Tuesday, 20 September 2011

Ratio Analysis

A ratio analysis is a mathematical expression. It is the quantitative relation between two. It is the technique of interpretation of financial statements with the help of meaningful ratios. Ratios may be used for comparison in any of the following ways.
ü  Comparison of a firm its own performance in the past.
ü  Comparison of a firm with the another firm in the industry
ü  Comparison of a firm with the industry as a whole

TYPES OF RATIOS

ü  Liquidity ratio
ü  Activity ratio
ü  Leverage ratio
ü  profitability ratio

1. Liquidity ratio: These are ratios which measure the short term financial position of a firm.
i. Current ratio: It is also called as working capital ratio. The current ratio measures the ability of the firm to meet its currnt liabilities-current assets get converted into cash during the operating cycle of the firm and provide the funds needed to pay current liabilities.  i.e
Current assets
---------------------------- Current liabilities
Ideal ratio is 2:1

ii. Quick or Acid test Ratio: It tells about the firm’s liquidity position. It is a fairly stringent measure of liquidity.
=Quick assets/Current Liabilities
Ideal ratio is 1:1
Quick Assets =Current Assets – Stock - Prepaid Expenses
iii. Absolute Liquid Ratio:
A.L.A/C.L
AL assets=Cash + Bank + Marketable Securities.

2. Activity Ratios or Current Assets management or Efficiency Ratios:
These ratios measure the efficiency or effectiveness of the firm in managing its resources or assets

ü    Stock or Inventory Turnover Ratio: It indicates the number of times the stock has turned over into sales in a year. A stock turn over ratio of ‘8’ is considered ideal. A high stock turn over ratio indicates that the stocks are fast moving and get converted into sales quickly.
= Cost of goods Sold/ Avg. Inventory
ü    Debtors Turnover Ratio: It expresses the relationship between debtors and sales.
=Credit Sales /Average Debtors
ü    Creditors Turnover Ratio: It expresses the relationship between creditors and purchases.
=Credit Purchases /Average Creditors
ü    Fixed Assets Turnover Ratio: A high fixed asset turn over ratio indicates better utilization of the firm fixed assets. A ratio of around 5 is considered ideal.
= Net Sales / Fixed Assets
ü    Working Capital Turnover Ratio: A high working capital turn over ratio indicates efficiency utilization of the firm’s funds.
=CGS/Working Capital
=W.C=C.A – C.L.

3. Leverage Ratio: These ratios are mainly calculated to know the long term solvency position of the company.

ü    Debt Equity Ratio: The debt-equity ratio shows the relative contributions of creditors and owners.

= outsiders fund/Share holders fund

Ideal ratios 2:1

ü    Proprietary ratio or Equity ratio: It expresses the relationship between networth and total assets. A high proprietary ratio is indicativeof strong financial position of the business.

=Share holders funds/Total Assets

= (Equity Capital +Preference capital +Reserves – Fictitious assets) / Total Assets

ü    Fixed Assets to net worth Ratio: This ratio indicates the mode of financing the fixed assets. The ideal ratio is 0.67
=Fixed Assets (After Depreciation.)/Shareholder Fund