Ratio Analysis
Why are these Ratios Important ?
• Every firm is most concerned with its
Profitability and Efficiency.
• Profitability measures are important to
company managers, owners, investors, banks
and creditors.
• These show a company's overall efficiency and
performance.
IS THE
PERFORMANCE
GETTING BETTER
OR WORSE?
HOW IT
IS IT GENERATING PERFORMS
PROFITS ? COMPARED TO ITS
PEERS?
Ability to
translate sales
into profits
Ability to
generate
returns for its
shareholders
Gross Profit Margin
• Looks at the cost of goods sold as a percentage of sales.
• This ratio looks at how well a company controls the cost of its
1. inventory
2. manufacturing products
• The calculation is:
𝑮𝒓𝒐𝒔𝒔 𝑷𝒓𝒐𝒇𝒊𝒕
𝑮𝑷𝑴 = × 𝟏𝟎𝟎
𝑵𝒆𝒕 𝑺𝒂𝒍𝒆𝒔
The larger the gross profit margin, the better for the company.
Operating Profit Margin
• Operating profit is also known as EBIT (earnings before interest and
taxes).
• The operating profit margin looks at EBIT as a percentage of sales. The
operating profit margin ratio is a measure of overall operating
efficiency, incorporating all of the expenses of ordinary, daily business
activity.
• The calculation is:
𝑬𝑩𝑰𝑻
𝑶𝑷𝑴 = × 𝟏𝟎𝟎
𝑵𝒆𝒕 𝑺𝒂𝒍𝒆𝒔
Net Profit Margin
• The net profit margin shows how much of each sales shows up as net
income after all expenses are paid.
• For example, if the net profit margin is 5 %, that means that 5 paisa of
every Rupee are profit.
• The net profit margin measures profitability after consideration of all
expenses including taxes, interest, and depreciation.
• The calculation is:
𝑵𝒆𝒕 𝑰𝒏𝒄𝒐𝒎𝒆
𝑵𝑷𝑴 = × 𝟏𝟎𝟎
𝑵𝒆𝒕 𝑺𝒂𝒍𝒆𝒔
WIDGET MANUFACTURING COMPANY
CONDENSED INCOME STATEMENT
FOR YEAR ENDING MAR. 31, 2017
Net Sales 112,500
Cost of Goods Sold (COGS) 85,040
Gross Margin 27,460
Operating Expenses (Marketing & Administrative) 18,950
Net Income Before Taxes (EBIT) 8,510
Less: Income Taxes 4,163
Net Income After Taxes 4,347
27460
• 𝐺𝑃𝑀 = × 100 = 24%
112500
8510
• 𝑂𝑃𝑀 = × 100 = 7%
112500
4347
• 𝑁𝑃𝑀 = × 100 = 4%
112500
Interpretation of Increase/decrease in
Gross Profit Margin
1. The selling price of goods has gone up without corresponding increase in
the cost of goods sold.
2. The cost of goods sold has gone down without corresponding decrease in
the selling price of the goods.
3. Stock at the end may have been undervalued or the opening stock may
have been overvalued.
Interpretation of Increase/Decrease in
Operating Profit Margin-
1) Operating profit is the company’s earnings before interest deductions and
taxes.So,increase in operating profit margin shows better control over
costs and expenses related to the business operations.
2) Costs related to the manufacturing labor, to the supplies necessary for the
manufacturing process or to the direct purchase of inventories may have
been cut.
3) Other small expenses like Electricity bills may have been reduced and
cheaper insurance coverage may have been chosen so as to reduce the
premium.
Interpretation of Increase/Decrease in Net
Profit Margin-
The Net Profit Margin reflects the company’s ability to turn revenue into net
profit after accounting for all the expenses of running the business including
taxes and debt payments.
1)If the Gross Profit Margin is constant than an increase in Net Profit Margin
indicates improvement in the operational efficiency of the business while
decrease in NPM indicates degrading operational efficiency.
2)An increase in NPM may also occur if production is increased as the cost of
each item decreases without affecting the selling price.
Expense ratio
𝑨𝒅𝒎𝒊𝒏+𝑺𝒆𝒍𝒍𝒊𝒏𝒈 𝑬𝒙𝒑𝒆𝒏𝒔𝒆𝒔
𝑶𝒑𝒆𝒓𝒂𝒕𝒊𝒏𝒈 𝑬𝒙𝒑𝒆𝒏𝒔𝒆𝒔 𝒓𝒂𝒕𝒊𝒐 = × 𝟏𝟎𝟎
𝑵𝒆𝒕 𝑺𝒂𝒍𝒆𝒔
𝑨𝒅𝒎𝒊𝒏 𝑬𝒙𝒑𝒆𝒏𝒔𝒆𝒔
𝑨𝒅𝒎𝒊𝒏𝒊𝒔𝒕𝒓𝒂𝒕𝒊𝒗𝒆 𝑬𝒙𝒑𝒆𝒏𝒔𝒆𝒔 𝒓𝒂𝒕𝒊𝒐 = × 𝟏𝟎𝟎
𝑵𝒆𝒕 𝑺𝒂𝒍𝒆𝒔
𝑺𝒆𝒍𝒍𝒊𝒏𝒈 𝑬𝒙𝒑𝒆𝒏𝒔𝒆𝒔
𝑺𝒆𝒍𝒍𝒊𝒏𝒈 𝑬𝒙𝒑𝒆𝒏𝒔𝒆𝒔 𝒓𝒂𝒕𝒊𝒐 = × 𝟏𝟎𝟎
𝑵𝒆𝒕 𝑺𝒂𝒍𝒆𝒔
Return On Assets
Measure of how efficiently firm utilizes its assets.
A high value means that company is efficiently generating earnings
using its assets
𝑷𝒓𝒐𝒇𝒊𝒕 𝒂𝒇𝒕𝒆𝒓 𝒕𝒂𝒙
𝑹𝑶𝑨 𝒓𝒂𝒕𝒊𝒐 =
𝑻𝒐𝒕𝒂𝒍 𝑨𝒔𝒔𝒆𝒕𝒔
Return On Equity
Measures a corporation’s profitability by revealing how much profit a
company generates with the money that shareholders have invested.
Shareholder’s fund doesn’t include preference shares.
𝑷𝒓𝒐𝒇𝒊𝒕 𝒂𝒇𝒕𝒆𝒓 𝒕𝒂𝒙−𝑷𝒓𝒆𝒇.𝑫𝒊𝒗𝒊𝒅𝒆𝒏𝒅
𝑹𝑶𝑬 𝒓𝒂𝒕𝒊𝒐 =
𝑺𝒉𝒂𝒓𝒆𝒉𝒐𝒍𝒅𝒆𝒓′ 𝒔 𝒇𝒖𝒏𝒅
Return On Capital Employed
Measures company’s profitability with which its capital is employed.
Unlike ROE, which only analyzes profitability related to company
common equity, it also considers debt and other liabilities as well.
𝑷𝒓𝒐𝒇𝒊𝒕 𝒂𝒇𝒕𝒆𝒓 𝒕𝒂𝒙
𝑹𝑶𝑪𝑬 𝒓𝒂𝒕𝒊𝒐 =
𝑨𝒗𝒆𝒓𝒂𝒈𝒆 𝑪𝒂𝒑𝒊𝒕𝒂𝒍 𝑬𝒎𝒑𝒍𝒐𝒚𝒆𝒅
Cap employed= shareholder’s fund + total debt
OR
Cap employed = Total assets-current liabilities
Earning Per Share
EPS is the portion of the company’s profit allocated to each share of the
stock.
Really important tool to gauge the profitability of a company.
𝑬𝒂𝒓𝒏𝒊𝒏𝒈𝒔 𝒂𝒇𝒕𝒆𝒓 𝒕𝒂𝒙
𝑬𝑷𝑺 =
𝑵𝒐.𝒐𝒇 𝒔𝒉𝒂𝒓𝒆𝒔
𝑬𝒂𝒓𝒏𝒊𝒏𝒈𝒔 𝒂𝒇𝒕𝒆𝒓 𝒕𝒂𝒙
𝑫𝒊𝒍𝒖𝒕𝒆𝒅 𝑬𝑷𝑺 =
𝑵𝒐.𝒐𝒇 𝒔𝒉𝒂𝒓𝒆𝒔+𝒄𝒐𝒏𝒗𝒆𝒓𝒕𝒊𝒃𝒍𝒆 𝒅𝒆𝒃𝒕+𝒄𝒐𝒏𝒗𝒆𝒓𝒕𝒊𝒃𝒍𝒆 𝒑𝒓𝒆𝒇
Dividend Per Share
DPS is the total dividend paid out by the company for every share of the
stock.
Something that investors look for.
𝑻𝒐𝒕𝒂𝒍 𝑫𝒊𝒗𝒊𝒅𝒆𝒏𝒅𝒔 𝑷𝒂𝒊𝒅
𝑫𝑷𝑺 =
𝑵𝒐.𝒐𝒇 𝒔𝒉𝒂𝒓𝒆𝒔
Dividend Payout Ratio
Dividend payout ratio provides an indication about how much money a
company is returning as compared to its earnings.
𝑫𝑷𝑺
𝑫𝑷𝑹 =
𝑬𝑷𝑺
Dividend Payout Ratio
DPR can provide us with significant information about a firm.
DPR is often decided considering a company’s future earning
expectations.
Steady increase in a firm’s DPR indicates healthy operation
Fixed Assets Turnover Ratio
It is the ratio of sales to the value of fixed assets.
It indicates how well the business is using its fixed assets to generate sales.
𝑺𝒂𝒍𝒆𝒔
𝑭𝑨𝑻𝑹 =
𝑭𝒊𝒙𝒆𝒅 𝑨𝒔𝒔𝒆𝒕𝒔
Or
𝑪𝒐𝒔𝒕 𝒐𝒇 𝒈𝒐𝒐𝒅𝒔 𝒔𝒐𝒍𝒅
𝑭𝑨𝑻𝑹 =
𝑭𝒊𝒙𝒆𝒅 𝑨𝒔𝒔𝒆𝒕𝒔
Inventory Turnover Ratio
It measures how many times a company has sold and replaced its
inventory during a certain period of time.
𝑪𝒐𝒔𝒕 𝒐𝒇 𝒈𝒐𝒐𝒅𝒔 𝒔𝒐𝒍𝒅
𝑰𝑻𝑹 =
𝑨𝒗𝒆𝒓𝒂𝒈𝒆 𝒊𝒏𝒗𝒆𝒏𝒕𝒐𝒓𝒚 𝒂𝒕 𝒄𝒐𝒔𝒕
Debtors Turnover Ratio
It simply measures how many times the receivables are collected during a
particular period.
Also, Known as Accounts receivable turnover ratio
𝑵𝒆𝒕 𝑪𝒓𝒆𝒅𝒊𝒕 𝑺𝒂𝒍𝒆𝒔
𝑰𝑻𝑹 =
𝑨𝒗𝒆𝒓𝒂𝒈𝒆 𝑻𝒓𝒂𝒅𝒆 𝑹𝒆𝒄𝒆𝒊𝒗𝒂𝒃𝒍𝒆𝒔 (𝒏𝒆𝒕)
Liquidity ratio
Measure the short-term solvency of the business, i.e. the firm’s ability to
meet its current obligations.
Liquidity ratios measure a company's ability to pay debt obligations and
its margin of safety
Current liabilities are analyzed in relation to liquid assets to evaluate the
coverage of short-term debts in an emergency.
Bankruptcy analysts and mortgage originators use liquidity ratios to
evaluate going concern issues, as liquidity measurement ratios indicate
cash flow positioning
Liquidity ratio
Few ratios included are:
1. Current Ratio
2. Quick Ratio
3. Super Quick ratio
Current Ratio
The current ratio is a liquidity ratio that measures a company's ability to
pay short-term obligations.
Current ratio can be used to make a rough estimate of a company's
financial health.
𝑪𝒖𝒓𝒓𝒆𝒏𝒕 𝑨𝒔𝒔𝒆𝒕𝒔
C𝑹 =
𝑪𝒖𝒓𝒓𝒆𝒏𝒕 𝑳𝒊𝒂𝒃𝒊𝒍𝒊𝒕𝒆𝒔
It is mainly used to give an idea of a company's ability to pay back its
liabilities (debt and accounts payable) with its assets (cash, marketable
securities, inventory, accounts receivable).
Current Ratio
Generally, a current ratio of 2:1 is considered healthy
2:1 implies that current assets are twice its current
Liabilities.
❑Significance:
provides a measure of degree to which current assets
cover current liabilities.
Should neither be very high nor very low.
Example
Company Current Assets Current Liabilities Current Ratio
Apple Inc. $128.65 billion $100.81 billion 𝟏𝟐𝟖.𝟔𝟓
=1.28
𝟏𝟎𝟎.𝟖𝟏
Walt Disney Co. $15.89 billion $19.6 billion 𝟏𝟓.𝟖𝟗
= 0.81
𝟏𝟗.𝟔
Costco Wholesale $17.32 billion $17.5 billion 𝟏𝟕.𝟑𝟐
=0.98
𝟏𝟕.𝟓
• Acceptable current Ratios vary depending on the industry .
• Generally, a current ratio in the range of 1:1.5 to 1:3 is considered good.
• The current ratio is also known as the Working Capital Ratio
• Working Capital = Current Assets – Current Liabilities
Quick Ratio
The quick ratio is an indicator of a company’s short-term liquidity,
and measures a company’s ability to meet its short-term obligations with
its most liquid assets.
𝑪𝒖𝒓𝒓𝒆𝒏𝒕 𝑨𝒔𝒔𝒆𝒕𝒔−𝑰𝒏𝒗𝒆𝒏𝒕𝒐𝒓𝒊𝒆𝒔
𝑸𝑹 =
𝑪𝒖𝒓𝒓𝒆𝒏𝒕 𝑳𝒊𝒂𝒃𝒊𝒍𝒊𝒕𝒆𝒔
𝒄𝒂𝒔𝒉 𝒂𝒏𝒅 𝒆𝒒𝒖𝒊𝒗𝒂𝒍𝒆𝒏𝒕𝒔 + 𝒎𝒂𝒓𝒌𝒆𝒕𝒂𝒃𝒍𝒆 𝒔𝒆𝒄𝒖𝒓𝒊𝒕𝒊𝒆𝒔 +𝒕𝒓𝒂𝒅𝒆/𝒂𝒄𝒄𝒐𝒖𝒏𝒕𝒔 𝒓𝒆𝒄𝒆𝒊𝒗𝒂𝒃𝒍𝒆
𝑸𝑹 =
𝑪𝒖𝒓𝒓𝒆𝒏𝒕 𝑳𝒊𝒂𝒃𝒊𝒍𝒊𝒕𝒆𝒔
Example
(In Millions) Procter&Gamble Johnson & Kimberly-Clark
Johnson
Current Assets $26,494 $65,032 $5,115
Less: Inventories ($4,624) ($8,144) ($1,679)
Quick Assets $21,870 $56,888 $3,436
Current Liabilities $30,210 $26,287 $5,846
Quick Ratio 0.7239 2.16 0.5878
• Generally, Companies with a quick ratio of less than 1 are not able to
pay their current liabilities on time.
• It is only good in comparing companies within same industry .
• The quick ratio is also known as the Acid-Test Ratio
Super Quick Ratio or Cash Ratio
This ratio goes one step ahead of current ratio and liquid ratio.
𝑺𝒖𝒑𝒆𝒓 𝑸𝒖𝒊𝒄𝒌 𝑨𝒔𝒔𝒆𝒕𝒔
𝑺𝑸𝑹 =
𝑪𝒖𝒓𝒓𝒆𝒏𝒕 𝑳𝒊𝒂𝒃𝒊𝒍𝒊𝒕𝒆𝒔
Strictly includes only cash & marketable securities
𝑪𝒂𝒔𝒉+𝒎𝒂𝒓𝒌𝒆𝒕𝒂𝒃𝒍𝒆 𝒔𝒆𝒄𝒖𝒓𝒊𝒕𝒊𝒆𝒔
𝑺𝑸𝑹 =
𝑪𝒖𝒓𝒓𝒆𝒏𝒕 𝑳𝒊𝒂𝒃𝒊𝒍𝒊𝒕𝒆𝒔
Find the super quick assets and super quick ratio.
𝑪𝒂𝒔𝒉+𝒎𝒂𝒓𝒌𝒆𝒕𝒂𝒃𝒍𝒆 𝒔𝒆𝒄𝒖𝒓𝒊𝒕𝒊𝒆𝒔
• 𝑺𝑸𝑹 =
𝑪𝒖𝒓𝒓𝒆𝒏𝒕 𝑳𝒊𝒂𝒃𝒊𝒍𝒊𝒕𝒆𝒔
𝟐𝟎,𝟎𝟎𝟎+𝟏,𝟓𝟎,𝟎𝟎𝟎
• 𝑺𝑸𝑹 = = 2.833
𝟔𝟎,𝟎𝟎𝟎
• Higher the super quick ratio, the better the liquidity of business.
• In this case, for every 1 unit of current liability, the company has
2.833 units of super quick assets, which is good.
Solvency ratio
Determines the ability of the business to service its debt in the long run
❑ Debt-Equity ratio
measures the relationship between long-term debt and equity
𝑳𝒐𝒏𝒈 𝑻𝒆𝒓𝒎 𝑫𝒆𝒃𝒕𝒔
𝑫/𝑬 =
𝑺𝒉𝒂𝒓𝒆𝒉𝒐𝒍𝒅𝒆𝒓′ 𝒔 𝒇𝒖𝒏𝒅𝒔
Safe ratio= 2:1 (but varies from industry to industry).
❑ Significance:
Measures the degree of indebtedness of an enterprise.
Higher Ratio is good and bad depending on different perspectives.
𝑳𝒐𝒏𝒈 𝑻𝒆𝒓𝒎 𝑫𝒆𝒃𝒕𝒔
• 𝑫/𝑬 =
𝑺𝒉𝒂𝒓𝒆𝒉𝒐𝒍𝒅𝒆𝒓′ 𝒔 𝒇𝒖𝒏𝒅𝒔
• Long term debt/Debt = LT borrowings + other LT liabilities + LT provisions
• Debt = 4,00,000 + 40,000 + 60,000
• Debt = 5,00,000
• Shareholder’s fund/ Equity = Share capital + Reserves and Surplus + Money received against share warrants
• Equity = 12,00,000 + 2,00,000 + 1,00,000
• Equity = 15,00,000
Alternatively,
• Shareholder’s Fund/ Equity = Non-current assets + Current Assets – Current liabilities – Non-current Liabilities
• Equity = 18,00,000 + 7,00,000 – 5,00,000 – 5,00,000
• Equity = 15,00,000
𝑫 𝟓,𝟎𝟎,𝟎𝟎𝟎
• = = 0.33:1
𝑬 𝟏𝟓,𝟎𝟎,𝟎𝟎𝟎
