SECURITY ANALYSIS

INTRODUCTION:

Fundamental analysis is a method of evaluating a security(Stocks, Bonds, Debts) .It

attempts to measure intrinsic value of a security by examining related economic, financial
and other qualitative and factors. quantitative

Fundamental analysts study anything that can affect the security's value, including
macroeconomic factors such as the overall economy and industry conditions, and
microeconomic factors such as financial conditions and company management.

The key objective of doing this kind of analysis is to produce a particular value which can be
compared against the current price so that an investor can figure out if he or she is going to
buy or sell the security. If the value is lower than the current price, the stock is said to be
overpriced and an investor can decide to sell. On the other hand, if the value is more than
what is currently reflected in the current price, the stock is labelled as undervalued which is a
basis for buying because the investor aims to capture that gap as gains once the market
realizes this and adjusts upward.

5.2 ECONOMIC INDUSTRY COMPANY(EIC) ANALYSIS OF A COMPANY:

In the security selection process, a traditional approach of Economic Industry Company

analysis is employed. EIC analysis is the abbreviation of economic, industry and company.
The person conducting EIC analysis examines the conditions in the entire economy and then
ascertains the most attractive industries in the light of the economic conditions. At last the
most attractive companies within the attractive industries are pointed out by the analyst.

Fundamental Analysis:

(1) ECONOMY ANALYSIS:

All investment decisions are made within the economic environment of the country. This
environment varies as the economy goes through stages of prosperity.

Measure of Economic Activity: Following are the measure of Economic activities!

(1) Gross Domestic Product: Economic activity is measured by aggregate indicators such as
the level of production and national output. The most widely and commonly quoted measure
is Gross Domestic Product (GDP), which is the total value of all final goods and devices
newly produced within the country's boundaries with domestic factors of production.

(2) Invest Rates: The level of interest rate is the most important macroeconomic factor to
consider in one's invest analysis. Forecasts of interest rates directly affect the forecast of
returns in the fixed income market.
(3) Government Policy: The government has two broad classes of macroeconomic tools
those that affect the demand of goods and services and those that affect their supply.
Government policies may have little impact in the short run but they produce sustainable
long run growth in the economy.

(4) Fiscal Policy: Fiscal policy refer to the government's spending and tax action to achieve
an economic goal. It is the most direct way to influence the economy.

(5) Monetary Policy: Monetary policy are in the form of changing SLR (statutory liquidity
ratio18% as on 2023)and CRR(Cash reserve ratio 4.5% as on 2022) it changes the money
supply through variety of policies and thus influence the economy.

(6) Saving and Investment: Growth of an economy require proper amount of investment
which in turn is dependent upon amount of domestic saving. The amount of saving is
favourably related to investment in a country.

(7) Price Level and Inflation: Price level and inflation affect the economy of the country.
Agriculture and Monsoons: Agriculture is directly and indirectly linked with the industries.
Hence increase or decrease in agriculture production has a significant impact on the
industrial production and corporate performance. A good monsoon leads to higher demand
for inputs. If the monsoon is bad, agriculture production suffers and cast a shadow on the
share market.

(9) Tax Structure: The type of tax exemption has impact on the profitability of the industries.
Concession and incentive gives to certain industry encourages investment in that industry
and have favourable impact on stock market.

(10) Demographic Factor: Demographic data details about the population by age,
occupation, literacy and geographic location. These factors have direct impact on the
economy of a country.

(II) INDUSTRY ANALYSIS:

By industry life cycle, we mean the different stages of the development of an industry. This
helps in making investment decisions. Life cycle of an industry has the following stage:

(i) Pioneering stage: It is the stage of start-up of an industry. In this stage the technology
and/or the product is relatively new. The risk at this stage is very high. Many entrepreneurs
enter the field but only a few entrants may survive at this stage.

(ii) Rapid growth stage: At this stage of the industry life cycle demand for the product in the
industry increases at a fast pace and every day new participants/companies’ entry the
industry. Due to competitions the market share of companies keeps fluctuating during this
stage.

(iii) Maturity and stabilization: After enjoying an above- average rate of growth during the
rapid growth, the industry enters the maturity and stabilisation stage. During this stage, when
the industry is more or less fully developed, its growth rate is comparable to that of the
economy as a whole.

(iv) Decline stage/diversification: At this stage, poor performers start winding up their
businesses. Only strong companies survive during this stage. Few companies take up
diversification to overcome this phase. If companies diversify, then they enter into a new
industry life cycle.

III) COMPANY ANALYSIS:

A company analysis is a study of the variable which influence the future price of a company's
competitive company's share. It is an assessment of capacity and position, earning
profitability. It is a method of finding out the intrinsic value of a company's share. This
requires internal as well as external information of the company. Internal information consists
of data and events of the company which is available from its financial statements. External
information consists of demand, supply, competitors, pricing, market share etc. which case
be obtained from industry associations, chambers of commerce, government departments
and stock exchange bulletins.

The most frequently used tools for company analysis are as follows:

(1) Ratio Analysis.

(2) Trend Analysis.

(3) Fund Flow Analysis.

(4) Common Size Statement Analysis.

(5) Technical Analysis.

5.3 PRACTICAL PROBLEM ON FINANCIAL RATIOS:

A ratio analysis is a quantitative analysis of information contained in a company's financial

statements. Ratio analysis is used to evaluate various aspects of a company's operating and
financial performance such as its efficiency, liquidity, profitability and solvency.

Most investors are familiar with a few key ratios, particularly the ones that are relatively easy
to calculate. Some of these ratios include the current ratio, return on equity (ROE),
the debt-equity (D/E) ratio, the dividend payout ratio, and the price/earnings (P/E) ratio.
While there are numerous financial ratios, ratio analysis can be categorized into six main
groups:

(a) Liquidity Ratios: Liquidity ratios assess a business's liquidity, i.e. its ability to convert its
assets to cash and pay off its obligations without any significant difficulty (i.e. delay or loss of
value). Liquidity ratios are particularly useful for suppliers, employees, banks, etc. Liquidity
ratios measure a company's ability to pay off its short-term debts as they come due using
the company's current or quick assets. Liquidity ratios include current ratio, quick ratio, and
working capital ratio.

(b) Solvency Ratios: also called financial leverage ratios, solvency ratios compare a
company's debt levels with its assets, equity, and earnings to evaluate whether a company
can stay afloat in the long-term by paying its long-term debt and interest on the debt.
Examples of solvency ratios include debt-equity ratio, debt-assets ratio, and interest
coverage ratio.

(c) Profitability Ratios: these ratios show how well a company can generate profits from its
operations. Profit margin, return on assets, return on equity, return on capital employed, and
gross margin ratio are examples of profitability ratios.

(d) Efficiency Ratios: also called activity ratios, efficiency ratios evaluate how well a company
uses its assets and liabilities to generate sales and maximize profits. Key efficiency ratios
are the asset turnover ratio, inventory turnover, and days' sales in inventory.

(e) Coverage Ratios: these ratios measure a company's ability to make the interest
payments and other obligations associated
with its debts. Times interest earned ratio and debt-service coverage ratio are two examples
of coverage ratios.

(f) Market Prospect Ratios: e.g. dividend yield, P/E ratio, earnings per share, and dividend
payout ratio. These are the most commonly used ratios in fundamental analysis. Investors
use these ratios to determine what they must receive in earnings from their investments.

LIQUIDITY RATIOS:-
1.Current Ratio = Current Assets/Current Liabilities
It measures a company's short-term liquidity, indicating its ability to cover its short-term
liabilities with its short-term assets. It's also sometimes called the working capital ratio.
Current Assets typically include cash, accounts receivable, inventory, and other assets that
are expected to be converted into cash.

Current Liabilities are the company's obligations, such as accounts payable, short-term
debt, and other short-term liabilities.
A current ratio above 1.0 indicates that a company has more current assets than current
liabilities, suggesting it has a good buffer to cover its short-term obligations. A ratio below 1.0
may indicate that the company may struggle to meet its short-term financial obligations with
its current assets alone.

Components of current Assets:-

1. Stock
2. Debtors
3. Short term Investments
4. Cash in hand
5. Inventory
6. Prepaid Expenses
Components Of current liability
1. Creditors
2. Bills Payable
3. Bank Overdraft
4. Pre-received Expenses

2. Quick Ratio = Current Assets – Stock – Prepaid Expenses/ Current Liabilities - Bod

The quick ratio, also known as the acid-test ratio, It measures a company's short-term
liquidity and ability to cover its immediate or near-term liabilities using its most liquid assets.
It's a more stringent measure of liquidity than the current ratio because it excludes inventory
from current assets, as inventory can sometimes be less liquid and harder to convert into
cash quickly.

We exclude bank overdraft from current liabilities because bod are considered as a source
of short term financing rather than a short term liability when it comes to quick ratio.

2. Profitability Ratios:

1.Gross Profit Ratio = Gross profit/Net sales X 100

The gross profit ratio, also known as the gross margin ratio, it expresses the relationship
between a company's gross profit and its total revenue. It measures the percentage of total
revenue that represents gross profit, which is the profit a company makes after subtracting
the cost of goods sold (COGS) from its revenue.

The gross profit ratio is expressed as a percentage. It provides insight into how efficiently a
company manages its production costs and pricing strategy. A higher gross profit ratio
indicates that a company is effectively controlling its production costs and generating a
larger gross profit for each dollar of revenue. This can be a positive sign of profitability.

For example: If a company is having gross profit ratio of 50% then it means that for every 1
rupee of revenue the company generates it retains 0.5 rupee as gross profit after subtracting
cost of goods sold.

2. Operating Cost Ratio = Operating Cost/ Net sales X 100

The operating cost ratio measures the proportion of a company's revenue that is consumed
by its operating expenses. It is typically expressed as a percentage.

Operating expenses include costs such as salaries, rent, utilities, and other day-to-day
expenses required to run a business. The operating cost ratio helps assess the efficiency of
a company's operations by showing how much of its revenue is used to cover these
expenses. A lower operating cost ratio is generally considered more favourable
For example: An operating Cost Ratio of 30% means that 30% of company’s total revenue
is used for covering its operating expenses.
3. Operating Profit Ratio = Operating Profit/Net Sales X 100
The operating profit ratio, also known as the operating profit margin or operating margin,
measures the profitability of a company's core operating activities. It indicates the
percentage of revenue that remains as operating profit after deducting all operating
expenses. This ratio is often used to assess how efficiently a company is managing its
operating costs and generating profit from its core business operations.

- Operating Profit (also known as Operating Income or Earnings Before Interest and Taxes -
EBIT)

Interpreting the operating profit ratio:

- A higher operating profit ratio indicates that a company is more efficient at generating profit
from its core operations.
- A lower operating profit ratio suggests that a significant portion of revenue is being
consumed by operating expenses, which could be a concern.
Example: An operating Cost profit of 60% means that a company is generating a profit equal
to 60% of its total revenue.

4.Net Profit Ratio = Net Profit/Net sales X 100

The net profit ratio, also known as the net profit margin or simply profit margin, that
assesses a company's overall profitability after accounting for all expenses, including
operating expenses, interest, taxes, and any other non-operating costs. It's a crucial
indicator of a company's financial health and its ability to generate profit from its total
revenue.

- *Net Profit* is the profit remaining after subtracting all expenses, including operating
expenses, interest, taxes, and any other costs.

- The net profit ratio is expressed as a percentage, indicating the portion of total revenue that
remains as profit after all expenses are accounted for.
- A higher net profit ratio is generally favorable because it suggests that the company is
efficient in controlling its expenses and is generating a larger profit relative to its revenue.
- A lower net profit ratio may indicate that a significant portion of revenue is being consumed
by various expenses, which could be a concern for the company's profitability.

Example: A net profit ratio of 40% means that a company is generating a profit equal to 40%
of its total revenue after accounting for all expenses, including operating expenses, interest,
taxes, and any other costs.

5. Return on investment/Return on Capital employed = EBIT/Capital Employed X 100

6.Earning Per Share = PAT – Preference Dividend/ No of equity Share

7.Dividend Payout Ratio = DPS/EPS X 100

8.Dividend Yield Ratio = DPS/MPS X 100
The dividend yield ratio is like a measure of how much money you can make from owning a
stock.
Imagine you have some shares of a company's stock. The dividend yield ratio tells you how
much money you'll get from the company as a percentage of the price you paid for each
share.

For example, if you bought a share for $100, and the company pays you $5 in dividends per
year for owning that share, then the dividend yield ratio would be:

(5 / 100) x 100 = 5%

So, in this case, you'd get a 5% return on your investment each year from dividends.

9.Price earnings Ratio = MPS/EPS X 100

Price: This is how much one share of a company's stock costs right now in the stock market.
It's what people are currently willing to pay for it.

Earnings: This is how much profit a company makes for each share of its stock. It's like how
much money the company makes for each piece of the pie.

10.Return On Equity = NPAT/Shareholders Fund X 100 OR

The ROE ratio measures how efficiently a company is using its shareholders' equity to
generate profits. A higher ROE percentage indicates that the company is generating more
profit for each dollar of shareholders' equity, which is generally seen as a positive sign.

Illustration 1: The following Trading and profit and Loss account of fantasy LTD for the year
31-3-2017 is given below:
Particulars Rs Particulars Rs
To opening Stock 76,250 By Sales 5,00,000
To Purchases 3,15,250 By Closing stock 98,500
To carriage & freight 2000
To wages 5000
To gross profit b/d 2,00,000
5,98,500 5,98,500
To administration exp 1,01,000 By gross profit b/d 2,00,000
To selling and dist 12,000 By Interest on 1500
exp securities
To non-operating Exp 2,000 By dividend on shares 3750
To Net Profit c/d 91,000 By profit on sale of 750
shares
2,06,000 2,06,000
Calculate 1. Gross profit ratio 2. Operating Ratio 3. Net Profit Ratio 4. Administration
expense Ratio
Sol: 1. Gross Profit Ratio = Gross profit/Net Sales X 100
= 2,00,000/5,00,000 X 100
= 40%

2. Operating Ratio = Operating expense/Net Sales X 100

= 4,13,000/5,00,000 X 100 = 82.6%

Operating expenses = COGS + Operating Expenses

= 3,00,000 + 1,13,000
= 4,13,000

COGS = Op stock + purchases + Direct Exp – closing Stock

= 76,250 + 3,15,250 + 7000 – 98500
COGS = 3,00,000

Operating Expenses = Admin Exp + S & D exp = 1,01,000+ 12,000 = 1,13,000

3. Net Profit Ratio = Net Profit/Net Sales X 100

=91,000/5,00,000 X 100
= 18.2%

4.Administration expense Ratio = Admin Exp/ Net sales X 100

= 1,01,000/5,00,000 X 100
= 20.2%

Illustration 2: The balance sheet of Punjab Auto Limited as on 31-12-2002 was as follows

Liabilities Rs Assets Rs
Equity Share capital 40,000 Plant & machinery 24,000
Capital reserve 8,000 Land & Building 40,000
8% loan on mortgage 32,000 Furniture & Fixtures 16,000
Creditors 16,000 Stock 12,000
Bank Overdraft 4,000 Debtors 12,000
Bills Payable 8,000 Investments(short term) 4,000
Profit & Loss A/C 12,000 Cash in hand 12,000
1,20,000 1,20,000
From the above compute
1.Current Ratio 2. Quick Ratio 3.Debt-Equity Ratio 4.Proprietary Ratio
5.Capital Gearing Ratio.

1. Current Ratio = Current Assets/ Current Liabilities X

= 12,000+12,000+4,000+12,000/16,000+4,000+8,000
= 40,000/28,000
=1.43 : 1
Quick Ratio = Current Assets – Stock – Prepaid Expenses/ Current liabilities – Bank
overdraft
= 40,000 – 12,000 – 0 / 28,000 – 4,000 = 28,000/24,000= 1.16:1

3.Debt equity Ratio = Debt Fund/ Equity Fund

It is a capital Structure Ratio. It compares a company's total debt to its total equity. It's used
to assess a company's financial leverage and risk by examining the proportion of debt and
equity used to finance its operations and investments. If the Debt to equity ratio is 0.5 :1 then
it means that for every 1 rupee of equity the company has 0.5 rupee of debt.
Under equity fund we will include: Equity Share capital + Reserve & Surplus – misc Exp

= 32,000/ 40,000 + 8,000 + 12,000 – 0

= 32,000/ 60,000
= 0.53:1

4.Proprietary Ratio = Shareholders Fund/Total Assets X 100

It is a capital structure ratio also known as the equity ratio or net worth-to-total assets
ratio, is a financial metric that assesses the proportion of a company's assets financed by its
shareholders' equity. In other words, it measures the extent to which a company relies on its
own funds (equity) to support its assets, rather than relying on debt or external financing.

Shareholders fund = Equity Share capital + preference share capital + Reserve &
surplus(PnL A/C) = 40,000 + 8,000 + 12,000 = 60,000

Total Assets = Fixed Assets + Current Assets. = 1,20,000

60,000/1,20,000 X 100 = 50%

5.Capital Gearing Ratio = Debt fund + Preference share capital/ Equity Fund.
It is a capital structure Ratio. It assesses the relationship between a company's equity
(shareholders' funds) and its long-term debt (borrowings). This ratio helps analyze the
proportion of a company's financing that comes from equity as opposed to debt.

A high capital gearing ratio indicates that a significant portion of the company's financing
comes from long-term debt, which implies higher financial leverage and potentially higher
financial risk.
A capital gearing ratio of 0.3 indicates that a company's long-term debt represents 30% of its
shareholders' equity. In other words, for every 1$ of shareholders' equity, the company has
0.30 Cents of long-term debt.

A low capital gearing ratio suggests that the company relies more on equity financing,
indicating a lower level of financial risk but potentially lower returns on equity.

Under equity fund we will include: Equity Share capital + Reserve & Surplus – misc Exp
32,000/ 60,000
= 0.53:1
3.Following Information is available relating to TCS Ltd and Accenture LTD
Particulars TCS Ltd(Rs in lakhs) Accenture Ltd(Rs in
lakhs)
Equity Share capital @10 Rs each 200 250
12% Pref share Capital 80 100
PAT 50 70
Proposed Dividend 35 40
MPS 25 35
You are required to calculate:
1.EPS 2.P/E 3.Dividend Payout Ratio. 4.Dividend yield Ratio.

Solution:
Sr Particulars TCS Accenture
No
1 EPS = Pat- Pref Dividend/ No 50 – 9.6/20 2.32
of equity Share = Rs 2.02

2. P/E= MPS/EPS 25/2.02 = 12 times 15 times

3. DPR = DPS/EPS X 100 1.75/2.02 X 100 = 86.63% 68.96%

DPS = Proposed Dividend/No 35/20 = 1.75 1.6
of Equity Shares

4. DYR= DPS/MPS X100 1.75/25 X 100 = 7% 4.57%

A Price-to-Earnings (P/E) ratio of 12 times means that, in the context of stock valuation,
investors are willing to pay 12 times the company's earnings per share (EPS) to own a share
of that company's stock.
Illustration 4:
Wipro Ltd. Gives you the following information for the year ended 31st march 2017.
Profit before interest and Tax(EBIT) 16,50,000
Tax Rate 30%
Proposed equity dividend 25%

Capital Employed:
80,000 Equity share of FV Rs 10 each 8,00,000
10% Preference Share Capital 15,00,000
15% Debentures of Rs100 each 7,00,000
Reserve & Surplus 12,00,000
Total 42,00,000
Current market price (MPS) is RS 50 per share.
Calculate: 1.EPS 2.P/E Ratio 3.Dividend payout ratio 4. Dividend yield ratio
5. Return on capital employed 6.Return on equity fund. 7. Book value per share

Solution:
HINT: In order to solve this problem we need to find EAESH so that we can find EPS
For that we will be preparing the income statement depending upon the information given to
us in the sum as we used to do in the chapter leverages.

Income Statement

Sr No Particulars RS
1 EBIT 16,50,000
2 Less: (Interest) (15% of debt) 1,05,000
3 EBT 15,45,000
4 Less: (Tax @ 30%) 4,63,500
5 EAT 10,81,500
6 Less : (Pref Dividend) (10% of Pref Sh) 1,50,000
7 Earnings available for equity shareholders 9,31,500

1. EPS = EAESH/ No of equity share

= 9,31,500/80,000
= RS 11.64 Per share

Calculation of No of Equity Share = Equity share capital/FV = 8,00,000/10 = 80,000

2. P/E Ratio= MPS/EPS = 50/11.64 = 4.3 times

3.Dividend Payout ratio = DPS/EPS X 100

= 2.5/11.64 X 100
= 21.48%
Calculation of DPS when Dividend Payout is given as %.
In this case we are given the proposed dividend in the form of % rather than amount.
So we will use the formula FV X Rate of dividend = 10 X 25% = 2.5RS per share

For DPS we have 2 formula

1.When proposed dividend is given in Amt = Proposed Dividend/No of Equity Share
2.When proposed dividend is given in % = FV X Rate of dividend.

4.Dividend Yield Ratio = DPS/MPS X 100

= 2.5/50 X 100 = 5%

5.Return on Capital employed = EBIT/Capital Employed X 100

= 16,50,000/42,00,000 X 100
= 39.29%
The capital employed is given in the question itself

6.Return on Equity = EAESH/Equity Fund X 100

Equity Fund = Equity Share Capital + R/S – Misc. Expenses
= 8,00,000+12,00,000 – NIL
= 20,00,000

= 9,31,500/20,00,000 X 100
= 46.58%
7.Book value per share = Equity Share Capital + Reserve and surplus/No of equity shares
= 8,00,000+12,00,000/80,000 = RS 25 per share

A company’s book value is the amount of money shareholders would receive if assets
were liquidated and liabilities paid off. MPS is based on the current price of the share
Illustration 5:
Following Information is available relating to ABC Ltd and XYZ LTD
Particulars ABC Ltd(Rs in lakhs) XYZ Ltd(Rs in lakhs)
Equity Share capital @10 Rs each 200 250
10% Pref share Capital 80 100
15% Debentures 20 60
EBIT 60 80
Proposed Dividend 20 25
Provision for Tax 17 21
MPS Rs 50( Per Share) Rs 60( Per Share)
You are required to calculate:
1.EPS 2.P/E 3.Dividend Payout Ratio. 4.Dividend yield Ratio.
5. Return On equity 6. Return on capital employed

Hint:
We will prepare income statement first so that we get EAESH and then we will use
ratios accordingly
Solution:
Sr No Particulars ABC Ltd (Rs in lakhs) XYZ Ltd (Rs in lakhs)
1 EBIT 60 80
2 Interest( 15 % of 20) (3) (9)
3 EBT 57 71
4 Tax (17) (21)
5 EAT 40 50
6 Preference Dividend10 % 0f 80) (8) (10)
7 EAESH 32 40
Ratio:
Sr No Formula ABC XYZ
1 EPS = EAESH/No of equity share 32/20 = 1.6 1.6

2 P/E Ratio = MPS/EPS 50/1.6 = 31.25 37.5

3 DPR = DPS/EPS X 100 1/1.6 X 100 = 62.5% 62.5

DPS = Proposed Div/ No of Eq sh 20/20 = 1

4 DYR = DPS/MPS X100 1/50X100 = 2% 1.67

5 Return on equity = EAESH/ Equity 32/200 X 100 = 16% 16%

fund X 100

6 ROCE = EBIT/ Cap employed X 60/300X100 = 20% 19.51%

100
Capital Employed = Equity Share
capital + preference share capital +
debentures
Illustration 6: Avengers Ltd has presented the financial information for the year 2017 as
follows:
Income Statement for the year ended 31st march 2017
Particular Rs
Net Sales 1,02,00,000
Cost of good sold 79,20,000
Selling and admin expenses 15,45,000
EBT 7,34,000

Balance Sheet as on 31st March,2017

Liabilities Amt Assets Amt
Equity share @10rs 12,00,000 Fixed assets 28,60,000
each
Reserve and surplus 8,00,000 Stock 19,80,000
10% long term debt 22,70,000 Debtors 16,50,000
Current liabilities 23,50,000 Cash 1,30,000
66,20,000 66,20,000
Additional info:
1. Tax is 30%
2. Company has declared dividend @ 25%
3. MPS is 50
1. EPS 2.P/E 3. ROCE 4.Dividend Payout Ratio 5. Dividend yield
ratio 6. Gross Profit ratio.

Solution:
Income Statement
Particulars Rs
EBIT 9,61,000
(Interest)(22,70,000 X 10%) 2,27,000
EBT 7,34,000
(TAX) @30% 2,20,200
EAT 5,13,800

Sr No Formula ABC
1 EPS = EAESH/No of equity share 5,13,800/1,20,000= 4.2 per share

2 P/E Ratio = MPS/EPS 50/4.2 = 11.68 times

3 DPR = DPS/EPS X 100 2.5/4.2 X 100 = 59.52%

DPS = FV X dividend % 2.5

4 DYR = DPS/MPS X100 2.5/50 X 100 = 5%

5 GP Ratio = Gross Profit/Net Sales X 22,80,000/1,02,00,000 X 100 = 22.35%

100
 GP = Sales – COGS = 1,02,00,000 –
79,20,000 = 22,80,000

6 ROCE = EBIT/ Cap employed X 9,61,000/42,70,000 X 100 = 22.5%

100
Capital Employed = Equity Share 12,00,000+22,70,000 = 42,70,000
capital + Reserve & surplus +
preference share capital + debentures

Illustration 7: Following is the balance sheet of Amit LTD as on 31st march

2019.
Liabilities Amt Assets Amt
Equity share @10rs 6,00,000 Land & Building 6,00,000
each
Reserve and surplus 4,00,000 Plant & machinery 5,00,000
8% long term debt 5,00,000 Stock 2,60,000
Creditor 2,00,000 Debtors 3,00,000
Proposed Dividend 60,000 Cash at bank 1,00,000
17,60,000 17,60,000
Additional Information:
1. COGS = 9,00,000
2. Administrative and other expenses = 1,00,000
3. Sales = 15,00,000
4. NPAT = 3,60,000
5. MPS = Rs 600 Per share
Calculate: 1. Return On equity 2. Dividend yield Ratio 3. Dividend
Payout Ratio 4. Net profit Margin 5. Debt Equity Ratio 6. EPS 7. P/E
8. GP

Solution:
Sr No Formula Amit LTD.
1 EPS = Pat – Pref Div/No of equity share 3,60,000/60,000 = Rs 6

2 P/E Ratio = MPS/EPS 600/6 = 100 times

3 DPR = DPS/EPS X 100 1/6 X 100 = 16.67%

DPS = 60,000/60,000 = 1

4 DYR = DPS/MPS X100 1/600 X 100 = 0.167%

5 GP Ratio = Gross Profit/Net Sales X 100 6,00,000/15,00,000X100 =

GP = Sales – COGS = 15,00,000 – 40%
 9,00,000=6,00,000

6 Net Profit Margin = PAT/Net Sales X 100 3,60,000/15,00,000X 100 =

24%
7 Debt Equity Ratio = Debt Fund/Equity Fund 5,00,000/10,00,000 = 0.5 : 1
Equity Fund + R/S – Misc Expenses
6,00,000 + 4,00,000 = 10,00,000

8 Return on Equity = Pat – Pref Dividend/Equity 3,60,000/10,00,000 X 100 =

Fund X 100 36%

Illustration 8:
Following is the balance sheet of Adani ltd as on 31st march 2017.
Balance sheet as on 31-03-2017
Liabilities Rs Assets Rs
8% Preference share 56,000 Fixed assets 3,38,000
capital
Equity share capital 1,00,000 Investment 39,000
Reserves 1,04,000 Cash 13,000
Long term loan 1,82,000 Debtors 52,000
Creditors 44,200 Stock 78,000
Provision for tax 33,800
5,20,000 5,20,000

Income Statement For the year ended 31-03-2017

Particular Rs
Net Sales 3,90,000
Less: COGS (3,35,400)
Gross Profit 54,600
Less: Operating Expenses (22,750)
EBIT(Operating Profit) 31,850
Less: Interest (9,100)
NPBT 22,750
Additional Information:
A.Tax Rate 30%
B. Face Value of equity share= Rs 10
C. Proposed Dividend = 5%
D. Market Price of equity share = 35
Calculate the following:
1.Interest Coverage Ratio 2.EPS 3.Debt Equity ratio 4.P/E Ratio
5. Stock turnover Ratio 6.Dividend Payout ratio 7.Gross profit
8. Current Ratio 9. Proprietary Ratio 10. Fixed Asset Turnover
ratio 11.Operating Profit Ratio.
Solution :
Income Statement
Particulars Rs
EBT 22,750
Less : Tax @30% (6,825)
EAT 15,925
Less : Preference Dividend (4,480)
EAESH 11,445
Formula:
1.Interest coverage ratio = EBIT/Interest
= 31,850/9,100 = 3.5 times
The interest coverage ratio is used to assess a company's ability to meet its
interest payment obligations on its debt.

The resulting interest coverage ratio indicates how many times a company can
cover its interest expenses with its operating profit. A higher interest coverage
ratio is generally seen as more favourable because it suggests that the company
has a strong ability to meet its interest obligations. It indicates that the company
has sufficient earnings to comfortably cover its interest costs.

2.EPS = Rs 1.14

3.Debt Equity Ratio = Debt Fund/ Equity Fund

= 1,82,000/2,04,000 = 0.89 : 1
Equity fund = Equity Fund + R/s = 1,00,000 + 1,04,000 = 2,04,000

4.P/E Ratio = MPS/EPS = 35/1.14 = 30.7 Times

5.Stock Turnover Ratio = COGS/Avg. Stock

= 3,35,400/78,000 = 4.3 times
Avg stock = Opening stock + closing stock/2 = 78,000
In this case opening stock is not given hence we are taking closing stock as
average stock.

The stock turnover ratio, also known as inventory turnover ratio, measures how
efficiently a company manages its inventory. It calculates how many times a
 company's inventory is sold and replaced during a specific period, usually a
year. The stock turnover ratio is an important indicator of a company's
inventory management and its ability to generate sales from its inventory.

6.Dividend Payout ratio = DPS/EPS X 100 ( DPS = 10X5% = 0.5)

= 0.5/1.14X 100 = 43.86%.

7.Gross profit Ratio = GP/Net Sales X 100 =

= 54,600/3,90,000 X100
= 14%
8.Current Ratio = Current Assets/Current Liabilities
= 13,000 + 52,000 + 78,000/44,200 + 33,800
= 1,43,000/78,000
= 1.83 : 1

9.Proprietary Ratio = Shareholders Fund/Total Assets X 100

= 56,000 + 1,00,000 + 1,04,000/5,20,000 X 100
= 50%
10.Fixed Asset Turnover ratio = Net Sales/Fixed Assets
= 3,90,000/3,38,000 =1.15 times
The fixed assets turnover ratio is a financial metric used to assess how
efficiently a company utilizes its fixed assets (also known as long-term assets or
non-current assets) to generate sales revenue. Fixed assets typically include
things like property, plant, equipment, and other long-term investments. This
ratio helps evaluate the company's ability to generate sales from its investments
in these long-term assets.
The resulting fixed assets turnover ratio indicates how effectively the company
is using its fixed assets to generate sales revenue. A higher fixed assets turnover
ratio is generally seen as more favorable because it suggests that the company is
generating more sales revenue for each dollar invested in fixed assets.
Conversely, a lower ratio may indicate that the company is not efficiently
utilizing its fixed assets.

11. Operating Profit Ratio = Operating Profit(EBIT)/ Net Sales X 100

= 31,850/3,90,000 X 100
= 8.17%
Illustration 9: Following is the balance sheet of south ltd as on 31st march 2016:
Liabilities Rs Assets Rs
Equity share capital 20,00,000 Fixed Assets 55,00,000
10 % Pref Share cap 20,00,000 Stock 1,75,000
Reserves 11,00,000 Debtors 3,50,000
10% Debentures 10,00,000 Bills receivable 50,000
Creditors 1,00,000 Cash 2,25,000
Bank Overdraft 1,50,000 Fictitious Assets 1,00,000
Bills Payable 45,000
Outstanding Expenses 5,000
64,00,000 64,00,000

Income Statement
Particulars RS RS
Sales ( 40% of cash Sales) 15,00,000
Less : Cost of sales (7,50,000)
Gross Profit 7,50,000
Less: Office exp(Including 1,25,000
Interest on debt)
Selling Expenses 1,25,000 (2,50,000)
PBT 5,00,000
Less:Tax 2,50,000
PAT 2,50,000
Note: Opening Stock was of 3,25,000
Calculate: 1. GP ratio 2. Stock Turnover Ratio 3. Operating Profit
Ratio 4. Current Ratio 5. Liquid Ratio 6.Debtors Turnover
Ratio 7. Creditors Turnover Ratio 8.Proprietary Ratio
9. Return on Capital Employed 10. Return on equity Shares 11. Return on
shareholders fund

Solution:
Hint:If we notice in the sum out off total sales 40% is in cash so we have to
bifurcate it in cash and credit. Also in office expenses by mistake interest on
debentures has been added so we need to subtract that as well.
 Income Statement
Particulars Rs Rs
Sales
Cash Sales (40%) 6,00,000
Credit Sales (60%) 9,00,000 15,00,000
Less: Cogs (7,50,000)
Gross Profit 7,50,000
Less: Operating
Expenses
Office 25,000
expenses(excluding (1,25,000 – 1,00,000)
interest on debt)
Selling exp 1,25,000 (1,50,000)
EBIT 6,00,000
Less: Interest (1,00,000)
EBT 5,00,000
Less:Tax (2,50,000)
EAT/PAT 2,50,000

1.Stock Turnover Ratio = COGS/Avg Stock

= 7,50,000/2,50,000
= 3 Times
Avg stock = opening stock + Closing Stock/2
= 3,25,000+1,75,000/2 = 2,50,000

2.Debtors Turnover Ratio = Credit Sales/Debtor + Bills receivable

= 9,00,000/4,00,000
= 2.25 times
The Debtors Turnover Ratio is used to assess how efficiently a company
manages its accounts receivable (money owed by customers) during a specific
period, typically a year. It's an important metric for assessing a company's
ability to collect cash from credit sales.
A higher Debtors Turnover Ratio generally indicates that a company is
collecting its accounts receivable more quickly, which is typically seen as a
positive sign. Conversely, a lower ratio may suggest that a company is having
difficulty collecting payments from customers, which could potentially lead to
cash flow problems.
An accounts receivable turnover ratio of 2.25 times indicates that, on
average, the company collected its outstanding accounts receivable 2.25
times during the specific period being measured (usually a year)

3.Creditor Turnover Ratio = Credit Purchase/Creditor + Bills payable

= 7,50,000/1,45,000
= 5.17 times
NOTE: When credit Purchase is not given we take COGS as credit Purchases.

The Creditor Turnover Ratio is used to assess how efficiently a company

manages its accounts payable (money it owes to suppliers or creditors) during a
specific period, typically a year. It measures how quickly a company pays its
suppliers.

Illustration 10: Following is the balance sheet of ABC Ltd. For the year ended
31st march, 2017.
Balance sheet as on 31-03-2017
Liabilities Amt Rs Assets Amt Rs
Equity Share Capital 2,32,570 Fixed assets 2,68,210
8% preference share 1,00,000 Stock 68,690
General Reserve 61,560 Debtor 1,92,500
Profit & Loss A/C 62,280 Prepaid expenses 4,150
8% Debentures 92,500 Bank 1,04,360
Sundry creditors 53,370
Current Liabilities 35,630
6,37,910 6,37,910
Additional Information:
1. EBIT = 1,34,400
2. Tax = @50%
You are required to calculate:
1.Total Assets
2.Net Worth
3.Return on capital employed.
4. Return on equity capital.
5. Return on shareholders fund.
Solution:
Balance sheet as on 31-03-2017.
Sr no Particulars Debit Rs Credit Rs
1. Sources of fund
A.shareholders Fund(Own)
a. Share capital:
Equity share capital 2,32,570
8% Preference Share capital 1,00,000
3,32,570
b. Add: Reserves & surplus
General Reserves 61,560
Profit & Loss A/C 62,280
1,23,840
c. Less: Fictitious assets 0
Shareholders Fund(1) 4,56,410
2. Borrowed Fund
a. 8% Debentures 92,500
Borrowed Fund (2) 92,500
Total Capital Employed (1+2) 5,48,910

3. Application Of funds
a. Fixed Assets 2,68,210
b. Investments 0
C. Working Capital
Current Assets:(A)
Stock 68,690
Debtors 1,92,500
Prepaid Expenses 4,150
Bank 1,04,360
Total Current Assets 3,69,700
Less: Current Liabilities(B)
Sundry Creditors 53,370
Current liabilities 35,630
Total current liabilities (89,000)
Working Capital = (A-B) 2,80,700
Total Capital employed = Fixed 5,48,910
assets + investments + working
capital
 Income Statement
Sr No Particulars Rs
1 EBIT 1,34,400
2 Less: Interest (92500 X 8%) (7,400)
3 EBT 1,27,000
4 Less: Tax @50% (63,500)
5 EAT 63,500
6 Less : Preference Dividend (1,00,000 X 8%) (8000)
7 EAESH 55,500

A.Return on Capital employed = EBIT/Total capital employed X 100

= 1,34,400/5,48,910 X 100 = 24.48%

B.Return on Equity Capital = EAT-Pref Div/Equity Fund X100

= 55,500/3,56,410 X100
= 15.57%
Equity fund = eq sh cap + R/S – Fictitious assests( misc exp)
= 2,32,570 + 1,23,840 – 0 = 3,56,410

C. Return on shareholders fund = PAT/Shareholders Fund X 100

= 63,500/4,56,410 X 100
= 13.91%

Total assets = Fixed assets + investments + current assets

= 2,68,210+0+3,69,700
= 6,37,910
Net worth = shareholders fund = 4,56,410
Shareholders' funds are often referred to as "net worth" because they represent
the residual interest in a company's assets after deducting its liabilities. In other
words, it is the equity portion of a company's balance sheet, and it belongs to
the shareholders or owners of the company.
Illustration 11: Following is the balance sheet of Binance Ltd. As on 31-12-
2018

Balance sheet as on 31-12-2018

Liabilities Amt Rs Assets Amt Rs
Equity Share Capital 2,50,000 Goodwill 20,000
6% preference share 1,50,000 Land & Building 2,50,000
General Reserve 20,000 Machinery 1,75,000
Profit & Loss A/C 15,000 Furniture 10,000
5% Debentures 1,00,000 Stock 90,000
Sundry creditors 28,000 Sundry Debtors 21,000
Bills Payable 12,000 Cash at bank 5000
Preliminary Expenses 4000
5,75,000 5,75,000
Other information:
Total sales Rs. 4,00,000: 20% of which is made on credit. Gross Profit and Net
Profit (after tax) for the year ended amounted to Rs. 80,000 and Rs. 20,000
respectively.

You are required to calculate the following ratios:

(a) Current Ratio (b) Liquid Ratio (c) Proprietary Ratio (d) Debt Equity Ratio
(e) Capital Gearing Ratio (f) Debtors Turnover Ratio Period (g) GP Ratio (h)
NP Ratio (i) Stock Turnover Ratio (j) EPS.

Solution;
Total sales = 4,00,000
Credit Sales = 4,00,000 X 20% = 80,000
Cash sales = 3,20,000

Gross profit = net sales – cogs

Cogs = Net sales – GP
= 4,00,000 – 80,000
COGS = 3,20,000

A. Current Ratio = Current Assets/Current liabilities

= 1,16,000/40,000
= 2.9:1
B. Liquid Ratio = Current Assets – Stock – Prepaid Expenses/ Current Liabilities – Bod
= 1,16,000 – 90,000/40,000
= 0.65:1

C. Proprietary Ratio = Shareholders fund/Total Assets X 100

= 4,31,000/5,71,000 X 100 = 75.48%
Shareholders fund = Equity + Preference share capital
= 2,81,000 + 1,50,000
= 4,31,000
Total assets = fixed assets + investments + current Assets
= 4,55,000 + 1,16,000 = 5,71,000

D. Debt Equity Ratio = Debt Fund/Equity fund

= 1,00,000/ 2,81,000
= 0.356 : 1
Equity fund = equity share capital + reserve and surplus + PnL A/C credit
balance – misc exp
= 2,50,000 + 20,000 + 15,000 – 4,000
= 2,81,000

E. Capital gearing ratio = Pref share capital + debt fund/Equity fund

= 1,50,000 + 1,00,000/2,81,000
= 0.89 : 1

F. Debtors Turnover Ratio = Credit Sales/Debtors + B/R

= 80,000/21,000
= 3.8 times

G. GP Ratio = GP/Net Sales X 100

= 80,000/4,00,000 X 100 = 20%

H. NP Ratio = Net profit/Net sales X 100

= 20,000/4,00,000X100 = 5%

I. Stock Turnover Ratio = COGS/AVG Stock

= 3,20,000/90,000
= 3.55 times
J. EPS = EAT – Pref dividend/No of equiy Shares
= 20,000 – 9,000/25000 = Rs 0.44 per share