IMPORTANT FORMULAE OF RATIO ANALYSIS
LIQUIDITY RATIOS:
SOLVENCY RATIOS:
1. Debt to Equity ratio
= Long Term Debt ÷ Shareholder's Funds.
where,
(a) Shareholders’ Funds (Equity) = Share capital + Reserves and Surplus + Money received against share warrants
Share Capital = Equity share capital + Preference share capital
OR
(b) Shareholders’ Funds (Equity) = Non-current assets + Working capital – Non-current liabilities.
Working Capital = Current Assets – Current Liabilities
Low debt to equity ratio indicates that the company relies less on outside debt (loans) for running the business. This makes outsiders feel more comfortable in dealing with the company, especially the banks which give loans to the company.
2. Total Assets to Debt ratio
= Total Assets ÷ Long Term Debts
This ratio indicates how much of total assets have been financed by long-term debts.
The higher ratio indicates that assets have been mainly financed by owner's funds and less of long-term debts. On the other hand, a lower ratio indicates that assets are mainly financed by long term liabilities (debts) and less of the owner's fund.
Let's say a company has total assets of Rs.100/- and total long term debts/liabilities of Rs.40/-. In this case, the Total Assets to Debt ratio would work out to 2.5:1. This indicates that for every Rs.2.5/- invested in assets, Rs.1/- is being financed by debt (long term liabilities).
Suppose the ratio of some other company works out to 1.5:1. This indicates that for every Rs.1.5/- invested in assets, Rs.1/- is being financed by debt (long term liabilities).
If you compare the above two firms, you would realise that the 1st firm relies more on owners fund and less on debt whereas the latter one relies more on debt and less on owner's fund.
3. Proprietary ratio
= Proprietors fund or shareholders fund ÷ Total Assets
Shareholders Fund
= Share capital + reserves and surplus - Fictitious Assets.
This ratio shows the relationship between proprietor’s (shareholders) funds to total assets. A higher proportion of shareholders funds in financing the assets is a positive feature as it provides security to creditors.
TURNOVER 0R ACTIVITY OR PERFORMANCE RATIOS:
1. Working Capital Turnover ratio
=Net revenue from operation ÷ working capital
Net revenue from operation means net sales (Sales - Sales Return)
Working Capital
= Current assets - Current Liabilities.
For example, if a company's net sales for a recent year were Rs.24,00,000/- and its average amount of working capital during the year was Rs.4,00,000/-, its working capital turnover ratio was 6 (Rs.24,00,000/- divided by Rs.400,000).
High working capital turnover reflects the efficient utilisation of working capital employed.
2. Inventory Turnover Ratio
= Cost of revenue from operation ÷ Average Inventory
Cost of revenue means the cost of goods sold.
Cost of goods sold = Net Sales - Gross Profit
Average inventory
= (Opening inventory + Closing inventory) ÷ 2
If opening inventory is not given, closing inventory will be the average inventory.
This ratio determines the number of times inventory is converted into revenue from
operations during the accounting period under consideration. It expresses the relationship between the cost of revenue from operations and average inventory. It studies the frequency of conversion of inventory of finished goods into revenue from operations. It is also a measure of liquidity. It determines
how many times inventory is purchased or replaced during a year. Low turnover
of inventory may be due to bad buying, obsolete inventory, etc., and is a danger
signal. High turnover is good but it must be carefully interpreted as it may be due to buying in small lots or selling quickly at a low margin to realise cash
3. Debtors Turnover Ratio
= Net credit revenue from operation ÷ Average Debtors
Average Debtors
= (Debtors & Bills Receivables at the beginning of the year + Debtors & Bills Receivable at the end of the year) ÷ 2
4. Debt collection period
= 365 ÷ Debtors turnover ratio
5. Creditors (Payable) Turnover Ratio
= Net credit purchases ÷ Average Accounts Payable.
Average Accounts Payable
= (Creditors and Bills payable at the beginning of the year + Creditors and Bills payable at the end of the year) ÷ 2
6. Fixed Assets Turnover ratio
= (Revenue from operations or Cost of Revenue from operations) ÷ Net fixed assets.
If revenue from operations is not given, then the cost of revenue from operations will be in the numerator in the above formula).
This ratio indicates how effectively the fixed assets of the business are used by taking sales as a parameter.
For example, if sales/revenue from operations = Rs.200/- and net fixed assets = Rs.100/-, fixed assets turnover would be 2 times. In other words, the business generates sales worth an amount which is twice of the value of net fixed assets used. High fixed assets turnover indicates better utilisation of net fixed assets. For example, let us assume there are two firms in the same industry. One firm has fixed assets turnover ratio of 3:1 and another us having fixed assets turnover ratio is 2:1. The firm having the ratio of 3:1 is utilising its fixed assets better since against one rupee invested in fixed assets, it is generating sales worth 3 rupees while the other firm is only able to generate sales of Rs. 2 against every one rupee invested in fixed assets.
7. Current assets Turnover Ratio
= (Revenue from operation or Cost of revenue from the operation) ÷ Current Assets
If revenue from operations is not given, then the cost of revenue from operations will be in the numerator in the above formula)
Cost of Goods Sold/Cost of revenue from operation
= (Opening Stock + Purchases + Direct Expenses) - Closing Stock
OR
= Revenue from Operation - Gross Profit
PROFITABILITY RATIOS:
1. Gross Profit Ratio
= (Gross profit/Net Revenue from an operation) x l00
Gross Profit = Net Revenue from the operation - the cost of revenue from operation
This ratio measures the relationship between gross profit and net sales. It determines the efficiency with which functions of production/purchase of goods and selling of goods are carried.
Higher gross profit ratio indicates that the functions of production/purchase and sales of goods are being done in a good manner.
2. Net profit ratio
= (Net Profit/Net Revenue from operation) x 100
Net Profit = Gross Profit + (operating and non -operating income) - (operating and non - expenses)
This ratio shows the relationship between net profit and net sales.
This ratio reflects the overall efficiency of the business.
Non operating income includes income from non-trading activities such as interest received dividend received, profit on a sale of assets, tax refund, etc. The main purpose of this ratio is to know the return on investment.
3. Operating net profit ratio
= (Operating net profit ÷ Net Revenue from the operation) x 100
Where Operating Profit = Revenue from Operations – Operating Cost
This ratio is used to calculate the operating margin.
It helps us to analyse how efficiently the business is being conducted. A lower operating ratio is a very
healthy sign.
4. Operating Ratio
=[(Cost of revenue from operation + Operating expenses) ÷ Net revenue from operation] × 100
Cost of revenue from operations is Cost of Goods Sold
This ratio is calculated to compare the cost of operation in relation to revenue from operations.
Operating expenses include office expenses, administrative expenses, selling
expenses, distribution expenses, depreciation and employee benefit expenses etc.
Cost of operation is determined by excluding non-operating incomes and
expenses such as loss on the sale of assets, interest paid, dividend received, loss by
fire, speculation gain and so on.
5. Return on investment ( ROI)
= (Net Profit before interest, tax & dividend ÷ Capital Employed) x 100
Capital employed=
Share Capital + Undistributed profit +long term loans - fictitious assets (like underwriting commission, preliminary expenses, discount or loss on issue of shares) and non-operating assets like investments.
Or
Net fixed assets + Working capital
Working capital= Current assets-current liabilities.
This ratio indicates how much profit the company is able to generate per rupee of capital employed
6. Earning per share = (Net Profit - Preference dividend) ÷ no of Equity shares.
Net Profit = Profit after Tax.
This ratio is very important from the equity shareholders point of view and also for the share price in the stock market.
This ratio helps the comparison of a business with other companies/businesses to ascertain capacity to pay the dividend.
7. Dividend per share = (Net Profit after interest, taxes and preference dividend) ÷ Number of equity shares.
This ratio gives an indication as to what proportion of earning is being distributed to the shareholders. This indicates the company’s dividend policy.
8. Price Earning Ratio = Market price of a share ÷ Earning per share
Price / Earnings Ratio reflects the expectation of investors about the growth in the firm’s earnings and reasonableness of the market price of its shares. P/E Ratio varies from industry to industry and company to company in
the same industry depending upon investors perception of their future.
LIQUIDITY RATIOS:
There are two liquidity ratios. They help you understand liquidity (cash) position of the business.
1. Current ratio = Current Assets ÷ Current liabilities.
Current liabilities: Current liabilities are the liabilities which the business has to pay within a year. These are short-term liabilities. For example, trade creditors. Trade Creditors are the suppliers from whom we purchase the goods on credit. Usually, the payment to trade creditors is made within one year
1. Current ratio = Current Assets ÷ Current liabilities.
Current liabilities: Current liabilities are the liabilities which the business has to pay within a year. These are short-term liabilities. For example, trade creditors. Trade Creditors are the suppliers from whom we purchase the goods on credit. Usually, the payment to trade creditors is made within one year
Current Assets: These are short-term assets. Current assets are assets which are expected to be converted to cash within a year. For example, Debtors. Debtors are the customers to whom we have sold the goods on credit. Generally, the amount receivable from debtors is received within a year's time.
Thus current ratio helps you understand liquidity (cash) position of the company if you consider a one-year time frame.
The ideal current ratio is 2:1
If the current ratio is less than 2:1, it indicates that the business is likely to face a cash crunch in the next one year. It means the company is facing short term liquidity crunch and there may be delays in payment to suppliers/creditors. The company needs to sort it out quickly or else things will become more difficult to handle
However, it should also be noted that a very high current ratio is also not desirable. It indicates that business has too much liquidity and is not able to make productive use of its excess liquidity.
If the current ratio is less than 2:1, it indicates that the business is likely to face a cash crunch in the next one year. It means the company is facing short term liquidity crunch and there may be delays in payment to suppliers/creditors. The company needs to sort it out quickly or else things will become more difficult to handle
However, it should also be noted that a very high current ratio is also not desirable. It indicates that business has too much liquidity and is not able to make productive use of its excess liquidity.
2. Liquid or Quick or Acid Test Ratio
= Liquid Assets(Quick Assets) ÷ Current Liabilities
= Liquid Assets(Quick Assets) ÷ Current Liabilities
Liquid assets include cash and all other assets which can be converted into cash at very short notice. These are the assets which can be disposed off quickly. They are also called quick assets. For example, cash in hand, cash at bank, shares etc.
Liquid Assets (Quick Assets)
= Current Assets - Inventory(Stock) -Prepayments
= Current Assets - Inventory(Stock) -Prepayments
Thus quick ratio helps you understand the immediate liquidity position of the business.
Ideal liquid ratio = 1:1
If the liquid ratio is less than 1:1, it means business is facing a cash crunch.
If the liquid ratio is less than 1:1, it means business is facing a cash crunch.
SOLVENCY RATIOS:
1. Debt to Equity ratio
= Long Term Debt ÷ Shareholder's Funds.
where,
(a) Shareholders’ Funds (Equity) = Share capital + Reserves and Surplus + Money received against share warrants
Share Capital = Equity share capital + Preference share capital
OR
(b) Shareholders’ Funds (Equity) = Non-current assets + Working capital – Non-current liabilities.
Working Capital = Current Assets – Current Liabilities
Debt-Equity Ratio measures the relationship between external long-term debt/loans and equity (owners’ investment in the business)
Low debt to equity ratio indicates that the company relies less on outside debt (loans) for running the business. This makes outsiders feel more comfortable in dealing with the company, especially the banks which give loans to the company.
2. Total Assets to Debt ratio
= Total Assets ÷ Long Term Debts
This ratio indicates how much of total assets have been financed by long-term debts.
The higher ratio indicates that assets have been mainly financed by owner's funds and less of long-term debts. On the other hand, a lower ratio indicates that assets are mainly financed by long term liabilities (debts) and less of the owner's fund.
Let's say a company has total assets of Rs.100/- and total long term debts/liabilities of Rs.40/-. In this case, the Total Assets to Debt ratio would work out to 2.5:1. This indicates that for every Rs.2.5/- invested in assets, Rs.1/- is being financed by debt (long term liabilities).
Suppose the ratio of some other company works out to 1.5:1. This indicates that for every Rs.1.5/- invested in assets, Rs.1/- is being financed by debt (long term liabilities).
If you compare the above two firms, you would realise that the 1st firm relies more on owners fund and less on debt whereas the latter one relies more on debt and less on owner's fund.
3. Proprietary ratio
= Proprietors fund or shareholders fund ÷ Total Assets
Shareholders Fund
= Share capital + reserves and surplus - Fictitious Assets.
This ratio shows the relationship between proprietor’s (shareholders) funds to total assets. A higher proportion of shareholders funds in financing the assets is a positive feature as it provides security to creditors.
TURNOVER 0R ACTIVITY OR PERFORMANCE RATIOS:
1. Working Capital Turnover ratio
=Net revenue from operation ÷ working capital
Net revenue from operation means net sales (Sales - Sales Return)
Working Capital
= Current assets - Current Liabilities.
For example, if a company's net sales for a recent year were Rs.24,00,000/- and its average amount of working capital during the year was Rs.4,00,000/-, its working capital turnover ratio was 6 (Rs.24,00,000/- divided by Rs.400,000).
High working capital turnover reflects the efficient utilisation of working capital employed.
2. Inventory Turnover Ratio
= Cost of revenue from operation ÷ Average Inventory
Cost of revenue means the cost of goods sold.
Cost of goods sold = Net Sales - Gross Profit
Average inventory
= (Opening inventory + Closing inventory) ÷ 2
If opening inventory is not given, closing inventory will be the average inventory.
This ratio determines the number of times inventory is converted into revenue from
operations during the accounting period under consideration. It expresses the relationship between the cost of revenue from operations and average inventory. It studies the frequency of conversion of inventory of finished goods into revenue from operations. It is also a measure of liquidity. It determines
how many times inventory is purchased or replaced during a year. Low turnover
of inventory may be due to bad buying, obsolete inventory, etc., and is a danger
signal. High turnover is good but it must be carefully interpreted as it may be due to buying in small lots or selling quickly at a low margin to realise cash
3. Debtors Turnover Ratio
= Net credit revenue from operation ÷ Average Debtors
Average Debtors
= (Debtors & Bills Receivables at the beginning of the year + Debtors & Bills Receivable at the end of the year) ÷ 2
4. Debt collection period
= 365 ÷ Debtors turnover ratio
5. Creditors (Payable) Turnover Ratio
= Net credit purchases ÷ Average Accounts Payable.
Average Accounts Payable
= (Creditors and Bills payable at the beginning of the year + Creditors and Bills payable at the end of the year) ÷ 2
6. Fixed Assets Turnover ratio
= (Revenue from operations or Cost of Revenue from operations) ÷ Net fixed assets.
If revenue from operations is not given, then the cost of revenue from operations will be in the numerator in the above formula).
This ratio indicates how effectively the fixed assets of the business are used by taking sales as a parameter.
For example, if sales/revenue from operations = Rs.200/- and net fixed assets = Rs.100/-, fixed assets turnover would be 2 times. In other words, the business generates sales worth an amount which is twice of the value of net fixed assets used. High fixed assets turnover indicates better utilisation of net fixed assets. For example, let us assume there are two firms in the same industry. One firm has fixed assets turnover ratio of 3:1 and another us having fixed assets turnover ratio is 2:1. The firm having the ratio of 3:1 is utilising its fixed assets better since against one rupee invested in fixed assets, it is generating sales worth 3 rupees while the other firm is only able to generate sales of Rs. 2 against every one rupee invested in fixed assets.
7. Current assets Turnover Ratio
= (Revenue from operation or Cost of revenue from the operation) ÷ Current Assets
If revenue from operations is not given, then the cost of revenue from operations will be in the numerator in the above formula)
Cost of Goods Sold/Cost of revenue from operation
= (Opening Stock + Purchases + Direct Expenses) - Closing Stock
OR
= Revenue from Operation - Gross Profit
PROFITABILITY RATIOS:
1. Gross Profit Ratio
= (Gross profit/Net Revenue from an operation) x l00
Gross Profit = Net Revenue from the operation - the cost of revenue from operation
This ratio measures the relationship between gross profit and net sales. It determines the efficiency with which functions of production/purchase of goods and selling of goods are carried.
Higher gross profit ratio indicates that the functions of production/purchase and sales of goods are being done in a good manner.
2. Net profit ratio
= (Net Profit/Net Revenue from operation) x 100
Net Profit = Gross Profit + (operating and non -operating income) - (operating and non - expenses)
This ratio shows the relationship between net profit and net sales.
This ratio reflects the overall efficiency of the business.
Non operating income includes income from non-trading activities such as interest received dividend received, profit on a sale of assets, tax refund, etc. The main purpose of this ratio is to know the return on investment.
3. Operating net profit ratio
= (Operating net profit ÷ Net Revenue from the operation) x 100
Where Operating Profit = Revenue from Operations – Operating Cost
This ratio is used to calculate the operating margin.
It helps us to analyse how efficiently the business is being conducted. A lower operating ratio is a very
healthy sign.
4. Operating Ratio
=[(Cost of revenue from operation + Operating expenses) ÷ Net revenue from operation] × 100
Cost of revenue from operations is Cost of Goods Sold
This ratio is calculated to compare the cost of operation in relation to revenue from operations.
Operating expenses include office expenses, administrative expenses, selling
expenses, distribution expenses, depreciation and employee benefit expenses etc.
Cost of operation is determined by excluding non-operating incomes and
expenses such as loss on the sale of assets, interest paid, dividend received, loss by
fire, speculation gain and so on.
5. Return on investment ( ROI)
= (Net Profit before interest, tax & dividend ÷ Capital Employed) x 100
Capital employed=
Share Capital + Undistributed profit +long term loans - fictitious assets (like underwriting commission, preliminary expenses, discount or loss on issue of shares) and non-operating assets like investments.
Or
Net fixed assets + Working capital
Working capital= Current assets-current liabilities.
This ratio indicates how much profit the company is able to generate per rupee of capital employed
6. Earning per share = (Net Profit - Preference dividend) ÷ no of Equity shares.
Net Profit = Profit after Tax.
This ratio is very important from the equity shareholders point of view and also for the share price in the stock market.
This ratio helps the comparison of a business with other companies/businesses to ascertain capacity to pay the dividend.
7. Dividend per share = (Net Profit after interest, taxes and preference dividend) ÷ Number of equity shares.
This ratio gives an indication as to what proportion of earning is being distributed to the shareholders. This indicates the company’s dividend policy.
8. Price Earning Ratio = Market price of a share ÷ Earning per share
Price / Earnings Ratio reflects the expectation of investors about the growth in the firm’s earnings and reasonableness of the market price of its shares. P/E Ratio varies from industry to industry and company to company in
the same industry depending upon investors perception of their future.
Interesting Read.
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It covers all important Ratios along with Examples, Formula, Interpretation etc.
For example, learn Defensive Interval Ratio Formula
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