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Analysis of Financial Ratios

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(1)

Analysis of

Financial Ratios

Analysis of

Analysis of

Financial Ratios

Financial Ratios

CV.Alexander DGM &FM
(2)

Definition

Definition

• The relationship between two accounting figures expressed mathematically is known as financial ratio

(3)

Introduction

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

(4)

Objective

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

(5)

Factors that banks consider

Factors that banks consider

• Credit worthiness of the borrower • Integrity/reputation

• Credit risk profile

• Sensitivity to economic and market developments • Liquidity

• Solvency

• Profitability of business • Resource efficiency

(6)

Financial Analysis

Financial Analysis

• Trends in the financial planning

(7)

Assets &

Assets &

Liabililities

Liabililities

(

(

Rs.crore

Rs.crore

)

)

10756 9970 9270 Total Total 9270 9970 10756 297 278 168 Intangible Assets 1071 1298 840 Misc. Assets Net Worth 3742 3974 4065 6300 5527 5394 Net Fixed Assets Deferred Liability 3279 3688 039 Net Working Capital (619) (559) (436) 3088 2867 2868 Current Assets Current Liabilities 2249 2308 2652 Year 3 Year 2 Year 1 Category Category Year 1 Year 2 Year 3 Assets Liabilitiesm
(8)

Measures of Liquidity

Measures of Liquidity

• Net Working Capital • Current Ratio

• Quick Ratio

• Net Working Capital/Net Assets

(9)

Net Working Capital

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

(10)

Gross Working Capital

Gross Working Capital

• Gross Working Capital • How funded

• From own resources and other long term sources • Short fall if any from short term resources

(11)

Short Term Resources

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

(12)

Financing of Current Assets

Financing of Current Assets

(National Steel Corporation)

(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)

(13)

Concept of NWC

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

(14)

NWC

NWC

• Negative Net Working Capital • What is the Implication

• Business has applied part of surplus Current

Liabilities towards meeting shortfall in Long Term resources

(15)

NWC

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

(16)

NWC

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)

(17)

Current Ratio

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

(18)

Liquidity Ratios

Liquidity Ratios

3088 1040 2652 436 1.16 0.77 6104 7.14 14.12 2867 1846 2308 559 1.24 0.80 5526 10.12 19.50 2868 1792 2249 619 1.28 0.80 5635 10.98 21.58 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(%)
(19)

Quick Ratio

Quick Ratio

• From the ‘gone concern’ approach inventory is the least liquid of Current Assets

• Quick Ratio or Acid Test Ratio = Current Assets-Inventory/Current Liabilities

• Norm the QR should not be less than 1. • 1:1 is satisfactory

(20)

NWC/Net Sales

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

(21)

Falling NWC/Net Sales

Falling NWC/Net Sales

• Indicative of overtrading and serious liquidity problems

(22)

NWC/Current Assets

NWC/Current Assets

• This measures contribution of Long Term funds towards financing Current Assets

• Method of Lending

• 1st Method Amt. 2nd Method Amt.

Current Assets 370 25 (LTS) 370 Less CLs -150 278 WCG 220 -150 25% -55 MPBF 165 128 CR 1.17 CR 1.33

(23)

Debt Equity Ratio

Debt Equity Ratio

• DER = TLT Liabilitie/TNW

• Low ratio has a better leverage for borrowing

(24)

DSCR

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

(25)

Return on Assets

Return on Assets

• RoA = PBIT/Total Assets

• To measure profitability and efficiency

• Higher the ratio, the more efficient is the firm in using resources

(26)

Gross Profit Margin

Gross Profit Margin

• The surplus of sales over cost of goods sold

• Gross profit Margin= (Sales minus Cost of goods

sold )x 100/Sales

• A higher ratio indicates better managerial

(27)

Interest Coverage Ratio

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

(28)

Summary

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

• 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 Liquidity ratios

9 Leverage or solvency ratios 9 Activity Ratios

(29)

• ANY ???? • THANK YOU

References

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