financial health of a business concern. It signifies whether the financial health of a concern is vital, strong, good or poor and weak. Like doctors prescription, ratios represent the figures containing the condensed report of the position, progress, and problems of a concern. They facilitate the work or gauging the profitability, solvency, and activity of the concern. Like management, outsiders, viz., creditors, bankers, etc. may also use ratioanalysis as a tool for financial analysis and interpretation. Ratio Analysis may highlight upon the few phases of the business operations in which the outsiders are most interested by ascertaining the arte and directions of change and future potentialities. Thus, ratio analysis is a very powerful tool for both internal and external analysis. Ratio-analysis is a concept or technique, which is as old as accounting concept. Financial analysis is a scientific tool. It has assumed important role as a tool for appraising the real worth of an enterprise, its performance during a period of time and its pit falls. Financial analysis is a vital apparatus for the interpretation of financial statements. It also helps to find out any cross-sectional and time series linkages between various ratios. Unlike in the past when security was considered to be sufficient consideration for banks and financial institutions to grant loans and advances, nowadays the entire lending is need-based and the emphasis is on the financial viability of a proposal and not only on security alone. Further, all business decision

contains an element of risk. The risk is more in the case of decisions relating to credits. Ratio analysis and other quantitative techniques facilitate assessment of this risk. Lenders need it for carrying out the following: 1. 2. 3. 4. 5. Technical Appraisal Commercial Appraisal Financial Appraisal Economic Appraisal Management Appraisal

It is a tool, which enables the banker or lender to arrive at the following factors: 1. 2. 3. 4. 5. 6. Liquidity position Profitability Solvency Financial Stability Quality of the Management Safety & Security of the loans & advances to be or already been provided

The utility of ratio analysis will be further enhanced if following comparison is possible. 1. 2. 3. 4. Between the borrower and its competitor Between the borrower and the best enterprise in the industry Between the borrower and the average performance in the industry Between the borrower and the global average.

A tool used by individuals to conduct a quantitative analysis of information in a company's financial statements. Ratios are calculated from current year numbers and are then compared to previous years, other companies, the industry, or even the economy to judge the performance of the company. Ratio analysis is predominately used by proponents of fundamental analysis.

How a Ratio is expressed?

1. 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. 2. As Proportion - The above figures may be expressed in terms of the relationship between net profits to sales as 1: 4. 3. 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 Operating Ratio Gross Profit Ratio Operating Ratio Expense Ratio Net profit Ratio Stock Turnover Ratio

Balance Sheet and Profit & Loss Ratio Composite Ratio Fixed Asset Turnover Ratio, Return on Total Resources Ratio, Return on Own Funds Ratio, Earning per Share Ratio, Debtors Turnover Ratio

Financial Ratio Current Ratio Quick Asset Ratio Proprietary Ratio Debt Equity Ratio

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

Outside Liabilities
Current Assets are Short Term Use of Funds 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 Noncurrent.

 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 Current Liabilities 1,00,000 Total Current Assets 3, 00,000 Current Ratio = > 3, 00,000/1, 00,000 = 3: 1 Quick Ratio => 1, 50,000/1, 00,000 = 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. Average Inventory or Stocks = (Opening Stock + Closing Stock) Average Inventory or Stocks = (Opening Stock + Closing Stock) 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 Term Loan Bank C/C Trade Creditors Provisions

ASSETS 180Net Fixed Assets 20Inventories 300Cash 200Receivables 50Goodwill 50 800 800 400 150 50 150 50

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

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 Current Ratio : C A / C L Quick Ratio = 50

= 350 / 300 = 1.17 : 1

: Quick Assets / C L = 200/300 = 0.66 : 1

EXERCISE: 2 LIABILITIES 200506 Capital Reserves 300 140

200607 350 160

ASSETS 200506 NET 730 FIXED ASSETS SECURI 30 TY ELECT RICITY INVEST 110 MENTS RAW MATER IALS SIP 150 20

200607 750 30

Bank Term Loan Bank CC (Hyp) UNSEC.LON

320 490 150

280 580 170

110 170 30

G TL CREDITORS( 120 RM) BILLS 40 PAYABLE EXPENSES 20 PAYABLE PROVISIONS 20

170 80 30 40

FINISH ED GOODS CASH RECIEV ABLES LOANS/ ADVAN CES GOODW ILL TOTAL

140 30 310 30 50 1600

170 20 240 190 50 1760

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 Equity Capital Preference Capital Term Loan Bank CC (Hyp)

ASSETS 200Net Fixed Assets 100Inventory 600Receivables 400Investment In Govt. 800 300 150 50

Secu. Sundry Creditors Total 100Preliminary Expenses 1400 100 1400

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

Exercise: 4

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

ASSETS 355 Net Fixed Assets 7Cash 100Receivables 38Stocks 26Prepaid Expenses 265 1 125 128 1

Provision of Tax Proposed Dividend

9Intangible Assets 15 550

30

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 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 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. amount of Current Assets ? NWC is Rs.30,000/-. What is the

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

EXERCISE: 12
Under which of the following methods of depreciation on Fixed Assets, the annual amount of depreciation decreases? 1. 2. 3. 4. Written Down Value method Straight Line method Annuity method Insurance policy method

EXERCISE: 13
Debt Service Coverage Ratio (DSCR) shows:

1. Excess of current assets over current liabilities 2. Number of times the value of fixed assets covers the amount of loan 3. Number of times the companys earnings cover the payment of interest and repayment of principal of long term debt 4. Effective utilization of assets

EXERCISE: 14
Which of the following is not considered a Quick Asset? 1. 2. 3. 4. Cash and Bank balances Bank Fixed Deposits Current Book Debts Loans and Advances

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 utilization 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. Application of Funds 2. Sources of Funds

3. Surplus of sources over application 4. 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.

BIBOLOGRAPY