Intermediate (IPC)Course Paper 3 Part 2 Financial Management Chapter 3
Classification of Ratios Liquidity Ratios Capital Structure / Leverage Ratios
Activity Ratios Profitability Ratios
Liquidity Ratios
Current Ratio Quick Ratio
Cash Ratio / Absolute Liquidity Ratio
Basic Defense Interval Ratio
LIABILITIES ASSETS
CURRENT LIABILITIES
0 100 200 300 400 500 600 700 Working Capital
Current Ratio
Current Liability Current Asset0 50 100 150 200 250 300 350 Working Capital Current Ratio Current Liability Current Asset DANGER ZONE
Scenario I II III
Current Asset
Current Liability
Net Working Capital
600 300 200 300 300 -100 300 - 300 Current Ratio 2:1 1:1 0.67:1
0 50 100 150 200 250 300 350 Working Capital
Quick Ratio / Acid Test Ratio
Current Liability Current Assets Liquid Assets
CURRENT ASSET 300 CURRENT
LIABILITY 300
QUICK RATIO = QUICK ASSETS / CURRENT LIABILITY = 200/300
= 0.67:1
270 280 290 300 310 320 330 340 350 360 Working Capital
Preferable Liquidity Position
Current Liability Current Assets Liquid Assets
0 50 100 150 200 250 300 350 Working Capital
Absolute Liquid Ratio
Current Liability Absolute Liquid Assets
CURRENT ASSET 350
CURRENT
LIABILITY 300
ABSOLUTE LIQUID RATIO
= 150/300 = 0.50:1
LIQUID ASSETS 250 ABSOLUTE
LIQUID ASSET 150
= ABSOLUTE LIQUID ASSETS / CURRENT LIABILITY
CASH EXPENSES P.A. ---
365 DAYS
= CASH EXPENSE PER DAY
CASH RESOURCES AVAILABLE ---
CASH EXPENSE PER DAY
NO. OF DAYS
BASIC DEFENSE INTERVAL
Capital
Structure
Ratios
Share Holders Funds 100 EQUITY RATIO
= 100/400 = 25%
Total Capital Employed 400
= Share holder Funds ---
DEBT (OUTSIDE LIABILITIES) 400 DEBT RATIO = 400/500 = 80% TOTAL CAPITAL EMPLOYED 500
=DEBT (OUTSIDE LIABILITIES) --- TOTAL CAPITAL EMPLOYED
DEBT (OUTSIDE
LIABILITIES) 400
DEBT-EQUITY RATIO
= 400/100
EQUITY 100
=DEBT (OUTSIDE LIABILITIES) ---
DEBT – EQUITY RATIO TIMES PERCENTAGE% 400/100 4:1 400/100 x 100 400% DEBT
Coverage Ratio
Debt
service
coverage
Ratio
(DSCR)
Interest
Coverage
Ratio
Preference
Dividend
Coverage
Ratio
Capital
Gearing
Ratio
Interest on Loan = 100 Installment = 100 ---
Total Debt Obligation = 200 PBDIT = 400
DSCR = Profit Before Depreciation and Interest Interest + Installment
= 400/200 = 2 times
Profit before depn ; Interest and Tax (PBDI T) = 400 Interest on Loan =100
Interest coverage ratio = PBDIT
Interest on loan = 400/100
PAT = 100 Preference Dividend Liability = 25 Preference Dividend Coverage Ratio = = 100/25
= 4 times
Profit After Tax
Calculation :
Share holders funds = 200 Interest Bearing Funds = 700
Capital Gearing Ratio = Interest Bearing Funds Share holders funds
= 700/200 = 3.5 times
Activity Ratios
Capital
Turnover
Ratio
Fixed Asset
Ratio
Total Asset
Turnover
Ratio
Working
capital
Turnover
Ratio
Calculation I II III Sales Capital Employed Capital Turnover Ratio 1000 2000 500 1000 1000 1000
Fixed Asset Turnover Ratio =
Sales
--- Average Fixed Assets
Calculation I II III Sales Opening Assets Closing Assets 1000 2000 500 500 2000 Nil 1000 3000 1000 Total Assets Turnover Ratio Average Assets 750 2500 500 1 Times 0.80 Times 1.33 Times
Working Capital
Ratio
Inventory
Turnover
Ratio
Debtors
Turnover
Ratio
Creditors
Turnover
Ratio
Calculation I II III Cost of Sales Opening Inventory Closing Inventory 1000 1000 1000 500 500 500 500 250 750 Inventory T/O Average Inventory 500 375 625 1.60 Times 2.67 Times 2 Times
= Cost of Goods Sold per Day
Cost of Goods Sold
---
No. of. Days in a Year
Average Inventory
---
Cost of Goods Sold per day No. of. Days of Inventory =
Calculation I II III Sales Cash Sales Credit Sales 1000 1000 1000 400 400 400 600 600 600 Closing Debtors Opening Debtors 100 200 200 600 400 200 Average Debtors 150 300 400
Debtors T/O 4 Times 2 Times 1.5 Times
Recovery Speed
Good Better Should
= Average Daily Credit Sales Credit Sales
---
365
Opening Debtors + Closing Debtors
---
2
= Average Debtors
Average Debtors
---
Average Daily Credit Sales
Sales-3,65,000 Cash Sales 182500 Credit Sales 182500 Credit Sales per Day Open Debtors 15000 500 Closing Debtors 20000 Average Debtors 17500 Average Collection Period Avg. Drs =--- Avg. Credit Sales per Day
=35 Days (/ 365 Days)
Calculation I II III Purchases Credit Purchases(60)% Opening Creditors 1000 1000 1000 600 600 600 100 200 300 Average Creditors Closing Creditors 200 400 500 400 300 150
Creditors Turnover 4 Times 2 Times 1.5 Times Interpretation Rapid Settlement Average Rotation Liberal/Stre ss
= Credit Purchases per Day Annual Credit Purchases
---
365 Days
Opening Creditors + Closing Creditors
---
2
= Average Creditors
Average Creditors
---
Credit Purchases per Day Average Payment Period =
Purchases-3,65,000
Cash Purchases 182500
Credit Purchases 182500
Credit Purchases per Day Opening Crs- 15000 500 Closing Crs- 20000 Average Creditors- 17500 Average Payment Period Average Crs =--- Avg. Credit Purchase per Day =35 Days (/ 365 Days) 17500 = --- 500
General Profitability Ratio Gross Profit Ratio Operating Ratio Operating Profit Ratio Expenses Ratio Net Profit Ratio
Calculation:
Gross Profit 20 Net Sales 100
x 100 = 20%
Operating Ratio = Operating Cost
Sales 100 Sales return 10
Raw material Consumed 60 Manufacturing Expenses 10 Admin Expenses 5 Cost of goods sold Other operating expenses
Operating Ratio = Operating Cost Net Sales x100 Operating cost 75 Net Sales 90 = 75/90 x 100 = 83 %
Net Sales 100 Operating Cost 80
Operating Profit - 20
Operating Profit ratio =
Operating Profit 20 Net Sales 100
x 100
Expenses Cost
Goods Sold
Cost of goods sold x 100 Net sales Admin Expenses Admin expenses x 100 Net Sales Factory Cost Factory Cost x 100 Net Sales Specific Expenses Specific expenses x100 Net Sales
Selling & Distribution Expenses
S & D Expenses x 100 Net Sales
Calculation :
Net Profit After Tax 20 Net Sales 100
x 100
Return on Investment Ratio Return On Asset Return on Capital Employed Return on Shareholders Equity
Sales 100 Less: Operating Expenses 50 Profit before Interest 50 Less: Interest (10) Profit before Tax 40 Less: Tax @ 30% (12) Profit After Tax 28 TOTAL ASSETS - 100 ROA = ROA = PAT Total Assets = 28/100 = 28% PBIT Total Assets = 50/100 = 50%
28+10- 3 = 35 Profit After Tax Before Interest
BALANCE SHEET LIABILITIES ASSET Share holders funds 100
Bank Loan 100 Sundry Creditors 100 300 Fixed Assets 150 Current Asset 150 300
Total Capital Employed - 300 Income Statement
Sales 200 Less: Operating Expense (150)
Operating Profit 50 Less: Interest (10)
Profit before Tax 40
ROCE = Operating profit Capital employed
= 50/300x 100 = 16.67 %
Return on Share holders Funds
= Profit After Tax
Share holders Funds X 100
Return on Equity Share Holders Funds Earnings Per Share Cash Flow Earnings Per Share Dividend Per Equity Share Dividend Pay Out Ratio Dividend Yield Ratio
Comprehensive Illustration Depreciation 100 Profit after Tax 1000 Preference Dividend 100 Profit after Tax and
Preference Dividend 900 Equity Dividend 100
800
EP S
= Profit after Tax and Pref. Dividend No. Of Equity Shares
= 900 / 100 => 9 Per Share Div. Per
Share
= Equity Dividend
No. Of Equity Shares
= 100 / 100 => 1 Per Share Div.
Payout Ratio
= Dividend Per Share Earnings Per Share
= 1 / 9 => 11.11% Cash Flow
Earnings Per Share
= (PAT & Pref Dividend + Depn/Amtisn + Non Cash Expense) ÷ No. Of Equity Shares
= (1000+100)/100 = 11 Per Share
Div. Yield Per Share
= Div. Per Share
Market Price per Share
= 1/10 => 10%
100
Market Value Ratios Earnings Yield Ratio Price Earning Ratio Price to Cash Flow Ratio Market Value to Book Value Ratio
Earning Yield Ratio
(E/P ratio) = Earning Per Share Market Price Per Share
Price Earnings Ratio (or)
P/E Ratio
= Market Price Per Share Earning Per Share
EPS 10 MPS 100 SOLD 10 Times of Earnings Low Profit Low EPS
High P/E ratio
High
High P/E ratio High Expectations Low profit Compare High Expectations
High Risk Element Industry
Average
Other Shares
Cash Flow
Earning Per Share = Cash Flow Earnings Market Price Per Share
Book Value of Share
Market Value of Share
Equity Share Capital + Reserve & Surplus (-) Accumulated Loss Books Value No. Of Equity Shares
= Books Value Per Share
Book Value Per Share Balance sheet Past Value Market Value Market Future BV = 10 MV = 30 BV to MV ratio = 30/ 10 = 3
Long Term Sources of Funds Long Term Uses of Funds Surplus Deficit Changes in WC Requirement Increase in WC Decrease in WC Changes in WC
Balance Sheet
Long Term Sources
Short Term Sources
Inflow Outflow Long term Uses
Sources of Funds
Short Term Uses Inflow Outflow
(Increase in WC)
Uses of Funds
Sources of Funds Uses of Funds
LONG TERM FUNDS
LONG TERM USES
Sources of Funds Uses of Funds
LONG TERM USES LONG TERM FUNDS
Fund Flow Analysis
Sources of Funds
Use of Funds Working Capital Raising Long Term Funds Equity Debenture TLs Funds From Operations Profit before Depreciatio n and Tax Disposing Long Term
Assets Paying Long Term Funds Back Dividend & Tax Purchase of Long Term Assets Increase in WC Decrease in WC
Fund Flow Analysis Current Year Income Statement Two Year Balance Sheet Changes in WC Long Term Uses Long Term Sources Funds Generated Operations
Fund From Operations
Profit Before Tax (+)
Depreciation/Amortization (+)
Losses on the Sales of Assets/Investments
(-)
Profit on the Sales of Assets/Investments
Sales
Less: Operating Exp
Less: Depreciation Less: Tax 100 (50) (20) PBT 30 (10) PAT 20 Liabilitie s Capital Reserves Term loan Current Liabilities PY 100 50 50 40 CY 110 70 60 50 240 290 Assets Fixed Assets Current Assets 150 90 170 120 240 290
Funds From Operations Capital Term Loan (60-50) (110-100) (30+20) 50 10 10 Fixed Assets (170-150)+20 Working Capital PY[90-40] CY[120-50] 70 40 =70 =50 20 70
INCOME STATEMENT BALANCE SHEET
FUND FLOW STATEMENT
SOURCES OF FUNDS USES OF FUNDS
PY CY
50
Tax
Uses of Fund Flow Statement
Where Funds Have Come From
Funds Generated From Operations Long Term Fund
Support for WC Purpose Financial Soundness Despite Loss Liquidity Strain Indicators Despite Profits Diversion of Short Term Fund
for Long Term Purpose
