Ratio Analysis
Formulas
1) Financial ratios
S.no
Ratio
Formula
Current ratio
Current assets
Current liabilities
Quick ratio
Quick assets
Current liabilities
1:1
Debt Equity ratios
long term debt
equity
1:2
Proprietary ratio
Shareholders funds
Total tangible
assets
Notes
Ideal
ratio
2:1/1.33:
1
Comments
Indicates firms
commitment to meet
financial obligations.
Avery heavy ratio is not
desirable as it indicates
less efficient use of
funds
This ratio also indicates
short term solvency of a
firm
Indicates long term
solvency
Higher ratio is riskier for
the creditors
Variant of debt-equity
ratio
Shows the extent of
shareholders funds in
the total assets employed
in the business
Higher ratio indicates
relatively little danger to
creditors and vice versa
1) Current assets are those assets which can be converted into cash within a
period of one year or normal operating cycle of the business whichever is
longer
Examples : Cash in hand, cash at bank ,stock, debtors, bills receivable,
prepaid expenses
2) Current liabilities are those liabilities payable within an year or operating
cycle
3) Quick assets = current assets (stock+prepaid expenses)
4) Quick ratio is also known as the acid test ratio or liquidity ratio
5) Tangible assets are those assets which have physical existence
6) Long term debt /external funds/external equities =debentures+termloans
7) Share holders funds/internal funds/proprietary funds/owners funds=equity
share capital+preference share capital+reserves+profit and loss accountfictitious assets
2) Profitability ratios
S.no Ratio
Formula
Ideal ratio
comments
Gross profit X 100
Net sales
Higher the
ratio better
it is
This ratio expresses the
relationship between
gross profit and net
sales
Gross Profit
Ratio
Net Profit ratio
Net operating
profit ratio
Net profit X100
Net sales
(Net operating profit/net
sales)X100
Gross profit should be
adequate to cover
operating expenses
Higher the
This ratio expresses the
ratio, better relationship between
it is
net profit and Net sales
Higher ratio Helps in determining
is better
the efficiency with
which the affairs of the
business being
managed
4
Operating Ratio
Operating cost X100
net sales
Ratio
should be
low
Fixed charges
cover
PBIT
Interest
6 -7 times
for an
industrial
concern
It indicates whether the
business would earn
sufficient profits to pay
periodically the interest
charges
Indicates ability of the
company to repay
principal
Higher ratio Indicates the
is better
percentage return on
capital employed in the
business
Debt Service
coverage ratio
Overall
profitability
Operating profit
ratio/Return on
Capital employed X100
investment/return
on capital
employed
Return on share
Higher ratio Indicates the
holders funds
Profit after tax(PAT)
is better
percentage return on
Share holders funds X100
share holders funds
PBIT/interest+
(principal)/1-taxrate
This ratio is a test of
operating efficiency
with which the
business is being
carried
Important from
lenders point of view
Return on Equity
share holders
Funds
PAT-pref.dividend X100
Eq.shareholders funds
10
Price Earnings
Market price per share
Higher ratio Indicates the
is better
percentage return on
equity shareholders
funds
Higher ratio Indicates the number of
Ratio
11
Earnings per
share
Earnings per share
PAT pref.dividend
No of Equity shares
is better
times the earning per
share is covered by the
market price
Helps the investor in
deciding whether to
buy or not to buy the
shares
Higher ratio Helps in estimating
is better
companys capacity to
pay dividend to the
shareholders
Notes
1) Calculation of Gross profit
Gross profit = Sales- Cost of goods sold
Cost of goods sold (COGS) = opening stock +purchases+ all direct expenses
closing stock
2) Operating profit = Gross profit-operating expenses
Operating expenses= COGS +administration expenses +selling and distribution
expenses
Note: does not include financial charges like interest and provision for tax
3) Capital employed= sum total of all the long term funds employed in the
business
C E= Equity share capital+ preference share capital+ reserves+ profit and loss
account+ long term loans-fictitious assets
Shareholders funds= Equity share capital +preference share capital +reserves
+profit and loss account-fictitious assets
Equity share holders funds= equity share capital + reserves+ profit and loss
account-fictitious assets
3) Turnover ratios
S.no
Ratio
Formula
Ideal
ratio
Higher
ratio is
better
Fixed assets turn over
ratios
Net sales
Fixed Assets
Working capital turnover
ratio
Net sales
Working capital
Higher
ratio is
better
Debtors turnover
ratio(DTR)/debtors
velocity
Net credit sales
Average debtors
Higher
ratio is
better
Debt collection period
Months in a year
DTR
Creditors Turnover
ratio(creditors velocity)
(CTR)
Credit purchases
Average creditors
Lower
ratio is
better
Higher
ratio is
better
comments
Indicates the extent to
which investment in
fixed assets contribute
towards sales
This ratio indicates
whether or not working
capital has been
effectively utilized in
making sales
Average
debtors=(opening
debtors+opening bills
receivable+closing
debtors+closing bills
receivable)/2
Indicates the extent to
which debts have been
collected in time
Indicates the speed with
which the payments for
the credit purchases are
made
Average creditors=
opening creditors+bills
Credit payment period
Months in a year
CTR
Stock turnover ratio
Cost of goods sold
Average Stock
receivable+closing
creditors+closing bills
payable
Low ratio Indicates the promptness
is better
with which the payments
are made to the creditors
Higher
Indicates whether
ratio is
investment in stock is
better
efficiently used or not
Average stock= (opening
stock+closing stock)/2
