RATIO ANALYSIS AND INTERPRETATION

I. Liquidity Ratios
Liquidity is the ability of a firm to satisfy its short term obligations as they become due for payment. Liquidity Ratios reflects the short-term financial strength or solvency of the firm. Liquidity ratios are
measurements a company can use to identify whether it can pay off its current liabilities.

Sr. Expressed
Ratio Formulae Measure of Meaning Indicators
No. As

1 Current Ratio 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠 Pure Ratio Short Term Debt It indicates the rupee of current assets available for each rupee Higher current ratio indicates greater safety of
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 paying ability of current liability payable. It measures the firm’s ability to pay funds for short-term creditors. Firm with
for all its current liabilities, due within the next one year by higher current ratio has better liquidity /
selling off all their current assets. The higher the current ratio, short-term solvency. However, if the ratio is
the larger is the amount available per rupee of current liability very high it may indicate that certain current
and the more is the firm's ability to meet current obligations assets are lying idle and not being utilized
and avoid defaulting on payments. The ideal current ratio, properly. So maintaining the correct balance
according to the industry standard is 2:1. between the two is crucial.

2 Quick or Liquid 𝑄𝑢𝑖𝑐𝑘 𝐴𝑠𝑠𝑒𝑡𝑠 Pure Ratio Immediate Short It indicates a firm’s ability to service short-term liabilities Low Quick ratio identify that large part of the
or Acid Test 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 Term Debt instantly by converting liquid assets into cash. Quick current current asset is tied up in slow moving/
Ratio paying ability assets are those current assets of the firm which can be unsaleable/ obsolete/ overvalued inventories.
converted into cash immediately or at a short notice without The lower the ratio, the more likely a company
diminution of value. The reason behind exclusion of inventory may have problems paying debts.
and prepaid expenses is that inventory cannot be easily and A higher quick ratio signals that a company
readily convertible into cash and prepaid expenses, by their can be more liquid and generate cash quickly
nature, are not available to pay off current debts. Prepaid in case of emergency. The higher the ratio, the
expenses merely reduce the amount of cash required in one better the company’s financial health and its
period because of payment in the prior period. The ideal quick ability to easily pay off debts.
ratio is considered to be 1:1, so that the firm is able to pay off
all quick assets with no liquidity problems, i.e. without selling
fixed assets or investments.

3 Super Quick/ 𝐶𝑎𝑠ℎ 𝑐𝑎𝑠ℎ 𝑒𝑞𝑢𝑖𝑣𝑎𝑙𝑒𝑛𝑡𝑠 + Pure Ratio Short Term Debt It indicates ideal cash available to meet current obligation. It’s Higher the super quick ratio better the
Cash Ratio 𝑆ℎ𝑜𝑟𝑡𝑡𝑒𝑟𝑚 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐼𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡𝑠 paying ability the most stringent measure of liquidity. The scope of window liquidity condition of a business. However, if
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 using only cash dressing the liquidity position is minimised since not only the ratio is greater than 1 it indicates poor
& cash inventory but also dues from customers are not considered for resource management and very high liquidity.
equivalents measuring immediate debt payment capacity. It also indicates And high liquidity may mean low profitability.
what proportion of a company's assets are most liquid.

4 Cash-Flow From 𝑁𝑒𝑡 𝐶𝑎𝑠ℎ 𝐹𝑙𝑜𝑤 𝑓𝑟𝑜𝑚 𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑜𝑛𝑠 Pure Ratio Short Term Debt It indicates a company's ability to pay off its current liabilities The higher the ratio, the better is the liquidity
Operations 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 paying ability with its cash flow. It is a measure of how well a company can of the firm. A ratio less than 1 indicates short-
Ratio using cash pay off its current liabilities with the cash flow generated from term cash flow problems; a ratio greater than
generated from its core business operations. It is considered an accurate 1 indicates good financial health, as it
business measure of short-term liquidity, as it only uses cash generated indicates cash flow more than sufficient to
from core business operations rather than from all income meet short-term financial obligations.
sources. Operating cash flow is the cash generated by a
company's normal business operations.

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 RATIO ANALYSIS AND INTERPRETATION
II. Financial Strength / Financial Solvency / Capital Structure / Leverage Ratios
Financial Strength / Solvency is the firm's ability to handle financial risk. It reflects the long term solvency of a firm. It assesses the stability of the company’s capital structure. Solvency ratios measure a company's
ability to meet its future debt obligations while remaining profitable. Solvency ratios gives professionals insight into how efficiently companies pay off debt and interest and use assets to fund operations.

Sr. Expressed
Ratio Formulae Measure of Meaning Indicators
No. As

5 Debt Equity 𝐷𝑒𝑏𝑡 Pure Ratio Debt v/s Equity It indicates the relative proportion of long term debt and equity Greater D/E ratio, greater risk to creditors and
Ratio 𝐸𝑞𝑢𝑖𝑡𝑦 Financing in financing the assets of the firm. It calculates the weight of owners. Other’s money should be in
total debt and financial liabilities against total shareholders’ reasonable proportion to owner’s capital and
equity. It indicates the margin of safety to the creditors and the owners should have sufficient stake in the
borrowers and the degree to which a company is using debt to fortune of the enterprise.
fund operations (leverage). It reflects on a firm’s financial A higher debt-equity ratio indicates a levered
stability. This ratio highlights how a company’s capital firm, which is quite preferable for a company
structure is tilted, either toward debt or equity financing. that is stable with significant cash flow
generation, but not preferable when a
company is in decline. Conversely, a lower
ratio indicates a firm less levered and closer to
being fully equity financed. The appropriate
debt to equity ratio varies by industry.

6 Debt Ratio or 𝐷𝑒𝑏𝑡 Pure Ratio Creditor It measures the degree of financial leverage of the company. It A high ratio indicates that a company is
Debt to Asset 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠 Financing & indicates how financially stable a company is. The ratio borrowing more capital from the market to
Ratio Financial represents the proportion of the company’s assets that are fund its operations and its highly levered,
𝐸𝑞𝑢𝑖𝑡𝑦 Leverage financed by interest bearing liabilities (often called “funded implying high financial risk. Any losses
𝐹𝑖𝑥𝑒𝑑 𝐴𝑠𝑠𝑒𝑡 + 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡 + 𝐼𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡𝑠 debt.”). Generally, the cost of debt is lower than the cost of incurred the company will find it difficult to
equity, and therefore increasing the total debt-to-equity ratio pay back its debt and be under financial stress.
up to a specific point can decrease a firm’s weighted average A low debt ratio, or a ratio below 1, means
cost of capital (WACC). However too much debt just to reduce company has more assets than liabilities. In
WACC can affect the financial health and stability of the other words, company's assets are funded by
company. Debt is such an obligation of a company which if not equity instead of loans and is less levered.
paid back, may make a company to declare bankruptcy. A ratio of 1 indicates that the value of your
company’s assets and your liabilities are
equal. This means that if a company has to pay
its debt, it would have to sell all of its assets.

7 Equity Ratio or 𝐸𝑞𝑢𝑖𝑡𝑦 Pure Ratio Owner Financing It indicates the extent to which the assets are financed by A higher equity ratio indicates companies use
Proprietary 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠 owner's funds. Proprietor's funds mean owner's funds or more equity over debt, while lower ratios
Ratio shareholder’s funds or net worth. measures the amount of indicate a company uses more debt than
𝐸𝑞𝑢𝑖𝑡𝑦 leverage used by a company. It uses investments in assets and equity to support business outcomes. Equity
𝐹𝑖𝑥𝑒𝑑 𝐴𝑠𝑠𝑒𝑡 + 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡 + 𝐼𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡𝑠 the amount of equity to determine how well a company ratios that are .50 or below are considered
manages its debts and funds its asset requirements. Measures leveraged companies; those with ratios of .50
the amount of leverage used by a company. It uses investments and above are considered conservative, as
in assets and the amount of equity to determine how well a they own more funding from equity than debt.
company manages its debts and funds its asset requirements.

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 RATIO ANALYSIS AND INTERPRETATION
Sr. Expressed
Ratio Formulae Measure of Meaning Indicators
No. As

8 Interest 𝐸𝐵𝐼𝑇
𝑜𝑟
𝐸𝐵𝐼𝑇𝐷𝐴 Pure Ratio Protection in It indicates debt servicing capacity of a firm in so far as long A lower interest coverage ratio may show that
Coverage Ratio 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 meeting Interest term loan is concerned. It reflects firm’s ability to make interest a company struggles to pay its interest. A
Payments payments from its available earnings. It measures the number higher interest coverage ratio may indicate
of times it could pay its interest expenses using its available that a company can comfortably afford its
earnings. Since Depreciation is a non-cash expense, many debt.
prefer to EBITDA instead of EBIT in the numerator, however
ideal is to use EBIT.

III. Turnover/Activity/Efficiency Ratios

This ratio measures the speed with which various assets are converted into cash or sales. It computes the efficiency of the company in asset management.

Sr. Expressed
Ratio Formulae Measure of Meaning Indicators
No. As

9 Total Asset 𝑅𝑒𝑣𝑒𝑛𝑢𝑒 𝑓𝑟𝑜𝑚 𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑜𝑛𝑠 Number of Efficiency of It indicates the speed with which various assets are converted A higher ratio is generally favourable, as it
Turnover Ratio 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠 times Total Assets in into sales. i.e. the efficiency with which the firm uses all its indicates an efficient use of assets. Conversely,
generating sales assets to generate sales. It measures the efficiency in asset a lower ratio indicates poor efficiency, i.e. the
management i.e. how much revenue a company generates from company is not using its assets as efficiently.
every rupee of total assets. The asset turnover ratio is effective The total asset turnover ratio should be
at comparing businesses in the same sector, but it is not interpreted in conjunction with the working
meaningful when comparing businesses that operate in capital turnover ratio. This is because the
different industries. This ratio can either be calculated by presence of current assets in the ratio can lead
taking average or closing total asset. Since the sales relates to to misinterpretation of results. A lower ratio
whole of the year, it is better to take average total assets to have may be due to poor or underutilization of fixed
logical and consistent result. assets, poor collection methods, or poor
inventory management. All of these
categories should be closely managed to
improve the asset turnover ratio.

10 Fixed Asset 𝑅𝑒𝑣𝑒𝑛𝑢𝑒 𝑓𝑟𝑜𝑚 𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑜𝑛𝑠 Number of Efficiency of It indicates the efficiency with which a firm can turn its fixed A high ratio is favourable and indicates
Turnover Ratio 𝐹𝑖𝑥𝑒𝑑 𝐴𝑠𝑠𝑒𝑡𝑠 times Fixed Assets in assets into sales. It measures how much revenue a company greater efficiency.
generating sales generates from every rupee of fixed assets. This ratio can either A low ratio indicates inefficiency, or high
be calculated by taking average or closing fixed asset. Since the capital-intensive nature of the business. A low
sales relates to whole of the year, it is better to take average ratio could also mean that the company’s
fixed assets to have logical and consistent result. assets are new (less depreciation).

11 Inventory 𝐶𝑜𝑠𝑡 𝑜𝑓 𝐺𝑜𝑜𝑑𝑠 𝑆𝑜𝑙𝑑 (𝐶𝑂𝐺𝑆) Number of Efficiency of It measures the speed with which the inventory is sold. It A high ratio is favourable, as higher turnover
Turnover Ratio 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 times Inventory indicates the number of times inventory is replaced during the rates reduce storage and other holding costs.
Or Management year. Inventory may consist of finished goods only or it may Low turnover implies that a company’s sales

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 RATIO ANALYSIS AND INTERPRETATION
Sr. Expressed
Ratio Formulae Measure of Meaning Indicators
No. As
𝑅𝑒𝑣𝑒𝑛𝑢𝑒 𝑓𝑟𝑜𝑚 𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑜𝑛𝑠 consist of all three i.e. raw materials, work-in-progress and are poor, it is carrying too much inventory, or
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 finished goods. experiencing poor inventory management.
Cost of goods sold is the cost attributed to the production of the Unsold inventory can face significant risks
goods sold and inventory is the goods that are produced but not from fluctuating market prices and
yet sold, hence, it is better to consider COGS in the numerator obsolescence.
and not sales. This ratio can either be calculated by taking It is vital to compare the ratios between
average inventory or closing inventory. Since the cost of goods companies operating in the same industry and
relates to whole of the year, it is better to take average not for companies operating in different
inventory to have logical and consistent result. industries. The benchmark ratio varies greatly
depending on the industry.

12 Inventory 𝑀𝑜𝑛𝑡ℎ𝑠(𝑑𝑎𝑦𝑠)𝑖𝑛 𝑎 𝑦𝑒𝑎𝑟 Days/ Liquidity of It indicates the average time a company keeps its inventory A lower inventory holding period is
Holding Period 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟 𝑅𝑎𝑡𝑖𝑜 Months Inventory before it is sold i.e. how long funds are tied up in the form of favourable, as less time is required for the
or Days in inventory before they are realised as sales. It depicts the stock to be realised as revenue. Indicates good
Inventory number of days for which an organisation holds inventory efficiency and high liquidity.
365
𝐶𝑂𝐺𝑆
× 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 before sales. Period length refers to the amount of time you A high inventory holding period signifies that
want to calculate the days in inventory for. This number is often money is tied up in the form of inventory for
365 for the number of days in one year. longer periods, less liquidity. The increasing
inventory holding period is a warning sign for
businesses since it indicates that sales are
slowing down.
But a high inventory turnover may be a good
sign in some cases. It can show the ability of a
business to absorb sudden spurts in demand
effectively, especially during peak seasons.

13 Debtor 𝑁𝑒𝑡 𝐶𝑟𝑒𝑑𝑖𝑡 𝑆𝑎𝑙𝑒𝑠 Number of Efficiency of It indicates how many times trade receivables turn over to cash The higher ratio is favourable, as it indicates
Turnover Ratio / 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑇𝑟𝑎𝑑𝑒 𝑅𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒𝑠 times Collection / during the year. This ratio measures how rapidly/ quickly the greater efficiency of credit management and a
Accounts Receivables receivables are collected and are converted into cash. This ratio short time-lag between credit sales and cash
Receivable 𝐶𝑟𝑒𝑑𝑖𝑡 𝑅𝑒𝑣𝑒𝑛𝑢𝑒 𝑓𝑟𝑜𝑚 𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑜𝑛𝑠 Management can either be calculated by taking average or closing debtors. collection. A low ratio shows that the debts are
Turnover Ratio 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑇𝑟𝑎𝑑𝑒 𝑅𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒𝑠 Since the sales relates to whole of the year, it is better to take not being collected rapidly.
average debtors to have logical and consistent result.

14 Average 𝑀𝑜𝑛𝑡ℎ𝑠(𝑑𝑎𝑦𝑠)𝑖𝑛 𝑎 𝑦𝑒𝑎𝑟 Days/ Liquidity of It represents the number of days’ worth of credit sales that is Average collection period same/lesser than
Collection 𝐷𝑒𝑏𝑡𝑜𝑟 𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟 𝑅𝑎𝑡𝑖𝑜 Months Receivables locked/blocked in trade receivables. It should be compared credit period indicates prompt collection and
Period / Day's with firm’s credit terms to judge the efficiency of credit vice versa indicated slow in collection. Shorter
Sales 365 management. credit facility to customers may be interpreted
Outstanding × 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐷𝑒𝑏𝑡𝑜𝑟𝑠 as dearth of working capital and consequent
𝑁𝑒𝑡 𝐶𝑟𝑒𝑑𝑖𝑡 𝑆𝑎𝑙𝑒𝑠
forced sales at higher discount rate. Low
average collection period can also be possible
due to factoring arrangement where
receivables are sold to outside party. This

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 RATIO ANALYSIS AND INTERPRETATION
Sr. Expressed
Ratio Formulae Measure of Meaning Indicators
No. As
interpretation, however, should be cross-
checked with other evidences.

15 Creditor 𝑁𝑒𝑡 𝐶𝑟𝑒𝑑𝑖𝑡 𝑃𝑢𝑟𝑐ℎ𝑎𝑠𝑒 Number of Efficiency of It indicates the average number of times a company pays off its An increasing ratio, favourable, shows that a
Turnover Ratio / 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑇𝑟𝑎𝑑𝑒 𝑃𝑎𝑦𝑎𝑏𝑙𝑒𝑠 times Credit accounts payable during a specific time period, usually one company is paying off its debts more quickly
Accounts Management year. It shows how efficiently a company pays this debt. than it has in the past. This can indicate that it
Payable Creditors may consider this ratio to determine whether to has enough cash flow to pay its obligations in
Turnover Ratio extend a line of credit to the company, while investors may use a timely manner. An increasing ratio can also
it to see whether a company has enough cash to meet its short- mean that a company is getting incentives,
term obligations. such as early payment discounts, to make
these payments quickly. It could also mean the
company is actively working to improve its
credit rating.
While a decreasing ratio can sometimes
indicate that a company is having cash flow
problems, it can also mean that a company has
negotiated different payment terms or lower
interest rates with its creditors. If a company
has a decreasing ratio, it's a good idea to
compare this ratio with similar companies in
the same industry. If other businesses have
similar turnover ratios, it can show the
company is meeting the standard for the
industry.

16 Average 𝑀𝑜𝑛𝑡ℎ𝑠(𝑑𝑎𝑦𝑠)𝑖𝑛 𝑎 𝑦𝑒𝑎𝑟 Days/ Creditworthiness It indicates average time period taken by a firm for paying off A low average payment period is preferred, as
Payment Period 𝐶𝑟𝑒𝑑𝑖𝑡𝑜𝑟𝑠 𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟 𝑅𝑎𝑡𝑖𝑜 Months its dues with respect to purchases of materials that are bought it signifies that the company takes less time to
/ Days Payable on the credit basis from the suppliers of the company. It tells settle its outstanding supplier invoices. An
Outstanding 365 how long (average length of time) it takes for a company to excessively short average payment period
× 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐶𝑟𝑒𝑑𝑖𝑡𝑜𝑟𝑠 settle outstanding bills with suppliers. It analyses a company’s may suggest that the company is not fully
𝑁𝑒𝑡 𝐶𝑟𝑒𝑑𝑖𝑡 𝑃𝑢𝑟𝑐ℎ𝑎𝑠𝑒
ability to use credit over the short term as well as pay vendors utilizing the credit terms offered by its
in the long term. It serves as an indicator of how efficiently a suppliers.
company leverages its credit advantages to meet its short-term If a company’s average payment period is
supply needs. shorter than that of its competitors, it signifies
that the company has a higher capacity to
repay debts compared to others.

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 RATIO ANALYSIS AND INTERPRETATION
IV. Profitability Ratios
This ratio measures a company's ability to generate earnings relative to its sales, assets, capital and equity. It shows how well the company can convert its resources into profits.

Sr. Expressed
Ratio Formulae Measure of Meaning Indicators
No. As

17 Gross Profit 𝐺𝑟𝑜𝑠𝑠 𝑃𝑟𝑜𝑓𝑖𝑡 Percentage Profitability of It measures percentage of each sale rupee remaining after the A higher ratio is more favourable. The higher
× 100
Margin 𝑅𝑒𝑣𝑒𝑛𝑢𝑒 𝑓𝑟𝑜𝑚 𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑜𝑛𝑠 production firm has paid for its goods. It indicates whether a business sells the gross margin, the more money there is to
its products at higher prices than their actual direct cost. Firms cover other expenses. There can be many
increase sales, lowers production costs &/or retain customers factors for a high gross profit margin such as
to improve gross margins low cost of production, higher sales price or
sales volume without corresponding increase
in the cost of goods sold. Sometimes, high
gross profit margin can be an adverse signal
because the increase may not be because of
low cost of production or increase in sale price
or sales volume, but it is due to over-valuation
of closing stock or undervaluation of opening
stock. Therefore, before analysing the
increase in gross profit margin, this should be
taken care of. A low gross profit margin may
be a danger signal. Gross profit margin may
have reduced because of increase in cost of
production or decrease in sale price or sales
volume. Overall gross profit margin should be
stable.

18 EBITDA Margin 𝐸𝐵𝐼𝑇𝐷𝐴 Percentage Profitability from It measures how much in earnings a company is generating The higher the EBITDA margin, the smaller a
× 100
𝑅𝑒𝑣𝑒𝑛𝑢𝑒 𝑓𝑟𝑜𝑚 𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑜𝑛𝑠 Operations before interest, taxes, depreciation, and amortization, as a company’s operating expenses in relation to
percentage of revenue. EBITDA margin is considered to be the total revenue, increasing its bottom line and
cash operating profit margin of a business before capital leading to a more profitable operation. A low
expenditures, taxes, and capital structure are taken into EBITDA margin indicates that a business has
account. The margin does not include the impact of the profitability problems as well as issues with
company’s capital structure, non-cash expenses, and income cash flow. On the other hand, a relatively high
taxes. EBITDA margin means that the business
earnings are stable.

19 Net Profit 𝑁𝑒𝑡 𝑃𝑟𝑜𝑓𝑖𝑡 𝐴𝑓𝑡𝑒𝑟 𝑇𝑎𝑥 Percentage Overall This ratio measures percentage of each sale rupee remaining A high net profit margin endures adequate
× 100
Margin (NPM) 𝑅𝑒𝑣𝑒𝑛𝑢𝑒 𝑓𝑟𝑜𝑚 𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑜𝑛𝑠 Profitability after the firm has paid all its costs and expenses including return to the owners. It also ensures
interest and taxes. Profit margin gauges the degree to which a sustainability of the firm in adverse economic
company or a business activity makes money. It indicates the conditions such as when selling price
profit or net income obtained as a percentage of the revenue decreases, cost of production rises and
generated demand for the firm's product falls.

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 RATIO ANALYSIS AND INTERPRETATION
Sr. Expressed
Ratio Formulae Measure of Meaning Indicators
No. As

20 Earnings Per 𝑁𝑃𝐴𝑇 − 𝑃𝑟𝑒𝑓𝑒𝑟𝑒𝑛𝑐𝑒 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 Rs Absolute Profit It measures profit available to equity shareholders on every A bigger EPS number means a company is
Share (EPS) 𝑁𝑜. 𝑜𝑓 𝑂𝑢𝑡𝑠𝑡𝑎𝑛𝑑𝑖𝑛𝑔 𝐸𝑞𝑢𝑖𝑡𝑦 𝑆ℎ𝑎𝑟𝑒𝑠 per share share held by them. In other words, it calculates profit per more profitable and able to pay out more
equity share. It indicates the company's profitability by money to shareholders as dividends. A
showing how much money a business makes for each share of company with a consistently increasing EPS is
its stock. EPS measures each common share’s profit allocation a more reliable investment than a company
in relation to the company’s total profit. It indicates earning with a declining or unpredictable EPS.
capability of a company & determines the dividend payments
and the value of its stocks in the market.

21 Dividend Per 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 𝐴𝑚𝑜𝑢𝑡 𝑃𝑎𝑖𝑑 Rs Distributed It is the sum of declared dividends issued by a company for A high DPS depicts strong profitability. A
Share (DPS) 𝑁𝑜. 𝑜𝑓 𝑂𝑢𝑡𝑠𝑡𝑎𝑛𝑑𝑖𝑛𝑔 𝑆ℎ𝑎𝑟𝑒𝑠 Profit per share every ordinary share outstanding. Dividends are usually a cash consistent increase in DPS over time can also
payment paid to the equity shareholders. It tells investors the give investors’ confidence that the company's
quantum of dividends they would receive from the company for management believes that its earnings growth
every unit of share held. can be sustained. Increasing DPS is a good way
for a company to signal strong performance &
positive expectations about its future earnings
to its shareholders. If a company is expanding,
it might retain a larger portion of its profits
and pay limited dividends. In such cases, the
DPS would be low (but the company could
have good future prospects).

22 Dividend Payout 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 𝑃𝑒𝑟 𝑆ℎ𝑎𝑟𝑒 Percentage Earnings The proportion of earnings paid out as dividends to A high DPR means that the company is
× 100
Ratio (DPR) 𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝑃𝑒𝑟 𝑆ℎ𝑎𝑟𝑒 Distributed shareholders. The dividend pay-out ratio is not intended to reinvesting less money back into its business,
assess whether a company is a “good” or “bad” investment. while paying out relatively more of its
Rather, it is used to help investors identify what type of returns earnings in the form of dividends. Such
𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 𝐴𝑚𝑜𝑢𝑡 𝑃𝑎𝑖𝑑
× 100 – dividend income vs. capital gains – a company is more likely companies tend to attract income investors.
𝑁𝑃𝐴𝑇 − 𝑃𝑟𝑒𝑓𝑒𝑟𝑒𝑛𝑐𝑒 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑
to offer the investor. By virtue of investing in business growth, the
company will likely be able to generate higher
levels of capital gains for investors in the
future. Therefore, these types of companies
tend to attract growth investors.

23 Retention Ratio 𝐸𝑃𝑆 − 𝐷𝑃𝑆

× 100
Percentage Earning retained The retention ratio, also called the plowback ratio, is the Younger, more rapidly growing companies are
(RR) 𝐸𝑃𝑆 proportion of earnings retained or reinvested in the business more likely to report a high RR as they
as retained earnings. It refers to the percentage of net income reinvest most of their earnings into the
that is retained to grow the business, rather than being paid out business for expansion and future growth.
as dividends. It is the opposite of the pay-out ratio More mature, established companies, with a
steadier but probably slower growth rate, are
more likely to have a relatively low RR as they
do not feel the need to commit a high

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 RATIO ANALYSIS AND INTERPRETATION
Sr. Expressed
Ratio Formulae Measure of Meaning Indicators
No. As
percentage of their earnings to business
expansion.

24 Return on Asset 𝐸𝐵𝐼𝑇 (1 − 𝑡) Percentage Overall It indicates a company's profitability in relation to its total A higher ROA, more efficient the company's
× 100
(ROA) 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠 Profitability of assets. It shows how effectively a company uses its assets to management is in generating profit from its
Assets generate earnings. Some concern exists about ROA relying on assets. A ROA that rises over time indicates the
the book value of total assets rather than their market value, company is doing well at increasing its profits
giving a return that looks higher than it should be in reality. with each investment rupee it spends. A falling
There are diverse opinions on what to take in the numerator of ROA indicates the company might have over-
this ratio! Some prefer to take net income as the numerator, and invested in assets that have failed to produce
others like to put EBIT where they don’t want to consider the revenue growth, a sign the company may be in
interests and taxes. I advise considering EBIT as this term is some trouble. Lower ROA ratios indicate that
before interest and taxes (pre-debt and pre-equity). Likewise, less profit has been generated from the assets.
when comparing it with the denominator, i.e., Total Assets, we
are taking care of both the Equity and Debtholders. Net Income
/ Average Total Assets may be an incorrect comparison due to
its numerator. Net income is the return attributed to the equity
holders, and the denominator – Total Assets considers both
Equity and Debt. It means we are comparing apples to oranges

25 Return on 𝐸𝐵𝐼𝑇 (1 − 𝑡) Percentage Overall It indicates how well a company uses its capital to create a higher return on capital employed may
× 100
Capital 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝐸𝑚𝑝𝑙𝑜𝑦𝑒𝑑 Profitability of profits. This metric compares how much profit a company indicate better profitability and efficiency.
Employed Funds Raised generates per rupee of capital it employs. It assess a company’s Typically, ROCE should be higher than the rate
(ROCE) profitability and efficiency in utilizing its capital resources. at which firm is borrowing its capital. It shows
that the earnings from their capital exceed the
cost they have to pay against the capital
raised. i.e. ROCE > WACC i.e. r.k

26 Return on 𝑃𝑟𝑜𝑓𝑖𝑡 𝐴𝑓𝑡𝑒𝑟 𝑇𝑎𝑥 Percentage Overall it measures return on the owners (both preference and equity The higher the ROE, the more efficient a
× 100
Equity (ROE) 𝐸𝑞𝑢𝑖𝑡𝑦 Profitability of shareholders) investment in the firm. It indicates firm’s company's management is at generating
Owners management of equities and investments to produce returns. income and growth from its equity financing.
A good rule of thumb is to target an ROE that
is equal to or just above the average for the
company's sector—those in the same
business.
A firm that is under excessive debt also
experiences a sudden rise in ROE but, again,
this is not ideal. Additionally, a new firm may
not even have a positive return on equity until
it manages to break even. However, such a
state does not necessarily indicate
mismanagement of the firm.

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 RATIO ANALYSIS AND INTERPRETATION
V. Market/ Valuation Ratios
Market value ratios determine the current share price of a company's stock & help evaluate the economic status of publicly traded companies. Investors use these values to determine if a business's stock to decide
whether the stock of a company is currently selling at attractive (cheap/undervalued), fair (rightly priced) or expensive (overvalued) price.
Sr. Expressed
Ratio Formulae Measure of Meaning Indicators
No. As

27 Price Earnings 𝑃𝑟𝑖𝑐𝑒 Market Value It measures the amount the investors are willing to pay for each A high ratio means the stock is overvalued.
(P/E) Ratio 𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 relative to rupee of earnings. It is a valuation metric that provides However, a high ratio often signifies that it is a
Earnings investors with information about whether a company's shares growth stock, meaning there is a chance of
𝑀𝑎𝑟𝑘𝑒𝑡 𝑃𝑟𝑖𝑐𝑒 𝑃𝑒𝑟 𝑆ℎ𝑎𝑟𝑒 (𝑀𝑃𝑆) are trading at an attractive price given their prospective high future performance, even if the cost per
𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝑃𝑒𝑟 𝑆ℎ𝑎𝑟𝑒 (𝐸𝑃𝑆) earnings growth rate. It helps you understand whether markets share is high at the moment. However, growth
are overvaluing or undervaluing a stock. The market price of a stocks are also volatile, meaning they can be
stock tells you how much people are willing to pay to own the risky investments.
shares, but the P/E ratio tells you whether the price accurately A low ratio means the stock is undervalued.
reflects the company’s earnings potential, or its value over time. This means that while the company is doing
well growth- and profits-wise, the stock price
is below par, making it a bargain for investors.

28 Book Value Per 𝐵𝑜𝑜𝑘 𝑉𝑎𝑙𝑢𝑒 Rs Liquidation Book Value is a company’s equity value as reported in its If the value of BVPS exceeds the market value
Share (BVPS) 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑂𝑢𝑡𝑠𝑡𝑎𝑛𝑑𝑖𝑛𝑔 𝐸𝑞𝑢𝑖𝑡𝑦 𝑠ℎ𝑎𝑟𝑒𝑠 Value per share financial statements. The book value of a business is the total per share, the company’s stock is deemed
amount a company would generate if it was liquidated without undervalued. If the company’s BVPS rises, the
𝐵𝑜𝑜𝑘 𝑉𝑎𝑙𝑢𝑒 = 𝐸𝑞𝑢𝑖𝑡𝑦 selling any assets at a loss. A company’s book value is typically stock could be more valuable and this can
− 𝑃𝑟𝑒𝑓𝑒𝑟𝑒𝑛𝑐𝑒 𝑆ℎ𝑎𝑟𝑒 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 less than its market value. BVPS represents the equity/claim of result in a rise in the stock’s market price
equity shareholder per share. is based on the company’s If BVPS is negative, & company’s total
𝐵𝑜𝑜𝑘 𝑉𝑎𝑙𝑢𝑒 = 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠
historical accounting data. It represents the minimum value of liabilities are more than its total assets, it can
− 𝑇𝑜𝑡𝑎𝑙 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
a company's equity and measures the book value of a firm on a be interpreted as balance sheet insolvency.
− 𝑃𝑟𝑒𝑓𝑒𝑟𝑒𝑛𝑐𝑒 𝑆ℎ𝑎𝑟𝑒 𝐶𝑎𝑝𝑖𝑡𝑎𝑙
per-share basis.

29 Dividend Yield 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 𝑃𝑒𝑟 𝑆ℎ𝑎𝑟𝑒 Percentage Cash Return per It measures the quantum of cash dividends paid out to A high or low yield depends on factors such as
Ratio 𝑀𝑎𝑟𝑘𝑒𝑡 𝑃𝑟𝑖𝑐𝑒 𝑃𝑒𝑟 𝑆ℎ𝑎𝑟𝑒 equity share shareholders relative to the market value per share. the the industry and the business life cycle of the
percentage of a company’s market price of a share that is paid company. For example, it may be in the best
to shareholders in the form of dividends. interest of a fast-growing company to not pay
any dividends. The money might be better
used by reinvesting into the company to grow
the business.
On the other hand, a mature company may
report a high yield due to a relative lack of
future high growth potential. Therefore, the
yield ratio does not necessarily indicate a
good or bad company. Rather, the ratio is used
by investors to determine which stocks align
with their investment strategy.

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