Financial Ratio Analysis for Improved Decision Making

Financial Reporting, Financial Reporting, Statements and Analysis Statements and Analysis Module 4 FRSA Module 4 2019-20 SV/GS/PSR/SKK

Module 4 Module 4 Ratio Analysis Ratio Analysis Learning Outcome Able to analyse financial health through ratios Content Introduction to Ratios Types of Ratios Liquidity Ratios Solvency Ratios Activity Ratios Profitability Ratios and, Market Test Ratios FRSA Module 4 2019-20 SV/GS/PSR/SKK

Introduction to Ratio Introduction to Ratio A ratio is a mathematical number calculated as a reference to relationship of two or more numbers and can be expressed as a fraction, proportion, percentage and a number of times. Definition of Ratio A ratio is defined as the indicated quotient of two mathematical expressions and as the relationship between two or more things. Here ratio means financial ratio or accounting ratio which is a mathematical expression of the relationship between accounting figures. FRSA Module 4 2019-20 SV/GS/PSR/SKK

Introduction to Ratio Introduction to Ratio Objectives of Ratio Analysis 1. To know the areas of the business which need more attention; 2. To know about the potential areas which can be improved with the effort in the desired direction; 3. To provide a deeper analysis of the profitability, liquidity, solvency and efficiency levels in the business; 4. To provide information for making cross-sectional analysis by comparing the performance with the best industry standards; and 5. To provide information derived from financial statements useful for making projections and future estimations. FRSA Module 4 2019-20 SV/GS/PSR/SKK

Introduction to Ratio Introduction to Ratio Advantages of Ratio Analysis 1. Helps to understand efficiency of decisions 2. Simplify complex figures and establish relationships 3. Helpful in comparative analysis 4. Identification of problem areas 5. Enables SWOT analysis 6. Various comparisons FRSA Module 4 2019-20 SV/GS/PSR/SKK

Introduction to Ratio Introduction to Ratio Limitations of Ratio Analysis 1. Limitations of Accounting Data 2. Ignores Price-level Changes 3. Ignore Qualitative or Non-Monetary Aspects 4. Variations in Accounting Practices 5. Forecasting FRSA Module 4 2019-20 SV/GS/PSR/SKK

Types of Ratios Types of Ratios Liquidity Ratios - Liquidity or short-term solvency means ability of the business to pay its short-term liabilities. Activity Ratios - These ratios indicate the speed at which, activities of the business are being performed. Profitability Ratios - Profitability ratios are calculated to analyze the earning capacity of the business which is the outcome of utilization of resources employed in the business. Solvency Ratios - Solvency ratios are calculated to determine the ability of the business to service its debt in the long run Market Test Ratios Theses ratios indicate the firms performance level to the investors of the stock market. FRSA Module 4 2019-20 SV/GS/PSR/SKK

Liquidity Ratios Liquidity Ratios Liquidity ratios are calculated to measure the short-term solvency of the business, i.e. the firm s ability to meet its current obligations. Various Liquidity Ratios are: Current Ratio Quick Ratio or Acid Test Ratio Cash Ratio or Absolute Liquidity Ratio Basic Defense Interval or Interval Measure Ratios Net Working Capital Ratio FRSA Module 4 2019-20 SV/GS/PSR/SKK

Liquidity Ratios Liquidity Ratios Current Ratio = Current Assets / Current Liabilities Quick Ratio or Acid Test Ratio = (Current Assets Inventories-Prepaid Exp.) Current Liabilities Cash Ratio or Absolute Liquidity Ratio = Cash + Bank + Short Term Marketable Securities Net Working Capital Ratio = Current Assets - Current Liabilities (Excluding Current Liabilities Short term bank borrowing) FRSA Module 4 2019-20 SV/GS/PSR/SKK

Liquidity Ratios Liquidity Ratios FRSA Module 4 2019-20 SV/GS/PSR/SKK

Liquidity Ratios Liquidity Ratios 3 FRSA Module 4 2019-20 SV/GS/PSR/SKK

Liquidity Ratios Liquidity Ratios FRSA Module 4 2019-20 SV/GS/PSR/SKK

Q5: Current ratio 2.5.Working capital Rs.60,000. Calculate the amount of Current Assets and Current Liabilities. Q6: Current ratio = 4.5 Quick ratio = 3 Working Capital = Rs. 90,000. Calculate the Current Assets, Current Liabilities and Stock. FRSA Module 4 2019-20 SV/GS/PSR/SKK

Liquidity Ratios Liquidity Ratios - - Practice Practice FRSA Module 4 2019-20 SV/GS/PSR/SKK

Liquidity Ratios Liquidity Ratios Basic Defense Interval or Interval Measure Ratios BDI is a financial metric that indicates the number of days that a company can operate without needing to access noncurrent assets, long-term assets whose full value cannot be obtained within the current accounting year, or additional outside financial resources. BDI or IMR (expressed as number of days) = current assets / daily operational expenses Current assets = cash + marketable securities + net receivables Daily operational expenses = (annual operating expenses non cash charges) / 365 FRSA Module 4 2019-20 SV/GS/PSR/SKK

DIR DIR For example, A company has Rs. 100,000 cash on hand, Rs. 50,000 worth of marketable securities, and Rs.50,000 in accounts receivables, it has a total of Rs.200,000 in defensive assets. If the company's daily operational expenses equal Rs.5,000. The DIR value is = current assets / daily operational expenses = Rs.200,000 / Rs. 5,000. = 40 Days FRSA Module 4 2019-20 SV/GS/PSR/SKK

DIR DIR Hammer Industries is suffering through a cyclical decline in the heavy equipment industry, but the cycle appears to be turning up. The company expects a cash-in-advance payment from a major customer in 60 days. In the meantime, the CEO wants to understand the ability of the company to stay in business at its current rate of expenditure. The following information applies to the analysis: Cash = Rs.1,200,000; Marketable securities = Rs.3,700,000; Trade receivables = Rs. 4,100,000 Average daily expenditures = Rs. 138,500 The calculation of the defensive interval ratio is: ($1,200,000 Cash + $3,700,000 Marketable securities + $4,100,000 Receivables) $138,500 Average daily expenditures = 65 days FRSA Module 4 2019-20 SV/GS/PSR/SKK

Activity Ratios Activity Ratios Activity Ratios - These ratios indicate the speed at which, activities of the business are being performed. Various Types: Debtors Turnover Ratio Average Collection Period Creditors Turnover Ratio Average Payment Period Total Assets Turnover Ratio Inventory Turnover Ratio FRSA Module 4 2019-20 SV/GS/PSR/SKK

Activity Ratios Activity Ratios Debtors Turnover Ratio = Credit Sales / Average Debtors Average Collection Period = No. of days in a year or months / DTR Creditors Turnover Ratio = Credit Purchases / Average Creditors Average Payment Period = No. of days in a year or months/ CTR Inventory Turnover Ratio = Net Sales or Cost of Goods Sold / Average Total Assets Ratio = Net Sales / Total Assets Inventory FRSA Module 4 2019-20 SV/GS/PSR/SKK

Activity Ratios Activity Ratios 1. Calculate the Debtors Turnover Ratio and Average Collection Period from the following information: Total sales = Rs. 4,00,000 Cash sales = 20% of total sales Debtors on 1.1.2004 = Rs. 40,000 Debtors on 31.12.2004 = Rs. 1,20,000 2. From the following details, Calculate (a) Debtors Turnover Ratio and (b) Debtors Average Collection Period: Total Sales - Rs.4,00,000 Sales Returns Cash Sales - Rs. 30,000 Debtors Bills Receivables - Rs. 25,000 - Rs.25,000 Rs.10,000 FRSA Module 4 2019-20 SV/GS/PSR/SKK

Activity Ratios Activity Ratios 3. Calculate the Creditor s Turnover Ratio from the following figures. Credit purchases during 2005 = Rs. 12,00,000 Creditors + Bills Payables on 1.1.2005 = Rs. 4,00,000 Creditors + Bills Payables on 31.12.2005 = Rs. 2,00,000 4. From the following information, calculate (i) Payable Turnover Ratio (ii) Average Payment Period Total Purchases - Rs.80,000; Purchase returns - Rs. 5,000; Bills Receivables - Rs.12,000; Bills Payables - Rs. 15,000; Cash Purchases Sales returns Creditors Debtors Rs.20,000 Rs.10,000 Rs.20,000 Rs.40,000 FRSA Module 4 2019-20 SV/GS/PSR/SKK

Activity Ratios Activity Ratios 5. From the following information, calculate stock turnover ratio : Opening Stock Rs. 18,000 Wages Closing Stock Rs. 22,000 Sales Purchases Rs. 46,000 Carriage Inwards Rs. 4,000 Rs. 14,000 Rs. 80,000 6. From the following information, calculate stock turnover ratio. Sales: Rs. 4,00,000, Gross Profit Ratio : 10% on Sales Opening stock = Rs. 38,500 Closing stock = Rs.41, 500 Note: Cost of Goods Sold = Sales Gross Profit FRSA Module 4 2019-20 SV/GS/PSR/SKK

Activity Ratios Activity Ratios The data extracted from the books of the two cement companies are provided below: Particulars Ambuja Cements (Rs.) Rs. In Crore Acc Limited (Rs.) Sales 2500 2250 Purchases 1450 1125 Opening Stock 450 225 Closing Stock 275 145 Creditors 120 130 Debtors 240 220 Bills Payable 85 115 Bills Receivable 115 135 Required: Compute the Following Ratios: (i) Debtors Turnover Ratio (ii) Creditors Turnover Ratio and (iii) Stock Turnover Ratio FRSA Module 4 2019-20 SV/GS/PSR/SKK

Activity Ratios Activity Ratios 7. From the following information, calculate (i) Total Assets Turnover (ii) Fixed Assets Turnover and (iii) Working Capital Turnover Ratios: (Rs.) Preference Shares Capital 4,00,000 Equity Share Capital 6,00,000 General Reserve 1,00,000 Profit and Loss Account 3,00,000 15% Debentures 2,00,000 14% Loan 2,00,000 Creditors 1,40,000 Bills Payable 50,000 Outstanding Expenses 10,000 Sales for the year 2018 were Rs. 30,00,000. (Rs.) 8,00,000 5,00,000 2,00,000 1,00,000 1,80,000 1,10,000 80,000 30,000 Plant and Machinery Land and Building Motor Car Furniture Stock Debtors Bank Cash FRSA Module 4 2019-20 SV/GS/PSR/SKK

Profitability Ratios Profitability Ratios Gross Profit Ratio = Gross Profit / Net Sales x 100 Net Profit Ratio = Net Profit / Net Sales x 100 Operating Ratio = Cost of Goods Sold + Operating Expenses/ Net Sales x 100 Operating Profit Ratio = Operating Profit / Net Sales x 100 Operating Profit = Earnings before Interest and Taxes Operating Profit = Operating Revenue - COGS - Operating Expenses - Depreciation and Amortization FRSA Module 4 2019-20 SV/GS/PSR/SKK

Profitability Ratios Profitability Ratios The data extracted from the books of the two FMCG companies are provided below: Particulars Nestle (Rs.) 800000 50000 350000 120000 30000 50000 HUL (Rs.) 650000 25000 300000 85000 15000 15000 Sales Other Income Cost of Goods Sold Employee Benefit Cost Finance Cost Other Expenses Required: Compute the Following Ratios: (i) Gross Profit Ratio (ii) Net Profit Ratio (iii) Operating Ratio and (iv) Operating Profit Ratio FRSA Module 4 2019-20 SV/GS/PSR/SKK

Profitability Ratios Profitability Ratios The data extracted from the books of the two FMCG companies are provided below: Particulars Nestle (Rs.) 800000 50000 350000 120000 30000 50000 HUL (Rs.) 650000 25000 300000 85000 15000 15000 Sales Other Income Cost of Goods Sold Employee Benefit Cost Finance Cost Other Expenses Required: Compute the Following Ratios: (i) Gross Profit Ratio (ii) Net Profit Ratio (iii) Operating Ratio and (iv) Operating Profit Ratio FRSA Module 4 2019-20 SV/GS/PSR/SKK

Profitability Ratios Profitability Ratios ROI ( Return on Investment)/ROCE = Profit before Interest and Tax Capital Employed x 100 Capital Employed = FA + CA - CL ROE (Return on Equity) = PAT / Net worth X 100 Net worth = Share Capital + Reserves and Surplus ROTA (Return on Total Assets) = PAT / Total Assets FRSA Module 4 2019-20 SV/GS/PSR/SKK

Profitability Ratios FRSA Module 4 2019-20 SV/GS/PSR/SKK

Market Ratios EPS = PAT Preference Dividend / Number of Equity Shares Price to Earnings Ratio = Market Price of the share/ EPS Dividend Yield Ratio = Dividend per share / Market price of the Share x 100 Book Value per share = Net Assets / Number of shares Price to Book Value = Market price of the share/ Book Value per share FRSA Module 4 2019-20 SV/GS/PSR/SKK

Market Ratios

Solvency Ratios Debt to Equity Ratio = Total Debt (Long Term Debt) / Equity Capital Gearing Ratio = Total Debt / Total Capital Employed or Total Assets Solvency Ratio = PAT + Depreciation / Total Liabilities Equity or Proprietary Ratio = Shareholders Funds (or) Net worth Interest Coverage Ratio = Net Profit before Interest and Taxes / Total Interest Total Capital Employed or Total Assets FRSA Module 4 2019-20 SV/GS/PSR/SKK

Solvency Ratios

Balance Sheet Construction Balance Sheet Construction Future Retail Limited provides the following information as on 31.3.2018 Rs. Particulars Working Capital Bank Overdraft Fixed Assets to Proprietary Funds ratio Reserves and Surplus Current ratio Liquid ratio 2,40,000 40,000 0.75 1,60,000 2.5 1.5 Required: Prepare a summarized Balance Sheet as at 31.03.2018 FRSA Module 4 2019-20 SV/GS/PSR/SKK