Financial Management I

B. Pharm + MBA Semester 7

SVKM’s NMIMS Deemed-to-be University

Unit 5
Reading of corporate financial
statements

Dr. Ashique Ali K A

Assistant Professor (Finance)
School of Law
SVKM’s NMIMS Deemed-to-be University
Hyderabad
Accounting Ratios
• A mathematical expression of the relationship between two accounting figures.
Forms of Ratios
• Proportion – 2:1 etc.
• Percentage – 20% of Net sale
• Times – Sales are 3 times the fixed assets
• Fraction – 3/5 etc.
Classification according to nature of functions
• Liquidity ratios – Current ratio, Quick ratio, Absolute quick ratio
• Leverage ratios – Debt-equity ratio, Capital gearing ratio, proprietary ratio
• Activity ratios – Stock turnover ratio, Fixed assets turnover ratio, Debtors turnover ratio
• Profitability ratios – Gross profit ratios, Operating profit ratio, Return on investment
• Market test ratios – EPS, DPS, DPO ratio, P/E ratio
 Operating Statement
Gross sales
Less: Sales returns
Net sales
Less: Cost of goods sold (CGS):
Opening stock
Add: Purchase
Less: Closing stock CGS = Opening stock + Purchase + Wages
Gross Profit (Net sales – CGS) and other Direct expenses – Closing stock
Less: Operating Expenses:
Administrative expenses
Selling and distribution expenses
Operating Net Profit (EBIT)
Add: Non-operating income
Less: Non-operating expenses
Net profit before tax (EBT)
Less: Provision for taxation
Net profit after tax (EAT)
Less: Preference Dividend
Earnings available to Equity Shareholders (EATPD)
 Liquidity Ratios
• Short term solvency ratios. It refers to the firm’s ability to pay Current Current
its current liabilities out of its current assets. These ratios assets liabilities (C L)
measure the liquidity position of a firm. (C A)
Sundry
1. Current Ratio = Current Assets / Current Liabilities Cash in hand creditors
also called Working capital ratio. The standard is 2:1 and at bank
Bills payables
2. Quick Ratio = Quick Assets / Current Liabilities Marketable
Quick assets or Liquid assets = C A – (stock + prepaid securities Outstanding
expenses) expenses
also called Acid test ratio. The ideal ratio is 1:1 Short term
investments Short term
3. Absolute liquid ratio = Absolute liquid assets / C L advances
Absolute liquid assets = Cash and Cash equivalents Bills
(Marketable securities) receivables
Provision for
also called Cash ratio. The ideal ratio = 0.5:1 Sundry debtors taxation
Stock Dividends
Work in payable
Debtors less provision for doubtful debts are considered progress Bank overdraft
Prepaid
expenses Cash credit
Problem 1
• From the Following information, calculate the liquidity ratios
Machinery – 250,000
Prepaid expenses – 2000
Sundry debtors – 167,500
Cash balance – 15,500
Short term investments – 20,000
Sundry creditors – 150,000
Stock – 145,000
Bills payable – 38,000
Expenses outstanding – 12,000
Long term loans – 75,000
Problem 2
• From the Following information, calculate the liquidity ratios
Debtors – 200,000
Prepaid expenses – 20,000
Bills receivables – 50,000
Cash balance – 10,000
Marketable securities – 100,000
Sundry creditors – 230,000
Stock – 180,000
Bills payable – 75,000
Bank overdraft – 175,000
Problem 3

• Current Ratio = 1.75:1

• Working capital = 150,000.
• Calculate current assets?
Problem 4

• Current Ratio = 1.6:1

• Quick Ratio = 1.1:1
• Stock = 50,000.
• Calculate current assets, current liabilities, liquid
assets and working capital
Problem 5

• Current Ratio = 2.5:1

• Quick Ratio = 1.5:1
• Working Capital = 60,000.
• Calculate current assets, current liabilities, liquid
assets and stock
Problem 6

• Total Assets = Rs.11,00,000

• Fixed Assets = Rs. 5,00,000
• Capital Employed = Rs. 10,00,000
• Long Term Investment = Nil

Calculate Current Ratio

 Profitability Ratios
• Profitability refers to the ability of a firm to earn income. It indicates the operational efficiency
Profitability Ratios based on Sales
• Gross profit ratio
• Operating ratio
• Operating profit ratio
• Net profit ratio
• Expense Ratio
Profitability Ratios based on Investment
• Return on Investment or Return on Capital Employed
• Return on Shareholder’s fund
• Return on Equity Capital
Profitability Ratios based on Owners’ point of view
• Earnings per share
• Dividend per share
• Dividend Payout ratio
 Profitability Ratios based on Sales
Gross Profit Ratio (Gross Profit Margin)
Ratio = (Gross profit / Net sales) x 100
• Gross Profit = Net sales – Cost of goods sold
• The ideal ratio is 20% to 25%. Higher ratio is better
Operating Profit Ratio
Ratio = (Operating profit / Net sales) x 100
• Operating profit means profit from normal business operations
• Operating Profit or EBIT = Gross profit – Operating expenses
• EBIT = Net Sales – Cost of Goods Sold – Operating Expenses
• EBIT = EBT + Non-operating expenses – Non-operating income
• Operating ratio + Operating Profit ratio = 100%
• Higher ratio is better.
Profitability Ratios based on Sales
Operating Ratio
Ratio = (Operating cost / Net sales) x 100
It expresses the relationship between operating cost and sales. It indicates the
overall efficiency in operating the business.
Operating cost = Cost of goods sold + Operating expenses
Operating expenses include Office and administrative expenses, Selling and
distribution expenses, Financial expenses like Interest on short term loans, bad
debts, and discount allowed.
Financial expenses like Interest on long term funds will not be considered
Lower the ratio more is the operational efficiency. Ideal ratio of Manufacturing
concerns is 75% to 85%
Expense ratios
Break up of Operating ratio. It shows the relationship of various expenses to net
sales.
Ratio = (Concerned expenses / Net sales) x 100
 Profitability Ratios based on Sales
Example
Net profit ratio = 10%
Operating profit = 50000
Net Profit Ratio
Non – operating income = 20000
• It measures the overall profitability of a
business. Non – operating expenses = 5000
Ratio = (Net profit / Net sales) x 100 Sales returns = 10000
• Net Profit can be either before tax or after tax.
What is Net sales?
• Net Profit = EBIT+ Non operating income –
Non operating expenses
• The ideal ratio is 5% to 10% Net profit = 50000 + 20000 – 5000 = 65000
Net profit = 10% of Net sales = 65000
Net sales = 65000 x 100/10 = 650,000