Ratio analysis

Group members
Ashish Nakade 62
Deepti Nayak 65
Aditi Rahalkar 77
Girish Rathod 78
Chetan Shirasi 95
Leena Thakur 109
Introduction
Financial ratio analysis is the calculation and
comparison of ratios which are derived from the
information in a company's financial statements, i.e.
balance sheet and P&L a/c.

It is a powerful tool of financial analysis useful for

measuring the performance of an organization
Introduction
It is the process of comparing one figure against
another(X/Y=Z)

A ratio gains utility by comparison to other data and

standards(benchmarks).
Who uses ratios
Investors present as well potential
Mutual funds
Stockbroker and stock exchange authorities
Tax depts.
Research analysts
Company management
Crs
Banks and financial institutions
Credit rating agencies
Modes of expression

Ratios

Amount in Rs
Pure ratio Percentage Number of
EPS =Rs4per
e.g. 2:1 20% of X days/week/month
share
Classification of ratios
Balance sheet ratios comparison of items from
balance sheet
P&L ratios Comparison of ratios of P& L account
Composite Ratios Comparison between balance
sheet and P&L account
Types of ratios

Leverage Ratios which show the extent that

debt is used in a company's capital structure.

Liquidity Ratios which give a picture of a

company's short term financial situation or
solvency.

Operational Ratios which use turnover

measures to show how efficient a company is
in its operations and use of assets.

Profitability Ratios which use margin analysis

and show the return on sales and capital
employed.

Solvency Ratios which give a picture of a

company's ability to generate cash flow and
pay it financial obligations.
Liquidity
Current Ratio
 Looks at the ratio between Current Assets and Current
Liabilities

 Current Ratio = Current Assets : Current Liabilities

 Ideal level? – 2 : 1 (varies as per industry)

It represents margin of safety for liabilities.

 Too high – Might suggest that too much of its assets are
tied up in unproductive activities – too much stock, for
example?

 Too low - risk of not being able to pay your way

Acid test
 Also referred to as the ‘Quick ratio’
 (Current assets – stock) : liabilities
 1:1 seen as ideal
 The omission of stock gives an indication of the cash the
firm has in relation to its liabilities (what it owes)
 A ratio of 3:1 therefore would suggest the firm has 3 times
as much cash as it owes – very healthy!
 A ratio of 0.5:1 would suggest the firm has twice as many
liabilities as it has cash to pay for those liabilities. This
might put the firm under pressure but is not in itself the
end of the world!
Investment/Shareholders
 Investment/Shareholders
 Earnings per share – profit after tax / number of shares

 Price earnings ratio – market price / earnings per share –

the higher the better generally. Comparison with other
firms helps to identify value placed on the market of the
business.

 Dividend yield – ordinary share dividend / market price x

100 – higher the better. Relates the return on the investment
to the share price.
Gearing
Gearing

Gearing Ratio = Long term loans / Capital

employed x 100

The higher the ratio the more the business is exposed

to interest rate fluctuations and to having to pay back
interest and loans before being able to re-invest
earnings
Profitability

Profitability measures look at how much profit the

firm generates from sales or from its capital assets

Different measures of profit – gross and net

Gross profit – effectively total revenue (turnover) –
variable costs (cost of sales)
Net Profit – effectively total revenue (turnover) –
variable costs and fixed costs (overheads)
Profitability
Gross Profit Margin = Gross profit / turnover x
100
The higher the better
Enables the firm to assess the impact of its sales
and how much it cost to generate (produce) those
sales
A gross profit margin of 45% means that for every
£1 of sales, the firm makes 45p in gross profit
 Profitability
 Net Profit Margin = Net Profit / Turnover x 100
 Net profit takes into account the fixed costs involved in
production – the overheads
 Keeping control over fixed costs is important – could be
easy to overlook for example the amount of waste - paper,
stationery, lighting, heating, water, etc.
 e.g. – leaving a photocopier on overnight uses enough electricity to make
5,300 A4 copies. (1,934,500 per year)
 1 ream = 500 copies. 1 ream = £5.00 (on average)
 Total cost therefore = £19,345 per year – or 1 person’s salary
Profitability
Return on Capital Employed (ROCE) = Profit /
capital employed x 100
Profitability
The higher the better
Shows how effective the firm is in using its capital to
generate profit
A ROCE of 25% means that it uses every £1 of capital
to generate 25p in profit
Partly a measure of efficiency in organisation and use
of capital
Financial
Asset Turnover

 Asset Turnover = Sales turnover / assets employed

 Using assets to generate profit
 Asset turnover x net profit margin = ROCE
Stock Turnover
 Stock turnover = Cost of goods sold / stock expressed as times per
year
 The rate at which a company’s stock is turned over
 A high stock turnover might mean increased efficiency?
 But: dependent on the type of business – supermarkets might have
high stock turnover ratios whereas a shop selling high value musical
instruments might have low stock turnover ratio
 Low stock turnover could mean poor customer satisfaction if people
are not buying the goods (Marks and Spencer?)
Debtor Days

 Debtor Days = Debtors / sales turnover x 365

 Shorter the better
 Gives a measure of how long it takes the business to
recover debts
 Can be skewed by the degree of credit facility a firm offers
INCOME STATEMENT OF TATA MOTORS
(currency in million Rs.)
(2007) (2008)
Revenues 323,612.0 356,514.8
Other Revenues 19.6 65.0
TOTAL REVENUES 325,143.8 358,086.0
Cost of Goods Sold 234,753.6 254,571.5
GROSS PROFIT 90,390.2 103,514.5
Selling General & Admin Expenses, Total 30,811.0 35,136.3
R&D Expenses 850.2 659.5
Depreciation & Amortization, Total 6,880.9 7,820.7
Other Operating Expenses 17,508.5 24,046.6
OTHER OPERATING EXPENSES, TOTAL 56,050.6 67,663.1
OPERATING INCOME 34,339.6 35,851.4
Interest Expense -4,650.6 -9,127.2
Interest and Investment Income 592.5 1,696.6
NET INTEREST EXPENSE -4,058.1 -7,430.6
Income (Loss) on Equity Investments 394.2 652.0
Currency Exchange Gains (Loss) 652.1 1,376.1
Other Non-Operating Income (Expenses) -1.4 -0.6
EBT, EXCLUDING UNUSUAL ITEMS 31,326.4 30,448.3
Gain (Loss) on Sale of Assets -- 1,103.6
Other Unusual Items, Total -52.2 -37.0
EBT, INCLUDING UNUSUAL ITEMS 31,274.2 31,514.9
Income Tax Expense 8,832.1 8,515.4
Minority Interest in Earnings -742.2 -1,322.5
Earnings from Continuing Operations 21,699.9 21,677.0
NET INCOME 21,699.9 21,677.0
BALANCE SHEET OF TATA MOTORS
PAT on its share capital is decreased
(2007) (2008)
Assets (currency in millions Rs.)
Cash and Equivalents 11,542.7 38,331.7
TOTAL CASH AND SHORT TERM INVESTMENTS 11,542.7 38,331.7
Accounts Receivable 17,022.2 20,605.1
Notes Receivable 84,553. 76,938.9
Other Receivables 62.7 11.9
TOTAL RECEIVABLES 101,638.5 97,555.9
Inventory 31,669.0 32,946.4
Prepaid Expenses 1,247.3 3,334.8
Other Current Assets 16,681.7 20,504.7
TOTAL CURRENT ASSETS 162,779.2 192,673.5
Gross Property Plant and Equipment 129,408.3 182,484.4
Accumulated Depreciation - -54,266.5 -57,652.4
NET PROPERTY PLANT AND EQUIPMENT 75,141.8 124,832.0
Goodwill 4,430.1 5,661.6
Long-Term Investments 11,745.9 26,658.3
Deferred Charges, Long Term 119.3 2,442.1
Other Intangibles -- 1,429.6
Other Long-Term Assets - --
TOTAL ASSETS 254,216.3 353,697.1
LIABILITIES & EQUITY
Accounts Payable 48,723.3 67,832.8
Accrued Expenses 4,704.9 5,389.3
Short-Term Borrowings 34,325. 52,503.2
Current Income Taxes Payable 1,084.2 901.4
Other Current Liabilities, Total 38,789.2 62,104.1
Unearned Revenue, Current 6.7 218.0
TOTAL CURRENT LIABILITIES 127,633.7 188,948.8
Long-Term Debt 38,693.6 63,345.5
Capital Leases -- --
Minority Interest 2,499.6 4,683.1
Deferred Tax Liability Non-Current 8,172.7 9,744.5
TOTAL LIABILITIES 176,999.6 266,721.9
Common Stock 3,853.6 3,854.9
Additional Paid in Capital 19,364.0 15,372.2
Retained Earnings 44,087.8 58,523.7
Comprehensive Income and Other 9,911.3 9,224.4
TOTAL COMMON EQUITY 77,216.7 86,975.2
TOTAL LIABILITIES AND EQUITY 254,216.3 353,697.1
Liquidity ratio
Current ratio = Current assets / Current liability
2008 2007
Current Assets 192,673.5 162,779.2
Current Liability 188,948.8 127,633.7
Current Ratio (2008) 192,673.5/ 188,948.8 = 1.01
Current Ratio (2007) 162,779.2/ 127,633.7 = 1.27
Quick Ratio (2008) C.A. - Invent. / C.L.
192,673.5 - 32,946.4 / 188,948.8 = .85
Quick Ratio (2007) 162,779.2- 31,669.0/127,633.7 = 1.02
Interval measure - Current assets-inven. / avg. daily cash oper. Exp
For 2008-
Avg. daily cash oper. Exp - Total cash exp./ 365
67,663.1/ 365 = 185.3
Interval measure - 192,673.5 - 32,946.4 / 185.3 = 862 days
For 2007
Avg. daily cash oper. Exp - 56,050.6/ 365 = 153.5
Interval measure - 162,779.2- 31,669.0 / 153.5 = 854 days
In liquidity ratio, we observe that current ratio in 2008 is less in comparison of
2007. it means companies efficiency decreases in paying current liability. And
in
quick ratio, it also decreases. In 2008, regular cash meet was 862 days in
comparison of 854 of 2007. It means firms ability to pay its daily exp.
Increases.
Leverage Ratio
Total debt ratio – Total debt / capital employed
For 2008
Total debt - 63,345.5
Capital employed - Net worth + borrowing
Or Share capital + debt.
86,975.2+ 63,345.5= 150320.7
63,345.5 / 150320.7 = .42
For 2007
Total debt - 38,693.6
Capital employed - 77,216.7 + 38,693.6= 115910.3
(shr. cap) (debt)
38,693.6 / 115910.3 = .33
Debt equity ratio - Net worth / total debt
Net worth = share cap.
For 2008 86,975.2/63,345.5 = 1.37
For 2007 77,216.7 /38,693.6 = 1.99
Capital equity ratio - Capital employed / net worth
For 2008 150320.7 / 86,975.2= 1.73
For 2007 115910.3 / 77,216.7 = 1.50
Interest coverage ratio – EBIT + depreciation / Interest
2008 2007
Earning before tax 30,448.3 31,326.4
Add- Interest 9,127.2 4,650.6
39575.5 35977
For 2008 - 39575.5 + 7,820.7/9,127.2 = 5.19
For 2007 - 35977 + 6,880.9 / 4,650.6= 9.21
In 2008, the long term financial position getting strong than 2008. Capability of
paying long term debt. is increases. As we seen, debt ratio increases. And the
contribution of debt is increases in 2008 than 2007. and the part of share capital
is
also increases in total capital employed than 2007. it means, company is
increasing
its capital through shares.
Activity Ratio
Inventory Turnover Ratio:- Cost of goods sold /
Inventory
(2008) (2007)
Cost of goods sold 254,571.5 234,753.6
Inventory 32,946.4 31,669.0
For 2008:- 254,571.5 / 32,946.4 = 7.72
For 2007 :- 234,753.6 / 31,669.0 = 7.41
Debtor Turnover Ratio :- Sales / debtor
For 2008 :- 358,086.0 (sales) / 97,555.9 (debtor) =
3.67
For 2007 :- 325,143.8 (sales) / 101,638.5 (debtor) =
3.20
Average collection period (2008) = 360 / 3.67 = 98
days
Average collection period (2007) = 360 / 3.20 = 112
days
Assets Turnover Ratio :- Sales / Net assets or capital
employed
For 2008 :- 358,086.0 (sales) / 150320.7 (c.e.) = 2.38
For 2007 :- 325,143.8 (sales) / 115910.3 (c.e.) = 2.80
Working Capital Turnover Ratio:- Sales / Net working capital
Net Working Capital = Current assets – Current liability
For 2008 = 192,673.5 - 188,948.8 = 3724.7
For 2007 = 162,779.2 - 127,633.7 = 35145.5
For 2008 :- 358,086.0 (sales) / 3724.7 (N.W.C.) = 96.13
For 2007 :- 325,143.8 (sales) / 35145.5 (N.W.C) = 9.25
As we seen, company’s efficiency of using its assets is increasing in 2008 than
2007. The inventory turnover ratio which shows its efficiency of selling product
is
increasing. Average collection period is decreasing means company is selling its
product more on cash basis in 2008 than 2007. but company’s assets turnover
ratio is decreasing means sales is not growing according to its capital employed
and working capital.
Profitability Ratio
Gross Margin = Gross profit / Sales
Gross Margin (2008) = 103,514.5 / 358,086.0 = .29
Gross Margin (2007) = 90,390.2 / 325,143.8 = .28
EBIT Ratio = PAT / EBIT
For 2008 = 21,677.0 / 37878.9 = .57
For 2007 = 21,699.9 / 35384.5 = .61
Return on investment = EBIT / Capital employed
For 2008 = 39575.5 / 150320.7 = .26
For 2007 = 35977 / 115910.3 = .31
Return on equity = PAT / Net worth
For 2008 = 21,677.0 / 86,975.2 = .25
For 2007 = 21,699.9 / 77,216.7 = .28
In profitability ratio, the gross profit ratio is increasing in 2008 than 2007. it
means its profit is growing in sales. But company’s EBIT ratio is decreasing
means
interest on capital and tax rate is increased in 2008 than 2007 which is
responsible
in decreasing its PAT. And company’s return on investment is decreased that
indicates that its earning on capital employed is decreased in 2008 than
2007. and
its ROE is also decreases means its