Ratio Analysis

Current Ratio: Current Ratio also known as ‘Working Capital Ratio’, ‘Solvency Ratio’ or ‘2 to
1 Ratio’. Current Ratio indicates the relationship between current assets and current
liabilities. Current assets are the assets held on a short-term basis, i.e., an accounting
period. Current liabilities are obligations payable within the year. Current Ratio is
calculated by dividing current assets by current liabilities.
Current Liabilities are generally to be paid out of Current Assets. Ideally, the Currents
Assets should be more than Current Liabilities. If Current Ratio is more than 1, the currents
are said to be enough to pay current obligations. The analysts consider a ratio of 2 as ideal.
This ratio determines:

1. The availability of current assets to meet the current obligations, and thereby the
company’s ability to meet its current liabilities.
2. The credit strength of the company.
3. The adequacy of working capital: The working capital indicates the excess of current
assets over current liabilities. Adequate working connotes credit standing of a company.
Quick Ratio: It is also known as ‘Liquid Ratio’, ‘Acid Teat Ratio’ or ‘Near Money Ratio’. The
ratio indicates the relationship between liquid assets with liquid liabilities. Liquid assets
are those current assets which can be converted into cash easily. Quick liabilities indicate
all current liabilities excluding bank overdraft . Both the terms are explained in details in
the first chapter.
Quick Ratio is calculated by dividing quick assets by quick liabilities.
Quick Assets =Current Assets –Inventories
Ideally, the quick assets should be equal to or more than quick liabilities. If Quick Ratio is
more than 1, the quick assets are said to be enough to pay quick liabilities. The analysts
consider a ratio of 1 as satisfactory, but unless the majority of ‘quick assets’ are in accounts
receivable, and the pattern of accounts receivable collection lags behind the schedule for
paying current liabilities.
This ratio determines:
1. The liquidity position
2. The short-term financial position
3. The ability to meet commitments without delay
Debt–Equity Ratio: It indicates the relationship between two types of fund. It is calculated
by dividing debt with equity.
where
Debt indicates long-term borrowings and
Equity indicates shareholders’ fund.
This ratio indicates the proportion of debt fund in relation to owners’ fund.
It also indicates:
1. Capital structure of the company
2. Long-term financial and solvency position
Gross Profit Ratio: It is also called as ‘Turnover Ratio’. This ratio relates gross profit to
sales. It is calculated by dividing gross profit by sales.
It indicates:
1. Margin of profit on sales.
2. Company’s ability to control the cost of sales.
3. Operating profitability.
Net Profit Ratio:

It indicates profitability of the company.
Net profit ratio indicates:
1. Efficiency and profitability of the company.
2. High Net Profit Ratio indicates adequate returns to the owners.
Stock Turnover Ratio: It establishes a relation between cost of sales and average inventory.
It indicates the number of times stock is replaced during the year. It indicates velocity of
the movement of goods.
It indicates:
1. The rotation of stock
2. Inventory management.
3. Profitability of the company
Return on Capital Employed: It is a type of Return on Investment (ROI). It indicates the

available profit on total funds invested. It determines the profit earned on total funds.
Some do not include non-trade investment in capital employed.
It indicates:
1. Rate of return on total fund.
2. Profitability of the company.
3. Efficiency of the management.
4. Efficient utilisation of funds.
Earning per share (EPS): It measures the profit available per equity share. It indicates the
profitability of the company.
Price Earning Ratio (P/E Ratio): It indicates the relation between market price of a share
with its available earnings.
It indicates the amount investors are willing to pay for each rupee of earnings. The higher
ratio indicates higher profitability, and thereby investors’ confidence.
Debtors’ Turnover Ratio: It gives the relationship between sales and amount receivables. It
indicates the speed with which receivables are converted into cash.
It is calculated as under :
It indicates:
1. The speed with which amount receivables are being collected.
2. Credit management of the company.
3. Period of credit to customers.
4. Liquidity of the debtors.
The answer derived by this formula is in times.
Creditors’ Turnover Ratio: It is the ratio between credit purchases and the average amount
payable. It indicates the payment policy and management of credit purchases.
It indicates:
1. The speed with which payments are made.
2. Credit management of the company.
3. Period of credit from suppliers
4. Liquidity of the debtors.
High ratio in terms of times indicates rapid collection policy.

Ratio Analysis

Uploaded by

Copyright:

Available Formats

Ratio Analysis

Uploaded by

Document Information

Original Description:

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Ratio Analysis

Uploaded by

Copyright:

Available Formats

Current Ratio: Current Ratio also known as ‘Working Capital Ratio’, ‘Solvency Ratio’ or ‘2 to

This ratio determines:

Net Profit Ratio:

Return on Capital Employed: It is a type of Return on Investment (ROI). It indicates the

You might also like