What are accounting ratios?

8/8/2019 What are accounting ratios?

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PAKISTAN INSTITUTE OF DEVELOPMENT ECONOMICS

ISLAMABAD

Name: - HASSAN TAHIR

SUBMITTED TO: SIR ABDUL HAI

FINAL PROJECT ON: SUI SOUTHERN GAS COMPANY


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What are accounting ratios?

Introduction:

A number of measurements developed from financial statementswill be explained effectively through using accounting ratios. It is a factthat ratio analysis is one of the tools of the financial analysis. It is usedto diagnose the financial health of an enterprise. For example creditorsare concerned about the ability of a company to pay its currentobligation, management is concerned with the liquidly of stock ofgoods and seek information relating to the number of times stock haveturned over during its financial period, shareholders are concernedwith dividends and seek information relating earning per share.

Definition:-According to J. Batty,

The term accounting ratios is used to describe significantrelationships which exist between figures shown in a balance sheet, ina project and loss account, in a budgetary control system or in anyother part of the accounting organization.

Advantages of Ratio Analysis:-

Decision making:Mass of information contained in the financial statement may be

confusing. Ratios help in highlighting the areas deserving attention andcorrection.

Calculation of profitability:Accounting ratio is very useful to find the profitability of the

organizational business by. It helps the management to know aboutthe earning capacity of the business concern. Ratios illustrate the

actual performance of the business.

Solvency:Solvency of the company can be measured with the help of

accounting ratios. These ratios show the relationship between theliabilities and assets can be measured easily. In case external liabilitiesare more than that of the assets of the company, it shows the unsound


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position of the business. In this case the business has to make itpossible to repay its loans.

Future forecasting:

Ratio Analysis helps in planning and forecasting. A ratioprovides clues on trends and futures problems.

Analysis of financial statement:Ratio analysis helps the outsiders e.g. creditors,

shareholders, debenture-holders, bankers to know about theprofitability. It also shows ability of the company to pay interestand dividend to its creditors.

Performance analysis:

Ratio analysis of a company may have comparative study ofits performance to the previous years. In this way companycomes to know about its weak point and be able to improvethem.

To simplify the accounting information:Accounting ratios are very useful as they briefly summarize

the result of detailed and complicated computations.

To workout the operating efficiency:Ratio analysis helps to work out the operating efficiency of

the company with the help of various turnover ratios. All turnoverratios are worked out to evaluate the performance of thebusiness in utilizing the resources.

Useful to employees:Employees are interested in fair wages or benefits. Ratio

helps the employees to get information about the efficiency andprofitability of the organization.

Types of accounting ratios:

Different types of ratios are computed depending on the purpose forwhich they are needed. Types of accounting ratios are as under:


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Liquidity ratiosSolvency ratiosProfitability ratios

Liquidity ratios

A liquidity ratio measures the ability of the unit to meet its short-term obligations and reveals the short-term financial strength orweakness. Different types of Liquidity ratios are calculated fortesting short-term financial position.

Solvency Ratios

The long-term financial soundness of any business can be judgedby its long-term creditors by testing its ability to pay interest

charges and its ability to repay the principle as per schedule.

Solvency of any business is examined by calculating ratiosknown as leverage of capital structure ratios. These ratios help usthe interpreting repays long-term debt as per installmentsmentioned in the contract.

Profitability ratios

The main object of a business concern is to earn profits. Ingeneral terms, efficiency in business is measured by profitability. A

low profitability may arise due to lack control over the expenses.Bankers financial institutions and other creditors look at theprofitability ratios as an indicator whether or not the firm earnssubstantially more than it pays interest for the use of borrowedfunds and whether the ultimate repayment of their debt appearsreasonably certain. Owners are also interested to know theprofitability as it indicates the return which they can get on theirinvestments.

Formulas of accounting ratios:

Liquidity ratios:

i. Current ratio = current assets / current liabilities


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ii. Liquid ratio = current assets stocks / current liabilitiesiii. Debtors turnover = debtors / credit sales * 365iv. Creditors turnover = creditors / credit purchase * 365v. Stock turnover = average stock / cost of goods sold *365vi. Working capital cycle = debtors turnover + stock turnover

creditors turnovervii. Net working capital to sales ratio = net working assets/ sales*100

viii. Gearing ratio = fixed cost capital / total capital

Profitability ratios:

i. Gross profit margin = gross profit /sales *100ii. Net profit ratio = NPBI / sales*100iii. Return on capital employed = 100 * NPBI / capital employed

*100

iv. Return on equity = net profit / equity *100v. Return on total Assets = NPBI / total assets *100vi. Fixed assets turn over = net sales / total net book value of fixed

assets

Investment ratios:

i. Earnings per share = net profit / number of issued ordinaryshares

ii. Price earnings ratio = market price per share / earnings per

shareiii. Dividend yield = dividend paid and proposed / market priceiv. Dividend cover = profit available to pay for ordinary dividend /

ordinary dividend paidv. Dividend per share = ordinary dividend paid / number of issued

ordinary shares

Cash flow ratios:

i. Operating flow to sales ratio = operating cash flow / sales *100ii. Operating flow to current liability ratio = operating cash flow /

current liabilities *100iii. Operating flow to interest expense ratio = operating cash flow /

interest expense *100iv. Operating flow to dividend ratio = operating cash flow interest

and taxes/ ordinary share holder dividend*100


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Interpretation of ratios:

Calculation of ratios is simple in nature but interpretation ofratios is highly sophisticated. The benefit of ratio analysis depends agreat deal upon the correct interpretation. It needs skill, training andintelligence. Following are the different ways in which ratio can beinterpreted. Some points of interpretation are as under:

Inter-firm comparison:

Ratio of one unit may be compared with the ratios ofanother identical unit. Such comparison can be very helpful for theevaluation of financial position of another firm or unit.

Comparison with past:

Ratios may be interpreted by making comparison over aperiod of time. It will be helpful for revealing upward position (profit),downward position (loss) or stable position of a firm or an organization.

Helpful to Shareholder:Profitability of company of firm can be calculated with the

help of accounting ratios.

Helpful to creditors:

Accounting ratios are very useful for the creditors.Accounting ratios provide a clear view of a firms profit or loss so thatthey can invest their money carefully.


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CALCULATION OF FINANCIAL STATEMENTS OF SUI SOUTHERN GAS COMPANY WITHCOMPARISION OF YEAR 2008-2009:

S.NO

TITLE VALUES & CALCULATION RESULT2008

RESULT2009

DESCRIPTION

2008 2009

1 Currentratio

36,279,235/33,455,815

61,032,671/59,251,203

1.08 1.03

2 Liquid ratio 35766852/33,455,815

60,542,132/59,251,302

1.07 1.02

3 Debtorsturnover

365 X 29387130 /42271216

365X55538334/59292622

254DAYS

342DAYS

Debtors=trade d+others receivabCredit sales=5of sales

4 Creditorsturnover

365X30824628/34619118

365X50099746/51194429

325DAYS

357DAYS

Creditors=tradedebt +othpayablesCredit

purchases=50% cost of sales

5 Stockturnover

365X512383/69238236

365X490539/102388858

3DAYS

2DAYS

6 Workingcapital cycle

254+3-325 342+2-537 -68DAYS

-193DAYS

7 Net workingcapital tosales ratio

(2823420/84542431)x 100

100x(1781468/118585244)

3% 2% Working CapitalCurrent Assets Current Liabilities


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8 Gearingratio

27931963/37111368

31619203/40950608 0.75 0.77 Fixed cost capitalong term liabilit+ preferred shacapital

Total Capital issued ordinshare capital + reserves + loterm liabilities preference share

9 Gross profitmargin

100X(5387333/74625569)

100X(5762229/108151087)

7.22% 5.33%

10 Net profitratio

100X(2381632/74625569)

100X(416699/108151087)

3.19% 0.39%

11 Return oncapitalemployed

100X(2381632/37111368)

100X(416699/40950608)

6.42% 1.02% Capital employedIssued shares reserves + loterm liabilities

12 Return on

equity

100X(991072/91794

05)

100X(257489/933140

5)

10.80% 2.76% Equity = Iss

ordinary reservesReserves

13 Return ontotal Assets

100X(5387333/71702904)

100X(5762229/100554000)

7.51% 5.73% Total Assets Fixed Assets Current Assets

14 Fixed assetsturn over

74625569/33807564

108151087/38095632

2.21 2.84 property plant aequipment considered as fix


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assets

15 Earning pershare

991072/671174 257489/671174 1.48 0.38 No. of Sharesissued shares / favalue of shares

16 Priceearningratio

13.62/1.48 13.62/0.38 9.20 35.84 Market Price 14/01/2009 SSGC's Ordinshares.

17 Dividendyield

35587/13.62 838968/13.62 2612.85

61598.24

2008 0.5 per shadividend was pand in 2009 1per share dividewas paid

18 Dividendcover

991072/35587 257489/838968 27.85 0.31

19 Dividendper share

35587/671174 838968/671174 0.5 1.25

20 Operatingflow to salesratio

100X(4838743/84542431)

100X(5189460)/118585244

5.72% -4.38%

21 Operatingflow tocurrentliability ratio

100X4838743/33455815

100X(5189460)/59251203

14.46% -8.76%


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22 Operatingflow tointerestexpenseratio

100X(4838743/2038106)

100X(5189460)/4181967

237.41%

-124.09

%

23 Operating

flow todividendratio

100X(3448183/3558

7)

100X((5348670)/838

968)

9689.4

%

637.53

%


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Final assessment of SSGC:

LIQUIDITY RATIO:We have compared the accounting ratios of Sui southern

gas for the both year 2008 and 2009, in comparison we find that theliquidity ratio was 1.07 for the year 2008 and 1.02 for the current year2009 but the best ratio of liquidity is at 2, so we analyze that thebusiness was better in 2008 rather in 2009. Stock turnover ratio hasalso been decreased from 3 days to 2 days, as well as working capitalis also decreased from 68 days to 193 days.

From the above calculation I conclude that liquidityposition of SSGC is not very strong and day by day its position is fallingdown, the management of SSGC will have to take effective steps tomake organization strong.

PROFITABILITY RATIOS:In comparison of profitability ratio for both year 2008 and

2009 we may see that the gross profit and net profit of SSGC isdecreasing from 7.22% to 5.33% and 3.19% to 0.39% so we can see adownfall of 1.89% for the year 2009 and 2.8% downfall in net profit.

In profitability the profit of the company is decreasing, themanagement should take measures.

INVESTMENT RATIO:After a downward trend in SSGC finally we find a positive

trend price earning ratio is in increasing in year 2009 from 9.20 to35.84 with the difference of 26.64. Market values of the shares of SSGCare much better then the previous year. Dividend share is alsoincreased in year 2009.

CASHFLOW RATIOS:All cash flow ratios are representing a downward fall or

decrease of the SSGC. Steps should be taken by the management toimprove its position.

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What are accounting ratios?