Analysis of Financial RatiosFinancial Ratios

Analysis of Financial Ratios CV.Alexander DGM &FM Version: College of Agricultural Banking, RBI, PUNE Definition • The relationship between two accounting figures expressed mathematically is known as financial ratio Date: College of Agricultural Banking, RBI, PUNE 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 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 Date: College of Agricultural Banking, RBI, PUNE Factors that banks consider

Analysis of Financial Ratios

Analysis of Financial Ratios

CV.Alexander

DGM &FM

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

• 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

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

Financial Analysis

• Trends in the financial planning

• Analysis of projected financial statements

Assets & Liabililities

(Rs.crore)

10756 9970

9270 Total

Total 9270

9970 10756

297 278

168

Intangible Assets

1071 1298

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

Measures of Liquidity

• Net Working Capital

• Current Ratio

• Quick Ratio

• Net Working Capital/Net Assets

• Net Working Capital/Current Assets

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

Gross Working Capital

• Gross Working Capital

• How funded

• From own resources and other long term sources

• Short fall if any from 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

Financing of Current Assets (National Steel Corporation)

• 1.Current Assets = Current Liabilities + NWC or

• 2 NWC = Current Assets – Current Liabilities or

• 3 Current Assets = Current Liabilities +

Contribution from Long Term Liabilities

• 3088 = 2249 +[(8104-7668)] =2652+436

• (i.e.NWC = 3088)

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

• Negative Net Working Capital

• What is the Implication

• Business has applied part of surplus Current

Liabilities towards meeting shortfall in Long Term resources

• Positive NWC means

i.Borrower has brought in his

contribution

ii.Any fall in value of Current Assets will

be cushioned by borrower’s stakeiii.Loss in sale of Current Assets will not affect Short term creditors

intangibles Another measure of liquidity is the 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

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

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

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

Falling NWC/Net Sales

• Indicative of overtrading and serious liquidity

problems

• It needs to be investigated

NWC/Current Assets

• This measures contribution of Long Term funds

towards financing Current Assets

• 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

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

Return on Assets

• RoA = PBIT/Total Assets

• To measure profitability and efficiency

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

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

efficiency and profitability

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

– 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

9 Profitability Ratios

• ANY ????

• THANK YOU