Analysis of Financial Ratios

CV.Alexander DGM &FM

Version:

College of Agricultural Banking, RBI, PUNE

Definition
The relationship between two accounting figures expressed mathematically is known as financial ratio

Date:

College of Agricultural Banking, RBI, PUNE

Introduction
What is the purpose of analysis of financial ratios
It is for a meaningful study of information in the financial statements Ascertaining overall financial position of a business organisation Interpretation of key information in the financial statements

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College of Agricultural Banking, RBI, PUNE

Objective
The objectives:
Assess credit risk profile of the borrower Stipulation of terms and conditions Assess utilization of credit facility Establish sound well defined credit granting criteria Ensure safety of bank funds

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College of Agricultural Banking, RBI, PUNE

Factors that banks consider

Credit worthiness of the borrower Integrity/reputation Credit risk profile Sensitivity to economic and market developments Liquidity Solvency Profitability of business Resource efficiency

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College of Agricultural Banking, RBI, PUNE

Financial Analysis
Trends in the financial planning Analysis of projected financial statements

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College of Agricultural Banking, RBI, PUNE

Assets & Liabililities (Rs.crore)

Liabilitiesm
Year 3 2652 (436)
039 4065

Assets
Year 1
2249 (619) 3279 3742 Category Current Liabilities Net Working Capital Deferred Liability Net Worth Net Fixed Assets Misc. Assets Intangible Assets Category Current Assets

Year 2
2308 (559) 3688 3974

Year 1 2868

Year 2 2867

Year 3 3088

5394 840 168

5527 1298 278

6300 1071 297

10756

9970

9270

Total

Total

9270

9970

10756

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College of Agricultural Banking, RBI, PUNE

Measures of Liquidity
Net Working Capital Current Ratio Quick Ratio Net Working Capital/Net Assets Net Working Capital/Current Assets

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College of Agricultural Banking, RBI, PUNE

Net Working Capital

Gross Working Capital ( GWC) is the investment required to be made by the borrower in Current Assets How From own contributions From creditors, borrowings Other short term resources

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College of Agricultural Banking, RBI, PUNE

Gross Working Capital

Gross Working Capital How funded From own resources and other long term sources Short fall if any from short term resources

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College of Agricultural Banking, RBI, PUNE

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Short Term Resources

Short term resources constitute what are known as Current Liabilities Current Liabilities should be lower than Current Assets Excess o0f Current Assets over Current Liabilities is Net Working Capital Contribution from long term resources applied to financing of Current Assets ( excess of Current Assets) is owners stake or margin money

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College of Agricultural Banking, RBI, PUNE

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Financing of Current Assets (National Steel Corporation)

1.Current Assets = Current Liabilities + NWC or

3088 = 2652 + 436

2. NWC = Current Assets Current Liabilities or 436 = 3088 2652 3. Current Assets = Current Liabilities + Contribution from Long Term Liabilities 3088 = 2249 +[(8104-7668)] =2652+436 (i.e.NWC = 3088)
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Concept of NWC
NWC represents the surplus long term funds applied towards financing of Current Assets Current assets are financed from two sources
Surplus from Long Term Liabilities Current Liabilities Difference between Current assets and Current Liabilities should always be positive

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College of Agricultural Banking, RBI, PUNE

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NWC
Negative Net Working Capital What is the Implication Business has applied part of surplus Current Liabilities towards meeting shortfall in Long Term resources

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College of Agricultural Banking, RBI, PUNE

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NWC
Positive NWC means i.Borrower has brought in his contribution ii.Any fall in value of Current Assets will be cushioned by borrowers stake iii.Loss in sale of Current Assets will not affect Short term creditors

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College of Agricultural Banking, RBI, PUNE

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NWC
Net Working Capital ( NWC ) is a measure of liquidity Sources for NWC Long Term Liabilities net of Long Term Assets ( LTLs including Net Worth less LTAs which includes Fixed Assets, miscellaneous assets and intangibles. Another measure of liquidity is the Current Ratio)

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College of Agricultural Banking, RBI, PUNE

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Current Ratio
Current Ratio: Current Assets/ Current Liabilities

If Net Working Capital is to be of positive value the Current Ratio must be higher than 1. Ideally for calculating MPBF Current Ratio should be 1.33: 1

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College of Agricultural Banking, RBI, PUNE

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Liquidity Ratios
Year 1 Year 2 Year 3

1. Current Assets 2.Quick Assets 3.Current Liabilities 4.NWC (1-3) 5.Current Ratio 6.Quick Ratio 7.Net Sales 8 NWC/Net Sales (%) 9NWC/Current Assets(%)

2868 1792 2249 619 1.28 0.80 5635 10.98 21.58

2867 1846 2308 559 1.24 0.80 5526 10.12 19.50

3088 1040 2652 436 1.16 0.77 6104 7.14 14.12

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College of Agricultural Banking, RBI, PUNE

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Quick Ratio
From the gone concern approach inventory is the least liquid of Current Assets Quick Ratio or Acid Test Ratio = Current AssetsInventory/Current Liabilities Norm the QR should not be less than 1. 1:1 is satisfactory

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College of Agricultural Banking, RBI, PUNE

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NWC/Net Sales
This percentage should be around 8-12 % NWC is lower: Business is growing too fast without building an adequate cushion in the form of NWC

It indicates symptom of overtrading and Undue reliance on borrowed short term funds

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College of Agricultural Banking, RBI, PUNE

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Falling NWC/Net Sales

Indicative of overtrading and serious liquidity problems It needs to be investigated

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College of Agricultural Banking, RBI, PUNE

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NWC/Current Assets
This measures contribution of Long Term funds towards financing Current Assets Method of Lending 1st Method Amt. 2nd Method Current Assets 370 25 (LTS) Less CLs -150 WCG 220 25% -55 MPBF 165 CR 1.17 CR
Date: College of Agricultural Banking, RBI, PUNE

Amt. 370 278 -150 128 1.33

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Debt Equity Ratio

DER = TLT Liabilitie/TNW

Low ratio has a better leverage for borrowing Not more than 1.5 for providing finance by banks

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College of Agricultural Banking, RBI, PUNE

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DSCR
DSCR =( Net profit +Depcn+ Annual amount of int.on LTLs)/Interest + principal Indicative of funds available for servicing long term debt DSCR = 6+4+2/6 = 12/6= 2 This is comfortable Should not be less than 1.5:1 while considering projects

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College of Agricultural Banking, RBI, PUNE

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Return on Assets
RoA = PBIT/Total Assets To measure profitability and efficiency Higher the ratio, the more efficient is the firm in using resources

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College of Agricultural Banking, RBI, PUNE

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Gross Profit Margin

The surplus of sales over cost of goods sold Gross profit Margin= (Sales sold )x 100/Sales
minus

Cost of goods

A higher ratio indicates better managerial efficiency and profitability

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College of Agricultural Banking, RBI, PUNE

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Interest Coverage Ratio

ICR = PBDIT/Annual Int.Obligation To find out whether business generates sufficient profit to service interest payment Interest Coverage Ratio of 3 is reasonable and below 2 is considered risk prone

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College of Agricultural Banking, RBI, PUNE

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Summary
Ratio analysis is used as a major tool for financial analysis For a meaningful study of information contained in the financial statements Ascertaining the overall financial position of a Business Organization Ratios are calculated from the past financial statements Ratios could also be worked out based on the projected financial statements of the same firm

Easiest way of evaluating the performance of a firm is by comparing past and present ratios Used to judge operational efficiency, financial health, solvency or soundness To find out the liquidity position Major categories of ratios Liquidity ratios Leverage or solvency ratios Activity Ratios Profitability Ratios

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College of Agricultural Banking, RBI, PUNE

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 ANY ???? THANK YOU

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College of Agricultural Banking, RBI, PUNE

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