Ratios of a company have meaning only when they are compared with some standards and it is always a challenging job to find and adequate
standard.
Company Differences
Situations of two companies are never same. Similarly the factors influencing the performance of a company in one year change in another year. Thus, the comparison of the ratios of two companies becomes difficult and meaning less when are operating in different situations.
Price Level Challenges
The interpretation and comparison of the ratios are also rendered invalid by the changing value of money; a change in the price level can seriously affect the validity of comparison of ratios computed for different time periods.
A STUDY OF RATIO ANALYSIS
Several ratios, calculated from the accounting date, can be grouped into various classes according to financial activity or function to be evaluated.
Ratios are complied and studied for profitability’s, assessment of financial position sufficiency of working capital strategies perused by the organization short term and long term solvency. Liquidity etc
TYPES OF RATIOS
Classification according to nature of accounting statements is divided into three categories there are:
1. Balance sheet Ratios 2. Profit and Loss A/C Ratios 3. Combined Ratios
1. Balance sheet Ratios:
-These ratios are calculated to judge the financial position of the concern from long-term as well as short-term solvency point of view. These ratios can be divided into two broad categories.
A. Liquidity Ratios:
-If it is decided to study the liquidity position of the concerns, in order to highlight the relative strength of the concerns in meeting their current obligations to maintain sound liquidity and to pin point the difficulties if any in it, then liquidity ratios are calculated. These ratios are used to measure the firm’s ability to meet short-term obligations. The important liquidity ratios are:
CURRENT
RATIO:-This is the most widely used ratio. It is the ratio of current assets to current liabilities. It shows a firm’s ability to cover its current liabilities with its current assets. This is also known as Working Capital Ratio. It is expressed as follows:
Current Assets Current Ratio =
Current Liabilities
Generally current ratio of 2:1 is considered ideal for a concern i.e., Current Assets should be twice of the Current Liabilities.
TABLE 4.1
Year Wise Total Current Assets and Current Liabilities of The CCSL Ltd., Chittoor.
YEAR CURRENT ASSETS CURRENT LIABILITIES RATIO IN %
2002-2003 28,77,42,756 18,91,05,178 1.52
2003-2004 17,58,61,331 14,23,09,387 1.20
2004-2005 20,80,30,364 14,87,32,016 1.40
2005-2006 38,19,73,121 18,96,05,315 2.00
2006-2007 37,30,29,183 27,31,27,341 1.40
(Source: Annual Reports of the CCSL)
R A T IO S
YEARS
0 0.5 1 1.5 2 2.5
2003 2004 2005 2006 2007
2006-07 2005-06 2004-05 2003-04 2002-03
INTERPRETATION:
-Current ratio measures the firm’s short-term solvency. The standard norm for current ratio is (2:1). It is evident that in the year 2005-06 Current Ratio 2.00 is satisfactory. In remaining years current ratio is less then 2 is not satisfactory. There fore it can be calculated that the liquidity performance of the company is poor.
QUICK RATIO:
-It shows a firm’s ability to met current Liabilities with its most liquid (quick) Assets. Liquid Assets are those assets, which are readily converted
into cash. This is also known as Liquid Ratio and Acid Test Ratio. It is calculated as under;
= Liquid Assets LiquidRatio
CurrentLiabilities
TABLE 4.2
Year Wise Liquid Assets and Current Liabilities of The CCSL Ltd., Chittoor.
YEAR LIQUID ASSETS CURRENT
LIABILITIES RATIO IN %
2002-2003 6,80,79,952 18,91,05,178 0.36
2003-2004 7,90,11,591 14,23,09,387 0.55
2004-2005 9,79,87,205 14,87,32,016 0.66
2005-2006 7,66,08,657 18,96,05,315 0.40
2006-2007 9,34,86,511 27,31,27,341 0.34
(Source: Annual Reports of the CCSL)
R A T IO S
2003 2004 2005 2006 2007
2006-07
Generally a quick ratio is 1:1 it considered to represent a satisfactory current financial condition. The quick ratio has never exceeded the standard ratio.
Empirically the quick ratio has increased from 0.36 to 0.66 in 2002-03 to 2004-05 and declined from 0.40 to 0.34 in 2005-06 to 2006-07. Therefore it can be concluded the liquidity performance of the company is absolutely poor.
CASH RATIO:
-Cash is most liquid Asset, a financial analyst may examine cash ratio and it’s equivalent to current liabilities. Trade investment or marketable
securities are equivalent of cash; therefore, they may be included in the computation of cash ratio. This Ratio also known as Absolute and Super Quick Ratio.
+ −
= CashandBankBalance Short termmarketable SecuritiesCashRatio
CurrentLiabilities
TABLE 4.3
Year Wise Cash and Bank Balance plus short term securities and Current Liabilities of
The CCSL Ltd., Chittoor.
YEAR CASH AND BANK CURRENT LIABILITIES
RATIO IN %
2002-2003 53,79,219 18,91,05,178 0.028
2003-2004 1,59,03,765 1,23,09,387 0.11
2004-2005 2,00,18,969 14,87,32,016 0.13
2005-2006 73,90,813 18,96,05,315 0.03
2006-2007 1,79,39,018 27,31,27,341 0.06
(Source: Annual Reports of the CCSL)
R A T IO S
2003 2004 2005 2006 2007
2006-07
-The desirable norm for cash ratio is 1:2. -The cash ratio is very low in 2002-03, 2005-06 and 2006-07 years. There after it is increased slightly that is 0.028, 0.11 and 0.13 on the years 2002-03 to 2004-05 respectively and declined in 2005-06 to 0.03 then increases in 2006-07 to 0.06. Anyway finally the company failed in keeping sufficient cash and bank balance and marketable securities.
B. CAPITAL STRUCTURE RATIOS:
-These ratios help in ascertaining the long term solvency of a firm which depends on firm’s adequate resources. To meet its long term funds
requirements, appropriate debt equity mix to raise long term and earnings to pay interest and installment of long term loans in time. The following ratios can be calculated for this purpose:
DEBT EQUITY RATIO:
-This ratio is calculated to measure the relative proportions of outsider’s funds and shareholders funds invested in the company. This ratio is determined to ascertain the soundness of long-term financial policies of the company and is also known as external equity ratio. It is calculated as follows.
Term liabilities + Current Liabilities Total Debt Ratio =
Equity
Debt to equity Ratio of 2:1 in case of (i) and 2:3 in cases (ii) are acceptable.
TABLE 4.6
Year Wise Fixed Assets and Capital Employed of The CCSL Ltd., Chittoor.
YEAR LONG TERM DEBTS SHAREHOLDERS FUNDS
(Source: Annual Reports of the CCSL)
R A T IO S
2003 2004 2005 2006 2007
2006-07
-This ratio gives results relating to the capital structure of the firm. 2:3 is the acceptable Debt Equity Ratio. Empirically the debt equity ratio declined only in the year of 2003-04 (0.68) remaining that all years were increased from 0.78 to 1.10. Therefore 1.10 means lenders have financed of CCSL Capital Employed in 2006-07.