RATIO ANALYSIS

1. Liquidity Ratios
Liquidity ratios measure a company's ability to meet its short-term obligations using its short-term
assets. These are important for understanding how financially stable a business is in the short run.

Current Ratio indicates whether a company has enough current assets to cover its current liabilities. A
higher ratio suggests better short-term financial health.
Formula:
Current Ratio = Current Assets / Current Liabilities
This shows how many times the current assets can cover current liabilities. A ratio of 2:1 is generally
considered satisfactory.

Liquid Ratio, also called the quick ratio, is a stricter test of liquidity than the current ratio. It excludes
inventory and prepaid expenses, which may not be easily converted into cash.
Formula:
Liquid Ratio = Quick Assets / Quick Liabilities
Where,
QA = CA – Inventory – Prepaid Expenses
QL = CL – (Bank Overdraft)
This ratio helps in assessing a firm's ability to pay its liabilities with its most liquid assets.

Absolute Liquid Ratio considers only cash and cash equivalents for assessing liquidity. It reflects the
company’s immediate ability to pay off liabilities.
Formula:
Absolute Liquid Ratio = Absolute Liquid Assets / (Current Liabilities – Bank Overdraft)
Where,
Absolute Liquid Assets = Cash and Equivalent of Cash
This ratio is used in very conservative financial analysis and helps in emergency liquidity assessment.

2. Solvency Ratios
Solvency ratios show how capable a company is of meeting its long-term financial commitments. These
ratios help assess the financial structure and risk level.

Debt Equity Ratio indicates the proportion of long-term debt to shareholders’ funds. A lower ratio
means less risk and more financial stability.
Formula:
Debt Equity Ratio = Long Term Debt / Shareholders Fund
Where,
Shareholders Fund = Share Capital + Reserves and Surplus – Fictitious Assets
This ratio is used by creditors and investors to assess the riskiness of a firm.

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Proprietary Ratio shows the proportion of total assets financed by the owners (shareholders). A high
ratio indicates a strong equity base.
Formula:
Proprietary Ratio = Shareholders Fund / Total Assets
Where,
Total Assets = FA + CA
It reflects the financial soundness of the business from an ownership point of view.

Capital Gearing Ratio compares fixed cost-bearing funds to shareholders' equity. It indicates the
degree of financial leverage used by the company.
Formula:
Capital Gearing Ratio = Fixed Interest and Dividend Bearing Fund / Equity Shareholders Fund
This helps in understanding how much risk is borne by equity holders due to fixed commitments.

3. Profitability Ratios
Profitability ratios measure how efficiently a business is able to generate profit from its operations.
These are vital for performance evaluation.

Gross Profit Ratio indicates the margin between sales and cost of goods sold. It helps assess production
efficiency and pricing policy.
Formula:
Gross Profit Ratio = Gross Profit / Net Sales × 100
Where,
Gross Profit = Sales – Cost of Sale
Net Sales = Sales – Sales Return
A higher ratio reflects better profitability and control over production costs.

Net Profit Ratio shows the percentage of profit earned from total sales after deducting all expenses.
Formula:
Net Profit Ratio = Net Profit / Net Sales × 100
It is an important indicator of the overall profitability of the company.

Operating Ratio indicates the percentage of net sales that is consumed by operating expenses. A lower
ratio suggests higher operating efficiency.
Formula:
Operating Ratio = Operating Cost / Net Sales × 100
Where,
Operating Cost = Cost of Sale + Office and Administration Expenses + Selling and Distribution
Expenses
It reflects how much of the revenue is used in operations and how much remains as operating profit.

Operating Profit Ratio measures the efficiency of the company’s core business operations.
Formula:
Operating Profit Ratio = Operating Profit or EBIT / Net Sales × 100
This shows how much of the net sales result in operating profit before interest and taxes.

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Return on Capital Employed (ROCE) assesses how effectively the long-term funds of the business are
being used to generate earnings.
Formula:
Return on Capital Employed = EBIT / Capital Employed × 100
Where,
Capital Employed = Long term funds
It indicates how efficiently capital is being used to generate profits.

4. Turnover Ratios
Turnover ratios evaluate how efficiently the company uses its assets to generate revenue.

Inventory Turnover Ratio shows how many times inventory is sold and replaced during a period. A
higher ratio means efficient inventory management.
Formula:
Inventory Turnover Ratio = Cost of goods sold / Average Stock
Where,
Average Stock = (Opening Stock + Closing Stock) / 2
This ratio helps in assessing inventory handling efficiency.

Debtors Turnover Ratio measures how quickly a company collects its receivables. A high ratio
suggests effective credit and collection policies.
Formula:
Debtors Turnover Ratio = Net Credit Sales / Average Debtors
It is used to evaluate the efficiency of the credit department.

Creditors Turnover Ratio shows how quickly a company pays its suppliers. A low ratio might indicate
delay in payments.
Formula:
Creditors Turnover Ratio = Net Credit Purchases / Average Creditors
It helps evaluate the company’s relationship with its suppliers.

Assets Turnover Ratio measures how efficiently the company's tangible assets are used to generate
sales.
Formula:
Assets Turnover Ratio = Net Sales / Total Tangible Assets
A higher ratio indicates better utilization of assets to drive revenue.

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