Module 3

RATIO ANALYSIS
Ratio simply refers to one number expressed in terms of another number. It shows numerical relationship between
two figures. It is found by dividing one number by the other number.
Meaning of Accounting Ratio
Accounting ratios are ratios calculated from the financial statements.
"The term accounting ratio is used to describe the significant relationship which exists between figures shown in
a Balance Sheet, P/L A/C, in a budgetary control system or in any other part of the accounting organisation”.
Expression of Ratio
1. Proportion
2. Percentage
3. Times
4. Fraction
Meaning of Ratio Analysis
An analysis o financial statements with the help of ratios is termed as ratio analysis. It is a systematic use of
accounting ratios to interpret the financial statements for studying the financial position and performance of an
enterprise.
Objectives or Purposes of Ratio Analysis
1. To study the short term solvency of a firm
2.To study the long term solvency of a firm
3. To determine the profitability of a firm.
4.To measure the performance of a firm .
5. To facilitate the process of financial forecasting
6.To communicate the strength and weakness of a firm.
7.To facilitate comparison.
8. To enable managerial decision making.
Uses or Ratio Analysis (Advantages or Importance)
1. Utility to management: Ratio analysis helps the management in
(a) formulating the policies,
(b) forecasting and planning,
(c) decision making,
(d) knowing the trends of business,
(e) measuring efficiency,
(f) inter-firm and intra-firm comparison.
2.Utility to shareholders and investors
Accounting ratios help the prospective investors in selecting best companies to invest their funds
3. Utility to creditors: To know the liquidity position or short term financial position, they use liquidity ratios.
4. Utility to employees: The employees are interested in the profitability of the company for demanding wage
increase and other benefits.
5. Utility to government: The government uses ratio analysis for studying the cost structure of the industries to
formulate various policies.
Limitations of Accounting Ratios
1. Inherent limitations of accounting: Ratios also suffer from inherent limitations of accounting records.
2. Non-monetary factors ignored: It ignores the non-monetary factors( morale and loyalty of employees, human
relations etc.)
3. Qualitative factors ignored: It ignores qualitative factors.
4. Not a substitute for judgment: Ratios do not make conclusions. It is only a technique for making judgment
5. Need for comparative analysis: A single ratio will not be much helpful. So it is necessary to make a comparative
analysis of all relating ratios.
6. Lack of adequate standards: There are no well accepted standards for all ratios .This makes the interpretation
difficult.
7. Window dressing: Financial statements can easily be window-dressed. This is done by manipulating accounts
with a view to present a better picture of its financial and profitability position than what actually it is. Ratios
calculated from such statements are not reliable.
8. Price level changes: Changes in price level may affect the comparability of ratios.
Classification or Types of Ratios
(A) Classification according to Accounting Statement (Structural Classification):
(1) Balance Sheet or Financial Ratios are calculated by using the figures appearing in the balance sheet
(2) Profit and Loss Account Ratios are calculated by using the figures appearing in the profit and loss account.
(3) Combined or Mixed Ratios are calculated by using one item from the profit and loss account and the other
from the balance sheet.
(B) Classification according to Nature or Functions
(1) Liquidity Ratios: These ratios measure the short term solvency (or liquidity) of a firm. It is the ability to meet
short term liability.
Current ratio, quick ratio etc. are examples.
(2) Leverage Ratios: These ratios analyse the long term solvency or financial position of a firm. example :- Debt-
equity ratio, capital gearing ratio, etc. These are also called capital structure ratios or solvency ratios.
(3) Activity Ratios: These ratios indicate how effectively the resources or assets are being utilised by a firm. Stock
turnover ratio, fixed assets turnover ratio, debtors turnover ratio etc. are the important activity ratios. These ratios
are called turnover ratios or efficiency ratios.
(4) Profitability Ratios: These ratios measure the capacity of a firm to earn profits and to ensure returns to owners.
Gross profit ratio, operating ratio, return on investment etc. are examples.
(5) Market Test Ratios: These ratios are used for evaluating the shares and stock which are traded in the market.
Important market test ratios are earnings per share, dividend per share, dividend payout ratio, price earning ratio
etc.
LIQUIDITY RATIOS (SHORT TERM SOLVENCY RATIOS )
These ratios are used to assess the short term debt paying ability of a firm. These include current ratio, quick ratio,
super quick ratio etc.

Current Ratio
Current ratio is defined as the ratio of current assets to current liabilities. It shows the relationship between total
current assets and total current liabilities.
It is calculated as follows:

Current Ratio =Current Assets

Current Liability
Current assets

1. Cash in hand
2. Cash at bank
3. Marketable or short term securities
4. Short term investment
5.Bills Receivable
6.Sundry debtors
7.Stock or inventories
8.Work in progress
9. Prepaid expenses

current liabilities

1.Sundry creditors
2. Bills payable
3. Outstanding expenses
4.Short term advances
5. Provision for tax
6.Dividend payable
7.Bank overdraft
Standard Current Ratio: A current ratio of 2:1 is considered satisfactory or ideal.
Interpretation of Current Ratio: A very high current ratio indicates that too much of money is blocked in current
assets. That means too much cash is idle.
Limitations of Current Ratio
1. Current ratio measures only the quantity of current assets but not their quality.
2. All current assets are treated alike.
3. Another defect of current ratio is the window dressing and manipulation.
Window Dressing
Window Dressing is the practice of improving the current ratio through manipulation of accounts.
Liquid Ratio or Quick Ratio
Liquid ratio is the ratio of liquid assets (or quick assets) to current liabilities. It establishes the relationship between
quick assets and comment liabilities. It is the measure of the instant debt paying Ability of the business enterprise.
It is also called acid test ratio near money ratio .
Liquid Ratio=Liquid Assets
Current Liabilities

Quick assets(liquid assets) = current assets-stock and prepaid expenses

Objective of Quick Ratio: It helps to measure the ability of the firm to meet its short term liabilities as and when
due without depending upon the sale of stock.

Standard Quick Ratio: Ideal ratio is 1:1

If the ratio is less than 1:1 indicates that the firm will not be able to pay off its current liabilities when they become
due.
Interpretation of Quick Ratio:Quick ratio used in combination with current ratio can be a good test of liquidity.
If the current ratio is 2:1 and quick ratio is 1:1, the liquidity position may be considered satisfactory.
LEVERAGE RATIOS (or SOLVENCY RATIOS)
The term solvency refers to the ability of a firm to pay its outside liabilities (i.e., both long term and short term).
Solvency may be short term solvency or long term solvency. Short term solvency refers to the ability of a firm to
meet short term obligation in time. The term long term solvency refers to the ability of a firm to repay the long
term liabilities such as debentures, long term loans etc.

These ratios are used to analyse the capital structure of a firm.

Types of solvency or leverage ratios.
a) Structural ratios :- These ratios are calculated from the balance sheet items.
b) Coverage ratios:- These ratios are computed from the Profit and Loss A/c
Structural Ratios
Structural ratios indicate the long term solvency of the firm. These ratios measure the extent of debt financing in
a firm. It is also known as capital structure ratios.
Important structural ratios are debt-equity ratio, proprietary ratio etc.
Debt Equity Ratio
Debt to equity ratio indicates the relative proportion of debt and equity in financing the assets of a firm. It expresses
the relationship between debt (external equity) and equity (internal equity). It is also known as External - Internal
Equity Ratio.
Two forms of debt equity ratio
a)Long Term Debt Equity Ratio
b)Total Debt Equity Ratio
Long Term Debt Equity Ratio: This expresses the relationship between long term debt and equity.
Long Term Debt Equity Ratio = Long term debt
Equity

Long term debt refers to the funds invested by the outsiders (i.e., outsiders' funds). It includes debentures,
mortgages and all long term loans.
equity means funds invested by the shareholders. It includes equity share capital, preference share capital, reserves
and surpluses. Total Debt Equity Ratio: This ratio expresses the relationship between total debt and equity.
Total Debt Equity Ratio =Total debt
equity

Total debt includes long term debt plus current liabilities.

Proprietary Ratio
Proprietary ratio establishes the relationship between shareholders' or proprietors' fund avid total asset. This ratio
shows how much funds have been contributed by the shareholders in the total assets of the firm. It is also known
as equity ratio or net-worth ratio.
Proprietary Ratio = Shareholders' Fund
Total Asset

It can be expressed as a percentage.

Shareholders' fund includes share capital (equity and preference), all reserves and surpluses and undistributed
profits (accumulated losses are deducted).
Total assets include all current assets and fixed assets, Realisable value of intangible assets (e.g., goodwill etc.)
also is included. Fictitious assets such as preliminary expenses discount on shares and debentures, underwriting
commission etc. are excluded (or deducted from reserves).
Standard Proprietary Ratio: Generally a ratio of 0.5:1 or above (or 50% or more) is considered ideal.
Interpretation of Proprietary Ratio : A higher ratio indicates that the firm is less dependent on creditors for its
working capital. Therefore, a higher proprietary ratio indicates a sound financial position.
Ratio of Total Asset to Total Debt (Solvency Ratio)

This ratio expresses the relationship between total assets and total liabilities of a business . It is called solvency
ratio.

Solvency Ratio=Total Assets

Total Debt

Total Assets include total fixed assets and total current assets.
Total debt means total outside liabilities. It includes total long term debt (Debentures + Long term loans +
Mortgage) and total current liabilities.
Standard Solvency Ratio: Generally, higher the solvency ratio, the stronger is its financial position and vice
versa..
Interpretation of Solvency Ratio: A higher solvency ratio indicates that the solvency and the financial position
are strong. A lower solvency ratio indicates that the solvency and the financial position are weak.
Fixed Assets to Networth or Fixed Assets to Proprietors Fund Ratio
This ratio establishes the relationship between fixed assets and proprietors fund.
Fixed Assets to Networth = Fixed Assets
Proprietors' fund

Standard Ratio : 0.60 to 0.65 (60 to 65%) is

considered to be satisfactor
Interpretation : If the ratio is less than 1 (or 100%), it will mean that all fixed assets are purchased out of proprietors
fund and a part of proprietors fund is invested in working capital. If the ratio is more than 1, it will mean that
outsiders funds have been used to acquire a part of fixed assets.

Fixed asset ratio

All fixed assets must be financed out of long term funds. Short term funds (current liabilities) shall be used only
for working capital requirement. If short term funds are used in the purchase of fixed assets , it will affect the
liquidity position.

Fixed asset ratio is the ratio of fixed assets to long term funds or capital employed. It is computed as follows:

Fixed assets ratio = Fixed Assets (after depreciation)

Long Term Funds

The ratio can also be expressed as a percentage by multiplying the above formula by100
Here, Fixed assets mean fixed assets after depreciation and long term investments . Long term funds include
shareholder's fund and long term borrowed funds (long term loans, debentures, mortgage etc.)
Thus long term funds mean capital employed. I can be computed in two ways:
(a) Fixed Assets + Investments + Current Assets - Current Liabilities
or (b) Share Capital (both equity and preference) + Reserves and Surplus + Long Term Liabilities

Standard Fixed Asset Ratio: Fixed asset ratio should not exceed 1:1 or 100%. Generally a ratio of 0.67:1 or 66
2/3% is considered as satisfactory or ideal.
Interpretation of the Ratio : A higher ratio indicates that the financial position is not sound. Lower the ratio, better
is the financial position.
Capital Gearing Ratio
capital gearing or leverage refers to the proportion between fixed income bearing funds and equity shareholders'
funds.
Capital Gearing ratio = Fixed income bearing funds
Equity Shareholders' funds
Or
Preference share capital + Debentures +Long term loans
Equity Shareholders' funds

Fixed income bearing funds include debentures, other long term loans and preference share capital.
Equity shareholders' funds include equity capital and all reserves and surpluses that belong to equity shareholders.
Coverage Ratios
These ratios are computed from the profit and loss account. Coverage ratios are used to test the firm's debt servicing
capacity. Debt servicing capacity means the ability of the firm to make periodic payments of interest and preference
dividend.
Important coverage ratios
Interest Coverage Ratio

This ratio measures the capacity of the firm to pay interest on loans and debentures regularly. It establishes the
relationship between operating profit and interest charges.

Interest coverage ratio=Profit before interest and tax

Interest
It is generally expressed in times . It is also knownas debt-service ratio
standard ratio is 6 to 7 times
significance : It shows how many times the interest charges are covered by the earnings
Interpretation :The higher the ratio, the stronger is the ability of a company to pay interest. A low ratio indicates
the inability to offer assured payment of interest to creditors
Dividend Coverage Ratio

Dividend coverage ratio measures the ability of a company to pay dividend on preference shares carrying a fixed
rate of dividend.
Dividend Coverage Ratio = Earnings After Tax (EAT)
Preference dividend
The standard for this ratio is generally taken to be two times.
Total or Overall Coverage Ratio
This ratio is also known as fixed charges coverage ratio. It measures the ability of a company to service all fixed
obligations out of its earnings.
Total Coverage Ratio =EBIT
Total Charges
ACTIVITY RATIOS (Turnover ratios)

Activity ratios show how effectively a firm uses its available resources or assets or efficiency in asset management.
These ratios are also known as efficiency ratios or performance ratios or assets utilisation ratios. These ratios
indicate the speed with which the resources are turned over or converted into cash. That is why these ratios are
called turnover ratios.
It always expressed in number of times
Inventory Turnover Ratio (Stock Turnover Ratio)
It shows the relationship between cost of goods sold and average inventory or stock. It indicates the number of
times the stock is turned over or converted into sales.
Stock Turnover Ratio =Cost of Goods Sold
Average stock

Cost of goods sold = Opening stock + Purchases + Direct expenses (including wages) - Closing stock.
or
Cost of goods sold = Sales - Gross profit
If it is gross loss, it should be added to sales.

Average stock = Opening stock + Closing stock

2
If opening stock is not given in the question, closing stock may be used as the average stock. It is expressed in
times.
It can also be expressed in days or months. Then it is called stock velocity or stock turnover period.

Stock Velocity=12 or 360

Stock Turnover Ratio (in times)
or
Average stock × 12 or 360
Cost of goods sold

Standard Stock Turnover Ratio: Generally a ratio of 8 times is considered satisfactory. .

Interpretation of Stock Turnover Ratio: A high turnover ratio (or shorter inventory period) indicates that inventory
is sold fast. It is an indication of good inventory management. On the other hand, a low turnover ratio (or longer
inventory period) reflects over investment in inventories, accumulation of huge stock, dull business etc.
Debtors Turnover Ratio
It explains the relationship between net credit sales and average including bills receivable. This ratio shows how
quickly debtors are realised or converted into cash. It indicates how efficiently the firm collects cash from debtors.
Debtors Turnover Ratio = Net Credit Sales
Average Drs + Average B/R

Or
debtors Turnover Ratio = Net Credit Sales
Debtors including B/R

Net credit sales = Gross credit sales - Sales returns

Gross credit sales = Total sales – Cash sales
Average Debtors = Opening Debtors +Closing Debtors
2

Average B/R = Opening B/R + Closing B/R

2

Average Collection Period: It refers to debtors turnover ratio expressed in days or months. It is also known as
debtors velocity or average age of debtors.
Average Collection Period= 360 (or 12)
Debtors Turnover Ratio
or
Average Collection period = Average Debtors (including B/R)
Credit Sales per day
Credit Sales per day = Net Credit Sales
360

Or
Average Collection Period = Av. Drs. (including B/R) ×360(or12)
Net Credit Sales
Standard Debtors Turnover Ratio: Generally, a turnover ratio of 7 (collection period of 45 days) may be taken as
satisfactory.
Interpretation of Debtors Turnover Ratio: A higher debtors turnover ratio (or shorter collection period) shows the
efficiency in collection from debtors, A lower turnover ratio (or longer collection period) indicates inefficiency of
management in collecting debtors, i.e., payments by debtors are delayed.
Creditors Turnover Ratio
It shows the relationship between net credit purchase and average creditors including bills payable, This ratio
indicates the number of times the creditors are paid. It is called payables turn over ratio.
Creditors Turnover Ratio = Net Credit Purchase
Average Creditors including B/P
Or

Creditors Turnover Ratio = Net Credit Purchase

Average Creditors + Average B/P

Net Credit Purchase = Total Credit Purchase - Purchase Returns

Total Credit Purchase = Total Purchase - Cash purchases

Creditors arise in respect of credit purchases. Therefore, only credit purchases will be taken and not total purchases.
If credit purchase is not given, total purchases may be used
Average Creditors= Opening Creditors + Closing Creditors
2

Average Bills Payable= Opening B/P + Closing B/P

2
If opening creditors and opening bills payable are not given, their closing values may be used for the computation
of the ratio.
But, “provision for discount on creditors' should not be deducted from creditors.

Average Payment Period: It means the credit period enjoyed by the firm in paying creditors. it is expressed in
days or months. It is also known as creditors velocity or average age of creditors.
(a) Average Payment Period = 360 (or 12)
Creditors Turnover Ratio
or
(b) Average Payment Period = Average Creditors (including B/P)
Credit Purchase per day

Credit Purchases per day = Net Credit Purchase

(360)
or
(c) Average Payments Period = Av. Creditors (including B/P)× 360
Net Credit Purchase
Interpretation of Creditors Turnover Ratio: Higher turnover ratio indicates, the firm enjoys the credit allowed by
creditors. If the turnover ratio is lower, it means early payment to creditors and the firm is not taking the full
advantage payments to creditors are delayed.
Working Capital Turnover Ratio
It shows the relation between sales and working capital in called working capital turnover ratio. This ratio shows
how many times the working capital is turned over (i.e., rotated) to produce sales
Working Capital Turnover Ratio = Net Sales
Working Capital

Sometimes cost of sale is taken instead of sales.

This ratio is usually expressed in number of times.
Net Sales = Total Sale - Sales Returns
Total sale cash sales + credit sales.
Working Capital = Current Assets - Current Liabilities
Standard: The standard or ideal working capital turnover ratio is 7 or 8 times..
Interpretation: Higher the ratio means better utilisation of working capital. This means a lower investment in
working capital has generated more volume of sales. A low ratio indicates under trading, i.e., working capital is
not effectively utilised in generating sales.
Fixed Asset Turnover Ratio
It establishes the relationship between net sales and fixed assets. It measures the efficiency with which a firm is
utilising its fixed assets in generating sales.
Fixed Assets Turnover Ratio = Net Sales
Net Fixed Assets
Sometimes cost of sales (or cost of goods sold) is taken in the place of sales.
This ratio is usually expressed in number of times.

Net fixed assets mean fixed assets after depreciation. Investments should not be included in fixed assets. This is
because investments do not affect sales.
Interpretation: A higher ratio indicates better utilisation of fixed assets. A low ratio indicates under utilisation of
fixed assets in generating sales.
PROFITABILITY RATIOS
A firm should earn profits to survive and grow over a long period of time. To the management, profit is the
measure of efficiency and control. To the owners, it is a measure of worth of their investment. To the creditors, it
is the margin of safety. So profit is important for everyone associated with the company.

The term profitability refers to the ability of a firm to earn income. The profitability of a firm can be easily
measured by its profitability ratios.
Types of profitability ratios
1.profitability ratios based on sales
2. profitability ratios based on investment.
Profitability Ratios based on Sales

These ratios are calculated on the basis of sales.

Gross Profit Ratio
This is the ratio of gross profit to sales expressed as a percentage. It is also known as gross margin.
Gross Profit Ratio = Gross Profit X100
Net sales

Net Sales = Gross Sales - Sales Returns

Gross sales means all sales, i.e., both cash sales and credit sales.
Gross Profit = Net Sales - Cost of goods Sold.

Cost of Goods Sold Opening stock + Purchases + Wages + All other direct expenses - Closing stock
All other direct expenses mean all expenses incurred on purchases,
Standard G/P Ratio: The ideal ratio is 20% to 25%.Interpretation of G/P Ratio: A high G/P ratio is a sign of efficient
production or purchase management. A low G/P ratio is a danger signal.
Operating Ratio
Operating ratio expresses the relationship between operating cost and sales.

Operating Ratio = Cost of Goods Sold + Operating Expenses x 100

Net Sales

This ratio is usually expressed in percentage.

Operating cost includes two sub Components - Cost of goods sold and operating expenses include: (a) Office
and administrative expenses, (b) Selling and distribution expenses, and (c) Financial expenses like interest on short
term loans, bad debts, discount allowed etc.
Standard: The ideal operating ratio for manufacturing concern is 75 % to 85%.
Interpretation of Operating Ratio: Lower the ratio more is the efficiency and higher is the operating profit. A higher
operating ratio indicates that the margin for meeting non-operating expenses, creating reserves and paying dividend
is less

Operating Profit Ratio

Operating profit ratio explains the relationship between operating profit and net sales.
Operating Profit Ratio = Operating Profit x 100
Net Sales

This ratio also is expressed in percentage.

Operating Profit = Net sales - Cost of goods sold - Operating expenses
or
Gross Profit - Operating Expenses
Operating profit is ascertained from net profit
Operating Profit = Net Profit + Non-operating Expenses and interest on Long Term Loans and Debentures – Non-
operating Income
Significance of Operating Profit Ratio :It measures the operational efficiency.
Expense Ratios
Expense ratio expresses the relationship between various expenses to net sales.
(a) Direct Material Cost Ratio = Direct Material Cost x100
Net Sales

(b) Direct Labour Cost Ratio = Direct Labour Cost x 100

Net Sales

(C) Factory Expenses Ratio = Factory Expenses x100

Net Sales

(d) Office and AdministrativeExpenses Ratio =

Office & Administration Exp. x 100
Net Sales

(e) Selling and DistributionExpenses Ratio =

Selling & Distribution Exp x100
Net Sales

Expenses ratios are generally expressed in percentages.

Net Profit Ratio
Net profit ratio is the ratio of net profit earned by a business and its net sales. It measures overall profitability.

N/P Ratio = Net profit before Tax x 100

Net Sales

or

N/P Ratio = Net profit after Tax x 100

Net Sales

Net profit is the balance of the P/L A/c.

It can also be calculated from operating profit. It is calculated in the following manner:
Operating Net Profit XXX

Add: Non-operating incomes XXX

XXXX
Less: Non-operating expensesXXX
Net profit XXX
Standard N/P Ratio: The ideal N/Pratio is 5% to 10%.
Interpretation of N/P Ratio: Higher the ratio, better is the profitability. This means higher returns to shareholders.
Profitability Ratios based on Investment

These are overall profitability ratios. These ratios are computed on the basis of investment in business.
Return On Investment (ROI)
This ratio helps the firm wants to know how much profit is earning on its investment. It establishes the relationship
between profit or return and investment. It is also called accounting rate of return or Rate of Return or Return on
Capital Employed.

ROI =Profit before Interest and Tax x 100

Capital Employed

This ratio is usually expressed as a percentage. ROI is also known as

The overall profitability ratio (ROI) may be said to emerge from two other ratios - operating net profit ratio and
capital turnover ratio.
(1) Capital Turnover ratio = Sales
Capital employed
(2) Operating Net Profit ratio = Operating net profit x 100
Sales
The ROI can be derived as a product of capital turnover ratio and operating net profit ratio.
Thus,
ROI =Sales × operating N/P× 100
Capital employed sales
= operating N/P × 100
Capital employed

capital employed may be 'Gross capital employed' or Net capital employed' .

Gross Capital Employed = Fixed Assets + Current Assets
Net Capital Employed = Fixed Assets + Current Assets - Current Liabilities
or,
Share Capital + Reserves + Debentures + Other long term loans
Fictitious assets and accumulated losses should be deducted. Generally net capital employed is taken.
PBIT = G/P - Operating expenses.

Standard: The ideal ratio is 15%.

Objective: The objective of computing ROI is to know how much profit is earning on capital employed. or how
efficiently the capital employed in business is utilised.
Interpretation of ROI: The higher the ROI greater is the overall profitability and more is the efficient use of capital
employed.
Uses or Advantages of ROI
1. It measures overall profitability.
2. It measures success of business.
3. It helps to compare the performance of different divisions of a firm.
4. It helps in investment decisions.
5. It is useful for planning the capital structure.
6. It can be used for determining the price of a product.
7. It serves as foundation for optimum utilisation of the assets of a firm.

Return on Shareholders' Fund

This is the ratio of net profit to Shareholders' fund or net worth.

Return on shareholders' fund = Net profit after interest and tax × 100
Shareholders' fund

Net profit means 'net income' after interest and tax (but before preference dividend). The non-operating expenses
and non-operating incomes also should be adjusted. Shareholders' fund or net worth includes both preference and
equity capital and all reserves and surpluses belonging to shareholders.
Return on Equity Capital
The equity shareholders are entitled to all the profits remaining after meeting all the claims of outsiders and
preference shareholders.

Return on Equity Capital =

Net profit after tax and preference dividendx 100
Equity Shareholders' fund

Here the net profit is the profit after tax and preference dividend after tax. . Equity shareholders' fund include
equity capital and reserves and surpluses.
MARKET TEST RATIOS
Market test ratios are used for evaluating the shares and stock which are traded in the market. Market test ratios
are also known as investors' ratios or stock market ratios or market valuation ratios.
Earning Per Share (EPS)
This ratio indicates the profits available for each equity share.
EPS = Net profit available to equity shareholders
Number of equity shares
Here net profit is the final profit after tax and preference dividend.
Dividend Per Share (DPS)
The net profits after tax and preference dividend belong to equity shareholders.. The dividend paid to equity
shareholders on a per share basis is DPS.
DPS = Dividend paid to equity shareholders
Number of equity shares

Dividend Payout Ratio (D/P)

Dividend payout ratio measures the relationship between the dividend paid to equity shareholders and the earnings
belonging to them. It is the ratio of dividend per share to earnings per share.

Dividend payout ratio = Dividend paid to equity shareholders

Net profit belonging to equity shareholders

or = Dividend per share

Earnings per share
Ideal ratio : A dividend cover of 2 or 3 times is considered to be ideal

Price Earning Ratio (P/E)

This ratio is mainly used to value the company's performance as expected by equity shareholders. It shows the
number of times the EPS is covered by its market price.
Price Earning Ratio = Market price per share
Earnings per share

Market price per share = PER X EPS

Earning Yield Ratio

Yield is the rate of return on the amount invested in the business. Earning yield ratio shows a relationship between
earnings per share and market price of shares.
Earnings Yield Ratio =Earnings Per Share
Market Price Per Share
Thus, earnings yield ratio is the inverse of price earning ratio.