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INTRODUCTION
A ratio shows the relationship between two numbers. Accounting
ratio shows the relationship between two accounting figures. Ratio analysis is the
process of computing and presenting the relationship between the items in the
financial analysis, because it helps to study the financial performance and position
of a concern.
As aratio are simple to calculate and easy to understand there is a tendency
to employ them profusely. While such statistical calculationstimulate be thinking
and develop understanding there is a danger of accumulation of a mass of data
that obscures rather than clarifies to steer a careful course. His experience and
objectives of analysis help him in determine which of the ratios are more
meaningful in a given situation.
The Parties Interested:- the person interested in the analysis of financial can be
grouped under three heads.
Owners Or Investor
Creditors And
Financial Executives.
Although all these three groups are interested in the financial conditions and
operating results of an enterprises the primary information that each seeks to
obtain forms these statement is to serve. Investors desire a primary basis for
estimating earning capacity. Creditors (trade and financial) are concerned
primarily with liquidity and ability to pay interest and redeem loan within a
specific period. Management is interested in evolving analysis tools that will
measure costs,efficiency, liquidity and profitability with a view to making
intelligent decisions.
2. FORMS
There are three different forms in which an accounting ratio can be expressed.
1) Pure Ratio 2) Percentage and 3) Rate
3. CLASSIFICATION
3.1. BASED ON FINANCIAL STATEMENT
Accounting ratios express the relationship figures taken from financial
statements. Figures may be taken from Balance sheet, Profit & Loss Account or
both. One way of classification of ratios is based upon the source from which
figures are taken. This is known as the conventional classification.
1) BALANCE SHEET RATIOS: -If ratios are based on figures of Balance sheet,
they are called Balance sheet ratio e.g. ratio of current assets to current
liabilities or ratio of Debt to Equity. While calculating these ratios, there is
no need to refer to the Revenue statement. These ratios judge the liquidity.
Solvency and capital structure of the concern. We are going to study the
following six balance sheet ratios in this chapter. Ratio, capital Gearing
Ratio, Debt-Equity Ratio and stock working Capital Ratio.
2) REVENUE STATEMENT RATIOS:- Ratios based on the figures from the
Revenue statement are called revenue statement ratios. These ratios study
the relationship between the profitability and the sales of the concern. We
are going to Gross Profit Ratio and Net Operating Profit Ratio and stock
Turnover Ratio.
3) COMPOSITE RATIOS:- These ratios indicate the relationship between two
items, of which one is found in the balance sheet and the other in the
revenue statement. There are two types of composite ratios.
a) Same composite ratios study the relationship between the profits and
the investments of the concern. E.g. Return On Capital Employed on
Proprietors Funds, Return of Equity Capital etc.
b) other composite ratios that we going to study are debtors Turnover,
Creditors Turnover, Dividend payout and debt service.
Accounting ratio can also be classified according to their functions (i.e. their
purpose) into Liquidity ratios, Leverage ratios, Activity ratios, Profitability ratios
and Coverage ratios.
1. Liquidity ratios show the relationship between the current assets and
current liabilities of the concern.
Examples are Liquidity ratio and current ratio.
2. Leverage ratios show the relationship between proprietors funds and
debts used in financing the assets of the concern. Examples are capital
Gearing ratio, Debt-Equity ratio and Proprietor ratios. These are also known
as Capital structure ratios or Solvency ratios.
3. Activity ratios (also known as turnover ratios or productivity ratios) show
the relationship between the sales and the assets. Examples are stock
turnover ratio; Debtors turnover ratio etc.
4. Profitability ratios show the relationship between.
a) Profits and sales; for example, Operating ratio, Gross profit ratio,
Operating net profit ratio, Expenses ratio etc. OR
b) profits and investors; for example, Return on Investments Return on
equity Capital etc.
5. Coverage ratios show the relationship between the profits on one hand the
claims of outsiders (divided, interest etc.) to be paid out of such profits.
Examples are Dividend payout ratio, Debt service and Debt service
coverage ratio.
I
1
2
3
4
5
6
7
II
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
ITEM
SOURCE OF FUND
Equity Share Capital
Reserve & Surplus
Equity Shareholder Funds (1+2)
Preference Share Capital
Proprietors Funds (3+4)
Borrowed Funds
Capital Employed
(5+6)
ITEM
USE OF FUND
Fixed Assets
Debtors
Bills Receivable
Other Quick Assets
Total Quick Assets
(2+3+4)
Closing Stock
Pre-payments
Current Assets
(5+6+7)
Creditors
Bills Payable
Other Quick Liabilities
Total Quick Liabilities
(9+10+11)
Bank Overdraft
Current Liabilities (12+13)
Working Capital
(8-14)
Capital Employed
(1+15)
AMOUNT
FC
RS
EF
PC
PE
BF
CE
AMOUNT
FA
DR
BR
OQA
QA
CST
PP
CA
CD
BP
OQL
QL
OD
CL
WC
CE
Equity/ Formula
Para
4.1
Current Ratio
CR=CA/CL
4.2
2
Proprietors Ratio
QR=QA/QL
SWC=
PR=PF/TA*100
[ TA= Total Assets=FA+CA=CE+CL
=Total of Horizontal B/s-factious
Assets]
4.3
4.4
4.5
5
Debt-Equity Ratio
DER=BF/PF
4.6
6
CGR=PC+BF/EF
4.4.3. Components
Proprietors Funds [PF] will include
1. Paid up Equity Capital (EC)
2. Reserve & Surplus (R&S) including, Capital Reserves, P&L A/c cr.
Less:- Accumulated Losses (i.e. P&L A/c Dr. balance)
Less: - fictitious Assets Like Miscellaneous Expenditure not Written Off.
3. Paid Up Preference Capital (PC)
Thus, PF=EC +RS+PC or EF+PC
Total Assets [TA] (Fixed Assets +Investments + current Assets)
= Total Liabilities [TL] (Own Funds + Loans+ Current Liabilities)
= Total of the (Horizontal) Balance Sheet excluding Fictitious Assets &
Accumulated Losses (if any = Capital Employed +current Liabilities)
COMPONENTS
Borrowed Funds [BF] includes
1. Debenture, Loan, etc.
2. Interest accrued and due on such BF
FORMULA
Capital Gearing Ratio =
1. = Capital Entitled to Fixed Rate of Interest OR Dividend/
Capital not So Entitled to Fixed Rate of Interest OR Dividend
2. Preference Capital + Debentures/Equity Capital + Share Premium A/c+ CR
Components
Capital entitled to fixed interest or dividend
1. Preference Capital (PC)
2. Debenture, Long term Loans, i.e. Borrowed funds (BF)
Capital not entitled to fixed interest or dividend (= Equity Funds)
1. Equity Capital (EC)
2. Reserve & Surplus (RS)
Less: - Profit & Loss A/c Dr. balance.
Less: - Fictitious Assets
thus, CGR= PC+BF/EF
Credit Sales
cash Sales
Total Sales (1+2)
Opening Stock
Credit Purchase
Cash Purchase
Total Purchase (5+6)
Direct Expenses
Less:- Closing Stock
Cost of Goods Sold
(4+7+8-9)
Gross Profit
(3-10)
Administration Expenses
Selling expenses
Finance Expenses (Excl. Interest)
Operating Expenses
(12+13+14)
Operating Profit(11-15)
Net Non- Operating Income/ Expenses
Profit before Interest & Tax (16+17)
Interest On Loans
Net Profit Before Tax(18-19)
Income Tax
Net Profit After Tax (20-21)
Preference Dividend
Profit Available for Equity Shareholders(22-23)
Equity Dividends
Retained Earning(24-25)
AMOUNT
CRS
CAS
S
OST
CRP
CAP
P
DE
(CST)
COGS
GP
AE
SE
FE
OE
OP
NO
PBIT
INT
NPAT
IT
NPAT
PD
PAES
ED
RET
Equation / Formula
Para
1.
GPR=GP/S*100
5.1
2.
Opening Ratio
OR=COGS+DE/S*100
5.2
3.
Expenses Ratio
ER=AE or SE or FE/S*100
5.3
4.
OPR=OP/S*100
5.4
5.
NPR= NPBT/S*100
5.5
5.6
Average Stock
6.
Opening stock
Add: - Purchase
Add: - Direct Expenses
Less; - Closing Stock
= COGS
5.2.2 Formula
Operating Ratio: - Cost of Goods Sold + Operating Expenses/Net Sales*100
= COGS + OE/S * 100
5.2.3 Components: - Cost of Goods Sold [COGS] [as per Para 5.1.3]
operating Expenses [OE] =
1. Office and Administration Expenses
2. Selling and Distribution Expenses
3. Finance Expenses Excluding Interest on Loans and Debenture Net Sales
[S] [as per Para 5.1.3]
5.4.3 Components
Operating profit [OP]
1. Gross Profit
2. Less: - Operating expenses [OE] (as per Para 5.2.3)
(Net per Para 5.2.3)
Net Sales [S] =
Sales Less Returns Less Allowances.
6. COMPOSITE RATIO
COMOSEITE RATIOS AT A GLANCE
Composite Ratios
Formula / equation
Para
1.
6.1
2.
6.2
3.
6.3
4.
Dividend Payout
DP = ED / PAES * 100
6.4
5.
DSR = PBIT/INT
6.5
6.
6.6
7.
DTR = CRS / DR + BR
6.7
8.
CTR = CRP/ CD + BP
6.8
1.
2.
3.
4.
5.
1.
2.
3.
4.
6.2.2. FORMULA
Return Proprietors Funds: -Net Profit (after Tax)/ Proprietors Funds *100
NPAT/PF * 100
6.23. Components
Net Profit [NPAT] = Profit after interest and tax proprietors funds [PF] =
1. Equity Capital [EC]
2. Add: - Reserve & Surplus [RS]
Less: - Fictitious Assets like Miscellaneous Expenses not written off
Less: - Profit & Loss A/c Dr. Balance (loss)
3. Add: -Preference Capital [PC]