Module 2: Ratio Analysis - Comprehensive Study Material

Balance Sheet Ratios

Current Ratio
- Formula: \frac{\text{Current Asset}}{\text{Current Liabilities}}
- Purpose: Measures a company's ability to pay off its short-term liabilities with its short-term assets. A higher ratio indicates better liquidity.
Quick Ratio (Liquid Ratio)
- Formula: \frac{\text{Quick Asset}}{\text{Quick Liabilities}}
- Purpose: A more stringent measure of liquidity than the current ratio, as it excludes inventory and prepaid expenses from current assets.
Stock Working Capital
- Formula: \frac{\text{Closing Stock}}{\text{Working Capital}} \times 100
- Purpose: Indicates the proportion of working capital tied up in closing stock.
Proprietary Ratio
- Formula: \frac{\text{Proprietary Fund}}{\text{Total Asset}}
- Definition of Proprietary Fund: \text{Equity Share Capital (ESC)} + \text{Reserves & Surplus (R&S)} + \text{Preference Share Capital (PSC)} - \text{Preference Share Dividend}
- Purpose: Shows the proportion of total assets financed by shareholders' funds, indicating financial strength and long-term solvency.
Debt-Equity Ratio
- Formula: \frac{\text{Loan Fund}}{\text{Proprietary Fund}} or \frac{\text{Borrowed Fund}}{\text{Net Worth}}
- Purpose: Measures the relative proportion of shareholders' equity and debt used to finance a company's assets. A higher ratio indicates higher financial risk.
Capital Gearing Ratio
- Formula: \frac{\text{Loan Fund} + \text{Preference Share Capital (PSC)}}{\text{Equity Share Capital (ESC)} + \text{Reserves & Surplus (R&S)}}
- Alternative Interpretation: Can also refer to the ratio of fixed-interest/dividend bearing capital to equity shareholders' funds.
- Purpose: Indicates the proportion of fixed-cost capital (debt and preference shares) to equity capital, showing the company's financial structure and leverage.

Components of Assets and Liabilities

Current Assets
- Quick Assets:
  - Debtors
  - Loose Tools
  - Outstanding Income (O/S Income)
  - Bills Receivable (B/R)
  - Cash & Cash Equivalents
  - Marketable Investments
- Non-Quick Assets:
  - Stock (Inventory)
  - Prepaid Expenses
  - Advance Tax, etc.
Current Liabilities
- Quick Liabilities:
  - Sundry Creditors
  - Bills Payable (B/P)
  - Outstanding Expenses (O/S Expenses)
  - Unpaid Dividend
  - Provision for Taxation, etc.
- Non-Quick Liabilities:
  - Bank Overdraft
  - Outstanding Interest (O/S Interest)

Revenue Statement Ratios

Gross Profit Ratio
- Formula: \frac{\text{Gross Profit}}{\text{Sales}} \times 100
- Purpose: Measures the percentage of sales revenue that is left after subtracting the cost of goods sold. Indicates pricing strategy and production efficiency.
Operating Ratio
- Formula: \frac{\text{Cost of Goods Sold (COGS)} + \text{Operating Expenses}}{\text{Sales}} \times 100
- Purpose: Shows the operational efficiency of the business by relating operating costs to sales.
Expense Ratio
- Formula: \frac{\text{Administrative Expenses} + \text{Selling & Distribution Expenses} + \text{Financial Expenses}}{\text{Sales}}
- Purpose: Measures the proportion of sales consumed by various categories of expenses.
Operating Profit Ratio
- Formula: \frac{\text{Operating Profit}}{\text{Sales}} \times 100
- Purpose: Indicates the profitability of a company's core operations before interest and taxes.
Net Profit Ratio
- Formula: \frac{\text{Net Profit Before Tax}}{\text{Sales}} \times 100
- Purpose: Measures the percentage of sales revenue that translates into net profit before tax.
Stock Turnover Ratio
- Formula: \frac{\text{Cost of Goods Sold (COGS)}}{\frac{\text{Opening Stock} + \text{Closing Stock}}{2}}
- Note: If opening stock is not given, the formula simplifies to \frac{\text{COGS}}{\text{Closing Stock}}.
- Purpose: Measures how many times inventory is sold and replaced over a period. A higher ratio generally indicates efficient inventory management.

Composite Ratios

Return on Investment (ROI)
- Formula: \frac{\text{Profit Before Interest & Tax}}{\text{Capital Employed}} \times 100
- Definition of Capital Employed:
  - Net Worth + Loan Fund
  - OR Real Asset - Real Liabilities
  - OR Fixed Assets (FA) + Current Assets (CA) - Current Liabilities (CL)
- Purpose: Measures the profitability of a company in relation to the capital invested.
Return on Proprietary Fund
- Formula: \frac{\text{Profit After Tax}}{\text{Proprietary Fund}} \times 100
- Purpose: Measures the return generated for the owners (proprietors) of the business.
Return on Equity
- Formula: \frac{\text{Profit Available to Equity}}{\text{Equity Fund}} \times 100
- Purpose: Measures the rate of return on the ownership interest (shareholders' equity) of the common stock owners.

Profit Availability and Payout Ratios

Profit Available to Equity Shareholder
- Calculation Steps:
  1. Profit Before Interest & Tax (PBIT)
  2. Less: Interest
  3. Equals: Profit Before Tax (PBT)
  4. Less: Tax
  5. Equals: Profit After Tax (PAT)
  6. Less: Preference Share Dividend
  7. Equals: Profit Available to Equity Shareholder
- Purpose: This is the amount of profit that can be distributed to equity shareholders or retained in the business.
Dividend Payout Ratio
- Formula: \frac{\text{Equity Dividend}}{\text{Profit Available to Equity Shareholder}} \times 100
- Purpose: Indicates the percentage of net income distributed to shareholders in the form of dividends.

Debt Ratios

Debt Service Ratio
- Formula: \frac{\text{Profit Before Interest & Tax}}{\text{Interest}}
- Purpose: Measures a company's ability to cover its interest payments.
Debt Service Coverage Ratio
- Formula: \frac{\text{Cash Profit}}{\text{Interest} + \text{Installment}}
- Definition of Cash Profit: \text{Profit After Tax (PAT)} + \text{Non-Cash Expenses} + \text{Interest on Loans}
- Purpose: Measures a company's ability to pay its current debt obligations.

Activity Ratios

Debtor Turnover Ratio
- Formula: \frac{\text{Credit Sales}}{\text{Debtors} + \text{Bills Receivable}}
- Purpose: Measures how efficiently a company collects its receivables.
Debtor Velocity
- Formula: \frac{12 \text{ (months) or } 365 \text{ (days) or } 52 \text{ (weeks)}}{\text{Debtor Turnover Ratio}}
- Purpose: Indicates the average number of days (or months/weeks) it takes for a company to collect its receivables.
Creditor Turnover Ratio
- Formula: \frac{\text{Credit Purchase}}{\text{Creditors} + \text{Bills Payable}}
- Purpose: Measures how quickly a company pays off its suppliers.
Creditor Velocity
- Formula: \frac{12 \text{ (months) or } 365 \text{ (days) or } 52 \text{ (weeks)}}{\text{Creditor Turnover Ratio}}
- Purpose: Indicates the average number of days (or months/weeks) it takes for a company to pay its creditors.

Illustrative Examples and Calculations

Sales Calculation
- Total Sales: 77,76,000
- Less: Cash Sales: (5,76,000)
- Equals: Credit Sales: 72,00,000
Gross Profit (GP) Calculation
- GP = 25% of Total Sales
- GP = 77,76,000 x 25% = 19,44,000
Opening Stock
- Opening Stock = 4,32,000
Liquid Ratio Example
- Formula: \frac{\text{Liquid Asset}}{\text{Liquid Liabilities}}
- Components:
  - Liquid Asset = Sundry Debtors + Bank
  - Liquid Liabilities = Current Liabilities + Provision
- Example Calculation:
  - Liquid Asset = 8,00,000 + 7,90,000 = 15,90,000
  - Liquid Liabilities = 5,40,000 + 8,10,000 = 13,50,000
  - Liquid Ratio = \frac{15,90,000}{13,50,000} = 1.177
Proprietary Ratio Example
- Formula: \frac{\text{Proprietary Fund}}{\text{Total Asset}} \times 100
- Components:
  - Proprietary Fund = ESC + PSC + R&S
  - Total Asset = Fixed Assets (FA) + Current Assets (CA)
- Example Calculation:
  - Proprietary Fund = 12 + 5.4L + 8 + 1.2L + 2.9 = 29.5 (assuming values are in Lakhs or similar units)
  - Total Asset = 172 (assuming value is in Lakhs or similar units)
  - Proprietary Ratio = \frac{29.5}{172} \times 100 = 17.15\% (approx. 34.52% in original, likely different interpretation of values)
Gross Profit Ratio Example
- Formula: \frac{\text{GP}}{\text{Sales}} \times 100
- COGS Calculation:
  - Opening Stock: 4L
  - Purchase: 9.8L
  - Wage: 2.9L
  - Selling Exp: 1.9L
  - Total (before closing stock): 18.6L
  - Less: Closing Stock: 6L
  - COGS = 12.6L
- Example Calculation:
  - GP = 12,40,000
  - Sales = 25,00,000
  - Gross Profit Ratio = \frac{12,40,000}{25,00,000} \times 100 = 49.6\%
Stock Turnover Ratio Example
- Formula: \frac{\text{COGS}}{\frac{\text{Opening Stock} + \text{Closing Stock}}{2}}
- Example Calculation:
  - COGS = 12,60,000
  - Average Stock = \frac{4,00,000 + 6,00,000}{2} = 5,00,000
  - Stock Turnover Ratio = \frac{12,60,000}{5,00,000} = 2.52 times
Administrative Expense Ratio Example
- Formula: \frac{\text{General & Administrative Expenses (GAE)} + \text{Outstanding (OS)}}{\text{Sales}}
- Example Calculation:
  - GAE + OS = 1.3L + 1.2L = 2.5L
  - Sales = 25,00,000
  - Administrative Expense Ratio = \frac{2,50,000}{25,00,000} = 0.1\% (Note: Calculation in source shows 250000/2500000 = 0.1, but then 0.1% which is 0.001. Assuming 0.1 is the ratio, not percentage)
Net Profit Before Tax (NPBT) Ratio Example
- Formula: \frac{\text{NPBT}}{\text{Sales}} \times 100
- Example Calculation:
  - NPBT = 6,38,500
  - Sales = 25,00,000
  - NPBT Ratio = \frac{6,38,500}{25,00,000} \times 100 = 25.54\%
- Detailed Profit Breakdown:
  - Earnings Before Interest & Tax (EBIT)
  - Less: Interest
  - Equals: Earnings Before Tax (EBT) = 6,38,500
  - Less: Tax = 1,40,500
  - Equals: Profit After Tax (PAT) = 4,98,000
  - Less: Reserve = 2,00,000
  - Equals: Marketable Profit (MP) = 2,98,000

Module 2: Comprehensive Ratio Analysis

Module 2: Comprehensive Ratio Analysis