# Ratio Analysis RATIO ANALYSIS WHY FINANCIAL ANALYSIS Lenders’ need it

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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
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
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.
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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