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Exercise on Ratio Analysis

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					Exercise on Ratio Analysis The balance sheet of M/s Malhotra Engineering (P) Ltd is given for two years 2005 and 2006. Liabilities Amount as on Amount as on 31st March 2005 31st March 2006 I. Net Worth Share Capital 1,05,100 2,25,100 Reserve and Surplus 4,07,902 5,09,193 Total Net Worth 5,13,002 7,34,293 II. Term Liabilities Unsecured loans (for more than one 4,99,472 year) Term Loans from banks 72,500 Total Term Liabilities 5,71,972 III. Current Liabilities Sundry creditors Provision for Taxation Provision for Dividend Bank Borrowings Total Current Liabilities Total Liabilities

4,60,187 47,515 5,07,702

5,38,569 5,63,600 73,570 1,85,023 13,60,762 24,45,736

9,11,656 5,57,300 45,020 2,65,405 17,79,381 30,21,376

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Assets I. Fixed Assets Plant And Machinery Factory Building Furniture Car Other Fixed assets Total Fixed assets II. Current Assets Cash and bank Stock Sundry Debtors Loans and advances Total Current Assets III. Miscellaneous Assets Investment in shares of a sister concern Total Assets

Amount as on Amount as on 31st March 2005 31st March 2006 3,46,193 2,026 12,428 2,644 3,63,291 3,21,422 76,637 1,897 9,942 2,352 4,12,250

2,83,755 4,61,839 6,48,071 6,56,780 20,50,445

87,158 7,84,508 9,49,215 6,29,643 24,50,524

32,000 24,45,736

1,58,602 30,21,376

As on 31st March 2004, stock was Rs.5, 93,451and sundry debtors was Rs.5, 49, 276 and sundry creditors was Rs.4, 95,263

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Profit and loss account for both the years 2005 2006 26,71,550 31,87,276 20,86,359 24,24,061 5,85,191 155,352 7,63,215 1,84,746

1. Net Sales (all credit sales) 2. Cost of Sales 3. Gross Profit 4. Administrative and other Expenses 5. Interest Operating profit Other income Profit before Tax Provision for taxation Net Profit after Tax

84,245 3,45,594 26,887 3,72,481 2,42,300 1,30,181

1,28,729 4,49,740 10,820 4,60,560 3,15,000 1,45,560

Annual purchases (credit)

11,08,642 14,62,583

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Current Ratio Current Assets = ---------------------Current Liabilities 2005 20,50,445 ------------13,60,762 1.51:1 2006 24,50,524 -------------17,79,381 1.38:1

The current ratio which was 1.51 in 2005 deteriorated to 1.38 in 2006. If standard minimum ratio is to be taken as 1.5:1. The ratio was satisfactory in 2005. Although the current liabilities are fully covered in 2006, yet the margin coverage has gone down. For deciding the adequacy of margin one has to look at the components of current assets, which are as follows. Components of current assets 2005 % Cash and bank balance 13.84 Stock and stores 22.52 Sundry Debtors 31.61 Loans and advances 32.03 2006 % 3.56 32.01 38.74 25.69

100.00 100.00
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The above indicates that there is drastic change in the mix of current assets in 2005 and 2006. The most liquid item, cash and bank balance, has decreased by more than 3 times of the 2005 figure. Stocks and sundry debtors have increased to a high extent. A fall in current ratio along with greater accumulation of stocks and an increase in sundry debtors is not a happy position. In terms of net working capital (Current assets minus Current laiblities) the figure has declined marginally from 6.89 lacs to 6.72 lacs. This shows that the liquidity has declined substantially and the ability to pay the current liability has eroded to a great extent in view of composition of current assets. The Quick Ratio Current Assets - (inventory and prepaid expenses) = -------------------------------------------------------------Current liabilities - overdraft or cash credit facilities 2005 (20,50,445-4,61,839) Current assets15,88,606 Inventory Current LiabilitiesOverdraft
Exercise on Ratio Analysis

2006 (24,50,524-7,84,508) 16,66,016

(13,60,762-1,85,023) 11,75,739 1.35:1

(17,79,381-2,65,405) 15,13,976 1.1:1 5

Since a good quick ratio is considered as 1:1. The company’ quick ratio has gone down along with the current ratio. It shows that company is ability to pay its liability has gone down Under such a situation company’s increased lending to sister concern is not good. Working capital turnover Ratio Net Sales = ----------------Net Working Capital 2005 26,71,550 6,89,683 3.87 times 2006 31,87,276 6,71,144 4.75 times

Net Sales Net Working Capital Working capital Turnover ratio

The ratio indicates that working capital turnover comparatively improved in 2006. Even from absolute figures it can be noticed that with a less amount net working capital the company could make higher sales in 2006. The fall in current and quick ratio in 2006 is linked to this increase, as the company was trying to trade more with lesser liquid resources as compared to 2005.

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Debt Equity Ratio Long-term debt = ---------------------Tangible net worth 2005 Long term liabilities 5,71,972 Net Worth 5,13,002 Debt- Equity ratio 1.12:1

2006 5,07,702 7,34,293 0.69:1

The ratio indicates that the share of outside term liabilities has gone down. In 2005 the long-term lenders contributed more than the capital but in 2006 their share declined and fresh capital and reserves were introduced in the business. It shows that the company is not trading on equity and is not making use of leverage.

Debt ratio Total Debt = ----------------Capital Employed

2005 Total debt 5,71,972 Capital employed 10,84,974 Debt ratio 0.52:1

2006 5,07,702 12,41,995 0.41:1

This ratio has declined in 2006, indicating that the company has reduced its reliance on debt and is using its own funds.
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Interest coverage ratio EBIT = ---------Interest 2005 EBIT Interest Interest coverage 4,29,839 84,245 5.10:1 2006 5,78,469 1,28,729 4.49:1

In both the years the EBIT is quite sufficient to discharge the liability towards the interest. Inventory turnover ratio Cost of goods sold = ----------------------------Average inventory

2005 Cost of goods sold 20,86,359 Average inventory 5,27,645 (Inventory in 2004 is Rs.5,93,451) Inventory turnover 3.95times

2006 24,24,061 6,23,175 3.89 times

This ratio has declined in 2006 indicating that more stock being piled up in 2006.

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360 Number of days inventory held = -------------------Inventory Turnover

2005 360 -----3.89 91 days

2006 360 -------

93 days

In 2005 the company was keeping inventory for 91 days while in 2006 it was keeping the inventory for 93 days. We have to explore the reason for this and whether it can be reduced without affecting the production. That will be real profit. Debtor’s turnover ratio Credit sales = -----------------Average debtors 2005 6,48,071 5,98,674 2006 9,49,215 7,98,643

Sundry Debtors Average Debtors (Sundry Debtors in 2004 was 5,49, 276) Annual Credit Sales 26,71,550 (All sales are credit sales)
Exercise on Ratio Analysis

31,87,276 9

Debtor’s turnover Average collection period ( 360 -------------Debtor’s turnover)

4.46 81

3.99 91

This shows that average collection period has gone up from 81 days to 91 days. This should be analyzed and reason for delay should be found out. Average payment period Average Creditors = -----------------------------360 Credit purchases 2005 5,38,569 5,16,916 2006 9,11,656 7,25,112

Sundry Creditors Average Creditors (Creditors in 2004 were 4,95,263) Annual purchases (credit) 11,08,642 Average payment period 168

14,62,583 178

The company is heavily using this short-term source to purchase its goods. The dependence on working capital is reduced this way.

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Gross profit Margin Ratio Sales –Cost of Sales = -----------------------------Sales Sales –Cost of goods = Gross Profit 2005 Gross profit 5,85,191 Net Sales 26,71,550 Gross profit Ratio 21.90% 2006 7,63,215 31,87,276 23.95%

The ratio has increased in 2006, which is a good sign and may be possible due to a number of reasons. Net Profit Margin Ratio PAT = -----------Sales 2005 PAT 1,30,181 Net Sales 26,71,550 Net Profit Margin 4.87%

2006 1,45,560 31,87,276 4.56%

The net Profit margin has declined in 2006 while the gross profit margin has improved in 2006. It shows that while the unit has done well on the manufacturing front but to increase in overheads the net profit margin has declined.

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Operating Expenses Ratio Cost of goods sold+ selling expenses+ Gen. Administrative expenses (excluding interest) = ----------------------------------------------------------------Sales 2005 Net Profit before interest and Taxation Net Sales Operating Expenses Ratio 2006

2,61,349 26,71,550 0.097

3,21,011 31,87,276 0.10

This ratio indicates that for every sale of Rs 100 in 2005 Rs. 9.70 was available for paying interest, taxes and profit. In 2006 for every sale of Rs 100 Rs10 was available for paying interest, taxes and profit. Not much difference. But in both the years the ratio indicates that not much is left for the entrepreneur as profit. Strategies have to be evolved for improving this.

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Return on Investment PAT = ----------------------Capital employed 2005 1,30,181 5,13,002+ 5,71,972= 10,84,974 12% 2006 1,45,560 7,34,293+ 5,07,702= 12,41,995 11.72%

PAT Net Worth+ Term Loans= Capital Employed Return on Investment

The ratio has shown the downward trend and is not good sign and reason for this has to be analyzed, whether it is more interest or taxation etc. Return on Equity PAT = ------------Net Worth

PAT Net Worth Return on Equity

2005 1,30,181 5,13,002 25.38%

2006 1,45,560 7,34,291 19.82%

This ratio was satisfactory in 2005 but has gone down to 19.82% in 2006.

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Such a fall is not healthy since besides dividend, there should be enough money for building reserves and surpluses too. Normally 25 % is considered to be good ratio.

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