Lesson # 12
FUNDAMENTAL
ANALYSIS
What is Ratio Analysis?
Ratio analysis is a way to understand how a
business is doing by using numbers from financial
statements.
Helps analyze: Profitability, Bill payments, Growth,
Shareholder satisfaction
Why is Ratio Analysis
Important?
Tells us how well a business is performing
Compares performance over years and with
competitors
Helpful for students and real business decisions
What Do We Want Ratio
Analysis to Tell Us?
Is the business profitable?
Can it pay expenses on time?
Is it growing or shrinking?
Are shareholders benefiting?
What Will We Do with
Ratio Analysis?
Measure the health of the business
Compare: This year vs. Last year, With
competitors
Assist investors, managers, and lenders
Types of Financial Ratios
and Their Formulas
1. Profitability Ratios
2. Liquidity Ratios
3. Efficiency Ratios
4. Solvency Ratios
5. Market Ratios
Profitability Ratios
Examples
Gross Profit Margin = (Gross Profit ÷ Sales) × 100
Net Profit Margin = (Net Profit ÷ Sales) × 100
Liquidity Ratios Examples
Current Ratio = Current Assets ÷ Current
Liabilities
Quick Ratio = (Current Assets – Inventory) ÷
Current Liabilities
Efficiency Ratios Examples
Inventory Turnover = COGS ÷ Average Inventory
Debtor Days = (Trade Receivables ÷ Sales) × 365
Solvency Ratios Examples
Debt to Equity = Total Debt ÷ Shareholders’
Equity
Interest Coverage = EBIT ÷ Interest Expense
Market Ratios Examples
EPS = Net Profit ÷ Number of Shares
P/E Ratio = Market Price per Share ÷ EPS
Who Uses Ratio Analysis
and Why?
Managers: Business decisions
Investors: Buy/sell shares
Lenders: Loan repayment ability
Employees: Job security
Students: Learn business performance
How to Use Ratios (Step-
by-Step)
1. Find numbers from statements
2. Apply formulas
3. Compare with past and competitors
4. Understand results
5. Make decisions
Final Goal: Becoming Ratio
Experts
Learn to calculate and interpret each ratio
Analyze real business data
Make financial decisions confidently
🔹 LIQUIDITY RATIOS
Liquidity ratios help us check if a business can pay
its short-term debts (like bills and loans) using its
current (short-term) assets like cash, inventory,
and receivables.
Current Ratio (Working
Capital Ratio)
Formula:
Current Assets ÷ Current Liabilities
Meaning:
This ratio shows whether the business has enough
current assets (cash, inventory, receivables) to
cover its current liabilities (short-term debts).
Understanding Current
Ratio
How to Understand It:
• Above 1: Business can pay its short-term debts.
Good sign.
• Below 1: Business may struggle to pay its short-
term debts. Risky.
Important Notes:
•This ratio helps investors and creditors know if the company
is financially healthy in the short term.
•It’s important to compare this ratio with
other companies in the same industry.
Working Capital Concept
Formula:
Working Capital = Current Assets – Current
Liabilities
IF working capital is positive the business is in a
good
position.
If working capital is negative , the business might
face trouble in meeting short
term obligation.
Acid-Test Ratio (Quick
Ratio)
Formula: (Current Assets – Inventory) ÷ Current
Liabilities
This is a stricter version of the current ratio. It
removes inventory from current assets because
inventory takes time to sell and convert into cash.
Why Quick Ratio is
Important
Some stocks (like machinery parts) may take
months to sell.
It’s better to check if the business can pay debts
without relying on inventory.
Ideal use:
This ratio is useful when you want to test
liquidity in an emergency.
🔹 PROFITABILITY RATIOS
Shows how well a business makes profit from its
sales and operations.
Gross Profit Margin
Formula: (Gross Profit ÷ Sales) × 100
Gross Profit = Sales – COGS
Shows how much profit a business makes before
paying expenses like salaries, rent, advertising,
etc.
It shows how efficiently the business is
producing or buying goods.
Understanding Gross Profit
Margin
Higher gross margin = More profit per rupee of
sales.
Lower gross margin = High cost of goods, low
pricing, or poor sales.
Operating Margin
Formula:
Operating Income ÷ Net Sales
It tells us how much profit is left after paying
variable costs (like wages, materials) but
before interest and tax.
Importance of Operating
Margin
Shows the operational efficiency of a company.
Helps understand if the business is profitable
after daily expenses
Higher margin = Better cost control and pricing
strategy.
Net Profit Margin
Formula: (Net Profit ÷ Net Sales) × 100
Net Profit = Gross Profit – all Expenses
It tells how much profit the company actually
keeps after paying all expenses, including
taxes and interest.
Understanding Net Profit
Margin
Shows real profit the business gets from each
rupee of sales
Useful for understanding the overall profitability
Earnings Per Share (EPS)
Formula:
EPS = Profit Available to Shareholders ÷ Average
Common Shares Outstanding
EPS shows how much profit belongs to each
share. It helps investors see how valuable a
company is.
EPS Interpretation
Higher EPS = More profit per share = Attractive
to investors.
Used in stock market analysis
🔹 LEVERAGE (GEARING)
RATIO
These ratios tell us how much a business
depends on borrowed money (debt) compared
to its own money (equity).
Understanding Financial
Leverage
Formula:
Leverage = Long-term Debt ÷ Equity
Leverage = How much the company borrows
compared to its own funds.
Meaning:
• Tells us if the business is using more debt or
more equity to run.
• Shows financial risk — the more the debt, the
higher the risk.
High vs. Low Leverage
High Leverage:
• More risk because company must pay back loans
even if sales are low.
• May struggle in tough economic times.
Low Leverage:
• More equity, less debt = Safer position, stronger
in downturns.
Interest Coverage Ratio
Formula: EBIT ÷ Interest Expense
It shows how easily the business can pay its
interest on debt.
Why Interest Coverage
Ratio Matters
High ratio :company is safe and can easily pay
intertest.
Low risk: risky position. May struggle to pay
interest if profit falls
Why It Matters: Lenders and investors look at
this ratio to see how risky the business is.
