Ratio & Break Even Ratio & Break Even AnalysisAnalysis

Basic Financial ReportsBasic Financial Reports

Balance SheetBalance Sheet

It shows the position of a firm at It shows the position of a firm at the end of a financial year. It is the end of a financial year. It is built on the accounting equation.built on the accounting equation.

Assets = Liabilities + CapitalAssets = Liabilities + Capital

Income StatementIncome Statement

It compares the firm’s expenses against its It compares the firm’s expenses against its revenue over a period of time to show its revenue over a period of time to show its net income (or net loss)net income (or net loss)

Net Income = Sales Revenue - ExpensesNet Income = Sales Revenue - Expenses

Statement of Cash flowsStatement of Cash flows

It shows the changes in the working It shows the changes in the working capital of a firm over a period of time. This capital of a firm over a period of time. This is done by listing the sources and is done by listing the sources and application of funds. application of funds.

Key RatiosKey Ratios

Liquidity RatiosLiquidity Ratios

Leverage RatiosLeverage Ratios

Operating RatiosOperating Ratios

Profitability RatiosProfitability Ratios

Liquidity RatiosLiquidity Ratios

They are also known as ‘working capital They are also known as ‘working capital ratio’ and ‘short-term solvency ratio’.ratio’ and ‘short-term solvency ratio’.

An enterprise must have adequate An enterprise must have adequate working capital to run its day to day working capital to run its day to day operations.operations.

Inadequacy of working capital will bringing Inadequacy of working capital will bringing the buss operations to a halt.the buss operations to a halt.

Current RatioCurrent Ratio

It measures the ability of a firm to meet its It measures the ability of a firm to meet its current liabilities or its short term current liabilities or its short term obligations.obligations.

It measures solvency by showing the It measures solvency by showing the firm’s ability to meet its current liabilities firm’s ability to meet its current liabilities out of its current assets.out of its current assets.

Current ratio = current assets – current libCurrent ratio = current assets – current lib

SignificanceSignificance

A lower current ratio indicates that the firm A lower current ratio indicates that the firm is not in a position to meet its current is not in a position to meet its current liabilities.liabilities.

A higher current ratio indicates that the A higher current ratio indicates that the firm has inadequately employed the funds. firm has inadequately employed the funds. This means that the funds are blocked up This means that the funds are blocked up in current assets.in current assets.

Quick RatioQuick Ratio

It is also termed as ‘acid test ratio’.It is also termed as ‘acid test ratio’.

It is ascertained by comparing the liquid It is ascertained by comparing the liquid assets (CA- prepaid expenses and stock) assets (CA- prepaid expenses and stock) with the Current Liabilities.with the Current Liabilities.

Quick Ratio = Liquid assets Quick Ratio = Liquid assets

Current LiabilitiesCurrent Liabilities

Significance Significance

It is compared with the current ratio and It is compared with the current ratio and then we arrive at a conclusion.then we arrive at a conclusion.

Example:Example:

Suppose Firm ‘A’ & Firm ‘B’, doing similar Suppose Firm ‘A’ & Firm ‘B’, doing similar business have same current ratio (1.8: 1) business have same current ratio (1.8: 1) but the quick ratio of ‘A’s quick ratio is but the quick ratio of ‘A’s quick ratio is 0.75: 1 and ‘B’s quick ratio is 0.50: 1, it is 0.75: 1 and ‘B’s quick ratio is 0.50: 1, it is an indication of over stocking by ‘B’.an indication of over stocking by ‘B’.

Leverage RatioLeverage Ratio

Refers to the proportion between fixed Refers to the proportion between fixed interest or dividend bearing funds and interest or dividend bearing funds and non-fixed or dividend bearing funds in the non-fixed or dividend bearing funds in the total capital employed in the business.total capital employed in the business.

A proper proportion between the 2 funds is A proper proportion between the 2 funds is necessary in order to keep the cost of necessary in order to keep the cost of capital at the minimum. capital at the minimum.

Debt Equity RatioDebt Equity Ratio

Debt Equity Ratio is determined to Debt Equity Ratio is determined to ascertain the soundness of the long term ascertain the soundness of the long term financial policies of the company.financial policies of the company.

Debt equity ratio = Shareholders’ fundDebt equity ratio = Shareholders’ fund

Total long term debtTotal long term debt

SignificanceSignificance

This ratio in indicates the proportion of This ratio in indicates the proportion of owners’ stake in the business.owners’ stake in the business.

It tells the owners the extent to which they It tells the owners the extent to which they can gain the benefits with a limited can gain the benefits with a limited investment.investment.

Debt to Net Worth RatioDebt to Net Worth Ratio

It is the ratio of debt in the capital structure It is the ratio of debt in the capital structure to the net worth of the business.to the net worth of the business.

Debt to net worth ratio : DebtDebt to net worth ratio : Debt

Net worth Net worth

Turnover RatiosTurnover Ratios

They indicate the efficiency with which the They indicate the efficiency with which the capital employed is rotated in the capital employed is rotated in the business.business.

Average Inventory Turn over RatioAverage Inventory Turn over Ratio

This indicates the no of times the stock or This indicates the no of times the stock or inventory rotates in a business. inventory rotates in a business.

The more the ratio the more is the moving The more the ratio the more is the moving of stocks and vice versa.of stocks and vice versa.

Stock turnover ratio = cost of goods soldStock turnover ratio = cost of goods sold

avg. inventoryavg. inventory

Debtors Turn over Ratio Debtors Turn over Ratio

Debtors turnover ratio indicates the Debtors turnover ratio indicates the efficiency of the staff entrusted with the efficiency of the staff entrusted with the collection of book debts. collection of book debts.

The higher the ratio, the better it is and The higher the ratio, the better it is and vice versa.vice versa.

Debtors turnover ratio = total salesDebtors turnover ratio = total sales

Accounts rec.Accounts rec.

Creditors Turnover Ratio Creditors Turnover Ratio

It indicates the speed with which the It indicates the speed with which the payments for credit purchases are made payments for credit purchases are made to the creditors.to the creditors.

Creditors turnover ratio= cr. PurchCreditors turnover ratio= cr. Purch

av a/c recav a/c rec

Profitability RatiosProfitability Ratios

It is an indication of the efficiency with It is an indication of the efficiency with which the operations of the business are which the operations of the business are carried out.carried out.

Lack of control over the expense may Lack of control over the expense may result in low profitability.result in low profitability.

It is an indicator of whether a firm earns It is an indicator of whether a firm earns substantially more than what it pay as substantially more than what it pay as interest.interest.

Net Profit to sales RatioNet Profit to sales Ratio

This ratio indicates indicates the net This ratio indicates indicates the net margin on sales.margin on sales.

Net profit ratio = net profit X 100Net profit ratio = net profit X 100

net sales net sales

Break Even AnalysisBreak Even Analysis

It is the level of operation at which the business It is the level of operation at which the business neither earns a profit nor incurs a loss.neither earns a profit nor incurs a loss.

It is a useful planning tool because it shows It is a useful planning tool because it shows entrepreneurs minimum level of activity entrepreneurs minimum level of activity required to stay in business.required to stay in business.

With one change in the breakeven calculation, With one change in the breakeven calculation, an entrepreneur can also determine the sales an entrepreneur can also determine the sales volume required to reach a particular profit volume required to reach a particular profit target.target.