TREND ANALYSIS

VERTICAL and HORIZONTAL

VERTICAL ANALYSIS
HORIZONTAL ANALYSIS
2012 2011
2012 2011
RATIO ANALYSIS
OF FINANCIAL STATEMENTS
 Ratio Analysis
• is a method or process by which the
relationship of items or groups of items in the
financial statements are computed, and
presented.
• is an important tool of financial analysis.
• is used to interpret the financial statements so
that the strengths and weaknesses of a firm, its
historical performance and current financial
condition can be determined.
 Ratio
• ‘A mathematical yardstick that measures
the relationship between two figures or
groups of figures which are related to
each other and are mutually inter-
dependent’.
• It can be expressed as a pure ratio,
percentage, or as a rate
 Words of caution
• A ratio is not an end in itself. They are only a
means to get to know the financial position of
an enterprise.
• Computing ratios does not add any
information to the available figures.
• It only reveals the relationship in a more
meaningful way so as to enable us to draw
conclusions there from.
 Utility of Ratios
• Accounting ratios are very useful in
assessing the financial position and
profitability of an enterprise.

• However its utility lies in comparison of

the ratios.
 Utility of Ratios
• Comparison may be in any one of the following
forms:
• For the same enterprise over a number of years
• For two enterprises in the same industry
• For one enterprise against the industry as a whole
• For one enterprise against a pre-determined
standard
• For inter-segment comparison within the same
organisation
 Classification of Ratios
Ratios can be broadly classified into four groups
namely:
• Liquidity ratios
• Activity ratios
• Profitability Ratios
• Debt/Leverage Ratios
• Market Ratios
 Liquidity ratios
These ratios analyse the short-term financial
position of a firm and indicate the ability of the firm
to meet its short-term commitments (current
liabilities) out of its short-term resources (current
assets).
These are also known as ‘solvency ratios’. The
ratios which indicate the liquidity of a firm are:
• Current ratio
• Quick ratio or Acid-test ratio
 Current Ratio
- Measures the firm’s ability to meet its short-term
obligations
- It is calculated by dividing current assets by current
liabilities.
Current ratio = Current Assets
Current Liabilities
Conventionally a current ratio of 2:1 is considered satisfactory
 CURRENT ASSETS
includes –
Inventories of raw material, WIP, finished goods,
stores and spares,
sundry debtors/receivables,
short term loans deposits and advances,
cash in hand and bank,
prepaid expenses,
incomes receivables and
marketable investments and short term securities.
 CURRENT LIABILITIES
include –
sundry creditors/bills payable,
outstanding expenses,
unclaimed dividend,
advances received,
incomes received in advance,
provision for taxation,
proposed dividend,
instalments of loans payable within 12 months,
bank overdraft and cash credit
 Quick Ratio or Acid Test Ratio
- It is similar to Current Ratio except that it excludes inventory (which is
usually the least-liquid current asset). The generally low liquidity of
inventory results from two factors, 1.) many types of inventory cannot be
sold , 2.) inventory is typically sold on credit
- The quick ratio is calculated as follows

Quick ratio = Current Assets - Inventory

Current liabilities

Conventionally a quick ratio of 1:1 is considered

satisfactory.
 QUICK ASSETS & QUICK LIABILITIES

QUICK ASSETS are current assets (as stated

earlier)
less prepaid expenses and inventories.

QUICK LIABILITIES are current liabilities (as

stated earlier)
less bank overdraft and incomes received in
advance.
 ACTIVITY RATIO
These ratios are also called efficiency ratios / asset
utilization ratios or turnover ratios. These ratios
show the relationship between sales and various
assets of a firm. The various ratios under this
group are:
 Accounts Receivable Turnover
 Average Collection Period
 Inventory Turnover
 Average age of Inventory
 Average Payment Period
 Operating Cycle
 Cash Conversion Cycle
ACTIVITY RATIO
 ACTIVITY RATIO
Operating Cycle = Average Collection Period +
Average Age of Inventory

Cash Conversion Cycle = Operating Cycle –

Average Payment Period
 Current Ratio = 2.64
 Quick Ratio = 1.60
 AR Turnover = 44.44
 ACP = 8.2 days
 Inventory Turnover = 10
 Ave. Age of Inventory = 36.5
 Operating Cycle = 44.7 days
DEBT RATIOS
LEVERAGE RATIOS
 Debt/Leverage Ratios
These ratios indicate the long term solvency
of a firm and indicate the ability of the firm
to meet its long-term commitment with
respect to
(i) repayment of principal on maturity or in
predetermined instalments at due dates and
(ii) periodic payment of interest during the
period of the loan.
 Financial Leverage
Financial leverage refers to the company’s use of debt. It
defines the company’s capital structure which indicates how
much of the total assets are financed by debt and equity.
Debt Ratios or Leverage Ratios
The different ratios are:
– Debt Ratio
– Debt-to-Equity Ratio
– Interest Coverage Ratio
Debt Ratio
 PROFITABILITY RATIO
These ratios measure the operating efficiency of
the firm and its ability to ensure adequate
returns to its shareholders.
The profitability of a firm can be measured by its
profitability ratios.
Further the profitability ratios can be
determined
(i) in relation to sales and
(ii) in relation to investments
PROFITABILITY
Profitability refers to the company’s ability to
generate earnings. It is one of the most
important goals of businesses.

PROFITABILITY RATIOS
Profitability ratios in relation to sales:
• Gross Profit Margin
• Operating Profit margin
• Net Profit Margin
PROFITABILITY RATIOS
Profitability ratios in relation to investments
• Return on assets (ROA)
• Return on shareholder’s equity (ROE)
• Earnings per share (EPS)
• Dividend per share (DPS)
• Dividend payout ratio (D/P)
• Price earning ratio (P/E)
 Gross Profit Margin
Gross profit margin shows how many pesos of gross profit is earned for every
peso of sale. It provides information regarding the ability of a company to
cover its manufacturing cost from its sales.
Remember that gross profit is just sales less cost of goods or cost of services.

This ratio is calculated by dividing gross profit by sales. It is expressed as a

percentage. ( x 100)
Gross profit is the result of relationship between prices, sales
volume and costs.
Gross Profit Margin = Gross Profit
Net sales
 Operating Profit
Margin
- Operating profit margin shows how many pesos of operating
profit is earned for every peso of sale. It measures the amount of
income generated from the core business of a company.

Operating Profit Margin = Operating Income

Net Sales
Higher the ratio, greater is the capacity of the firm to withstand
adverse economic conditions and vice versa
 Net Profit Margin
- Net profit margin measures how much net profit a company
generates for every peso of sales or revenues that it generates.
Net Profit Margin = Net Income
Sales
 Return on Assets (ROA)
This ratio measures the profitability of the total funds
of a firm. It measures the relationship between net
profits and total assets. The objective is to find out
how efficiently the total assets have been used by the
management.
Return on Assets = Operating Income______

Total Assets
Total assets exclude fictitious assets. As the total
assets at the beginning of the year and end of the year
may not be the same, average total assets may be used
as the denominator.
Return on Shareholders Equity
This ratio measures the relationship of profits to
owner’s funds. Shareholders fall into two
groups i.e. preference shareholders and equity
shareholders. So the variants of return on
shareholders equity are

ROE = Net Income______

Total Shareholder’s Equity

.
• TOTAL SHAREHOLDER’S EQUITY includes
preference share capital plus equity share
capital plus reserves and surplus less
accumulated losses and fictitious assets. To
have a fair representation of the total
shareholders funds, average total
shareholders funds may be used as the
denominator
Return on ordinary shareholders equity =
net profit after taxes – pref. dividend x 100
Ordinary shareholders equity or net
worth
ORDINARY SHAREHOLDERS EQUITY OR NET
WORTH includes equity share capital plus
reserves and surplus minus fictitious assets.
 Earnings per share (EPS)
This ratio measures the profit available to the
equity shareholders on a per share basis. This
ratio is calculated by dividing net profit available
to equity shareholders by the number of equity
shares.
Earnings per share =
net profit after tax – preference dividend
Number of equity shares
 Dividend per share (DPS)
This ratio shows the dividend paid to the
shareholder on a per share basis. This is a better
indicator than the EPS as it shows the amount of
dividend received by the ordinary shareholders,
while EPS merely shows theoretically how much
belongs to the ordinary shareholders
Dividend per share =
Dividend paid to ordinary shareholders
Number of equity shares
 Dividend payout ratio (D/P)
This ratio measures the relationship between the
earnings belonging to the ordinary shareholders and the
dividend paid to them.
Dividend pay out ratio =
total dividend paid to ordinary shareholders x 100

Net profit after tax –preference dividend

OR
Dividend pay out ratio = Dividend per share x 100
Earnings per share
 Price earning ratio (P/E)
This ratio is computed by dividing the market
price of the shares by the earnings per share. It
measures the expectations of the investors and
market appraisal of the performance of the firm.
Price earning ratio = market price per share
Earnings per share