2. CONTENTS
How does Ratio Analysis came into picture?
What is Ratio Analysis?
Significance of Ratio Analysis
Purpose of Ratio Analysis
Precautions to be taken while using ratio analysis
Types of Ratios
Case study
3. Learning Outcomes
Understand the contextual environment in which
we apply financial ratios
Explain the calculation and application of ratios
in the areas of profitability, efficiencies, liquidity,
etc. and apply them to a set of financial
statements
Calculate different ratios from supplied company
details and interpret these ratios
Explain the different classifications of financial
ratios
Explore the results of ratio analysis in terms of
what it tell us about the organisation
4. NEED FOR A CHANGE..
Traditional financial statements( balance sheet,
profit and loss accounts) do not give all the
information related to the firm
It ignores the significance of financial operations
that the firm has undertaken in the entire year.
Understanding Financial statements is a
complex task for a lay man(non commerce), this
gave rise to ratio analysis.
5. WHAT IS RATIO ANALYSIS ??
Ratio-analysis means the process of computing,
determining and presenting the relationship of
related items and groups of items of the financial
statements.
It is the systematic use of ratios to interpret the
performance and status of the firm.
They provide information in a summarized and
concise form.
6. SIGNIFICANCE OF RATIO
ANALYSIS
The significance of a ratio can only truly be appreciated
when:
It is compared with other ratios in the same set of
financial statements of the competitors.
It is compared with the same ratio in previous
financial statements.
It is compared with a standard of performance
(industry average). Such a standard may be either the
ratio which represents the typical performance of the
trade or industry, or the ratio which represents the
target set by management as desirable for the
business.
7. PURPOSE OF RATIO
ANALYSIS-
It’s a tool which enables the banker or lender to
arrive at the following factors i.e :
Liquidity position
Profitability
Solvency
Financial Stability
Quality of the Management
Safety & Security of the loans.
8. Before looking at the ratios there are a number of
cautionary points concerning their use that need to
be identified :
a. The dates and duration of the financial statements being
compared should be the same. If not, then wrong
conclusions will be drawn.
b. The accounts to be compared should have been prepared on
the same bases. Different treatment of stocks or
depreciations or asset valuations will distort the results.
c. In order to judge the overall performance of the firm, a
group of ratios, as opposed to just one or two should be
used. In order to identify trends at least three years of
ratios are normally required.
9. HOW A RATIO IS EXPRESSED?
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.
11. A: LIQUIDITY RATIOS
The main concern of liquidity ratio is to
measures the ability of a firm to meet their short-
term obligations.
Failure to do this will result in the total failure of
the business.
These ratios are concerned with the examination
of the financial stability of the organization.
12. 1: CURRENT RATIOS
It expresses the relationship between current
assets and current liabilities
The concept behind this ratio is to find out
whether a company's short-term assets are
readily available to pay off its short-term
liabilities or not.
Current Ratio = Current Assets/Current
Liabilities
The ideal Current Ratio is 2 : 1
13. COMPARISON AMONG TWO FIRMS
Particulars Firm A Firm B
Current assets
Current liabilities
1,80,000
1,20,000
30,000
10,000
Current Ratio = 3 : 2 = 3 : 1
14. 2:QUICK RATIO OR ACID TEST
It is the ratio between Quick Current Assets and Current
Liabilities.
Acid Test or Quick Ratio = Quick Current
Assets/Current Liabilities
Example :
Cash 50
Debtors 100
Inventories 200
Current Liabilities 100
Total Current Assets 350
Current Ratio = > 350/100 = 3.5 : 1
Quick Ratio = > 150/100 = 1.5 : 1
15. 3:CASH RATIOS
The cash ratio is an indicator of a company's
liquidity by measuring the amount of cash, cash
equivalents or invested funds there in the
current assets to cover current liabilities.
Cash ratio = cash + cash equivalents
current liabilities
4: NET WORKING CAPITAL
It indicates the amount of money in hand to meet
current obligations.
Net Working Capital = Current Assets – Current
Liabilities
16. 5: DAYS PAYABLE OUTSTANDING
It indicates the number of days to settle all payables.
Days payable outstanding is an efficiency ratio that
measures the average number of days a company
takes to pay its suppliers
Days Payable outstanding =
Average Accounts Payable * 365
COGS
Average Accounts Payable is the average of the opening
and closing balances of Accounts Payable.
17. B: ACTIVITY RATIOS
If a business does not use its assets effectively,
investors in the business would rather take their
money and place it somewhere else.
It is also known as Asset Management process.
Activity ratios are used to assess how active
various assets are in the business.
18. 1: AVERAGE COLLECTION PERIOD
The average collection period measures the quality of
debtors since it indicates the speed of their collection.
The shorter the average collection period, the better
will be the quality of debtors, as a short collection
period implies the quick payment by the debtors.
An excessively long collection period implies a very
liberal and inefficient credit and collection
performance.
Debtor collection period= debtors x 365
credit sales
19. 2: INVENTORY TURNOVER
It determines how often the stock turns over in
the business.
It indicates the efficiency of the firm in selling its
product.
This ratio measures the number of times in one
year that a business turns over its stock of goods
for sale.
Stock Turnover= average stock x 365 (days)
cost of goods sold
Average Inventory = (Opening Stock + Closing Stock)
2
20. 3: TOTAL ASSETS TURNOVER
It indicates the efficiency with which the firm
uses all its assets to generate sales.
Asset turnover = sales
net assets
21. Cash turnover = sales / cash and cash equivalents
Accounts Receivable ratio= Annual Sales / average
Accounts Receivable
Current Asset Turnover Ratio = Annual Sales /
Current Assets
Fixed Assets Turnover ratio = Sales / Net Fixed
Assets
Accounts Payable ratio= Annual Sales / Accounts
Payable
22. Working capital turnover = sales / working
capital
Days in Inventory = Average inventory / cost of
sales per day
Days in Accounts Receivable = Accounts
Receivable / sales per day
Days in Accounts Payable = Accounts Payable /
sales per day
Operating cycle = Days in Inventory + Days in
Accounts Receivables.
23.
24. C: LEVERAGE RATIOS
A financial leverage ratio is the comparison between
debts and assets. This means that the values being
compared here are the size of debts and whatever
measurement of assets value is available.
Technically , these ratios speak volumes about a
company’s reliance on loans and other sources of
borrowed money.
The leverage ratio is used to calculate the financial
leverage of a company.
25. 1:DEBT TO EQUITY RATIO
The debt-to-equity ratio is a financial ratio indicating
the relative proportion of equity and debt used to finance
the assets.
It is the key of financial ratios and is used as a standard
for judging a company's financial standing.
Debt to Equity Ratio = Total debt/ total equity
2: TIMES INTEREST EARNED RATIO
It is used to measure the long term viability of a business to
pay off its debts.
Times Interest Earned = Earnings before Interest & Tax
Net Interest Expense
26. 3: GEARING
The most common use of the term 'gearing' is to describe
the level of a company's net debts compared with its
equity capital.
It is expressed as a percentage.
In simpler terms, gearing explains how a company
finances its operations - either through outside lenders or
through shareholders.
Gearing =Long-term debt + Short-term debt + Bank overdrafts
Shareholders' equity
4: DEBT RATIOS
Debt Ratio is a financial ratio that indicates the
percentage of a company's assets that are provided
via debt.
Debt ratio= Total debts/ total assets
28. 1:GROSS PROFIT MARGIN
This ratio examines the relationship between the
profits made on trading activities only (gross
profit) against the level of turnover/sales made.
It is given by the formula
Gross Profit Margin = gross profit x 100
turnover (sales)
29. 2:NET PROFIT MARGIN
As opposed to gross profit margin this ratio
measures the relationship between the net profit
(profit made after all other expenses have been
deducted) and the level of turnover or sales made
Net Profit Margin = net profit x 100
turnover (sales)
30. 3:RETURN ON INVESTMENT
A performance measure used to evaluate the
efficiency of an investment or to compare the
efficiency of a number of different investments.
To calculate ROI, the benefit (return) of an
investment is divided by the cost of the
investment; the result is expressed as a
percentage or a ratio
ROI = After tax earnings/ total assets
31. 4:RETURN ON EQUITY
The amount of net income returned as a
percentage of shareholders equity. Return on
equity measures a corporation's profitability by
revealing how much profit a company
generates with the money shareholders have
invested.
ROE = After tax Earnings/ Stockholder’s equity
32. 5:EARNING PER SHARE
The portion of a company's profit allocated to each
outstanding share of common stock. Earnings per
share serves as an indicator of a company's
profitability.
EPS = Net income after tax- pref. dividend / no.
of issued equity shares
34. 1:DIVIDEND YIELD RATIO
A financial ratio that shows how much a company
pays out in dividends each year relative to its
share price. In the absence of any capital gains,
the dividend yield is the return on investment for
a stock.
Dividend yield = Dividend per share / share price
Dividend per share = total dividend / no. of
shares outstanding
35. 2:PRICE EARNING RATIO
A valuation ratio of a company's current share
price compared to its per-share earnings.
P/E ratio = Market price per share/ current
earnings per share
For example: a company is currently trading at
Rs.43 a share and earnings over the last 12
months were Rs.1.95 per share, the P/E ratio for
the stock would be 22.05
36. ~~CASE STUDY~~
RATIO ANALYSIS FOR JET
AIRWAYS
Jet Airways was incorporated on April 1, 1992 as a
private company with limited liability under the
Companies Act.
In 2005, Jet Airways Limited has filed its draft Red
Herring Prospectus with the Securities and Exchange
Board of India (Sebi) to enter the capital market with
its initial public offering. The company will offer
17,266,801 (1.72 crore shares) equity shares of Rs 10
each for cash at a price to be decided through the
book-building process. It is learnt that the value of
each share will be Rs 870. The IPO proceeds will
essentially be used to fund its international expansion
plans.
Jet Airways IPO was subscribed 4.25 times on the
first day of the offer.
37. MANAGEMENT
Designation Names
Chairman / Chair Person Naresh Goyal
Director Ali Ghandour
Director Javed Akhtar
Director Aman Mehta
Director Victoriano P Dungca
Director I M Kadri
Director Yash Raj Chopra
Once we are done with the presentation, you will be able to:
Ok now, how cum ratio analysis came into the picture 2) ) i.e they do not provide information regarding changes in d firms financial positions
The aim of analysing the financial statements is to build up a picture of how the company has been performing and how it is likely to perform in future in order to take decisions.
i.e what we called it as Inter firm comparison I.e Trend analysis Next is comparing the performance of a company with the standards performances of industry
Now moving over to the purpose of ratio analysis 1)
A ratio can be expressed in 3 forms
RATIOS are classified as- 1 liquidity- it depicts the ability of the firm to pay its debts 2)Activity ratios depict how easily or efficiently we Increase our turnover 3) profitability- it tells us, how effective the firm is at generating profits 4) Leverage ratios looks at the balance between loans and shares in a business, how v r using our debts for the growth of the firm 5)Market value ratio is used to determine if a company is over or undervalued
Liquidity ratios Aims at finding How solvent the business is? Deals with current assets n current liabilities
---For every 1Re of a firms current obligations, firm has 2Rs ---Current assets normally includes cash , bank balance, marketable securities, accounts receivable and inventories. Current liabilities consist of accounts payable, short term notes payable, short-term loans, current maturities of long term debt, accrued income taxes and other accrued expenses ---More the current ratio, more is the stability of a firm
If we look at the current ratios of both the firms, the liquidity position is better in case of B as compared to A. because a slight decline in value of assets of firm A, will adversely affect the ability of a firm A to meet its obligations.
Quick current assets are those assets that are quickly converted into cash and they are compared with current liabilities. Quick assets are- cash, bank balance, recivables etc
Cash equivalents are short-term investments, such as Treasury bills, that can be quickly converted to cash. i.E it is the money which is left in our hand once we pay the debts
COGS- cost of goods sold (year) Example: a business has $ 2,500 in accounts payable, $ 12,500 in cost of goods sold. Days payable outstanding = (2,500 / 12,500) * 365 = 73 days
We are done with the liquidity ratios, next is activity ratios Under these ratios we will b studying various imp ratios ……
It is also known as debtors collection period -On the other hand, too low “collection period” is not necessarily favorable, rather it may indicate a very restrictive credit and collection policy which may affect profit. Debtors- is the amount of money owed
i.E how quickly we convert our inventories to sales Opening stock is nothing but the finished goods which can be sold as our end product and any stock which remains during the first year becomes the ending stock for 1 st year and opening for the 2 nd year.,
Asset turnover gives the relationship between sales and assets. The firm should manage its assets efficiently to maximise sales.
==Cash turn over indicates a firms efficiency in its use of cash for generation of sales revenue. == accounts recievables turnover measures the efficiency of business in collecting its credit sales ==Fixed assets- furniture, property, house, lands Accounts payable turnover measures the speed with which a company pays its suppliers . If the turnover ratio declines from one period to the next, this indicates that the company is paying its suppliers more slowly, and may be an indicator of worsening financial condition
The working capital turnover ratio measure the efficiency with which the working capital is being used by a firm. A high ratio indicates efficient utilization of working capital and a low ratio indicates otherwise. But a very high working capital turnover ratio may also mean lack of sufficient working capital which is not a good situation.
An operating cycle is very important as it defines how a company uses its cash to produce a product or provide services. It starts and end with cash. It is the time period involves in the conversion of raw material into finished goods including d credit period. == suppose on 1 st jan we purchase raw material, it takes 1month to convert them into finished goods i.e 1 feb,, on 1feb the goods are ready n they r kept in stock fr anothr 1month as thr is no demnd rite now i.e upto 1march,, thn on 1 st march, goods r being sold to customers on credit,, afta a month i.e 1 st april,, v get the money from customers n d revenue we got will b used to buy another raw materials. So operating cycle is of 3months
Leverage is The amount of debt that has been used to finance activities. A company with much more debt than equity is generally called "highly leveraged."
-It measures how well a company can meet its interest expense obligations. -Higher value of times interest earned ratio is favourable i.e greater ability of a business to repay its interest and debts. Lower values are unfavourable. In general, times interest earned ratio of 1.5 or below is unsafe. If TIE = 1 all the income is used to pay debts n interests If TIE= 10 that means one tenth of income is used to service the debts
- It is the ratio of (the sum of current liabilities and long-term liabilities) and (the sum of current assets, fixed assets) -If the ratio is less than 0.5, most of the company's assets are financed through equity. If the ratio is greater than 0.5, most of the company's assets are financed through debt
Profitability is the ability of a business to earn profit over a period of time. Although the profit figure is the starting point for any calculation of cash flow, as already pointed out, profitable companies can still fail for a lack of cash. Note: Without profit, there is no cash and therefore profitability must be seen as a critical success factors. A company should earn profits to survive and grow over a long period of time. Profits are essential, but it would be wrong to assume that every action initiated by management of a company should be aimed at maximising profits, irrespective of social consequences. The ratios examined previously have tendered to measure management efficiency and risk. Profitability is a result of a larger number of policies and decisions. The profitability ratios show the combined effects of liquidity, asset management (activity) and debt management (gearing) on operating results. The overall measure of success of a business is the profitability which results from the effective use of its resources.
Interpretation: Obviously the higher the profit margin a business makes the better. However, the level of gross profit margin made will vary considerably between different markets. For example the amount of gross profit percentage put on clothes, (especially fashion items), is far higher than that put on food items. So any result gained must be looked at in the context of the industry in which the firm operates.
Interpretation: As with gross profit, a higher percentage result is preferred. This is used to establish whether the firm has been efficient in controlling its expenses. It should be compared with previous years’ results and with other companies in the same industry to judge relative efficiency. The net profit margin should also be compared with the gross profit margin. For if the gross profit margin has improved but the net profit margin declined, this shows that profits made on trading are becoming better, however the expenses incurred in the running of the business are also increasing but at a faster rate than profits. Thus efficiency is declining.
Income is earned by using the assets of a business productively. The more efficient the production, the more profitable the business. The rate of return on total assets indicates the degree of efficiency with which management has used the assets of the enterprise during an accounting period. This is an important ratio for all readers of financial statements. Investors have placed funds with the managers of the business. The managers used the funds to purchase assets which will be used to generate returns. If the return is not better than the investors can achieve elsewhere, they will instruct the managers to sell the assets and they will invest elsewhere. The managers lose their jobs and the business liquidates.
et income is for the full fiscal year (before dividends paid to common stock holders but after dividends to preferred stock.) Shareholder's equity does not include preferred shares.
Whatever income remains in the business after all prior claims, other than owners claims (i.e. ordinary dividends) have been paid, will belong to the ordinary shareholders who can then make a decision as to how much of this income they wish to remove from the business in the form of a dividend, and how much they wish to retain in the business. The shareholders are particularly interested in knowing how much has been earned during the financial year on each of the shares held by them.
Now we come to another head of the kinds of ratios. That is Market Value Ratios These ratios indicate the relationship of the firm’s share price to dividends and earnings. Note that when we refer to the share price, we are talking about the Market value and not the Nominal value as indicated by the par value. For this reason, it is difficult to perform these ratios on unlisted companies as the market price for their shares is not freely available. One would first have to value the shares of the business before calculating the ratios. Market value ratios are strong indicators of what investors think of the firm’s past performance and future prospects.
The dividend yield ratio indicates the return that investors are obtaining on their investment in the form of dividends. This yield is usually fairly low as the investors are also receiving capital growth on their investment in the form of an increased share price. It is interesting to note that there is strong correlation between dividend yields and market prices. Invariably, the higher the dividend, the higher the market value of the share.
P/E ratio is a useful indicator of what premium or discount investors are prepared to pay or receive for the investment. The higher the price in relation to earnings, the higher the P/E ratio which indicates the higher the premium an investor is prepared to pay for the share. This occurs because the investor is extremely confident of the potential growth and earnings of the share High P/E generally reflects lower risk and/or higher growth prospects for earnings