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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


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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 roleas a tool for appraising the real worth of an enterprise, its performanceduring a period of time and its pit falls. Financial analysis is a vital apparatusfor the interpretation of financial statements. It also helps to find out anycross-sectional and time series linkages between various ratios.

Unlike in the past when security was considered to be sufficientconsideration for banks and financial institutions to grant loans andadvances, nowadays the entire lending is need-based and the emphasis is onthe 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 caseof decisions relating to credits. Ratio analysis and other quantitativetechniques facilitate assessment of this risk.

Ratio-analysis means the process of computing, determining, and presentingthe relationship of related items and groups of items of the financialstatements. They provide in a summarized and concise form of fairly goodidea about the financial position of a unit. They are important tools for financial analysis.


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RELEVANCE OF RATIO ANALYSIS

When it comes to investing, analyzing financial statement information (alsoknown as quantitative analysis), is one of, if not the most important elementin the fundamental analysis process. At the same time, the massive amountof numbers in a company's financial statements can be bewildering andintimidating 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 presentingthe relationship of related items and groups of items of the financialstatements. They provide in a summarized and concise form of fairly goodidea 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 ratio-analysis has increased considerably. It is now being used as a device todiagnose the financial health of a business concern. It signifies whether thefinancial health of a concern is vital, strong, good or poor and weak. Likedoctors prescription, ratios represent the figures containing the condensedreport of the position, progress, and problems of a concern. They facilitatethe work or gauging the profitability, solvency, and activity of the concern.Like management, outsiders, viz ., creditors, bankers, etc. may also use ratio-analysis as a tool for financial analysis and interpretation. Ratio Analysismay highlight upon the few phases of the business operations in which theoutsiders are most interested by ascertaining the arte and directions of change and future potentialities. Thus, ratio analysis is a very powerful toolfor both internal and external analysis.

Ratio-analysis is a concept or technique, which is as old as accountingconcept. Financial analysis is a scientific tool. It has assumed important roleas 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 apparatusfor the interpretation of financial statements. It also helps to find out anycross-sectional and time series linkages between various ratios. Unlike in the

past when security was considered to be sufficient consideration for banksand financial institutions to grant loans and advances, nowadays the entirelending is need-based and the emphasis is on the financial viability of a

proposal and not only on security alone. Further, all business decision


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contains an element of risk. The risk is more in the case of decisions relatingto credits. Ratio analysis and other quantitative techniques facilitateassessment of this risk.Lenders need it for carrying out the following:

1. Technical Appraisal2. Commercial Appraisal3. Financial Appraisal4. Economic Appraisal5. Management Appraisal

It is a tool, which enables the banker or lender to arrive at the followingfactors:

1. Liquidity position2. Profitability3. Solvency4. Financial Stability5. Quality of the Management6. Safety & Security of the loans & advances to be or already been

provided

The utility of ratio analysis will be further enhanced if following comparisonis possible.

1. Between the borrower and its competitor 2. Between the borrower and the best enterprise in the industry3. Between the borrower and the average performance in the industry4. 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 fromcurrent 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?


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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 therelationship between net profits to sales as 1: 4.

3. As Pure Number/Times - The same can also be expressed in analternatively way such as the sale is 4 times of the net profit or profit is 1/4 th

of the sales.

Classification of Ratios


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Balance Sheet Ratio P&L Ratio or

Income/RevenueStatement Ratio

Balance Sheet and Profit

& Loss Ratio

Financial Ratio Operating Ratio Composite Ratio

Current RatioQuick Asset RatioProprietary RatioDebt Equity Ratio

Gross Profit RatioOperating RatioExpense Ratio

Net profit RatioStock Turnover Ratio

Fixed Asset TurnoverRatio, Return on Total

Resources Ratio,Return on Own Funds

Ratio, Earning per

Share Ratio, DebtorsTurnover Ratio


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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 dateof Balance Sheet

Current Assets are those which undergo change in their shape/formwithin 12 months. These are also called Working Capital or GrossWorking 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 calledOutside 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 asCurrent Liability only for Calculation of Current Ratio & Quick Ratio.

If there is profit it shall become part of Net Worth under the headReserves 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 inallied/associate/sister units or firms to be treated as Non-current.


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Bonus Shares as issued by capitalization of General reserves and assuch 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 andcurrent liabilities of a concern.

Current Ratio = Current Assets/Current Liabilities If the Current Assets and Current Liabilities of a concern are Rs.4,00,000and 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 TermSources over Long Tern Uses; alternatively, it is the difference of CurrentAssets 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 quicklymarketable/quoted shares and Bank Fixed Deposits

Acid Test or Quick Ratio = Quick Current Assets/Current Liabilities


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Example:

Cash 50,000Debtors 1, 00,000Inventories 1,50,000 Current Liabilities 1,00,000Total Current Assets 3, 00,000Current Ratio = > 3, 00,000/1, 00,000 = 3: 1Quick 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 NatureTotal 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 LacsLong Term Loans/Liabilities = Rs. 800 LacsDebt Equity Ratio will be => 800/500 i.e. 1.6 : 1

5. PROPRIETARY RATIO : This ratio indicates the extent to whichTangible Assets are financed by Owners Fund.

Proprietary Ratio = (Tangible Net Worth/Total Tangible Assets) x100

T he 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 themanufacturing efficiency as well as the pricing policy of the concern.

Gross Profit Ratio = (Gross Profit / Net Sales ) x 100Alternatively , 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 100A higher Gross Profit Ratio indicates efficiency in production of the

unit.


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7. OPERATING PROFIT RATIO :

It is expressed as => (Operating Profit / Net Sales ) x 100Higher the ratio indicates operational efficiency

8. NET PROFIT RATIO :

It is expressed as => ( Net Profit / Net Sales ) x 100It 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 therelevant accounting period 10. DEBTORS TURNOVER RATIO : This is also called DebtorsVelocity 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 Assets12. FIXED ASSET TURNOVER RATIO : Net Sales /Fixed Assets13. CURRENT ASSET TURNOVER RATIO : Net Sales / CurrentAssets14. CREDITORS TURNOVER RATIO : This is also called CreditorsVelocity 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


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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 atthe beginning and end of the accounting period.

Composite Ratio17. RETRUN ON EQUITY CAPITAL (ROE) :

Net Profit after Taxes / Tangible Net Worth18. EARNING PER SHARE : EPS indicates the quantum of net profit of

the year that would be ranking for dividend for each share of thecompany being held by the equity share holders .

Net profit after Taxes and Preference Dividend/ No. of EquityShares19. PRICE EARNING RATIO : PE Ratio indicates the number of timesthe 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 mostimportant one which indicates the ability of an enterprise to meet itsliabilities by way of payment of installments of Term Loans and Interestthereon from out of the cash accruals and forms the basis for fixation of therepayment 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 + AnnualInstallments payable on Long Term Loans & Liabilities

( Where PAT is Profit after Tax and Depr. is Depreciation)


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EXERCISE: 1

LIABILITES ASSETS

Capital 180Net Fixed Assets 400

Reserves 20Inventories 150

Term Loan 300Cash 50

Bank C/C 200Receivables 150

Trade Creditors 50Goodwill 50

Provisions 50

800 800


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a. What is the Net Worth : Capital + Reserve = 200

b. Tangible Net Worth is : Net Worth - Goodwill = 150

c. Outside Liabilities : TL + CC + Creditors + Provisions = 600

d. Net Working Capital : C A - C L = 350 - 250 = 50

e. Current Ratio : C A / C L = 350 / 300 = 1.17 : 1

f. Quick Ratio : Quick Assets / C L = 200/300 = 0.66 : 1

EXERCISE: 2LIABILITIES 2005-

062006-07

ASSETS 2005-06

2006-07

Capital 300 350 NETFIXEDASSETS

730 750

Reserves 140 160 SECURITYELECTRICITY

30 30

Bank Term

Loan

320 280 INVEST

MENTS

110 110

Bank CC(Hyp)

490 580 RAWMATER IALS

150 170

UNSEC.LON 150 170 SIP 20 30


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G TLCREDITORS(RM)

120 170 FINISHEDGOODS

140 170

BILLSPAYABLE

40 80 CASH 30 20

EXPENSESPAYABLE

20 30 RECIEVABLES

310 240

PROVISIONS 20 40 LOANS/ADVANCES

30 190

GOODWILL

50 50

TOTAL 1600 1760 TOTAL 1600 1760

1. Tangible Net Worth for 1 st Year : ( 300 + 140) - 50 = 3902. Current Ratio for 2 nd Year : (170 + 20 + 240 + 2+ 190 ) /(580+70+80+70) 820 /800 = 1.023. Debt Equity Ratio for 1 st Year : 320+150 / 390 = 1.21

Exercise: 3

LIABIITIES ASSETS

EquityCapital

200Net FixedAssets

800

PreferenceCapital

100Inventory 300

Term Loan 600Receivables 150

Bank CC(Hyp)

400InvestmentIn Govt.

50


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Secu.

SundryCreditors

100PreliminaryExpenses

100

Total 1400 14001. Debt Equity Ratio will be : 600 / (200+100) = 2 : 12. Tangible Net Worth : Only equity Capital i.e. = 2003. Total Outside Liabilities / Total Tangible Net Worth :(600+400+100) = 11 : 24. Current Ratio will be : (300 + 150 + 50 ) / (400 + 100 ) =1 : 1

Exercise: 4

LIABILITIES ASSETS

Capital +Reserves

355 Net FixedAssets

265

P & L CreditBalance

7Cash 1

Loan From S FC

100Receivables 125

BankOverdraft

38Stocks 128

Creditors 26PrepaidExpenses

1


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Provision of Tax

9IntangibleAssets

30

ProposedDividend

15

550 550

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 TurnoverRatio in Times ?Ans : Net Sales / Average Inventories/Stock 1500 / 128 = 12 timesapproximately

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 = 0.3months


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Exercise: 5

Profit to sales is 2% and amount of profit is say Rs.5 Lac. Then What isthe amount of Sales?

Answer: Net Profit Ratio = (Net Profit / Sales) x 1002 = (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. Thereis no intangible Assets or other Non Current Assets. Calculate its NetWorking Capital.

Answer: Total Assets = 16 + 25 = Rs. 41 Lac


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Total Liabilities = NW + LTL + CL = 5 + 10+ CL = 41 LacCurrent 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 WorkingCapital ?

Answer : It suggest that the Current Assets is equal to CurrentLiabilities hence the NWC would be NIL

Exercise: 8

Suppose Current Ratio is 4 : 1. NWC is Rs.30,000/-. What is theamount of Current Assets ?

Answer : 4 x - 1 x = 30,000Therefore x = 10,000 i.e. Current Liabilities is Rs.10,000Hence 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, monthlyaverage interest on TL is Rs.5000/-. If the amount of Depreciation isRs.30,000/- p.a. and PAT is Rs.2,70,000/-. What would be the DSCR ?

DSCR = (PAT + Depr + Annual Intt.) / Annual Intt + AnnualInstallment= (270000 + 30000 + 60000 ) / 60000 + 120000

= 360000 / 180000 = 2

Exercise: 10


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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. 70Lac and Debt Equity Ratio being 3 : 1. What would be the Long TermLiabilities?

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, thenCurrent Liabilities works out to be Rs. 20 Lac. That means theaggregate of Net Worth and Long Term Liabilities would be Rs. 80Lacs. If the Debt Equity Ratio is 3 : 1 then Debt works out to be Rs. 60Lacs and equity Rs. 20 Lacs. Therefore the Long Term Liabilities wouldbe Rs.60 Lac.

Exercise: 11Current 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. Whatwould 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 Liabilitiesfigure 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. Written Down Value method2. Straight Line method3. Annuity method4. Insurance policy method

EXERCISE: 13

Debt Service Coverage Ratio (DSCR) shows:


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1. Excess of current assets over current liabilities2. Number of times the value of fixed assets covers the amount of

loan3. Number of times the companys earnings cover the payment of

interest and repayment of principal of long term debt4. Effective utilization of assets

EXERCISE: 14

Which of the following is not considered a Quick Asset?

1. Cash and Bank balances2. Bank Fixed Deposits3. Current Book Debts4. Loans and Advances

Questions on Fund Flow Statement

Q. Fund Flow Statement is prepared from the Balance sheet:

1. Of three balance sheets2. Of a single year3. Of two consecutive years4. None of the above.

Q. Why this Fund Flow Statement is studied for?

1. It indicates the quantum of finance required2. It is the indicator of utilization of Bank funds by the concern

3. It shows the money available for repayment of loan4. It will indicate the provisions against various expenses

Q. In a Fund Flow Statement, the assets are represented by ?

1. Application of Funds2. Sources of Funds


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3. Surplus of sources over application4. Deficit of sources over application

Q. In Fund Flow Statements the Liabilities are represented by ?

1. Sources of Funds2. Use of Funds3. Deficit of sources over application4. All of the above.

Q. When the long term sources are more than long term uses, in thefund flow statement, it would suggest?

1. Increase in Current Liabilities

2. Decrease in Working Capital3. Increase in NWC4. Increase in NWC

Q. When the long term uses in a fund flow statement are more than thelong term sources, the n it would mean?

1. Reduction in the NWC2. Reduction in the Working Capital Gap

3. Reduction in Working Capital4. All of the above

Q. How many broader categories are there for the Sources of funds, inthe Fund Flow Statement?

1. Only One, Source of Funds2. Two, Long Term and Short Term Sources3. Three , Long, Medium and Short term sources4. None of the above.


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