Accounting Ratio analysis
What is a Accounting Ratio analysis?
What is Accounting Ratio analysis? Importance or advantages of ratio analysis & Types of accounting ratios
What is a Accounting Ratio analysis?
What is Accounting Ratio analysis? Importance or advantages of ratio analysis & Types of accounting ratios
Introduction
Financial statements are prepared past times summarizing the fiscal transactions during a item year. They are prepared to render the fiscal information information that assist to accept decisions. The information properly analyzed. Analysis of fiscal statements is useful unless they are properly an
Financial statements are prepared past times summarizing the fiscal transactions during a item year. They are prepared to render the fiscal information information that assist to accept decisions. The information properly analyzed. Analysis of fiscal statements is useful unless they are properly an
Meaning of ration analysis
Ration is the numerical or an arithmetical relationship betwixt 2 figures. It is expressed when 1 figure is divided past times another. Ration analysis is the procedure of determining as well as interpreting numerical human relationship betwixt figures of fiscal statements. Ration is used equally an index or year-stick for evaluation the fiscal seat as well as performance. It helps analysis to brand quatitave judgment close the fiscal seat as well as performance of a firm.
"A ration is only 1 set out expressed inwards damage of another. It is found past times dividing 1 set out past times the other." R.N.ANTHONY
From the higher upward definition, it is clear that ration is a relation of 1 amount to or thus other amount, as well as is a uncomplicated fraction or integer or percentage. Ration analysis shows the numerical human relationship betwixt the information presented inwards the fiscal statements. It helps to mensurate profitability, solvency as well as performed of whatever describe of piece of employment organisation firm. It facilitates the conclusion makers to accept the appropriate decisions based on dissimilar rations.
Presentation of ration
The quantitative human relationship betwixt 2 or to a greater extent than items of the fiscal statements connected with each other is referred equally accounting ratio. The accounting rations may travel expressed inwards the next ways.
1. Percentage method: nether this method, the human relationship betwixt 2 figures is presented is percentage. For example, if full assets of a theatre are rs. 500,000 as well as fixed assets are rs. 100,000, the human relationship tin travel presented equally fixed assets to travel 20% of full assets i.e.
2. Rate method: nether this method, ration is expressed only past times the segmentation of 1 set out past times another. For example, if full assets were rs. 500,000 as well as fixed assets were rs. 100,000, the ration send betwixt the 2 tin travel said equally fixed assets to travel 0.2 fourth dimension full assets.
3. Ratio method: nether this method, the human relationship betwixt 2 figures is presented inwards ratio. Taking the previous example, the ration of fixed assets to full assets tin travel said to travel 100, 0000: 500,000 or 1:5.
Importance or advantages of ratio analysis
Ration analysis stands for the procedure of determining as well as presenting the human relationship of items as well as groups of items inwards the fiscal statements. It is an of import technique of fiscal analysis. It is a way past times which fiscal stability as well as wellness of a concern tin travel judged. The next are the master copy points to highlight the importance of ration analysis.
1. Useful inwards fiscal seat analysis: accounting rations reveal the fiscal seat of the concern. It helps the banks, insurance companies as well as other fiscal institutions inwards lending as well as making investment decision.
2. Useful inwards simplifying accounting figures: accounting rations simplify, summarize as well as systematize the accounting figures inwards guild to brand them to a greater extent than understandable, often the figures standing solitary cannot assist them pick out whatever pregnant but rations assist them to relate with other figures.
3. Useful inwards assessing the operational efficiency: accounting rations helps to remove hold an thought of the working of a concern. The efficiency of the theatre tin travel measured past times the rations. It analysis management to asses fiscal requirement as well as operational efficiency.
4. Useful inwards forecasting purposes: ration analysis is real much useful inwards fiscal forecasting as well as planning. It tabulates the fiscal information of past times years for analysis the fiscal performance which helps for estimating the trend for the future.
5. Useful inwards locating weaknesses of the business: accounting rations are of slap-up assistance inwards locating the weakness of the describe of piece of employment organisation fifty-fifty though the overall performance may travel efficient. Management tin as well as thus pay attending to the weaknesses as well as accept remedial mensurate to overcome them.
6. Useful inwards comparing of performance: accounting rations facilitate the comparing betwixt 1 with or thus other theatre inwards guild to evaluate the fiscal performance. Management is interested inwards such comparing inwards guild to know the proper as well as smoothen functioning of a firm. Ration analysis also helps to brand the necessary charges inwards the organizational structure.
Limitations of ration analysis
Ration analysis is an of import tool the fiscal seat of a business. However, it has or thus limitations which are equally follows:
1. Based on historical information: ration analysis is based on the accounting information which is historical inwards nature. Sometimes, rations larn unable to predict the hereafter status of business.
2. Ignores qualitative aspects: fiscal statements practise non comprise the entire information necessary for evaluating the progress as well as hereafter procespects of an organization. It exclusively manager, human relationship with customers etc.
3. Fails to break electrical flow worth of enterprises: fiscal disputation analysis fails to break the electrical flow worth of an enterprise. It is based on historical facts as well as information which practise non reckon the changes inwards the cost level.
4. Not gratis from bias: fiscal disputation analysis is done equally per the personal judgment of analysis. The accountant has to brand a pick out of diverse alternatives available thus the fiscal statements are non gratis from bias.
Types of accounting rations
Ration may travel classified inwards a set out of ways keeping inwards persuasion the particulate purpose. The rations used for fiscal analysis of describe of piece of employment organisation tin travel classified into 4 categories, which are equally follows:
Liquidity ratio
Liquidity ratio measures the short-term solvency or liquidity seat of a firm. Liquidity refers to the mightiness of a theatre to run across its short-term obligation. It reflects the short-term fiscal clitoris of the business. These rations dot whether the theatre would travel inwards a seat to run across its short-term obligations inwards time. Liquidity or short-term fiscal seat of a theatre tin travel measured past times the next ratios:
Current ratio
a. Meaning: it shows the human relationship betwixt electrical flow assets as well as electrical flow liabilities.
b. Objectives: it master copy objective is to mensurate the mightiness of the theatre to run across its short-term obligations as well as o provide information close fiscal strength/ solvency.
c. Components: in that place are 2 components of this ratio equally follows:
i. Current assets: those assets, which are held for their conversion into cash commonly inside a twelvemonth or at nowadays or already inwards cash.
j. Current liabilities: those liabilities which are to travel paid commonly inside 1 twelvemonth or immediately.
d. Computation: this ratio is computed past times dividing the electrical flow assets past times the electrical flow liabilities. This ratio is usually expressed equally a pure ratio e.g. 2:1 inwards the shape a formula, this ration is limited equally follows:
e. Interpretation: traditionally, a electrical flow ration ratio of 2:1 is considered to travel a satisfactory ratio. One the Blue Planet of traditional rule, if the electrical flow ration 2 or more, if agency the theatre is adequately liquid as well as has the mightiness to run across its electrical flow obligation. if the electrical flow ratio is less than 2 it agency the theatre has difficulty inwards coming together its electrical flow obligations.
However, the traditional touchstone of 2:1 should non travel used blindly since in that place may travel firms having electrical flow ration of less than 2, which are usually efficient inwards coming together their short-term obligation. Some of get-go having electrical flow ratio to a greater extent than than 2 may non travel able to run across their electrical flow obligation inwards time. This is thus because the electrical flow ratio measures the quantity of electrical flow assets as well as non their quality.
Quick ratio
a. Meaning: it shows the human relationship betwixt quick assets as well as electrical flow liabilities.
b. Objectives: its master copy objective is to mensurate the mightiness of the theatre to run across its short-term obligation equally as well as when without relying upon the realization of stock.
c. Components: in that place are 2 components of this ration equally follows:
i. Quick assets: those electrical flow assets which tin travel converted into cash at nowadays or at a curt notice without loss of value. All the electrical flow assets except closing stock as well as prepaid expenses are quick assets.
ii. Current liabilities: those liabilities which are expected to travel matured commonly inside a year.
d. Computation: this ratio is computed past times dividing the quick assets past times the electrical flow liabilities, this ratio is scaly expressed equally a pure ratio e.g. 1:1. This ration may travel expressed equally under.
e. Interpretation: traditionally, a quick ratio of 1:1 is considered to travel a satisfactory ration. However, this traditional dominion should non travel used blindly since a theatre having a quick ratio of to a greater extent than than 1 may non travel coming together its short-term obligation inwards fourth dimension if its liquid assets consist of doubtful as well as irksome paying debtors.
Working capital
The dissimilar betwixt electrical flow assets as well as liabilities is knows equally working capital. It is calculated past times deducting full electrical flow liabilities from electrical flow assets.
Working uppercase = full electrical flow assets – full electrical flow liabilities
Current assets = working uppercase + electrical flow liabilities
Current liabilities = electrical flow assets – working capital
Leverage ratio of uppercase construction rations
Leverage rations demo the long-term solvency or liquidity of a firm. It indicates whether the theatre is financially audio or solvent inwards relation to its long-term obligations. These rations mensurate the firms' abilities to pay the investors regularly as well as repay the principal on the due date. they are also know equally solvency or uppercase construction rations.
Long-term solvency of a theatre tin travel measured past times the next rations:
Debt equity ratio (debt to shareholders' fund ratio)
a. Meaning: this ratio shows the human relationship betwixt long-term debts or full debts as well as shareholder's funds. It is a show of long-term solvency of a firm.
b. Objective: the objectives of computing this ratio is to mensurate the relative proportion of debt as well as equity inwards financing the assets of a firm.
c. Components: in that place are 2 components of this ration equally follows"
i. Long term debt: the debt that is is payable or measured inwards a long, menstruum of fourth dimension i.e. to a greater extent than than 1 twelvemonth is knows equally long term debt.
ii. Shareholder's fund: the debt that is payable or matured inwards a long menstruum of fourth dimension i.e. to a greater extent than than 1 twelvemonth is knows equally long term debt.
iii. Shareholders' fund: it is the fund, which is fiscal or claimed past times the internal parties of the business. it is a also knows a shareholder's equity or cyberspace worth.
d. Computation: this ration is computed past times dividing the long-term debts or full debts past times the shareholder's fund.
e. Interpretation: it indicates the margin of security to long-term creditors. H5N1 depression debt equity ratio implies the utilization of to a greater extent than equity than debt which agency larger security margin for creditor since shareholder's equity is considered equally a margin of security past times creditors as well as vice versa.
Debt to full uppercase ratio (debt to long –term fund ratio)
a. Meaning: this ratio establishes a human relationship betwixt debt as well as full uppercase of a company. It helps to constitute a link betwixt funded debt as well as full long-term fund available inwards the business.
b. Objective: the master copy objectives of computing this ratio is to mensurate the relative percentage of the debt inwards full uppercase of the scheme indicating long-term solvency.
c. Components: there are 2 components of this ration equally follows:
Debt to full uppercase ratio (debt to long –term fund ratio)
a. Meaning: this ratio establishes a human relationship betwixt debt as well as full uppercase of a company. It helps to constitute a link betwixt funded debt as well as full long-term fund available inwards the business.
b. Objective: the master copy objectives of computing this ratio is to mensurate the relative percentage of the debt inwards full uppercase of the scheme indicating long-term solvency.
c. Components: in that place are 2 components of this ration equally follows:
I. Long-term debt: bonds, debentures, mortgage, long-term loans, secured loan, other loan payable 1 year
II. Total capital: it is alos knows equally uppercase employed or long-term fund or permanent capital. Total uppercase includes long-term debt plus shareholder's equity.
d. Computation: this ration is computed past times dividing the long debt or full debt past times full uppercase or uppercase employed or permanent uppercase or long term fund.
e. Interpretation: inwards indicates the margin of security to long-term debt or full debt. H5N1 depression debt to full uppercase ratio refers to the utilization of to a greater extent than equity than debt which agency larger security of margin for creditors because shareholders' equity is considered equally a margin of security past times creditor as well as vice versa.
Activity or turnover ratios
For smoothen operations, a theatre needs to invest inwards both short-term as well as long-term assets. Activity ratios clitoris the human relationship betwixt the firm's bird of operations (sales) as well as assets needed to sustain the activity.
Activity rations tin also utilization to forecast a firm's uppercase requirements (both operating as well as long-term). Increase inwards sales volition require investment inwards additional assets. Activity rations enable the analysts to forecast these requirements as well as to assets the firm's mightiness to larn the assets needed to sustain the forecasted growth. The followings rations tin travel calculated equally the activity ratios.
Inventory turnover ratio (stock turnover ratio)
a. Meaning: if shows the human relationship betwixt cost of skillful as well as average investor or cyberspace sales as well as closing inventory.
b. Objective: the objective of computing this ratio is to create upward one's hear the efficiently with which the inventory is converted into sales.
c. Components: in that place are 2 components of this ratio equally follows:
i. Cost of goods sold or cyberspace sales:
ii. Averages inventory or closing inventory
d. Computation: this ration is computed past times dividing cost of goods sold or cyberspace sales past times average inventory or closing inventory.
e. Interpretation: inventory turnover ratio measures the frequency sales as well as gives the answer of such enquiry "how chop-chop the inventory is selling". High inventory turnover indicates the efficient inventory management.
Debtor turnover ratio (accounts receivable turnover ratio)
a. Meaning: it shows the human relationship betwixt credit as well as average debtor i.e. receivable or cyberspace sales as well as ending debtor i.e. receivable.
b. Objective: the objective of computing this ratio is to create upward one's hear the efficiency with which the debebture are converted into cash.
c. Components: there are 2 components of this ration equally follows:
i. Net credit sales or cyberspace sales:
Net credit sales = full credit sales – sales return
Net sales = full sales – sales render
Total sales = cash sales + credit sales.
ii. Average debtors or closing debtors:
d. Computations: this ratio is computed past times dividing cyberspace credit sales or cyberspace sales past times average debtor or closing debtor.
Notes:
(i) If credit sale as well as average debtor both tin travel calculated inwards this illustration cyberspace credit sales as well as average debtor are used to create upward one's hear debtor turnover ratio.
iii. If cyberspace credit sales as well as average debtor whatever 1 cannot travel calculated inwards this illustration cyberspace sales as well as closing debtor as well as used to create upward one's hear debtor ratio.
iv. The plough debtor include merchandise debtor, mass debt, describe of piece of employment organisation human relationship receivable, bills receivable but excluding the debtors which practise non arise from the sales of goods inwards which the describe of piece of employment organisation deals in.
v. Provision for doubtful debt is non deducted from the full amount of debtor since here, the purpose us to calculate the set out of days for which sales are tied upward inwards debtors as well as non to ascertain the realization value of debentures. If the provision for doubtful debt were deducted, if would plough over as well as impression that a seat of debtors (to the extent of such provision) has already been collected.
e. Interpretation: this ratio provides the information close the set out of times each twelvemonth a company's debtor's plough into cash. H5N1 high debtor turnover ratio indicates that debtors were converted often into cash as well as the character of the company's debtors tin travel considered equally good.
Average collection period/days sales outstanding
a. Meaning: it shows the human relationship betwixt days or weeks or months inwards a twelvemonth as well as debtor turnover ratio or average debtor as well as average cyberspace credit sales per day.
b. Objective: the objective of computing this ratio is to know close the average length of fourth dimension that an describe of piece of employment organisation human relationship has outstanding. It measures the leads as well as legs inwards collection relative to the company's credit period. It shows the efficient inwards the collection procedure of the receivables.
c. Components: in that place are 2 components of this ratio equally follows:
i. Days or calendar week or months inwards a twelvemonth (365 or 360 days, 52 or 50 weeks, 12 months)
ii. Debtor turnover ratio
d. Computation: this ratio is computed equally below.
e. Interpretation: this ratio mensurate how chop-chop how ruddily the illustration is collecting from debtors as well as lower average collection menstruum is preferred than to a greater extent than average collections period.
Fixed assets turnover ratio
a. Meaning: this ratio establishes a human relationship betwixt cyberspace sales as well as fixed assets.
b. Objective: the objective of computing this ratio is to create upward one's hear the efficieny with which fixed assets are utilized.
c. Components: in that place are 2 components of this ratio equally follows:
i. Net sales which hateful full sales minus sales return.
ii. Net fixed assets which hateful gross fixed assets less depreciation.
d. Components: this ratio is computed past times dividing the cyberspace sales past times the cyberspace fixed assets.
e. Interpretation: inwards indicated the firm's mightiness to generate sales due to the investment inwards fixed assets. Higher ratio is an indication of to a greater extent than efficient assets management.
Total assets turnover ratio
a. Meaning: this ratio shows human relationship betwixt cyberspace sales as well as full assets.
b. Objective: the objective of computing this ratio is to create upward one's hear the efficiency of management inwards utilization of assets for generating sales.
c. Components: in that place are 2 components of this ratio equally follows:
i. Net sales = full sales – sales return
ii. Total assets, which include electrical flow assets, tangible fixed assets as well as intangible assets.
d. Computation: this ratio is computed past times dividing the cyberspace sales past times full assets.
e. Interpretation: it indicates the firms' mightiness generate sales due to the investment inwards full assets. Higher the ratio to a greater extent than efficient the management as well as utilization of full assets as well as vice-avers.
Capital employed turnover ratio
a. Meaning: it shows the human relationship betwixt cyberspace sales as well as uppercase employed.
b. Objective: the objective of computing this ratio is to practise create upward one's hear efficiency with which the uppercase employed or long-term fund or permanent uppercase is utilized.
c. Components: in that place are 2 components of this ratio equally follows:
i. Net sales: it is calculated past times subtracting the sales render from full sales.
ii. Capital employed: it is the full of shareholder's fund as well as long term debt.
d. Computation: this ratio is computed byb dividing the cyberspace sales past times the uppercase employed. This ratio is usually expressed inwards times.
e. Interpretation: this ratio indicates the firms' mightiness to generate sales per rupee of uppercase employed. In general, higher the ratio the to a greater extent than efferent the management as well as utilization of uppercase employed as well as cive-versa.
Profitability ratios
The efficiency of a describe of piece of employment organisation is measured past times the profitability is an of import mensurate of a company's operating success. The long-term survival of a describe of piece of employment organisation enterprise depends on satisfactory income earned past times it. An evaluation of company's past times turn a profit may plough over to the investors, creditors as well as other a improve agreement for division-making. Profitability rations mensurate the marking of operating success of a companionship inwards an accounting period. Profitability rations endeavour to constitute human relationship alongside profit, turnover, uppercase employed, etc. the next are the of import profitability ratios:
Gross turn a profit margin or gross turn a profit ratio
a. Meaning: this ration measures the human relationship betwixt gross turn a profit as well as cyberspace sales.
b. Objective: the master copy objective of computing this ratio is to create upward one's hear the efficiency which production as well as or buy performance as well as selling operations carried on.
c. Components: in that place are 2 components of this ratio equally follows:
Gross profit: it is the excess of cyberspace sales over cost of goods sold.
d. Computation: this ratio is computed past times dividing the goods turn a profit past times the cyberspace sales. It is expressed equally percentage.
e. Interpretation: this ratio indicates i. an average gross margin earned on sales of rs. 100(ii) the bound beyond which the autumn inwards sales cost definitely upshot inwards loss as well as (ii) what portion of sales is left to comprehend operating limited ( other than cost of goods sold) as well as non operating expenses. Higher the ratio, the to a greater extent than efficient the production as well as buy management as well as vice-versa.
Net turn a profit ratio (net turn a profit margin)
a. Meaning: this ratio shows the human relationship betwixt cyberspace turn a profit as well as cyberspace sales.
b. Objective: the master copy objective of computing this ratio is to create upward one's hear the overall proftibitly due to diverse factors such equally operational efficiency, trading on equity etc.
c. Components: in that place are 2 components of this ration equally follows:
Net profit: it is the excess of gross turn a profit as well as other incomes over operating as well as non-operating expenses as well as losses.
d. Computation: this ratio is computed past times dividing the cyberspace turn a profit afterward taxation past times the cyberspace sales. It is expresses equally percentage.
e. Interpretation: this ratio indicates an average cyberspace margin earned on sales of rs. 100 as well as the higher ratio is preferred. In other words, words, higher the ratio, higher the overall efficiency as well as improve utilization of recourse. H5N1 lower ratio is indication of hapless fiscal planning, depression efficiency as well as lower utilization of describe of piece of employment organisation reserve.
Return on assets (ROA) or render on investment (ROI)
a. Meaning: this ratio mensurate the human relationship betwixt cyberspace turn a profit earlier involvement as well as taxation or cyberspace turn a profit afterward taxation plus involvement or cyberspace turn a profit afterward taxation as well as full assets.
b. Objective: the objective of computing this ratio is to notice out how efficiently the full assets remove hold been used past times the management.
c. Components: in that place are 2 components of this ratio equally follows:
i. Net turn a profit earlier involvement as well as taxation or cyberspace turn a profit afterward taxation plus involvement or cyberspace turn a profit afterward tax.
ii. Total assets = electrical flow assets + tangible fixed assets + intangible fixed assets
d. Computation: this ratio is computed past times dividing the cyberspace turn a profit earlier involvement as well as taxation or cyberspace turn a profit afterward taxation plus involvement or cyberspace turn a profit afterward tax.
e. Interpretation: this ratio indicates the firm's mightiness of generating turn a profit utilizing the full assets. Higher the ratio, the to a greater extent than efficiency of the management inwards the utilization of full assets as well as vice versa.
Return on shareholder's equity (ROSE)
a. Meaning: the ratio shows the human relationship betwixt cyberspace turn a profit afterward taxation as well as shareholder's fund.
b. Objective: the objective of computing this ratio is to notice out how efficiently the funds supplied past times the shareholder's remove hold been used.
c. Components: in that place are 2 components of this ratio equally follows:
i. Net profit: it is the excess gross turn a profit as well as other incomes than operating as well as non-operating expenses as well as losses.
ii. Shareholders' equity or shareholders' funds: it is the full claim of shareholder to the business.
D. computation: this ratio is computed past times dividing cyberspace turn a profit afterward taxation to shareholder's equity.
E. interpretation: this ratio indicates the firm's mightiness of generating turn a profit per rupees of shareholders funds. Higher the ratio, the to a greater extent than efficient the management as well as utilization of shareholders' funds.
Return on mutual shareholders' fund or render on equity (ROE)
a. Meaning: this ratio measures the human relationship betwixt earning available to equity shareholder as well as equity shareholder's funds.
b. Objective: the objective of computing this ratio is to notice out how efficiency the funds supplied past times the equity shareholders remove hold been used.
c. Component: in that place are 2 components of this ratio equally follows:
i. Earnings available to equity shareholder: the remaining amount afterward deducting preference dividend from cyberspace turn a profit afterward tax.
ii. Equity or mutual shareholder's fund = equity percentage uppercase + reserve as well as surplus + P/L a/c – losses
d. Computations: this ratio is computed past times dividing earning available to equity shareholder past times equity shareholder's funds.
e. Interpretation: this ratio indicates the firms' mightiness of generating turn a profit per rupees of equity shareholders funds. Higher the ratio, the to a greater extent than efficient the management as well as utilization of equity shareholders' funds.
Earnings per percentage (EPS)
a. Meaning: this ratio measures the earning available to equity shareholder on a per percentage basis.
b. Objective: the objective of this ratio is to mensurate the profitability of the theatre on per equity percentage basis.
c. Components: in that place are 2 components of this ratio equally follows:
i. Earning available to equity shareholder: the remaining amount afterward deducting preference percentage dividend from cyberspace turn a profit afterward taxation is considered equally earning available to equity shareholder'
ii. No of equity share
d. Computation: this ratio is computed past times dividing the full earning available to equity shareholder past times set out of equity shares.
e. Interpretation: higher the earning per shares improve it is as well as vice versa.
Dividend per shares (DPS)
a. Meaning: it shows the human relationship betwixt full amount of dividend paid to equity shareholder as well as set out of equity shares.
b. Objective: the objective of computing this ratio is to know how much per percentage the dividend is distributed to mutual shareholders.
c. Computation: in that place are 2 components of this ratio equally follows:
i. Dividend paid to equity shareholder
Total dividend to equity shareholder = % of dividend x full amount of paid upward capita.
ii. Number of equity share
d. Components: this ratio is computed past times dividing full amount of divined paid to equity shareholders past times set out of equity shares.
e. Interpretation: inwards general, higher the dividend per share, improve it is as well as vice versa.
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