1. Compiled by Prof. M B. Thakoor
RATIO ANALYSIS
15. RATIOS AT A GLANCE
Standard
No. Ratio Formula Composition Test of Interpretation
Ratio
1. Current Current Current Assets : 2:1 Short- 1. Measures short-term
Ratio Assets 1. Debtors, term financial strength.
2. Stock, solvency 2. Ability to pay current
Current 3. Loose tools, obligations.
Liabilities 4. Accrued income 3. Adequacy of working
5. Pre-payments, capital-a quantitative
6. Bills receivables, test and not qualitative
7. Cash & Bank. test.
4. Higher ratio implies
Current Liabilities sound financial
1. Creditors position but may also
2. Bills payable mean idle funds, under
3. Outstanding trading.
expenses, 5. Lower ratio indicates
4. Unclaimed Inadequate working
dividends, capital, short-term
5. Provision for solvency in danger,
taxation, over trading.
6. Proposed
dividend,
7. Bank overdraft.
2 Liquid Quick Quick Assets = 1:1 Imme- 1. Stringent (tough) test
Ratio/A Assets Current Assets diate of solvency.
cid test Less stock and pre- solvency 2. Measures ability to
Ratio Quick payments meet the immediate
Liabilities liabilities.
Quick Liabilities = 3. Qualitative test to
Current Liabilities measure liquidity.
less Bank overdraft. 4. Higher Ratio : Sound
financial position, idle
funds.
5. Lower Ratio :
dangerous financial
position inability to met
immediate obligations.
3 Stock to Closing Stock = Closing Should be Investm 1. Extent of working
working Stock stock less than ents in capital blocked in
capital Working capital = 100 % stocks stock.
Working
Current Assets Less 2. Higher ratio : Unsound
Capital
Current Liabilities working capital
position; if stock is not
/ x 100
saleable, situation
becomes dangerous.
3. Lower Ratio : Sound
working capital
position and effective
inventory
management.
4. Should be studied with
quick and current ratio.
1

2. Compiled by Prof. M B. Thakoor
Standard
No. Ratio Formula Composition Test of Interpretation
Ratio
4 Propriet Prop’s Proprietor’s 65% to Long 1. Shows percentage of
ary Ratio Fund Funds = 75% term total assets financed
Preference Capital stability by the proprietor /
Total
+ or organisation.
Assets
Equity Capital + solvency 2. All fixed assets and
Reserves & part of current assets
x 100
Surplus should be financed out
Losses Fictitious of proprietors Fund in
Assets like order to build a solid
miscellaneous foundation for the
expenditure. company.
Total Assets = 3. Higher ratio : Lesser
Total Liabilities = dependence on
Fixed assets + outside funds-sound
Current Assets + financial position but
Investments over capitalization and
(Excluding fictitious low returns.
assets) 4. Lower Ratio : More
dependence on
outside funds, under
capitalization, over-
trading, unsound
financial position.
5 Capital Preference Capital with fixed -- Capital High Gearing :
Gearing Capital + interest bearing Gearing 1. IF fixed interest,
Ratio Debentures securities dividend bearing
+ term ----------------- capital exceeds the
loans Equity Share equity capital &
Capital + Reserves reserves, the company
Equity
& Surplus – Losses is said to be highly
Share
& Fictitious Assets geared.
Capital +
2. High gearing is
Reserves &
favorable only when
Surplus
rate of earning of the
- Losses & business is greater
Fictitious than fixed interest.
Assets 3. It may amount to under
capitalization.
4. Equity shareholders
expect higher dividend
and share become
speculative.
Low Gearing :
1. Majority interest lies
with equity share
holders.
2. Over capitalization.
3. Low rate of return or
equity shares.
2

3. Compiled by Prof. M B. Thakoor
Standard
No. Ratio Formula Composition Test of Interpretation
Ratio
6 Debt- (1) Debt Debt includes : (i) 2 : 1 Long- 1. Test of long-term
Equity i) Debentures term financial position or
Equity
Ratio ii) Long term loans financial capital structure of the
iii) Redeemable position company.
OR
Preference share 2. Higher ratio indicates
capital greater dependence
(2) Debt
Equity includes : (ii) 65% on loans, higher
Debt + i) Equity Capital to 75% amount of interest
Equity ii) Reserves and payable. Such trading
Surplus on equity affects
iii) Preference adversely during
Capital other than recession.
redeemable 3. Lower ratio indicates
Preference Shares low owed funds and
Less fictitious high equity.
assets. Compulsory payment
like interest, low
returns for equity
holders, over
capitalization.
7 Gross Gross Gross Profit = Should be Profitabi 1. Used for analyzing
Profit Profit Sales compared lity trading results.
Ratio Less : over the 2. Higher ratio means
Sales Cost of good sold years or greater profitability
with the attained by
x 100 Sales = Net Sales other a. Increasing sales prices
i.e. Gross Sales – company- b. Cost Saving
Sales Returns or ies ratio c. Over-Valuing
return inwards. closing stock
3. Lower ratio indicates
low profitability.
4. Limitations-indirect
expenses are not
considered hence
overall profitability
cannot be known.
8. Operating COGS + Cost of goods Should Operatio 1. Indicates profitability &
Ratio Operating sold (COGS) = be nal managerial efficiency
Expenses opening stock + compare efficienc in controlling costs.
purchases + direct over the y& 2. Higher ratio means
Sales expenses – Closing years profitabi lower margin of profit.
Stock : lity 3. Lower ratio means
X 100 greater margin of
Operating profit.
Expenses = 4. Comparison with
office & previous year would
administrative indicate saving or
expenses + selling increase in cost.
& distribution 5. For better results this
expenses + ratio is broken into
financial expenses various cost ratios.
3

4. Compiled by Prof. M B. Thakoor
Standard
No. Ratio Formula Composition Test of Interpretation
Ratio
9 Expenses Expense Respective Should Operatio 1. Shows portion of sales
Ratio expenses viz. be nal consumed by various
Sales factory overheads, compare efficienc items of expenses.
office expenses, d with y 2. Trend over the years
x 100 selling & last should be studied.
distribution years. Management should
expenses. concentrate on those
expenses which
Sales = Net Sales increase
= Gross Sales – disproportionately.
Sales Returns or 3. Higher ratio means
Return inward. lower profitability and
inefficiency of
management in
controlling expenses.
10. Net Net Profit Operating Net To be Profita- 1. It measures overall
Profit Sales Profit = Net profit compared bility & profitability and
Ratio excluding non- with the efficie- operating efficiency.
x 100
trading income and previous ncy 2. Should be studied with
not-trading year’s G.P. ratio and
expenses ratios operating ratio.
ii) Op. NP
3. Higher ratio indicates
Sales Sales = Net Sales higher profitability and
x 100 = Gross Sales – lower ratio indicates
Sales Returns or lower profitability.
Return inward.
11 Stock Cost of Cost of goods 5–6 Operatio 1. It shows efficiency in
Turnove good sold sold = Sales less times nal inventory
r Ratio Average Gross Profit efficienc management.
Stock Average Stock = y& 2. Higher ratio indicates
Op.Stock + Cl.Stock investm favorable trading
2 ent in situation, no loss due
stock to obsolescence as
OR When Opening stock is turned into
Sales stock is not given sales regularly, no
the denominator is excessive blocking of
Closing
closing stock and funds in inventory,
Stock
not zero + closing over-trading.
stock / 2 3. Lower ratio indicates
stock is not movable,
blocking of funds,
wrong buying or
excessive production,
under trading.
4

5. Compiled by Prof. M B. Thakoor
Standard
No. Ratio Formula Composition Test of Interpretation
Ratio
12 Return on Net Profit Net Profit (NP) = To be Profitabi 1. This is the broadest
Capital Capital Net profit before Compar lity measure of
Employed Employed interest and tax ed with Producti performance
(RoCE) less abnormal, similar vity 2. It combines the effect
x 100
non-recurring ratio of of Net profit Ratio and
items. other Capital turnover ratio
Capital Employed compani Turnover ratio
= Fixed Assets + es measures productivity
Current Assets – and Net Profit ratio
Current Liabilities. measures profitability.
(Excluding 3. This ratio with other
Fictitious Assets) expenses ratio and
turnover ratios is
helpful in financial
analysis.
4. Higher ratio is
regarded as favorable
and lower ratio is
unfavorable.
13 Return Net Profit Proprietor’s --- Profit 1. It shows earning
on available Funds = Earning power of proprietors
propriet to the Preference Capital Capacity Funds.
or’s Share + Reserves & Minimum return must
Fund/Ne holders Surplus be earned to keep
t-wroth Prop. Less : Fictitious proprietors happy.
Fund x assets. 2. This ratio is helpful to
100 a future investor.
3. Useful for inter-
Company
comparisons.
4. High rate of return
means growing &
prosperous company.
Lower is unfavorable.
14 Return Net Profit Net Profit --- Earning 1. It shows the
on available available to Per profitability of the
Equity to Equity Equity Share Equity company in terms of
Capital Share holder = Divisible Share earnings available for
holder NP = Net Profit equity shareholders.
OR Eq. Share after tax & pref. 2. Higher ratio means
Cap Div. and trsfd. To effective use of equity
Return x 100 Reserves. capital & advantage of
on Equity Capital = trading on equity.
Equity Paid up Capital 3. Lower ratio indicates
Share low profitability.
holders
Fund
5

6. Compiled by Prof. M B. Thakoor
Standard
No. Ratio Formula Composition Test of Interpretation
Ratio
15 Debtor’s Drs. + BR Debtors (Drs.) will Should be Receiva 1. It shows average credit
Turnover Cr. Sales include only trading compared bles granted to customers.
debtors, prevision with the Manage 2. Should be compared
x 365
for doubtful debt credit ment with credit terms
should not be terms granted to know
deducted efficiency of credit
BR = Bills collection department.
Receivable Less 3. Higher ratio means
dishonored bill. greater funds blocked
in receivables, liberal
credit terms for
increasing sales, laxity
of collection dept. or
debtors no longer
liquid assets.
4. Low ratio would mean
Funds not blocked in
receivables, efficient,
collection department,
debtors are liquid
assets.
This ratio should be
studied with other
short term solvency
ratios.
6

7. Compiled by Prof. M B. Thakoor
RATIO ANALYSIS
RATIOS FROM INVESTORS POINT OF VIEW
(1) Return on Total Shareholders Equity = Profit after Tax
Total Networth / Shareholders Funds
(2) Return on Equity Shareholders Equity = Profit after Tax – Preference Dividend
Equity Shareholders Fund
(3) Earning Per Share (EPS) = Profit after Tax available to
Equity Holders
No. of Equity Shares
(4) Dividend Per Share (DPS) = Profit Paid to Equity Shareholders
No. of Equity Shares
(5) Dividend Payout Ratio = Dividend Per Share i.e. DPS
Earning Per Share EPS
(6) Price Earning Ratio = Market Price Per Share i.e. MPS
Earning Per Share EPS
(7) Dividend Yield = Dividend Per Share i.e. DPS
Market Price Per Share MPS
(8) Earning Yield or Earning Price Ratio = Earning Per Share i.e. EPS
Market Price Per Share MPS
(9) Cover for Ordinary Dividend = PAT – Preference Dividend –
transfer to reserves
i.e. Cover for Equity Dividend
Equity Dividend Payable
(10) Cover for Preference Dividend = Profit after Tax
Preference Dividend Payable
7