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Ratio Analysis

Profitability

  1. \[GP\ Ratio\ =\ \frac{Gross\ Profit}{Net\ Sales}\]
  2. Operating Profit Margin i.e. $\(OPM\ = \ \frac{EBIT}{Total\ Sales}\)$ $\(OPM\ = \ Total Sales\ - \ (All \ Direct\ Expenses \ + Factory\ Overheads\ + Office \ \& \ Administration Expenses + sales \ \& \ Distribution Expenses)\)$
    • Operating earnings is the same as Earnings Before Interests and Taxes
  3. \[Net\ Profit\ Ratio\ = \frac{PAT}{Total\ Income}\]
  4. ROI
    • Return on Total Assets or Return on Total Investments $\(ROI\ =\ \frac{PAT}{Total\ Assets}\)$
  5. Return on Capital Employed (ROCE) Capital Employed = Total Assets - Current Liabilities $\(ROCE\ = \ \frac{PAT}{Capital\ Employed}\)$
  6. Return on Net Worth (RONW) Net Worth = Total Share Capital + Reserves and Surplus$\(RONW\ = \ \frac{PAT}{Net\ Worth}\)$

  7. Return on Equity (ROE)$\(\frac{PAT}{Equity}\)$

  8. Higher the ration better is health (of the company)

  9. Decline in these rations is an adverse sign for company's health

Liquidity

  • Liquidity is about short term Solvency
  • It is the ability of a business firm to pay short term liabilities such as payments to suppliers, workers and repayment of short term loans

  • Current Ratio

    • This should be '\(2:1\)' $\(Current\ Ration\ =\ \frac{Total\ Current\ Assets}{Total\ Current\ Liabilities}\)$
    • Current Assets: Inventory + Receivables (Debtors) + Short term investments + Cash & bank balance
    • Current Liabilities : Creditors (Parables) + Short term Borrowings + Other short term payables

  • Quick Ratio

    • Should be at least '\(1:1\)' $\(Quick\ Ratio\ = \ \frac{Current\ Assets\ - \ Inventory - \ Prepaid}{Total\ Current\ Liabilities\ - \ Bank\ overdraft\ (if\ any)}\)$

Turnover Ratios

  • Higher the ratio, better is your efficiency for all the following cases
  • Inventory Turnover Ratio $\(Inventory\ Turnover\ Ratio\ = \ \frac{Total\ Sales}{Average\ Inventory}\)$
  • Debtors Turnover Ratio$\(Debtors\ Turnover\ Ratio\ = \ \frac{Total\ Sales}{Average Debtors}\)$
  • Total Assets Turnover Ratio $\(Total\ Assets\ Turnover\ Ratio\ = \ \frac{Total\ Sales}{Total\ Assets}\)$
  • Creditors turnover ratio $$Creditors turnover ratio = \frac{Total Purchases}{Average Creditors} $$

Stock Market Ratios

  • These ratios are only applicable for listed companies (The ones with shares being traded in stock exchanges)
  • P/E Ratio
    • Price-Earning Ratio
    • Price -> Market Price of share
    • Earnings -> Earnings per share is called EPS $\(P/E\ Ratio \ = \ Market\ Price\ / \ Earnings\ Ratio\ (EPS)\)$ $\(EPS \ = \frac{(PAT\ - \ Dividend\ on\ preference\ shares)}{Total\ Number\ of\ equity\ shares\ in\ the \ company}\)$
      • In short, EPS = PAT by No. of shares

Long Term Solvency Ratio

  • '\(Debt: Equity Ratio\)' : $\(\frac{Long\ Term\ Debt}{Equity\ Share\ Capital\ + \ Reserves\ \&\ Surplus + \ Preference\ Share \ Capital}\)$
  • The above ratio should not exceed 2:1!