INTRODUCTION

Financial Analysis is said to be the process of identifying the financial strengths or weaknesses
of a firm by properly establishing relationships and evaluating the balance sheet and profit & loss
Account in order to form an opinion on whether the business is healthy in financial sense and as
to how well it is achieving its financial objectives.
Financial Analysis can be carried out through:
Straight forward criticisms in prose form
Ratio Analysis
ash Flow statement.
Ratio Analysis
!his is a powerful tool of financial Analysis. "t is primarily concerned with analysis and
interpreting the financial statements of a reporting entity and to ultimately highlight the financial
strength and weakness of such company so as to make an effective economic decision.
According to #andey$ ".%$ &'()(*$ +"n financial analysis$ a ratio is used as a benchmark for
evaluating financial position and performance of a firm. ,ence$ Ratio helps to summari-ed large
.uantities of financial data and to make .ualitative judgment about the firm financial
performance/
A single ratio in itself does not indicate favourable or unfavourable condition. "t should be
compared with some standard for useful interpretation.
Theoretical frame work
%any writers over the years have recogni-es the importance of ratio analysis as a vital tool in
evaluating a company0s performance. !his fact was reflected in many theoretical and academic
e1ercises that have been carried out in the areas of financial Accounting$ Financial
%anagement$ Auditing$ 2usiness %anagement$ etc.
,aber &'((3* wrote that +Accounting ratios are relationships between figures e1pressed as
ratios. !o be meaningfully$ the ratios have to be compared with ratios of other periods$ some
selected companies and industry average to indicate strength or weakness./
#andey&'()(*$ wrote that +Ratio analysis is a very powerful analytical techni.ue used to raise
pertinent .uestions on number of managerial issues and a tool of financial analysis used in
evaluating a company0s performance. "t involves comparing one figure with another to produce
ratios which indicate weakness or strength/.
4arbuth &)56'* wrote that the overall position of the firm can be best gauged by comparing the
ratios between various related items. A ratio is one number e1pressed in terms of another. "f
judiciously interpreted$ it allows an opinion to be formed on whether the business is healthy
financially. !herefore$ Ratio analysis provides a yardstick by which the financial soundness and
stability of a business can be measured and a basis for making .ualitative judgments.
7ood &'((8* wrote that$ +Ratio analysis helps to interpret or put meanings of the financial
statements into simple terms for the benefit of users.
Stoner and 7ankell &)599* described Ratio Analysis as key summary figures from the financial
statements reported as percentages or fractions. !his provides .uick assessments of financial
performance.
Standards of Comparison
Standards are yardsticks by which actual performance can be measured. According to
#andey&'()(*$ ratio analysis involves comparison for a useful for a useful interpretation of the
financial statements. A single ratio in itself does not indicate favourable or unfavourable
condition. "t should be compared with some standard. !he standards of comparison may consist
of:
Time series analysis: this is comparison of the firm0s present ratio with past ratios. !his
gives an indication of the direction of change and reflects whether the firm0s financial
performance has improved$ deteriorated or remain constant over time.
"nter:firm analysis: this comparing the firm0s ratios with ratios of a few carefully selected
competitors$ who have similar operations. !his indicates the relative financial position and
performance of the firm.
Industry analysis: this is used to determine the financial condition and performance of a
firm by comparing its ratios with average of the industry of which the firm is a member. "t
helps to ascertain the financial standing and capability of the firm vis: :vis other firms. 2ut
there are certain practical difficulties in using the industry ratios as follows:
"t is difficult to get average ratios of the industry.
Averages of the industry are of strong and weak firms.
"f firms within the same industry widely differ in their accounting policies and practice
it will make averages meaningless and the comparison futile.
Proforma analysis: !his is where future ratios developed from projected or current or
proforma financial statements are compared with current or past ratios. !his shows the firm0s
relative strengths and weaknesses in the past and the future.
TP!S O" RATIOS
Ratios can be divided into four major categories:

#rofitability Sustainability
;perational <fficiency
=i.uidity
=everage &Funding > ?ebt$ <.uity$ 4rants*

!he ratios presented below represent some of the standard ratios used in business practice
Profita#ility Sustaina#ility Ratios
,ow well is our business performing over a specific period$ will your social enterprise have the
financial resources to continue serving its constituents tomorrow as well as today@

Ratio $hat does it tell you%
Sales &rowth '
urrent #eriod >#revious #eriod Sales
#revious #eriod Sales
#ercentage increase &decrease* in sales between two time
periods.
"f overall costs and inflation are increasing$ then you
should see a corresponding increase in sales. "f not$ then
may need to adjust pricing policy to keep up with costs.
Reliance on Re(enue Source '
Revenue Source !otal
Revenue !otal Revenue
%easures the composition of an organi-ation0s revenue
sources &e1amples are sales$ contributions$ grants*.
!he nature and risk of each revenue source should be
analy-ed. "s it recurring$ is your market share growing$ is
there a long term relationship or contract$ is there a risk
that certain grants or contracts will not be renewed$ is
there ade.uate diversity of revenue sources@
;rgani-ations can use this indicator to determine long and
short:term trends in line with strategic funding goals &for
e1ample$ move towards self:sufficiency and decreasing
reliance on e1ternal funding*.
Operatin) Self*Sufficiency '
2usiness Revenue
!otal <1penses
%easures the degree to which the organi-ation0s e1penses
are covered by its core business and is able to function
independent of grant support.
For the purpose of this calculation$ business revenue
should e1clude any non:operating revenues or
contributions. !otal e1penses should include all e1penses
&operating and non:operating* including social costs.
A ratio of ) means you do not depend on grant revenue or
other funding.
&ross Profit +ar)in '
4ross #rofit !otal Sales
!otal Sales
,ow much profit is earned on your products without
considering indirect costs.
"s your gross profit margin improving@ Small changes in
gross margin can significantly affect profitability. "s there
enough gross profit to cover your indirect costs. "s there a
positive gross margin on all products@
Net Profit +ar)in '
Aet #rofit
Sales
,ow much money are you making per every B of sales.
!his ratio measures your ability to cover all operating
costs including indirect costs
S&A to Sales '
"ndirect osts &sales$ general$ admin*
Sales
#ercentage of indirect costs to sales.
=ook for a steady or decreasing ratio which means you are
controlling overhead
Return on Assets ' %easures your ability to turn assets into profit. !his is a
Aet #rofit Average
!otal Assets
very useful measure of comparison within an industry.
A low ratio compared to industry may mean that your
competitors have found a way to operate more efficiently.
After ta1 interest e1pense can be added back to numerator
since R;A measures profitability on all assets whether or
not they are financed by e.uity or debt
Return on !,uity '
Aet #rofit
Average Shareholder <.uity
Rate of return on investment by shareholders.
!his is one of the most important ratios to investors. Are
you making enough profit to compensate for the risk of
being in business@
,ow does this return compare to less risky investments
like bonds@
Operational !fficiency Ratios
,ow efficiently are you utili-ing your assets and managing your liabilities@ !hese ratios are used
to compare performance over multiple periods.

Ratio $hat does it tell you%
Operatin) !-pense Ratio '
;perating <1penses
!otal Revenue
ompares e1penses to revenue.
A decreasing ratio is considered desirable since it
generally indicates increased efficiency.
Accounts Recei(a#le Turno(er '
Aet Sales
Average Accounts Receivable
Days in Accounts Recei(a#le '
Average Accounts
Receivable Sales 1 CD8
Aumber of times trade receivables turnover during the
year.
!he higher the turnover$ the shorter the time between sales
and collecting cash.
7hat are your customer payment habits compared to your
payment terms. Eou may need to step up your collection
practices or tighten your credit policies. !hese ratios are
only useful if majority of sales are credit &not cash* sales.
In(entory Turno(er '
ost of Sales
Average "nventory
Days in In(entory '
Average "nventory
ost of Sales 1 CD8
!he number of times you turn inventory over into sales
during the year or how many days it takes to sell
inventory.
!his is a good indication of production and purchasing
efficiency. A high ratio indicates inventory is selling
.uickly and that little unused inventory is being stored &or
could also mean inventory shortage*. "f the ratio is low$ it
suggests overstocking$ obsolete inventory or selling
issues.
Accounts Paya#le Turno(er ' !he number of times trade payables turn over during the
ost of Sales
Average Accounts #ayable
Days in Accounts Paya#le '
Average Accounts #ayable
ost of Sales 1 CD8
year.
!he higher the turnover$ the shorter the period between
purchases and payment. A high turnover may indicate
unfavourable supplier repayment terms. A low turnover
may be a sign of cash flow problems.
ompare your days in accounts payable to supplier terms
of repayment.
Total Asset Turno(er '
Revenue
Average !otal Assets
"i-ed Asset Turno(er '
Revenue
Average Fi1ed Assets
,ow efficiently your business generates sales on each
dollar of assets.
An increasing ratio indicates you are using your assets
more productively.
.i,uidity Ratios
?oes your enterprise have enough cash on an ongoing basis to meet its operational obligations@
!his is an important indication of financial health.

Ratio $hat does it tell you%
Current Ratio '
urrent Assets
urrent =iabilities
&also known as $orkin) Capital
Ratio*
%easures your ability to meet short term obligations with
short term assets.$ a useful indicator of cash flow in the
near future.
A social enterprise needs to ensure that it can pay its
salaries$ bills and e1penses on time. Failure to pay loans
on time may limit your future access to credit and
therefore your ability to leverage operations and growth.
A ratio less that ) may indicate li.uidity issues. A very
high current ratio may mean there is e1cess cash that
should possibly be invested elsewhere in the business or
that there is too much inventory. %ost believe that a ratio
between ).' and '.( is sufficient.
!he one problem with the current ratio is that it does not
take into account the timing of cash flows. For e1ample$
you may have to pay most of your short term obligations
in the ne1t week though inventory on hand will not be
sold for another three weeks or account receivable
collections are slow.
/uick Ratio ' A more stringent li.uidity test that indicates if a firm has
ash FAR F %arketable Securities
urrent =iabilities
enough short:term assets &without selling inventory* to
cover its immediate liabilities.
!his is often referred to as the +acid test/ because it only
looks at the company0s most li.uid assets only &e1cludes
inventory* that can be .uickly converted to cash*.
A ratio of ):) means that a social enterprise can pay its
bills without having to sell inventory.
$orkin) Capital '
urrent Assets > urrent =iabilities
7 is a measure of cash flow and should always be a
positive number. "t measures the amount of capital
invested in resources that are subject to .uick turnover.
=enders often use this number to evaluate your ability to
weather hard times. %any lenders will re.uire that a
certain level of 7 be maintained.
Ade,uacy of Resources '
ash F %arketable Securities F
Accounts Receivable
%onthly <1penses
?etermines the number of months you could operate
without further funds received &burn rate*
.e(era)e Ratios
!o what degree does an enterprise utili-e borrowed money and what is its level of risk@ =enders
often use this information to determine a business0s ability to repay debt.

Ratio $hat does it tell you%
De#t to !,uity '
Short !erm ?ebt F =ong !erm ?ebt
!otal <.uity &including grants*
ompares capital invested by ownersGfunders &including
grants* and funds provided by lenders.
=enders have priority over e.uity investors on an
enterprise0s assets. =enders want to see that there is some
cushion to draw upon in case of financial difificulty. !he
more e.uity there is$ the more likely a lender will be
repaid. %ost lenders impose limits on the debtGe.uity
ratio$ commonly ':) for small business loans.
!oo much debt can put your business at risk$ but too little
debt may limit your potential. ;wners want to get some
leverage on their investment to boost profits. !his has to
be balanced with the ability to service debt.
Interest Co(era)e '
<2"!?A "nterest
<1pense
%easures your ability to meet interest payment obligations
with business income. Ratios close to ) indicates company
having difficulty generating enough cash flow to pay
interest on its debt. "deally$ a ratio should be over ).8
Other Ratios
Operatin) Self*Sufficiency '
Sales Revenue
!otal osts &;perating and Social osts*
0 Staffin) Costs spent on Tar)et &roup '
!arget Staff osts
!otal Staffing osts
Social Costs per !mployee '
!otal Social osts
Aumber of !arget <mployees
0 Social Costs co(ered #y &rants '
4rant "ncome
!otal Social osts
.imitations of usin) Ratio Analysis
"t is difficult to decide on the proper basis of comparison.
!he comparison is rendered difficult because of differences in situation of two companies
or of one company over time.
!he price level changes make the interpretation of ratio invalid.
!he difference in the definition of items in the balance sheet and the profit and loss
accounts make the interpretation of ratio difficult.
!he ratios calculated at a point in time are less informative are less informative and
defective as they suffered from short:term changes.
!he ratios are generally calculated from past financial statements and$ are thus no
indication of the future.

onclusively$ Ratio Analysis is a process of identifying the financial strengths and weaknesses
of the firms. !his may be done either through trend analysis of the firm0s ratio over time or
through a comparison of the firm0s ratios with its nearest competitors and with the industry
averages. !he four most important financial dimensions which a firm would like to analy-e are
=i.uidity$ =everage$ #rofitability Sustainability$ and ;perational ,E#<R="AH
Ihttp:GGwww.demonstratingvalue.orgGresourcesGfinancial:ratio:analysisI <fficiency .
Ratio Analysis is a very useful tools to raise relevant .uestions on a number of managerial
issues. "t provides clues to investigate those issue in detail.
,owever caution needs to applied while interpreting ratios as they are calculated from the
accounting numbers. Accounting numbers suffers from accounting policy change$ arbitrary
allocation procedures and inflation.