Embed Size (px)
Citation preview
1
Ratio Analysis
Padmaja Buzruk
Financial Management
2
Agenda
What is Financial Statement? Parties interested in the analysis of financial
statements. Tools of Analysis and Interpretation of
Financial Statement. Ratio Analysis of Financial Statements Classification of Ratios.
3
Understanding Financial Statement Financial Statement
End Product of a financial accounting system
Importance of Financial Statement
Portrait of the financial performance of a company
Examples of Financial Statement
Income statement or Profit and loss account
Balance Sheet
Business Transaction
Entry
Books of Prime entry
Books of Secondary entry - Ledger
Trial Balance
Financial statements
4
Financial statements – Example 1 Profit and Loss Account
Particulars Rs. Particulars Rs.
To Opening stock 99,500 By Sales 9,50,000
To Purchases 5,45,000 By Closing stock 1,50,000
To Carriage inward 15,500
To Gross Profit 4,40,000
11,00,000 11,00,000
To Operating expenses 2,00,000 By Gross Profit 4,40,000
To Non operating expenses 40,000 By Non operating income
60,000
To Net Profit 2,60,000
5,00,000 5,00,000
5
Financial statements – Example 2 Balance Sheet
Liabilities Rs. Asset Rs.
Capital (Equity shares of Rs.10 each)
2,00,000 Land and Building 1,50,000
Reserves 2,00,000 Plant and Machinery 1,80,000
Profit and Loss account 60,000 Stock 50,000
Other current liabilities 90,000 Debtors 45,000
Bills payable 40,000 Cash and Bank 60,000
Bills receivable 1,05,000
5,90,000 5,90,000
Do you understand the financial stability of an organization easily from above figures? And can you compare it with other organization in the same industry?
6
Parties interested in analysis of Financial Statements
Shareholders and prospective investors Short term creditors Long term creditors Management Others
Note: Analysis And Interpretation - Study the financial statements and arrive at the conclusion.
7
Tools of analysis and interpretation of financial statements
Comparative financial statements Preparation of Profit and Loss a/c and Balance Sheet for two or more years
Common size statements Financial figures are converted into percentages to some common base. Each
statement is reduced to 100 and each individual item is stated as percentage of total 100. In common size statement analysis condensed and compact figures are available and relative importance of each item can be known at a glance.
Trend analysis A year is taken as base year and each item in that year is taken as 100. Percentage of
the same item for year under study is calculated. As large amounts are reduced to percentages, management finds it easy to compare and know the trends and their directions.
Funds flow analysis A statement which indicates various means by which the funds have been obtained
during a certain period and the ways to which these funds have been used during that period. “funds” means working capital ie. Excess of current assets over current liabilities
Ratio analysis
8
Ratio Analysis and it's Importance
Ratio Analysis is the process of determining and interpreting numerical relationship between two figures taken from the financial statements.
To measure general efficiency To measure financial solvency To help in forecasting, planning and decision making To help in inter firm comparison
Investopedia definition - A tool used by individuals to conduct a quantitative analysis of information in a company's financial statements. Ratios are calculated from current 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.
9
Balance Sheet Ratio
P&L Ratio or Income/Revenue Statement Ratio
Balance Sheet and Profit & Loss Ratio
Financial Ratio Operating Ratio Composite Ratio
Current Ratio
Quick Asset Ratio or Acid Test Ratio
Proprietary/Net worth Ratio
Debt Equity Ratio
Capital Gearing Ratio
Gross Profit Ratio
Operating Ratio
Expense Ratio
Net profit Ratio
Stock Turnover Ratio
Fixed Asset Turnover Ratio
Return on shareholders
Fund Ratio
Earning per Share Ratio
Debtors’ Turnover Ratio
Return on capital employed
Classification of Ratios
10
How is Ratio expressed?
As Percentage - Such as 25% or 50% . For example if net profit is
Rs.25,000/- and the sales are 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 as, the sale is 4 times of the net profit or profit is 1/4th of the sales.
11
Calculation of Ratios
2,60,0001,30,000
=2:1
LiquidAssets
LiquidLiabilities
2,10,0001,30,000
=1.62 :1
ShareholdersFunds
TotalAssets
4,60,0005,90,000
=0.78:1
Proprietary Ratio - High ratio indicates high financial strength.
Standard ratio is 1:3.
CurrentAssetsCurrentLiabilities
Current Ratio - It is an index of firms financial stability. Ideal ratio is 2:1.
Acid Test Ratio - Liquid assets can be converted into cash immediately.
Ideal ratio is 1:1.
Liabilities Rs. Asset Rs.
Capital (Equity shares of Rs.10 each) 2,00,000 Land and Building 1,50,000
Reserves 2,00,000 Plant and Machinery 1,80,000
Profit and Loss account 60,000 Stock 50,000
Other current liabilities 90,000 Debtors 45,000
Bills payable 40,000 Cash and Bank 60,000
Bills receivable 1,05,000
5,90,000 5,90,000
12
Calculation of Ratios
Operating Ratio – Higher the ratio lower is the margin of operating profit.
Gross Profit Ratio - High Gross Profit Ratio is better, it shows high margin for covering expenses, other than cost of goods sold.
GrossProfitSales
∗100
4,40,0009,50,000
∗100=46.32
NetProfitSales
∗100
2,60,0009,50,000
∗100=27.36
Net Profit Ratio - It reveals overall profitability of the organisation. Higher the ratio, better is the efficiency.
Particulars Rs. Particulars Rs.
To Opening stock 99,500 By Sales 9,50,000
To Purchases 5,45,000 By Closing stock 1,50,000
To Carriage inward 15,500
To Gross Profit 4,40,000
11,00,000 11,00,000
To Operating expenses 2,00,000 By Gross Profit 4,40,000
To Non operating expenses 40,000 By Non operating income 60,000
To Net Profit 2,60,000
5,00,000 5,00,000
Costofgoodssoldoperatingexpenses netsales ∗100
13
14
Calculation of Ratios
Current Ratio
Acid Test Ratio
Proprietary Ratio
CurrentAssets
CurrentLiabilities
2,60,0001,30,000
=2:1
LiquidAssetsLiquidLiabilities
2,10,0001,30,000
=1.62 :1
ShareholdersFunds
TotalAssets
4,60,0005,90,000
=0.78:1
It is an index of firms financial stability. Ideal ratio is 2:1.
Liquid assets can be converted into cash immediately. Ideal ratio is 1:1.
High ratio indicates high financial strength. Standard ratio is 1:3.
15
Calculation of Ratios
Gross Profit Ratio
Net Profit Ratio
Operating Ratio
High Gross Profit Ratio is better, it shows high margin for covering expenses, other than cost of goods sold.
It reveals overall profitability of the organisation. Higher the ratio, better is the efficiency.
GrossProfitSales
∗100
4,40,0009,50,000
∗100=46.32
NetProfitSales
∗100
2,60,0009,50,000
∗100=27.36
Costofgoodssoldoperatingexpenses
netsales∗100
