RATIO ANALYSIS MEANING:Ratio Analysis:It is the relationship between two financial values. To make it clear the word relationship stands for a financial ratio which is the result of two mathematical values.Uses:

It is useful to know whether the concern is making profit or loss. It is useful for making decisions in the management. Interpreting of financial statements.

Classification of ratios:

1. Profitability ratios 2. Activity turn over ratios 3. Financial ratios

a) Liquidity ratios b) Leverage ratios

1. Miscellaneous ratios

 Before going to ratios we need to know about what the current assets are & what the current liabilities are…… Current Assets:

Ø Cash in hand Ø Cash at bank Ø Inventory (or) Stock Ø Sundry debtors Ø Bills receivable Ø Investment (or) Securities Ø Prepaid expenses (or) Income to be received

 Fixed Assets:

Ø Furniture & fixtures Ø Tools and equipment Ø Motor vehicles Ø Plant & machinery Ø Land & Buildings Ø Lease hold premises

Intangible Assets:

Ø Trade marks

Ø Patents Ø Copy rights Ø Goodwill

Current Liabilities:

Ø Sundry creditors Ø Bills payable Ø Bank overdraft Ø Outstanding expenses Ø Provision for taxation Ø Income received in advance

Long Term Liabilities:

Ø Mortgage loan Ø Bank loan Ø Loan from family members

Profitability Ratios:Formulae’s:a) Gross profit ratio: Gross profit--------------- × 100Net salesThis ratio tells us the result from trading activity to know operating efficiency of the organization. b) Net profit ratio:  Net profit------------- × 100Net salesIt indicates the final result to organization and overall efficiency of the organization.   c) Operating ratio:CGS + operating expenses---------------------------------- × 100Net salesThis ratio speaks of the operational performance of the organization and refers the managerial efficiency of the firm.  Where,CGS = Sales – Gross profit (or)Opening stock + purchases + manufacturing expenses – closing stock

Operating expenses = Office Administrative Expenses + Selling & Distribution Expenses + Financial Expenses.      d) Operating net profit ratio:100 – Operating ratio   Expenses ratios:

Cost of goods sold ratio:

Cost of goods sold------------------------- × 100Net Sales 

Operating expenses ratio:

 Operating expenses------------------------- × 100Net Sales

Administrative office expenses ratio:

 Administrative office expenses--------------------------------------- × 100Net Sales 

Selling & distribution expenses ratio:

 Selling & distribution expenses-------------------------------------- × 100Net sales  

Financial expenses ratio:

 

Financial expenses----------------------- × 100Net sales 

Non-operating expenses ratio:

Non - operating expenses---------------------------------- × 100Net salese) Return on capital employed (or)Return on Investment(or)Rate of returnNet profit---------------------- × 100Capital employed (or) Return-------------- × 100Investment   Where,Capital employed = Equity share capital + Preference share capital + Reserves & surplus + Fixed liabilities (Long term) – Fictitious assets.(or)Fixed Assets + Current Assets – Current liabilities.       f) Return on shareholder’s fund:Net profit after taxes--------------------------- × 100Shareholder’s fund g) Return on equity shareholder’s fund:Net profit after Interest, taxes & Pref. dividend-------------------------------------------------------- × 100Equity shareholder’s fund h) Earnings per share: (EPS)Profit available to Equity Shareholder’s

------------------------------------------------No. of equity shares(or)Net profit after taxes - Preference share dividend-----------------------------------------------------------No. of equity sharesi) Dividend per share: (DPS) Dividend on Equity Share Capital-----------------------------------------No. of equity shares j) Dividend yield ratio: (DYR) Dividend per share----------------------------- × 100Market value per share     k) Dividend pay-out ratio: (DPR)Dividend per equity shares---------------------------------Earnings per share l) Earnings yield ratio: (EYR) Earnings per share---------------------------- × 100Market value per share m) Retained earnings ratio:  Retained earnings------------------------ × 100Total earningsActivity Turnover Ratio’s:Formulae’s:a) Stock turnover ratio:(or)Inventory turnover ratio:Cost of goods sold--------------------------------Average Inventory at cost b) Debtors turnover ratio:(or)Receivable turnover ratio:

Net credit sales-----------------------------------Average accounts receivable (Average account receivable = Debtors + Bills receivable)    c) Creditors turnover ratio:(or)Payable turnover ratio:Net credit purchases---------------------------------Average accounts payable(Average accounts payable =creditors + Bills payable) d) Fixed assets turnover ratio: Net sales----------------------Net Fixed Assets e) Current assets turnover ratio:Net sales-------------------Current Assets    f) Total assets turnover ratio:Net sales-----------------Total Assets g) Working capital turnover ratio:Net sales---------------------------Net Working Capital Financial Ratios:Formulae’s:a) Current ratio:Current Assets------------------------Current Liabilities b) Quick ratio:Quick assets

---------------------Quick liabilities    Where,Quick assets = CA – Stock & Prepaid expensesQuick liabilities = CL – Bank overdraft            c) Absolute liquid assets:Absolute liquid assets----------------------------Current liabilities   Where,(Absolute liquid assets = Quick assets)    d) Debt equity ratio: Outsider’s fund------------------------Shareholders fund    Where,Outsiders fund = Debentures, Secured loans,Mortgage loans & Bank loan.    

       e) Proprietary ratio:Shareholders fund------------------------Total Assets  Where,Shareholders fund = Equity shareholders fundPreference shareholders fundR&S + P&L – Intangible assetsUndistributed Profits.  f) Solvency ratio:(or)Total liabilities to total assets:Total Liabilities--------------------- × 100Total Assets    Miscellaneous Ratios:Formulae’s:a) Capital turnover ratio: Net sales----------------------Capital employed b) Stock to current assets ratio: Stock-------------------Current Assets c) Inventory to working capital ratio: Inventory----------------------Working Capital 

 Other Important formulae’s:a) Profit earnings ratio: (P/E) Market value per share-----------------------------Earnings per share It is a measure for determining the value of a share. May also be used to measure the ratio of return expected by investors. b) Break-even-point: (BEP) Fixed Cost------------------------Profit volume ratio This a point at which there is no profit or no loss.c) Profit volume ratio: Contribution----------------- × 100Sales It is a ratio between contribution and sales d) Margin of safety: (M/S)Total sales – Break-even point e) Capitalization method: Future maintainable profitsNet Capital employed = ------------------------------------Normal rate of return   Debit note:It is the note prepared and sent to the supplier while returning the goods purchased on credit from him, intimating that his account is debited to the extent.Credit note:It is the note prepared and sent to the customer after receiving the goods returned by him, intimating that his account is credited to that extent.Definition of Accounting:Accounting has been defined by the American Institute of Certified Public Accountants, a "The art of recording, classifying and summarizing in a significant manner and in terms of money, transactions and events which are, in part at least, of a financial character, and interpreting the results thereof".Principles of Accounting:a) Personal account:

Debit the receiverCredit the giverb) Real account:Debit what comes inCredit what goes outc) Nominal account:Debit all expenses & lossesCredit all gains & incomesAccounting process:TransactionGeneration of VoucherRecording in JournalPosting into LedgerGeneration of Trial BalanceTrading & Profit & loss accountBalance Sheet Concepts of Accounting:

1. 1. Business entity concept: According to this concept, the business is treated as a separate entity distinct from its owners and others.

2. 2. Going concern concept: According to this concept, it is assumed that a business has a reasonable expectation of continuing business at a profit for an indefinite period of time.

3. 3. Money measurement concept: This concept says that the accounting records only those transactions which can be expressed in terms of money only.

4. 4. Cost concept: According to this concept, an asset is recorded in the books at the price paid to acquire it (Actual cost) and that this cost is the basis for all subsequent accounting for the asset.

5. 5. Dual aspect concept: In every transaction, there will be two aspects – the receiving aspect and the giving aspect; both are recorded by debiting one accounts and crediting another account. This is called double entry.

6. 6. Accounting period concept: It means the final accounts must be prepared on a periodic basis. Normally accounting period adopted is one year, more than this period reduces the utility of accounting data.

7. 7. Realization concept: According to these concepts, revenue is considered as being earned on the data which it is realized, i.e., the date when the property in goods passes the buyer and he become legally liable to pay.

8. 8. Materiality concept: It is a one of the accounting principle, as per only important information will be taken, and unimportant information will be ignored in the preparation of the financial statement.

9. 9. Matching concept: The cost or expenses of a business of a particular period are compared with the revenue of the period in order to ascertain the net profit and loss.

10.10. Accrual concept: The profit arises only when there is an increase in owner’s capital, which is a result of excess of revenue over expenses and loss.

Accounting Conventions:

1. 1. Consistency: Accounting practices should remain the same from year to year.

2. 2. Disclosure: All information which is essential for fully understanding the financial statements should be disclosed in addition to the information required to be disclosed by law.

3. 3. Conservatism: Financial statements should be drawn up on a conservative basis i.e., anticipated income should not be recorded where as likely losses should be provided for.

Journal:The journal contains details of transactions (other than those relating to receipts or payments in cash or through bank), recorded in chronological order.Ledger:Ledger is a set of accounts. It contains all accounts of the business enterprise whether real, nominal, personal.Trail balance:A trial balance is a statement of debit and credit balances extracted from the various accounts in the ledger with a view to test the arithmetical accuracy of books. Debit note:It is the note prepared and sent to the supplier while returning the goods purchased on credit from him, intimating that his account is debited to the extent.Credit note:It is the note prepared and sent to the customer after receiving the goods returned by him, intimating that his account is credited to that extent.Single Entry system:Under this system, only one aspect of each transaction is recorded. This is not a scientific method of accounting and is prone to error and manipulation.Double Entry system:Under this system, both aspects of each transaction are recorded, ensuring that the sum of all debits is equal to the sum of all credits. This is the most scientific method of accounting and reduces the occurrence of errors and scope for manipulation.Trading account:It is the account prepared to find out trading profit or loss of the business i.e., Gross profit or loss during the period. This is a Nominal Account in its nature hence all the Trading expenses should be debited where as all the Trading incomes should be credited to Trading Account. The Balance of Trading Account will be considered as Gross profit (credit balance) or Gross loss (debit balance) and will be transferred to Profit and loss account.While preparing the Trading Account the following equation also can be usedSales less returns (-) Cost of Goods sold =Gross Profit or Gross loss.Sales=Total (Cash + Credit) salesCost of goods sold = Opening stock of goods = Purchases (Cash + Credit) less returns +Direct Expenses (-) Closing Stock of Goods.Profit & Loss account: (P&L a/c)It is the Account prepares to find out net profit or loss of the business during the period. This is a Nominal Account in its nature. Hence all the other expenses and losses should be debited where as all the other incomes and gains should be credited to profit & loss account. The balance of Profit & loss account will be considered as Net Profit (Credit Balance) or Net Loss (Debit Balance) and will be transferred to Capital Account.While preparing Profit & Loss Account the following equation can be used.

Gross Profit + Other incomes / gains (-) in Direct Expenses/Losses = Net Profit or Net LossBalance sheet: (B/S)It is the statement prepared to find out financial Position i.e., Assets and Liabilities of a concern on a given date. It is a statement (not an account) prepared by taking all the real accounts & personal accounts.Bank Reconciliation Statement: (BRS)It is a statement reconciling the balance as shown by the bank pass book and balance shown by the cash book. Depreciation:Depreciation denotes gradually and permanent decrease in the value of asset due to wear and tear, technology changes, laps of time and accident. Depreciation Methods:

1. Fixed installment method2. Diminishing balance method/ Written down value method3. Annuity method4. Depreciation/Sinking fund method5. Insurance Policy method6. Machine hour rate method7. Depletion method8. Revaluation method

 Capital Reserve: The reserve which transferred from the capital gains is called capital reserve. General Reserve:The reserve which is transformed from the normal profits of the firm is called general reserve.Capital Expenditure:Any amount spent in increasing the earning capacity of a business is called as Capital Expenditure and includes Expenses like Purchase, Installation and improvement of Fixed Assets and repayment of loans.Revenue Expenditure:Any amount spent in earning Revenue/Profit is called as Revenue Expenditure and includes the Expenses like salaries, rent, wages, repairs, maintenance, stores, depreciation and materials etc.,Capital Receipts:Any amount Received as investment by the owners, raised by the way of loans and sale proceeds of fixed Assets is called as capital Receipt.Revenue Receipts:Any amount Received in the normal course of Business is called as Revenue Receipts and includes sale of goods, interest, discount, commission, rent received.Deferred Revenue Expenditure:The benefit of the expenditure will be differed to the future periods for which the expenditure is charges. Differed revenue expenditure is known as asset in balance sheet.

Ex: Preliminary expenses, Advertisement expenses.Deferred Revenue Income:Deferred revenue income which is income differed to the future periods. That means it is not related to one period but related to more than one period.Ex: Pension Fund Scheme. Accrued expenses:The expenditure which is incurred and the payment there of might or might not be paid.Accrued income:Income earned during the current accounting year but has not been actually received by the end of the same year.Prepaid expenses:The amount paid for the expenditure relating to the future years. Prepaid expenses are to be deducted from such expenses in the debit side of profit and loss account, Shown on the asset side of a Balance sheet as an asset.Outstanding expenses:Outstanding expenses refer to those expenses which have become due during the accounting period for which the final accounts have been prepared but have not yet been paid.Outstanding income:Outstanding income means income which has become due during the accounting year but which has not so far been received by the firm.Account receivable:Money owed by customers to another entity in exchange for goods or services that have been delivered or used, but not yet paid for. Receivables usually come in the form of operating lines of credit and are usually due within a relatively short time period, ranging from a few days to a year.Account payable:Money which a company owes to vendors for products & services purchased on credit. Since the exception is that the liability will be fulfilled is less than a year. When accounts payable are paid off, it represents the negative cash flow of the company.Debentures: (AS-6)When a company borrows money from investing people, it issues a bond which is stamped with the official seal of the company. These bonds are called "Debentures".

Debentures are the most common form of loan capital which is made available by investors on a long-term basis.

Debenture holders will get fixed rate of interest. Interest is payable whether company earns profits or not. It is repayable on a specific date.

Memorandum of Association: (MOA)It is the main document of the company. This document represents constitution of that company. It subordinates to the act and it is must for every company.It contains1) Name clause,2) Objective clause,

3) State clause,4) Capital clause,5) Liability clause, and6) Situation clause.Articles of Association: (AOA)This document represents rules and regulations of the company. It is a secondary document. It defines duties, rights, and regulations of the company between themselves and companyCash flow statement: (AS-3)Cash flow statement is a statement shows how much cash is generated and expensed in the organization during the year, it also opening and closing balance of cash.

It is useful for investors and creditors It provides vital information about the company’s ability to generate future cash

flow to satisfy investors and creditors expectation.

Fund flow statement:A statement that uses net working capital as a measure of liquidity position is referred to as funds flow statement.

Reveals the changes in the working capital and gives the details of the sources from which working capital has been financed.

Helps in the analysis of the financial operations and explains causes for the changes on the liquidity position of the company.

Helps in making correct decisions in planning and development of the company

Differences between cash flow & fund flow statement:Cash flow statementFunds flow statement 1) Cash flow statement is concerned only with the change in cash position. 1) Funds flow statement is concerned with change in working capital position between two balance sheet dates. 2) A cash flow statement is merely record of cash receipts and disbursements.3) A funds flow is the studying the solvency of a business one is interested not only in cash bal but also in the assets which are easily convertible into cash Differences between equity shares & preference share holdersEQUITY SHARESPREFERENCE SHARES1) Equity Share Holders get Equity Shares of the Company.  1) Preference Share Holders get Preference Shares.2) Equity shares which are not having preference rights.2) Preference shares which are carrying the preference rights. 

3) Equity Shares are shares whose profit sharing depends on Profit Making of the Co. If the company makes huge profits, there dividend sharing will be high else it will be low.  3) Preference Share Holders, Dividend is a fixed income to them. They get dividend at a fixed rate, Irrespective of the Profit Making of the Company.  4) Dividends to Equity Share Holders is optional and at company's discretion.4) Preference Share Holder, it is a right to get cumulative or non cumulative dividends from the company. 5) Equity Shareholders are called RESIDUAL OWNERS of the company. After all the obligations of the company are over, the Equity Share Holders get their share.  5) Preference Share Holders get paid their dividends ahead of Equity Shareholders.Difference between Public Limited Co & Private Limited CoPublic Limited CompanyPrivate Limited Company1) Public limited co is a listed company at the stock exchange.1) Private limited company is not a listed company at the stock exchange. 2) In public limited company there are minimum seven members require to start it operations, and there is no limit for maximum.2) In private limited company there are minimum two members require to start its operations, and maximum members are 50. 3) In public ltd company minimum directors-3.3) In private ltd company minimum directors-2. 4) Public ltd company starts its operations only after getting business commencement certificate (but not after incorporation). 4) Private ltd company can start business after incorporation.5) Public ltd company can go to public issue.5) Private ltd company shall not issue shares to the outsiders. Bombay Stock Exchange: (BSE)Bombay stock exchange is the first and securities market in India, the BSE was established in the year 1875 as the Native share & stock brokers association based on Mumbai, India. The BSE list over 6000 companies & is one of the largest exchanges in the world. The BSE has helped to develop the country’s capital markets, including the retail debt market and helped to grow the Indian corporate sector. National Stock Exchange: (NSE)

The National Stock exchange is India’s largest financial market. Established in the year 1992, the NSE has developed into a sophisticated, electronic market, which ranks third in the world for transacted volume.The national stock exchange conducts transactions in the wholesale debt, equity & derivative markets. Initial Public Offering: (IPO)IPO stands for Initial Public offering. The shares are issued for the first time to the public as opposed to the secondary market.IPOs are often risky investments, but often have the potential for significant gains.IPOs are often used as a way for a young company to gain necessary market capital.Follow on Public offering: (FPO)An issuing of shares to investors by a public company i.e., already listed on a stock exchange.An FPO is essentially a stock issue of supplementary shares made by a company that is already publicly listed and has gone through the IPO process. Mutual Fund:A mutual fund is made up of money i.e., pooled together by a large number of investors who give their money to a fund manager to invest in a large portfolio of stocks and/or bonds.Open-ended fund:Open ended funds means investors can buy and sell units of fund, at NAV related prices at anytime, directly from the fund this is called open ended fund. For ex: unit 64.Close-ended fund:Close ended funds means it is open for sale to investors for a specific period, after which further sales are closed. Any further transaction for buying the units or repurchasing them, happen, in the secondary markets. Capital Market:The market for long term funds where securities such as common stock, preferred stock, and bonds are traded. Both the primary market for existing securities is the part of capital market.

Primary market:

Primary Market is a channel for issuance of new securities. Every organization, corporate as well as Government needs funds for further expansion. Primary Market provides an opportunity to the issuers of the securities, Government as well as corporates, to raise resources to meet their requirements of investment. The securities may be in various forms such as equity or debt. The primary market is regulated by the Securities and Exchange Board of India (SEBI a government authority).

Secondary market:

 

Secondary Market refers to a market where securities are traded after being initially offered to the public in the primary market and/or listed on the stock exchange. Majority of the trading is done in the secondary market. Secondary market comprises of equity market and the debt markets.Bonds:A debt instrument issued for a period of more than one year with the purpose of raising capital by borrowing.A bond is a promise to repay the principle along with interest on a specified date.Bonds are often divided into different categories based on tax status, credit quality, issuer type, maturity & secured/unsecured. Suspense account:A suspense account is the account prepared to transfer difference in trial balance if any to be rectified in future.Rectification of errors:It is the process of rectifying or correcting errors if committed any in the books of accounts.Bad debts:Bad debts denote the amount lost from debtors to whom the goods were sold on credit.Fictitious assets:These are assets not represented by tangible possession or property. Examples of preliminary expenses, discount on issue of shares, debit balance in the profit and loss account when shown on the assets side in the balance sheet.   Working capital:The funds available for conducting day to day operations of an enterprise. Also represented by the excess of current assets current liabilities.Venture capital:It refers to the financing of high risk ventures promoted by new qualified entrepreneurs who require funds to give shape to their ideas.  Amortization:The process of writing of intangible assets is term as amortization.Capital employed:The term capital employed means sum of total long term funds employed in the business. i.e.(Share capital + reserves & surplus + long term loans – (non business assets + fictitious assets)  Minority Interest:Minority interest refers to the equity of the minority shareholders in a subsidiary company.    

Leverage:It is a force applied at a particular point to get the desired result. Operating leverage:The operating leverage takes place when a changes in revenue greater changes in EBIT. Financial leverage:It is nothing but a process of using debt capital to increase the rate of return on equity. Combined leverage:It is used to measure of the total risk of the firm = operating risk + financial risk. Joint Venture:A joint venture is an association of two or more the persons who combined for the execution of a specific transaction and divide the profit or loss thereof an agreed ratio.Partnership:Partnership is the relation b/w the persons who have agreed to share the profits of business carried on by all or any of them acting for all.Factoring:It is an arrangement under which a firm (called borrower) receives advances against its receivables, from financial institutions (called factor). Capital budgeting:Capital budgeting involves the process of decision making with regard to investment in fixed assets. Or decision-making with regard to investment of money in long term projects.Payback period: Payback period represents the time period required for complete recovery of the initial investment in the project. ARR:Accounting or Average rates of return means the average annual yield on the project. NPV:The net present value of an investment proposal is defined as the sum of the present values of all future cash inflows less the sum of the present values of all cash out flows associated with the proposal.Profitability index:Where different investment proposal each involving different initial investments and cash inflows are to be compared. IRR: Internal rate is the rate at which the sum total of discounted cash inflows equals the discounted cash out flow.GDR: (Global depository receipts)A depository receipt is basically a negotiable certificate, dominated in us dollars that represent a non-US company publicly traded in local currency equityshares.ADR: (American depository receipts)

Depository receipt issued by a company in the USA is known as ADRs. Such receipts are to be issued in accordance with the provisions stipulated by the securities Exchange commission (SEC) of USA like SEBI in India.Budget:It is a detailed plan of operations for some specific future period. It is an estimate prepared in advance of the period to which it applies. Budgetary control:It is the system of management control and accounting in which all operations are forecasted and so for as possible planned ahead, and the actual results compared with the forecasted and planned ones. Cash budget:It is a summary statement of firm’s expected cash inflow and outflow over a specified time period. Master budget:A summary of budget schedules in capsule form made for the purpose of presenting in one report the highlights of the budget forecast. Fixed budget:It is a budget which is designed to remain unchanged irrespective of the level of activity actually attained. Zero-based budgeting: It is a management tool which provides a systematic method for evaluating all operations and programs, current of new allows for budget reductions and expansions in a rational manner and allows reallocation of source from low to high priority programs. Marginal cost:It is a technique of costing in which allocation of expenditure to production is restricted to those expenses which arise as a result of production, i.e. materials, labour, and direct expenses and variable overheads. Marginal costing:An additional cost which is involved for production of additional unit. DERIVATIVESDerivative: This derivative concept was introduced in India in the year 1992.Derivative is product whose value is derived from the value of one or more basic variables of underlying asset.(or)A Derivative is a “financial contract whose value is derived from or depends on the price of some underlying asset”. Equivalently the value of a derivative changes when there is a change in the price of an underlying related asset.Underlying assets:

Shares Securities

Commodities ( food grains, oils, cotton etc ) Bullion Stocks Bonds Currency

Types of derivatives:Mainly there are four types of derivatives they are

1. Forward contract2. Future contract3. Options

a) Call option b) Put option

1. Swaps

1. 1. Forward contract:

A forward contract is customized contracts between two entities were settlement takes place on a specific date in the future at today’s pre agreed price.(or)It is an agreement between two parties for exchanging of underlying asset at a specific consideration amount at specified time period. The price of forward contract remains fixed till maturity. 

1. 2. Future contract:

A future contract is an agreement between two parties to buy or sell an asset at a certain time in the future at a certain price. Future contracts are standardized exchange traded contracts.(or)It is an agreement between two parties for exchanging of underlying asset at a specific maturity date to the future maturity date market value, in future contract maturity value is fixed on the rate of maturity date at market price.

1. 3. Options:

An option gives the holder of the option the right to do something. The option holder option may exercise or not.Call option:A call option gives the holder the right but not the obligation to buy an asset by a certain date for a certain price.Put option:A put option gives the holder the right but not obligation to sell an asset by a certain date for a certain price. American option:

This American option should be exercised before the maturity date or earlier to maturity date.European option:This European option should be exercised only after the maturity date.Bermuda option:This Bermuda option is an combination of both American & European option.

1. 4. Swaps:

Swaps are private agreements between two parties to exchange cashflows in the future according to a pre-agreed formula.Types of swaps:

Interest rate swaps:

An interest rates swap is an agreement between two parties to exchange interest payment for a specific maturity for an agreed notional (principle) amount.

Currency swaps:

It is an agreement between two parties for exchanging of two different currencies for a specified date along with exchange of principles.