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Ratio Analysis
SIESCOMS – EMBA - SEM2 (2013-14)
Financial Management
Assignment By: Sanjay Gupta (20), Kaushik Mandal (24), Baiju (11), Sharad Shitole (35)
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 Analysis
It’s a tool which enables the banker or lender to arrive at the following factors :
› Liquidity position
› Profitability
› Solvency
› Financial Stability
› Quality of the Management
› Safety & Security of the loans & advances to be or already been provided
Why Financial Analysis
› Lenders need it for carrying out the following
› Technical Appraisal
› Commercial Appraisal
› Financial Appraisal
› Economic Appraisal
› Management Appraisal
Why Financial Analysis
Before looking at the ratios there are a number of cautionary points concerning their use that need to be identified :
› The dates and duration of the financial statements being compared should be the same. If not, the effects of seasonality may cause erroneous conclusions to be drawn.
› The accounts to be compared should have been prepared on the same bases. Different treatment of stocks or depreciations or asset valuations will distort the results.
› In order to judge the overall performance of the firm a group of ratios, as opposed to just one or two should be used. In order to identify trends at least three years of ratios are normally required.
Why Financial Analysis
The utility of ratio analysis will get further enhanced if following comparison is possible.
› Between the borrower and its competitor
› Between the borrower and the best enterprise in the industry
› Between the borrower and the average performance in the industry
› Between the borrower and the global average
How a Ratio is expressed?
› As Percentage - such as 25% or 50% . For example if net profit is Rs.25,000/- and the sales is Rs.1,00,000/- then the net profit can be said to be 25% of the sales.
› As Proportion - The above figures may be expressed in terms of the relationship between net profit to sales as 1 : 4.
› As Pure Number / Times - The same can also be expressed in an alternatively way such as the sale is 4 times of the net profit or profit is 1/4th of the sales.
Classification of RatiosBalance Sheet Ratio P&L Ratio or
Income/Revenue Statement Ratio
Balance Sheet and Profit & Loss Ratio
Financial Ratio / Liquidity Ratio
Operating Ratio / Profitability / Leverage Ratio
Composite Ratio / Market Valuation Ratio
›Current Ratio›Quick Asset Ratio›Proprietary Ratio›Debt Equity Ratio
›Gross Profit Ratio›Operating Ratio›Expense Ratio›Net profit Ratio›Stock Turnover Ratio
Fixed Asset Turnover Ratio, Return on Total Resources Ratio, Return on Own Funds Ratio, Earning per Share Ratio, Debtors’ Turnover Ratio, P/E
Format of Balance Sheet for Ratio AnalysisLIABILITIES ASSETS
NET WORTH/EQUITY/OWNED FUNDS›Share Capital/ Partner’s Capital/ Paid up Capital/ Owners Funds
›Reserves ( General, Capital, Revaluation & Other Reserves)
›Credit Balance in P&L A/c
FIXED ASSETS : LAND & BUILDING, PLANT & MACHINERIES ›Original Value Less Depreciation
›Net Value or Book Value or Written down value
LONG TERM LIABILITIES/ BORROWED FUNDS :
›Term Loans (Banks & Institutions)
›Debentures/Bonds, Unsecured Loans, Fixed Deposits, Other Long Term Liabilities
NON CURRENT ASSETS› Investments in quoted shares & securities
›Old stocks or old/ disputed book debts
›Long Term Security Deposits
›Other Misc. assets which are not current or fixed in nature
CURRENT LIABILTIES›Bank Working Capital Limits such as CC/ OD/ Bills/ Export Credit
›Sundry/ Trade Creditors/ Creditors/ Bills Payable, Short duration loans or deposits
›Expenses payable & provisions against various items
CURRENT ASSETS : Cash & Bank Balance, Marketable/ quoted Govt. or other securities, Book Debts/ Sundry Debtors, Bills Receivables, Stocks & inventory (RM,SIP,FG) Stores & Spares, Advance Payment of Taxes, Prepaid expenses, Loans and Advances recoverable within 12 months
INTANGIBLE ASSETSPatent, Goodwill, Debit balance in P&L A/c, Preliminary or Preoperative expenses
Some important notes› Liabilities have Credit balance and Assets have Debit balance
› Current Liabilities are those which have either become due for payment or shall fall due for payment within 12 months from the date of Balance Sheet
› Current Assets are those which undergo change in their shape/form within 12 months. These are also called Working Capital or Gross Working Capital
› Net Worth & Long Term Liabilities are also called Long Term Sources of Funds
› Current Liabilities are known as Short Term Sources of Funds
› Long Term Liabilities & Short Term Liabilities are also called Outside Liabilities
› Current Assets are Short Term Use of Funds
Some important notes › Assets other than Current Assets are Long Term Use of Funds
› Instalments of Term Loan Payable in 12 months are to be taken as Current Liability only for Calculation of Current Ratio & Quick Ratio.
› If there is profit it shall become part of Net Worth under the head Reserves and if there is loss it will become part of Intangible Assets
› Investments in Govt. Securities to be treated current only if these are marketable and due. Investments in other securities are to be treated Current if they are quoted. Investments in allied / associate / sister units or firms to be treated as Non-current.
› Bonus Shares as issued by capitalization of General reserves and as such do not affect the Net Worth. With Rights Issue, change takes place in Net Worth and Current Ratio.
Ratio analysisRatio analysis is a tool which enables the banker or lender to arrive at the following factors :
1. Liquidity – the ability of the firm to pay its way
2. Investment / Shareholders – information to enable decisions to be made on the extent of the risk and the earning potential of a business investment
3. Gearing – information on the relationship between the exposure of the business to loans as opposed to share capital
4. Profitability – how effective the firm is at generating profits given sales and or its capital assets
5. Financial – the rate at which the company sells its stock and the efficiency with which it uses its assets
Liquidity Ratios › Liquidity Ratios : measure a firm’s ability to meet its financial obligations.
The overall health of a firm has traditionally been measured by these ratios.
› Current Ratio : Total Current Assets . Total Current Liabilities
If the Current Assets and Current Liabilities of a concern are
Rs.4,00,000 and Rs.2,00,000 respectively,
then the Current Ratio will be : Rs.4,00,000/Rs.2,00,000 = 2 : 1
The ideal Current Ratio preferred by Banks is 1.33 : 1
› Acid Test ration Or Quick Ratio : It is the ratio between Quick Current, Assets and Current Liabilities. The ratio should be at least equal to 1.
› Quick Ratio : Cash and Equivalents – Inventory Total Current Liabilities
Leverage / Solvency / Profitability Ratios
› Leverage of a firm: Proportion of its long term liabilities that are debts
› Debt/Equity ratio: Long term Debt . Shareholders’ Funds
For instance, if the Firm is having the following :
Capital = Rs. 200 LacsFree Reserves & Surplus = Rs. 300 LacsLong Term Loans/Liabilities = Rs. 800 LacsDebt Equity Ratio will be = 800/500 i.e. 1.6 : 1
› Debt to Assets: (Debts /Total Assets) X 100
Asset Utilization Ratios (AUR)/Capital structure
› Return to Total Assets: (Net Profit /Total Assets) X 100
› Return on Capital Employed (ROCE) : (Net Profit / Capital Employed) X 100
ORNet Profit before Interest and tax / Capital Employed X 100
– Average Capital Employed is the average of the equity share capital and long term funds provided by the owners and the creditors of the firm at the beginning and end of the accounting period.
› Return on Shareholders’ Equity (ROE) : Net Profit / Shareholders Funds X 100
Market Value /Investment /Valuation Ratios)› EPS (Earning Per Share) :
(Net Profit – Preference Dividend) No. of equity Shares
› P/E : Market Price / Earnings Per Share :
Market Price of Share EPS
› Earning Yields : (EPS / Market Price) X 100
Management / Turnover / Financial Ratios› Sales / Inventory :
High and low turnover relative to the industry could mean either poor inventory management (high turnover) or poor utilization of related resources (low turnover).
› Interest Coverage : (PBIT : Interest + Income Tax+ Net Profit) / Interest )
› Fixed Charge Coverage : PBIT / (Interest + Preference Dividend)
› Stock Turn Over : Cost of Goods Sold / Average Inventories
› Debtors Turn Over : Credit Sales / Debtors
› Average Collection Period : 360 days / Debtors Turnover
Ratio Analysis - Assignments
› Compare the performance of the company for three/five successive years
› The absolute numbers change so compare ratios
› Compare two companies of differing size but from the same industry, e.g., HUL and Godrej
› Calculate industry-wide numbers (net profit margins for consumer-able products )
Assignment - Undertaken
We have compared balance sheets / Profit and loss account statements of two companies viz. Hindustan Unilever Ltd. and Godrej Consumer products.
Comparative Financial Analysis
The following are various analysis metrics considered to compare the performance of HUL and GCPL:-› Short term Investment
› Long term Investment
› Short term Lending
› Long term Lending
Short term investment is the investment wherein it happens the continual buying and selling of stock of companies. Normally investments are done for less than a year.
Short term investment includes investment in stocks and other short term debt. The various ratios and factors to be taken into consideration are:-
› P/E ratio
› P/BV ratio
› EPS
Short Term Investment
P/E RatioThe P/E ratio tells us how much an investor in common stock pay per rupee of current earnings'
Computation: PE Ratio = Market Value per share / Earning per share
Interpretation:
A higher P/E ratio means that investors are paying more for each unit of net income, so the stock is more expensive, that is overvalued, compared to one with a lower P/E ratio
Trend Analysis:
P/E ratios for both the companies are increasing with almost equal rate and the absolute values are also more or less equal. Hence, we can’t conclude anything on the basis of this ratio alone.
2008 2009 2010 2011 2012
HUL 26.72 24.44 24.77 26.65 41.15
GCPL 21.6 21.13 32.48 27.18 40.53
2.57.5
12.517.522.527.532.537.542.5
26.7224.44 24.77
26.65
41.15
21.6 21.13
32.4827.18
40.53
Profit Earning Ratio
HULGCPL
Rati
o
P/BV Ratio This ratio is used to compare a stock's market value to its book value.
Computation: Price to Book Value = Market price per share / book value per share
Interpretation:
A lower P/BV ratio could mean that the stock is undervalued. Higher the P/BV ratio better is the shareholders position in terms of capital gain
Trend Analysis:
P/BV ratio of GCPL is 6.46 and it is decreasing but for HUL, it is 25.22 and increasing. So, we can say that GCPL share is under-valued as compared to HUL. This ratio for GPCL is not too low to get tense about returns from investment
2008 2009 2010 2011 2012
HUL 32.5 25.25 20.16 23.12 25.22
GCPL 18.96 6.36 9.74 7.71 6.47
2.5
7.5
12.5
17.5
22.5
27.5
32.532.5
25.25
20.1623.12
25.22
18.96
6.369.74
7.71 6.47
Profit Book Value Ratio
HULGCPL
Rati
o
EPS The earnings per share is a good measure of profitability. It gives a view of the comparative earnings of the similar firm.
Computation: Earnings per share (EPS) Ratio = (Net profit after interest, tax and Preference dividend) / No. of equity shares (common shares)
Interpretation:
Higher the EPS better it is and vice versa. It helps the company in estimating its capacity to pay dividend.
Trend Analysis:
EPS has been increasing for both the companies but GCPL is at a better position since the percentage increase in EPS and the absolute value of EPS is much better as compared to HUL
2008 2009 2010 2011 2012
HUL 8.12 11.47 10.09 10.68 12.45
GCPL 6.56 6.29 8.05 13.44 17.76
1
5
9
13
17
8.12
11.47 10.09
10.68
12.45
6.566.29 8.05
13.44
17.76
EPSR
ati
o
Long Term Investing refers to the fact that investment is made for a period greater than 1 year. The various factors to be considered are:-
› Fixed asset turnover ratio
› Return on Equity
› Return on capital employed
› Operating profit margin
Each of these factors has a role to play in the selection of the company for investment. However, the degrees to which they affect the returns vary in response to the other factors as well. Hence, for arriving at a decision for the investment, the entire basket needs to be considered. Following is a brief discussion for each of them.
Long Term Investing
Fixed-asset Turnover Ratio: This ratio measures a company's ability to generate net sales from fixed-asset investments - specifically property, plant and equipment (PP&E) - net of depreciation.
Computation:
Interpretation:
A higher fixed-asset turnover ratio shows that the company has been more effective in using the investment in fixed assets to generate revenues.
Trend Analysis:
The ratio is increasing for both the companies but for GCPL, it is increasing at a higher rate as compared to HUL, also, the absolute value for GCPL is higher than HUL. So, GCPL is more efficient of the two
2008 2009 2010 2011 2012
HUL 9.8 7.81 5.35 5.63 6.26
GCPL 4.6 4.18 4.73 6.09 7.49
1
3
5
7
9
11 9.8
7.81
5.35
5.636.26
4.6 4.184.73
6.097.49
Fixed-asset Turnover Ratio
HULGCPL
Rati
o
Return on EquityThe objective of computing this ratio is to find out how efficiently the funds supplied by the suppliers (Equity and Preference) have been used.
Computation: Return on Equity = Net Income/Shareholder's Equity
Interpretation:
Return on equity measures a corporation's profitability by revealing how much profit a company generates with the money shareholders have invested. So higher the ROE, better is the performance of the company.
Trend Analysis : ROE for both the companies are decreasing but for HUL the absolute value is much higher as compared to GCPL. Hence, of the two, HUL is a better option.
2008 2009 2010 2011 2012
HUL 122.91% 121.27% 85.25% 87.54% 76.62%
GCPL 98.47% 30.08% 29.98% 28.36% 23.94%
10.00%
30.00%
50.00%
70.00%
90.00%
110.00%
130.00% 122.91% 121.27%
85.25% 87.54%76.62%
98.47%
30.08% 29.98% 28.36% 23.94%
ROE
HULGCPL
Rati
o
Return on Capital Employed (ROCE)It is used to find out how efficiently the total assets have been utilized by the management.
Computation: ROCE = EBIT / (Total asset – current liabilities)
Interpretation:
ROCE indicates firm’s ability of generating profit per rupee of total assets. So higher the ROCE, better is the performance of the company
Trend Analysis : ROCE has been decreasing for both the companies but the absolute value of ROCE for HUL is more than 4 times than GCPL, which shows that HUL is performing much better and hence, it is a better option
2008 2009 2010 2011 2012
HUL 138.72 118.59 106.78 102.47 93.08
GCPL 66.03 32.65 35.73 28.43 21.42
10
30
50
70
90
110
130
150 138.72
118.59106.78 102.47
93.08
66.03
32.65 35.7328.43 21.42
ROCE
HULGCPL
Rati
o
Operating Profit Margins A ratio used to measure a company's pricing strategy and operating efficiency.
Computation: Operating Profit Margin = Operating Income / Net Sales
Interpretation: Operating margin gives analysts an idea of how much a company makes (before interest and taxes) on each rupee of sales. If a company's margin is increasing, it is earning more per rupee of sales. Higher the operating profit margin, the better the performance of the company.
Trend Analysis : HUL is a better option as its operating margin is high as well as it is increasing from the last year which is not the case with GCPL
Overall Analysis : After considering all the parameters, we can say that HUL is better for long term investment since it provides better dividends as compared to GCPL.
2008 2009 2010 2011 2012
HUL 0.127 0.122 0.136 0.128 0.142
GCPL 0.175 0.118 0.131 0.12 0.111
0.01
0.05
0.09
0.13
0.17
0.127
0.1220.136 0.128 0.142
0.175
0.1180.131
0.120.111
Operating Profit Margin
HULGCPL
Rati
o
The analysis of short term will depend on how much returns our investment will give us in the short run. A bank will thus lend only to the company, which is more efficient in running business, and will have higher sales in the near future that will ensure that the loan will be repaid on time.
Thus we must analyze why the company is borrowing money and what will be the application of funds. We must find out whether the company will apply the funds to pay back loans (principal or interest) or to raise fixed assets or to increase current assets. For short term lending the primary concern for any bank are the liquidity ratios of the company(s) concerned. So the parameters that we will take into consideration are:-
›Current Ratio
›Debtors Turnover Ratio
›Inventory Turnover Ratio
Short Term Lending
Current RatioA liquidity ratio that measures a company's ability to pay short-term obligations.
Computation:
Interpretation: The higher the current ratio, the more capable the company is of paying its obligations. It indicates rupees of current assets available for each rupee of current liability. Traditionally , a current ratio of 2:1 is considered to be satisfactory ratio. A ratio under 1 suggests that the company would be unable to pay off its obligations if they came due at that point. While this shows the company is not in good financial health, it does not necessarily mean that it will go bankrupt - as there are many ways to access financing - but it is definitely not a good sign.
Trend Analysis : When we compare the ratios for both the companies, HUL has a lower current ratio as compared to GCPL. The current ratio for HUL is decreasing as well unlike GCPL. This means that GCPL is a better company in paying off its obligations
2008 2009 2010 2011 2012
HUL 0.85 1.32 1.01 0.88 0.86
GCPL 0.95 2.23 1.46 0.74 1.2
0.25
0.75
1.25
1.75
2.25
0.85
1.321.01
0.88
0.86
0.95
2.23
1.46
0.74
1.2
Current Ratio
HULGCPL
Rati
o
Debtors Turnover RatioThis ratio shows how efficiently the company is making its credit sales and thereby making use of its assets.
Computation: Debtors Turnover ratio = Sales / Average Debtors
Interpretation: A high ratio indicates the company is doing well at lending credit and collecting debts. A low ratio indicates that company has to look back its credit policies.
Trend Analysis : In the last 5 years, the ratio has decreased for both the companies but it is decreasing at a much faster rate for GCPL as compared to HUL. The absolute value of GCPL is, however, marginally more than HUL. But, according to the trend HUL is doing better at lending credit and collecting debts
2008 2009 2010 2011 2012
HUL 31.41 41.83 29.24 24.28 27.27
GCPL 81.1 99.37 59.25 35.1 30.17
10
30
50
70
90
110
31.4141.83
29.24 24.28 27.27
81.1
99.37
59.25
35.1 30.17
Receivable Turnover Ratio
HULGCPL
Rati
o
Inventory Turnover RatioThis ratio gives number of times inventory is sold i.e. for it is sales to inventory ratio.
Computation: Inventory turnover ratio= sales/inventory
Interpretation: High value of this ratio indicates that a lot of inventory is either being sold or there is ineffective buying because of low prices. Low value indicates high inventory which is not good. It shows that sales are not happening.
Trend Analysis: Inventory turnover ratio of GCPL is low and decreasing from last year but for HUL, it is increasing which shows that HUL is more efficient in utilizing inventory
Overall Analysis: HUL is better at Receivable turnover ratio and Inventory turnover ratio signifying that for providing short term loans, HUL is a better company as compared to GCPL
2008 2009 2010 2011 2012
HUL 7.2 9.26 8.99 7.91 9.93
GCPL 5.7 9.25 7.93 8.2 7.16
1
3
5
7
9
11
7.2
9.26 8.99
7.91
9.93
5.7
9.257.93
8.2
7.16
Inventory Turnover Ratio
HULGCPL
Rati
o
The main purpose of long term lending is:
› Steady return for a long period of time
› Reduce risk
The lender generally looks at four ratios apart from the above analysis:
› Debt equity ratio
› Interest coverage ratio
› Fixed asset turnover ratio
› ROCE
Long Term Lending
D/E Ratio It is a measure of a company's financial leverage. It indicates what proportion of equity and debt the company is using to finance its assets.
Computation: D/E = Total liabilities / Net worth
Interpretation:
While a lower total debt to equity ratio generally reflects conservative financial policies and mean diluted earnings for equity investors as it probably suggests that the company is not leveraging itself optimally to achieve growth in return on equity funds.
A high debt/equity ratio generally means that a company has been aggressive in financing its growth with debt. This can result in volatile earnings as a result of the additional interest expense.
2008 2009 2010 2011 2012
HUL 0 0 0 0 0
GCPL 0.83 0.1 0 0.17 0.09
0.050.150.250.350.450.550.650.750.85
0 0 0 0 0
0.83
0.10
0.170.09
D/E Ratio
HULGCPL
Rati
o
Interest Coverage Ratio A ratio used to determine how easily a company can pay interest on outstanding debt.
Computation:
Interpretation: The lower the ratio, the more the company is burdened by debt expense. When a company's interest coverage ratio is 1.5 or lower, its ability to meet interest expenses may be questionable. An interest coverage ratio below 1 indicates the company is not generating sufficient revenues to satisfy interest expenses.
Trend Analysis : Interest coverage ratio of HUL is higher than GCPL and it has increased by almost 3000% and for GCPL, it has increased by almost 90% which clearly tells that HUL will be in better condition to repay interest on loans.
2008 2009 2010 2011 2012
HUL 92.3 119.5 404.94 12238.54 2796.6
GCPL 25 28.87 226.79 86.33 44.17
1000
3000
5000
7000
9000
11000
13000
92.3 119.5 404.94
12238.54
2796.6
25 28.87 226.79 86.33 44.17
Interest Coverage RatioR
ati
o
Fixed Asset Turnover Ratio This ratio measures a company's ability to generate net sales from fixed-asset investments - specifically property, plant and equipment (PP&E) - net of depreciation.
Computation:
Interpretation: A higher fixed-asset turnover ratio shows that the company has been more effective in using the investment in fixed assets to generate revenues.
Trend Analysis : From the last 3 years, the ratio is increasing for both the companies but the increase in percentage of GCPL as well as absolute value is greater as compared to HUL and hence, GCPL is a better option
2008 2009 2010 2011 2012
HUL 9.8 7.81 5.35 5.63 6.26
GCPL 4.6 4.18 4.73 6.09 7.49
1
3
5
7
9
11 9.8
7.81
5.355.63 6.26
4.6 4.18
4.73
6.097.49
Fixed-asset Turnover Ratio
HULGCPL
Rati
o
Return on Capital Employed It is a ratio that indicates the efficiency and profitability of a company's capital investments.
Computation: ROCE = EBIT / (Total asset – Current Liabilities)
Interpretation: ROCE measures a corporation's profitability by revealing how much profit a company generates with respect to the total investment made. So higher the ROCE, better is the performance of the company
Trend Analysis : ROCE has been decreasing for both the companies but the absolute value of ROCE for HUL is more than 4 times than GCPL, which shows that HUL is performing much better and hence, it is a better option
Overall Analysis : While comparing the two companies, we can see that HUL is better than GCPL for long term lending on parameters like ROCE, Interest coverage which signify that HUL is doing well in business.
2008 2009 2010 2011 2012
HUL 138.72 118.59 106.78 102.47 93.08
GCPL 66.03 32.65 35.73 28.43 21.42
10
30
50
70
90
110
130
150 138.72
118.59106.78 102.47
93.08
66.03
32.65 35.73 28.43 21.42
ROCE
HULGCPL
Rati
o
Queries ??
Thank You!Sanjay Gupta (20), Kaushik Mandal (24), Baiju (11), Sharad Shitole (35)
