I.H.M Dehradun Accountancy ( Theory)

Notes by -:

G.K Sawhney

7895190950 TOPIC - RATIO ANALYSIS

Ratio Analysis- Ratio is the relationship between two items or two group of items on the basis of amounts given in financial statement i.e Income statement & Position statement .It is most important tool of Financial management. With the help of Ratio analysis normally management compare the result of two companies relating same year financial statement or between financial statement of two years of same company. With the help of Ratio analysis financial managers may able to make effective planning for next financial year/years.

TYPES OF RATIO’SThere are three types of ratios:

1) In percentage- Normally all profitability ratios are analysed or explained in terms of percentage. For eg: Gross profit ratio, Net profit ratio, operating ration , operating profit ratio, etc.

2) In Turnover / In times- All turnover ratios’s are computed / analysed in times.For eg: Stock turnover ratio(Inventory turnover ratio), Current assets turnover ratio, Fixed assets turnover ratio, Average collection period , etc.

3) Simple ratio- 2:1 , 3:1 ,4:1 ,5:1 etc..

CLASSIFICATION OF RATIO’S(a) On the basis of Financial statements

1) On the basis of Income statement or Profit & loss Account following ratios may be computed / calculated. i) Gross Profit Ratio- Gross Profit

Net sale x 100 ii) Net Profit ratio-Net profit/ Net sale x 100 iii) Operating ratio-Cost of good sold+ Operating expense/ Net sale x100 iv) Operating Profit ratio- Operating Profit / Net sale ×100 v) Stock / Inventory / Merchandise Turnover ratio- Cost of good sold / Average stock vi) Interest coverage ratio- Profit before interest & tax / Interest on debenture / loan vii) Particular / Specific expense ratio- Particular expense / Net sale × 100

b) On the basis of balance sheet / Position Statement: i) Current Ratio- Current Assets / Current liabilities (NOTE- 2:1 is assumed satisfactory) ii) Liquidity ratio/ Quick ratio / Acid test ratio- Quick asset / Liquid Asset / Current liability / Liquid liability (NOTE- Quick asset= Current asset – closing stock – Prepaid expense Liquid asset = Current liability – bank overdraft iii) Debt equity ratio = Debt / equity (Working note- Capital employed = Fixed asset + Current asset – current liability Capital Employed = Debt + equity iv) Fixed asset to net worth = Fixed asset / Net worth ( or equity or shareholder funds) v) Properirtory ratio / Shareholder funds to asset = Shareholder funds (equity) / Total asset (Fixed asset + Current asset) vii) Equity to total long term funds , Equity to total investment , Shareholder funds to total investment = Shareholder fund / Capital employed / Total Investment WORKING NOTE- Net sale = Gross sale – Sales return Cost of goods sold = Net sale –Gross profit OR Cost of goods sold = Opening stock + Purchases + Wages + Direct expense – Closing stock