Ratio Analysis

Detailed study of ratios What is RA? Why RA? Classification of Ratios Profitability ratio Turnover ratio Financial ratio Limitations of accounting ratios What is Ratio Analysis? Detailed study of ratios 𝒂𝒃𝒄 𝒙𝒚𝒛

𝒙:𝒚 Why Ratio Analysis? Simplifies Financial Terms What is RA? Why RA? Classification of Ratios Profitability ratio Turnover ratio Financial ratio Limitations of accounting ratios Why Ratio Analysis? Simplifies Financial Terms Inter-firm Comparison Intra-firm Comparison Planning And Forecasting 𝒙:𝒚

Classification Of Ratios What is RA? Why RA? Classification of Ratios Profitability ratio Turnover ratio Financial ratio Limitations of accounting ratios Classification Of Ratios Traditional Classification Profit and loss account ratios Balance sheet ratios Composite ratios Functional Classification Profitability ratios Turnover ratios Financial ratios

What is RA? Why RA? Classification of Ratios Profitability ratio Turnover ratio Financial ratio Limitations of accounting ratios Profitability Ratio These ratios measure the operating efficiency of the firm and its ability to ensure adequate returns to its shareholders

Profitability Ratio Overall Profitability Ratio or What is RA? Why RA? Classification of Ratios Profitability ratio Turnover ratio Financial ratio Limitations of accounting ratios Profitability Ratio Overall Profitability Ratio or Return on investment = 𝑶𝒑𝒆𝒓𝒂𝒕𝒊𝒏𝒈 𝑷𝒓𝒐𝒇𝒊𝒕 𝑪𝒂𝒑𝒊𝒕𝒂𝒍 𝑬𝒎𝒑𝒍𝒐𝒚𝒆𝒅 * 100 Operating profit : profit before interest tax Capital employed : sum total of the long term funds employed in the funds

Profitability Ratio 2. Gross Profit Ratio 𝑮𝒓𝒐𝒔𝒔 𝒑𝒓𝒐𝒇𝒊𝒕 𝑵𝒆𝒕 𝒔𝒂𝒍𝒆𝒔 ∗𝟏𝟎𝟎 What is RA? Why RA? Classification of Ratios Profitability ratio Turnover ratio Financial ratio Limitations of accounting ratios Profitability Ratio 2. Gross Profit Ratio 𝑮𝒓𝒐𝒔𝒔 𝒑𝒓𝒐𝒇𝒊𝒕 𝑵𝒆𝒕 𝒔𝒂𝒍𝒆𝒔 ∗𝟏𝟎𝟎 Indicates the degree to which the selling price of goods per unit may decline without resulting in losses from operations to the firm It also helps in ascertaining whether the average percentage of markup on the goods is maintained

Profitability Ratio 3. Net Profit Ratio What is RA? Why RA? Classification of Ratios Profitability ratio Turnover ratio Financial ratio Limitations of accounting ratios Profitability Ratio 3. Net Profit Ratio 𝑵𝒆𝒕 𝒐𝒑𝒆𝒓𝒂𝒕𝒊𝒏𝒈 𝒑𝒓𝒐𝒇𝒊𝒕 𝑵𝒆𝒕 𝒔𝒂𝒍𝒆𝒔 ∗𝟏𝟎𝟎 An increase in the ratio over the previous period indicates improvement in the operational efficiency of the business, provided the gross profit ratio is constant.

What is RA? Why RA? Classification of Ratios Profitability ratio Turnover ratio Financial ratio Limitations of accounting ratios Turnover Ratio Turn over ratio indicates the number of times the capital has been rotated in the process of doing business. Higher the rate of rotation, greater will be the profitability = 𝑺𝒂𝒍𝒆𝒔 𝑪𝒂𝒑𝒊𝒕𝒂𝒍 𝒆𝒎𝒑𝒍𝒐𝒚𝒆𝒅

Turnover Ratio = 𝑵𝒆𝒕 𝑺𝒂𝒍𝒆𝒔 𝑭𝒊𝒙𝒆𝒅 𝑨𝒔𝒔𝒆𝒕𝒔 1. Fixed assets turnover ratio What is RA? Why RA? Classification of Ratios Profitability ratio Turnover ratio Financial ratio Limitations of accounting ratios Turnover Ratio 1. Fixed assets turnover ratio = 𝑵𝒆𝒕 𝑺𝒂𝒍𝒆𝒔 𝑭𝒊𝒙𝒆𝒅 𝑨𝒔𝒔𝒆𝒕𝒔 This ratio indicates the extend to which the investment in fixed assets contributed towards sales If it is compared with previous period, it indicates whether the investment in fixed assets has been judicious or not

= 𝑵𝒆𝒕 𝑺𝒂𝒍𝒆𝒔 𝑾𝒐𝒓𝒌𝒊𝒏𝒈 𝑪𝒂𝒑𝒊𝒕𝒂𝒍 What is RA? Why RA? Classification of Ratios Profitability ratio Turnover ratio Financial ratio Limitations of accounting ratios Turnover Ratio 2. Working capital turnover ratio = 𝑵𝒆𝒕 𝑺𝒂𝒍𝒆𝒔 𝑾𝒐𝒓𝒌𝒊𝒏𝒈 𝑪𝒂𝒑𝒊𝒕𝒂𝒍 Indicates whether or not the working capital has been effectively utilized in making sales

What is RA? Why RA? Classification of Ratios Profitability ratio Turnover ratio Financial ratio Limitations of accounting ratios Financial Ratio It indicates the financial position of the company. Financial position of the company has to be judged from two angles: long-term as well as short-term. Long term requirements of funds should be met out of long term funds and short term requirements should be met out of short term funds.

Financial Ratio = 𝐹𝑖𝑥𝑒𝑑 𝐴𝑠𝑠𝑒𝑡𝑠 𝐿𝑜𝑛𝑔𝑡𝑒𝑟𝑚 𝐹𝑢𝑛𝑑𝑠 1. Fixed assets ratio What is RA? Why RA? Classification of Ratios Profitability ratio Turnover ratio Financial ratio Limitations of accounting ratios Financial Ratio 1. Fixed assets ratio = 𝐹𝑖𝑥𝑒𝑑 𝐴𝑠𝑠𝑒𝑡𝑠 𝐿𝑜𝑛𝑔𝑡𝑒𝑟𝑚 𝐹𝑢𝑛𝑑𝑠 The ratio should be more than 1 If it is less than 1, it shows that a part of the working capital has been financed through long term funds.

Financial Ratio 2. Current ratio = 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 What is RA? Why RA? Classification of Ratios Profitability ratio Turnover ratio Financial ratio Limitations of accounting ratios Financial Ratio 2. Current ratio = 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 This ratio indicates the firm’s commitment to meet its short-term liabilities An ideal current ratio is 2. it is considered as a safe margin of solvency due to the fact that if the current assets are reduced to half then also the creditors will be able to get the payments in full

Financial Ratio 3. Liquidity ratio Or Acid test ratio Quick ratio What is RA? Why RA? Classification of Ratios Profitability ratio Turnover ratio Financial ratio Limitations of accounting ratios Financial Ratio 3. Liquidity ratio Or Acid test ratio Quick ratio = 𝐿𝑖𝑞𝑢𝑖𝑑 𝐴𝑠𝑠𝑒𝑡𝑠 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 Conventionally a quick ratio of 1:1 is considered satisfactory

Financial Ratio 4. Proprietary Ratio What is RA? Why RA? Classification of Ratios Profitability ratio Turnover ratio Financial ratio Limitations of accounting ratios Financial Ratio 4. Proprietary Ratio = 𝑆ℎ𝑎𝑟𝑒ℎ𝑜𝑙𝑑𝑒𝑟𝑠 𝐹𝑢𝑛𝑑𝑠 𝑇𝑜𝑡𝑎𝑙 𝑇𝑎𝑛𝑔𝑖𝑏𝑙𝑒 𝐴𝑠𝑠𝑒𝑡𝑠 This ratio is particularly important to the creditors who can find out the proportion of shareholder’s funds in the total assets employed in the business. Higher the ratio, the better it is

Limitations Of Accounting Ratios What is RA? Why RA? Classification of Ratios Profitability ratio Turnover ratio Financial ratio Limitations of accounting ratios Limitations Of Accounting Ratios Comparative study required Ratio alone are adequate Window dressing Problem of price level changes No fixed standards

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