Dr. D.

Y PATIL DEPARTMENT OF BUSINESS

MANAGEMENT
PADMASHREE Dr. D.Y. PATIL UNIVERSITY

Ratio analysis & Its Advantages & Disadvantages

SUBMITTED TO: - SUBMITTED BY: -

Professor Roopali Patil Sonal Chitte MBA – IB –
29
It’s a tool which enables the banker or
lender to arrive at the following factors
:
Liquidity position
Profitability
Solvency
Financial Stability
Quality of the Management
Safety & Security of the loans &
advances to be or already been
provided
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.
 As Proportion - The above figures may
be expressed in terms of the relationship
between net profit to sales as 1 : 4.
 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.
Balance Sheet P&L Ratio or Balance Sheet
Ratio Income/Revenue and Profit &
Statement Ratio Loss Ratio

Financial Ratio Operating Ratio Composite Ratio

Current Ratio Gross Profit Ratio Fixed Asset
Quick Asset Operating Ratio Turnover Ratio,
Ratio Expense Ratio Return on Total
Proprietary Ratio Net profit Ratio Resources Ratio,
Debt Equity Ratio Stock Turnover Return on Own
Ratio Funds Ratio,
Earning per Share
Ratio, Debtors’
Turnover Ratio,
 LIABILITIES
NET WORTH/EQUITY/OWNED FUNDS
Share Capital/Partner’s Capital/Paid up
Capital/ Owners Funds
Reserves ( General, Capital, Revaluation &
Other Reserves)
Credit Balance in P&L A/c
LONG TERM LIABILITIES/BORROWED
FUNDS : Term Loans (Banks &
Institutions)
Debentures/Bonds, Unsecured Loans, Fixed
Deposits, Other Long Term Liabilities
CURRENT LIABILTIES
Bank Working Capital Limits such as
CC/OD/Bills/Export Credit
Sundry /Trade Creditors/Creditors/Bills
Payable, Short duration loans or deposits
Expenses payable & provisions against
various items
ASSETS
FIXED ASSETS : LAND & BUILDING,
PLANT & MACHINERIES
Original Value Less Depreciation
Net Value or Book Value or Written down
value
NON CURRENT ASSETS
Investments in quoted shares & securities
Old stocks or old/disputed book debts
Long Term Security Deposits
Other Misc. assets which are not current or
fixed in nature
CURRENT ASSETS : Cash & Bank Balance,
Marketable/quoted Govt. or other
securities, Book Debts/Sundry Debtors, Bills
Receivables, Stocks & inventory (RM,SIP,FG)
Stores & Spares, Advance Payment of
Taxes, Prepaid expenses, Loans and
Advances recoverable within 12 months
INTANGIBLE ASSETS
Patent, Goodwill, Debit balance in P&L A/c,
Preliminary or Preoperative expenses
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
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 Non-current.
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

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.
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
• DEBT EQUITY RATIO : It is the relationship between
borrower’s fund (Debt) and Owner’s 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 Owner’s 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
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.

 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)

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2
 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
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

• 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.
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
 To work out profitability
 To work out the solvency
 Helpful in analyses of financial statement
 Helpful in comparative analyses of the
performance
 To simplify the accounting information
 To work out operating efficiency
 To work out short term financial
position
 Helpful for forecasting purpose
Limited comparability
False results
Effect of price level changes
Qualitative factors are ignored
Effect of window dressing
Costly techniques
Misleading results
Absence of standard university
accepted technology