Analysis of
Financial Ratios
CV.Alexander
DGM &FM
Version:
College of Agricultural Banking, RBI, PUNE
1
Definition
• The relationship between two accounting figures
expressed mathematically is known as financial
ratio
Date:
College of Agricultural Banking, RBI, PUNE
2
Introduction
• What is the purpose of analysis of financial ratios
– It is for a meaningful study of information in the
financial statements
– Ascertaining overall financial position of a business
organisation
– Interpretation of key information in the financial
statements
Date:
College of Agricultural Banking, RBI, PUNE
3
Objective
• The objectives:
– Assess credit risk profile of the borrower
– Stipulation of terms and conditions
– Assess utilization of credit facility
– Establish sound well defined credit granting criteria
– Ensure safety of bank funds
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College of Agricultural Banking, RBI, PUNE
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Factors that banks consider
•
•
•
•
•
•
•
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Date:
Credit worthiness of the borrower
Integrity/reputation
Credit risk profile
Sensitivity to economic and market developments
Liquidity
Solvency
Profitability of business
Resource efficiency
College of Agricultural Banking, RBI, PUNE
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Financial Analysis
• Trends in the financial planning
• Analysis of projected financial statements
Date:
College of Agricultural Banking, RBI, PUNE
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Assets & Liabililities
(Rs.crore)
Liabilitiesm
Year 3
Year 2
Year 1
Category
Category
Year 1
Year 2
Year 3
2652
2308
2249
Current
Liabilities
Current
Assets
2868
2867
3088
(436)
(559)
(619)
Net Working
Capital
039
3688
3279
Deferred
Liability
Net Fixed
Assets
5394
5527
6300
4065
3974
3742
Net Worth
Misc.
Assets
840
1298
1071
Intangible
Assets
168
278
297
9270
9970
10756
10756
Date:
Assets
9970
9270
Total
Total
College of Agricultural Banking, RBI, PUNE
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Measures of Liquidity
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•
•
•
•
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Net Working Capital
Current Ratio
Quick Ratio
Net Working Capital/Net Assets
Net Working Capital/Current Assets
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Net Working Capital
• Gross Working Capital ( GWC)
• is the investment required to be made by the
borrower in Current Assets
• How
• From own contributions
• From creditors, borrowings
• Other short term resources
Date:
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Gross Working Capital
•
•
•
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Gross Working Capital
How funded
From own resources and other long term sources
Short fall if any from short term resources
College of Agricultural Banking, RBI, PUNE
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Short Term Resources
• Short term resources constitute what are known
as ‘ Current Liabilities’
• Current Liabilities should be lower than Current
Assets
• Excess o0f Current Assets over Current Liabilities
is Net Working Capital
• Contribution from long term resources applied to
financing of Current Assets ( excess of Current
Assets) is owner’s stake or margin money
Date:
College of Agricultural Banking, RBI, PUNE
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Financing of Current Assets
(National Steel Corporation)
• 1.Current Assets
•
= Current Liabilities + NWC or
3088 = 2652 + 436
• 2. NWC = Current Assets – Current Liabilities or
•
436 = 3088 – 2652
• 3. Current Assets = Current Liabilities +
Contribution from Long Term Liabilities
• 3088 = 2249 +[(8104-7668)] =2652+436
• (i.e.NWC = 3088)
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College of Agricultural Banking, RBI, PUNE
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Concept of NWC
• NWC represents the surplus long term funds
applied towards financing of Current Assets
• Current assets are financed from two sources
– Surplus from Long Term Liabilities
– Current Liabilities
Difference between Current assets and Current Liabilities
should always be positive
Date:
College of Agricultural Banking, RBI, PUNE
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NWC
• Negative Net Working Capital
• What is the Implication
• Business has applied part of surplus Current
Liabilities towards meeting shortfall in Long Term
resources
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College of Agricultural Banking, RBI, PUNE
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NWC
• Positive NWC means
i.Borrower has brought in his
contribution
ii.Any fall in value of Current Assets will
be cushioned by borrower’s stake
iii.Loss in sale of Current Assets will not
affect Short term creditors
Date:
College of Agricultural Banking, RBI, PUNE
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NWC
• Net Working Capital ( NWC ) is a measure of
liquidity
• Sources for NWC
Long Term Liabilities net of Long Term Assets
( LTLs including Net Worth less LTAs which includes
Fixed Assets, miscellaneous assets and
intangibles. Another measure of liquidity is the
Current Ratio)
Date:
College of Agricultural Banking, RBI, PUNE
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Current Ratio
• Current Ratio:
Current Assets/ Current Liabilities
If Net Working Capital is to be of positive value
the Current Ratio must be higher than 1.
Ideally for calculating MPBF Current Ratio should be
1.33: 1
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College of Agricultural Banking, RBI, PUNE
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Liquidity Ratios
Year 1
1. Current Assets
2.Quick Assets
3.Current Liabilities
4.NWC (1-3)
5.Current Ratio
6.Quick Ratio
7.Net Sales
8 NWC/Net Sales (%)
9NWC/Current Assets(%)
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Year 2
2868
1792
2249
619
1.28
0.80
5635
10.98
21.58
College of Agricultural Banking, RBI, PUNE
2867
1846
2308
559
1.24
0.80
5526
10.12
19.50
Year 3
3088
1040
2652
436
1.16
0.77
6104
7.14
14.12
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Quick Ratio
• From the ‘gone concern’ approach inventory is
the least liquid of Current Assets
• Quick Ratio or Acid Test Ratio = Current AssetsInventory/Current Liabilities
• Norm the QR should not be less than 1.
• 1:1 is satisfactory
Date:
College of Agricultural Banking, RBI, PUNE
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NWC/Net Sales
• This percentage should be around 8-12 %
• NWC is lower:
•
Business is growing too fast without
building an adequate cushion in the form of NWC
• It indicates symptom of overtrading and
• Undue reliance on borrowed short term funds
Date:
College of Agricultural Banking, RBI, PUNE
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Falling NWC/Net Sales
• Indicative of overtrading and serious liquidity
problems
• It needs to be investigated
Date:
College of Agricultural Banking, RBI, PUNE
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NWC/Current Assets
• This measures contribution of Long Term funds
towards financing Current Assets
•
Method of Lending
• 1st Method
Amt. 2nd Method
Current Assets 370
25 (LTS)
Less CLs
-150
WCG
220
25%
-55
MPBF
165
CR
1.17
CR
Date:
College of Agricultural Banking, RBI, PUNE
Amt.
370
278
-150
128
1.33
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Debt Equity Ratio
• DER
= TLT Liabilitie/TNW
• Low ratio has a better leverage for borrowing
• Not more than 1.5 for providing finance by banks
Date:
College of Agricultural Banking, RBI, PUNE
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DSCR
• DSCR =( Net profit +Depcn+ Annual amount of
int.on LTLs)/Interest + principal
• Indicative of funds available for servicing long
term debt
• DSCR = 6+4+2/6 = 12/6= 2
• This is comfortable
• Should not be less than 1.5:1 while considering
projects
Date:
College of Agricultural Banking, RBI, PUNE
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Return on Assets
• RoA = PBIT/Total Assets
• To measure profitability and efficiency
• Higher the ratio, the more efficient is the firm in
using resources
Date:
College of Agricultural Banking, RBI, PUNE
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Gross Profit Margin
• The surplus of sales over cost of goods sold
• Gross profit Margin= (Sales
sold )x 100/Sales
minus
Cost of goods
• A higher ratio indicates better managerial
efficiency and profitability
Date:
College of Agricultural Banking, RBI, PUNE
26
Interest Coverage Ratio
• ICR = PBDIT/Annual Int.Obligation
• To find out whether business generates sufficient
profit to service interest payment
• Interest Coverage Ratio of 3 is reasonable and
below 2 is considered risk prone
Date:
College of Agricultural Banking, RBI, PUNE
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Summary
– Ratio analysis is used as a
major tool for financial
analysis
– For a meaningful study of
information contained in the
financial statements
– Ascertaining the overall
financial position of a
Business Organization
– Ratios are calculated from the
past financial statements
– Ratios could also be worked
out based on the projected
financial statements of the
same firm
Date:
• Easiest way of evaluating the
performance of a firm is by
comparing past and present
ratios
• Used to judge operational
efficiency, financial health,
solvency or soundness
• To find out the liquidity
position
• Major categories of ratios
9
9
9
9
Liquidity ratios
Leverage or solvency ratios
Activity Ratios
Profitability Ratios
College of Agricultural Banking, RBI, PUNE
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• ANY ????
• THANK YOU
Date:
College of Agricultural Banking, RBI, PUNE
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