Session Coverage

• Introduction
• Financial Ratios – Lender’s Perspective
• Numerical

 INTRODUCTION  RATIO ANALYSIS

• Ratio-analysis means the process of computing, determining and presenting the relationship of related items and groups of items of the financial statements.
• They provide a summarized and concise form of fairly good ideas about the financial position of a unit. They are important tools for financial analysis. 
• It has assumed important role as a tool for-

                -   appraising the real worth of an enterprise

                 -   its performance during a period of time .

• It is used to interpret the financial statements so that the strengths and weaknesses of a firm, its historical performance and current financial condition can be determined.

 INTRODUCTION RATIO ANALYSIS

It’s a tool which enables the banker or lender to arrive at the following factors : 

UTILITY OF RATIOS

Accounting ratios are very useful in assessing the financial position and profitability of an enterprise.

Comparison may be in any one of the following forms:

• For the same enterprise over a number of years
• For two enterprises in the same industry
• For one enterprise against the industry as a whole
• For one enterprise against a predetermined  standard
•  For inter-segment comparison within the same  organization.

 RATIO ANALYSIS 

Ratio  Analysis Lender’s  Perspective

• To ascertain the Long -Term solvency
• Short Term Liquidity position
• Long Term Debt Servicing Capacity
• Earning Assets in total balance sheet
• Whether long term assets are financed by long term sources & Short term assets are financed by short term sources and partly by long term sources
• Earning Capacity of the firm

 Liquidity Ratio

• Current Ratio
• Acid Test/Quick Ratio
• Cash Ratio

 Balance Sheet 

Liquidity Ratios

• Current Ratio :  It is the relationship between the current assets and current liabilities of a concern. 

Current Ratio = Current Assets/Current Liabilities

 If the Current Assets and Current Liabilities of a concern are Rs.150000 and Rs.1,00,000

respectively, then the Current Ratio will be :    Rs.1,50,000/Rs.1,00,000  = 1.5 : 1

The ideal Current Ratio preferred  by Banks is   1.33 : 1

• Net Working Capital  :  This is worked out as surplus of Long Term Sources over Long Term Uses, alternatively it is the difference of Current Assets and Current Liabilities. 

NWC  = Current Assets – Current Liabilities. 

This is a long term source of finance for current assets and should be at least 25% of current assets or it can also be known as margin from long term sources.

•  ACID TEST or QUICK RATIO : It is the ratio between Quick Current Assets and Current Liabilities. They should be at least equal to 1.

Quick Current Assets  :  Cash/Bank Balances + Receivables up to 6 months + Quickly realizable securities such as Govt. Securities or quickly marketable/quoted shares and Bank Fixed Deposits.

Acid Test or Quick Ratio  = Quick Current Assets/Current Liabilities

 Example :     

Cash                 10,000

Debtors                 60,000

Investment                       10,000

Inventories                 70,000      Current Liabilities    1,00,000

Total Current Assets   1,50,000

Cash Ratio = Cash+ Cash Equivalent / Current Liability

Current Ratio   = >

Quick Ratio       = >

Cash Ratio          =>

Cash Ratio = Cash+ Cash Equivalent / Current Liability

Current Ratio   = >             1,50,000/1,00,000       =  1.5: 1

Quick Ratio       = >               80,000/1,00,000       = .8 : 1

Cash Ratio          =>               20,000/ 1,00,000         = 20 %  

 Solvency Ratio

• Debt Equity Ratio
• Interest Coverage Ratio
• Debt Service Coverage Ratio

• DEBT EQUITY RATIO  :  It is the relationship between borrower’s  fund (Debt) and Owner’s Capital (Equity). 

Long Term Outside Liabilities / Tangible Net Worth

↓

Liabilities of Long  Term Nature ↓

Total of Capital and Reserves & Surplus Less Intangible Assets

             For instance, if the Firm is having the following :

Capital                                             = Rs. 200 Lacs        

Free Reserves & Surplus            = Rs. 300 Lacs

Long Term Loans/Liabilities   = Rs. 800 Lacs

             Debt Equity Ratio  will be    =>   800/500   i.e. 1.6 : 1

• DEBT SERVICE COVERAGE RATIO : This ratio is one of the most important one which indicates the ability of an enterprise to meet its liabilities by way of payment of installments of Term Loans and Interest thereon from out of the cash accruals and forms the basis for fixation of the repayment schedule in respect of the Term Loans raised for a project.  (The Ideal DSCR Ratio is considered to be 1.5 )

       PAT + Depr. + Annual Interest on Long Term Loans & Liabilities

        ---------------------------------------------------------------------------------

    Annual interest on Long Term Loans & Liabilities + Annual Installments payable on Long Term Loans & Liabilities

     ( Where PAT is Profit after Tax and Depr. is Depreciation)

• INTEREST SERVICE COVERAGE RATIO : This ratio is one of the most important one which indicates the ability of an enterprise to meet its interest liabilities.

 PBT + Depr. + Interest + non cash expenses

        ---------------------------------------------------------------------------------

interest

Operating Efficiency Ratio

• Inventory Turnover Ratio
• Average Holding Period
• Debtor Turnover Ratio
• Creditors Turnover Ratio
• Working Capital Turnover Ratio
  
  

Holding Ratios 

STOCK/INVENTORY TURNOVER RATIO :

      (Cost of Sales/Average Inventory)

         Average Inventory  or Stocks  = (Opening Stock + Closing Stock)

                                                                  ----------------------------------------- 

                                                                                    2

    This ratio indicates the number of times the inventory is rotated during the relevant accounting period. An increasing & higher ratio indicates better use of stocks.

DEBTORS TURNOVER RATIO :  

This is also called  Debtors Velocity . It indicates the efficiency of realization of book debts after sales. A higher & increasing ratio is preferable.

Sales/Debtors (including book debts & receivables ) x 365 for days (52 for weeks & 12 for months)

ASSET TURNOVER RATIO :  

Net Sales/Tangible Assets

Ratio indicates how the tangible assets have been used. A higher ratio is reflection of better utilization of assets that leads to reduction in cost & increase in profits.

FIXED ASSET TURNOVER RATIO :

Net Sales /Fixed Assets 

Determines as to how the fixed assets have been utilized. A higher or increasing ratio indicates better use of the assets and a lower ratio reflects that the use should be improved. 

CURRENT ASSET TURNOVER RATIO :  

Net Sales / Current Assets : Indicates the use pattern of assets. A higher or increasing ratio is indicative of better use of such assets.

CREDITORS TURNOVER RATIO : 

This is also called Creditors Velocity Ratio, which determines the creditor payment period.

             (Average Creditors/Purchases)x365 for days  (52 for weeks & 12 for months) 

Balance Sheet 

Profit & Loss 

Profitability Ratio

Sales Based Ratios

• Gross Profit Ratio
• EBITDA  Margin
• Net Profit Ratio

Assets Based Ratios

• ROCE
• ROE
• EPS

 Profitability Ratio

Sales Based Ratios 

Assets Based Ratios 

CHART OF INTERPRETATION OF VARIOUS RATIOS