Financial Ratios

RATIO ANALYSIS

Ratio-analysis means the process of computing,

determining and presenting the relationship of related
items and groups of items of the financial statements.
They provide in a summarized and concise form of fairly
good idea about the financial position of a unit. They are
important tools for financial analysis.
 Ratio Analysis
It’s a tool which enables the banker or lender to arrive at the
following factors :
 Liquidity position
 Profitability
 Solvency
 Financial Stability
 Quality of the Management
 Safety & Security of the loans & advances to be or already been
provided
Before looking at the ratios there are a number of cautionary
points concerning their use that need to be identified :

a.The dates and duration of the financial statements being

compared should be the same. If not, the effects of
seasonality may cause erroneous conclusions to be drawn.

b.The accounts to be compared should have been prepared

on the same bases. Different treatment of stocks or
depreciations or asset valuations will distort the results.

c.In order to judge the overall performance of the firm a group

of ratios, as opposed to just one or two should be used. In
order to identify trends at least three years of ratios are
normally required.
 How a Ratio is expressed?
As Percentage - such as 25% or 50% . For
example if net profit is Rs.25,000/- and the sales is
Rs.1,00,000/- then the net profit can be said to be
25% of the sales.
As Proportion - The above figures may be
expressed in terms of the relationship between net
profit to sales as 1 : 4.
As Pure Number /Times - The same can also be
expressed in an alternatively way such as the sale is 4
times of the net profit or profit is 1/4th of the sales.
 Classification of Ratios
Balance Sheet P&L Ratio or Balance Sheet and
Ratio Income/Revenue Profit & Loss Ratio
Statement Ratio

Financial Ratio Operating Ratio Composite Ratio

Current Ratio Gross Profit Ratio Fixed Asset Turnover
Quick Asset Ratio Operating Ratio Ratio, Return on Total
Proprietary Ratio Expense Ratio Resources Ratio,
Debt Equity Ratio Net profit Ratio Return on Own Funds
Stock Turnover Ratio Ratio, Earning per
Share Ratio, Debtors’
Turnover Ratio,
 Format of balance sheet for ratio analysis
LIABILITIES ASSETS
NET WORTH/EQUITY/OWNED FUNDS FIXED ASSETS : LAND & BUILDING, PLANT &
Share Capital/Partner’s Capital/Paid up Capital/ Owners MACHINERIES
Funds Original Value Less Depreciation
Reserves ( General, Capital, Revaluation & Other Reserves) Net Value or Book Value or Written down value
Credit Balance in P&L A/c
LONG TERM LIABILITIES/BORROWED FUNDS : NON CURRENT ASSETS
Term Loans (Banks & Institutions) Investments in quoted shares & securities
Debentures/Bonds, Unsecured Loans, Fixed Deposits, Old stocks or old/disputed book debts
Other Long Term Liabilities Long Term Security Deposits
Other Misc. assets which are not current or fixed in nature
CURRENT LIABILTIES CURRENT ASSETS : Cash & Bank Balance,
Bank Working Capital Limits such as Marketable/quoted Govt. or other securities, Book
CC/OD/Bills/Export Credit Debts/Sundry Debtors, Bills Receivables, Stocks &
Sundry /Trade Creditors/Creditors/Bills Payable, Short inventory (RM,SIP,FG) Stores & Spares, Advance
duration loans or deposits Payment of Taxes, Prepaid expenses, Loans and Advances
Expenses payable & provisions against various items recoverable within 12 months

INTANGIBLE ASSETS
Patent, Goodwill, Debit balance in P&L A/c, Preliminary
or Preoperative expenses
 Financial Ratios to Watch for in Startups
Business model
As a startup, it's important to keep a close eye on your financial ratios. This will give you an indication of how
well your business is doing and whether or not you need to make any changes to your business model. Here are
some of the most important financial ratios to watch for in startups:
A. debt-to-equity ratio (D/E). This ratio measures how much debt you have for every rupee of equity you have.
A high D/E ratio is a bad sign because it means you're using more debt to finance your business than equity.
B. interest coverage ratio (ICR). This ratio measures how much profit you're making for every rupee of interest
you're paying. A high ICR is a good sign because it means you're making more money than you're paying in
interest.
C. Cash flow to sales ratio (CFS). This ratio measures how much cash flow you have for every unit of sales. A
high CFS is a good sign because it means you have more cash than you're generating in sales.
D. Working capital ratio (WCR). This ratio measures how much working capital you have for every rupee of
sales. A high WCR is a good sign because it means you have more working capital than you're generating in
sales.
E. Free cash flow (FCF). This ratio measures how much cash flow you have after subtracting all capital
expenditures (such as new equipment or property). A high FCF is a good sign because it means you have
more cash than you're spending on capital expenditures.
 Funding Sources
As a startup, it's important to be aware of your financial ratios and how they might impact your ability to
secure funding from different sources. Here are a few key ratios to watch for:
1. Debt-to-Equity Ratio
This ratio measures the amount of debt financing relative to equity financing. A high debt-to-equity ratio
indicates that a company is heavily reliant on debt financing, which can be risky for lenders. A low debt-
to-equity ratio, on the other hand, may make it difficult to secure enough financing to grow.
2. Interest Coverage Ratio
This ratio measures a company's ability to pay interest on its outstanding debt. A low interest coverage
ratio indicates that a company may have difficulty making interest payments, which could lead to default.
3. Operating Cash Flow Ratio
This ratio measures a company's ability to generate cash from its operations. A low operating cash flow
ratio may indicate that a company is struggling to generate enough cash to fund its operations.
4. Free Cash Flow Ratio
This ratio measures a company's ability to generate cash after accounting for capital expenditures. A low
free cash flow ratio may indicate that a company is struggling to generate enough cash to fund its growth.
5. Current Ratio
This ratio measures a company's ability to pay its short-term obligations with its current
assets. A low current ratio may indicate that a company is at risk of defaulting on its
obligations.
6. Quick Ratio
This ratio measures a company's ability to pay its short-term obligations with its liquid assets.
A low quick ratio may indicate that a company is at risk of defaulting on its obligations.
7. Revenue Growth Rate
This measures the year-over-year growth in a company's revenue. A high revenue growth rate
indicates that a company is growing quickly. A low revenue growth rate may make it difficult
to secure funding from investors.
8. Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA) Margin
This margin measures a company's profitability before accounting for interest, taxes,
depreciation, and amortization expenses. A high EBITDA margin indicates that a company is
profitable and may be able to secure funding from investors. A low EBITDA margin may
make it difficult to secure funding from lenders.
 Competition
In any startup business, it is essential to have a clear understanding of the competitive
landscape. This understanding starts with an analysis of the financial ratios of the competition.
There are a number of financial ratios that are important to watch for in startups. The most
important ones are:
1) Gross margin: This is the difference between the price of a product or service and the cost of
producing it. A high gross margin means that the company has a lot of pricing power and is
able to make a healthy profit.
2) Operating margin: This is the difference between the revenue and the costs of running the
business (excluding interest and taxes). A high operating margin means that the company is
efficient and has a lot of room to grow.
3) Sales growth: This is the percentage change in sales from one period to another. A company
with high sales growth is typically taking market share from its competitors.
4) Profit growth: This is the percentage change in profits from one period to another. A
company with high profit growth is typically doing a better job of converting sales into profits
than its competitors.
5) Return on equity: This is the percentage of profits that are returned to shareholders. A company
with a high return on equity is typically doing a good job of using its assets to generate profits.
6) Market share: This is the percentage of total sales in a given market that are generated by a
company. A company with a high market share is typically dominant in its market.
7) Cash flow: This is the amount of cash that is generated by the business. A company with
positive cash flow is typically doing a good job of managing its finances.
8) Debt-to-equity ratio: This is the ratio of a company's debt to its equity. A high debt-to-equity
ratio means that the company is highly leveraged and may be at risk of defaulting on its debt
obligations.
9) Interest coverage ratio: This is the ratio of a company's earnings before interest and taxes to its
interest expenses. A high interest coverage ratio means that the company can easily make its
interest payments.
10) Price-to-earnings ratio: This is the ratio of a company's stock price to its earnings per share. A
high price-to-earnings ratio means that investors are willing to pay a lot for each rupee of earnings.
These are just a few of the most important financial ratios to watch for in startups. By monitoring
these ratios, you can get a better understanding of the competitive landscape and how your startup
stacks up against its rivals.
 Financial Ratios
There are a number of financial ratios that startup companies should keep an eye on. Some of the more
important ratios include:
1) Gross margin: This ratio measures how much profit a company makes on each rupee of sales. A
high gross margin indicates that a company is able to generate a lot of profit from its sales.
2) Operating margin: This ratio measures how much profit a company makes after accounting for its
operating expenses. A high operating margin indicates that a company is efficient at generating profit
from its operations.
3) Debt-to-equity ratio: This ratio measures the amount of debt a company has relative to its equity. A
high debt-to-equity ratio indicates that a company is highly leveraged and may be at risk of defaulting
on its debts.
4) Interest coverage ratio: This ratio measures how much profit a company generates relative to its
interest payments. A high interest coverage ratio indicates that a company is able to generate enough
profit to cover its interest payments.
5) Cash flow: This ratio measures the amount of cash a company generates from its operations. A high
cash flow indicates that a company is able to generate a lot of cash from its operations.
Each of these ratios is important in its own way, and startups should focus on all of them in order to
ensure their financial health.
 Stock Prices
When it comes to startups, there are a lot of financial ratios to pay attention to. But, when it
comes to the stock prices of these startups, there are a few key ratios to keep an eye on.
Price-to-earnings (P/E) ratio. This ratio measures how much investors are willing to pay for
each rupee of a company's earnings. In general, a higher P/E ratio indicates that investors
are willing to pay more for the company's earnings.
Price-to-sales (P/S) ratio. This ratio measures how much investors are willing to pay for
each rupee of a company's sales. In general, a higher P/S ratio indicates that investors are
willing to pay more for the company's sales.
Price-to-book (P/B) ratio. This ratio measures how much investors are willing to pay for
each rupee of a company's book value. In general, a higher P/B ratio indicates that investors
are willing to pay more for the company's book value.
All three of these ratios will give you a good sense of how investors are valuing a particular
startup. Keep in mind, however, that these ratios should be used as a starting point for your
analysis - they should not be used as the sole basis for making investment decisions.
ROI is full of talented entrepreneurs and professionals, and we want to help each of them
tap into the incredible power the collective has to offer and to contribute what they can.

Lynn Schusterman
 Trends
As a startup, you will be focused on many things at once. One of the most important things to keep
track of is your financial ratios. Financial ratios can give you a clear picture of your company's overall
financial health and performance.
There are many different financial ratios that you can track, but there are a few that are particularly
important for startups. Here are four financial ratios to watch for in your startup:
1. Revenue growth. Revenue growth is a key metric for any business, but it is especially important for
startups. You need to track your revenue growth carefully to make sure that your business is on track.
2. Operating margin. The operating margin is a measure of how much profit you are making on each
sale. It is important to track your operating margin so that you can see how efficient your business is.
3. Burn rate. The burn rate is the rate at which you are spending your cash. It is important to track your
burn rate so that you can see how quickly you are using up your cash reserves.
4. Customer churn. Customer churn is the rate at which your customers are leaving your business. It is
important to track customer churn so that you can see how well your business is retaining customers.
Keep an eye on these four financial ratios and you will have a good idea of how your startup is
performing. If you see any red flags, take action to correct the problem so that your business can
continue to grow and thrive.
The financial ratios tell us how healthy a firm is. 4 ratios must be leveraged are : Liquidity Ratio,
Leverage Ratio, Efficiency Ratio, Profitability Ratio.
What is Liquidity Ratio?
Liquidity ratio is also called as short term solvency ratio. That is, we can tell if the company can pay off
its short term liabilities quickly or not.Since Liquidity ratio focuses on current asset and current
liabilities, current ratio is a measure of short term liquidity.
Current Ratio = Current Assets/Current Liabilities
Higher current ratio indicates that the firm has the ability to pay off their short term debt.
Now let us take a scenario where the inventory is very hard to convert to cash. Additionally inventory
can be obsolete, damaged or lost.
Then in this case, measuring the current assets might not give us the true picture of the liquidity since it
includes the inventories. Thus we go to measure Quick ratio.
Quick ratio = (Current asset — inventories and prepaid expenses)/ Current liabilities
Now, Say for example if cash flow starts to dry up, then how long the company can keep running?
In such scenarios, interval measure are handy. It indicates how long the company can operate until it
needs another round of financing.
Interval measure = current assets/ average daily operating assets
 What is Leverage Ratio?
Leverage ratio is also called as Long term solvency ratio. That is, we can tell if
the company can pay off its Long term debt.
Following ratios commonly used to measure that help us to identify the firm’s
ability to generate cash from operations :
Total debt ratio = total debt / total assets,
where Total debt = total assets - total equity.
Debt-equity ratio = total debt / total equity.
Equity multiplier = total assets / total equity.
Interest earned ratio = EBIT / interest expenses.
Since EBIT does not really tells us the cash available to pay interest, we define
cash coverage ratio.
Cash coverage ratio = EBIT + depreciation + amortization(EBITDA) / interest.
3. What is efficiency ratio?
Efficiency ratio is often called asset utilization ratios. Commonly used
efficiency ratios are:
Inventory turn over ratio = COGS/Inventories , the reason we do not use sales
and use cogs is because sales includes profit and may inflate the turnover.
Days sale inventory = 365 days/inventory turnover
Receivable turnover rate = sales/ accounts receivable, tells us how fast we can
collect on sales.
Asset turnover ratio = sales/total assets, measures big picture of firm’s
efficiency.
In addition to these ratios, there are net working capital turnover ratio and fixed
asset turnover ratio. These ratios measure how much worth we get out of our
working capital or fixed assets.
4. What is Profitability ratio?
Profitability ratio measures how efficiently a firm uses its assets and manages
its operations.
Profit margin = Net income / sales
ROA = net income/ total assets,
ROE = net income / total equity,
In order to verify if our ROA and ROE is good or bad, we need to compare our
company’s current vs previous year’s performance.
Market value ratio can be used to evaluate the share price if the company is
publicly held.
So, when it comes to the world of start up business, I believe understanding
these important ratios can greatly increase your confidence to run a successful
company.
Question 1

LIABILITES ASSETS
Capital 180 Net Fixed Assets 400
Reserves 20 Inventories 150
Term Loan 300 Cash 50
Bank C/C 200 Receivables 150
Trade Creditors 50 Goodwill 50
Provisions 50
800 800

a. What is the Net Worth

b. Tangible Net Worth is
c. Outside Liabilities
d. Net Working Capital
e. Current Ratio
f. Quick Ratio
 Question 2
LIABILITIES 2005-06 2006-07 2005-06 2006-07
Capital 300 350 Net Fixed Assets 730 750
Reserves 140 160 Security Electricity 30 30
Bank Term Loan 320 280 Investments 110 110
Bank CC (Hyp) 490 580 Raw Materials 150 170
Unsec. Long T L 150 170 S I P 20 30
Creditors (RM) 120 70 Finished Goods 140 170
Bills Payable 40 80 Cash 30 20
Expenses Payable 20 30 Receivables 310 240
Provisions 20 40 Loans/Advances 30 190
Goodwill 50 50
Total 1600 1760 1600 1760

1. Tangible Net Worth for 1st Year

2. Current Ratio for 2nd Year
3. Debt Equity Ratio for 1st Year
 Question 3.

LIABIITIES ASSETS
Equity Capital 200 Net Fixed Assets 800
Preference Capital 100 Inventory 300
Term Loan 600 Receivables 150
Bank CC (Hyp) 400 Investment In Govt. Secu. 50

Sundry Creditors 100 Preliminary Expenses 100

Total 1400 1400

1. Debt Equity Ratio

2. Tangible Net Worth
3. Total Outside Liabilities / Total Tangible Net Worth
4. Current Ratio
 Question 4
LIABILITIES Rs. ASSETS Rs.
Capital + Reserves 355 Net Fixed Assets 265
P & L Credit Balance 7 Cash 1
Loan From S F C 100 Receivables 125
Bank Overdraft 38 Stocks 128
Creditors 26 Prepaid Expenses 1
Provision of Tax 9 Intangible Assets 30
Proposed Dividend 15
550 550

Q. What is the Current Ratio ?

Q What is the Quick Ratio ?
Q. What is the Debt Equity Ratio ?
Q. What is the Proprietary Ratio ?
Q. What is the Net Working Capital ?
Q. If Net Sales is Rs.15 Lac, then What would be the Stock Turnover.
Q. What is the Debtors Velocity Ratio ? If the sales are Rs. 15 Lac.
Q. Q. What is the Creditors Velocity Ratio if Purchases are Rs.10.5 Lac ?
Question 5. : Profit to sales is 2% and amount of profit is say Rs.5
Lac. Then What is the amount of Sales ?

Question 6. A Company has Net Worth of Rs.5 Lac, Term Liabilities

of Rs.10 Lac. Fixed Assets worth RS.16 Lac and Current Assets are
Rs.25 Lac. There is no intangible Assets or other Non Current Assets.
Calculate its Net Working Capital.

Question 7: Current Ratio of a concern is 1 : 1. What will be the Net

Working Capital ?

Question 8 : Suppose Current Ratio is 4 : 1. NWC is Rs.30,000/-.

What is the amount of Current Assets ?
Question 9. The amount of Term Loan installment is Rs.10000/ per month,
monthly average interest on TL is Rs.5000/-. If the amount of Depreciation
is Rs.30,000/- p.a. and PAT is Rs.2,70,000/-. What would be the DSCR
(Debt-Service Coverage Ratio)?

Question 10 : Total Liabilities of a firm is Rs.100 Lac and Current Ratio is

1.5 : 1. If Fixed Assets and Other Non Current Assets are to the tune of Rs. 70
Lac and Debt Equity Ratio being 3 : 1. What would be the Long Term
Liabilities?

Question 11 : Current Ratio is say 1.2 : 1 . Total of balance sheet being

Rs.22 Lac. The amount of Fixed Assets + Non Current Assets is Rs. 10 Lac.
What would be the Current Liabilities?
Question 12 . From the following financial statement calculate (i) Current Ratio (ii) Acid test Ratio (iii)
Inventory Turnover (iv) Average Debt Collection Period (v) Average Creditors’ payment period.

C. Assets
Sales 1500 Inventories 125
Cost of sales 1000 Debtors 250
Gross profit 500 Cash 225

C. Liabilities
Trade Creditors 200
Thank You