Meaning of ratio analysis

INTRODUCTION:
Ratio analysis is a very important rate of financial analysis .it is the process of
establishing a significant relationship between the financial statements to provide a
meaningful understanding to the performance and financial position of the firm.

MEANING OF RATIO:
Ratio can be defined as the mathematical expression of the relationship between two
accounting figure. But this figure must be related to each other. I.e. figure must have a
cause & effect relationship. To produce a meaningful & useful ratio.

e.g.:-
If the profit of the company A is Rs:1,00,000 and company B is Rs 1,50,000 and if one is
asked which company is doing better, naturally answer would be company B. But it is not
complete answer. Unless & until the figure of the profit are related either with the volume
of capital employed or it is carried on message. If sales of company A is Rs: 2, 00,000 &
for B Rs 4, 50,000 then the result would be as under.

NET PROFIT RATIO: NP/sales*100

Company A: 1, 00,000/2, 00,000 *100=50%

Company B: 1, 50,000/4, 50,000*100=33.33%

Thus, if we see the percentage of profit on sale, the answer obviously is that company A
is doing better. It is clear from the example that the ratio is a very important tool for the
user of financial statement. Ratio is an expression relating one number to another
number. It is also a statically yardstick that provides a relationship between different
variables.

Advantage of ratio analysis:-

There are various groups of people who are interested in analysis of
financial position of a company. They use the ratio analysis to work out a
particular financial characteristic of the company in which they are
interested. Ratio analysis helps the various groups in the following manner:

(1) To work out profitability :

Accounting ratio helps to measure the profitability of business by
calculating the various profitability ratios. It helps the management
to know about the earning capacity of the firm. In this way
profitability ratio show the actual performance of the business.

(2) To work out the solvency :

With the help of solvency ratios, solvency of the company can be
measure. These ratios show the relationship between the liabilities
assets. In case external liabilities are more then that of the assets of
the company, it shows the unsound position of the business. In this
case the firm has to make it possible to repay its loan.

(3) Help in analysis of financial statement :

Ratio analysis helps the outsider just like creditor, share holder,
debenture holder, bankers to know about the profitability and
ability of the firm to pay them interest, dividend, etc.

(4) Helpful in comparative analysis of the performance :

With the help of ratio analysis, the company may have
comparative study of its performance to the previous years. In this
way company comes to know about its weak point and able to
improve them.

(5) To simplify the accounting information :

 Accounting ratios are very useful as they briefly summaries the
result of detail and complicated calculation.

(6) To know about the efficiency :

The ratio analysis helps to know the operating efficiency of the
company with the help of various turnover ratios. All turnover
ratios are calculated to evaluate the performance of the business in
utilizing the resource.

(7) To know about the liquidity position :

Ratio analysis helps to know the short term financial position
(liquidity position) of the company with the help of it. In case short
term financial position is not good, effort are made to improve it.

(8) Helpful for forecasting purpose :

Accounting ratio indicates the trend of the business. The trend is
useful for estimating future. With the help of previous year’s
ratios, estimates ratios for future can be made. In this way, ratio
provides the bases for preparing budget and help for future course
of action.

Dis- advantage of ratio analysis:

 In spite of many advantage there are many limitation of ratio analysis
techniques and they should be kept in mind while using them in interpreting
financial statement. The following are the limitations of accounting ratio.

1. LIMITED COMPAREBILIYTY:

Different firm apply different policy. Therefore the ratio of one firm can
not always be compared with the ratio of other firm. Some firm may
value the closing stock on first into bases while some other firm similarly
there may be difference in providing deprecation on fixed assets on
certain provision also.

2. FALES RESULT:
Accounting ratios are bases on data taken from accounting records. In
case that data is correct then only the ratios will be correct. E.G:
valuation is based on very high prize, the profits of the firm will be
inflated and it will indicate a wrong financial position. The data
therefore must be absolutely correct.

3. PRICE LEVEL

The prize level changes often make the comparison of figures difficult
over a period of time. Changes in prize affect the cost of production,
sales and also the value of assets. Therefore it is necessary to make
proper adjustment for prize level changes before any comparison.

4. QUALITATIVE FACTOR ARE IGNORED:

Ratio analysis is technique of quantitative analysis and thus ignores
qualitative factors which may be ignoring in decision making E.G:
average collection period may be equal to standard credit period but
some debtors may be in the list of doubtful debt, which is not
disclosed while, ratio analysis
5. EFFECT OF WINDOW DRESSING:
In order to cover-up their bed financial position. Some companies use
window dressing. The main record the accounting data according to
the conventions to show the financial position of the company in a
better way costly teach.

6. COSTLY TECHNIQUE:
Ratio analysis is a costly technique in business houses. Small business
units are not able to effort it.

7. ABSENCE OF DATA: In the absence of absolute data, the result may be

misaligning. E.G: the gross profit of two firms is 25% where the profit
earned by one firm is just Rs: 5000 & sales are Rs: 20000. Profit earned
by other firm is Rs: 10, 00,000 and sales Rs: 40, 00,000 even the profit of
the firm is same but the magnitude of their business is guide different.

8. ABSENCE OF STANDERED UNIVERSITY ACCEPTED TERMINOLOGY:

There are no standard ratios, which are universally accepted for
cooperation purpose. As, such the significance of ratio analysis
techniques is reduce.

Classification of ratio
 1 Profitability ratios

 In relation to sales In relation to investment

1) Gross Profit Ratio 1) Return to capital employed

2) Net Profit Ratio 2) Return on share-holders fund
3) Expense Ratio 3) Return on eq. share-holders fund
4) Operating Ratio 4) Return on equity share capital
5) Earning per share
6) Dividend per share
7) Price Earning Ratio
8) Dividend Yield Ratio

Profitability Ratio

Introduction:

This ratio measures management overall effectiveness as shown by

the returns generated on sales and investment. Usually three types of
profitability ratios are calculated.
1. In relation to sales
2. In relation to investment and
3. In relation to equity shareholders fund
  Profitability Ratio in relations to sales

 GROSS PROFIT

Meaning:
This ratio measures the relationship between gross profit & net sales.

Objective:
There are two components of this ratio which are as under:
1. Gross Profit:
This is the access of net sales over cost of goods sold
(COGS?)
I.e. Net Sales – Cost Of Goods Sold

COGS = Opening stock + Net purchases (purchase –

purchase expenses) + direct expenses – Closing stock
2. Net Sales:
Which means Sales – Sales return

Calculation:
This ratio is calculated by dividing the gross profit by net sales. It is
expressed as percentage. In the form of a formula this ratio may be
expressed as under:

Formula: -
Gross Profit = Gross Profit * 100
Net Sales
Calculation: -
year

2008 2009
2007-08 -09 -10
1871 1121
Gross profit 7813.7 3.03 7
1538 1815
Net sales 13947.53 8.1 3.19
56.6 61.7
Gross profit ratio 56.02% % %

62

61

60

59

58
GP
57

56

55

54

53
2008 2009 2010

Interpretation: -
Here gross profit ratio decreased in 2008-09.which shows efficient use of
raw material and there is decrease in manufacturing expenses. It means that
a low ratio suggests that the firm is not able to buy at reasonable prices or
that the cost of production is not under control. The firm has to work better
for it and reduce its cost of production.

Interpretation:
This ratio indicates
A. An average gross margin earned on a self of rs. 100
 B. The limit beyond which the fall in selling prise definitely result in
losses.
C. What portion of sales is to cover operating express(Other than the
COGS) and non operating expresses (interest on borrowed funds)
to pay dividend & to create reserves. Higher the ratio, the more
efficient the production of purchase management. This ratio may
increase due to any one of the following resons:
1. Higher selling prise with constant cost of goods sold
2. Cover cost of goods sold
3. Combination of above two factor.

 NET PROFIT RATIO

Meaning:
This ratio measures the relationship between net profit & net sales.

Objective:
The main objective of computing this ratio is to find the overall
profitability due to various factors such as operational efficiency, trading on
equity etc.

Components:
There are two components of this ratio which are as under:
1. Net Profit
2. Net Sales

Calculation:
This ratio is calculated by dividing the next profit by net sales. It is
expressed as percentage. In the form of a formula this ratio may be
expressed as under:

Formula: -
Net Profit Ratio = Net Profit * 100
Net Sales
Calculation: -
Year 2007-08 2008-09 2009-10
Net profit 724.45 858.14 61.31
Net sales 13947.53 15388.11 18153.19
Net profit ratio 5.19% 5.58% 0.34%
6

3 Net profit

0
2008 2009 2010

Interpretation: -
Here in the three years the net profit ratio of the company shows downward
trend. It shows profitability of firm and management of the firm is not
efficient this suggest that company is not satisfactory position and can be
harmful for the company.

Interpretation:
This ratio indicates an average net margin earned on a sale of rs. 100.
What portion of sales is left to pay dividing & to create reserves.
Firm’s capacity to face adverse economic condition when selling price
declining, cost of production is rising & demand for the product is falling.
Higher the ratio greater is the capacity of the firm to face adverse
economic condition & vice-versa.

 Return on Shareholder’s Fund

Meaning:
 The ratio measures the relationship between net profit after tax,
interest & shareholder’s fund.

Objective:
The objective of calculating this ratio is to find out how efficiently
defends invested by the equity shareholders have been used.

Components:
There are two components of this ratio as under:
1. Net Profit after Interest & Tax (PAT)
2. Shareholder’s Fund which mean equity share capital + Preference share
capital + Reserves & surplus – Fictitious assets.

Calculation:
This ratio is calculated by dividing the net profit after interest and tax
by shareholder’s fund. It is expressed as percentage. In the form of a formula
this ratio may be expressed as under:

Net Pr ofit after Interest∧Tax

Return on Shareholder’s Fund = Shareholde r ' s Fund
×100

Year 2007-08 2008-09 2009-10

Net profit(PAT) 3120.10 3263.59 4061
Shareholder’s fund 12057.67 13735.08 14064.38
Returns 25.88% 23.76% 28.87%
3
 30

25

20

15
returns on shareholder's fund

10

0
2008 2009 2010

Interpretation:
This ratio indicates the firm’s analyzing of generating profit per rupee
of shareholder’s fund. Higher the ratio the more efficient funds.

 RETURN ON EQUITY SHARE HOLDERS’ FUND

Meaning:
This ratio measures a relationship between net profit after interest, tax
and preference dividend and equity shareholder’s funds.

Objective:
The objective of calculating this ratio is to find out how efficiently the
funds supplies by the equity shareholder’s have been used.

Components:
There are two components of this ratio they are as under:
1. Net Profit after Interest, Tax & Preference dividend
 2. Equity Shareholder’s Fund which means Equity Share Capital +
Reserves & Surplus – Fictitious Assets

Calculation:
This ratio is computed by dividing the net profit after interest & tax
and preference dividend by equity shareholder’s fund. It is expressed as
percentage. In the form of a formula this ratio may be expressed as under:

Formula: -
Return on Eq. sh. holders fund = Profit after tax
* 100
Equity share holder’s
fund

Calculation:
Year 2007-08 2008-09 2009-10
Net profit(PAT) 3120.10 3263.59 4061
Shareholder’s fund 12057.67 13735.08 14064.38
Returns 25.88% 23.76% 28.87%

30

25

20

15 returns on equity
shareholder's fund

10

0
2008 2009 2010

Interpretation: -
Return on equity share holder fund was 36.55%in 2006-07 which increased
40.41% and again decreased to 33.11% it indicates that fund which is
provided by the owners have been not used properly by the firm which can
be unsatisfactory for the company in the future.

Interpretation:
This ratio indicates the firm’s ability of generating profit per rupee of
equity shareholder’s fund. Higher the ratio the more efficient the
management & utilization of equity shareholder’s fund.

 Operating Ratio
Meaning:
This ratio measures a relationship between operating cost and net sales.

Objective:
The main objective of computing this ratio is to find out the operating
efficiency with which production or purchase & selling operations are
carried on.

Components:
There are two components of this ratio which are as under:
A. Cost of Goods Sold
B. Other Operating expenses
Ex. Administrative expenses, selling & distribution expenses,
interest on short term loans, discount allowed and bed debts, net
sales (Gross Sales – Sales Return).

Calculation:
This ratio is calculated by dividing the operating cost by net sales.
This ratio is expressed as percentage. In the form of a formula this ratio may
be expressed as under:
 Cost of Goods Sold+Operating Expenses
Operating Ratio = Net Sales ×100

Year 2007-08 2008-09 2009-10

Cogs 6133.83 6675.08 6936.19

Operating exp 3531.30 4101.11 5161.15

Net sales 13947.53 15388.11 18153.19

Operating ratio 69.3% 70.03% 66.64%

71

70

69

68

Operating ratio
67

66

65

64
2008 2009 2010

Interpretation:
This ratio indicates an average operating cost incurred on sales of
goods worth rs. 100. Lower the ratio, greater is the operating profit to cover
the operating expense to pay dividend and to create reserves & vice-versa.

 Expenses Ratio
Meaning:
This ratio measures the relationship between different types of ratio
with expenses & net sales.

Objective:
The main objective of computing different types of expenses the
incurrence of different types of expenses.
Components:
There are two components of this ratio which are as under:
1. Different type of expenses
2. Net Sales

Calculation:
This ratio is calculated by dividing different types of expenses by the
net sales. This ratio is expressed as a percentage. In the form of a formula
this ratio may be expressed as under:

Name of Expenses
Expense Ratio = Net Sales ×100

Year 2007-08 2008-09 2009-10

Manufacturing 3531.50 4101.11 5161.15
&selling exp.
Net sales 13947.53 15388.11 18153.19
expenses ratio 25.32% 26.65% 28.43

expense ratio
29

28

27
expense ratio
26

25

24

23
2008 2009 2010

Interpretation:
This ratio indicates an average expenses incurred on sales of goods
worth rs. 100. Lower the ratio, greater is the operating profit to cover
operating expenses, to pay dividend and to create reserves & surplus & vice-
versa
  Return on Capital Employee
Meaning:
This ratio measures a relationship between not profit before interest &
tax and capital employed.

Objective:
The objective of calculating this ratio is to find out how efficiently the
long term fund supplied by the creditors & shareholders has been used.

Components:
There are two Components of this ratio which are as under:
1. Net Profit Before Interest & Tax
2. Capital Employed Which Refers to Long Term Fund Supplied by
the long term creditors & shareholders.
It comprises the long term debts & shareholder’s fund.

Calculation:
This ratio is calculated by dividing the net profit before interest & tax
by capital employed. This is expressed as percentage. In the form of a
formula this ratio may be expressed as under:

Net profit before Interest ∧Tax

Return on Capital Employed = capital Emplyoed × 100

Calculation of Capital Employed = Equity Share Capital + Preference

Share Capital + Reserves & Surplus + Profit & Loss A/C Credit balance +
Long term debt - Fictitious Assets.

Year 2007-08 2008-09 2009-10

 Net profit(BIT) 4571.77 4825.74 6051.31
Cap employed 12057.67 13735.08 14064.38
Returns 37.92% 35.13% 42.77%

45

40

35

30

25

20 returns on cap employed

15

10

0
2007 2008 2009

Interpretation:
This ratio indicates the ability of the firm to generate profit per rupee
on capital employed. Higher the ratio the more efficient the management &
utilization of capital employed.

 EARNING PER SHARE

Meaning:
This ratio measures the earnings available to an equity shareholder on
a per share basis.

Objective:
The objective of computing this ratio is to find out the profitability of
the firm on per equity share basis.

Components:
There are two components of this ratio which are as under:
1. Net Profit after Interest, Tax & Preference dividend
2. No. of equity Shares

Calculation:
This ratio is calculated by regarding the net profit after
interest, tax and preference dividend by the no. of equity shares. It is
expressed as absolute figure. In the form of a formula this ratio may be
expressed as under:

Formula: -
Earning per share = net profit – preference divide
No. of equity shares

Year 2007-08 2008-09 2009-10

NP-pref share 3120.10 3263.59 4061.
No. of eq share 376.22 377.44 381.82
Earning per share (Rs.) 8.29 8.65 10.64

Earning per share ratio

12

10

8
Earning per share ratio

0
2007-08 2008-09 2009-10

Interpretation:
In general, higher the ratio better it is vice-versa. While interpreting
this ratio, it must be seen weather there is any increase in equity
shareholder’s fund as a result of retained earning without any change a no.
of outstanding shares.

 DIVIDEND PER SHARE

Meaning:
This ratio measures relationship between dividend and no. of equity
shares.
Objective:
The objective of computing this ratio is to find out net distributed
profit after interest, tax and preference dividend to equity shareholders.

Components:
There are two components of this ratio which are as under:
1. Dividend paid to equity shareholders
2. No. of equity shares

Calculation:
This ratio is calculated by dividing dividend paid to equity
shareholders by no. of equity shares. It is expressed as absolute figure. In the
form of a formula this ratio can be expressed as under:

Formula: -
Dividend per share = total dividend declared
No. of shares
Calculation: -
Year 2007-08 2008-09 2009-10
Total dividend declared 1319.01 1396.53 1718.53
No. of share 376.22 377.44 381.82
Dividend per share (Rs.) 3.5 3.7 4.5
4.5

3.5

2.5
dividend per share ratio
2

1.5

0.5

0
2007 2008 2009

Interpretation: -
Dividend per share has increase from 1.3 to 2.05 it means that constant
upward trend in the firm. It gives good impression on the share holders
mind. And the reputation of the company increase.

 PRICE EARNING RATIO

Meaning:
This ratio measures relationship between market value of equity
shares & earning per share.

Objective:
The objective of computing this ratio is to find out expected return on
investment in equity shares.

Components:
There are two components of this ratio which are as under:
1. Market price per equity share
2. Earnings per share

Calculation:
This ratio is calculated by dividing market price per equity share by
earning per share. It is expressed has an absolute this figure. In the form of a
formula this ratio may be expressed as under:

Formula: -
Price earning ratio = market value per share
Earning per share
Year 2007-08 2008-09 2009-10
Market price 1 1 1
Earning per share 8.28 8.65 10.64
Price earning ratio
(times) 0.12 0.12 0.09
0.12

0.1

0.08

0.06
price e arning ra tio

0.04

0.02

0
2007 2008 2009

Interpretation: -
This ratio indicates price earning per share with market price of share has
increased. Here price-earning ratio is also increased from 13.62 times to
24.23 times which can be satisfactory for the company and it effect the well
being of the company. Higher the ratio is better for the company.

Liquidity Ratio

 CURRENT RATIO

Meaning:
This ratio establishes a relationship between current assets & current
liabilities.

Objective:
The objective of computing this ratio is to find the ability of the firm
to meet its short term obligation & to reflect the short term financial strength
or solvency of the firm.
Components:
There are two components of this ratio which are as under:

1. Current Assets:

Current Assets means the assets which are convertible in too cash within
a year & include the following:
 Cash balance, Marketable securities, Bills Receivables(less
provisions), Prepaid expenses, advanced payment of tax, Bank
balance, Debtors(less provisions), Stock of all types (raw-
materials, work in progress, Finished goods), Short term loans
and advances(debit balance), Incomes due but not received.

The provision for bed debt & or bills is deducted from the total
amount of trade.
2. Current Liabilities:
A current liability means the liabilities which are the expected to be
matured within a year and include the following.
 Creditors, Bills payable, short term loans & advances, Provision
for taxation, Bank overdraft, and income received in advances,
unclaimed dividend.

Calculation:
This ratio is calculated by dividing the current assets by current
liabilities. This ratio is usually express as pure ratio.
Ex. 2:1
A form of a formula this ratio may be express as under.
Formula: -
Current ratio = Current asset
Current liabilities

Calculation: -

Year 2006-07 2007-08 2008-09

Current assets 7019.27 8161.11 8127.08
Current liabilities 4432.30 4705.01 8048.24
Current ratio 1.58 : 1 1.73 : 1 1:1

1.8

1.6

1.4

1.2

0.8

0.6

0.4

0.2

0
2007 2008 2009

Interpretation: -
Current ratio of the firm has remained all most constant around as it has kept
constant trend. The company has satisfactory current assets for its future
need. Current assets are more than current liabilities. It means company can
utilized properly current assets. The ideal ratio is 2:1

Interpretation:
 This ratio indicates as of current assets available for each rupee of current
liability. Higher the ratio, greater the margin of safety for short term
creditors & vise-versa. However too high too or low ratio requires
investigation because it shows extra funds in the firm or the absence of
investment opportunity with the firm & too low ratio may indicate over
trading or under capitalization. Traditionally a current ratio of 2:1 is
considered to be a satisfactory ratio.

 LIQUID RATIO(QUICK RATIO/ACID TEST RATIO)

Meaning:
This ratio establishes the relationship between quick assets and liquid
liabilities.

Objective:
The objective of calculating this ratio is to find out the ability of the
firm to meet its short term obligations as and when due without relying upon
the realization of stock.

Components:
There are two components of this ratio which are as under:
1. Quick assets/Liquid assets:
Which means those assets which can be converted short noticed
without a loss of value. They are:
 Cash balance, Marketable securities, Bills receivable, Bank
balance
& debtors.
2. Liquid Liabilities:
Liquid Liabilities = Current liabilities – Bank over Draft

Calculation:
 This ratio is calculated by dividing by the liquid assets by liquid
liabilities. This ratio is usually express as a pure ratio.
Ex. 1:1
In the form of a formula this ratio may be expressed as under:

Formula: -
Liquid ratio = Current asset - stock
Current liability-bank overdraft

Calculation: -
Year 2007-08 2008-09 2009-10
Liquid assets 2968.75 3561.39 3578.01
Liquid liabilities 4432.30 4705.91 8048.24
Liquid ratio 0.67:1 0.76:1 0.44:1
0.8

0.7

0.6

0.5

0.4
liquid ratio

0.3

0.2

0.1

0
2007 2008 2009

Interpretation:
Liquidity ratio of the firm has decreased from 0.96 in 2006-07 to 0.76 in
2008-09. It shows inefficient management and inefficient use of liquid
assets. Ideal ratio is 1:1 so company has satisfactory ratio.
 Activity Ratio
Introduction:
This ratio measures the effectiveness with which a firm uses its available
resources. These ratios are also called turnover ratios since they indicate the
speed with which the resources are converted in to sales. Usually the
following activity ratios are calculated.
1. Stock Turnover Ratio
2. Working Capital Turnover Ratio
3. Debtors Ratio
4. Creditors Ratio
5. Total Assets Turnover Ratio
6. Book Value per Share Ratio

 Working Capital Turn Over Ratio

Meaning:
This ratio establishes a relationship between net sales & working
capital.
Objective:
The objective of computing this ratio is to find out the efficiency with
which the working capital is utilized.

Components:
There are two components of this ratio which are as under:
1. Net Sales which means Gross Profit – Sales Return
2. Working Capital which means Current Assets – Current Liabilities

Calculation:
This ratio is calculated by dividing the net profit by the working
capital. This ratio is usually expressed as no. of times. In the form of a
formula this ratio may be expressed as under.

Formula: -
Net Sales
Working Capital Turnover ratio = Working Capital

Year 2007-08 2008-09 2009-10

Net sales 13947.53 15388.11 18153.19
Working capital 2586.97 3456.1 78.84
WCT 5.39 4.45 230.25

250

200

150

working capital
100

50

0
2007 2008 2009

Interpretation:
This ratio indicates the firm’s ability to generate sales per rupee of
working capital. In general, higher the ratio, the more efficient the
management & utilization of working capital and vice-versa.
  STOCK TURNOVER RATIO

Meaning:
This ratio establishes a relationship between costs of goods sold
(COGS)
And average inventory.

Objective:
The objective of computing this ratio is to find out the efficiency with
which the inventory is utilized.

Components:
There are two components of this ratio they are as under:

1. Cost of Goods Sold which is calculated as under

 Opening stock + Net purchases + Direct expenses – Closing
stock
Or

COGS = Net Sales – Gross Profit

2. Average Inventory or Average Stock

Calculation:
This ratio is calculation by dividing the cost of goods sold by average
inventory. This ratio is usually expressed as number of times.

Formula: -
Stock turnover ratio = cost of goods sold
Average inventory
Calculation: -
Year 2007-08 2008-09 2009-10
Cost of goods sold 6133.83 6674.78 6936.19
Average inventories 3702.28 4325.12 4574.40
Stock turnover ratio (times) 1.66 1.54 1.52

1.7

1.65

1.6

1.55
sock turn over ratio

1.5

1.45

1.4
2007 2008 2009

Interpretation:

This ratio indicates the speed with which is converted in to sales. A

high ratio indicates efficient performance since an improvement in ratio
shows that either the same volume of sales has been maintained since a
lower investment in stock or volume of sales has increased without any
increase in the amount of stock. However too high ratio & to low ratio
require further investigation. A too very low inventory level which may
result in frequent stock outs & the firm may incur high stock out cost low
ratio may be the result of excessive inventory levels & thus, the firm may
incur high caring cost. Thus, a firm should have neither a very high nor a
very low stock turnover ratio.

 Total Turnover Ratio

Meaning:
This ratio measures the overall performance or activity of the business
enterprise.

Objective:
 The objective of calculating this ratio is to point out the efficiency or
inefficiency in the use of total assets.

Components:
There are two components of this ratio which
1. Net Sales
2. Total Assets

Calculation:
This ratio is calculated by dividing net sales by total assets.
Net Sales
Total Assets Turnover Ratio = Total Assets

Year 2007-08 2008-09 2009-10

SALES 13947.53 15388.11 18153.19
Total assets 17249.47 19484.83 23005.34
Total assets turnover
ratio 0.81:1 0.78:1 0.79:1
0.81

0.81

0.8

0.8

0.79

0.79 Total asset turnover

0.78

0.78

0.77

0.77
2006 2007 2008

Interpretation:
An ideal total assets turnover ratio is 2:1 i.e. sales are twice the value
of total assets. A lower ratio than this will signify that the assets are not
utilized properly.

 Book Value Per Share

Meaning:
This ratio establishes relationship between equity share capital &
reserves and surplus with no. of shares.

Objective:
The objective of computing this ratio is to find out the proportion of
share capital & reserves & surplus with no. of equity shares.

Components:
There are two components of this ratio
1. Equity share capital & reserves and surplus
2. No. of equity shares

Calculation:
This ratio is computed by dividing equity share capital & reserves &
surplus by no. of equity shares. It is expressed as an absolute figure.

Equity Share Capital+ Reserves∧Surplus

Book Value per Share Ratio = No . of Equity Shares

Year 2007-08 2008-09 2009-10

Eq. shares 376.66 377.44 381.82
Reserves & surplus 11680.81 13357.64 13682.56
No. of eq shares 376.22 377.44 381.82
Book value per share 32.05 36.39 36.84
 37

36

35

34

33
book value per share

32

31

30

29
2007 2008 2009

Interpretation:
In general higher the ratio better it is because this ratio measures
relationship between share capital and reserves & surplus with no. of equity
shares. In the most of the companies the amount of equity share capital
remains constant & the value of reserves & surplus charges. Whenever
company has high amount of profits, the value of reserves & surplus will
increase. Therefore higher book value per share means high amount of
profitability.

 Debtors Ratio
Meaning:
This ratio establishes a relationship between debtors and bills
receivables with average daily credit sales.

Objective:
The objectives of computing this ratio is to find out the efficiency
with the trade debtors are managed.

Components:
There are two components of this ratio
1. Debtors and Bills receivable
2. Net Credit Sales

Calculation:
This ratio is calculated by dividing debtors and bills receivables by net
credit sales. This ratio is usually expressed as X no. of times (days).
 Debtors+ Bills Receivables
Debtors Ratio = Net Credit Sales ×365

Year 2007-08 2008-09 2009-10

Debtors + b/r 736.93 668.67 858.80
Credit sales 13947.53 15388.11 18153.19
Debtors ratio 19days 16days 17days

19

18.5

18

17.5

17
debtors ratio
16.5

16

15.5

15

14.5
2007 2008 2009

Interpretation:
This ratio shows average collection period for credit it can be said that
the time period given to debtors to pay their payments can be known from
this ratio. This ratio is also known as Debtor’s velocity.

 CREDITORS RATIO

Meaning:
This ratio establishes a relationship between creditors and bills
payable and average daily credit purchases.

Objective:
The objective of computing this ratio is to determine the efficiency
with which creditors are managed.
Components:
There are two components of this ratio
1. Creditors and Bills Payable
2. Net Credit Purchases

Calculation:
This ratio is calculated by dividing the creditors and Bills Payables by
Net credit purchases. This ratio is usually expressed as X no. of times (days).
Formula: -
Creditors ratio = Creditors + bills payable *365
Credit purchase

Calculation: -
Year 2007-08 2008-09 2009-10
Creditors 2739.07 2914.11 3444.07
Average daily purchase 5110.80 5031 6334.28
Creditors ratio (days) 196 211 198

215

210

205

200
creditors ratio

195

190

185
2007 2008 2009

Interpretation: -
This ratio of the firm has decreased in 2 years from 71 in 2006-07 to 62 in
2008-09. It shows the bad position of the company and company can not
collect debt easily which can be a loss to the firm.
Interpretation:
This ratio shows an average time period for which the credit purchase
remain outstanding or the average credit period allowed by the creditors.
This ratio is also known as Debt Payment period or Creditors Velocity

Leverage Ratio
Capital Structure Ratio (Capital Gearing Ratio)
Meaning:
Capital structure of a company consist of a verity of securities
Ex. Equity share & preference share which satisfy its share capital
requirements while by other securities such as debentures, warrants etc. the
company satisfies its access requirement of long term capital & borrowed
capital, leverage ratios are calculated. Sum of the leverage ratios are as
under.
1. Debt equity ratio
2. Proprietary ratio
3. Capital Gearing ratio
4. Long term funds to fixed assets ratio

 Debt Equity Ratio

Meaning:
This ratio establishes a relationship between long term debts &
shareholders funds.

Objective:
The objective of computing this ratio is to find out the relative
proportion of debt & equity in financing the assets of a firm.

Components:
There are two components of this ratio which are as under:
1. Long term debt which means all types of secured and unsecured
loans.
Ex. Debtors, Loans from financial institution
 2. Shareholder’s funds which means equity share capital + Preference
share capital + Reserves & surplus – Fictitious Assets

Calculation:
This ratio is calculated by dividing the long term debts of the firm by
shareholder’s fund. This ratio is usually expressed as a pure ratio.
Ex. 2:1

LongTerm Debts
Debt Equity Ratio = Shareholde r ' s Fund
Calculation:

Year 2007-08 2008-09 2009-10

Long term debt 127.59 127.55 107.71
Share holders fund 12057.67 13735.08 14064.38
Debt eq ratio 0.01:1 0.009:1 0.008:1

0.01

0.01

0.01

0.01

0.01

0.01
debt equity ratio
0

0
2007 2008 2009

Interpretation:
This ratio indicates the margin of safety to long term creditors. Lower ratio
means a larger safety margin for creditors & vice-versa.

 PROPRIETOR’S RATIO

Meaning:
This ratio measures the relationship between shareholder’s funds &
total assets of the company.

Objective:
The objective of calculating this ratio is to find out how efficiency the
properties have utilized the funds for purchasing the assets.

Components:
There are two components of this ratio which are as under:
1. Shareholder’s funds or proprietor’s fund
2. Total assets or total liabilities

Calculation:
This ratio is computed by dividing shareholder’s fund by total assets.
In the form of a formula their ratio may be expressed as under:

Formula: -
Proprietor’s ratio = Shareholder’s fund * 100
Total asset/liability

Calculation: -
Year 2007-08 2008-09 2009-10
Proprietary fund 12057.67 13735.08 14064.38
Net assets 12817.17 14779.82 14957.10
Proprietary ratio 94% 92.33% 94.03%

94.5

94

93.5

93

properitory ratio
92.5

92

91.5

91
2007 2008 2009
Interpretation: -
Proprietary ratio shows 2006-07 an upward move and after in year 2007-08
downward trend. However, it has showed such satisfactory position that is
ideal for the firm.

 Capital Gearing Ratio

Meaning:
This ratio measures a relationship between equity shares capital and
fixed interest bearing capital.

Objectives:
The objective of computing this ratio is to find out the proportion
between fixed interest bearing capital & equity share capital.

Components:
There are two components of this ratio which are as under:
1. Fixed interest bearing capital (preference share capital, debenture,
long term loan)
2. Equity share capital

Calculation:
This ratio is calculated by dividing fixed increased bearing capital by
equity share capital. This ratio is expressed as a pure ratio. In the form of a
formula this ratio may be expressed as under:

¿ Interest −bearing capital

Capital Gearing Ratio = Equity share capital

Interpretation:
Higher the ratio, more portion of borrowed capital in such
circumstances, a huge part of profit is paid to fixed charge bearing securities.
As a result dividend on equity shares and market price of equity share will
frequently fluctuate.

 LONG TERM FUND TO FIXED ASSET RATIO

Meaning:
This ratio measures a relationship between long term funds to fixed
assets.

Objective:
With the help of this ratio one can move how efficiently the long term
funds have been invested in fixed assets.

Components:
There are two components of this ratio which are as under:
1. Shareholder’s funds + Long term debts
2. Fixed assets

Calculation:
This ratio is calculated by dividing shareholder’s funds & long term
debts by fixed assets. It is expressed as pure ratio.

Formula:

Long Term Funds to

Shareholde r ' s Funds+ LongTerm Debts
Fixed Assets Ratio = ¿ Assets
'
Shareholde r s Funds+ LongTerm Debts
¿ Assets

Here, Shareholder’s Funds = Preference share + Reserves & Surplus +

Equity Share Capital + Profit and Loss A/c credit balance – Fictitious Assets

And Long Term Debts = Debenture and Long Term Loan

Calculation: -
Year 2007-08 2008-09 2009-10
Long term funds 504.45 504.99 489.53
Fixed assets 7295.65 8485.97 9151.39
Long term funds to fixed ratio 0.07:1 0.06:1 0.05:1
 0.07

0.06

0.05

0.04

long term fund

0.03

0.02

0.01

0
2007 2008 2009

Interpretation: -
Long-term ratio decreased from 2.84 to 1.91. It has shown fall in the
ratio. The fixed assets should always be acquired out of long-term funds,
meaning thereby that this ratio should not be less than 100. The company
has not achieved a good ratio as it shows a downward trend.

Coverage Ratio
Introduction:
Coverage ratio examines the paying the capacity of borrowers. By
using this ratio, financial institutions and banks are checking whether the
borrower will be able to pay installments of principle amount & interest
regularly.

There are two types of coverage ratio

1. Debt Service Coverage Ratio and
2. Interest Coverage Ratio

 Debt Service Coverage Ratio

Meaning:
This ratio measures the firm’s ability to pay back the amount of debts.

Objective:
This is a useful ratio to money Landers, banks and financial institution
to know the capacity of the firm to pay the installments inclusive of interest
out of Profit.

Components:
There are two components of this ratio which are as under:
1. Profit available to pay debts
2. Instalment principle amount + Interest amount for the current year

Calculation:
This ratio is calculated by dividing profit available to pay debts by
principle & interest amount for the current year. In the form of a formula this
ratio may be expressed as under:

Debt Service Coverage Ratio =

Profit available ¿ pay deb t ¿
Principle + Interest amount of Current Year

Interpretation:
Higher the ratios the safer are the money Lenders. However no.
standard is fixed to decide ideal proportion.

 Interest Coverage Ratio

Meaning:
This ratio is useful to know if the firm has sufficient profit to pay its
liability of interest.

Objective:
This ratio shows that how many times the interest payable is covered
by the amount of profit. As a result, it will be easy for a firm to decide
whether more capital should be borrowed to get the benefit of trading on
equity.
Components:
There are two components of this ratio which are as under:
1. Earnings before interest & tax
2. Interest

Calculation:
This ratio is calculated by dividing earnings before interest & tax by
interest.

Earnings Before Interest∧Tax

Interest Coverage Ratio = Interest
Earnings Before Interest∧Tax
Interest

Calculation: -
Year 2006-07 2007-08 2008-09
Profit(bit) 4571.77 4825.74 6051.31
Int & tax
Int coverage ratio.

0.9

0.8

0.7

0.6

0.5
intrest coverage ratio
0.4

0.3

0.2

0.1

0
2007 2008 2009

Interpretation:
The interest coverage ratio is very important from Landers point of
view. It gives an ides the no. of times the fixed interest charges are covered
by the earnings. The standard of an industrial firm is that the interest charges
should be covered by 6 to 7 times. A higher ratio assures the Lander a
regular interest income.