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A MINI PROJECT SUBMITTED TO JAWAHARLAL NEHRU TECHNOLOGICAL UNIVERSITY, HYDERABAD IN PARTIAL FULFILLMENT FOR THE AWARD OF THE DEGREE OF MBA. by B.SHIVAJI H.T.NO 10N81E0035 Under the guidance of MR. SRI HARSHA MR.LAKSHMA REDDY MR.RAMA RAO MR.SRAVAN KUMAR
DEPARTMENT OF BUSINESS ADMINISTRATION SPHOORTHY ENGINEERING COLLEGE NADARGUL(V),NEAR VANASTHALIPURAM,SAGAR ROAD SAROORNAGAR(M),R.R(DIST)
DECLARATION
I hereby declare that this project titled Ratio Analysis with State Bank of India submitted by me to the department of management studies SPHOORTHY ENGINEERING COLLEGE is a bonafide work undertaken by me and it is not submitted to any other university or institution for the award of any degree/certificate or published any time before.
B.SHIVAJI
ACKNOWLEDGEMENT
I am immensely indebted to SRI HARSHA REDDY, Head of the department Sphoorthy Management Studies to carry out this project work.
I am also thankful to my course director Prof T LAXMA REDDY, my heartful thanks to my faculty guide SRAVAN KUMAR and RAMA RAO for his valuable guidance and sustained interest in my project work.
I would like to acknowledge my sincere thanks to all my faculty members for their valuable advices and suggestions.
B.SHIVAJI
P.NO
Research Methodology limitations History of the company Functions of the company investments of the company savings of the company Infra structure facilities No. of employees / employee turn over Competition of the company Suppliers of the company Customer of the company profitability of the company Ratio Analysis techniques with formulae Collection of Balance sheet & profit and loss account for last
5 years from present
CHAPTER-I
INTRODUCTION
Financial statement analysis is the calculation and comparison of ratios which are derived from the information in a company's financial statements. The level and historical trends of these ratios can be used to make inferences about a company's financial condition, its operations and attractiveness as an investment. Financial statements are calculated from one or more pieces of information from a company's financial statements. For example, the "gross margin" is the gross profit from operations divided by the total sales or revenues of a company, expressed in percentage terms. In isolation, a financial ratio is a useless piece of information. In context, however, a financial ratio can give a financial analyst an excellent picture of a company's situation and the trends that are developing. A statement gains utility by comparison to other data and standards. Taking our example, a gross profit margin for a company of 25% is meaningless by itself. If we know that this company's competitors have profit margins of 10%, we know that it is more profitable than its industry peers which are quite favorable. If we also know that the historical trend is upwards, for example has been increasing steadily for the last few years, this would also be a favorable sign that management is implementing effective business policies and strategies. Financial statement analysis groups the ratios into categories which tell us about different facets of a company's finances and operations. An overview of some of the categories of ratios is given below. It is imperative to note the importance of the proper context for statement analysis. Like computer programming, financial ratio is governed by the GIGO law of "Garbage In...Garbage Out!" A cross industry comparison of the leverage of stable utility companies and cyclical mining companies would be
worse than useless. Examining a cyclical company's profitability ratios over less than a full commodity or business cycle would fail to give an accurate longterm measure of profitability. Using historical data independent of fundamental changes in a company's situation or prospects would predict very little about future trends. For example, the historical ratios of a company that has undergone a merger or had a substantive change in its technology or market position would tell very little about the prospects for this company. Credit analysts, those interpreting the financial ratios from the prospects of a lender, focus on the "downside" risk since they gain none of the upside from an improvement in operations. They pay great attention to liquidity and leverage ratios to ascertain a company's financial risk. Equity analysts look more to the operational and profitability ratios, to determine the future profits that will accrue to the shareholder. Although financial ratio analysis is well-developed and the actual ratios are well-known, practicing financial analysts often develop their own measures for particular industries and even individual companies. Analysts will often differ drastically in their conclusions from the same ratio analysis.
To present an overall view of the Airtel company To evaluate the financial performance of AIRTEL Company To calculate various Financial Ratios and to analyze and comment on
the financial performance of AIRTEL COMPANY during 2006-2010
Research Methodology:
The data used for analysis and interpretation from annual reports of the company which are the secondary forms of data The project is presented by using tables, graphs and with their interpretations Secondary data: Secondary data obtained from the annual reports, magazines and web sites
1. Many statements are calculated on the basis of the balance-sheet, profit & loss account figures. These figures are as on the balance-sheet and p&l account date only and may not be indicative of the year-round position. 2. Comparing the ratios with past trends and with competitors may not give a correct picture as the figures may not be easily comparable due to the difference in accounting policies, accounting period etc. 3. It gives current and past trends, but not future trends. 4. Impact of inflation is not properly reflected, as many figures are taken at historical numbers, several years old. 5. There are differences in approach among financial analysts on how to treat certain items, how to interpret ratios etc. 6. The ratios are only as good or bad as the underlying information used to calculate them.
Chapter-II
service licence to provide GSM services in five circles including Uttar Pradesh (East), West Bengal & Andaman Nicobar, Orissa, Bihar and Jammu & Kashmir. The licence has been granted to Bharti Cellular Ltd (BCL), the cellular arm and subsidiary of BTVL. -Airtel announces the signing of the first-ever bilateral roaming agreement between an Indian mobile service provider and its counterpart in Pakistan. This facility will be available to pre-paid as well as post-paid customers. AirTel's roaming agreement is with Mobilink, the only GSM cellular service provider in Pakistan Nokia Siemens Networks on Jan 3 declared that it has been awarded a multi million euro contract from Bharti Airtel Ltd for deployment of a single interactive voice response (IVR) platform across 23 circles. The three-year turnkey contract comprises designing, planning, systems integration and optimisation services to raise overall customer experience. The new IVR solution will enable Airtel to deliver services such as voice SMS, televoting, call management services, caller ring back tone and voice portal on a faster time-to-market basis and, therefore, reduce OPEX costs. - Bharti Airtel Ltd on February 13, 2008 has announced that it has achieved the 60 million customer mark. This landmark has catapulted Bharti Airtel into the club of top mobile operators in the world in terms of subscriber base. The 60 million customer base covers mobile as well as fixed line and broadband customers. - Bharti Airtel tied up with US-based Apple Inc to bring the popular GSMbased iPhone in the country. - Bharti Airtel Ltd has forged a technology alliance with Infosys Technologies Ltd to launch its Direct-to-Home (DTH) television services. Infosys, through its digital convergence platform, will offer a suite of products including devices, application servers and interactive applications for Airtel's DTH services. - Gearing up for the roll out its 3G services soon, Bharti Airtel on Monday said it has chosen Ericsson India, Nokia Siemens Networks and Huawei
Technologies as network partners to launch the third generation mobile services. All the three partners will plan, design, deploy and maintain a state-of-the-art 3G HSPA (high speed packet access) network in 13 telecom circles of the total 22 for which Bharti Airtel has bagged the licences for over Rs.12,000 crore.
The company had 212 million mobile customers across 19 countries, but more than 162 million of these customers came from India, where the company is struggling with falling average revenue per user (ARPU). Competition among operators has pushed down monthly ARPU by 12 percent to 194 rupees in the quarter, from 220 rupees per month in the same quarter last year. Airtel Africa had 44 million customers in 16 countries at the end of the quarter, adding 2.1 million customers in the quarter. The company has also rolled out 3G services in over 21 cities in India, but these investments are unlikely to start earning large revenue for the company soon, as the 3G market is still nascent in India, analysts said
Savings
Saving Deposit In saving deposit, annual 7% interest is provided to the account-holders with the facilities that is available in this type of accounts. The interest is calculated on the daily balance and added to the concerned account at the three/three. The holders of this account are supposed to maintain Rs. 500/= as minimum balance. Special Saving Deposit In Special saving deposit, we are offering three saving account. Airtel Saving Minimum Balance Rs. 5,000/- Interest 8.5% Minimum Balance Rs. Airtel Special Saving Interest 9.5% 25,000/Airtel Premium Minimum Balance Rs. Interest 10 Saving 50,000/12% Recurring/Periodic Saving In this saving account, save your amount for the fixed/certain period. After the maturity period, we will pay total interest with deposit amount.It is simply a daily saving scheme. Period 3 Months 6 Months 1 Year 2 Years 3 Years Interest 8.5% 9.5% 10.5% 11.5% 12.5%
Fixed Deposit As name suggests itself; the clients of this type of accounts are required to operate their accounts within specified period of time that they mention the time of account opening in application form. As per the duration of accounts and time span for calculation of interest, ASCCL is providing varieties of comparative attractive interest rates. Period 1 Year 2 Years 3 Years 4 Years 4 Years 6 Months Monthly 12% 13% 14% 15% Quarterly 13% 14% 15% 16% Yearly 15% 16% 17% On Maturity 16% 17% 18% 19% Double
Senior Citizen Saving Respecting to the spirit of Co-operative revolution of government of Nepal, Airtel Saving & Credit Co- Operative Ltd (ASCCL) is established under the Co-Operative Act 2048, with the slogan "Customer Satisfaction with Maximum Return" in 9 Chaitra 2066 B.S. With due respect to the spirit of co-operative revolution of the government of Nepal. Airtel Saving & Credit Co- Operative Ltd (ASCCL) has been operating with no. of financial opportunities to its needy members & society as a whole ignoring cheap assurance of the market. In the contest of competitive market due to government's liberal and free economic policy along with pace of technological enhancement, our entrepreneurs are facing no. of threats. Considering the competition from any corner of the world our national entrepreneurs are supposed to be provided varieties of resources and facilities (if necessary) as far as possible to any sector of the economy. For this ASCCL is operating with modern computerized system in the financial market with different schemes towards economic up-liftmen through entrepreneurial development on the belief of Todays investment is tomorrow's return " like a cash cow by taking corporate social responsibility (CSR) into account. Hence, ASCCL in its true sense is the peoples representative in Nepalese financial market. To Serve is our ultimate goal. Taking the view in mind drops make sea lets shake our hands for economic development through successful
entrepreneurial development. For this, dont worry, we manage blood i.e. fund for your business organization. You just come with your sound business scheme (i.e. plan). We would like to draw your attention towards the belief of getting opportunity to serve through the habits of daily saving. Hence, it is the right times to shake our hands.
Savings
Saving Deposit In saving deposit, annual 7% interest is provided to the account-holders with the facilities that is available in this type of accounts. The interest is calculated on the daily balance and added to the concerned account at the three/three. The holders of this account are supposed to maintain Rs. 500/= as minimum balance. Recurring/Periodic Saving In this saving account, save your amount for the fixed/certain period. After the maturity period, we will pay total interest with deposit amount.It is simply a daily saving scheme.
Fixed Deposit As name suggests itself; the clients of this type of accounts are required to operate their accounts within specified period of time that they mention the time of account opening in application form. As per the duration of accounts and time span for calculation of interest, ASCCL is providing varieties of comparative attractive interest rates.
[edit]Investments
Alternatively, low turnover may indicate the presence of employee 'investments' (also known 'side bets') [10] in their position: certain benefits may be enjoyed while the employee remains employed with the organization, which would be lost upon resignation (e.g. health insurance, discounted home loans, redundancy packages, etc.). Such employees would be expected to demonstrate lower intent to leave than if such 'side bets' were not present.
and engagement along the way, shows employees they are valuable through information or recognition rewards, making them feel included. When companies hire the best people, new talent hired and veterans are enabled to reach company goals, maximizing the investment of each employee.
Bharti Airtel Mar '10 Sources Of Funds Total Share Capital Equity Share Capital Share Application Money Preference Share Capital Reserves Revaluation Reserves Networth Secured Loans Unsecured Loans Total Debt Total Liabilities Idea Cellular Mar '10 Reliance Comm Mar '10 Tata TataTeleservice Comm Mar '10 Mar '10
1,898.77 1,898.77 186.09 0.00 34,650.1 9 2.13 36,737.1 8 39.43 4,999.49 5,038.92 41,776.1 0 Bharti Airtel Mar '10
3,299.84 3,299.84 44.45 0.00 8,112.95 0.00 11,457.24 5,988.61 537.81 6,526.42 17,983.66 Idea Cellular Mar '10
1,032.01 1,032.01 0.00 0.00 49,466.88 0.00 50,498.89 3,000.00 21,478.28 24,478.28 74,977.17 Reliance Comm Mar '10
285.00 285.00 0.00 0.00 6,995.78 0.00 7,280.78 1,281.76 1,357.15 2,638.91 9,919.69
1,897.20 1,897.20 0.00 0.00 -2,563.53 0.00 -666.33 2,300.43 1,309.00 3,609.43 2,943.10
Application Of Funds Gross Block Less: Accum. Depreciation Net Block Capital Work in Progress Investments 44,212.5 3 16,187.5 6 28,024.9 7 1,594.74 15,773.3 2 22,834.40 7,907.34 14,927.06 462.58 2,755.13 39,838.17 9,225.69 30,612.48 1,683.52 31,898.60 6,820.94 2,316.14 4,504.80 386.15 2,501.30 5,574.14 2,070.32 3,503.82 196.91 120.00
Inventories Sundry Debtors Cash and Bank Balance Total Current Assets Loans and Advances Fixed Deposits Total CA, Loans & Advances Deffered Credit Current Liabilities
One of the main methods used by technical analysts to forecasting security prices is by the recognition of patterns and trends of security
84
prices, and the easiest way to spot patterns and trends is through the use of charts. In fact, the use of charts is so prevalent, that technical analysts are often called chartists. Originally, charts were drawn by hand, but most charts nowadays are drawn by computer. Charts are graphical displays of price information of securities over time. Often, such charts also show volume. Besides allowing the technical analyst to easily spot patterns and trends, the main benefits of charts are the concise presentation of price and volume information over a period of time, which can be used by fundamentalists to study how the market has reacted to specific events. Market volatility can also be easily gleaned from charts. Charts also help technical analysts to decide on entrance and exit points, and at what prices to place stops to reduce risk. The main chart types used by technical analysts are the line chart, bar chart, candlestick chart, and point-and-figure charts. Charts can also be displayed on an arithmetic or logarithmic scale. The types of charts and the scale used depends on what information the technical analyst considers to be most important, and which charts and which scale best shows that information.
The logarithmic scale (aka semi-logarithmic scale) uses percentages as the primary unit rather than absolute differences. On a logarithmic scale, a $10 stock increasing by $10 would plot higher than a $100 stock rising by $10. Hence, a chart based on a logarithmic scale presents price change information more accurately than a chart based on an arithmetic scale. A chart based on the logarithmic scale can also cover a wider range of prices than a chart of the same size based on the arithmetic scale. However, if the price range displayed in the graph is narrow, then there is little difference between the 2 scales.
6-month bar chart of Citigroup using the logarithmic scale. Note that the gridlines are drawn closer together at higher prices, and that the price difference between gridlines also increases at higher prices.
Line Charts
Line charts are the simplest form of charts depicting price changes over an interval of time. Usually, only the closing price is graphed, depicted by a single point. The series of these points constitutes a linehence, the name. However, intraday price changes can also be plotted, either by plotting each trade, or by selecting the last price of a given interval, such as an hour or 15 minutes. Because line graphs are simple, it is easier to compare the prices of multiple securities or indexes on the same graph. The line chart also shows trends the best, which is simply the slope of the line.
1-month line chart of Exxon-Mobil Corporation.
Bar Charts
One of the basic tools of technical analysis is the bar chart, where the open, close, high, and low prices of stocks or other financial instruments are embedded in bars which are plotted as a series of prices over a specific time period. Bar charts allows traders to see patterns more easily. In other words, each bar is actually just a set of 4 prices for a given day, or some other time period, that is connected by a bar in a specific wayhence, it is often referred to as a price bar. A price bar shows the opening price of the financial instrument, which
is the price at the beginning of the time period, as a left horizontal line, and the closing price, which is the last price for the period, as a right horizontal line. These horizontal lines are also called tick marks. Thehigh price is represented by the top of the bar and the low price is depicted by the bottom of the bar.
1-month bar chart of Exxon-Mobil Corporation.
Candlestick Charts
Another type of chart used in technical analysis is the candlestick chart, so called because the main component of the chart representing prices looks like a candlestick,
with a thick body, called the real body, and usually a line extending above and below it, called the upper shadow and lower shadow, respectively. The top of the upper shadow represents the high price, while the bottom of the lower shadow represents the low price. Patterns are formed both by the real body and the shadows. Candlestick patterns are most useful over short periods of time, and mostly have significance at the top of an uptrend or the bottom of a downtrend, when the patterns most often signify a reversal of the trend. While the candlestick chart shows basically the same information as the bar chart, certain patterns are more apparent in the candlestick chart. The candlestick chart emphasizes opening and closing prices. The top and bottom of the real body represents the opening and closing prices. Whether the top represents the opening or closing price depends on the color of the real bodyif it is white, then the top represents the close; black, or some other dark color, indicates that the top was the opening price. The length of the real body shows the difference between the opening and closing prices. Obviously, white real bodies indicate bullishness, while black real bodies indicate bearishness, and their pattern is easily observable in a candlestick chart.
1-month candlestick chart of Exxon-Mobil Corporation.
Point-And-Figure Charts
Point-and-figure charts list only significant price information as columns of X's and O's without regard to time, so that trends, resistance and support levels are more apparent. Although time is depicted on the horizontal axis, the units of time are determined by when the trend changes. There are several ways of constructing point-and-figure charts, but all are based on box size, which is the minimum price differential necessary before a price is recorded as an X or an O. Columns of X's show an uptrend, and O's show a downtrend. Generally, closing price differentials are used. There is no high, low, opening, or closing prices recorded, since only the change in price greater than the box size is recorded as an X if the price differential is up or as an O if it is down. Each consecutive X is recorded in the same column above the previous X until the price reverses by more than the box size, then a new column is started by recording an O in a box below and to the right of the highest X in the previous column. O's are added downward with each price decrease greater than the box size until the downtrend reverses to an uptrend, starting a new column where the 1st X is placed in the box above and to the right of the last O in the previous column. For example, if the box size is considered to be 1 point, then if XYZ stock rises from 10 to 11, it is recorded as an X because the price rose by at least 1 dollar. If the stock rose only $.50, then it would not be recorded since the price increment was not at least the box size of 1 dollar. If the price increased by at least 1 dollar the next day, then another X would be recorded above the previous one in the same column. If the next day, the price declined by $.25, then nothing would be recorded, since the change is less than the box size. If on the following day, the price declined by more than 1 dollar, then a new
column of O's would be started with the 1st O recorded 1 box below the top X of the adjacent column. Each time the price declined by more than the box size, then another O would be placed below the last O of the column. When the stock rises by more than the box size, then a new column of X's would be started, with the 1st X placed 1 box above the bottom O of the adjacent column. Note that, except for the first and last columns, each X column is flanked by O columns, and vice versa. The construction of point-and-figure charts simplifies the drawing of trend lines, and support and resistance levels, which is why point-andfigure charts are ideal for detecting trends, and determining support and resistance levels.
Point-and-figure chart of Intel Corporation. In this chart, the X's are green and the O's are red, which increases their contrast, making patterns more apparent.
This seems to be the most common type of point-and-figure chart, but keep in mind there are several variations that differ significantly from the above description.
Mar '06
Mar '07
Mar '08
Mar '09
Mar '10
12 mths
12 mths
12 mths
12 mths
12 mths
Sources Of Funds Total Share Capital Equity Share Capital Share Application Money Preference Share Capital Reserves Revaluation Reserves Networth Secured Loans Unsecured Loans Total Debt Total Liabilities 1,893.88 1,893.88 12.13 0.00 5,437.42 2.13 7,345.56 2,863.37 1,932.92 4,796.29 12,141.85 Mar '06 1,895.93 1,895.93 30.00 0.00 9,515.21 2.13 11,443.27 266.45 5,044.36 5,310.81 16,754.08 Mar '07 1,897.91 1,897.91 57.63 0.00 18,283.82 2.13 20,241.49 52.42 6,517.92 6,570.34 26,811.83 Mar '08 1,898.24 1,898.24 116.22 0.00 25,627.38 2.13 27,643.97 51.73 7,661.92 7,713.65 35,357.62 Mar '09 1,898.77 1,898.77 186.09 0.00 34,650.19 2.13 36,737.18 39.43 4,999.49 5,038.92 41,776.10 Mar '10
12 mths
12 mths
12 mths
12 mths
12 mths
Application Of Funds Gross Block Less: Accum. Depreciation 17,951.74 4,944.86 26,509.93 7,204.30 28,115.65 9,085.00 37,266.70 12,253.34 44,212.53 16,187.56
Net Block Capital Work in Progress Investments Inventories Sundry Debtors Cash and Bank Balance Total Current Assets Loans and Advances Fixed Deposits Total CA, Loans & Advances Deffered Credit Current Liabilities Provisions Total CL & Provisions Net Current Assets Miscellaneous Expenses Total Assets
13,006.88 2,341.25 719.70 17.74 1,076.17 201.81 1,295.72 1,937.54 105.61 3,338.87 0.00 6,735.36 537.44 7,272.80 -3,933.93 7.94 12,141.84
19,305.63 2,375.82 705.82 47.81 1,418.52 239.11 1,705.44 3,160.02 541.35 5,406.81 0.00 9,809.83 1,232.84 11,042.67 -5,635.86 2.66 16,754.07
19,030.65 2,751.08 10,952.85 56.86 2,776.46 200.86 3,034.18 5,103.13 302.08 8,439.39 0.00 12,400.38 1,961.95 14,362.33 -5,922.94 0.20 26,811.84
25,013.36 2,566.67 11,777.76 62.15 2,550.05 153.44 2,765.64 5,602.83 2,098.16 10,466.63 0.00 13,832.49 634.40 14,466.89 -4,000.26 0.09 35,357.62
28,024.97 1,594.74 15,773.32 27.24 2,104.98 54.89 2,187.11 6,276.12 761.86 9,225.09 0.00 12,183.25 658.75 12,842.00 -3,616.91 0.00 41,776.12
4,740.34 38.71
7,615.04 60.19
7,140.59 106.34
4,104.25 145.01
3,921.50 96.24
Chapter-IV
been said that business seeds money to make more money. However it is also true that money budgets more money only when it is properly managed. Financial statement: A Financial statement is an organized collection of data according to logical and consistent accounting procedures. It is purpose is to convey an understanding of some financial aspects of a business firm.
The term financial statement is generally refers to two basic statements. Income statement Balance sheet of cover business may also prepare Statement of retained earnings Statement showing the changes in financial position
Comparative financial statements Common size financial statements Trend percentage Funds flow analysis Cash flow analysis Cup analysis (cost volume profit) Ratio analysis Working capital managemen III.3 CLASSFICATION OF RATIOS:
A ratio is an arithmetical relationship between two figures. Financial ratio analysis is a study of ratios between various items or groups of items n financial statements. Financial ratios are classified into five types.
1. Liquidity ratios. 2. Leverage ratios. 3. Turnover ratios. 4. Profitability ratios. 5. Valuation ratios.
I. Liquidity ratios:
Liquidity refers to the ability of a firm to meet its obligations in the short run usually one year. Liquidity ratios are generally based on the relationship between current assets and current liabilities. The important liquidity ratios are: current ratio, acid test ratio and cash ratio.
1. Current ratio:
Current assets Current Ratio = ------------------------------Current liabilities Current assets include cash, marketable securities, debtors, investors, loans and advances and pre-paid expenses. Current liabilities that are expected to mature in the next twelve months. These comprise loans; secured or
unsecured those are due in the next twelve months and current liabilities and provisions.
The current ratio measures the ability of the firm to meet its current liabilities- current assets get converted into cash n the operating cycle of the firm and provide the funds needed to pay current liabilities. Apparently, the higher the current ratio, the greater the short term solvency. However, in interpreting the current ratio the composition of current assets must not be overlooked. A firm with a high proportion of current assets in the form of cash and debtors is more liquid than one with a high proportion of current assets in the form of inventories even though both the firms have the same current ratio. The general norm for current ratio in India is 1.33. Internationally it is 2.
2. Acid-test ratio: Also called the quick ratio, the acid-test ratio is defined as:
The acid-test ratio is a fairly stringent measure of liquidity. It is based on those current assets which are highly liquid-inventories are excluded from the numerator of this ratio because inventories are deemed to be least component of current assets. 3. Cash ratio:
Because cash and bank balances and short term marketable securities are the most liquid assets of a firm, financial analysis look at cash ratio, which is defined as:
Cash and bank balances + Current investments Cash ratio = -------------------------------------------------------------------Current liabilities Clearly, the cash ratio is perhaps the most stringent measure of liquidity.
Financial leverage refers to the use of debt finance. While debt capital is a cheaper source of finance, it is also a riskier source of finance. Leverage ratios help in assessing the risk arising from the debt capital. Two types of ratios are commonly used to analyze financial leverage: structural
ratios and coverage ratios. Structural ratios are based on the proportions of debt and equity in the financial structure of the firm. The important structural ratios are debt-equity ratio and debt-assets ratio Coverage ratios show the relationship between debt servicing commitments and the sources for meeting these burdens. The important coverage ratios are: interest coverage ratio, fixed charges ratio, and debt service coverage ratio.
1. Debt-equity ratio: The debt-equity ratio shows the relative contributions of creditors and owners. It is defined as:
The numerator of this ratio consists of all debt, short-term as well as long-term, and denominator consists of net worth plus preference capital.
In general, the lower the debt-equity ratio, the higher the degree of protection enjoyed by the creditors.
2. Debt-asset ratio:
The debt-assets ratio measure the extent to which borrowed funds supports the firm assets. It is defined as:
Debt Debt-assets ratio = ------------Assets The numerator of this ratio includes all debt, short-term as well as longterm, and the denominator of this ratio is the total of all assets.
Also called the times interest earned, the interest coverage ratio is defined as:
Interest
Note that profit before interest and taxes is used in the numerator of this ratio because of the ability of a firm to pay interest is not affected by tax payment, as interest on debt funds is a tax-deductible expense. A high interest coverage ratio means that the firm can easily meet its interest burden even if profit before interest and taxes suffer a considerable decline. A low interest coverage ratio may result in financial embarrassment when profit before interest and taxes decline. This ratios is widely used by lenders to assets a firms debt capacity. Further, it is a major determinant of bond rating.
Though widely used, this ratio is not a very appropriate measure of interest coverage because the source of interest payment is cash flow before interest and taxes not profit before interest and taxes. In view of this, we may use a modified interest coverage ratio.
Turnover ratios, also referred to as activity ratios or assets management ratios, measure hoe efficiently the assets are employees by a firm. These ratios are based on the relationship between the level of activity, represented by sales or cost of goods sold, and levels of various assets. The important turnover ratios are: inventory turn over, average collection period, receivables turnover, fixed assets turnover, and total assets turnover.
1. Inventory turnover:
The inventory turnover, or stock turnover, measures how fast the inventory is moving through the firm and generating sales. It is defined as:
The inventory turnover reflects the efficiency of inventory managements. The higher the ratio, the more efficient the management of inventories and vice-versa. However, this may not always be true. A high inventory turnover may be caused by a low level of inventory which may result in frequent stock outs and loss of sales and customer goodwill.
Notice that as inventories tend to change over the year, we use the average of the inventories at the beginning and end of the year. In general, averages may be used when a flow figure is related to a stock figure.
2. Debtor turnover:
This ratio shows how many times receivable turnover accounts during the year. It is defined as: Net credit sales Debtors turnover = ----------------------------------------Average accounts receivable
Obviously, the higher the debtors turnover the greater the efficiency of credit management.
The average collection period represents the number of days worth of credit sales that is locked in debtors. It is defined as:
If the figure for credit sales is not available, one may have to make do with the net sales figure.
Note that the average collection period and the accounts receivable turnover are related as follows:
The average collection period may be compared with the firms credit terms to judge the efficiency of credit management.
4. Fixed assets turnover: This ratio measures sales per rupee of investment n fixed assets It is defined as: Net Sales Fixed assets turnover = -----------------------------------Average net fixed assets
This ratio is supposed to measure the efficiency with which fixed assets is employed a high ratio indicates a high degree of efficiency in asset utilization and a low ratio reflects inefficient use of assets. However, in interpreting this ratio, one caution should be Bourne in mind. When the fixed assets turnover tends to be high because the denominator of the ratio is very low.
Akin to the output-capital ratio in economic analysis, the total assets turnover is defined as:
IV. Profitability ratios: Profitability reflects the final result of business operations. There are two types of profitability ratios.
1. Profit margins ratios and 2. Rate of return ratios Profit margin ratios show the relationship between profit and sales. The two popular profit margin ratios are: gross profit margin ratio and net profit margin ratio. Rate of return ratios reflect the relationship between profit and investment. The important rate of return measures is; return on total assets, earning power and return on equity.
The gross profit margin ratio is defined as: Gross profit Gross profit ratio = --------------------Net sales
Gross profit is defined as the difference between net sales and cost of goods sold. This ratio shows the margin left after meeting manufacturing costs. It measures the efficiency of production as well as pricing. To analyze the factors underlying the variation in gross profit margin the proportion of various elements of cost of sales may study in detail.
The net profit margin ratio is defined as: Net profit Net profit ratio = -------------------Net Sales
This ratio shows the earnings left for shareholders as a percentage of net sales. It measures the overall efficiency of production, administration,
selling, financing, pricing and tax management. Jointly considered, the gross and net profit margin ratios provide a valuable understanding of the cost and profit structure of the firm and enable the analyst to identify the sources of business efficiency or inefficiency.
A commonly used rate of return measure, the return on total assets also called return on capital employed or return on investment id defined as:
Net income (Profit) Return on total assets ratio = -----------------------------Average total assets
The net income to total assets ratio is supposedly a measure of how efficiency the capital is employed. Though widely used, this is an odd measure because the numerator measures the return to shareholders (equity and preference) and the denominator represents the contribution of shareholders as well as creditors.
To ensure internal consistency, the following variant of return on total assets may be employed:
4. Return on Equity:
A measure of great interest to shareholders, the return on equity is defined as: Equity earning Return on Equity ratio = -------------------------Average net worth
The numerator of this ratio is equal to profit after tax less preference dividends. The denominator includes all contributions made by equity shareholders (paid-up capital = reserve and surplus). This ratio is also called the return on net worth.
The return on equity measures the profitability of equity invested in the firm. It is regarded as a very important because it reflects the productivity of the ownership capital employed in the firm. It is influenced by several factors: earning power, debt-equity ratio, average cost of debt funds and tax rate.
In judging all the profitability measures it should be borne in the mind that the historical valuation of assets imparts an upward bias to profitability measures during an inflationary period. This happens because the numerator of these measures represents current values whereas the denominator represents historical values.