What is Ratio Analysis

Accounting RatiosAccounting Ratios are the relationship between two amounts or two group of amounts given in financial statements(Income statement/Profit & Loss A/c & Position Statements/Balance Sheet) . It is a process of simplify the complex amounts it is helpful to understand the quantitative and qualitative relations of items shown in financial statements. It is a significant tool of managerial and financial analysis and decision making .It is also helpful in forecasting of growth of profits and wealth .

In order to compute a meaningful ratios, there must be a significant relation between the two figures . A ratio focuses attention on a relation which is significant, but a full interpretation of the ratio usually requires further investigation of the underlying data. Ratios are an aid to analysis and interpretation, they are not a substitute for sound thinking.

TYPES OF RATIOS/ CLASSIFICATION OF RATIOS

Liquidity Ratios1.Current Ratio 2. Liquid Ratio/Quick Ratio/Acid Test Ratio

Profitability Ratio1. Gross profit Ratio2.Net Profit Ratio3.Return on Equity4.Return on Capital Employed/Total Investment5.Return on Total Assets

Turnover Ratios

1.inventry/Stock turnover ratio2.Fixed Asset turnover ratio3.Current Asset Turnover Ratio4.Working Assets Turnover Ratio Stability Ratios/Capital Ratios

1.Debt Equity ratio2.Fixed Asset to Capital ratio

On the basis of P/L A/C Or Income Statement

1. Gross Profit Ratio Gross Profit × 100

Net sales (credit sale+cash)

2.

Net Profit Ratio Net profit ×100 Net sales

3. Operating ratio Cost of goods sold + Op. exp. × 100 Net sales

4.

Expenses Ratio Particular expenses × 100 Net sales

5. Stock or Inventory turnover Ratio

Net sales Or Cost of goods sold Average Inventory Average stock = Opening +closing 2

6. Operating expenses ratio Operating expenses ×100 Net sales

7. Operating profit ratio Operating Profit×100 Net sales Operating profit = Gross Profit –operating expenses

8. Interest coverage ratio PBIT (Profit before interest and terms) Interest on long term debts

1. Current Ratio Current Asset (2:1) Current liability

2. Quick or Liquid Ratio Quick or Liquid Assets (1:1) Quick Liabilities Quick assets = Current – ( Closing Stock + Prepaid ) Quick liabilities = Current liabilities – Bank overdraft

3. Proprietary Ratio (Net worth to total asset ratio )

Equity or share holder fund Total Assets or total equities Share holders fund = Eq. share capital + Reserve fund +reserve for dividend

4. Fixed Asset Ratio ( Fixed Asset to net worth )

Fixed Assets Net worth or long term loans

5. Capital gearing ratio

Shareholders fund (Total debts capital = Debentures + Total debts capital preference share capital)

Share holder fund = Equity share capital+ Reserve fund +

Reserve for dividend 6. Debt equity

ratio Long term debt or External equity Share holder eq. or fund Internal Equity

7. Solvency Ratio Total assets (1:1) Total liability