Financial Analysis Through Ratios.docx
-
Upload
chandramouli-kolavasi -
Category
Documents
-
view
220 -
download
0
Transcript of Financial Analysis Through Ratios.docx
Financial Analysis Through Ratios
Ratio Analysis
Need of ratio analysis
Much of the financial information is mentioned in the Financial Statements of a company,but sometimes an absolute figures conveys no meaning.a figure may become more meaningful if it is compared with some other informative figure. Also the figure mentioned in financial statements may not give the qualitative information. For analyzing and interpretation of financial statements Ratio Analysis is used.
Importance of Ratio Analysis
As the absolute figure do not convey any meaning unless they are compared eith each other. Various ratios can be obtained from financial ratio by grouping and regrouping of figure in order to draw fruitful meanings. The importance of ratio analysis are mentioned.
i. Ratio analysis states the financial position of the firm. It helps insurance companies,bank other financial institution s for assessing the firm before sanctioning loan to them.
ii. Financial ratios are also useful for investors for finding the profitability of the firm.iii. The financial ratios of organization may be compared with the ratio of previous year of
the same organization to find the exact growth of firm.this comparison is called intra- firm comparison.
iv. The ratio of one organizations are compared with other organization of similar industry.this is called as inter-firm comparision.
v. Ratio analysis helps in setting future plans and forecasting of the firm.vi. Ratios reflects the actual asset and liability so the weaknesses of the firm can be point out
and remedial steps can be taken to overcome this situation.vii. Ratios indicates the efficiency of the firm.
viii. Ratios reflects the ability of the firm to meet the financial obligations.
Classification of Ratios
Following types of financial ratios are particularly important to managerial control.i. Liquidity ratios.
ii. Activity ratios/ Asset management ratios.iii. Debt management ratios/Leverage ratios.iv. Profitability ratios.
Liquidity Ratios
Liquidity ratios can be classified into two types.
1.Current Ratio.
2.Quick Ratio.
Current Ratio
Current Assets
Current Ratio= ------------------------------
Current Liability
Quick Ratio
Quick Assets
Quick Ratio= -------------------------
Current Liabilities
Where ,
Quick Assets=Current Assets-(stock+ prepaid Expenses)
Activity Ratio
Activity ratio is calssified as.
1.Inventory Turnover Ratio.
2.Debtors Turnover Ratio.
Inventory Turnover Ratio
Cost of goods sold
Inventory Turnover Ratio= -------------------------
Average inventory
Where,
Cost of goods=sales - gross profit
Opening Inventory + Closing Inventory
Average Inventory=------------------------------------------------------
2
365 days
Inventory holding period= ------------------------------------
Inventory Turnover Ratio
Debtor’s Turnover Ratio
Credit Sales
Debtor’s turnover ratio= --------------------
Average debtor’s
Where ,
Credit sales refers to goods sold on credit,
Credit sales=Gross credit sales-returns.
Debtors at the beginning of year + Debtors at the end of year
Average debtor= ---------------------------------------------------------------------------
2
Capital Structure Ratios
Capital structure ratios are classified as
1.Debt-equity ratio
2.Inerest coverage ratio
Debt-equity Ratio
Debt
Debt-equity Ratio= -------------
Equity
Interest Coverage Ratio
Net Profit before interest and taxes
Interest Coverage Ratio =------------------------------------------------------
Interest
Profitability Ratios
Profitability ratio measures profitability of the firm. if provides information as following
-Quantum of profit.
-Rate of return.
-Earning for each share.
-Amount for each divided.
Various types of profitability ratios are1.Gross profit ratio.2.Net profit ratio.3.Price/Earning ratio(P/E ratio).4.Earning per share(EPS).
Gross Profit Ratio
Gross Profit
Gross Profit Ratio= ------------------ x100
Sales
Where ,
Gross Profit = Sale - cost of goods sold.
Net Profit Ratio
Net profit after taxes
Net Profit Ratio = --------------------------- x100
Net sales
Earnings Per Share(EPS)
Net profit after taxes
EPS = ------------------------------------
Number of shares out standings
Price /Earning Ratio(P/E ratio)
Price /Earning ratio is given by- Market value per share
P/E ratio = --------------------------------------- EPS
Limitations of Ratio Analysis
1.Accounting ratios are retrospective.
2.Accounting methods,policies and procedures are not common.
3.Inflationary tendencies cannot be highlighted.
4.Concept of ratios are not the same.
5.Ratios by itself has no utility.
6.Factors weakening ratio analysis.
Problems
1.Two companies ABC Limited and XYZ Limited have approached ICICI Bank for a loan sanction of Rs. 50,000 for working capital purpose.
ABC LIMITED (Rs.) XYZ LIMITED (Rs.)Net sales 9,10,000 7,50,000Gross profit 3,82,000 2,92,500Interest paid 20,000 8,200Income Tax 75,000 5,000Profit after Tax 82,000 56,200Inventories 90,000 65,200Debtors 70,000 56,000Cash 6,000 18,000Current liabilities 1,82,000 1,16,000Long term liability 1,60,000 1,30,000Shareholders equity 1,80,000 1,40,000
2. From the following extract of a balance sheet of airline company calculate the debt equity ratio and interest coverage ratio. Given that the debt equity ratio is in the range of 10:1,how do u interpret this ratio?50,000,10% preference shares of Ra.100 each 2,00,000 equity shares of Rs.10 each 10%,3,00,000 debentures of Rs.100 each Net profit during the year was Rs.10,00,000.
3.Selected financial information about Siri Traders Limited is given below:
2001 2002Sales
Cost of goods sold
Debtors
Inventories
Cash
Other current assets
Current liabilities
6,00,000
5,70,000
72,000
1,14,000
15,000
40,000
1,60,000
4,30,000
3,25,000
30,000
55,000
8,000
27,000
1,10,000 Compute the current ratio, quick ratio, debt collection period and inventory turnover ratios for
the above two years and comment on the results.
4.The following are the extracts from the financial statements of Blue and Red Ltd. As on 31st March 2001 and 2002 respectively.
31st March 2001 (Rs.)
31st March 2002 (Rs.)
Stock
Debtors
Bills receivables
Cash in hand
Bills payable
Bank overdraft
9% debentures
Sales for the year
10,000
20,000
10,000
18,000
15,000
----
5,00,000
3,50,000
25,000
20,000
5,000
15,000
20,000
2,000
5,00,000
3,00,000
Gross profit 70,000 50,000 Compute for both the years the following.
a) Current ratio.b) Liquidity ratio.c) Stock turnover ratio. Also interpret the results.
5. The summarized balance sheet of Alpha Ltd,as on 31st March 2000,2001 and 2002 is given below.
As on March 31st
2000 2001 (Rs.in lakhs) 2002 (Rs. In lakhs)Liabilities:Paid up capitalBorrowing long term
i. Bonds ii. Others
Current liabilities
194
6828152----595
194
9734354---688
194
12437999---796
Assets:Gross BlockLess depreciation
Net BlockCurrent AssetsProfit and LossAccount
35569----
286143166
35695----
261199228
361122-----
239234323
Total 595 688 796From the above compute the following as on 31st March 2000 and 2002:
a) Debt to Equity Ratiob) Current Ratio and comment on the results.
6. Following is the Profit and Loss Account and Balance Sheet of Jai Hind Ltd. Calculate the following ratios.
a) Gross Profit Ratio b) Current Ratio c) Liquidity ratio.
Profit and Loss Account
Dr. Cr.
Liabilities Rs. Assets Rs.To Opening stock of finished goods
To opening shock of raw materials
To Purchase of raw materials
To manufacturing Expenses
To administration Expenses
To selling and distribution expenses
To Loss on sale of plant
To Interest on debentures
To Net profit
1,00,000
50,000
3,00,000
1,00,000
50,000
50,000
55,000
10,000
3,85,00011,00,000
By sales
By closing stock of raw materials
By closing stock of finished goodsBy Profit or sale of shares
8,00,000
1,50,000
1,00,000
50,000
11,00,000Balance sheet
Liabilities Rs. Assets Rs.Share Capital:
Equity share capital
Preference share capital
Reserves
Debentures
Sundry creditors
Bills paable
100000
100000
100000
200000
100000
50000650000
Fixed Assets:
Stock of raw materials
Stock of finished goods
Sundry debtors
Bank balance
250000
150000
100000
100000
50000
650000