Financial ratios - Non

Financial Sector

[Issued in May 2022]

Background
Financial ratios are used by CARE Ratings to make a holistic assessment of financial performance of the entity, and
also help in evaluating the entity’s performance vis-à-vis its peers within the industry. Financial ratios are not an
‘end’ by themselves but a ‘means’ to understanding the fundamentals of an entity. This document gives a general
list of the ratios used by CARE Ratings in its credit risk assessment for manufacturing and services sector entities.
These ratios are applied on the past financial statements of an entity as well as for the future projections. In
addition to the ratios mentioned in this document, various other sector-specific ratios are used, or certain
adjustments are made to financial ratios of entities belonging to certain sectors like real estate, construction,
infrastructure companies, etc., for evaluating entities in that sector. Sector-specific rating methodologies for these
sectors are available on CARE Ratings website (www.careedge.in).

The common ratios used by CARE Ratings can be categorised into the following five types:
• Growth ratios
• Profitability ratios
• Leverage and Coverage ratios
• Turnover ratios
• Liquidity ratios

These are given in detail below:

A. Growth ratios
Trends in the growth rates in income and profitability of an entity vis-à-vis the industry reflect the entity’s
ability to sustain its market share, profitability and operating efficiency. In this regard, focus is drawn to growth
in income, Profit Before Interest, Lease rentals, Depreciation and Taxation (PBILDT) and Profit After Taxation
(PAT). The growth ratios considered by CARE Ratings include the following (‘t’ refers to the current period
while ‘t-1’ refers to the immediately preceding period):
Ratio Formula

[(Net Salest × 12 / No. of Months)–(Net Salest-1 × 12 / No. of Months)]× 100

Growth in Net Sales
[Net Salest-1 × 12 / No. of Months]

[(TOI t × 12 / No. of Months)–(TOI t-1 × 12 / No. of Months)]× 100

Growth in Total
[TOIt-1 × 12 / No. of Months]
Operating Income
TOI = Total Operating Income
[(PBILDTt × 12 / No. of Months)–(PBILDTt-1 × 12 / No. of Months)]× 100
Growth in PBILDT
[PBILDTt-1 × 12 / No. of Months]
[(PAT t × 12 / No. of Months)–(PAT t-1 × 12 / No. of Months)]× 100
Growth in PAT
[PATt-1 × 12 / No. of Months]

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• Total Operating Income- In computing the Total Operating Income (TOI), CARE Ratings considers all
operating income of the entity. For arriving at the core sales figure, the indirect taxes incurred by the
entity (like Goods & Services Tax [GST], excise duty, sales tax, service tax, etc.) are netted off against
the gross sales. CARE Ratings also includes some other income related to the core operations like
income derived from job work done by the entity, any royalty/ technical knowhow/ commission received
in relation to the core operations, refund of indirect taxes, sale of scrap, cash discounts received, duty
drawback and other export incentives received by the entity and exchange rate gains (not related to
debt). Non-core income items do not form part of TOI.

• PBILDT- To arrive at the PBILDT, all operating expenses are deducted from TOI. Operating expenses
include raw material cost, stores & spares, power and fuel, employee costs, selling and distribution
expenses and administrative and general expenses, and include royalty/ technical knowhow/ commission
incurred, insurance cost, directors’ fees, exchange rate loss (not related to debt), bad debts, etc.

• PAT- PAT is arrived at by deducting (-) /adding (+) the following from PBILDT:

(-) interest and finance charges net of interest cost which has been capitalized- This includes all finance
charges incurred by the entity including interest on term loans, interest on working capital borrowings,
interest on unsecured loans from the promoters, interest on lease liability, premium on redemption of
bonds, exchange rate profit/loss on debt, etc.

(-) depreciation/amortization on assets including depreciation on right-to-use asset

(+/-) non-operating income/expense (including non-core income/expenses and profit/loss on sale of

assets and investments)

(+/-) prior period items

(-) tax expense

• Gross Cash Accruals (GCA)- GCA is computed by adding all non-cash expenditure (like depreciation
excluding depreciation on the right-to-use asset created pursuant to adoption of Ind AS116, provision for
deferred tax, write-offs, etc.) to PAT.

B. Profitability and Return Ratios

Capability of an entity to earn profits determines its position in the value chain. Profitability reflects the final
result of business operations. Important measures of profitability are PBILDT margin, PAT margin, ROCE and
RONW. Profitability ratios are not regarded in isolation but are seen in conjunction with the peers and the
industry segments in which the entity operates. The profitability ratios considered by CARE Ratings include:

Ratio Formula Significance in analysis

PBILDT × 100 A key indicator of operating efficiency in
Margin PBILDT any manufacturing/service activity
TOI without considering the financing mix
and the tax expenditure of the entity.
PAT × 100 Considers both business risk and the
Margin PAT financial risk. This is the margin available
TOI to service the equity shareholders.

ROCE [PBIT + Non-Operating Income +/- ROCE reflects the earnings capacity of
Extraordinary Income/Expenses] +/- × 100 the assets deployed, ignoring taxation

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 Financial ratios - Non Financial Sector

Ratio Formula Significance in analysis

Other Comprehensive Income × [12 / and financing mix. It is a powerful tool
No. of Months] for comparison of performance of
Avg. (TCEt , TCEt-1) companies within an industry.

TCE = Total Capital Employed =

Networth + Total debt (OR) Net fixed
assets + Net Working Capital
RONW PAT +/- Other Comprehensive Income × 100 RONW reflects the return to equity
× [12 / No. of Months] shareholders.
Avg. (Tangible Networtht , Tangible
Networtht-1)

• Tangible Networth of the entity includes the equity share capital, all reserves and surplus (excluding
revaluation reserve), unsecured loans from the promoters which are subordinated to the outside loans,
equity share warrants, share application money, ESOPs outstanding, minority interest (in case of
consolidated financials). Other considerations while calculating networth are highlighted below:
o Miscellaneous expenditure not written off and Accumulated Losses- Both Miscellaneous expenditure
not written off and Accumulated Losses are deducted from the above to arrive at the tangible
networth.

o Revaluation Reserves- Revaluation reserves arising out of revaluation of fixed assets are not treated
as a part of the tangible networth of the entity.

o Treatment of intangible assets- An intangible asset is an asset which is not physical in nature.
Examples of intangible assets include computer software, patents, copyrights, licenses, intellectual
property, trademark (including brands and publishing titles), customer lists, mortgage servicing
rights, import quotas, franchises, customer or supplier relationships, customer loyalty, market
share, marketing rights, goodwill, etc.

Generally, intangible assets are excluded from the tangible networth of the entity (e.g., software,
internally generated goodwill, goodwill on consolidation). However, in case the intangible asset is
critical to the core operations of the entity, CARE Ratings considers the same as a part of the
tangible networth of the entity. Examples include:

- Telecom license fees paid by the telecom operators to the Government of India
- Surface rights paid by the miners to undertake mining activity in India
- Media rights like movie rights, audio rights, video rights, broadcasting rights, television rights,
theatrical rights, satellite rights, music rights, digital rights, overseas rights, copyrights, etc.
- Intellectual Property Rights (IPRs) - Intellectual Property is a non-physical property created by
the intellect of the human mind. Examples of Intellectual Property include patents, copyrights,
trademarks, designs, etc. IPRs are generally seen in the IT and pharmaceutical sectors.

C. Leverage and Coverage Ratios

Financial leverage refers to the use of debt finance. While leverage ratios help in assessing the risk arising
from the use of debt capital, coverage ratios show the relationship between debt servicing commitments and
the cash flow sources available for meeting these obligations. CARE Ratings uses ratios like Debt-Equity Ratio,

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 Financial ratios - Non Financial Sector

Overall gearing ratio, Total Outside Liabilities to Networth, Interest Coverage, Debt as a proportion of cash
accruals, PBILDT and cash flow from operations and Debt Service Coverage Ratio to measure the degree of
leverage used vis-à-vis level of coverage available with the entity for debt servicing. Ratios considered by CARE
Ratings include:
Ratio Formula Significance in analysis
• Debt equity, Overall Gearing and Total
Total Long-term Debt (including current Outside Liabilities to networth ratios
Debt Equity
portion of debt) indicate the extent of financial leverage in
Ratio
Tangible Networth an entity and are a measure of financial
risk. Though higher leverage would
indicate higher returns to equity
shareholders, the degree of risk increases
Overall for debt holders in case of uncertainty or
Gearing volatility of earnings.
Total Debt (including • While calculating the debt equity ratio,
(Including
Acceptances/Creditors on LC) only the long-term debt (including the
Acceptances
Tangible Networth
/ Creditors current portion of the long-term debt) is
on LC) considered.
• Both debt equity and overall gearing ratios
are adjusted for the exposure to the group
companies and analysis is done in
conjunction with the performance of the
respective group companies.
Total
• CARE Ratings also considers the impact of
Outside the non-fund-based working capital limits
Total Outside Liabilities
Liabilities to (availed by the entity) on the leverage
Networth
Networth levels of the entity.
• Total Outside Liabilities include Total debt,
Other long-term liabilities and provisions,
net of deferred tax liability.
PBILDT It indicates extent of cover available to meet
Interest
Total Interest & Finance Charges – interest payments. It is a simple indicator of
Coverage
Amortization of Premium on Debentures profitability and cushion available to secured
(if any) – Interest Capitalized creditors.

Term Debt / Total Long-term Debt (including current

• Term debt/ GCA and total debt/ GCA
Gross Cash portion of debt)
indicate the number of years that would be
Accruals Gross Cash Accruals
required for repayment of the long-term
Total Debt / debt and the entire debt, respectively,
Gross Cash Total Debt (including considering current levels of GCA.
Accruals Acceptances/Creditors on LC) • Term debt/PBILDT and total debt/PBILDT
Gross Cash Accruals (GCA) indicate the number of years that would be
required to repay long-term and total debt
considering current levels of operating
profit.
Term Total long-term Debt (including current • Total debt/CFO indicates the number of
Debt/PBILDT portion of long-term debt) years that would be required to repay total
PBILDT debt considering current levels of CFO.
CFO is cash generated from operations
after adjusting for working capital
Total Debt (including
Total changes.
Acceptances/Creditors on LC)
Debt/PBILDT
PBILDT

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Ratio Formula Significance in analysis

Total Debt (including
Total Debt
Acceptances/Creditors on LC)
/CFO
Cash flow from operations (CFO)
DSCR indicates adequacy of cash accruals to
meet debt obligations. This ratio is seen in
GCA+ Interest and finance charges- conjunction with the cumulative DSCR (given
Internal accruals committed for capex or below) which incorporates prior period cash
Debt Service
investment accruals. Though DSCR is an important
Coverage
Gross Long-term loan repayable in the indicator of an entity’s repayment capacity,
ratio (DSCR)
year+ Standalone CP + Short-term debt CARE Ratings also takes into account financial
repayments + Interest and finance flexibility or refinancing ability of an entity
charges considering factors like group strength or
liquidity.
Cash DSCR is computed by deducting the
(GCA+ Interest and finance charges- margin money for the working capital (25% of
Internal accruals committed for capex or incremental working capital) from the funds
investment)- 25% increase in the working available for debt servicing on the assumption
capital that it will be met out of the GCA and hence
Cash DSCR
Gross Long-term loan repayable in the will not be available for debt servicing. The
year + Standalone CP + Short-term debt balance 75% of the incremental working
repayments + Interest and finance capital is assumed to be met through working
charges capital borrowings.

It indicates running position of average DSCR

Cumulative/
every year. Cumulative DSCR for the last year
Average
of projections would be equivalent to the
DSCR
average DSCR for the tenure of the instrument.

• Total debt- In total debt, CARE Ratings considers all forms of short-term and long-term debt, including
redeemable preference share capital, optionally convertible debentures, interest free loans, foreign
currency loans, vehicle loans, fixed deposits, unsecured loans, commercial paper, inter-corporate
borrowings, borrowings from promoters, associates, other group companies and bills discounted. Apart
from these, CARE Ratings also considers acceptances/ creditors on LC, lease liability and mobilization
advances (in case of Construction entities) as a part of the total debt of the entity. Any corporate
guarantee given to subsidiaries or other companies is also added to debt to calculate adjusted leverage
ratios.

However, if any part of the borrowings from the promoters/related parties are subordinated to the loans
from outsiders that are being rated, the same is treated as a part of networth. Nevertheless, the interest
expense on the subordinated debt is treated as a normal interest expenditure of the entity.

If the debt is fully backed by a dedicated/ lien-marked Fixed Deposits/ cash margin, CARE Ratings
excludes the same from the total debt.

• Treatment of Hybrid instruments- Hybrid instruments are instruments which have the characteristics
of both debt and equity. Examples include Redeemable Preference Shares, Compulsorily Convertible
instruments, Optionally Convertible instruments, including Foreign Currency Convertible Bonds (FCCBs),
Perpetual Debt, etc. These instruments normally carry a fixed rate of coupon/ dividend. At times, the

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 Financial ratios - Non Financial Sector

coupon/ dividend may be deferrable, thus giving the issuer the flexibility to conserve cash in times of
stress.
o Redeemable Preference Shares- Preference shares have a fixed tenure at the end of which
they have to be redeemed by the issuer. Furthermore, they also carry a fixed rate of dividend. As
per the Companies Act, companies cannot issue preference shares of more than 20 years maturity
(except for infrastructure companies). Hence, preference share capital typically has the
characteristics of debt and is treated as such by CARE Ratings in its analysis. However, if preference
shares are issued to the promoters of the company and are redeemable after repayment of the
outstanding term debt of the company, they assume the nature of long-term funding from the
promoters and hence CARE Ratings treats them as quasi equity.
o Compulsorily Convertible Instruments- Sometimes the instrument could be compulsorily
convertible into equity at the end of a long time frame, e.g., 5-7 years. Hence, the company does
not have to redeem the instrument at the end of the tenure and as such there is no credit risk. In
all, such cases where the terms of the preference shares/ debentures give it equity like
characteristics, CARE Ratings treats the Compulsorily Convertible instruments (including
Compulsorily Convertible Preference Share Capital (CCPS)/ Compulsorily Convertible Debentures
(CCDs)) as quasi equity and considers it as a part of the networth of the company. However, if the
terms of the compulsorily convertible instruments are such that the investors have an exit option
on the company, CARE Ratings treats these instruments as debt.
o Optionally Convertible Instruments- At times, companies also issue optionally convertible
instruments (typically Optionally Convertible Preference Shares (OCPS)/ Optionally Convertible
Debentures (OCDs)). Here, the investor has the option to convert the instrument into equity shares
at the end of a certain time frame at a pre-determined price. In this case, the alternative of
redemption of the instrument cannot be ruled out till it is actually converted into equity. The
instrument thus has debt like characteristics till the time it is actually converted into equity. Thus,
CARE Ratings generally treats the optionally convertible instruments as debt in its analysis.

D. Turnover Ratios
Turnover ratios, also referred to as activity ratios or asset management ratios, measure how efficiently the
assets are employed by the entity. These ratios are based on the relationship between the level of activity,
represented by sales or cost of goods sold, and level of various assets, including inventories and fixed assets.
The turnover ratios considered by CARE Ratings include:
Ratio Formula Significance in analysis
This indicates the turnaround time of
inventory. High average inventory period may
indicate high levels of obsolescence of
Avg. (INVt , INVt-1)× 30 × No. of
inventory, while low levels of inventory may
Months
be inadequate to meet emergencies.
Avg. Inventory Costs of Sales – Selling Expenses
The ratio is compared with normal inventory
Period
holding policy of the company and the
industry practice. CARE Ratings also looks at
INV = Total Inventory
the Average Raw Material Inventory Period,
Average WIP Inventory Period and the
Average Finished Goods Inventory Period.
This indicates quality of debtors. Very low
Avg. (RECt , RECt-1)× 30 × No. of figure can indicate strict trade terms resulting
Avg. Collection
Months in possible loss in sales. Very high average
Period
Gross Sales + Traded Goods Sales + collection period may indicate slow realization
Job Work Income + Scrap Sales of debtors and in turn may be an indicator of

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Ratio Formula Significance in analysis

stressed liquidity position. It is compared with
REC = Total Receivables the normal (‘stated’) credit period extended to
customers and the industry norms.

It is compared with normal credit period

Avg. (CREDt , CREDt-1)× 30 × No. of enjoyed by the entity and the industry norms.
Months Very high figure will indicate possible delays
Avg. Creditors
Cost of Sales – Misc. Expenses in payments to the creditors, which would
Period
Written Off ultimately reflect in high cost of raw material,
as the ‘interest’ on the ‘delayed’ payments
CRED = Total Creditors normally gets loaded to the raw material cost.

Avg. Inventory Period + Avg.

Working
Collection Period – Avg. Creditors The effect of all the above-mentioned ratios is
Capital Cycle
Period reflected in the working capital cycle.

In general, higher the ratio, higher the

[TOI – Other Income Not Related to
efficiency of asset/capital utilization. However,
Core Business] × [12 / No. of
Fixed assets very high figure can indicate old assets
Months]
turnover ratio requiring large outlay on modernization going
Avg. (Gross Blockt , Gross Blockt-1)
forward. Hence, the ratio has to be looked at
in conjunction with the industry average.
Gross Block: Net of Intangible Assets
such as Goodwill etc.
[TOI – Other Income Not Related to
Core Business] × [12 / No. of
Months]
In general, higher the ratio, higher is the
Avg. (NWCt , NWCt-1)
Working efficiency. Too high a figure can, however,
Capital indicate low levels of inventory, which may be
NWC = Net Working Capital
Turnover Ratio inadequate to meet emergencies.
= Total Current Assets – [Total
Current Liabilities related to
Operations – Creditors for
Capital Goods]

E. Liquidity Ratios
Liquidity ratios such as current ratio and quick ratio are broad indicators of liquidity level and are important
ratios for rating short-term instruments. Cash flow statements are also important for liquidity analysis. Liquidity
ratios considered by CARE Ratings include:
Ratio Formula Significance in analysis
Current Total Current Assets This indicates short-term liquidity
Ratio Total Short-term Debt (includes Current Portion position. CARE Ratings compares the
of Long-term Debt/Fixed Deposits and bills same with the industry trends and
discounted) + Total Current Liabilities and banking norms.
Provisions
Quick Total Current Assets – Total Inventories This indicates capacity to meet short-
Ratio Total Short-term Debt (includes Current Portion term obligations using near-liquid
of Long-term Debt/Fixed Deposits) + Total assets. CARE Ratings compares the
Current Liabilities and Provisions same with the industry trends and
banking norms.
[For previous version please refer methodology on “Financial Ratios – Non-Financial Sector” issued in March 2021]

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Disclaimer:
The ratings of CARE Ratings Ltd are opinions on the likelihood of timely payment of the obligations under the rated instrument and
are not recommendations to sanction, renew, disburse or recall the concerned bank facilities or to buy, sell or hold any security. The
ratings do not convey suitability or price for the investor. The ratings do not constitute an audit on the rated entity. CARE Ratings
has based its ratings/outlooks on information obtained from sources believed by it to be accurate and reliable. CARE Ratings does
not, however, guarantee the accuracy, adequacy or completeness of any information and is not responsible for any errors or
omissions or for the results obtained from the use of such information. Most entities whose bank facilities/instruments are rated by
CARE Ratings have paid a credit rating fee, based on the amount and type of bank facilities/instruments. CARE Ratings or its
subsidiaries/associates may also have other commercial transactions with the entity. In case of partnership/proprietary concerns,
the rating /outlook assigned by CARE Ratings is, inter-alia, based on the capital deployed by the partners/proprietor and the financial
strength of the firm at present. The rating/outlook may undergo change in case of withdrawal of capital or the unsecured loans
brought in by the partners/proprietor in addition to the financial performance and other relevant factors. CARE Ratings is not
responsible for any errors and states that it has no financial liability whatsoever to the users of rating. Our ratings do not factor in
any rating related trigger clauses as per the terms of the facility/instrument, which may involve acceleration of payments in case of
rating downgrades. However, if any such clauses are introduced and if triggered, the ratings may see volatility and sharp downgrades.

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