ACCOUNTING RATIOS

Presented by Group 7, BY Students USN Number 71-80. This

slide deck explores the meaning, process, benefits and types of
accounting ratios.
Meaning Of Ratio Analysis
Accounting ratios are basically tools used to analyze a company's financial health. They
are calculated by comparing two or more numbers from a company's financial
statements, like the income statement, balance sheet, and cash flow statement.

By looking at these ratios, you can get a sense of things like the company's profitability,
how good it is at managing debt, and how efficiently it's using its resources. Investors
and other financial professionals use accounting ratios all the time to evaluate
companies and make investment decisions.
Process Of Accounting Ratios

• Collect the relevant financial data, such as

balance sheet, income statement, and cash
flow statement.

• Identify the key performance indicators

(KPIs) and financial ratios that are most
meaningful for the business.
• Calculate the ratios by applying the appropriate formulas to the financial data.

• Analyze the ratios to understand the company's financial health, trends, and areas
for improvement.
• Interpret the results and use the insights to make informed business decisions.
Benefits/Significance Of Accounting Ratios

Understanding Company Performance: Ratios act as translators, transforming complex

financial statements into clear metrics. They help assess a company's profitability,
efficiency in using resources, ability to pay short-term debts (liquidity), and long-term
financial stability (solvency). This provides a clear picture of how well the company
generates profits, manages debt, and utilizes its resources.

Early Warning Signs: Certain ratios can act as red flags, highlighting potential financial
troubles. For instance, a consistently low current ratio (indicating short-term liquidity
issues) might warn of difficulties meeting upcoming debt obligations. Ratios can be like
financial alarms, letting you know when to investigate further.
Limitations Of Ratio Analysis
• Uses Historical Data: Ratios are based on past financial statements, which reflect
what has already happened, not necessarily what will happen in the future. A
company's performance can change over time due to various factors.

• Limited Industry Comparison: Ratios can be misleading if you compare

companies from different industries. Each industry has its own average
profitability, asset intensity, and financial structures. Comparing a tech startup's
ratios to a manufacturing company's ratios might not be very insightful..
• Potential for Manipulation: Financial statements can be manipulated to a certain
extent, and this can distort the resulting ratios. Companies might adjust accruals
or defer expenses to improve their financial ratios in the short term.

• Accounting Policy Changes: Companies have some flexibility in their accounting

policies, which can affect the numbers used to calculate ratios. For example, a
change in depreciation method can significantly alter ratios like return on equity
(ROE). It's important to consider these potential variations when comparing
ratios.
Comparison and Benchmarking: Ratios allow for comparisons between companies
within the same industry or against a company's historical data. This benchmarking
helps identify strengths, weaknesses, and industry trends. Imagine comparing two retail
stores and finding one has a significantly higher inventory turnover ratio. This might
indicate the first store is managing its inventory more efficiently.

Informed Decision-Making: Investors, creditors, and company management all leverage

these ratios to make well-informed decisions. Investors use them to evaluate potential
investments, creditors assess the risk of lending money, and management tracks
progress towards financial goals and identifies areas for improvement.
Types Of Accounting Ratios

Liquidity Ratios Solvency/ Profitability Activity/

Leverage Ratios Ratios Turnover Ratios

Liquidity ratios Solvency and Profitability Activity or

assess a leverage ratios ratios assess a turnover ratios
company's ability evaluate a company's ability measure how
to meet its short- company's long- to generate effectively a
term obligations. term financial earnings and company uses its
They measure stability and its profits. They assets to generate
the availability of ability to meet provide insights sales. They
cash and other debt obligations. into the efficiency indicate the
liquid assets to They indicate the of operations and efficiency of a
Types Of Liquidity Ratio
Current Ratio: This is the most widely used liquidity ratio. It compares a company's
current assets (cash, inventory, accounts receivable) to its current liabilities (short-term
debts like accounts payable and upcoming loan payments). A ratio greater than 1
indicates the company has sufficient current assets to cover its current liabilities.

Formula: Current Ratio = Current Assets / Current Liabilities

Quick Ratio (Acid-Test Ratio): This ratio takes a more conservative approach than the
current ratio. It excludes inventory (which can be slow to sell) and prepaid expenses
from current assets, focusing on the most liquid assets like cash, marketable securities,
and accounts receivable. This gives a more realistic picture of a company's ability to
meet immediate obligations.
Absolute Liquid or Quick Ratio: This is the most stringent liquidity ratio. It only
considers the most liquid assets, which are cash and marketable securities, and
compares them to current liabilities. This shows the company's ability to meet short-
term obligations using only the most readily available cash on hand and easily sold
investments.

Formula: Absolute Liquid Ratio = Absolute Liquid Assets/Liquid Liabilities

(Absolute Liquid Assets=Cash+ Bank Balance +Market Securities)

(Liquid Liabilities=Current Liability-Bank Over Draft)

Types Solvency/Leverage Ratio

1. Debt Equity ratio ;is a financial metric used to analyze a company's financial
leverage. It compares the total amount of debt a company has to its shareholder equity.
In other words, it shows how much a company finances its operations with debt
compared to the money invested by its shareholders.

Formula: D/E Ratio = Total Long Term Debt/ Shareholders' Funds

Total Long Term Debt=Debentures+Term Loan+Loan On Mortgage+Loan From

Financial Institutions +Other Long Term Loans+Redeemable Preference Shares
Calculate Debt to Equity Ratio from the following information:

Particulars ₹ Amount Particulars ₹ Amount

Fixed Assets 8,40,000 Current Assets 3,50,000

(Gross)

Accumulated 1,40,000 Current 2,80,000

Depreciation Liabilities

Non-current 14,000 10% Long-term 4,20,000

Investments Borrowings

Long-term 56,000 Long-term 1,40,000

2.Proprietory Ratio :The proprietary ratio, also known as the equity ratio or net worth
ratio, is a financial metric that dives into a company's solvency. It specifically assesses
the proportion of a company's total assets financed by its shareholders' equity. In
simpler terms, it tells you how much of the company's assets are funded by the money
invested by its owners.

Proprietory Ratio :Proprietors Fund or Shareholders Fund /Total Assets

Calculate Proprietary Ratio from the following:

Equity Shares ₹ 4,50,000 9% Debentures ₹ 3,00,000

Capital

10% Preference ₹ 3,20,000 Fixed Assets ₹ 7,00,000

Share Capital

Reserves and ₹ 65,000 Trade Investment ₹ 2,45,000

Surplus

Creditors ₹ 1,10,000 Current Assets ₹ 3,00,000

Interest Coverage Ratio

The ICR assesses how well a company's current earnings before interest and taxes
(EBIT) cover its interest expenses on outstanding debt. In simpler terms, it shows how
easily the company can service its debt obligations with its operating income

The formula for ICR is

Interest Coverage Ratio (ICR) = Net Profit Before Interest And Tax/ Interest Expense
Find the interest coverage ratio from the above provided information.

Sales Revenue = 500,000

COGS = 120,000

Operating expenses in the form of

Salary – 50,000

Rent – 40,000

Utilities – 20,000

Interest Expense – 30,000

The capital gearing ratio: also known as the equity to debt ratio, is a financial metric
used to assess a company's capital structure. In other words, it tells you how much debt
a company has compared to its shareholders' equity

The Formula is

Capital Gearing Ratio =Equity Share Capital + Reserves and Surplus/Preference

Share Capital + Long Term Debt Bearing Fixed Interest

1.From the following calculate capital gearing ratio:

Particulars ₹ Amount
Types Of Profitability Ratos

Gross profit ratio

also known as the gross margin ratio, is a key profitability metric used to assess a
company's efficiency in generating profit from its core business operations. It essentially
measures how much profit a company makes after covering the direct costs of producing
its goods or services.

Formula

Gross Profit Ratio = (Gross Profit / Net Sales) x 100%

Gross Profit=Net Sales - Cost Of Goods Sold

Net Profit Ratio

The net profit ratio, also known as the net margin ratio, is a metric used in India and
elsewhere to assess a company's profitability. It measures the percentage of revenue
remaining as net profit after accounting for all expenses, taxes, and operating costs.

Formula

Net Profit Ratio = (Net Profit / Net Sales) x 100%

Net Profit=Net sales-(Cost of Sales +Indirect Expenses)

Cost Of Goods Sold = Opening Stock + Purchases+Direct Expenses-Closing Stock

The operating ratio is a financial metric used to assess a company's operational
efficiency. It measures the portion of revenue consumed by operating expenses. In
simpler terms, it shows how much a company spends on its regular business activities
compared to the revenue it generates.

Formula

Operating Ratio = Cost of Goods Sold + Operating Expenses / Net Sales x 100%

Cost Of Goods Sold = Opening Stock + Purchases+Direct Expenses-Closing Stock

Operating Profit Ratio

The operating profit ratio, also known as the EBIT margin or earnings before interest
and taxes (EBIT) to revenue ratio, is a profitability metric that measures the portion of a
company's revenue remaining after covering operating expenses. It indicates how
efficiently a company can convert its sales into profit from its core operations, before
considering the impact of financing decisions (interest) and taxes.

Formula

Operating Profit Ratio = Operating Profit / Net Sales x 100%

Operating Profit=Sales-(Cost Of Goods Sold + Expenses)

Expenses Ratio

This ratio shows the several expenses and net sales.This ratio depicts the increase and
decrease of expenses.Lower expense ratio shows efficiency in operations

Formula-

Expenses Ratio = Amount of Expenses / Net Sales x 100%

Net Sales=Total Sales - Sales Return

Return on capital employed/return on investment Ratio

Measures the efficiency of a company in generating profits from the capital it employs
(debt and equity). It essentially shows how well a company utilizes its invested capital to
create profits.

Formula

Return on capital employed/return on investment Ratio = Net Income Before Interest

And Tax / Capital Employed x 100%

Capital Employed=Equity Share Capital

Return on Equity or Return on equity shareholders
Fund

ROE is a financial metric that tells you how well a company is using its shareholders'
money to generate profits. It's expressed as a percentage and calculated by dividing the
company's net income by its total shareholders' equity.

Formula

Return on Equity=Net Profit After Interest and Tax/ Shareholder's Fund x 100%

Shareholders fund=Equity Share Capital + Preference Share Capital + Share

Premium
Earnings Per Share

The term Earnings Per Share (EPS) itself is a ratio, not a ratio of ratios. It's a widely
used financial metric that helps assess a company's profitability per share of common
stock.

Formula

Earnings Per Share = Net Profit After Interest and Tax/ No Of Equity Shares
Price Earning Ratio

The Price-to-Earnings Ratio, also known as P/E Ratio or P/E, is a metric used to assess a
company's stock valuation relative to its profitability. It essentially tells you how much
an investor is willing to pay for each rupee of the company's earnings.

Formula

Calculation: P/E Ratio = Current Market Price Per Share / Earnings Per Share (EPS)
Types of Activity/Turn Over Ratio
The Fixed Asset Turnover Ratio

The Fixed Asset Turnover Ratio (FAT) is a financial metric that gauges a company's
efficiency in utilizing its fixed assets to generate sales. In simpler terms, it tells you how much
revenue a company can squeeze out of each dollar invested in fixed assets.

Formula

The Fixed Asset Turnover Ratio = Net Sales / Net Fixed Assets

Net Sales=Total Sales - Sales Return

Net Fixed Assets=Gross Fixed Assets- Depriciation

The Stock Turnover Ratio

The Stock Turnover Ratio, also known as the Inventory Turnover Ratio, is a financial metric
that measures how efficiently a company manages its inventory. In other words, it tells you
how many times a company sells and replaces its inventory within a specific period (usually a
year).

Formula:

Stock Turnover Ratio = Cost of Goods Sold / Average Inventory

Average Stock=Closing stock + Opening Stock / 2

Cost Of Goods Sold = Sales- Gross Profit

The Debtors Turnover Ratio

The debtors turnover ratio, also known as the accounts receivable turnover ratio, is a
financial metric that analyzes a company's efficiency in collecting payments from
customers who buy on credit. In simpler terms, it tells you how quickly a company
converts credit sales into cash.

Formula:

Debtors Turnover Ratio = Net Credit Sales / Average Accounts Receivable

Accounts Recieevables=Debtors+Bills Recievabls

The Creditors Turnover Ratio

The creditors turnover ratio, also known as the accounts payable turnover ratio,
payables turnover ratio, or trade payables ratio, is a financial metric that measures how
efficiently a company manages its accounts payable (short-term debts owed to
suppliers). In simpler terms, it tells you how quickly a company pays off its suppliers
after purchasing goods or services on credit.

Formula:

Creditors Turnover Ratio = Net Credit Purchase/Average Trade Creditors

Net Credit Purchase=Gross Credit Purchase - Purchase Return

Average Trade Creditors=Creditors+Bills Payable

Conclusion

In conclusion, accounting ratios provide invaluable insights into a

company's financial health and performance. By analyzing
liquidity, solvency, profitability, and activity ratios, businesses
can identify strengths, weaknesses, and opportunities for
improvement.
Introduction-Sandeep L

Meaning Of Accounting Ratios—Shreyas GS

Accounting Ratio Process-Shreegowri

Benefits Of Accounting Ratios-Shashidhar

Limitations Of Accounting Ratios-Sanjay

Introduction To Types Of Ratios-Shruthi

Liquidity Ratios-Shashank BS

Solvency Ratio-Sandhyaa

Profitability Ratios-Sandeep And Shashank SG

Thank You

We appreciate your time and attention throughout this

presentation on accounting ratios. These powerful analytical tools
provide invaluable insights to help businesses make informed
decisions and improve financial performance.