Ratio analysis is a quantitative way of achieving wisdom into a company’s liquidity, working efficiency, and profitability by examining its monetary reports such as the balance sheet and income report. Ratio analysis is a cornerstone of fundamental equity research. This type of research is especially helpful to critics beyond an enterprise since their immediate reference of knowledge about an institution is its financial reports. Ratio analysis is slightly beneficial to corporate insiders, who have more suitable credentials to more elaborate on working knowledge about the association.
Liquidity Ratios
Liquidity ratios calculate a firm capability to spend off its short-term debts as they evolve owed, using the firm current or quick investments. Liquidity ratios retain the current ratio, quick ratio, and working capital ratio.
| S.No. | Ratios | Formulas |
| 1 | Current Ratio | Current Assets/Current Liabilities |
| 2 | Quick Ratio |
Quick Assets/Current Liabilities Quick Assets = Current Assets – Inventory – Prepaid Expenses |
| 3 | Absolute Liquid Ratio | Cash + Marketable Securities/Current Liabilities |
Profitability Ratios
These ratios tell how nicely a firm can develop earnings from its processes. Earnings margin, the yield on investments, the yield on equity, the yield on capital employed, and gross margin ratios are all instances of profitability ratios.
| S.No. | Ratios | Formulas |
| 1 | Gross Profit Ratio | Gross Profit/Net Revenue of Operations × 100 |
| 2 | Operating Cost Ratio | Operating Ratio = (Cost of Revenue from Operations + Operating Expenses)/Net Revenue from Operations ×100 |
| 3 | Operating Profit Ratio | Operating Profit/ Revenue from Operations × 100 |
| 4 | Net Profit Ratio | Net profit/Revenue from Operations × 100 |
| 5 | Return on Investment Ratio | Net Profit After Interest And Taxes/ Shareholders Funds or Investments X 100 |
| 6 | Return on Capital Employed Ratio | Net Gain After Surcharges/ Gross Capital Employed X 100 |
| 7 | Earnings Per Equity Share | Net Gain After Surcharges & Preference Premium /No of Equity Shares |
| 8 | Dividend Yield Ratio | Premium Per Equity Claim/Earning Per Equity Claim X 100 |
| 9 | Price Earnings Ratio | Net Gain after Taxation& Preference Premium / No. of Equity Share |
| 10 | Dividend Yield Ratio | Dividend Per Share/ Market Value Per Share X 100 |
| 11 | Price Earnings Ratio | Demand Expense Per Share Equity Claim/ Gaining Per Share X 100 |
| 12 | Net Profit to Net Worth Ratio | Net Profit after Surcharges/ Shareholders Net Worth X 100 |
Working Capital Ratios
“Working capital” is the capital you require to sustain short-term processes. It is this emphasis on the short term that indicates working capital from longer-term assets in fixed assets or R&D.
| S.No. | Ratios | Formulas |
| 1 | Inventory Ratio | Net Sales / Inventory |
| 2 | Debtors Turnover Ratio | Total Sales / Account Receivables |
| 3 | Debt Collection Ratio | Receivables x Months or days in a year / Net Credit Sales for the year |
| 4 | Creditors Turnover Ratio | Net Credit Purchases / Average Accounts Payable |
| 5 | Average Payment Period | Moderate Trade Creditors / Net Credit Purchases X 100 |
| 6 | Working Capital Turnover Ratio | Net Sales / Working Capital |
| 7 | Fixed Assets Turnover Ratio | Price of goods Traded / Whole Designated Assets |
| 8 | Capital Turnover Ratio | Cost of Sales / Capital Employed |
Capital Structure Ratios
Both debt and equity can be located on the balance sheet. Corporation assets, also documented on the balance sheet, are bought with debt or equity. Capital structure can be a combination of a business’s long-term debt, short-term debt, joint-stock, and select stock. A firm balance of short-term debt versus long-term debt is believed when examining its capital structure.
| S.No. | Ratios | Formulas |
| 1 | Debt Equity Ratio | Total Long Term Debts / Shareholders Fund |
| 2 | Proprietary Ratio | Shareholders Fund/ Total Assets |
| 3 | Capital Gearing ratio | Equity Allocation Funds / Specified Interest Bearing Funds |
| 4 | Debt Service Ratio | Net Earnings Before Welfare & Taxations / Fixed Welfare Payments |
Overall Profitability Ratio
The overall profitability ratio is also called return on investment. It shows the ratio of return on the whole capital employed in the enterprise. It is also named as retrieval on assets, return on capital employed.
| S.No. | Ratios | Formulas |
| 1 | Overall Profit Ability Ratio | Net Profit / Total Assets |
Sample Problems
Problem 1: For a firm, some measurable terms are as follows:
Current Assets = Rs. 11971
Inventory = Rs. 8338
Current Liability = Rs. 8035
Find the value of the Quick ratio.
Solution:
As given,
Current Assets = Rs. 11971
Inventory = Rs. 8338
Current Liability = Rs. 8035
And formula for quick ratio is:
QuickRatio = Totalcurrentratio−InventoryTotalCurrentLiabilities
QuickRatio = 11971−83388035
Quick ratio = 0.45
Problem 2: A company has a capital of Rs. 10, 00,000; its turnover is 3 times the capital and the margin on sales is 6%. What is the return on investment?
Solution:
Capital Turnover Ratio = Sales / Capital
3 = Sales / Rs. 10,00,000
Sales = Rs. 30,00,000
Rate of Return on Investment = (Gross Profit / Investment) × 100
= (Rs.1,80,000 / Rs.10,00,000) × 100
= 18%
Gross Profit = 6% of Rs.30,00,000
= Rs. 1,80,000
Problem 3: The following is the Balance Sheet of a company as of 31st March:
| Liabilities | Rs. | Assets | Rs. |
| Share Capital | 2,00,000 | Land and Buildings | 1,40,000 |
| Profit & Loss Account | 30,000 | Plant and Machinery | 3,50,000 |
| General Reserve | 40,000 | Stock | 2,00,000 |
| 12% Debentures | 4,20,000 | Sundry Debtors | 1,00,000 |
| Sundry Creditors | 1,00,000 | Bills Receivables | 10,000 |
| Bills Payables | 50,000 | Cash at Bank | 40,000 |
| 8,40,000 | 8,40,000 |
Calculate
- Current Ratio
- Quick Ratio
- Inventory to working capital
- Debt to Equity Ratio
- Proprietary Ratio
- Capital Gearing Ratio
- Current Assets to Fixed Assets
Solution:
1) Current Ratio = Current Assets / Current Liabilities
= Rs. 3,5,000 / Rs. 1,50,000
= 2.33 : 1
2) Quick Ratio = Liquid Assests / Liquid Liabilities
= Rs. 1,50,000 / 1,50,000
= 1 : 1
3) Inventory to Working Capital = Inventory / Working Capital
= Rs. 2,00,000 / Rs. 2,00,000
= 1 : 1
(Working Capital = Current Assets – Current Liabilities
= Rs. 3,50,000 – Rs. 1,50,000
= Rs. 2,00,000)
4) Debt to Equity Ratio = Long Term Debts / Shareholder’s Fund
= Rs. 4,20,000 / Rs. 2,70,000
= 1.56 : 1
5) Proprietary Ratio = Shareholder’s Fund / Total Assets
= Rs. 2,70,000 / Rs. 8,40,000
= 0.32 : 1
6) Capital Gearing Ratio = Fixed InterestBearing Securities / Equity Share Capital
= Rs. 4,20,000 / Rs. 2,00,000
= 2.1 : 1
7) Current Assets to Fixed Assets Ratio = Current Assets / Fixed Assets
= Rs. 3,50,000 / Rs. 4,90,000
= 0.71 : 1
Problem 4: From the following particulars found in the Trading, Profit and Loss Account of A Company Ltd., work out the operation ratio of the business concern:
TRADING ACCOUNT OF A COMPANY LTD.
for the period ending December 31
| Expenses | Rs. | Income | Rs. |
| To Opening Stock | 1,400 | By Net Sales | 10,000 |
| To Purchases | 6,400 | By Closing Stock | 600 |
| To Direct Expenses | 300 | ||
| To Gross Profit | 2,500 | ||
| 10,600 | 10,600 |
PROFIT AND LOSS ACCOUNT OF A COMPANY LTD.
for the period ending December 31
| Expenses | Rs. | Income | Rs |
|
To Operating Expenses a)Administrative Expenses b)Selling and Distribution Expenses |
1,600 300 |
By Gross Profit | 2,500 |
| To Financial Expenses | 100 | ||
| To Net Profit | 500 | ||
| 2,500 |
Solution:
Operating Ratio = (Cost of goods sold and other operating expenses / Net Sales) × 100
Cost of Goods Sold: Rs,
Opening Stock 1,400
Purchases 6,400
Direct Expenses 300
8,100
Less Closing Stock 600
Cost of Goods Sold 7,500
Operating Expenses: Rs.
a) Administrative Expenses 1,600
b) Selling and Distribution Expenses 300
c) Financial Expenses 100
Operating Expenses 2,000
Operating Ratio = (7,500 + 2.000 / 10,000) × 100 = 95%
Problem 5: From the following Balance Sheet and additional information, you are required to calculate:
(i) Return on Total Resources
(ii) Return on Capital Employed
(iii) Return on Shareholders’ Fund
Balance Sheet as of 31st Dec.
| Rs. | Rs. | ||
| Share Capital (Rs. 10) | 8,00,000 | Fixed Assets | 10,00,000 |
| Reserves | 2,00,000 | Current Assets | 3,60,000 |
| 8% Debentures | 2,00,000 | ||
| Creditors | 1,60,000 | ||
| 13,60,000 | 13,60,000 |
The net operating profit before tax is Rs. 2,80,000. Assume tax rate at 50% Dividend declared amounts to Rs.1,20,000
Solution:
I) Return on Total Resources = (Profit after Tax / Total Assets) × 100
= (Rs. 1,40,000 / Rs. 13.60.000) × 100 = 10.29%
ii) Return on Capital Employed = (Profit before Tax & Interest / Capital Employed) × 100
= (Rs. 2,96,000 / Rs.12,00,000) × 100 = 24.7%
iii) Return on Shareholder’s Fund = Profit after Tax / Shareholders Fund
= (Rs.1,40,000 / Rs.10,00,000) × 100 = 14%
Problem 6: The following Trading and Profit and Loss Account of Fantasy Ltd. for the year 31‐3‐2000 is given below:
| Particular | Rs. | Particular | Rs. |
| To Opening Stock | 76,250 | By Sales | 5,00,000 |
| Purchases | 3,15,250 | Closing Stock | 98,500 |
| Carriages and Freight | 2,000 | ||
| Wages | 5,000 | ||
| Gross Profit b/d | 2,00,000 | ||
| 5,98,500 | 5,98,500 | ||
| To Administration Expenses | By Gross Profit b/d | 2,00,000 | |
| Selling and Dist. expenses | 1,01,000 | Non-operating incomes | |
| Non operating expenses | 12,000 | Interest on securities | 1,500 |
| Financial Expenses | 7,000 | Dividend on Shares | 3,750 |
| Net Profit c/d | 84,000 | Profit on sale of shares | 750 |
| 2,06,000 | 2,06,000 |
Calculate:
1. Gross Profit Ratio 2. Expenses Ratio 3. Operating Ratio
4. Net Profit Ratio 5. Operating (Net) Profit Ratio 6. Stock Turnover Ratio.
Solution:
1) Gross Profit Margin = (Gross profit / Sales) × 100
= (2,00,000 / 5,00,000) × 100
= 40%
2) Expenses Ratio = (Op.Expenses / Net Sales) × 100
= (1,13,000 / 5,00,000) × 100
= 22.60%
3) Operating Ratio = (Cost of goods sold + Op. Expenses / Net Sales) × 100
= (3,00,000 + 1,13,000 / 5,00,000) × 100
= 82.60%
Cost of Goods sold = Op. stock + purchases + carriage and Freight + wages – Closing Stock
= 76250 + 315250 + 2000 + 5000 ‐ 98500
= Rs.3,00,000
4) Net Profit Ratio = (Net Profit / Net Sales) × 100
= (84,000 / 5,00,000) × 100
= 16.8%
5) Operating Profit Ratio = (Op. Profit / Net Sales) × 100
Operating Profit = Sales – (Op. Exp. + Admin Exp.)
= (87,000 / 5,00,000) × 100
= 17.40%
6) Stock Turnover Ratio = Cost of goods sold / Avg. Stock
= 3,00,000 / 87,375
= 3.43 times