RATIO ANALYSIS

MEANING

A ratio analysis is a quantitative analysis of information contained in a

coinancial statements. Ratio analysis is used to evaluate various aspects of a
company’s operating and financial performance such as its efficiency, liquidity,
profitability and solvency.

DEFINITION

Khan and Jain define the term ratio analysis as “the systematic use of
ratios to interpret the financial statements so that the strengths and weaknesses
of a firm as well as its historical performance and current financial conditions
can be determined.”

RATIO ANALYSIS INVOLVES FOUR STEPS

 Collection of relevant accounting data from financial statements.

 Constructing ratios of related accounting figures.
 Comparing the ratios thus constructed with the standard ratios which may
be the corresponding past ratios of the firm or industry average ratios of
the firm or ratios of competitors.
 Interpretation of ratios to arrive at valid conclusion.

ADVANTAGES OF RATIO ANALYSIS

The following are the principel advantages of ratio analysis:

FORECASTING AND PLANNING

The trend in costs, sales, profits and other facts can be known by
computing ratios of relevant accounting figures of last few years. This trend
analysis with the help of ratios may be useful for forecasting and planning
future business activities.
 CURRENT RATIO

MEANING

Current ratio may be defined as the ratio of current assets and current
liabilities and is obtained by dividing current assets by current liabilities. It is
also known as working capital ratio. Working capital is defined as excess of
current assets over current liabilities. This ratio is it indicator of short-term
liquidity position of a firm. The term liquidity means the ability of the firm to
meet its short-term maturing obligations.

FORMULA
CURRENT RATIO = CURRENT ASSETS
CURRENT LIABILITIES
Current assets = Current assets = Debtors + Stock + Bills Receivables + Cash
& Bank balance + Prepaid expenses + Income due + Short term investment.

YEAR CURRENT CURRENT

CURRENT RATIO
ASSETS LIABILITY

2014-2015 1,380,200,000 987,300,000 1.39

2015-2016 1,515,600,000 964,600,000 1.57

2016-2017 1,569,300,000 1,049,900,000 1.49

2017-2018 1,967,400,000 1,225,600,000 1.60

2018-2019 2,374,200,000 1,459,500,000 1.62

Current liabilities = Creditors + Bank overdraft + Bills payable + Outstanding

Expenses + Income received in advance.
SIGNIFICANCE

Ideal ratio is 2:1 A higher ratio indicates there is sufficient assets in the
firm to meet its current liabilities a lower ratio indicates inadequate current
assets to meet is current liabilities.

INTERPRETATION

The above table show, during the year 2014-2015 the ratio was lowest
this indicates that a company may have difficulty meeting current obligations.
In the year 2018-2019 the ratio was high this indicates that the company may
not be using its current assets or its short-term financing facilities efficiently.
 LIQUID RATIO

MEANING

Quick ratio or liquid ratio is the ratio between quick or liquid assets and
quick or current liabilities. It shows the availability of funds for meeting the
immediate liabilities. Liquid asset mean those assets which are immediately
convertible into cash without much loss. It includes cash, debtors-less bad debts,
short-term bills receivable and temporary investment held in lieu of cash.
Inventories and pre-paid expenses are excluded from liquid assets.

FORMULA

LIQUID RATIO = LIQUID ASSETS

CURRENT LIABILITIES

Liquid assets = Current assets – Stock and Prepaid expenses.

Current liabilities = Creditors + Bank overdraft + Bills payable + Out Standing
expenses + Income received in advance.

LIQUID CURRENT
YEAR LIQUID RATIO
ASSET LIABILITIES

2014-2015 1,108,100,000 987,300,000 1.1

2015-2016 1,206,400,000 964,600,000 1.2

2016-2017 1,214,100,000 1,049,900,000 1.1

2017-2018 1,606,900,000 1,225,600,000 1.3

2018-2019 1,865,200,000 1,459,500,000 1.2

SIGNIFICANCE

The ideal liquid ratio is 1:1. Higher ratio indicates prepaid expenses). The
ratio is not preferable.

INTERPRETATION

The above table shows, during the year 2014-2015 the ratio percentage
was low this indicates that the company may struggle to pay short-term
obligations. In the year 2018-2019 the ratio was high this indicates that the
business is holding too much cash that could be utilized in other areas.
 DEBT EQUITY RATIO

MEANING

This ratio shows the relationship between debt capital and equity or
shareholders fund in the capital structure of the firm. It is determined to
measure the firm’s obligations to creditors in relation to funds invested by the
owners.

FORMULA

DEBT EQUITY RATIO = LONGTERM DEBT

SHAREHOLDERS FUNDS

Long term debt = Debentures + Long term loans from bank and financial
institutions.

Shareholders fund = Equity share capital + Preference share capital + Reserves

and surplus.

LONG TERM SHAREHOLDERS DEBT EQUITY

YEAR
DEBT FUNDS RATIO

2014-2015 700,000 2,097,700,000 0.0

2015-2016 1,200,000 1,803,000,000 0.0

2016-2017 59,900,000 1,588,600,000 0.03

2017-2018 168,300,000 1,300,200,000 0.12

2018-2019 187,500,000 1,137,900,000 0.16

SIGNIFICANCE

A ratio of between 1 and 1.5 is considered ideal. Anything higher than 2,

for most industries, is too high.

INTERPRETATION

The above shows the debt equity ratio during the year 2016-2017 the ratio
was low this indicates that the lower amount of financing by debt via lenders,
during the year 2018-2019 the ratio was highest this indicates that the company
is getting more of its financing by borrowing money.
 GROSS PROFIT RATIO

MEANING

Gross profit ratio is a profitability ratio that shows the relationship

between gross profit and total net sales revenue. It is a popular tool to evaluate
the operational performance of the business. The ratio is computed by dividing
the gross profit figure by net sales.

FORMULA

GROSS PROFIT = GROSS PROFIT ×100

NET SALES
Gross Profit = Sales – Cost of goods sold

YEAR GROSS PROFIT NETSALE GROSS PROFIT

RATIO

2014-2015 2,015,000,000 4,164,100,000 48.3

2015-2016 2,290,700,000 4,484,200,000 51.0

2016-2017 2,292,200,000 4,659,400,000 49.1

2017-2018 2,342,600,000 4,841,000,000 48.3

2018-2019 2,457,700,000 5,138,900,000 47.8

Net sales = Sales – sales return

SIGNIFICANCE

A higher ratio is preferable its indicates higher profitability. A lower ratio

indicates lower profitability.

INTERPRETATION

From the above table, during the year 2015-2016 the ratio was highest
this indicates that a company can make a reasonable profit on sales, as long as it
keeps overhead costs in control. In the year 2018-2019 the ratio became low this
indicates that the company is under-pricing.
 NET PROFIT RATIO
MEANING:

This is the ratio of net profit after taxes to net sales. Net profit, as used
here, is the balance of profit and loss account which is arrived at after
considering all non-operating incomes such as interest on investment; dividend
received etc. and operating expenses such as office and administrative expenses,
selling and distribution expenses and non-operating expenses like loss on sale of
fixed assets, provision for contingent liability, etc.

FORMULA

NET PROFIT RATIO = NET PROFIT × 100

NET SALES

Net profit = Non-operating incomes + Profits

Net sales = Sales – Sales return

YEAR NET PROFIT NET SALE NET RATIO

2014-2015 161,100,000 4,164,100,000 3.8

2015-2016 257,600,000 4,484,200,000 5.7

2016-2017 349,300,000 4,659,400,000 7.4

2017-2018 357,500,000 4,841,000,000 7.3

2018-2019 365,300,000 5,138,900,000 7.1

SIGNIFICANCE

Higher the ratio is better the operational efficiency of the business,

concern is good. A lower ratio indicates less operational efficiency of the
business concern.

INTERPRETATION

The above table shows as net profit ratio. During the year 2014-2015 the
ratio was very low this indicates that the net profit efficiency is below industry
norms. In the year 2016-2017 the percentage of ratio was high this indicates that
a company is able to effectively control its costs and provide goods or services
at a price significantly higher than its costs. Therefore, a high ratio can result
from efficient management.
 OPERATING PROFIT RATIO

MEANING

The operating profit ratio indicates how much profit a company makes
after paying for variable costs of production such as wages, raw material, etc. it
is also expressed as a percentage of sales and then shows the efficiency of a
company controlling the costs and expenses associated with business
operations.

FORMULA

OPERATING PROFIT RATIO = OPERATING PROFIT × 100

NET SALES

Operating ratio = Net profit + Non-operating expenses + Non-operating

incomes

Net Sales = Sales – Sales return

OPERATING OPERATING
YEAR NET SALE
PROFIT PROFIT RATIO

2014-2015 454,900,000 4,164,100,000 10.92

2015-2016 544,300,000 4,484,200,000 12.1

2016-2017 732,200,000 4,659,400,000 15.7

2017-2018 758,700,000 4,841,000,000 15.6

2018-2019 677,800,000 5,138,900,000 13.1
SIGNIFICANCE

This ratio shows the operational efficiency of the firm. A lower ratio is
more efficient the ratio should be low enough provide fair returns to the
shareholders and other investors. High ratio is more inefficient.

INTERPRETATION

The above shows, during the year 2014-2015 the operating profit ratio
was very low. In the year 2017-2018 the ratio was highest it indicates greater
potential to derive profits. During the year 2018-2019 the ratio percentage was
very lowest.
 OPERATING RATIO

MEANING

This is the ratio of cost of goods sold plus operating expenses to net sales
of the firm. This is closely related to the ratio of operating profit to net sales.
Operating cost consists of cost of goods sold, office and administrative expenses
and selling and distribution expenses. Financial charges such as interest,
provision for taxation and loss on sale of investments etc. are excluded from
operating expenses.

FROMULA

OPERATING RATIO = COST GOODS SOLD + OPERATING RATIO ×

100

NET SALES

Operating expenses= Cost of goods sold + Administrative expenses + Selling

and distribution expenses.

Net sales = Sales – sales return

(COST OF GOODS)
+ OPERATING
YEAR NET SALES
(OPERATING RATIO
EXPENSES)

2014-2015 6,964,500,000 4,164,100,000 1.6

2015-2016 7,298,400,000 4,484,200,000 1.6

2016-2017 7,326,600,000 4,659,400,000 1.5

2017-2018 7,644,300,000 4,841,000,000 1.5

2018-2019 8,338,800,000 5,138,900,000 1.6

SIGNIFICANCE

It indicates the operational efficiency of the concern. A lower ratio is

more efficient. The ratio should be though enough to provide fair return to
shareholders and other investors. A higher ratio is more inefficient.

INTERPRETATION

The above table shows an operating ratio, during the year 2014-2015 the
ratio was highest. In the year 2016-2018 the ratio was lowest this indicates that
the greater the organization’s ability to generate profit. During the year 2018-
2019 the ratio became highest.
 WORKING CAPITAL TURNOVER RATIO

MEANING

The working capital turnover ratio is also referred to as net sales to

working capital. It indicates a company’s effectiveness in using its working
capital. The working capital turnover ratio is calculated as follows: net annual
sales divided by the average amount of working capital during the same year.

FORMULA

WORKING CAPITAL TURUNOVER RATIO = COST OF SALES

WORKING CAPITAL

Working capital = current asset- current liabilities

Cost of sales = Stock + Purchases – closing stock

CAPTIAL
WORKING
YEAR COST OF SALES TRUNOVER
CAPITAL
RATIO

2014-2015 2,149,100,000 392,900,000 5.4

2015-2016 2,193,500,000 551,000,000 3.9

2016-2017 2,367,200,000 519,400,000 4.5

2017-2018 2,498,400,000 741,800,000 3.3

2018-2019 2,681,200,000 914,700,000 2.9

SIGNIFICANCE

A higher ratio is an indication of the lower investment of working capital

and more profit. A lower ratio indicates high investments of working capital and
loss profit.

INTERPRETATION

The above table shows during the year 2014-2015 a high turnover ratio
this indicates that management is being extremely efficient in using a firm short
term assets and liabilities to support sales. In the year 2018-2019 the ratio was
lowest.
 FIXED ASSET TURNOVER RATIO

MEANING

Fixed asset turnover is the ratio of sales (on the profit and loss account) to
the value of fixed assets (on the balance sheet). It indicates how well the
business is using its fixed assets to generate sales.

FORMULA
FIXED ASSET TRUNOVER RATIO = COST OF SALES
FIXED ASSETS
Net fixed assets = Fixed assets - Depreciation

Cost of sales = Stock + Purchases – closing stock

FIXED ASSETS
YEAR COST OF SALES FIXED ASSETS TRUNOVER
RATIO

2014-2015 2,149,100,000 1,170,700,000 1.8

2015-2016 2,193,500,000 1,043,200,000 2.1

2016-2017 2,367,200,000 1,208,200,000 1.9

2017-2018 2,498,400,000 1,141,500,000 2.1

2018-2019 2,681,200,000 1,183,700,000 2.2
SIGNIFICANCE

Higher the ratio more is the efficiency in utilization of fixed assets.

Lower the ratio indicates inefficiency in the utilization of fixed assets.

INTERPRETATION

The above table shows the fixed asset turnover ratio. In the year 2014-
2015 the ratio was lowest this indicates that a company has over-invested in
fixed asset. During the year 2018-2019 the ratio was highest this indicates that a
company spent less money in fixed asset for each rupees of sales revenue.
 CAPITAL TURNOVER RATIO

MEANING

Capital turnover ratio indicates the efficiency of the organization with

which the capital employed is being utilized. A high capital turnover ratio
indicates the capability of the organization to achieve maximum sales with
minimum amount of capital employed. Higher the capital turnover ratio better
will be the situation.

FORMULA

CAPITAL TRUNOVER RATIO = COST OF SALES

CAPITAL EMPLOYED

Cost of sales = Stock + Purchases – closing stock

CAPITAL
YEAR COST OF SALES TIMES
EMPLOYED

2014-2015 2,149,100,000 1,404,500,000 1.5

2015-2016 2,193,500,000 1,547,600,000 1.4

2016-2017 2,367,200,000 1,727,600,000 1.3

2017-2018 2,498,400,000 1,883,300,000 1.3

2018-2019 2,681,200,000 2,098,400,000 1.2

Capital employed = Equity share capital + Preference share capital + reserves

and surplus + long term borrowed funds
SIGNIFICANCE

A higher ratio is an indication of lower investment of working capital and

more profit. A lower ratio indicates high investments of working capital and
loss profit.

INTERPRETATION

The above table shows the capital turnover ratio, in the year 2014-2015
the ratio was high this indicates the capability of the organization to achieve
maximum sales with minimum amount of capital employed. During the year
2018-2019 the ratio was very low.