Ratio analysis
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This document provides an analysis of various financial ratios for a company over two years. It begins with an introduction to ratio analysis and its importance. It then calculates and interprets various ratios including current ratio, debt to equity ratio, net profit margin, gross profit margin, inventory turnover, debtors turnover, creditors turnover and return on capital employed. The analysis found that the current ratio and return on capital employed increased slightly but debt to equity ratio also increased, indicating less financial stability. Profit margins were low. Inventory turnover and creditors turnover decreased. The conclusion recommends the company improve utilization of assets, pricing strategies and timely payment of creditors.
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Ratio analysis
- 1. RATIO ANALYSIS GROUP ASSIGNMENT DONE BY : SHAILINI.M.SHAH ANU DAMODARAN KRITIKA MATHUR ASHWATHI 1
- 2. INTRODUCTION TO RATIO ANALYSIS A ratio is defined as a relationship between two numbers of the same kind. The ratio analysis is one of the most useful and common methods of analyzing financial statement. Ratio enables the mass of data to be summarized and simplified. 2
- 3. IMPORTANCE OF RATIO ANALYSIS Ratio analysis of a firm’s financial statement is of interest to a number of parties mainly: Shareholders - interested with earning capacity of the firm. Creditors - interested in knowing the ability of firm to meet financial obligation. Financial Executives - concerned with evolving analytical tools that will measure and compare costs, efficiency liquidity and profitability with a view to making intelligent decisions. 3
- 4. IMPORTANCE OF RATIO ANALYSIS Enables the banker or lender to arrive at the following factors : Liquidity position Profitability Solvency Financial Stability Quality of the Management Safety & Security of the loans & advances to be or already been provided 4
- 5. How a Ratio is expressed? As Percentage - such as 25% or 50% . As Proportion – The figures may be expressed in terms of the relationship as 1 : 4. As Pure Number /Times - The same can also be expressed in an alternatively way for example the sale is 4 times of the net profit or profit is 1/4th of the sales. 5
- 7. ADVANTAGES OF RATIO ANALYSIS Aids to measure general efficiency. Aids to measure financial liquidity and solvency. Aids in forecasting and planning. Facilitates decision making. Effective control and performance tool. 7
- 8. LIMITATIONS OF RATIO ANALYSIS Limitations of recording: Ratio analysis is based on financial statement, which are themselves subject to limitations. Changes in accounting procedure: Most often firms for their valuation follow different methods hence comparison will be practically of no use. 8
- 9. Lack of proper standard: It is very difficult to ascertain the standard ratio in order to make proper comparison. Because ratios differ from firm to firm and industry to industry. Limited use of single ratio: A single ratio will not be able to convey anything. Too many ratios: Are likely to confuse instead of revealing meaningful conclusions. Personal bias: Different people may interpret the same ratio in different ways. 9
- 11. RATIOS ANALYSED 1. 2. 3. 4. 5. 6. 7. 8. Current Ratio Debt/Equity Ratio Net Profitability Ratio Gross Profitability Ratio Inventory Turnover Ratio Debtor’s Turnover Ratio Creditor’s Turnover Ratio Return on Capital Employed 11
- 12. CURRENT RATIO The current ratio establishes the relationship between the current assets and the current liabilities. The ideal ratio is 2:1. Current Assets Current Ratio = -------------------------Current liabilities 12
- 14. INTERPRETATION: Here the current ratio seems to assure that the company is in a position to pay off any short term liabilities with liquid assets such as cash and bank balances, inventory, accounts receivables and short-term assets(can be converted to cash). This means that the company appears to be doing well and liquidity has remained stable. It can be seen that the current ratio has been increased from 1.91 to 2.2. 14
- 15. DEBT/EQUITY RATIO This ratio is calculated to measure the relative proportion of outsider’s funds invested in the company. Long term debt Debt Equity Ratio = --------------------Shareholder’s fund 15
- 17. INTERPRETATIONS A Debt to Equity ratio of 3.49 means that debt holders have a 3.49 times more claim on assets than equity holders. Thus this does not appear to be a healthy situation for the company , which means they cannot borrow more from banks. The Debt to Equity ratio has increased from 3.33 to 3.49 and hence decreases the protection of creditors. 17
- 18. NET PROFITIBILITY RATIO This ratio establishes the relationship between the amount of net profit or net income and the amount of sales revenue. Net Profit Net Profit Ratio = ------------------- * 100% Sales 18
- 19. NET PROFIT SALES (A) (B) Year RATIO (A/B*100%) 2009-2010 6,320.47 251489.41 2.51% 2010-2011 8786.56 340047.99 2.58% NET PROFIT RATIO 2.6 2.55 2.5 2.45 NET PROFIT RATIO 19
- 20. INTERPRETATIONS This is a low margin of profit indicating a low margin of safety, higher risk that a decline in sales will erase profits and result in a net loss. Different strategies and product mix should be used to get higher profit margin. Net profit margin is mostly used to compare a companies results overtime. In this case net profit margin has negligibly increased from 2.51 to 2.58. To compare Net profit margin between companies in the same industry might have little meaning as we can’t say which is more efficient or less efficient. 20
- 21. GROSS PROFITIBILITY RATIO This ratio establishes the relationship between gross profit on sales and net sales in terms of percentage indicating the percentage of gross profit earned on sales. Gross Profit Gross Profit Ratio = ------------------- * 100% Sales 21
- 22. GROSS PROFIT (A) NET SALES 2009-2010 18702.14 251489.41 7.43% 2010-2011 20617.72 340047.99 6.06% YEAR (B) RATIO (A/B*100) GROSS PROFIT RATIO 8 6 4 2 0 GROSS PROFIT RATIO 2009-2010 2010-2011 22
- 23. INTERPRETATIONS In this case the Gross Profit Ratio does not seem to be good enough and hence indicates reduced efficiency in production of the unit. Gross profit has decreased from 7.43 to 6.06. Gross profit margin can be used to compare a company with its competitors. 23
- 24. INVENTORY TURNOVER RATIO Inventory turnover ratio which is also called stock turnover ratio or stock velocity establishes the relationship between the cost of goods sold during a given period and the average of the costs of opening and closing stocks. Cost of goods sold Stock Turnover Ratio : ------------------------Inventory holdings 24
- 25. COST OF GOODS SOLD (A) INVENTORY HOLDINGS (B) 2009-2010 251489.41 15821.36 15.89 2010-2011 340047.99 23832.49 14.26 YEAR RATIO (A/B) INVENTORY TURNOVER RATIO 16 15.5 15 14.5 14 13.5 13 INVENTORY TURNOVER RATIO 25
- 26. INTERPRETATIONS This ratio can reflect both on the quality of the inventory and the efficiency of management. Typically, the higher the turnover rate, the greater the likelihood that profits would be larger and less working capital bound up in inventory. In this case the turnover rate is low and indicates more working capital being bound up in inventory. The inventory turnover ratio has decreased from 15.89 to 14.26. 26
- 27. DEBTORS TURNOVER RATIO Debtor turnover ratio, also known as receivables turnover ratio or debtors velocity establishes the relationship between the net credit sales of the year and the average receivable Net Sales Debtors Turnover Ratio = --------------------Debtors 27
- 28. NET SALES DEBTORS YEAR RATIO 2009-2010 251489.41 12686.88 19.82 2010-2011 340047.99 15954.32 21.31 DEBTORS TURNOVER RATIO 22 21 20 19 DEBTORS TURNOVER RATIO 28
- 29. INTERPRETATIONS In this case debtor turnover ratio is good which indicates that we are collecting money fast. Here debtor turn over ratio has increased from 19.82 to 21.31. 29
- 30. CREDITORS TURNOVER RATIO This ratio, also known as payable turnover ratio establishes the relationship between the net credit purchases and the average trade creditors. Net Purchases Creditors Turnover Ratio = ------------------Creditors 30
- 32. INTERPRETATIONS In this case , there is a low turnover which means that it takes longer for the company to pay off its creditors. The ratio has fallen from 0.12 to 0.089, it means the company is now taking longer to repay creditors. This may be the result of low sales, or other issues. A continued drop may be a cause for concern as it suggests the company cannot control its debt and may be at risk of bankruptcy. 32
- 33. RETURN ON CAPITAL EMPLOYED(ROCE) A ratio that indicates the efficiency and profitability of a company's capital investments. Calculated as: PROFIT BEFORE INTEREST AND TAX ROCE = ________________ CAPITAL EMPLOYED 33
- 34. YEAR PROFIT BEFORE TAX CAPTIAL EMPL0YED 2009-2010 251489.41 12686.88 19.82 2010-2011 28648.65 133641.06 21.43 RATIO RETURN ON CAPITAL EMPLOYED 22 21 20 19 RETURN ON CAPITAL EMPLOYED 34
- 35. INTERPRETATIONS The company has been utilising the capital invested in a favourable manner with returns increasing as compared to the previous financial year. The ROCE has increased from 19.82 to 21.43. 35
- 36. The current position of the company when assessed on the basis of current ratio and ROCE appears to be healthy though negligibly. It should be noted that the Debtors turnover ratio is high, thus indicating that the company is promptly receiving its debts back. On the basis of profitability, inventory turnover ratio and creditors turnover ratio, the company does not appear to be performing at a satisfactory level. 36
- 37. CONCLUSION & RECOMMENDATION Considering the above mentioned points it is advisable that the management should change its strategies in terms of better utilization of current assets to pay back its creditors on time, rework its pricing policies in order to avoid pressure on profit margins. 37
- 38. THANK YOU 38