IMPORTANT RATIOS & FORMULAE
IMPORTANT RATIOS & FORMULAE LIQUIDITY RATIOS
Current Ratio : Current assets / Current liabilities
Acid Test or Quick Ratio Quick assets / Current liabilities
Net working capital : Long term sources - long term uses OR current assets - current liabilities.
SOLVENCY or LEVERAGE RATIOS
Debt-Equity Ratio = Long term outside liabilities/Tangible net worth
Debtor service coverage ratio (DSCR) = (Net profit + depreciation + amount of interest on th long term liabilities) / (amount of
interest on the lob term liabilities + amount of instalment of long tern liabilities).
ACTIVITY RATIOS
Stock OR Inventory turnover= Sales / Stocks
Debtor turnover = Sales / sundry debtors (i.e. book debts, receivables)
Debtors' velocity or debt collection period Book-debts / sales x 12 PROFITABILITY
Return on equity = Profit / tangible net worth x 100
Return on investment or capital employed Profit / Investment (or capital employed) x 100
Net Profit Ratio -=Net profit / Sales x 100
BREAK-EVEN RATIOs
Costs of a business cart be classified into fixed and variable. Fixed costs are those costs which do not change with production like
rent, salaries and variable costs are those which change with production like raw material, wages, power, repair etc.
Profit = Sale minus fixed cost minus variable cost
Contribution = Sale price per unit minus variable cost per unit or Sale-variable cost
Break Even Point in units = Fixed Cost/(Sale Price per unit — Variable Cost per unit)or
Fixed cost/contribution per unit, Break Even Point in Rupees = Fixed cost x sale/(Sale- Variable Cost)
PV Ratio = contribution/sales x 100 , Break Even Point = Fixed cost/PV Ratio
Break Even Point in terms of capacity utilization=Break even units/Installed capacityx 100
Margin of Safety =(Actual Sale — Break Even Sale)/ Actual Sale*100
EarningPerShare(EPS) : The ratio denotes per share profit of a company. It can be used to compare 2 different companies" profitability. To
calculate the ration only the no. of equity share is taken (and not of preference shares). It can be calculated as under: Net profit after tax and
preference dividend/ no. of equity shares. It help in understandingmarket pricing of the equity share.
Price EarningRatio (PER) : The ratio indicates the currentmarket price vis-a-vis the earning per share. It can be calculated as under:Market price
of the equity share / earning per share
Different users of ratios
Long term creditors Short term lenders (Banks) Shareholders
Fixed charges cover =
Income before interest and tax /
Interest charges
Quick ratio ---
Quick assets / current liabilities
Earning per share =
Profit available for equity holders / no. of
equity shares
Debt service coverage ratio =
Cash profit for debt service / annual interest
and principal
Current ratio =
Current assets / current liabilities
Dividend Yield ratio =
Dividend per share / market price per
share
Cash Flow Statement :Cash flow statements are useful in planning short term operation of the business. Usually cash flow
statement is prepared by cash receipt & payment.
Fund Flow Statement : Fund flow statement is a statement of sources and uses of funds for a period. Fund means net working
capital. Fund flow statement indicates the changes in net working capital position and the reasons for the same.
For preparing this statement, balance sheet of two consecutive years and profit and loss account for the intervening period is
required.
Long term sources of funds include issue of capital, raising term loans, debentures, funds from operations and long term uses include
purchase of fixed assets, payment of dividend, payment of taxes, repayment of term loans.
If long term sources are more than long term uses, it will result in increase in net working capital and vice versa
Various types of long term source, short term sources and uses are given below:
Net Profit after Tax LTS Tax Payments LTU
Dividend Payments LTU Increase in Term Loans LTS
Increase in Other CL STS Increase in Stock STU
Decrease in TL LTU Depreciation Neither S nor U
Increase in short term bank borrowing STS Increase in Fixed Assets LTU
Net Loss LTU Increase in Receivables STU
Reduction in fixed assets LTS Drawings by partners LTU
Decrease in Receivables LTS Increase in Capital LTS
WHAT THE CHANGE IN RATIOSMEAN
If a firm realises book debts in cash — No change in current assets, quick ratio, current ratio or net working capital.
If a firm realises old assets or non current assets in cash or sell fixed assets in cash: current assets, quick ratio, current ratio or net
working capital will all improve
If a firm issues bonus shares — There is no change in any ratios
If a firm issues rights shares — Current ratio, quick ratio, net working capital, debt equity ratio, net worth will improve
If a firm revalues its fixed assets and creates revaluation reserve: Net worth and tangible networth increase. Debt equity ratio
declines / improves. There is no effect on current assets or quick assets or current ratio and quick ratio.
If increase in long term sources is more (say 125%) than increase in long term uses during a year liquid asset would increase,
liquidity would improve.
If increase in long term is uses more (say 125%) than increase in long term sources during a year — liquid asset would decrease,
liquidity would decline.
Lower and higher break even point : A firm with lower break even point has better chances for earning profits. A firm with higher
break even earns lower profits.
If break-even point of a firm goes up — It is an indication of dedine in profits
If break-even point of a firm goes down — It is an indication of increase in profits
If debtor-turnover ratio increase — It shows efficiency in recovery
If debtor-velocity ratio decrease — It shows firm is allowing credit to buyer of its products for a lesser period
If stock-turnover ratio increase — It is better use of stocks
If current ratio increases and quick ratio remain constant — It shows higher %age of stocks in or lower %age of receivables in total
current assets.
If current ratio is constant and quick ratio increases — It shows lower %age of stocks or higher %age in receivables in total current
assets.
SUMMARY -WORKINGCAPITAL TERMS
Particulars Classification
Working capital Current assets such as cash, stocks, book-debts, other current assets
Net capital working Current assets — current liabilities OR Long term sources — long term uses
Working gap capital Current assets — current liabilities (other than bank borrowing — i.e. OCL)
Working limits capital Bank facilities needed to purchase current assets. These facilities are cash credit, overdraft, bills
purchase/discounting, pre-shipment or post-shipment loans etc.
Factors which determine the working capital The following factors determine the overall working capital levels of the
industrial units: Policies for production, Manufacturing process, Credit Policy of the unit, Pace of turnover , Seasonality
Process for assessment of working capital requirements Generally there are three methods followed by banks for assessing
working capital of a firm i.e. (i) traditional method suggested under Tandon Committee, (ii) turnover method suggested by Nayak
Committee and (iii) cash budget method followed in case of seasonal industries.
Methods of Assessing Bank Finance
Holding Norms based Method of Assessment of Bank Finance Various steps used in the process include following
Deciding on the level of turnover: : in case of existing units, past performance can help in ascertaining projected turnover. In case
of new enterprise, it is based on production capacity, proposed market share, availability of raw materials, industry norms etc.
Assessment of Gross working capital: This is sum total of various components of working capital
inventory: For assessment of stock levels of raw material, work in process and finished goods, information like lead time, minimum
order quantity, location and number of suppliers, percentage of imported material, manufacturing process etc are considered.
Industry norms may be helpful in this regard.
Receivables/bills: it can be assessed easily. It is governed by market practice relating to a particular business.
Other Current assets: A reasonable estimate of other current assets like cash level, advance to suppliers, advance tax payment etc
is calculated. Sources of Meeting Working Capital Requirement
Own sources: This represents available net working capital. Further, as the estimate of limits is based on the projected balance
sheet at the end of the current accounting year, some internal accruals are also taken into account. Bank may stipulate additional
NWC if available NWC and anticipated internal accruals are not enough to maintain desired current ratio.
Suppliers's credit based on market practice
Other current liabilities like salary payable, advance from customers etc.
IMPORTANT RATIOS & FORMULAE LIQUIDITY RATIOS
Current Ratio : Current assets / Current liabilities
Acid Test or Quick Ratio Quick assets / Current liabilities
Net working capital : Long term sources - long term uses OR current assets - current liabilities.
SOLVENCY or LEVERAGE RATIOS
Debt-Equity Ratio = Long term outside liabilities/Tangible net worth
Debtor service coverage ratio (DSCR) = (Net profit + depreciation + amount of interest on th long term liabilities) / (amount of
interest on the lob term liabilities + amount of instalment of long tern liabilities).
ACTIVITY RATIOS
Stock OR Inventory turnover= Sales / Stocks
Debtor turnover = Sales / sundry debtors (i.e. book debts, receivables)
Debtors' velocity or debt collection period Book-debts / sales x 12 PROFITABILITY
Return on equity = Profit / tangible net worth x 100
Return on investment or capital employed Profit / Investment (or capital employed) x 100
Net Profit Ratio -=Net profit / Sales x 100
BREAK-EVEN RATIOs
Costs of a business cart be classified into fixed and variable. Fixed costs are those costs which do not change with production like
rent, salaries and variable costs are those which change with production like raw material, wages, power, repair etc.
Profit = Sale minus fixed cost minus variable cost
Contribution = Sale price per unit minus variable cost per unit or Sale-variable cost
Break Even Point in units = Fixed Cost/(Sale Price per unit — Variable Cost per unit)or
Fixed cost/contribution per unit, Break Even Point in Rupees = Fixed cost x sale/(Sale- Variable Cost)
PV Ratio = contribution/sales x 100 , Break Even Point = Fixed cost/PV Ratio
Break Even Point in terms of capacity utilization=Break even units/Installed capacityx 100
Margin of Safety =(Actual Sale — Break Even Sale)/ Actual Sale*100
EarningPerShare(EPS) : The ratio denotes per share profit of a company. It can be used to compare 2 different companies" profitability. To
calculate the ration only the no. of equity share is taken (and not of preference shares). It can be calculated as under: Net profit after tax and
preference dividend/ no. of equity shares. It help in understandingmarket pricing of the equity share.
Price EarningRatio (PER) : The ratio indicates the currentmarket price vis-a-vis the earning per share. It can be calculated as under:Market price
of the equity share / earning per share
Different users of ratios
Long term creditors Short term lenders (Banks) Shareholders
Fixed charges cover =
Income before interest and tax /
Interest charges
Quick ratio ---
Quick assets / current liabilities
Earning per share =
Profit available for equity holders / no. of
equity shares
Debt service coverage ratio =
Cash profit for debt service / annual interest
and principal
Current ratio =
Current assets / current liabilities
Dividend Yield ratio =
Dividend per share / market price per
share
Cash Flow Statement :Cash flow statements are useful in planning short term operation of the business. Usually cash flow
statement is prepared by cash receipt & payment.
Fund Flow Statement : Fund flow statement is a statement of sources and uses of funds for a period. Fund means net working
capital. Fund flow statement indicates the changes in net working capital position and the reasons for the same.
For preparing this statement, balance sheet of two consecutive years and profit and loss account for the intervening period is
required.
Long term sources of funds include issue of capital, raising term loans, debentures, funds from operations and long term uses include
purchase of fixed assets, payment of dividend, payment of taxes, repayment of term loans.
If long term sources are more than long term uses, it will result in increase in net working capital and vice versa
Various types of long term source, short term sources and uses are given below:
Net Profit after Tax LTS Tax Payments LTU
Dividend Payments LTU Increase in Term Loans LTS
Increase in Other CL STS Increase in Stock STU
Decrease in TL LTU Depreciation Neither S nor U
Increase in short term bank borrowing STS Increase in Fixed Assets LTU
Net Loss LTU Increase in Receivables STU
Reduction in fixed assets LTS Drawings by partners LTU
Decrease in Receivables LTS Increase in Capital LTS
WHAT THE CHANGE IN RATIOSMEAN
If a firm realises book debts in cash — No change in current assets, quick ratio, current ratio or net working capital.
If a firm realises old assets or non current assets in cash or sell fixed assets in cash: current assets, quick ratio, current ratio or net
working capital will all improve
If a firm issues bonus shares — There is no change in any ratios
If a firm issues rights shares — Current ratio, quick ratio, net working capital, debt equity ratio, net worth will improve
If a firm revalues its fixed assets and creates revaluation reserve: Net worth and tangible networth increase. Debt equity ratio
declines / improves. There is no effect on current assets or quick assets or current ratio and quick ratio.
If increase in long term sources is more (say 125%) than increase in long term uses during a year liquid asset would increase,
liquidity would improve.
If increase in long term is uses more (say 125%) than increase in long term sources during a year — liquid asset would decrease,
liquidity would decline.
Lower and higher break even point : A firm with lower break even point has better chances for earning profits. A firm with higher
break even earns lower profits.
If break-even point of a firm goes up — It is an indication of dedine in profits
If break-even point of a firm goes down — It is an indication of increase in profits
If debtor-turnover ratio increase — It shows efficiency in recovery
If debtor-velocity ratio decrease — It shows firm is allowing credit to buyer of its products for a lesser period
If stock-turnover ratio increase — It is better use of stocks
If current ratio increases and quick ratio remain constant — It shows higher %age of stocks in or lower %age of receivables in total
current assets.
If current ratio is constant and quick ratio increases — It shows lower %age of stocks or higher %age in receivables in total current
assets.
SUMMARY -WORKINGCAPITAL TERMS
Particulars Classification
Working capital Current assets such as cash, stocks, book-debts, other current assets
Net capital working Current assets — current liabilities OR Long term sources — long term uses
Working gap capital Current assets — current liabilities (other than bank borrowing — i.e. OCL)
Working limits capital Bank facilities needed to purchase current assets. These facilities are cash credit, overdraft, bills
purchase/discounting, pre-shipment or post-shipment loans etc.
Factors which determine the working capital The following factors determine the overall working capital levels of the
industrial units: Policies for production, Manufacturing process, Credit Policy of the unit, Pace of turnover , Seasonality
Process for assessment of working capital requirements Generally there are three methods followed by banks for assessing
working capital of a firm i.e. (i) traditional method suggested under Tandon Committee, (ii) turnover method suggested by Nayak
Committee and (iii) cash budget method followed in case of seasonal industries.
Methods of Assessing Bank Finance
Holding Norms based Method of Assessment of Bank Finance Various steps used in the process include following
Deciding on the level of turnover: : in case of existing units, past performance can help in ascertaining projected turnover. In case
of new enterprise, it is based on production capacity, proposed market share, availability of raw materials, industry norms etc.
Assessment of Gross working capital: This is sum total of various components of working capital
inventory: For assessment of stock levels of raw material, work in process and finished goods, information like lead time, minimum
order quantity, location and number of suppliers, percentage of imported material, manufacturing process etc are considered.
Industry norms may be helpful in this regard.
Receivables/bills: it can be assessed easily. It is governed by market practice relating to a particular business.
Other Current assets: A reasonable estimate of other current assets like cash level, advance to suppliers, advance tax payment etc
is calculated. Sources of Meeting Working Capital Requirement
Own sources: This represents available net working capital. Further, as the estimate of limits is based on the projected balance
sheet at the end of the current accounting year, some internal accruals are also taken into account. Bank may stipulate additional
NWC if available NWC and anticipated internal accruals are not enough to maintain desired current ratio.
Suppliers's credit based on market practice
Other current liabilities like salary payable, advance from customers etc.
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