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Assignment: Ratio Analysis
Assignment: Ratio Analysis
Assignment: Ratio Analysis
PRINCIPLES OF FINANCE
RATIO ANALYSIS
Liquidity means having cash or access to cash readily available to meet obligations to make payments.
For ratio analysis, liquidity is measured on the assumption that the only sources of cash available are:
Current ratio
The quick ratio is also called the acid test ratio.
The more suitable ratio for use depends on whether inventory is considered a liquid asset that will soon be used or
sold, and converted into cash from sales.
Current Ratio
The current ratio is the ratio of current assets to current liabilities.
Formula:
CURRENT ASSETS
CURRENT RATIO=
CURRENT LIABILITIES
The amounts of current assets and current liabilities in the statement of financial position at the end of the
year may be used. It is not necessary to use average values for the year.
Formula:
The amounts of current assets and current liabilities in the statement of financial position at the end of the
year may be used. It is not necessary to use average values for the year.
PROFITABILITY:
The profit/sales ratio is the ratio of the profit that has been achieved for every Rs.1 of sales.
PROFIT
PROFIT /SALES RATIO= X 100
SALES
Profit/sales ratios are commonly used by management to assess financial performance, and a variety of different
figures for profit might be used. The definition of profit can be any of the following:
The gross profit ratio is often useful for comparisons between companies in the same industry or comparison with
an industry average. It is also useful to compare the net profit ratio with the gross profit ratio. A high gross profit
ratio and a low net profit ratio indicate high overhead costs for administrative expenses and selling and
distribution costs.
Return on Equity
Return on shareholder capital (ROSC), or return on equity, measures the return on investment that the
shareholders of the company have made. This ratio normally uses the values of the shareholders’
investment as shown in the statement of financial position (rather than market values of the shares).
Return on Assets
The normal convention is to use ‘total assets’ which includes both current and non-current assets.
However, other variations are sometimes used such as non-current assets only.
The return on assets ratio is a profitability ratio and measures the return produced by the total assets. It
helps both, the management and the investors, to know how well the entity can convert its investment in
assets into profits. The figures of ROA depend highly on the industry and hence can vary substantially.
This suggests that when ROA has to be used as a comparative measure then the best practice is to
compare it against a company’s previous ROA figures or the ROA of a company in a similar business
line.
Gearing, also called leverage, measures the total long-term debt of a company as a percentage of either:
Alternatively:
LONG−TERM DEBT
GEARING= X 100
SHARE CAPITAL∧RESERVES + LONG−TERM DEBT
It is usually appropriate to use the figures from the statement of financial position at the end of the year. However,
a gearing ratio can also be calculated from average values for the year.
When there are redeemable preference shares it is usual to include them within debt capital. This is because
redeemable preference shares behave more like a long-term loan or bond with fixed annual interest followed by
future redemption.
Irredeemable preference shares behave more like Equity (as they are never redeemed) and should therefore be
treated as equity.
A company is said to be high-geared or highly leveraged when its debt capital exceeds its share capital and
reserves. This means that a company is high-geared when the gearing ratio is above either 50% or 100%,
depending on which method is used to calculate the ratio.
A company is said to be low-geared when the amount of its debt capital is less than its share capital and reserves.
This means that a company is low-geared when the gearing ratio is less than either 50% or 100%, depending on
which method is used to calculate the ratio.
The gearing ratio can be used to monitor changes in the amount of debt of a company over time. It can also be
used to make comparisons with the gearing levels of other, similar companies, to judge whether the company has
too much debt, or perhaps too little, in its capital structure.
COVERAGE RATIO:
The interest coverage ratio is a debt and profitability ratio used to determine how easily a company can pay
interest on its outstanding debt. The interest coverage ratio is calculated by dividing a company's earnings before
interest and taxes (EBIT) by its interest expense during a given period.
The interest coverage ratio is sometimes called the times interest earned (TIE) ratio. Lenders, investors, and
creditors often use this formula to determine a company's riskiness relative to its current debt or for future
borrowing.
CALCULATION FOR THE YEAR 2000
LIQUIDITY:
Current Ratio
CURRENT ASSETS
CURRENT RATIO=
CURRENT LIABILITIES
1,124,000
CURRENT RATIO=
481,600
CURRENT RATIO=2.33TIMES
408,800
QUICK RATIO=
481,600
QUICK RATIO=0.85׿
PROFITABILITY:
87,960
NET PROFIT MARGIN RATIO= X 100
3,432,000
209,100
INTEREST COVER RATIO=
62,500
INTEREST COVER RATIO=¿3.35 TIMES
LIQUIDITY:
Current Ratio
CURRENT ASSETS
CURRENT RATIO=
CURRENT LIABILITIES
1,926,802
CURRENT RATIO=
1,733,760
CURRENT RATIO=1.11 TIMES
639,422
QUICK RATIO=
1,733,760
QUICK RATIO=0.37׿
PROFITABILITY:
NET PROFIT
NET PROFIT MARGIN RATIO= X 100
SALES
(519,936)
NET PROFIT MARGIN RATIO= X 100
5,834,400
(690,560)
INTEREST COVER RATIO=
176,000
INTEREST COVER RATIO=¿ -3.92 TIMES
For the Year 2001 For the Year 2000
Despite having a current ratio of about 1.11, the quick ratio is below 1.0. This means that the company may
face liquidity problems should payment of current liabilities be demanded immediately. But it does not seem to
be a huge cause for concern.
Gross Profit Margin
Note: Above comparison is between the two years of the same organization and comments are totally
dependent on both year ratios but the market analysis is necessary for any final statement.