1. Ratio Analysis
B.V.Raghunandan,
SVS College,
Bantwal Page 1
2. Definition
Ratio Analysis is a financial technique of
measuring the strength and weakness of
an organisation out of information
available from financial reports
specifically from the Balance Sheet and
Income Statement
Page 2
3. Advantages
• Measuring the efficiency of organisations
• Measuring the liquidity position of the companies
• Measuring the capacity of companies to borrow in the
future
• Understanding the overall financial position of
organisations
• Estimating the solvency of the companies
• Helping in forecasting Page 3
4. Disadvantages
• Only quantitative tools
• Manipulation of accounting
figures
• Too many analytical tools lead to
varied interpretation
• Based on past data
• Same data may be interpreted in
different ways
• Vested interests
• Measuring the changes in price
levels
• Accounting policies have the
impact
• Only symptoms and not cure
Page 4
6. A] Liquidity Ratio
CurrentAssets
• Current Ratio =
CurrentLiabilities
CurrentAss ets Clo sin gStock
• Acid Test Ratio=
CurrentLia bility
Sales
• Working Capital Turnover Ratio =
WorkingCapital
Page 6
7. A. Liquidity Ratios
• Used to study the ability of the organisation in
meeting short-term payments or obligations
• Includes:
1) Current Ratio,
2) Acid Test Ratio and
3) Working Capital Turnover Ratio
Page 7
8. 1) Current Ratio
• Relation between current assets and current
liabilities
• Long Term Sources Financing the Current
assets give a stable base for the liquidity of the
organisation
• Normally , the ratio should not be less than 2
i.e., the current assets should be double the
size of current liabilities
Page 8
10. Precautions to be Taken for Current Ratio
• Proper Valuation of assets and • Advance payments for fixed
liabilities assets should be excluded
• Provision for Bad Debts • Instalment payments are part
• Useless Inventory Deducted of current liabilities
• Loose Tools are not current • Bank overdraft and cash credit
assets are part of current liabilities
• Short Term Investment can be • Bills Receivables are a part of
part of current assets current assets
• Long Term investment like • Bank Loans should not be
capital of subsidiary is not treated as current liabilities
current asset • Advances to Employees or
Utilities are to be treated as
current assets
Page 10
11. 2) Acid Test Ratio/Quick Ratio
• It is the ratio between quick assets and
quick liabilities
• Quick assets include current assets except
inventory and pre-paid expenses
• Quick liabilities include current liabilities
other than bank overdraft
• A 1:1 ratio is healthy
• Healthy indicator of cash management
Page 11
12. Measurement of Acid Test Ratio
QuickAssets
Acid Test Ratio =
QuickLiabilities
Page 12
13. 3) Working Capital Turn-over Ratio
• Shows the efficiency of usage of working
capital
• Relation between Sales and Working
Capital
• Determination of number of times the
working capital is turned over to achieve
the maximum profit
Page 13
15. B. Solvency Ratios
• Measure long-term liquidity ratio
• Reflect the ability of the firm to pay interest
and repayment of loans at due dates on
the long-term loans taken
• Avoidance of over-borrowing (over-
leverage)
• Avoidance of bankruptcy by maintaining
healthy solvency ratios
Page 15
16. Types of Solvency Ratios
1) Interest Coverage
Ratio
2) Debt Ratio
3) Debt-Equity Ratio
4) Capital Gearing
Ratio
5) Proprietary Ratio
Page 16
22. C] Activity Ratios
1) Inventory Turnover Ratio
2) Debtors Turnover Ratio
3) Average Collection Period
4) Fixed Assets Turnover Ratio
5) Total Assets Turnover Ratio
6) Capital Turnover Ratio
Page 22