RATIO ANALYSIS

OBJECTIVE OF RATIO
TO UNDERSTAND THE RELATIONSHIP BETWEEN TWO VARIABLES. FACILITATES COMPARISON WITH SIMILAR TYPE OF BUSINESS CONCERN. FACILITATES TO ASSESS FINANCIAL STRENGTH OF A BORROWER. HELPS IN ASSESSING REPAYING CAPACITY OF A BORROWER. FOR ASSESSMENT OF LIQUIDITY & SOLVENCY OF A BUSINESS CONCERN.

OBJECTIVE OF RATIO
TO KNOW THE TREND OF BUSINESS GROWTH. ASSIST CONCERN TO FORECAST BUSINESS AND FOR PLANNING. HELP CREDITOR TO TAKE A CREDIT DECISION. HELPS INVESTORS TO TAKE A DECISION FOR MAKING INVESTMENT.

HOW DO WE EXPRESS RATIOS?

AS A PERCENTAGE EG. NET PROFIT IS 25% OF SALES. AS FRACTION / DECIMALS EG. NET PROFIT IS 1/4 OF SALES AS A PROPORTION EG. THE RATIO OF NET PROFIT TO SALE IS 1 :4 AS A NUMBER OF TIMES EG. SALES ARE 4 TIMES OF NET PROFIT

TYPES OF RATIOS
SOLVENCY RATIO LIQUIDITY RATIO LEVERAGE RATIO PROFITABILITY RATIO ACTIVITY RATIO

SOLVENCY RATIO
A UNIT IS SAID TO BE SOLVENT IF ITS TANGIBLE ASSETS ARE MORE THAN IT OUTSIDE LIABILITIES. SOLVENCY CAN BE MEASURED BY FINDING OUT TANGIBLE NET WORTH (TNW) ---TNW = NET WORTH - INTANGIBLE ASSETS A UNIT IS SOLVENT IF ITS TNW IS POSSITIVE . WHERE THE TNW IS NEGATIVE IT IS NOT SOLVENT.

SOLVENCY RATIO
TNW CAN ALSO BE FOUND OUT BY DEDUCTING TOTAL OUT SIDE LIABILITIES (TOL) FROM TOTAL TANGIBLE ASSETS ( TTA) TNW = TTA - TOL ANOTHER METHOD OF MEASURING SOLVENCY RATIO TOTAL TANGIBLE ASSETS SOLVENCY RATIO = -------------------------------------------TOTAL OUTSIDE LIABILITIES WHERE THIS RATIO IS MORE THAN ONE , THE UNIT IS SOLVENT.

 ABILITY T0 MEET CURRENT OBLIGATION IS KNOWN AS LIQUIDITY. A CONCERN IS SAID TO HAVE LIQUIDITY IF IT IS IN A POSITION TO MEET ITS CURRENT LIABILITY OUT OF ITS CURRENT ASSETS.. LIQUIDITY IS ALSO REFERRED TO AS SHORT TERM SOLVENCY WHICH MEANS THE UNIT IS IN A POSITION TO MEET ITS SHORT TERM LIABILITIES ( CURRENT LIABILITIES ) OUT OF ITS SHORT TERM ASSETS ( CURRENT ASSETS )

LIQUIDITY RATIO

 CURRENT ASSETS OF A FIRM ARE THE ASSETS REQUIRED TO RUN THE DAY TO DAY OPERATIONS OF THE FIRM IT IS ALSO CALLED THE WORKING FUND OR WORKING CAPITAL IN A WIDER SENSE CURRENT LIABILITIES ARE SUPPOSED TO BE MET THROUGH REALIZATION OF CURRENT ASSETS TO ASCERTAIN THE RELATIONSHIP BETWEEN CURRENT ASSETS AND CURRENT LIABILITIES.

WHAT IS THE IMPORTANCE OF CURRENT ASSETS OF A BUSINESS CONCERN?

CURRENT RATIO
CURRENT ASSETS CURRENT RATIO = -------------------------CURRENT LIABILITIES THE IDEAL CURRENT RATIO IS 2:1 ACCEPTABLE CURRENT RATIO IS 1.33 : 1, 1.17 : 1 AS AN ACCEPTABLE LEVEL. A HIGHER CURRENT RATIO MAY INDICATE A VERY COMFORTABLE POSITION FOR SHORT TERM LENDERS BUT IT AFFECTS PROFITABILITY ADVERSELY. I F THE CURRENT RATIO IS LESS THAN ONE, THE UNIT MAY BE SICK OR TENDING TOWARDS SICKNESS.

QUICK RATIO ( ACID TEST RATIO )

INDICATES THE EXTENT TO WHICH LIQUID RESOURCES ARE AVAILABLE TO QUICKLY ( IMMEDIATELY ) MEET CURRENT OBLIGATION. IT IS A MEASURE OF INSTANT LIQUIDITY POSITION OF THE CONCERN QUICK ASSETS QUICK RATIO =--------------------------OUTSIDE LIABILITIES

QUICK RATIO (ACID TEST RATIO)

QUICK ASSETS = C.A. - INVENTORY OUT SIDE LIABILITIES = CURRENT LIABILITIES - BANK BORROWING THE IDEAL QUICK RATIO IS ; 1: 1 QUICK RATIO SHOULD BE STUDIED WITH CURRENT RATIO AND NOT IN ISOLATION. A HIGHER CURRENT RATIO BUT LOW QUICK RATIO MAY INDICATE LARGE STOCK OF INVENTORY.

LEVERAGE RATIO
LONG TERM DEBT DEBT EQUITY RATIO = --------------------------TANGIBLE NET WORTH MEASURES THE BORROWINGS OF A FIRM COMPARED TO ITS EQUITY /NET WORTH ALSO MEASURED AS TOTAL OUTSIDE LIABILITY TO EQUITY ( TOL/TNW) ACCEPTABLE ; 2 :1 (NORMAL) : 4:1 ( SSI) HIGHER THE RATIO MORE THE BORROWED FUNDS.

PROFITABILITY RATIOS
A STRONG AND HEALTHY UNIT MUST ACHIEVE PROFIT AT EACH STAGE OF ITS OPERATION. 1. IT SHOULD MANUFACTURE GOODS AT LEAST COST AND SHOULD GENERATE SUFFICIENT GROSS PROFIT. 2. IT SHOULD KEEP OPERATING EXPENSES UNDER CONTROL AND SHOULD LEAVE SUFFICIENT OPERATING PROFIT. 3. IT MUST EARN ENOUGH FOR ITS SHARE HOLDERS/OWNERS BY GENERATING MORE NET PROFIT AFTER TAX.

PROFITABILITY RATIOS
A STRONG AND HEALTHY UNIT MUST ACHIEVE PROFIT AT EACH STAGE OF ITS OPERATION. 1. IT SHOULD MANUFACTURE GOODS AT LEAST COST AND SHOULD GENERATE SUFFICIENT GROSS PROFIT. 2. IT SHOULD KEEP OPERATING EXPENSES UNDER CONTROL AND SHOULD LEAVE SUFFICIENT OPERATING PROFIT. 3. IT MUST EARN ENOUGH FOR ITS SHARE HOLDERS/OWNERS BY GENERATING MORE NET PROFIT AFTER TAX.

PROFITABILITY RATIOS
GROSS PROFIT GROSS PROFIT RATIO = --------------------- X 100 NET SALES IT IS A INDICATOR OF THE PRODUCTION EFFICIENCY. A LOW RATIO MAY INDICATE HIGH MANUFACTURING EXPENCES, LOW PRICE OR INABILITY TO PUSHUP SALES. A HIGHER GROSS PROFIT RATIO INDICATES EFFICIENCY IN PRODUCTI0N, HIGHER SALES VOLUME , LOW MANUFACTURING EXPENCES,OR ABILITY TO INCREASE THE SELLING PRICE.

PROFITABILITY RATIOS
OPERATING PROFIT OPERATING PROFIT RATIO = ---------------X100 NET SALES THIS RATIO INDICATES THE NET MARGIN ON SALES AFTER TAKING INTO ACCOUNT ALL EXPENSES , EXCEPT FINANCIAL EXPENSES ( INTEREST) & TAXES. A HIGHER MARGIN INDICATES THAT THE COMPANY HAS A HIGHER PERCENTAGE OF PROFIT ON SALES TO MEET THE PAYMENT OF INTEREST, DIVIDENT & OTHER CORPORATE NEEDS..

PROFITABILITY RATIOS
NET PROFIT NET PROFIT RATIO = ---------------------------X 100 NET SALES IT MEASURES OVERALL PROFITABILITY. NET PROFIT RATIO MAY GO UP DUE TO NON BUSINESS INCOME.

PROFITABILITY RATIOS
NET PROFIT AFTER TAX RETURN ON NET WORTH = ------------------X 100 TANGIBLE NET WORTH PROFIT BEFORE INTEREST & TAX RETURN ON NETINVESTMENT = ------------X 100 TOTAL TANGIBLE ASSETS THIS IS THE MOST WIDELY USED RATIO TO MEASURE THE PROFITABILITY

ACTIVITY RATIO
ACTIVITY RATIO ARE CALCULATED TO FIND OUT THE EFFICIENCY OF OPERATION INVENTORY TURNOVER RATIO. IT IS CALCULATED BY DIVIDING COST OF SALES BY AVERAGE INVENTORY. COST OF SALES ( COST OF GOODS SOLD) INVENTORY TURN OVER RATIO =---------------------AVERAGE INVENTORY A HIGHER TURN OVER COMPARED TO PAST YEAR MEANS BETTER MANAGEMENT OF INVENTORY /WORKING CAPITAL. A LOW TURN OVER MAY DUE TO EXCESS STOCKING OR SLOW / NON -MOVING INVENTORY.

ACTIVITY RATIO
DEBTORS TURNOVER RATIO INDICATE THE EFFICIENCY OF DEBT COLLECTION PROCESS / MECHANISM OF THE UNIT IT IS ALSO KNOWN AS DEBTORS VELOCITY IT INDICATES THE EFFECTIVENESS OF THE ORGANISATION IN GRANTING CREDIT AND THE COLLECTION OF DEBT.

ACTIVITY RATIO
SALES (GROSS SALES) DEBTOR T. RATIO AVERAGE DEBTORS AVERAGE DEBTOR = OPENING DEBTORS + CLOSING DEBTORS / 2 DEBTOR COLLECTION PERIOD = 365 / DTR =-------- NO. OF DAYS

UNION BANK OF INDIA

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