Ratio Analysis RATIO ANALYSIS WHY FINANCIAL ANALYSIS Lenders’ need it by crazysid

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									RATIO ANALYSIS
WHY FINANCIAL ANALYSIS

Lenders’ need it for carrying out the following
 Technical Appraisal

 Commercial Appraisal

 Financial Appraisal

 Economic Appraisal

 Management Appraisal
RATIO ANALYSIS
It’s a tool which enables the banker or lender to
   arrive at the following factors :
 Liquidity position
 Profitability
 Solvency
 Financial Stability
 Quality of the Management
 Safety & Security of the loans & advances to be or
   already been provided
HOW A RATIO IS EXPRESSED?
   As Percentage - such as 25% or 50% . For example
    if net profit is Rs.25,000/- and the sales is
    Rs.1,00,000/- then the net profit can be said to be
    25% of the sales.
   As Proportion - The above figures may be expressed
    in terms of the relationship between net profit to sales
    as 1 : 4.
   As Pure Number /Times - The same can also be
    expressed in an alternatively way such as the sale is 4
    times of the net profit or profit is 1/4th of the sales.
CLASSIFICATION OF RATIOS
 Balance Sheet            P&L Ratio or      Balance Sheet and
     Ratio             Income/Revenue       Profit & Loss Ratio
                        Statement Ratio

   Financial Ratio       Operating Ratio       Composite Ratio
Current Ratio        Gross Profit Ratio     Fixed Asset Turnover
Quick Asset Ratio    Operating Ratio        Ratio, Return on
Proprietary Ratio    Expense Ratio          Total Resources
Debt Equity Ratio    Net profit Ratio       Ratio,
                     Stock Turnover Ratio   Return on Own Funds
                                            Ratio, Earning per
                                            Share Ratio, Debtors’
                                            Turnover Ratio,
     FORMAT OF BALANCE SHEET FOR RATIO ANALYSIS
                 LIABILITIES                                           ASSETS
NET WORTH/EQUITY/OWNED FUNDS                     FIXED ASSETS : LAND & BUILDING, PLANT &
Share Capital/Partner’s Capital/Paid up Capital/ MACHINERIES
Owners Funds                                     Original Value Less Depreciation
Reserves ( General, Capital, Revaluation & Other Net Value or Book Value or Written down value
Reserves)
Credit Balance in P&L A/c
LONG TERM LIABILITIES/BORROWED FUNDS :             NON CURRENT ASSETS
Term Loans (Banks & Institutions)                  Investments in quoted shares & securities
Debentures/Bonds, Unsecured Loans, Fixed           Old stocks or old/disputed book debts
Deposits, Other Long Term Liabilities              Long Term Security Deposits
                                                   Other Misc. assets which are not current or fixed
                                                   in nature
CURRENT LIABILTIES                                 CURRENT ASSETS : Cash & Bank Balance,
Bank Working         Capital Limits such as        Marketable/quoted Govt. or other securities,
CC/OD/Bills/Export Credit                          Book Debts/Sundry Debtors, Bills Receivables,
Sundry /Trade Creditors/Creditors/Bills Payable,   Stocks & inventory (RM,SIP,FG) Stores & Spares,
Short duration loans or deposits                   Advance Payment of Taxes, Prepaid expenses,
Expenses payable & provisions against various      Loans and Advances recoverable within 12
items                                              months
                                                   INTANGIBLE ASSETS
                                                   Patent, Goodwill, Debit balance in P&L A/c,
                                                   Preliminary or Preoperative expenses
SOME IMPORTANT NOTES
   Liabilities have Credit balance and Assets have Debit balance
   Current Liabilities are those which have either become due for
    payment or shall fall due for payment within 12 months from
    the date of Balance Sheet
   Current Assets are those which undergo change in their
    shape/form within 12 months. These are also called Working
    Capital or Gross Working Capital
   Net Worth & Long Term Liabilities are also called Long Term
    Sources of Funds
   Current Liabilities are known as Short Term Sources of Funds
   Long Term Liabilities & Short Term Liabilities are also called
    Outside Liabilities
   Current Assets are Short Term Use of Funds
SOME IMPORTANT NOTES
   Assets other than Current Assets are Long Term Use of Funds
   Installments of Term Loan Payable in 12 months are to be taken as
    Current Liability only for Calculation of Current Ratio & Quick Ratio.
   If there is profit it shall become part of Net Worth under the head
    Reserves and if there is loss it will become part of Intangible Assets
   Investments in Govt. Securities to be treated current only if these are
    marketable and due. Investments in other securities are to be
    treated Current if they are quoted. Investments in
    allied/associate/sister units or firms to be treated as Non-current.
   Bonus Shares as issued by capitalization of General reserves and as
    such do not affect the Net Worth. With Rights Issue, change takes
    place in Net Worth and Current Ratio.
1.    Current Ratio : It is the relationship between the current
      assets and current liabilities of a concern.
       Current Ratio = Current Assets/Current Liabilities
     If the Current Assets and Current Liabilities of a concern are
      Rs.4,00,000 and Rs.2,00,000 respectively, then the
      Current Ratio will be : Rs.4,00,000/Rs.2,00,000 = 2 : 1
        The ideal Current Ratio preferred by Banks is 1.33 : 1

2.   Net Working Capital : This is worked out as surplus of Long
     Term Sources over Long Tern Uses, alternatively it is the
     difference of Current Assets and Current Liabilities.
      NWC = Current Assets – Current Liabilities
3. ACID TEST or QUICK RATIO : It is the ratio between Quick Current
Assets and Current Liabilities.

Quick Current Assets : Cash/Bank Balances + Receivables upto 6 months +
Quickly realizable securities such as Govt. Securities or quickly marketable/quoted
shares and Bank Fixed Deposits

  Acid Test or Quick Ratio = Quick Current Assets/Current Liabilities

Example :
Cash                  50,000
Debtors              1,00,000
Inventories          1,50,000              Current Liabilities 1,00,000
Total Current Assets 3,00,000

Current Ratio = >                  3,00,000/1,00,000            = 3:1
Quick Ratio   =>                   1,50,000/1,00,000            = 1.5 : 1
4. DEBT EQUITY RATIO : It is the relationship between
   borrower’s fund (Debt) and Owner’s Capital (Equity).

   Long Term Outside Liabilities / Tangible Net Worth

   Liabilities of Long Term Nature

      Total of Capital and Reserves & Surplus Less Intangible Assets

   For instance, if the Firm is having the following :

   Capital                     = Rs. 200 Lacs
   Free Reserves & Surplus     = Rs. 300 Lacs
   Long Term Loans/Liabilities = Rs. 800 Lacs

   Debt Equity Ratio will be => 800/500 i.e. 1.6 : 1
5. PROPRIETARY RATIO : This ratio indicates the extent to which
    Tangible Assets are financed by Owner’s Fund.
    Proprietary Ratio = (Tangible Net Worth/Total Tangible
    Assets) x 100
    The ratio will be 100% when there is no Borrowing for purchasing
    of Assets.

6. GROSS PROFIT RATIO : By comparing Gross Profit percentage to
   Net Sales we can arrive at the Gross Profit Ratio which indicates the
   manufacturing efficiency as well as the pricing policy of the concern.

   Gross Profit Ratio = (Gross Profit / Net Sales ) x 100

   Alternatively , since Gross Profit is equal to Sales minus Cost of
   Goods Sold, it can also be interpreted as below :

   Gross Profit Ratio = [ (Sales – Cost of goods sold)/ Net Sales]
   x 100
    A higher Gross Profit Ratio indicates efficiency in production of the unit.
7. OPERATING PROFIT RATIO :

  It is expressed as =>    (Operating Profit / Net Sales ) x 100

  Higher the ratio indicates operational efficiency


8. NET PROFIT RATIO :

   It is expressed as =>    ( Net Profit / Net Sales ) x 100

   It measures overall profitability.
   9. STOCK/INVENTORY TURNOVER RATIO :



    (Average Inventory/Sales) x 365 for days
    (Average Inventory/Sales) x 52 for weeks
    (Average Inventory/Sales) x 12 for months


   Average Inventory or Stocks = (Opening Stock + Closing Stock)
                                  -----------------------------------------
                                                        2
. This ratio indicates the number of times the inventory is
   rotated during the relevant accounting period
 10. DEBTORS TURNOVER RATIO : This is also called Debtors
Velocity or Average Collection Period or Period of Credit given .

(Average Debtors/Sales ) x 365 for days
                            (52 for weeks & 12 for months)

 11. ASSET TRUNOVER RATIO :              Net Sales/Tangible Assets

 12. FIXED ASSET TURNOVER RATIO :        Net Sales /Fixed Assets

 13. CURRENT ASSET TURNOVER RATIO : Net Sales / Current Assets

 14. CREDITORS TURNOVER RATIO : This is also called Creditors
Velocity Ratio, which determines the creditor payment period.

(Average Creditors/Purchases)x365 for days
                              (52 for weeks & 12 for months)
15. RETRUN ON ASSETS :        Net Profit after Taxes/Total Assets


16. RETRUN ON CAPITAL EMPLOYED :

   ( Net Profit before Interest & Tax / Average Capital Employed) x 100

   Average Capital Employed is the average of the equity share
   capital and long term funds provided by the owners and the
   creditors of the firm at the beginning and end of the accounting
   period.
                          Composite Ratio

17. RETRUN ON EQUITY CAPITAL (ROE) :
         Net Profit after Taxes / Tangible Net Worth

18. EARNING PER SHARE : EPS indicates the quantum of net profit
    of the year that would be ranking for dividend for each share of
    the company being held by the equity share holders.

   Net profit after Taxes and Preference Dividend/ No. of Equity
   Shares

19. PRICE EARNING RATIO : PE Ratio indicates the number of times
    the Earning Per Share is covered by its market price.

    Market Price Per Equity Share/Earning Per Share
20. DEBT SERVICE COVERAGE RATIO : This ratio is one of the most
    important one which indicates the ability of an enterprise to
    meet its liabilities by way of payment of installments of Term
    Loans and Interest thereon from out of the cash accruals and
    forms the basis for fixation of the repayment schedule in
    respect of the Term Loans raised for a project. (The Ideal DSCR
    Ratio is considered to be 2 )

   PAT + Depr. + Annual Interest on Long Term Loans & Liabilities
    ---------------------------------------------------------------------------------
    Annual interest on Long Term Loans & Liabilities + Annual
   Installments payable on Long Term Loans & Liabilities

   ( Where PAT is Profit after Tax and Depr. is Depreciation)
EXERCISE 1

     LIABILITES                  ASSETS
     Capital               180 Net Fixed Assets       400
     Reserves               20 Inventories            150
     Term Loan             300 Cash                    50
     Bank C/C              200 Receivables            150
     Trade Creditors        50 Goodwill                50
     Provisions             50
                           800                        800


a.    What is the Net Worth : Capital + Reserve = 200
b.    Tangible Net Worth is : Net Worth - Goodwill = 150
c.    Outside Liabilities : TL + CC + Creditors + Provisions = 600
d.     Net Working Capital : C A - C L = 350 - 250 = 50
e.     Current Ratio : C A / C L   = 350 / 300 = 1.17 : 1
f.     Quick Ratio : Quick Assets / C L = 200/300 = 0.66 : 1
   EXERCISE 2

LIABILITIES         2005-06     2006-07                         2005-06 2006-07
Capital                   300        350 Net Fixed Assets          730        750
Reserves                  140        160 Security Electricity       30         30
Bank Term Loan            320        280 Investments               110        110
Bank CC (Hyp)             490        580 Raw Materials             150        170
Unsec. Long T L           150        170 S I P                      20         30
Creditors (RM)            120         70 Finished Goods            140        170
Bills Payable              40         80 Cash                       30         20
Expenses Payable           20         30 Receivables                310       240
Provisions                 20         40 Loans/Advances             30        190
                                           Goodwill                 50         50
Total                   1600        1760                          1600        1760

1. Tangible Net Worth for 1st Year : ( 300 + 140) - 50 = 390
2. Current Ratio for 2nd Year : (170 + 20 + 240 + 2+ 190 ) / (580+70+80+70)
                                     820 /800 = 1.02
3. Debt Equity Ratio for 1st Year : 320+150 / 390 = 1.21
Exercise 3.

 LIABIITIES                            ASSETS
 Equity Capital                  200 Net Fixed Assets                  800
 Preference Capital              100 Inventory                         300
 Term Loan                       600 Receivables                       150
 Bank CC (Hyp)                   400 Investment In Govt. Secu.          50
 Sundry Creditors                100 Preliminary Expenses              100
 Total                          1400                                  1400


 1. Debt Equity Ratio will be : 600 / (200+100)      = 2:1

2. Tangible Net Worth : Only equity Capital i.e. = 200


3. Total Outside Liabilities / Total Tangible Net Worth : (600+400+100) / 200
                                                         = 11 : 2

4. Current Ratio will be : (300 + 150 + 50 ) / (400 + 100 ) = 1 : 1
    Exercise 4.

 LIABILITIES                            ASSETS
 Capital + Reserves              355    Net Fixed Assets             265
 P & L Credit Balance                7 Cash                            1
 Loan From S F C                 100 Receivables                     125
 Bank Overdraft                   38 Stocks                          128
 Creditors                        26 Prepaid Expenses                  1
 Provision of Tax                    9 Intangible Assets              30
 Proposed Dividend                15
                                 550                                 550

Q. What is the Current Ratio ?       Ans : (125 +128+1+30) / (38+26+9+15)
                                         : 255/88 = 2.89 : 1

Q What is the Quick Ratio ?   Ans : (125+1)/ 88 = 1.43 : 11

Q. What is the Debt Equity Ratio ?     Ans : LTL / Tangible NW
                                            = 100 / ( 362 – 30)
                                            = 100 / 332 = 0.30 : 1
   Exercise 4.    contd…

   LIABILITIES                            ASSETS
   Capital + Reserves               355   Net Fixed Assets             265
   P & L Credit Balance                7 Cash                            1
   Loan From S F C                  100 Receivables                    125
   Bank Overdraft                    38 Stocks                         128
   Creditors                         26 Prepaid Expenses                 1
   Provision of Tax                    9 Intangible Assets              30
   Proposed Dividend                 15
                                    550                                550

Q . What is the Proprietary Ratio ? Ans : (T NW / Tangible Assets) x 100
                                         [ (362 - 30 ) / (550 – 30)] x 100
                                            (332 / 520) x 100 = 64%
Q . What is the Net Working Capital ?
 Ans : C. A - C L. = 255 - 88 = 167

 Q . If Net Sales is Rs.15 Lac, then What would be the Stock Turnover
 Ratio in Times ? Ans : Net Sales / Average Inventories/Stock
                            1500 / 128 = 12 times approximately
     Exercise 4.   contd…
     LIABILITIES                         ASSETS
     Capital + Reserves           355    Net Fixed Assets         265
     P & L Credit Balance            7 Cash                         1
     Loan From S F C              100 Receivables                 125
     Bank Overdraft                 38 Stocks                     128
     Creditors                      26 Prepaid Expenses             1
     Provision of Tax                9 Intangible Assets           30
     Proposed Dividend              15
                                  550                             550

 Q. What is the Debtors Velocity Ratio ? If the sales are Rs. 15 Lac.

  Ans : ( Average Debtors / Net Sales) x 12 = (125 / 1500) x 12
                                            = 1 month


Q. What is the Creditors Velocity Ratio if Purchases are Rs.10.5 Lac ?
Ans : (Average Creditors / Purchases ) x 12 = (26 / 1050) x 12 = 0.3 months
Exercise 5. : Profit to sales is 2% and amount of profit is say
Rs.5 Lac. Then What is the amount of Sales ?

Answer : Net Profit Ratio = (Net Profit / Sales ) x 100
               2           = (5 x100) /Sales
        Therefore Sales = 500/2 = Rs.250 Lac
 Exercise 6. A Company has Net Worth of Rs.5 Lac, Term
 Liabilities of Rs.10 Lac. Fixed Assets worth RS.16 Lac and
 Current Assets are Rs.25 Lac. There is no intangible Assets
 or other Non Current Assets. Calculate its Net Working
 Capital.
                                Answer
 Total Assets      = 16 + 25 = Rs. 41 Lac
 Total Liabilities = NW + LTL + CL = 5 + 10+ CL = 41 Lac
  Current Liabilities = 41 – 15 = 26 Lac

 Therefore Net Working Capital = C. A – C.L
                               = 25 – 26 = (- )1 Lac
Exercise 7 : Current Ratio of a concern is 1 : 1. What will be the Net
Working Capital ?

Answer : It suggest that the Current Assets is equal to Current Liabilities
hence the NWC would be NIL

Exercise 8 : Suppose Current Ratio is 4 : 1. NWC is Rs.30,000/-. What
is the amount of Current Assets ?

Answer : 4 x - 1 x = 30,000
        Therefore x = 10,000 i.e. Current Liabilities is Rs.10,000
        Hence Current Assets would be 4x = 4 x 10,000 = Rs.40,000/-


 Exercise 9. The amount of Term Loan installment is Rs.10000/ per
 month, monthly average interest on TL is Rs.5000/-. If the amount
 of Depreciation is Rs.30,000/- p.a. and PAT is Rs.2,70,000/-. What
 would be the DSCR ?

 DSCR = (PAT + Depr + Annual Intt.) / Annual Intt + Annual Installment
      = (270000 + 30000 + 60000 ) / 60000 + 120000
       = 360000 / 180000 = 2
Exercise 10 : Total Liabilities of a firm is Rs.100 Lac and Current Ratio
is 1.5 : 1. If Fixed Assets and Other Non Current Assets are to the tune
of Rs. 70 Lac and Debt Equity Ratio being 3 : 1. What would be the Long
Term Liabilities?

 Ans : We can easily arrive at the amount of Current Asset being Rs. 30 Lac
i.e. ( Rs. 100 L - Rs. 70 L ). If the Current Ratio is 1.5 : 1, then Current
Liabilities works out to be Rs. 20 Lac. That means the aggregate of Net
Worth and Long Term Liabilities would be Rs. 80 Lacs. If the Debt Equity
Ratio is 3 : 1 then Debt works out to be Rs. 60 Lacs and equity Rs. 20 Lacs.
Therefore the Long Term Liabilities would be Rs.60 Lac.


Exercise 11 : Current Ratio is say 1.2 : 1 . Total of balance sheet being
Rs.22 Lac. The amount of Fixed Assets + Non Current Assets is Rs. 10
Lac. What would be the Current Liabilities?

Ans : When Total Assets is Rs.22 Lac then Current Assets would be 22 – 10
i.e Rs. 12 Lac. Thus we can easily arrive at the Current Liabilities figure
which should be Rs. 10 Lac
                    Questions on Fund Flow Statement

 Q . Fund Flow Statement is prepared from the Balance sheet :

1.   Of three balance sheets
2.   Of a single year
3.   Of two consecutive years
4.   None of the above.


Q. Why this Fund Flow Statement is studied for ?

1.   It indicates the quantum of finance required
2.   It is the indicator of utilisation of Bank funds by the concern
3.   It shows the money available for repayment of loan
4.   It will indicate the provisions against various expenses

 Q . In a Fund Flow Statement , the assets are represented by ?

1.   Application of Funds
2.   Sources of Funds
3.   Surplus of sources over application
4.   Deficit of sources over application
Q . In Fund Flow Statements the Liabilities are represented by ?

1.   Sources of Funds
2.   Use of Funds
3.   Deficit of sources over application
4.   All of the above.

 Q . When the long term sources are more than long term uses, in the
fund flow statement, it would suggest ?

1.   Increase in Current Liabilities
2.   Decrease in Working Capital
3.   Increase in NWC
4.   Increase in NWC

Q . When the long term uses in a fund flow statement are more than the
long term sources, the n it would mean ?

1.   Reduction in the NWC
2.   Reduction in the Working Capital Gap
3.   Reduction in Working Capital
4.   All of the above
 Q. How many broader categories are there for the Sources of funds, in
the Fund Flow Statement ?

1.    Only One, Source of Funds
2.   Two, Long Term and Short Term Sources
3.   Three , Long, Medium and Short term sources
4.   None of the above.

 Q. Which of following item is not an application of funds in the

								
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