Ratio & Break Even Analysis

Basic Financial Reports

Balance Sheet It shows the position of a firm at the end of a financial year. It is built on the accounting equation.

Assets = Liabilities + Capital

Income Statement
It compares the firms expenses against its revenue over a period of time to show its net income (or net loss)

Net Income = Sales Revenue - Expenses

Statement of Cash flows

It shows the changes in the working capital of a firm over a period of time. This is done by listing the sources and application of funds.

Key Ratios
Liquidity Ratios Leverage Ratios Operating Ratios Profitability Ratios

Liquidity Ratios
They are also known as working capital ratio and short-term solvency ratio. An enterprise must have adequate working capital to run its day to day operations. Inadequacy of working capital will bringing the buss operations to a halt.

Current Ratio
It measures the ability of a firm to meet its current liabilities or its short term obligations. It measures solvency by showing the firms ability to meet its current liabilities out of its current assets. Current ratio = current assets current lib

Significance
A lower current ratio indicates that the firm is not in a position to meet its current liabilities. A higher current ratio indicates that the firm has inadequately employed the funds. This means that the funds are blocked up in current assets.

Quick Ratio
It is also termed as acid test ratio. It is ascertained by comparing the liquid assets (CA- prepaid expenses and stock) with the Current Liabilities. Quick Ratio = Liquid assets Current Liabilities

Significance
It is compared with the current ratio and then we arrive at a conclusion. Example: Suppose Firm A & Firm B, doing similar business have same current ratio (1.8: 1) but the quick ratio of As quick ratio is 0.75: 1 and Bs quick ratio is 0.50: 1, it is an indication of over stocking by B.

Leverage Ratio
Refers to the proportion between fixed interest or dividend bearing funds and non-fixed or dividend bearing funds in the total capital employed in the business. A proper proportion between the 2 funds is necessary in order to keep the cost of capital at the minimum.

Debt Equity Ratio

Debt Equity Ratio is determined to ascertain the soundness of the long term financial policies of the company. Debt equity ratio = Shareholders fund Total long term debt

Significance
This ratio in indicates the proportion of owners stake in the business. It tells the owners the extent to which they can gain the benefits with a limited investment.

Debt to Net Worth Ratio

It is the ratio of debt in the capital structure to the net worth of the business. Debt to net worth ratio : Debt Net worth

Turnover Ratios
They indicate the efficiency with which the capital employed is rotated in the business.

Average Inventory Turn over Ratio

This indicates the no of times the stock or inventory rotates in a business. The more the ratio the more is the moving of stocks and vice versa. Stock turnover ratio = cost of goods sold avg. inventory

Debtors Turn over Ratio

Debtors turnover ratio indicates the efficiency of the staff entrusted with the collection of book debts. The higher the ratio, the better it is and vice versa. Debtors turnover ratio = total sales Accounts rec.

Creditors Turnover Ratio

It indicates the speed with which the payments for credit purchases are made to the creditors. Creditors turnover ratio= cr. Purch av a/c rec

Profitability Ratios
It is an indication of the efficiency with which the operations of the business are carried out. Lack of control over the expense may result in low profitability. It is an indicator of whether a firm earns substantially more than what it pay as interest.

Net Profit to sales Ratio

This ratio indicates indicates the net margin on sales. Net profit ratio = net profit X 100 net sales

Break Even Analysis

It is the level of operation at which the business neither earns a profit nor incurs a loss. It is a useful planning tool because it shows entrepreneurs minimum level of activity required to stay in business. With one change in the breakeven calculation, an entrepreneur can also determine the sales volume required to reach a particular profit target.