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| Corporate practice bd |
What is Ratio Analysis in Corporate Finance?
Ratio analysis is that the process of examining and comparing the company’s financial performance by providing valuable information about the organization’s profitability, solvency, and operational efficiency, and liquidity positions as represented by the financial statements.
Why use Ratio Analysis in corporate Finance?
There are several reasons for applying Ratio analysis within the corporate world. There’s a most investor or financial analysts can easily calculate the company’s financial performance, financial health by scrutinizing past and current financial statements. It helps the CFO of the corporate to research the financial data and take a financial decision effectively. There are some advantages of ratio analysis like-
Advantages of ratio analysis: -
01. Analyzing & comparing Financial performance :-( it helps in comparing the financial performance of two companies.)
02. Recent trend line Analysis :-( Companies trend to use the activity ratio in order to find any kind of trend in the performance.)
03. Operational Efficiency :-( Financial ratio analysis can also help to determine the efficiency of managing the asset and liabilities under the enterprise resource planning (ERP) also.
Limitations of Monetary ratio analysis:-
Financial ratio analysis is quantitative instead of qualitative. It, therefore, doesn't address certain factors which may play an enormous role in determining a company’s prospects. As an example, it cannot analyze the standard of its management.
Types of Ratio analysis
There are many sorts of economic ratios that you just can use for financial performance Measurement of the corporate practice. These are as follows-
Categories under-Liquidity Ratio: -
01. Current Ratio = (Current Assets/Current Liabilities)
02.Quick ratio or Acid test ratio= (current assets – inventory) / current liabilities
03. Cash ratio = Cash and equivalent / Current liabilities
04. Basic liquidity ratio = Monetary assets / monthly expenses
05. Interest Coverage Ratio = Earnings before Interest and Taxes or EBIT/ Interest Expense
06. Operating cash flow ratio = Operating cash flow / Current liabilities
Categories under - Solvency Ratio: -
01. Debt to equity ratio = Long term debt / shareholder’s funds
02. Debt Ratio = Long Term Debt / Capital or Debt Ratio = Long Term Debt / Net Assets
03. Proprietary Ratio = Shareholder’s funds / Capital or Shareholder’s funds / Total Assets
04. Interest coverage ratio = EBIT / interest on long term debt
05. Debt- to -Assets Ratio=Total- Debt /Total-Assets
Categories under-Profitability Ratio: -
01. Gross Profit Ratio = Gross profit / Net sales
02. Operating Profit Ratio = Operating income / Net sales
03 .Net Profit Ratio = net income/ sales
04. Profit Margin Ratio =Net income/net sale.
05. Return on Investment (ROI)= Operating Profit /capital employed) *100
Categories under-Efficiency Ratio:
01. Accounts Receivables Ratio = Net Sales / Average Accounts Receivables
02. Inventory Turnover Ratio = Cost of Goods Sold / Average Inventory
03. Fixed Asset Turnover = Net sales / Average Fixed Assets
04. Total Asset Turnover = Net sales / Average Total Assets
Categories under Others- Ratio): -
01. Shareholder equity Ratio =Total shareholder equity ratio/Total Assets
02. Total Debt ratio = Total liabilities / Total assets
03. Debt service coverage ratio = Operating income / Total debt service
04. Asset turnover ratio = Net sales / Average total assets
05. Return on Total Assets ratio = Net income / Total assets
06. Return on equity ratio = Net income / Shareholder’s equity
07. Book value per share ratio = (Shareholder’s equity – Preferred equity) / Total common shares outstanding
08. Dividend yield ratio = Dividend per share / Share price
09. Earnings per share ratio = Net earnings / Total shares outstanding
10. Price-earnings ratio = Share price / Earnings per share
11. Return on common stockholder’s equity= (Net income/Average common stock holders’ equity)
12 Operating Ratio= (cost of sales+ operating expense/net sales)*100
13. Retain earnings Ratio= (Retain earning/net profit after tax+ Preference dividend) *100
14. Working capital turnover Ratio=sales/cost of sales/net working capital
15. Cash position ratio=cash +Bank balance marketable securities/Current liabilities
16. Return on Net Worth = Net worth/ share holders equity capital.
Let’s started a practical Example, where we are trying to better understanding you about the Ratio analysis…
Step 01:-
Ratio -analysis -Table - (Imaginary Figure).
|
Liability |
Amount |
Assets
|
Amount |
Remark |
|
01.Term loan Balances (LTL)
|
3,00,000 |
11. Prepaid expense (CA) |
30,000
|
|
|
02. Reserve (NW) |
1,60,000 |
12.Land & building ( FA) |
2,50,000 |
|
|
03. Bank overdraft (CL) |
2,00,000 |
13. Investment in share (NCA) |
50,000 |
|
|
04. Provision (CL) |
50,000 |
14. Goodwill (IA) |
40,000 |
|
|
05. Debenture (LTL) |
2,00,000 |
15.Debtors (CA-QA) |
3,20,000 |
|
|
06. Capital ( NW) |
2,40,000 |
16.Plant& Machinery (FA) |
1,90,000 |
|
|
07. Creditors (CL) |
1,80,000 |
17.Preliminary expense (IA) |
10,000 |
|
|
08. Accrued Payable (CL) |
40,000 |
18.Cash in hand (CA-QA) |
30,000 |
|
|
09.Loan from Personal(LTL) |
1,00,000 |
19. Stock (CA) |
5,60,000 |
|
|
10.Advance from customers (CL)
|
50,000 |
20.Advance to Suppliers(CA-QA) |
40,000 |
|
|
Total Liabilities |
15,20,000 |
Total asset |
15,20,000 |
|
|
Sales revenue |
25,00,000 |
Net profit |
2,50,000
|
|
Step-02: -
Again summaries “ B ” sheet for Ratio Analysis (as per nature of the Account)…
|
Liability |
Amount |
Assets
|
Amount |
Remark |
|
Capital Reserved(2+6) |
4,00,000 |
Fixed asset (12+16) |
4,40,000 |
|
|
Long term liabilities(1+5+9) |
6,00,000 |
Non -current asset(13) |
50,000 |
|
|
Current liabilities(3+4+7+8+10) |
5,20,000 |
Intangible assets(14+17) |
50,000 |
|
|
|
|
Current assets(11+15+18+19+20) |
9,80,000 |
|
|
|
|
Quick asset(15+18+20) |
(3,90,000) |
|
|
Total liabilities |
15,20,000 |
Total assets |
15,20,000 |
|
|
Sales revenue |
25,00,000 |
Net profit |
2,50,000
|
|
Where,
LTL=Long term liabilities.
NW=Net worth.
CL=Current liabilities.
CA=Current Asset.
FA=Fixed Asset.
NCA=Non- current asset.
IA=Intangible Asset.
CA-QA= Current asset as well as Quick asset.
TNW=Tangible Net Worth (6, 00,000-2, 50,000) = 3, 50,000
Step-03: -
Let’s started Ratio analysis on the basis of summaries “B ” sheet,
01. Current Ratio (CA/CL) = (9, 80,000/5, 20,000) = 1.88:1
02. Quick Ratio/Asset test Ratio (QA/CL) = (3,90,000/5,20,000) = 0.75:1
03.Debt Equity /Leverage Ratio(LTL/TNW) = (6,00,000/3,50,000) = 1.71:1
04. Total Outside Liabilities (LTL+CL)/TNW= (6,00,000+5,20000)/3,50,000=3.2:1
05. Stock/Inventory Turnover ratio= (Sales revenue/Stock) = (25,00,000/320000) =4.5 times
06. Debtors Turnover ratio= (Sales revenue/Debtor) =2500000/320000=7.8times
07. Debtors collection period= (Debtor/sales) *12= (320000/2500000) *12=1.54 Months
08. Net profit/Sales= (Net profit/sales) *100= (250000/2500000) *100=10%
09. Return on equity Ratio= (Net profit/TNW)*100=(250000/350000)*100=71%
10. Return on investment (ROI) =Net profit/(TNW+LTL) =250000/(350000+600000)*100=26%.
11. Debt service coverage ratio= (Net Profit + Depreciation+ Inst. on term loan)/(TLI+TLinterest) =(250000+30,000+30,000)/(70,000+30,000)=3.1%
The END…….