Ratio Analysis: It is concerned with the calculation of

relationships, which after proper identification & interpretation

may provide information about the operations and state of
affairs of a business enterprise. The analysis is used to
provide indicators of past performance in terms of critical
success factors of a business. This assistance in decision-
making reduces reliance on guesswork and intuition and
establishes a basis for sound judgments.
Types of
Ratios
Liquidity Profitabilit Financial Operating Investment
Measurem y Leverage/ Performan Valuation
ent Indicators Gearing ce
Current Profit Equity Fixed Price/Earni
Ratio Margin Ratio Assets ngs Ratio
Analysis Turnover
Quick Return on Debt Ratio Sales/ Price/Earni
Ratio Assets Revenue ngs to
Growth
ratio
Return on Debt- Average Dividend
Equity Equity Collection Yield
Ratio Period
Return on Capitalizati Inventory Dividend
Capital on Ratio Turnover Payout
Employed Ratio
 Interest Total assets
Coverage Turnover
Ratio
Liquidity Measurement Ratios
Liquidity refers to the ability of a firm to meet its short-term
financial obligations when and as they fall due. The main
concern of liquidity ratio is to measure the ability of the firms to
meet their short-term maturing obligations. The greater the
coverage of liquid assets to short-term liabilities the better as it
is a clear signal that a company can pay its debts that are
coming due in the near future and still fund its ongoing
operations. On the other hand, a company with a low
coverage rate should raise a red flag for investors as it may be
a sign that the company will have difficulty meeting running its
operations, as well as meeting its obligations.
Ratio Formula Meaning Analysis
Current Current The number of Higher the
Ratio Assets/Curre times that the ratio, the
nt Liabilities short term better it is,
Current assets assets can however but
includes cash, cover the short too high ratio
marketable term debts. In reflects an in-
securities, other words, it efficient use of
accounts indicates an resources &
receivable and ability to meet too low ratio
inventories. the short term leads to
Current obligations as insolvency.
liabilities & when they The ideal ratio
includes fall due is considered
accounts to be 2:1.,
 payable, short
term notes
payable, short-
term loans,
current
maturities of
long term
debt, accrued
income taxes
and other
accrued
expenses
Quick Ratio (Cash+Cash Indicates the The ideal ratio
or Acid Test Equivalents+ ability to meet is 1:1. Another
Ratio Short Term short term beneficial use
Investments+ payments is to compare
Accounts using the most the quick ratio
Receivables) / liquid assets. with the
Current This ratio is current ratio.
Liabilities more If the current
conservative ratio is
than the significantly
current ratio higher, it is a
because it clear
excludes indication that
inventory and the company's
other current current assets
assets, which are dependent
are more on inventory.
difficult to
turn into cash
Profitability Indicators Ratios
Profitability is the ability of a business to earn profit over a
period of time.The profitability ratios show the combined
effects of liquidity, asset management (activity) and debt
management (gearing) on operating results. The overall
measure of success of a business is the profitability which
results from the effective use of its resources.
Ratio Formula Meaning Analysis

Gross Profit (Gross A company's Higher the

Margin Profit/Net cost of goods ratio, the
Sales)*100 sold represents higher is the
the expense profit earned
related to on sales
labor, raw
materials and
manufacturing
overhead
involved in its
production
process. This
expense is
deducted from
the company's
net
sales/revenue,
which results
in a company's
gross profit.
The gross
 profit margin
is used to
analyze how
efficiently a
company is
using its raw
materials,
labor and
manufacturing
-related fixed
assets to
generate
profits.
Operating (Operating By Lower the
Profit Margin Profit/Net subtracting sel ratio, lower
Sales)*100 ling, general the expense
and related to the
administrative sales
expenses from
a company's
gross profit
number, we
get operating
income.
Management
has much
more control
over operating
expenses than
its cost of
sales outlays.
 It Measures
the relative
impact of
operating
expenses
Net Profit (Net This ratio Higher the
Margin Profit/Net measures the ratio, the more
Sales)*100 ultimate profitable are
profitability the sales.
Return on Net Income / This ratio Higher the
Assets Average Total illustrates how return, the
Assets well more efficient
( Earnings management management is
Before Interest is employing in utilizing its
& Tax = Net the company's asset base
Income) total assets to
make a profit.
Return on Net Income / It measures Higher
Equity Average how much the percentage
Shareholders shareholders indicates the
Equity*100 earned for management is
their in utilizing its
investment in equity base
the company and the better
return is to
investors.

Return on Net Income / This ratio It is a more

Capital Capital complements comprehensive
Employed Employed the return on profitability
Capital equity ratio by indicator
Employed = adding a because it
Avg. Debt company's gauges
Liabilities + debt liabilities, management's
Avg. or funded ability to
Shareholders debt, to equity generate
Equity to reflect a earnings from
company's a company's
total "capital total pool of
employed". capital.
This measure
narrows the
focus to gain a
better
understanding
of a
company's
ability to
generate
returns from
its available
capital base.

Financial Leverage/Gearing Ratios

These ratios indicate the degree to which the activities of a
firm are supported by creditors’ funds as opposed to owners
as the relationship of owner’s equity to borrowed funds is an
important indicator of financial strength. The debt requires
fixed interest payments and repayment of the loan and legal
action can be taken if any amounts due are not paid at the
appointed time. A relatively high proportion of funds
contributed by the owners indicates a cushion (surplus) which
shields creditors against possible losses from default in
payment.
Financial leverage will be to the advantage of the ordinary
shareholders as long as the rate of earnings on capital
employed is greater than the rate payable on borrowed funds.

Ratio Formula Meaning Analysis

Equity Ratio (Ordinary This ratio A high equity

Shareholder’s measures the ratio reflects a
Interest / strength of the strong
Total financial financial
assets)*100 structure of structure of the
the company company. A
relatively low
equity ratio
reflects a more
speculative
situation
because of the
effect of high
leverage and
the greater
possibility of
financial
difficulty
arising from
excessive debt
 burden.
Debt Ratio Total Debt / This compares With higher
Total Assets a company's debt ratio (low
total debt to its equity ratio), a
total assets, very small
which is used cushion has
to gain a developed thus
general idea as not giving
to the amount creditors the
of leverage security they
being used by require. The
a company. company
This is the would
measure of therefore find
financial it relatively
strength that difficult to
reflects the raise
proportion of additional
capital which financial
has been support from
funded by external
debt, includingsources if it
preference wished to take
shares. that route. The
higher the debt
ratio the more
difficult it
becomes for
the firm to
raise debt.
Debt – EquityTotal . This ratio A lower ratio
Ratio Liabilities / measures how is always
Total Equity much safer, however
suppliers, too low ratio
lenders, reflects an in-
creditors and efficient use of
obligors have equity. Too
committed to high ratio
the company reflects either
versus what there is a debt
the to a great
shareholders extent or the
have equity base is
committed. too small
This ratio
indicates the
extent to
which debt is
covered by
shareholders’
funds.
Capitalizatio Long Term This ratio A low level of
n Ratio Debt / (Long measures the debt and a
Term Debt + debt healthy
Shareholder’s component of proportion of
Equity) a company's equity in a
capital company's
structure, or capital
capitalization structure is an
(i.e., the sum indication of
of long-term financial
debt liabilities fitness.
and A company
shareholders' too highly
equity) to leveraged (too
support a much debt)
company's may find its
operations and freedom of
growth. action
restricted by
its creditors
and/or have its
profitability
hurt by high
interest costs.
This ratio is
one of the
more
meaningful
debt ratios
because it
focuses on the
relationship of
debt liabilities
as a
component of
a company's
total capital
base, which is
the capital
raised by
shareholders
and lenders.
Interest EBIT / This ratio The lower the
Coverage Interest on measures the ratio, the more
Ratio Long Term number of the company is
Debt times a burdened by
company can debt expense.
meet its When a
interest company's
expense interest
coverage ratio
is only 1.5 or
lower, its
ability to meet
interest
expenses may
be
questionable.

Operating Performance Ratios:

These ratios look at how well a company turns its assets into
revenue as well as how efficiently a company converts its
sales into cash, i.e how efficiently & effectively a company is
using its resources to generate sales and increase
shareholder value. The better these ratios, the better it is for
shareholders.

Ratios Formula Meaning Analysis

Fixed Assets Sales / Net This ratio is a High fixed
Turnover Fixed Assets rough measure assets
of the turnovers are
productivity of preferred since
a they indicate a
company's fix better
ed assets with efficiency in
respect to fixed assets
generating utilization.
sales
Average ( Accounts The average The shorter the
Collection Receivable/A collection average
Period nnual Credit period collection
Sales )*365 measures the period, the
days quality of better the
debtors since quality of
it indicates the debtors, as a
speed of their short
collection. collection
period implies
the prompt
payment by
debtors. An
excessively
long collection
period implies
a very liberal
and inefficient
credit and
collection
 performance.
The delay in
collection of
cash impairs
the firm’s
liquidity. On
the other hand,
too low a
collection
period is not
necessarily
favorable,
rather it may
indicate a very
restrictive
credit and
collection
policy which
may curtail
sales and
hence
adversely
affect profit.
Inventory Sales / It measures High ratio
Turnover Average the stock in indicates that
Inventory relation to there is a little
turnover in chance of the
order to firm holding
determine how damaged or
often the stock obsolete stock.
turns over in
 the business.
It indicates the
efficiency of
the firm in
selling its
product.
Total Assets Sales / Total This ratio Higher the
Turnover Assets indicates the firm’s total
efficiency asset turnover,
with which the the more
firm uses all efficiently its
its assets to assets have
generate sales. been utilised.
Investment Valuation Ratios:
These ratios can be used by investors to estimate the
attractiveness of a potential or existing investment and get an
idea of its valuation.
Ratio Formula Meaning Analysis

Price Earning Market Price This ratio A stock with

Ratio ( P/E per Share / measures how high P/E ratio
Ratio ) Earnings Per many times a suggests that
Share stock is investors are
trading (its expecting
price) per each higher
rupee of EPS earnings
growth in the
future
compared to
 the overall
market, as
investors are
paying more
for today's
earnings in
anticipation of
future earnings
growth.
Hence, stocks
with this
characteristic
are considered
to be growth
stocks.
Conversely, a
stock with a
low P/E ratio
suggests that
investors have
more modest
expectations
for its future
growth
compared to
the market as a
whole.

Price ( P/E Ratio ) / The The general

Earnings to Earnings Per price/earnings consensus is
Growth Ratio Share to growth that if the PEG
ratio, ratio indicates
commonly a value of 1,
referred to as this means that
the PEG ratio, the market is
is obviously correctly
closely related valuing (the
to the P/E current P/E
ratio. The ratio) a stock
PEG ratio is a in accordance
refinement of with the
the P/E ratio stock's current
and factors in estimated
a stock's earnings per
estimated share growth.
earnings If the PEG
growth into its ratio is less
current than 1, this
valuation. By means that
comparing a EPS growth is
stock's P/E potentially
ratio with its able to surpass
projected, or the market's
estimated, ear current
nings per valuation. In
share (EPS) other words,
growth, the stock's
investors are price is being
given insight undervalued.
into the degree On the other
of overpricing hand, stocks
or under with high PEG
 pricing of a ratios can
stock's current indicate just
valuation, as the opposite -
indicated by that the stock
the traditional is currently
P/E ratio. overvalued.

Dividend ( Annual This ratio This enables

Yield Ratio Dividend per allows an investor to
Share / investors to compare ratios
Market Price compare the for different
per latest dividend companies and
Share ) *100 they received industries.
with the Higher the
current market ratio, the
value of the higher is the
share as an return to the
indictor of the investor
return they are
earning on
their shares
Dividend (Dividend per This ratio
Payout Ratio Share / identifies the
Earnings per percentage of
Share ) * 100 earnings (net
income) per
common share
allocated to
paying
cash dividends
to
shareholders.
The dividend
payout ratio is
an indicator of
how well
earnings
support the
dividend
payment.