14 The Economic Times Wealth, July 17-23, 2017 Learn & Keep

USEFUL RATIOS
TO FIND IN
BALANCE SHEETS
Most of you would have already received the balance sheets of companies you are invested in.
Narendra Nathan explains how to compute a few useful ratios from the available data.

VALUATION EFFICIENCY ACCOUNT RECEIVABLES

TURNOVER RATIO
PBV RATIO INVENTORY THE FORMULA
TURNOVER RATIO
Total sales average accounts receivable
THE FORMULA
(Total sales considered because total credit sales
Share price book value per share THE FORMULA not available)
(or market cap net worth) Cost of goods sold average inventory
WHAT DOES IT MEAN? Indicates the number of
WHAT DOES IT MEAN? It compares the WHAT DOES IT MEAN? Indicates how many times a times the average account receivable is collected in a
market value of a stock to its net worth, or company's inventory is sold and replaced in a year’s year. Since this ratio indicates the ability of a
assets minus liabilities. A low PB ratio means time (more the better). Since this ratio varies across company to collect funds from debtors in a timely
the stock is undervalued. industries, compare it against company's previous manner, higher the ratio, the better. This ratio also
values or with similar company. varies across industries.
USEFUL FOR All sectors, particularly for
banking where assets (ie loans) are close to USEFUL FOR Most manufacturing sectors that have USEFUL FOR Most manufacturing sectors that have
market value. large supply chains. large supply chains.

Firms with high PB ratios Most auto cos are managing inventory well Figures should be compared with similar cos
PB (times) Inventory turnover (times) Receivable turnovers (times)
Hindustan Unilever Hero MotoCorp Reliance Industries
36.92 46.41 59.11
Bajaj Finserve Ltd Bajaj Auto Colgate Palmolive India
23.73 31.90 39.06
Colgate Palmolive India Mahindra & Mahindra Bharti Infratel
23.04 17.43 35.07

FINANCIAL QUICK RATIO (ACID TEST RATIO) DEBT-EQUITY RATIO

STRENGTH
CURRENT RATIO
THE FORMULA
Current assets Current liabilities
WHAT DOES IT MEAN? Determines a company’s
ability to pay back short-term liabilities. A high
ratio means the company is not utilising enough
current liabilities. Be careful if ratio is below 1.
USEFUL FOR: Sectors with large supply chains.
THE FORMULA
(Current assets - inventories) Current liabilities
WHAT DOES IT MEAN? Tests the company’s
ability to pay off current liabilities at short
notice. Inventories are not considered as they
take time to liquidate. Ratio above 0.5 times is
considered good.
USEFUL FOR: Most manufacturing sectors
that have large supply chain on both sides.
THE FORMULA
Long-term debt net worth (or shareholders’ equity)
WHAT DOES IT MEAN? A high debt-equity
ratio indicates that most assets are funded
by debt. While zero debt companies are
best, investors should be careful if this ratio
is above 2.
USEFUL FOR: Most sectors except
financials.

Ratio is high for cash-rich businesses Cash-rich businesses have high ratio Investors should be wary of ratio above 2
Tata Consultancy Services Current ratio (times) Tata Consultancy Services Quick ratio (times) Idea Cellular Debt/equity (times)
6.41 6.41 2.33
Infosys Infosys JSW Steel
4.05 4.05 1.60
Zee Entertainment Enterprises Wipro Piramal Enterprises
3.68 3.50 0.71

PROFITABILITY RETURN ON CAPITAL EMPLOYED (ROCE) RETURN ON ASSETS (ROA)

RETURN ON EQUITY (ROE) THE FORMULA
THE FORMULA Profit before interest and tax total capital
Profit after tax net worth (or shareholders’ equity) employed
WHAT DOES IT MEAN? It measures the returns the WHAT DOES IT MEAN? The comparison here is
company is generating on shareholders’ equity. More between operating profit and total capital employed,
the better. This ratio should be significantly higher including debt. More useful than ROE to evaluate the
than the returns available in the market. longevity of a company.
THE FORMULA
Profit after tax total assets
WHAT DOES IT MEAN? Measures the efficiency
with which the management is utilising assets. Since
this ratio varies across industries, one needs to
compare it against the company’s previous values or
ratio of a similar company.

USEFUL FOR: Most sectors. USEFUL FOR: Most sectors other than financials. USEFUL FOR: Banking sector.

Concentrate on cos with very high ROE Companies should match your cost of capital Bet on companies with high ROA
ROE % ROCE % ROA %
Hindustan Unilever Hindustan Unilever Hindustan Unilever
70.73% 100.52% 31.68%
Colgate-Palmolive (India) Colgate-Palmolive (India) Tata Consultancy Services
50.48% 73.88% 29.08%
Hero MotoCorp Hero MotoCorp Hero MotoCorp
35.66% 49.24% 23.04%

Source: ETIG Database; Data based on

BSE 100 companies whose balance
sheet of 2016-17 available