Ratio Analysis Part 1

Analysis and Interpretation of
Financial Statements
Ashutosh Kolte
PUMBA, University of Pune
Classification of Accounting
Accounting
Financial Accounting Cost Accounting Management Accounting
Types of Financial Statements

• Profit and Loss Account
• Balance Sheet
Fundamental Accounting Assumptions
• Going Concern
• Consistency
• Accrual
Accounting Concepts and Conventions
• Business Entity Concept
• Conservatism
• Materiality
• Historical Cost Concept
Accounting Policies
• Depreciation
• Valuation of Inventories
• Treatment of Goodwill
• Recognition of Profit on Long Term contracts.
• Treatment of Retirement Benefits.
Accounting Standards
• Issued by ICAI
• Mandatory
• Represents ideal practice of Accounting
• Consistency in presentation of Financial
Statements.
• Ensures comparability of Accounts.
• Disclosure of Accounting Policies.
International Accounting Standards
Importance
• Globalization of the economy – Indian
Companies going Global.
• Appreciation by the Foreign Investors for
Accounts following IAS norms.
Contents of Annual Reports
• Financial Statements
• Notes to Accounts
• Statement of Significant Accounting
Policies
• Auditor’s Report
• Directors Report
• EVA at a Glance
Financial Analysis & control
Important tools in the hands of
management
 Ratio Analysis
 Fund Flow Statement
 Cash Flow Statement
 Horizontal and Vertical analysis
 Trend Analysis
 Common size statements
 Duo – Pont Analysis
Trading, P&L A/C
Particulars Rs. Particulars Rs.
To O/P Stock XXX By Sales XXX
To Purchases XXX By C/L Stock XXX
To Gross Profit c/f XXX
XXX XXX
To Expenses / depreciation /
interest / administrative XXX
expenses, etc.. By Gross Profit b/d XXX
By income from
investment XXX
To Provision for tax XXX
To Net Profit c/f XXX

XXX XXX
P&L Appropriation A/C
Particulars Rs. Particulars Rs.
To Proposed Dividend XXX To Net Profit b/d XXX
To Transfer to General
Reserve XXX
To Net Profit transferred to
Balance sheet XXX

XXX XXX
Balance Sheet As On……..
Liabilities Assets
Equity Share
Capital
XXX Goodwill
XXX
Preference Share
Capital
XXX Fixed Assets
XXX
Reserves &
surplus
XXX Investments
XXX
Secured Loans
XXX Current Assets
XXX
Unsecured Loans
XXX Miscellaneous
Expenses (To
XXX
The Extent
Not Written Off)
Current Liabilities
& Provisions
XXX
Financial Ratio Analysis
 Liquidity ratios
 Profitability or Efficiency ratios.
 Ownership ratios
* Earnings ratios
* Dividend ratios
* Leverage ratios
-- Capital structure ratios
-- Coverage ratios
 Turnover Ratios
Liquidity ratios
 Current ratio
Current Assets
Current Liabilities
 Quick ratio (Acid-test ratio)
Quick Assets
Current Liabilities
* Quick assets =
Current Assets – Inventories – Prepaid Expenses
– Taxes paid in advance.
 Quick ratio (Acid-test ratio)
Quick Assets
Quick Liabilities
Quick Liabilities = CL – Bank OD and CC.
Cash Ratio / Super Quick Ratio =

Cash + Marketable Securities
Quick liabilities
Profitability or Efficiency ratios
Profitability ratios measure a firm’s overall
efficiency and effectiveness in generating profit.
Profit before interest and tax (PBIT)

Margin 
Net sales
Profit after tax (PAT)
Net margin 
Net sales
PBIT
Before tax return on investment 
Net assets
Profit after tax
Return on equity 
Equity (net worth)
 Gross Profit Margin Ratio (GPM)
Gross Profit
Net Sales
* Net Sales = Sales – Excise Duty
 Net Profit Margin Ratio (NPM)
Net Profit
Net Sales
Cost of Goods Sold Ratio =
Cost of Goods Sold / Net Sales
Operating Expenses Ratio =

(Administrative Exp +Selling Exp)
Net Sales
Operating Ratio =
Cost of Goods Sold + Operating Expenses
Net Sales
Particular Expenses Ratio =

Particular Expenses / Net Sales.
Ownership ratios
 Equity-related ratios measure the shareholders’
return and value.
Profit after tax
EPS 
Number of ordinary shares
Dividends
DPS 
DPS Dividends
Payout ratio  
EPS Pr ofit after tax
DPS
Dividend yield 
Market value per share
EPS
Earnings yield 
P / E ratio =
EPS
Net worth
Book value per share 
M B value 
Book value per share
Market value of assets
Tobin ' s q 
Economic value of assets
Solvency Ratios / Leverage ratios
Also called as Capital structure ratios
 Solvency ratios measure the dependence of a

firm on borrowed funds.
Debt
Debt-equity ratio 
Equity (Net Worth)
Debt Debt
Debt ratio  
Debt  Equity Capital employed
Earnings before interest and tax
Interest coverage 
Interest
Debt-assets ratio = Debt
Assets
*Coverage ratios
Interest coverage ratio
“gives the relationship between the

financial charges of a firm and its ability
to service them”.
. EBIT .
Interest expense
Debt service coverage ratio
PAT+ Depreciation+ other non-cash

charges + Interest on term loan
Interest on term loan + Repayment of
the term loan
Turnover ratios
Accounts receivable/ Debtors turnover ratio
= Net credit sales

Average accounts receivable
Average collection period
= 360
Av. accounts receivable turnover
= Av.accounts receivable
Av. daily sales
Asset turnover ratio =
Cost of Goods Sold
Av. Assets
Inventory turnover ratio =

Cost of goods sold
Av. Inventory
Debtors Turnover Ratio =

Total Credit Sales
Average Debtors + Average Bills Receivable
Income Statement
Sales XXX
Less Variable Cost XXX
Contribution XXX
Less Fixed Cost XXX
Operating Profit XXX
(Earning Before Interest & Tax)
Less Interest on debt XXX
Earning Before Tax XXX
Less Tax XXX
Profit After Tax XXX
Less Preference Dividend XXX
Profit Available to
equity Share holder XXX
THANK YOU

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Analysis and Interpretation of

Financial Accounting Cost Accounting Management Accounting

Types of Financial Statements

To Gross Profit c/f XXX

To Provision for tax XXX

To Net Profit c/f XXX

To Net Profit transferred to

Balance sheet XXX

 Quick ratio (Acid-test ratio)

Cash Ratio / Super Quick Ratio =

Profit before interest and tax (PBIT)

 Net Profit Margin Ratio (NPM)

Operating Expenses Ratio =

Particular Expenses Ratio =

Also called as Capital structure ratios

 Solvency ratios measure the dependence of a

Interest coverage ratio

“gives the relationship between the

PAT+ Depreciation+ other non-cash

= Net credit sales

Average collection period

Inventory turnover ratio =

Debtors Turnover Ratio =

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