Ratio Analysis is one of the methods to analyze financial statements. The relationship between various financial factors of a business is defined through ratio analysis. In this article, we have covered various ratio analysis formulas and others in detail.
Ratio Analysis Formulas
Ratio analysis is a quantitative method of gaining insight into a company's liquidity, operational efficiency, profitability, and solvency by comparing line items in its financial statements. It is a crucial tool used by investors, creditors, and management to evaluate a company's financial performance.
Key Ratio Analysis Formulas include:
- Liquidity Ratios
- Solvency Ratios
- Activity or Turnover Ratios
- Profitability or Income Ratios
Liquidity Ratios
The short-term financial position of an enterprise is assessed by liquidity ratios. 'Liquidity' refers to the firm's ability to meet its current liabilities. Liquidity ratios indicate the firm's ability to meet its current obligations out of the current resources.
Liquidity ratios include:
Current Ratio or Working Capital Ratio
Current Ratio also called Working Capital Ratio is given by the formula:
Current~Ratio~=~\frac{Current~Assets}{Current~Liabilities}
Example: If Current Assets = 5,00,000 and Current liabilities = 2,50,000 :
Solution:
Current Ratio = 5,00,000/2,50,000
= 2:1
Quick Ratio Acid Test Ratio or Liquid Ratio
Quick Ratio also called Acid Test Ratio and Liquid Ratio is given by the formula:
Liquid~Ratio=\frac{Liquid~Assets}{Current~Liabilities}
Example : If Current Assets = 5,00,000 and Inventory = 1,00,000 and Current Liabilities = 2,50,000
Solution:
Liquid Ratio = (5,00,000 - 1,00,000)/ 2,50,000
= 4,00,000/ 2,50,000
= 1.6
Solvency Ratios
The firm's ability to meet its long-term liabilities at the time of maturity is computed by solvency ratios. Solvency ratios include:
Debt to Equity Ratio
Debt to is given by the formula:
Debt~to~Equity~Ratio=\frac{Debt}{Equity}
ORDebt~to~Equity~Ratio=\frac{Long-term~Loans}{Shareholder's~Fund~or~Net~Worth}
Example: If Debt is 6,00,000 and equity is 4,00,000.
Solution:
Debt to Equity Ratio = Debt / Equity
= 6,00,000/4,00,000
= 3:2
Total Assets to Debt Ratio
Total Assets to Debt Ratio is given by the formula:
Total~Assets~to~Debt~Ratio=\frac{Total~Assets}{Debt}
ORTotal~Assets~to~Debt~Ratio=\frac{Total~Assets}{Long-term~Loans}
Example: If Total Assets = 3,00,000 and Debts = 75,000.
Solution:
Total Assets to Debt Ratio = Total Assets / Debts
= 3,00,000/75,000
= 4:1
Proprietary Ratio
Proprietary Ratio is given by the formula:
Proprietory~Ratio=\frac{Proprietor's~Fund/Shareholder's~Fund/Net~Worth}{Total~Assets}
Example: If Total Assets = 16,00,000 Reserves & Surplus = 2,00,000 and Equity Share Capital = 6,00,000.
Solution:
Proprietary Ratio = 6,00,000 + 2,00,000/16,00,000
= 8,00,000/16,00,000
= 1:2
Interest Coverage Ratio
Interest Coverage Ratio is given by the formula:
Interest~Coverage~Ratio=\frac{Net~Profit~Before~Interest~and~Tax}{Fixed~Interest~Charges}
Example: If Net Profit Before Interest and Tax = 4,00,000 and Interest Expense = 1,20,000
Solution:
Interest Coverage Ratio = 4,80,000 / 1,20,000
= 4:1
Activity Ratios
Activity ratios indicate how efficiently the Working Capital and Inventory are used to obtain revenue from operations. It indicates the speed or number of times the capital employed has been rotated in the process of doing business. Activity Ratios include:
Inventory Turnover Ratio
The Inventory Turnover Ratio also called Stock Turnover Ratio is given by the formula:
Inventory~Turnover~Ratio=\frac{Cost~of~Revenue~from~Operations}{Average~Inventory}
Example: If COGS = 5,00,000 ,Opening Inventory = 1,00,000 and Closing inventory = 1, 50,000
Solution:
Inventory Turnover Ratio = 5,00,000 / Average Inventory
Average Inventory = 1,00,000 + 1,50,000/2 = 1,25,000
= 5,00,000/1,25,000
= 4 : 1
Debtors or Receivables Turnover Ratio
Debtors or Receivables Turnover Ratio is given by the formula:
Receivable~Turnover~Ratio=\frac{Net~Credit~Revenue~from~Operations}{Average~Receivable}
Example : If Net Credit Sales = 8,00,000 Opening Debtors = 1,00,000 and Closing Debtors =1,40,000
Solution:
Receivables Turnover Ratio = 8,00,000 / Average Receivables
Average Inventory = 1,00,000 + 1,40,000/2 = 1,20,000
= 8,00,000/1,20,000
= 20 : 3
Creditors or Payables Turnover Ratio
Creditors or Payables Turnover Ratio is given by the formula:
Payable~Turnover~Ratio=\frac{Net~Credit~Purchases}{Average~Payable}
Example: If Net Credit Purchases = 6,00,000 Opening Creditors = 9,00,000 and Closing Creditors = 1,10,000.
Solution:
Payables Turnover Ratio = 6,00,000 / Average Payable
Average Payable = 1,10,000 + 90,000/2 = 1,00,000
= 6,00,000/1,00,000
= 6:1
Working Capital Turnover Ratio
Working Capital Turnover Ratio is given by the formula:
Working~Capital~Turnover~Ratio=\frac{Net~Revenue~from~Operations}{Net~Working~Capital}
Example: If Net Sales = 12,00,000 Current Assets= 6,00,000 and Current Liabilities = 4,00,000.
Solution:
Working Capital Turnover Ratio = 12,00,000/ Working Capital
Working Capital = Current Assets - Current Liabilities
Working Capital = 6,00,000 - 4,00,000 = 2,00,000
= 12,00,000/2,00,000
=6 : 1
Profitability Ratios
The efficiency of any business is measured by the profit earned by the company. Profitability ratios measure the various aspects of the profitability of a company.
Profitability Ratios include:
- General Profitability Ratios
- Overall Profitability Ratios
General Profitability Ratios
Various general profitability ratios are:
Gross Profit Ratio
Gross Profit Ratio is given by the formula:
Gross~Profit~Ratio=\frac{Gross~Profit}{Net~Revenue~from~Operations}\times100
Example: If Gross Profit = 4,00,000 and Net Revenue from Operations = 10,00,000.
Solution:
Gross Profit Ratio = Gross Profit / Net Revenue From Operation x 100
= 4,00,000/ 10,00,000 x 100
= 40 %
Operating Ratio
Operating Ratiois given by the formula:
Operating~Ratio=\frac{Cost~of~Revenue~from~Operations+Operating~Expenses}{Net~Revenue~from~Operations(Net~Sales)}\times100
Example: If Cost of Revenue from Operation = 6,00,000, Net Revenue from Operation = 10,00,000 and Operating Expenses = 2,00,000.
Solution:
Operating Ratio = Cost of Revenue from Operation + Operating Expenses/ Net from Revenue from Operation
= 6,00,000 + 2,00,000/ 10,00,000
= 8,00,000/10,00,000 x 100
= 80%
Operating Profit Ratio
Operating Profit Ratiois given by the formula:
Operating~Profit~Ratio=\frac{Operating~Profit}{Net~Revenue~from~Operations(Net~Sales)}\times100
Example: If Cost of Revenue from Operation = 7,00,000 Net Revenue from Operation = 12,00,000 and Operating Expenses = 2,00,000.
Solution:
Operating Profit Ratio = 12,00,000 - ( 7,00,000 + 2,00,000 ) / 12,00,000 x 100
= 12,00,000 - 9,00,000/12,00,000 x 100
= 3,00,000/12,00,000 x 100
= 25 %
Net Profit Ratio
Net Profit Ratiois given by the formula:
Net~Profit~Ratio(before~Tax)=\frac{Net~Profit~before~Tax}{Net~Revenue~from~Operations(Net~Sales)}\times100
OrNet~Profit~Ratio(after~Tax)=\frac{Net~Profit~after~Tax}{Net~Revenue~from~Operations(Net~Sales)}\times100
ExampleIf Cost of Revenue from Operation = 6,00,000, Net Revenue from Operation = 10,00,000 debt-to-equity ratioOperating Expenses = 3,00,000, Non-Operating Expenses = 10,000.
Solution:
Net Profit Ratio (Before Tax) = 10,00,000 - 6,00,000 + 3,00,000 + 10,000 / 10,00,000 x 100
= 2,20,000/10,00,000 x 100
= 22 %
Return on Investment Ratio
Return on Investment is given by the formula:
Return~on~Investment~or~Return~on~Capital~Employed=\frac{Net~Profit~before~Interest~and~Tax}{Capital~Employed}\times100
Example: If Net Profit Before Interest and Tax = 3,00,000 and Capital Employed = 12,00,000
Solution:
Return on Investment Ratio = 3,00,000 / 12,00,000 x 100
= 25 %
Summary
Ratio analysis provides valuable insights into various aspects of a company's financial health, including liquidity, solvency, profitability, efficiency, and market valuation. By understanding and applying these key formulas, stakeholders can make informed decisions about investments, management strategies, and overall financial performance.