Ch.

25: Financial Ratio Analysis

CHAPTER 25

FINANCIAL RATIO ANALYSIS

Problem 1

(a) (Rs)
A. Sales 450,000
B. Cost of goods sold 240,000
C. Inventory 90,000
D. Inventory turnover [B/C] 2.67
E. Gross margin [(A - B)/A] 46.7%

(b) (Rs)
A. Cash 105,000
B. Inventories 560,000
C. Debtors 420,000
D. Total current assets [A+B+C] 1,085,000
E. Current ratio [CA/CL] 2
F. Current liabilities [D/E] 542,500
G. Quick ratio [(D – B)/F] 0.97

(c) (Rs)
A. Closing inventory 150,000
B. Cost of goods sold 975,000
C. Turnover (times) 5
D. Average inventory [B/C] 195,000
E. Opening inventory [(D x 2)-A] 240,000

Problem 2

(Rs)
A. Sales 400,000
B. Gross margin 20%
C. Average inventory 50,000
D. Cost of goods sold [A x (1-B)] 320,000
E. Inventory turnover [D/C] (times) 6.4

(b) (Rs)
A. Inventory 180,000
B. Debtors 115,000
C. Inventory turnover (times) 6
D. Gross margin 10%
E. Credit sales/total sales 20%
F. Collection period (days) [B/H x 360] 192
G. Sales [A x C] 1,080,000
H. Credit sales [G x E] 216,000

© (Rs)
A. Equity 200,000

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I. M. Pandey, Financial Management, 9th Edition, New Delhi: Vikas.

B. Total assets/equity 160%

C. Assets turnover (times) 4
D. Inventory turnover (times) 5
E. Total assets [A x B] 320,000
F. Sales [E x C] 1,280,000
G. Inventory [F/D] 256,000

Problem 3

(a) (Rs)
A. Cost 200,000
B. Sales 250,000
C. Assets turnover (times) 4
D. Profit [B - A] 50,000
E. Total assets [B/C] 62,500
F. ROA [D/E] 80%

(b) (Rs)
A. PBIT 80,000
B. Interest 8,000
C. Taxes 30,000
D. Total assets 500,000
E. Total liabilities 300,000
F. Equity [D – E] 200,000
G. PAT [A – B –C] 42,000
H. ROE [G/F] 21.00%
I. Interest coverage [A/B] (times) 10

(c) (Rs)
A. PAT 150,000
B. Number of shares 30,000
C. Share price 10
D. EPS [A/B] 5
E. P/E ratio [C/D] (times) 2
F. Expected return (on equity) [D/C] 50%

(d) (Rs)
A. PAT 120,000
B. Cash dividend 48,000
C. Number of shares 36,000
D. Share price 12
E. EPS [A/C] 3.33
F. DPS [B/C] 1.33
G. Earnings yield [E/D] 27.78%
H. Dividend yield [F/D] 11.11%
I. Dividend payout [B/A] 40.00%

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Ch. 25: Financial Ratio Analysis

Problem 4
(a)
Ratios S Ltd. T Ltd.
(i) NP/NA 8,000/100,000 = 8.0% 6,000/50,000 = 12.0%
(ii) NP/Sales 8,000/160,000 = 5.0% 6,000/120,000 = 5.0%
(iii) GP/Sales 64,000/160,000 = 40.0% 45,000/120,000 = 37.5%
(iv) CA/CL (times) 90,000/30,000 = 3.0 60,000/30,000 = 2.0
(v) Liquid ratio (times) (90,000 - 57,000)/30,000 = 1.1 (60,000 - 30,000)/30,000 = 1
(vi) Stock turnover (times) 96,000/57,000 = 1.7 75,000/30,000 = 2.5

(b) S Ltd. has higher gross profit margin than T Ltd. But the two firms have equal net margin and T Ltd. has a higher
net profit to net assets ratio. This implies that S Ltd. has higher operating expenses as well as lower assets turnover
as compared to T Ltd. T Ltd. is more efficient in turning over its stock, but it has lower liquidity as reflected by
current and liquid ratios.

Problem 5

Solvency ratios Year I Year II

(i) Current ratio: CA/CL 1.6 1.4
(ii) Liquidity ratio: (CA - stock)/CL 1.3 1.0
(iii) Stock turnover: sales/stock 35.0 15.0
(iv) Debtors turnover: sales/debtors 11.7 10.0
(v) Collection period: 360/debtors 31 36
turnover
(vi) NWC/Sales 6.3% 6.0%

XYZ Ltd.’s solvency position has deteriorated. Its current ratio, liquidity ratio, stock turnover and debtor’s turnover
have declined in year II. However, net working capital (current assets minus current liabilities) as a percentage of sales
has almost remained at the same level. The implication is that the company has incurred more current liabilities
(creditors and bank overdraft) to finance its higher current asset requirements.

Problem 6

Industry ABC Ltd Comments

average
Current ratio 2.95 2.68 Comparable with industry average
Quick ratio 1.05 1.22 Comparable with industry average
Debt-equity ratio Lower than industry average
0.50 0.23
Times interest earned 2.60 4.38 Higher than industry average
Inventory turnover 0.35 0.23 Lower than industry average
Fixed-asset turnover 0.8 0.66 Higher than industry average
Total assets turnover 0.5 0.20 Lower than industry average
Net profit margin 16.00% 15.65% Comparable with industry average
Return on assets (PBIT/TA) 15.00% 6.08% Lower than industry average
Return on equity 21.00% 4.23% Lower than industry average

ABC Ltd.’s short-term solvency (as shown by current ratio and quick ratio) is comparable with the industry average. It
is conservatively financed and has a strong long-term solvency (debt-equity ratio and times interest earned). But the
company is generally inefficient in utilising its assets and controlling its expenses. As a result, its profitability is much
lower than the industry average. The company must take measures to reduce its expenses, improve its working capital
management and increase productivity of its fixed assets.

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I. M. Pandey, Financial Management, 9th Edition, New Delhi: Vikas.

Problem 7

N M
(Rs) (Rs)
A. Sales 800,000 200,000
B. Total assets 4,000,000 600,000
C. Net profit 750,000 420,000
1. Assets turnover [A/B] 20.00% 33.33%
2. Net margin [C/A] 93.75% 210.00%
3. ROI [1 x 2 or C/B] 18.75% 70.00%

M has much lower sales than N. But it is much more efficient and ts assets productivity is high as well as its margin is
very high. Thus, overall, it earns a higher return on assets than N.

Problem 8

JAGAN LTD.

JAGAN LTD.
19X1 19X2 19X3 19X4 19X5
Current ratios
Current ratio [CA/CL] 20 30 40 50 60
Quick ratio [(CA-Stock)/CL] 4 4 4 4 4
Activity ratios
Sales/net assets 0.20 0.20 0.20 0.20 0.20
Sales/fixed assets 0.30 0.30 0.30 0.30 0.30
Sales/net current assets 0.63 0.62 0.62 0.61 0.61
Sales/stock 0.75 0.69 0.67 0.65 0.64
Average inventory holding (days) 480 520 540 552 560
Sales/debtors 6 9 12 15 18
Average collection period (days) 60 40 30 24 20
Capital structure ratios
Debt-equity ratio 0.20 0.82 1.43 2.04 2.65
Debt/capital employed ratio 16.95% 44.94% 58.82% 67.11% 72.63%
Times interest earned [EBIT/Int.] 11.67 3.70 2.35 1.79 1.48
Profitability ratios
Gross margin [GP/sales] 66.67% 66.67% 66.67% 66.67% 66.67%
Net margin [NP/sales] 30.82% 23.81% 16.49% 11.98% 8.54%
EBIT/sales 58.33% 55.56% 50.00% 46.67% 44.44%
Operating expenses/sales 8.33% 11.11% 16.67% 20.00% 22.22%
Interest/sales 5.00% 15.00% 21.25% 26.00% 30.00%
ROI [EBIT/NA] 11.86% 11.24% 10.08% 9.40% 8.94%
ROI [NP/NA] 6.27% 4.82% 3.33% 2.41% 1.72%
ROE [NP/NW] 7.55% 8.75% 8.08% 7.33% 6.28%
Notes:
Net current assets [NCA=CA-CL]
Net assets [NCA+NFA]

Jagan Ltd.’s gross margin and assets turnover have remained at the same level during last five years. However, all other
measures of profitability have shown significant decline. The firm’s debt-equity ratio has sharply increased, and as a
consequence, interest coverage and interest to sales ratio have shown deterioration. The reason for poor profitability is
sharp increase in operating expenses and interest charges (cost of gods sold to sales ratio has remained stable). The
company is earning very low return for the shareholders and perhaps, as result the price-earnings ratio is low and has

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Ch. 25: Financial Ratio Analysis

been declining. Given poor profitability, high debt-equity ratio and inefficient inventory management, the overall
financial capability of the company is quite week.

Problem 9

(Rs)
Sales: 54,000/0.20 270,000
Credit sales: 270,000 x 0.80 216,000
Cost of goods sold: 0.80 x 270,000 216,000
Long-term debt: 0.40 x 600,000 240,000
Inventory: 216,000/4 54,000
Total assets: 270,000/0.3 900,000
Total liabilities 900,000
Shareholders' equity 600,000
Creditors: [900,000 - 600,000-240,000] 60,000
Debtors 12,000
Current assets [60,000 x 1.8] 108,000

Liabilities (Rs) Assets (Rs)

Creditors 60,000 Cash 42,000
Long-term debt 240,000 Debtors 12,000
Shareholders’ equity 600,000 Inventory 54,000
Current assets 108,000
Fixed assets 792,000
Total liabilities 900,000 Total assets 900,000

Problem 10

SUENDRA MOHAN & SONS

Ratios 19X3 19X2 19X1

Sales/total assets 1.7 1.9 1.8
Sales/fixed assets 4.8 4.7 4.1
Sales/current assets 2.8 3.3 3.4
Sales/debtors 5.5 7.4 9.9
Sales/stock 7.8 7.2 5.9

Gross margin 35.40% 39.70% 42.40%

Net margin 6.00% 9.60% 12.20%
Operating expenses/sales 29.40% 30.20% 30.20%
Net profit/total assets (ROI) 10.40% 17.80% 22.20%
Net profit/net worth (ROE) 13.90% 24.10% 29.90%

Current asset/current liability 2.5 2.2 2.1

Quick assets/current liabilities 1.6 1.2 0.9

Debt-equity - - -

Surendra Mohan & Sons is not doing well. Its weak working capital management is reflected by declining stock
turnover, debtors’ turnover and current assets turnover. The rising current assets are reflected in the higher current ratio
and quick ratio which is good from the short-term lender’s point of view. The profitability of the firm is declining; both
ROI and ROE have become half of the ratios three years ago. Gross and net margins have also squeezed. Operating

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I. M. Pandey, Financial Management, 9th Edition, New Delhi: Vikas.

expenses have remained almost stable. The declining gross margin indicates that the firm’s cost of goods sold is rising.
The firm does not employ any debt. Thus there is no threat to its long-term solvency.

Problem 11

PLASTIC WORKS LTD.

PLASTIC WORKS LTD.

Activity ratios 19X3 19X2 19X1
Sales/total assets 1.8 2.1 2
Sales/fixed assets 8.2 9 8.9
Sales/current assets 2.4 2.7 2.6
Sales/debtors 8.7 7.7 6.8
Sales/finished stock 7 9 8.2
Profitability ratios
Gross margin 52.10% 52.00% 52.20%
Net margin 3.90% 6.50% 7.50%
Operating expenses/sales 45.20% 40.00% 38.20%
Net profit/total assets (ROI) 7.20% 13.30% 15.00%
Net profit/net worth (ROE) 15.10% 20.80% 22.70%
Liquidity ratios
Current asset/current liability 1.7 2.1 2.3
Quick assets/current liabilities 0.7 0.9 1
Leverage ratio
Debt-equity 0.21 0.02 -

Plastic Works Limited is not doing well. Its efficiency in utilising its assets to generate sales is showing a weakness.
The rising current assets are reflected in the higher current ratio and quick ratio which is good from the short-term
lender’s point of view. The profitability of the firm is declining; both ROI and ROE have decreased significantly. Gross
margin has remained same but net margin has squeezed due too increasing operating expenses. The firm was not using
any debt so far but in the most recent year, it has employed debt and its total debt-equity ratio is 0.21:1 which is not
significant in absolute terms. But in view of the firm’s poor financial performance, it may find it difficult even to
sustain a low debt-equity ratio.

Problem 12

TATA IRON & STEL CO. LTD.

TATA IRON & STEL CO. LTD.

1995 1996 1997 1998 1999 2000 2001 Average
Current ratios
Current ratio [CA/CL] 1.63 2.22 2.11 1.96 1.56 1.30 1.21 1.71
Quick ratio [(CA-Stock)/CL] 1.07 1.55 1.56 1.43 1.12 0.93 0.90 1.23
Activity ratios
Net sales/net assets 0.73 0.76 0.77 0.68 0.64 0.65 0.72 0.71
Net sales/Net fixed assets 0.87 1.07 1.13 1.00 0.87 0.84 0.92 0.96
Net sales/Current assets 1.79 1.60 1.58 1.61 1.70 1.83 1.92 1.72
Net sales/Net current assets 4.64 2.91 3.01 3.30 4.75 8.04 10.90 5.36
Net sales/inventory 5.26 5.35 6.09 6.05 6.07 6.58 7.49 6.13
Average inventory holding (days) 68 67 59 60 59 55 48 59
Net sales/debtors 3.39 3.34 2.86 3.23 3.29 3.33 3.35 3.26
Average collection period (days) 106 108 126 112 109 108 107 111

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Ch. 25: Financial Ratio Analysis

Capital structure ratios

Debt-equity ratio 1.33 1.03 1.03 1.28 1.32 1.09 0.96 1.15
Net assets/net worth 2.33 2.03 2.03 2.28 2.32 2.09 1.96 2.15
Debt/capital employed ratio 0.57 0.51 0.51 0.56 0.57 0.52 0.49 0.53
Times interest earned 2.87 3.48 3.23 3.19 2.94 3.33 3.66 3.24
[PBDIT/Interest]

Profitability ratios
Gross margin [PBDIT/sales] 17.75% 21.07% 20.25% 16.39% 17.14% 20.78% 21.84% 19.32%
Gross margin [PBIT/sales] 11.99% 15.90% 15.00% 10.93% 10.95% 13.92% 14.71% 13.34%
Net margin [NP/sales] 5.80% 9.83% 7.54% 5.12% 4.57% 6.80% 8.02% 6.81%
Interest/sales 6.18% 6.06% 6.28% 5.14% 5.84% 6.25% 5.98% 5.96%
ROI [EBIT/NA] 8.70% 12.07% 11.59% 7.41% 6.99% 9.11% 10.62% 9.50%
ROI [NP/NA] 4.21% 7.46% 5.82% 3.47% 2.92% 4.45% 5.79% 4.87%
ROE [NP/NW] 9.83% 15.12% 11.81% 7.92% 6.78% 9.27% 11.32% 10.29%

Payout ratio 44.76% 27.74% 35.31% 45.72% 52.12% 36.65% 35.43% 39.7%
Retention ratio 55.24% 72.26% 61.16% 49.71% 42.14% 59.32% 60.68% 57.2%

Performance analysis
A. Turnover: Net sales/net assets 0.73 0.76 0.77 0.68 0.64 0.65 0.72 0.71
B. Margin: PBIT/Net sales 11.99% 15.90% 15.00% 10.93% 10.95% 13.92% 14.71% 13.34%
C. ROI: PBIT/Net assets [A x B] 8.70% 12.07% 11.59% 7.41% 6.99% 9.11% 10.62% 9.50%
D. Leverage (income): PAT/PBIT 48.40% 61.83% 50.26% 46.87% 41.75% 48.83% 54.50% 50.35%
E. Leverage (balance sheet) : Net 2.33 2.03 2.03 2.28 2.32 2.09 1.96 2.15
assets/net worth
F. ROE: PAT/Net worth [C x D x 9.83% 15.12% 11.81% 7.92% 6.78% 9.27% 11.32% 10.3%
E]

1995 1996 1997 1998 1999 2000 2001 Average

2. Net current assets [CA-CL] 980.8 1,977.7 2,066.7 1,907.2 1,301.2 773.9 633.2 1,377.2
3. Net assets [NCA+NFA+ Invst.] 6,270.8 7,584.5 8,056.5 9,277.3 9,667.7 9,504.9 9,561.0 8,560.4
4. Capital employed [NW + Debt] 6,270.8 7,584.5 8,056.5 9,277.3 9,667.7 9,504.9 9,561.0 8,560.4
Comments:
There appears to be three phases in the performance of TISCO during 1990-1997. The period 1995-96 shows good
profitability. The performance of the company starts declining in 1997 and drops significantly in 19999, and then
again starts improving. ROE is highest at 15% in 1996. The use of debt is fluctuating, but debt-equity remains around
1.

Problem 13

AGRO-CHEMICALS & PESTICIDES COMPANIES

AGRO-CHEMICALS & PESTICIDES COMPANIES

Cyna- Kha- Mon- Mon- Pau- UP Unit- Ind.
Buyer mide Excel tau santo tari shak Searle straw ed Avg.
Market share 23.2% 10.7% 18.6% 2.8% 1.5% 6.3% 1.3% 7.9% 17.0% 10.7% -
Margin: PBIT/sales 13.0% 13.2% 20.4% 14.2% 11.7% 10.7% 10.6% 11.5% 0.8% 21.2% 12.7%
Net margin: PAT/sales 4.0% 6.1% 10.6% 4.4% 4.3% 3.3% 4.3% 5.6% 0.6% 14.0% 5.7%
Interest/sales 5.2% 2.1% 4.3% 9.8% 2.5% 7.4% 5.6% 3.5% 0.2% 18.0% 5.9%
Leverage factor: PAT/PBT 51.7% 54.4% 66.2% 30.90% 36.90% 30.50% 40.80% 48.90% 75.60% 66.40% 50.2%
Interest coverage: 3.0 7.3 5.2 1.9 4.8 1.7 2.2 3.8 5.7 1.2 3.7
PBDIT/interest
P/E ratio 38.6 24.2 23.4 20.3 40.3 37.7 20.8 34.9 16.4 29.5 28.6

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I. M. Pandey, Financial Management, 9th Edition, New Delhi: Vikas.

ROE 20.3% 22.1% 43.1% 12.2% 24.4% 21.7% 23.0% 13.9% 22.5% 59.3% 26.2%
Payout 44.1% 30.3% 37.6% 106.8% 37.1% 69.2% 27.2% 31.1% 0.0% 25.0% 40.8%
Retention ratio 55.9% 69.7% 62.4% -6.8% 62.9% 30.8% 72.8% 68.9% 100.0% 75.0% 59.2%
Growth: ROE x Retention 11.3% 15.4% 26.9% -0.8% 15.4% 6.7% 16.7% 9.6% 22.5% 44.5% 16.8%
ratio
MV/BV 7.8 5.4 10.1 2.5 9.8 8.2 4.8 4.8 3.7 17.5 7.5

60.0%
Market share
Percentage 50.0% ROE
40.0%

30.0%
20.0%

10.0%
0.0%
Cynamide

Paushak

United
Montari
Monsanto
Excel

Khatau

Searle
Buyer

UP straw
Com panies

Market Value/Book Value

18.00
16.00
14.00
12.00
Times

10.00
8.00
6.00
4.00
2.00
0.00
Cynamide

Paushak

United
Montari
Monsanto
Excel

Khatau

Searle
Buyer

UP straw

Com panies

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Ch. 25: Financial Ratio Analysis

Problem 14

GLASS MANUFACTURING COMPANIES

GLASS MANUFACTURING COMPANIES

Year Alemb Ashi Boros Excel Fgp. Hind Indo. Maha Trive Victo Indust
ic il ni ry ry
Margin: PBIT/sales 1991 8.1% 9.8% 15.4% 7.2% 16.0% 9.5% 22.7% 10.3% 19.7% 12.8% 14.6%
1992 9.6% 15.9% 19.0% 8.9% 13.0% 10.7% 15.2% 12.1% 30.9% 17.1% 16.7%
Net margin: PAT/sales 1991 1.5% 1.6% 4.9% 2.1% 7.1% 5.0% 16.6% 5.2% 10.8% 5.1% 7.7%
1992 3.5% 8.0% 6.4% 3.7% 6.5% 5.7% 6.4% 4.0% 16.4% 7.3% 7.7%
Leverage (income): 1991 18.8% 15.8% 31.6% 28.6% 44.7% 52.4% 73.2% 50.0% 54.8% 40.0% 52.8%
PAT/PBIT
1992 37.0% 50.0% 33.9% 41.7% 50.0% 53.7% 42.1% 33.3% 53.0% 42.9% 46.2%
ROE: EPS/BV 1991 12.0% 13.8% 6.8% 7.4% 11.1% 23.6% 44.1% 20.9% 25.4% 20.5% 18.6%
1992 29.7% 49.8% 11.5% 16.7% 9.6% 24.0% 18.0% 18.5% 37.5% 24.5% 24.0%
Payout: DPS/EPS 1991 0.0% 58.8% 80.6% 93.3% 62.9% 4.4% 14.4% 37.8% 10.3% 42.9% 40.5%
1992 0.0% 13.4% 4.5% 48.6% 71.0% 3.3% 36.6% 37.8% 5.3% 40.8% 50.5%
P/E ratio: MV/EPS 1992 14.9 20.3 15.2 20.3 27.4 1.1 17.7 1.6 10.0 9.2 8.9
MV/BV 1992 4.4 10.1 1.7 3.4 2.6 0.3 3.2 0.3 3.7 2.3 3.2

Top performers:
1991 1992
Market share
Hind. 24.38% Indo 24.52%
Indo 20.00% Hind 22.66%
Triveni 11.60% Triveni 14.24%
ROE
Indo 44.13% Ashi 49.78%
Triveni 25.39% Triveni 37.55%
Hind. 23.63% Alembic 29.71%
Industry 18.60% Industry 24.00%
MV/BV
Ashi 10.1
Alembic 4.4
Triveni 3.7
Industry 3.2