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Ratio Formula Remarks

The document discusses 20 financial ratios used to analyze the financial health and performance of a business. It provides the formulas and brief explanations for ratios such as current ratio, quick ratio, debt-equity ratio, return on assets, debt-service coverage ratio, inventory turnover, and others. The ratios measure aspects like liquidity, leverage, profitability, efficiency, and cash flow.

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mgajen
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193 views

Ratio Formula Remarks

The document discusses 20 financial ratios used to analyze the financial health and performance of a business. It provides the formulas and brief explanations for ratios such as current ratio, quick ratio, debt-equity ratio, return on assets, debt-service coverage ratio, inventory turnover, and others. The ratios measure aspects like liquidity, leverage, profitability, efficiency, and cash flow.

Uploaded by

mgajen
Copyright
© © All Rights Reserved
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
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Ratio

Formula

Remarks

Higher the ratio greater the short term liquidity.


This ratio is indicative of short term financial
position of a business enterprise. It provides
margin as well as it is measure of the business
1

Current
Ratio

Current Assets
Current Liabilities

enterprise to pay-off the current liabilities as they


mature and its capacity to withstand sudden
reverses by the strength of its liquid position. Ratio
analysis gives indications; to be made with
reference to overall tendencies and parameters in
relation to the project.

Higher the ratio, the greater the company's liquidity


(i.e., the better able to meet current obligations
using liquid assets). Quick Ratio measures the
ability of a company to use its near cash or quick
Quick Assets
2

Quick Ratio
Current Liabilities

assets to extinguish or retire its current liabilities


immediately. Quick assets include those current
assets that presumably can be quickly converted to
cash at close to their book values. A company with
a quick ratio of less than 1 cannot currently fully
pay back its current liabilities.

There cannot be a rigid rule to a satisfactory debtequity ratio, lower the ratio higher is the degree of
protection enjoyed by the creditors. These days the
Debt (Term Liabilities)

debt equity ratio of 1.5:1 is considered reasonable.


It, however, is higher in respect of capital intensive

Debt-Equity
Ratio

Total Share Holders


Equity
(Where, Equity = Share capital,

projects. But it is always desirable that owners


have a substantial stake in the project.

Other

features like quality of management should be kept

free reserves, premium on

in view while agreeing to a less favorable ratio.

shares, , etc. after adjusting loss

In financing highly capital intensive projects like

balance)

infrastructure, cement, etc. the ratio could be


considered at a higher level.

The proprietary ratio shows the contribution of


stockholders in total capital of the company. A
high proprietary ratio, therefore, indicates a strong
Total Shareholders
4.

Proprietary

Equity

Ratio
Total Tangible Assets

financial position of the company and greater


security for creditors. A low ratio indicates that the
company is already heavily depending on debts for
its operations. A large portion of debts in the total
capital may reduce creditors interest, increase
interest expenses and also the risk of bankruptcy.

High fixed assets turnover ratio indicates better


utilization of fixed assets and a low ratio means

Fixed
5

Net Sales

Assets
Fixed Assets

Ratio

inefficient or under-utilization of fixed assets. The


usefulness of this ratio can be increased by
comparing it with the ratio of other companies,
industry standards and past years.

Return
6

Return on Assets tells what earnings were

on
Annual Net Income

Assets

the Return on Assets number, the better, because

Ratio

Average Total Assets

(ROA)

Return
7

the company is earning more money on less


investment.

on

Capital

Return on capital employed ratio measures the


Earnings Before Interest
and Tax

Employed
(ROCE)

generated from invested capital (assets). The higher

Capital Employed

efficiency with which the investment made by


shareholders and creditors is used in the business.
It is a ratio of overall profitability and a higher
ratio is, therefore, better.
A ratio used to determine how easily a company
can pay interest on outstanding debt. The lower the

Interest
8

Coverage
Ratio

Earnings Before Interest

ratio, the more the company is burdened by debt

and Tax

expense. When a company's interest coverage ratio

Interest Expenses

is 1.5 or lower, its ability to meet interest expenses


may be questionable. An interest coverage ratio
below 1 indicates the company is not generating
sufficient revenues to satisfy interest expenses.

Gross profit ratio is a profitability ratio that shows


the relationship between gross profit and total net
sales revenue. It is a popular tool to evaluate the
9

Gross Profit
Ratio

Gross Profit
Net Sales

operational performance of the business. Gross


profit is very important for any business. It should
be sufficient to cover all expenses and provide for
profit. There is no norm or standard to interpret
gross profit ratio. Generally, a higher ratio is
considered better.

Net profit ratio is a useful tool to measure the


overall profitability of the business. A high ratio
indicates the efficient management of the affairs of
10

Net

Profit

Ratio

Net Profit
Net Sales

business. There is no norm to interpret this ratio.


To see whether the business is constantly
improving its profitability or not, the analyst
should compare the ratio with the previous years
ratio, the industrys average and the budgeted net
profit ratio.

11

Operating
Profit Ratio

Operating Profit
Net Sales

This ratio gives the margin available after meeting


cost of manufacturing. It provides a yardstick to
measure the efficiency of production and margin
on sales price i.e. the pricing structure.

An activity ratio that evaluates the liquidity of the


inventories of a company. It measures how many
times the company has sold and replaced its
inventory during a certain period. A high ratio
Stock
12

Cost of Goods Sold

Turnover
Ratio

Average Inventory

indicates fast moving inventories and a low ratio,


on the other hand, indicates slow moving or
obsolete inventories in stock. A low ratio may also
be the result of maintaining excessive inventories
needlessly.

Maintaining

unnecessarily

indicates

excessive
poor

inventories
inventory

management because it involves tiding up funds


that could be used in other business operations.
Accounts receivable turnover ratio measures the
liquidity of accounts receivables. There is no rule
of thumb to interpret this ratio. Generally, a high
Debts
13

Net Credit Sales

Turnover
Ratio

Average Debtors

ratio indicates that the receivables are more liquid


and are being collected promptly. A low ratio is a
sign of less liquid receivables and may reduce the
true liquidity of the business in the eyes of the
analyst even if the current and quick ratios are
satisfactory.

14

Creditors

Net Credit Purchases

creditworthiness of the company. A high ratio

Turnover
Ratio

Accounts payable turnover ratio indicates the

Average Creditors

means prompt payment to suppliers for the goods


purchased on credit and a low ratio may be a sign
of delayed payment.
Accounts payable turnover ratio also depends on
the credit terms allowed by suppliers. Companies

who enjoy longer credit periods allowed by


creditors usually have low ratio as compared to
others.
A high ratio (prompt payment) is desirable but
company should always avail the credit facility
allowed by the suppliers.
Fixed
15

Obligation

Total Equated Monthly


Installments

Income
Ratio

Net monthly Income

The percentage of this ratio should be under the


amount of 50%. So that the balance income can be
manage to control the other expenses in a firm. In
credit appraisal projected years are more important
than past years.

The Installment to Income Ratio restricts the


Installment
16

to

Loan Installment

Income

Ratio

Net monthly Income

equated monthly installment to 40% of the income.


Its to evaluate the feasibility, so that the company
can pay the installment from the net monthly
income.
This ratio of 1.5 to 2 is considered reasonable. A

Debt + Depreciation +
Net Profit (After Taxes)
Debt17

Service

+ Annual interest on long


term debt

Coverage
Ratio

Annual interest on long


term debt + Repayment
of debt

very high ratio may indicate the need for lower


moratorium period/repayment of loan in a shorter
schedule. This ratio provides a measure of the
ability of an enterprise to service its debts i.e.
`interest'

and

`principal

repayment'

besides

indicating the margin of safety. The ratio may vary


from industry to industry but has to be viewed with
circumspection when it is less than 1.5.

Tangible Net Worth (Paid


up Capital + Reserves
and Surplus
18

TOL / TNW

Intangible Assets)

Ratio

This ratio gives a view of borrower's capital


structure. If the ratio shows a decreasing trend, it
indicates that the borrower is relying more on his

Total outside Liabilities

own funds and less on outside funds and vice versa

(Total Liability - Net


Worth)
This ratio is of a primary importance to see how
best the assets are used. A rising trend of the ratio
Sales19

Tangible

reveals that borrower has been making efficient


Sales

Assets
Ratio

utilization of his assets. However, caution needs to


be exercised when fixed assets are old and

Total Assets - Intangible


Assets

depreciated, as in such cases the ratio tends to be


high because the value of the denominator of the
ratio is very low.

Sales
Output
20

Investment
Ratio

This ratio is indicative of the efficiency with which


Total capital employed
(in fixed & current
assets)

the total capital is turned over as compared to other


units in similar lines.

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