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1 INTRODUCTION
Financial management has vital and an integrated part of business management.
Financial management is concerned with the planning and controlling of the firms financial
resource. It is often said that the financial management has received less emphasis as
compared to topics like production and marketing. However, the task of financial planning
and controlling will assume relative more important role than in the past due to certain
changes that have taken place or will take place in economy. Factors such as increasing pace
of industrialization, technological innovations land inventions, raising price levels, increasing
influence of government in financial matters etc...
DEFINATION OF FINANCIAL MANAGEMENT:
Financial management is that managerial activity which is concerned with the planning
and controlling of the firms financial resources.
OBJECTIVES OF FINANCIAL MANAGEMENT:
The financial objective of a company is to maximize owners economic welfare. However,
there is disagreement as to how the economic welfare of owners can be maximized. They are
mainly two points discussed.
1. Profit maximization
2. Wealth maximization
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WEALTH MAXIMIZATION:
Wealth maximization means maximizing the net present value of a course of action to
shareholders. Wealth of a course of action is the difference between that present value of its
benefits and the present value of its costs.
1. Questions of the timing and risk of the expected benefits.
2. Wealth maximization objective is an appropriate and operationally feasible criterion to
choose among the alternative financial actions.
3. Maximize in making investment and financing decisions on behalf of shareholders.
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1.
2.
3.
4.
Past Ratios
Projected Ratio
Competitors Ratios
Industry ratios
Cross-Sectional Analysis:
Comparing the ratios of one firm with some selected firms in the same industry at the same
pint in time is known as the cross-sectional analysis.
The Ratio analysis is the most powerful tool of financial analysis with the help of ratios
one can determine:
The ability of the firm to meet its current obligations;
The extent to which the firm has used its long-term solvency by borrowing funds;
The efficiency with which of the firm is utilizing its assets in generating sales
revenue.
The overall operating efficiency and performance of the firm.
Performance Analysis:
A short-term creditor will be interested in the current financial position of the firm,
while a long-term creditor will pay more attention to the solvency of the firm. He will also be
interested in the profitability of the firm. The equity shareholders are generally concerned
with their return and also about the financial conditions only when their earnings are depress.
Credit Analysis:
In credit analysis, the analyst will usually select a few important ratios. He may
use the current ratio or quick-ratio to judge the firms liquidity or debt-paying ability debtequity ratio to determine the stake of the owners in the business and the firms capacity to
survive in the long run and any one of the profitability ratios.
Security Analysis:
The ratio analysis is also useful in security analysis. The major focus in
Security Analysis is on the long-term profitability. The detailed analysis of The earning
power is important for security analysis.
Comparative Analysis:
SHRI SAI INISTITUTE OF ENGINEERING AND TECHNOLOGY ATP
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The ratio of a firm by themselves does not reveal anything. For meaningful Interpretation, the
ratios of a firm should be compared with the ratios of similar firms and industry. This
comparison will reveal whether the firm is significantly out of line with its competitors. If it
is significantly out of line, the firm should undertake a detailed analysis to spot out the
trouble areas.
Trend Analysis:
Trend analysis of the ratios adds considerable significance to the financial analysis
because it studies ratios of several years and isolates the exceptional instances occurring In
one or two periods. Although the trend analysis of the companys ratios itself is Informative,
but it is more informative to compare the trends in the companys ratios with the trends in
industry ratios.
Management has to protect the interest of all the conditional parties, creditors, Owners
and others. They have to ensure some minimum operating efficiency and keep the risk of the
firm at a minimum level. Their survival depends upon their operating Performance.
RATIO ANALYSIS
The term Ratio refers to the numerical and quantitative relationship between two items or
variables. This relationship can be exposed as
Percentages
Fractions
Proportion of numbers
Ratio analysis is defined as the systematic use of the ratio to interpret the financial
statements. So that the strengths and weaknesses of a firm, as well as its historical
performance and current financial condition can be determined. Ratio reflects a quantitative
relationship helps to form a quantitative judgment.
The first task of the financial analysis is to select the information relevant to the
decision under consideration from the statements and calculates appropriate ratios.
To compare the calculated ratios with the ratios of the same firm relating to the
pas6t or with the industry ratios. It facilitates in assessing success or failure of the
firm.
Third step is to interpretation, drawing of inferences and report writing conclusions
are drawn after comparison in the shape of report or recommended courses of
action
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Group of ratios
Historical comparison
Projected ratios
Inter-firm comparison
Selection of ratios
Use of standards
Trade Creditors:
They are interested in firms ability to meet their claims over a very short period of
time. Hence their analysis is confined to evaluation of the firms liquidity position.
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They are concerned with firms long-term solvency and survival. They analyze the
firms profitability over time, its ability to generate cash to be able to pay interest and repay
principal and the relationship between various sources of funds.
Investors:
They are most concerned about the firms earnings. They are also interested in every
aspect of the firms financial structure to the extent it influences the firms earnings ability
and risk.
Management:
Financial analysis is the process of identifying the financial strength and weakness of firm by properly
establishing relationship between the items of balance sheet and the profit and loss account.
b) Trade creditors are interested in firms ability to meet their claims over a very short period of time.
Their analysis will therefore, confine to the evaluation of the firms liquidity position.
c) Suppliers of long-term debt are concerned with firms long-term solvency and survival. They analysis
the firms profitability overtime. Its ability to generate cash to be able to pay interest and repay
principal and relationship between various sources of funds.
d) Investors, who have interested their money in the firms. Shares are almost concerned about the firm
earnings. They restore more confidence in thos3e firms that shows steady growth in earnings.
e) As such, they concentrate on the analysis of the firms financial structure to the extent it influence the
firms earnings ability and risk.
f) Management of the firm would be interested in every aspect of the financial analysis. It is their overall
responsibilities to see that the resources of the firm are used most effectively and efficiently, and that
the firms financial condition is sound.
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2. Helps in communication:
The financial strength and weakness of a firm are communicated in a more easy and
understandable manner by the use of ratios. The information contained in the financial
statements is conveyed in a meaningful manner to the one for even if it meant. thus, ratios
help in communication and enhance the value of the financial statements.
3. Helps in co-ordination :
Ratios even in co-ordination which is of at most importance in effective business
management. Better communication of the efficiency and weakness of an enterprise
results in better co-ordination in the enterprise.
4. Helps in control:
Ratio analysis is also helps in making effective control of the business. Slandered ratios
can be based upon Performa of financial statements and variances or deviations, if any,
can be found by comparing the actual with the standard so as to take a corrective action at
the right time.
LIQUIDITY POSITION:
With the help of ratio analysis conditions can be drawn regarding the liquidity position of a firm. The
liquidity position of a firm would be satisfactory if it is able to meet its current obligations when they become
due. A firm can be said to have the ability to meet its short-term liabilities if it has sufficient liquid funds to pay
the interest on its short-maturing debt usually within a year as well the principal. The liquidity ratios are
particularly useful in credit analysis by bank and other suppliers of short-term loans.
LONG-TERM SOLVENCY:
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Ratio analysis is equally useful for assessing the long-term financial liability of a firm. The long-term
solvency is measured by the leverage and capital. Structure and profitability ratios which focus on earning
power and operating efficiency. Ratio analysis reveals and weakness of a firm in this respect.
OPERATING EFFICIENCY:
Yet another dimension of his usefulness of the ratio analysis, relevant from the viewpoint of management,
hates it brows light on the degree of efficiency in the management and utilization of its assets. It would be
recalled that the various activity ratios measure this kind of operational efficiency.
INTER-FIRM COMPARISON:
Ratio analysis not only throws light on the financial position of a firm but also serves as a stepping stone to
remedial measures. This is made possible due to inter firm comparison would demonstrate the relative position
vis--vis its competitors.
TREND ANALYSIS:
Ratio analysis enables a firm to take the time dimension into account in other words, whether the financial
position of a firm is improving or deteriorating over the years. The significance of the trend analysis of ratios
lies in the fact that the analysis cans now direction of improvement i.e. whether the movement is favorable or
unfavorable.
DIFFICULTY IN COMPARISION:
Once serious limitation of ratio analysis arises out of the difficulty associated with their comparison to
draw inferences. One technique that is employed is inter-firm comparison. But such comparisons are vitiated by
different procedure adopted by various firms. The differences may relate to estimation of assets and
amortization of intangible assets etc..
IMPACT OF INFLATION:
The second major limitation of the ratio analysis as a tool of financial analysis is associated with price level
changes. This, in fact, is a weakness of the traditional financial statements which are based on historical costs.
The one implication of this future of the financial statements as regards ratio analysis in the price level. As a
result, ratio analysis will not adjust for changes in the price level. As a result, ratio analysis will not yield strictly
comparable and, therefore, dependable results.
CONCEPTUAL DIVERSITY:
Yet another factory which affects the usefulness of ratios is that there are differences of opinion regarding
the various concepts used to compute the ratios. In brief, ratio analysis suffers from serious limitations. The
reliability and significance attached to ratios will largely depend on the quality of data on which they are based .
LIMITED SCOPE:
Ratio analysis is not suitable for sound judgment rather is useful tool to aid in applying
judgment to complex situation. But its scope is limited.
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World Reserves
The largest and commercially most important deposits are those in the mountainous
spine of south America and western north America, principally in the United State and Chile
but also include Canada, Mexico and Peru, large and important deposits are located in south
central Africa, principally in Zaire and Zambia. Together, north and South America and
Africa contain more than one half of the known copper deposits in the world.
However, Europe (primarily Russia and the confederation of Independent states of
CIS) and the Pacific Rim (Chiefly Australia and Papua New Guinea) also contain copper
mineralization. South America holds the largest shares of both reserves (31.1% if the world
total) and reserve base (18.5%). North and Central America follow, with 22.7% and 24.9% of
world reserves and reserve base, respectively.
Among individual countries, Chile has the largest fraction of the total reserve base at
19%, the United States ranks 2nd with 18%; the C.I.S and Zambia each have 7%; while
Canada Peru, and Zaire each account for 6%.
Raw Materials
The main component of brass is copper. The amount of copper varies between 55% and
95% by weight depending on the type of brass and its intended use. Brasses containing a high
percentage of copper are made from electrically refined copper that is at least 99.3% pure to
minimize the amount of other materials. Brasses containing a lower percentage of copper can
also be made from electrically refined copper, but are more commonly made from less
expensive recycled copper alloy scrap. When recycled scrap is used, the percentages of
copper and other materials in the scrap must be known so that the manufacturer can adjust the
amounts of materials to be added in order to achieve the desired brass composition.
The second component of brass is zinc. The amount of zinc varies between 5% and 40%
by weight depending on the type of brass. Brasses with higher percentages of zinc are
stronger and harder, but they are also more difficult to form and have less corrosion
SHRI SAI INISTITUTE OF ENGINEERING AND TECHNOLOGY ATP
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resistance. The zinc used to make brass is a commercial grade sometimes known as spelter.
Some brasses also contain small percentages of other materials to improve certain
characteristics. Up to 3.8% by weight of lead may be added.
Alloying additions are made to the basic copper-zinc alloys for a variety of reasons:To improve mach inability
To improve strength
To improve corrosion resistance
For other special reasons
Quality Control
FEATURES OF BRASS
Brass has a combination of strength, corrosion resistance, and formability that will
continue to make it a useful material for many applications in the foreseeable future.68 Brass
also has an advantage over other materials in that most products made from brass are
recycled or reused, rather than being discarded in a landfill, which will help ensure a
continued supply for many years.
Excellent Machinability
Good Strength
Ductility
Conductivity
Easily Joining
Non-sparking
Good Corrosion Resistance
Wear Resistant
Plating
Attractive Colour
Hygiene
Magnetic permeability
Cast ability
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year 2000. The main bankers of the company are State Bank of India, Main Branch, Sainagar,
and Anantapur with the work force numbering up to 45. Brass metal works has made
tremendous inroads in to the Builders Hardware in India.
They manufacture various hardware products of Builders Hardware from extruded
brass such as Tower bolts, hinges, Door handles, Window Rings, Doorstoppers, Baby latches
etc under the brand name called JYOTIBRASS the quality and perfect brass. Jyoti brass
brand enjoys 25% of the market share in the brass industry.
The company is manufacturing the products catering to the needs of particular and
specific customers. The target market changes from place to place like special extruded brass
and gold coated products catering to the needs of the customers in coastal place, SouthEastern parts of India where the chances of corrosion of the hardware material is very high.
Due to superior quality the Jyoti brass Brand has made an everlasting impact in the minds of
the customers. Though the products are highly prices Jyotibrass Brand is increasing its
market share, this is possible due to its superior quality and the excellent after sales service.
The product got ISI marked licenses granted by M/S. Bureau of Indian standards is
the first company to get ISI mark in brass.
1) Tower Bolts : CM/L 6372976
2) BUTT HINGES : CM/L 6387787
An ISO 9001:2000 certified company
The company has a wide network of dealers of up to 60 and a strong sales force.
These sales persons shall target the dealers and produce the orders from them. The turnover
of the company is over 1 crore during 2006 -07.
The basic raw material of the company is the Brass extruded sections. The raw
material is bought from various companies like Jindal, Balco, Hindalco etc after
succeeding in the hardware industry the company lying with the ideas of manufacturing the
basic raw material of the hardware industry Brass extrusions.
Extruded brass outstands in quality and strength than conventional cast and
machine draw hardware. Extruded hardware will have more molecular strength and better
surface finish. Extrusions are made from a uniform combination of alloys giving high tensile
strength with micro sized molecules giving no chance for blowholes. When the alloy is in
uniform combination there will not be impurities and the extrusion becomes harder in
comparison with cast materials. "JYOTIBRASS" hinges are recommended for heavy doors
and shutters.
JYOTIBRASS offers a better protective finish by giving ELECTRO-PHORETIC
coating which is ever coat and the latest technology in surface finish rendering the product
weather resistant, durability of the finish depends on the coating and at "JYOTIBRASS"
gives a polished brass finish with ever coat. This is a "state-of-the-art" process depositing
hardwearing material on the brass surface. This microscopic layer protects the product from
discoloration, even at the harshest of environments such as sunlight, pollution and humidity
etc, Hence "JYOTIBRASS" products are introduced with added strength better surface finish
and weather resistant requiring no maintenance at all.
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2) Larsen & Toubro Ltd., A1, B1, C1 & C2, C3, C4, D1 & D2 Towers of Serene County Project,
Hyderabad.
3) L & T Ltd., South City PDD, Renka, Bannerghatta Road, Bangalore.
4) Surya city, Bangalore and other different projects of Karnataka Housing Board, Bangalore.
5) Leo Meridian, Hyderabad.
6) India Heritage Foundation, ISKON, Bangalore.
7) Ramky Infrastructure Ltd., Cuddapah.
8) D.S.R. Constructions, Bangalore.
9) Subham Developers, Hyderabad.
10) Aparna Constructions, Hyderabad.
11) NCL (Jampana Constructions), Bangalore.
12) M/s. B.G. Shirke Const. Technology Ltd., Bangalore, Mysore and Pune.
13) Karnataka State Housing Board Projects through Contractors.
14) Medical Colleges, Belgaum and Hassan, Shimoga and Mandya under PWD.
15) Ambience Properties, Secunderabad.
16) APR Constructions, Hyderabad.
17) Omega Constructions, Hyderabad.
18) P.L. Raju Constructions, Hyderabad.
19) Venser Constructions, Hyderabad
20) Ramky Constructions, Hyderabad.
21) Sreenivasa Constructions, Hyderabad.
22) DLF Constructions, Hyderabad.
23) Alience Construction Ltd., Hyderabad.
24) IVRCL Infrastructure Medical College, Bidar.
25) IVRCL Navel Project, Payyanur, Kerala State.
26) Navayuga Construction Navel Project, Payyanur, Kerala State.
27) Nagarjuna Constructions, Ernakulam.
28) RDS Constructions, Ernakulam.
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LITERATURE
Books:
The information, which are required for the net working capital and ratio analysis
from I.M.Pandey, Prasanna Chandra & M.Y.Khan & P.K. Jain books.
Journals:
Journals are used for finding out new ideas and information required for the research
work.
Internet:
Internet has been used to get more information for the research from various web sites
like, www.Moneycontrol.com & www.google.com to explore new ideas to be implemented
in the statistical tools
Company records:
Made a thorough investigation about the companys existing ventures, new additions to
capture the attention towards Ratio Analysis.
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Financial Analysis has to be carried out. Financial analysis is the analysis and interpretation
of financial statements and a proper financial analysis can give the users better insight about
financial strengths and weakness of the firm. Financial analysis is the starting point for
making plans, before using any sophisticated forecasting and planning procedure.
For the purpose first the required information has to be collected like for ratio
analysis and owing capital management analysis, income statements, trading and profit and
loss accounts, balance sheet, funds flow statement, etc. are to be collected the, the data in the
statements is to be properly organized and arranged and then relationship is established
between financial statements and finally conclusions are drawn from the interpreted
information and presented in the form of reports.
Research Methodology:
Research involves getting tools, ideas from texts, journals, books, records, Websites. The
collection of data is an important aspect of Research.
The sources of information fall under two categories.
Internal Sources: Every company keeps certain records such as accounts, records, reports, etc. These records
provide sample information for research.
External Sources: When internal records are insufficient and required information is not available the
organization the organization depends on eternal sources. The external sources of data are:
I.
Primary Data
II.
Secondary Data
(I)
Primary Data: -
The data collected for a purpose in original and for the first time is known as primary
data. The data collected by the researcher himself to study a particular problem.
The primary data of the study is collected through interaction and discussion with the
officials and the staff an M/S JYOTHI BRASS METAL WORKS ANANTAPUR.
(II) Secondary Data: The data which is collected from the published sources that is for the first time is
called secondary data.
The secondary data for the study is collected from the annual reports of M/S JYOTHI
BRASS METAL WORKS ANANTAPUR from 2008 to 2012
Data Analysis: Data analysis is done by implementing various tools like ratio analysis, trend analysis,
etc.
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1.
2.
3.
Traditional Classification
Functional Classification
Significance ratios
1. Traditional Classification
It includes the following.
Balance sheet (or) position statement ratio: They deal with the relationship
between two balance sheet items, e.g. the ratio of current assets to current
liabilities etc., both the items must, however, pertain to the same balance sheet.
Profit & loss account (or) revenue statement ratios: These ratios deal with the
relationship between two profit & loss account items, e.g. the ratio of gross profit
to sales etc.,
Composite (or) inter statement ratios: These ratios exhibit the relation between a
profit & loss account or income statement item and a balance sheet items, e.g.
stock turnover ratio, or the ratio of total assets to sales.
2. Functional Classification
These include liquidity ratios, long term solvency and leverage ratios, activity ratios and
profitability ratios.
3. Significance ratios
Some ratios are important than others and the firm may classify them as primary and
secondary ratios. The primary ratio is one, which is of the prime importance to a concern. The
other ratios that support the primary ratio are called secondary ratios.
TYPES OF RATIOS
Several ratios, calculated from the accounting data, can be grouped into
various classes according to financial activity of function to be evaluated. The
management is interested in evaluating every aspect of the firms performance. They have
to protect the interest is in the liquidity position or the short-term solvency of the firm;
Long-term creditors are more interested in the long-term profitability and financial
condition. IN the view of the requirements of the various users of ratios, we may classify
them into the following categories. Ratio analysis enables the analyst to compare items on
a single financial statement or to examine the relationship between items on two financial
statements. After calculating ratios for each years financial data, the analyst can then
examine trends for the company across years. Since ratios adjust for size, using this
analytical tool facilities intercompany as well intercompany comparisons. Ratios are often
classified using the following terms:
Liquidity Ratios
Leverage Ratios
Activity Ratios
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Profitability
Profitability ratios are gauges of the companys operating success for a given period of
time.
Liquidity ratios are measures of the short term ability of the company to pay its debts
when they come due and to meet unexpected needs for cash. Solvency ratios indicate the
ability of the company to meet its long term obligations on a continuing basis and thus to
survive over a long period of time.
In judging how well on a company is doing, analysts typically compare a
companys ratios to industry statistics as well as to its own past performance.
Goals
A. Managerial uses of ratio analysis:
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Helps in communicating
Helps in co-ordination.
Helps in Control.
B. Utility to creditors.
C. Utility to employees.
D. Utility to government.
CLASSIFICATION OF RATIOS
LIQUIDITY
RATIO
LEVERAGE
RATIO
ACTIVITY
RATIO
PROFITABILITY
RATIOS
1. Current ratio
1. Debt equity
ratio
1. Inventory
turnover ratio
2. Liquidity ratio
2. Debt to total
capital ratio
2. Debtors
turnover ratio
3. Absolute ratio
3. Interest
coverage
ratio.
3. Fixed assets
turnover ratio
4. Capital
4. Total assets
turnover ratio
2. Operating ratio
3. Operating profit
ratio
4. Net profit ratio
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gearing ratio
5. Working
capital ratio
5. Equity ratio
6. Fixed assets
to net worth
ratio
7. Fixed assets
ratio
6. Payable
turnover ratio
7. Capital
employed
ratio
5. Return on
investment ratio
6. Return on equity
capital
7. Return on total
resources
8. Current assets
to proprietors
ratio.
8. Earnings per
share
9. Solvency ratio
9. Price earnings
ratio
A.LIQUIDITY RATIOS
Liquidity Ratios measure the ability of the firm to meet its current obligations. In fact,
analysis of liquidity needs the preparation of cash budgets and cash and fund flow statements;
but liquidity ratios, by establishing a relationship between cash and other current assets to
current obligations, provide a quick measure of liquidity. The failure of a company to meet its
obligations due to lack of sufficient liquidity, will result in a poor creditworthiness, loss of
credit worthiness, loss of creditors confidence, or even in legal tangles resulting in the closure
of the company. A very high degree of liquidity is also bad; idle assets earn nothing. The most
common ratio which indicates the extent of liquidity or lack of it is;
1. Current ratio
2. Quick ratio (or) acid-test ratio
3. Absolute liquid ratio (or)cash ratio
1. CURRENT RATIO:
The current ratio is a measure of the firms short-term solvency. It indicates the
availability of current assets in rupees for every one rupee of current liability. A ratio of
greater than one means that the firm has more current assets than current claims against them.
Current ratio is calculated by dividing current assets by current liabilities.
Current Assets
Current Ratio = -----------------------------Current Liabilities
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CURRENT LIABILITIES
Cash in hand
Cash at bank
Bills receivable
Bills payable
Inventories
Short-term advances
Work-in-progress
Sundry creditors
Marketable securities
Dividend payable
Short-term investments
Income-tax payable
Sundry debtors
Prepaid expenses
. The two basic components of this ratio are current assets and current liabilities. Current
assets include Cash and these assets which can be easily converted into cash within a short
period of time generally one year. Current assets are those obligation which are payable
within a short period of generally one year.
An ideal current ratio in 2:1. As a convention the minimum of two to one ratio is
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referred to as a bankers rule of thumb or arbitrary standard of liquidity for a firm. A ratio
equal or near to the rule of thumb of 2:1 be current assets double the current liabilities is
considered satisfactory. A relatively high current ratio is an indication that the firm is liquid
and has the ability to pay its current obligation in time as when they become due. On the
other hand relatively low current ratio represents that the liquidity position of the firm is not
good and the a ratio equal or near to the rule of thumb of 2:1 be current assets double the
current liabilities is considered satisfactory. A relatively high current ratio is an indication
that the firm is liquid and has the ability to pay its current obligation in time as and when they
become due. On the other hand a relatively low current ratio represents that the liquidity
position of the firm is not good and the firm shall not be able to pay its current liabilities in
time without facing difficulties.
2. QUICK RATIO:
Quick ratio is also called acid test ratio, establishes a relationship between quick or liquid
assets and current liabilities. An asset is liquid if it can be converted into cash immediately or
reasonable soon without a loss of value cash is the most liquid asset. Quick assets are debtors
and bills receivables and marketable securities.
Quick ratio is found out by dividing quick assets by current liabilities.
Quick Assets
Quick Ratio = --------------------------------Current Liabilities
CURRENT LIABILITIES
Cash in hand
Cash at bank
Bills receivable
Bills payable
Sundry debtors
Short-term advances
Marketable securities
Sundry creditors
Temporary investments
Dividend payable
Income tax payable
The quick ratio is very useful in measuring the liquidity position of firm. It measures the
firms capacity to pay off current obligations immediately and is a more rigorous test of
liquidity than ratio. It is used as a complementary ratio to the current ratio. A quick ratio
may be defined as the relationship between quick assets and current liabilities. Quick asset is
found by subtracting inventories and prepaid expenses from current ratio.
As a rule of thumb or as convention quick ratio of 1:1 is considered satisfactory. It
is generally thought that if quick assets are equal to current liabilities than the concern may be
able to meet its short-term obligations. Usually, a light acid test ratio is an indication that the
firm is liquid and has the ability to meet it current or liquid liabilities in time and on the other
hand a low quick ratio represent that the firm liquidity position is not good.
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cash.
Cash + Marketable Securities
Cash Ratio = ----------------------------------------------------------Current Liabilities
Cash at bank
Bills payable
Short-term advances
Sundry creditors
Dividend payable
Income tax payable
Although receivable, debtors and bills receivable are generally more liquid than inventories,
yet there may be doubts regarding their realization into cash immediately or in time. Hence,
some authorities are of the opinion that absolute liquid ratio should also be calculated
together with current ratio and acid test ratio so as to exclude even receivables from the
current assets and find at the absolute liquid assets.
Absolute liquid assets include cash in hand and at bank and marketable securities
or temporary investments. The acceptable norm for this ratio is 50% or 5:1 or 1:2 i.e. Re.1
worth absolute liquid assets are considered adequate to pay Rs.2 worth Current liabilities in
time as all creditors are not expected to demand cash at the same time and then cash may also
be realized from debtors and inventories.
B. LEVERAGE RATIOS:
The short-term creditors, like bankers and suppliers of raw material, are more concerned
with the firms current debt-paying ability. Long-term creditors like debenture holders,
financial institutions etc. are more concerned with the firms long-term financial strength.
To know the long-term financial position of the firm, financial leverage, or capital
structure ratios are calculated. These ratios indicate mix of funds provided by owners and
lenders. It has number of implications those are
a) Between debt and equity, debt is more risky from the firms point of view.
b) Use of debt is advantageous for shareholders in two ways.
1. They can retain control of the firm with a limited stake.
2. Their earning will be magnified.
3.
A highly debt burdened firm will find difficulty in raising funds from
Creditors and owners in future.
Leverage Ratios are calculated to measure the financial risk and firms ability of
using debt to shareholders advantage. Leverage ratio may be calculated from the balance
sheet items to determine the proportions of debt in total financing.
1. Debt ratio
2. Debt equity ratio
SHRI SAI INISTITUTE OF ENGINEERING AND TECHNOLOGY ATP
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1. DEBT RATIO:
Several debt ratios may be used to analyze the long-term solvency of a firm. The firm
may be interested in knowing the proportion of the interest-bearing debt in the capital
structure. Total debt includes short and long-term borrowings from financial institutions,
debentures, deferred payment arrangements for buying capital equipments, bank borrowings,
public deposits and any other interest-bearing loan. Capital employed will include total debt
and net worth (NW).Debt ratio is calculated as dividing total debt (TD) by capital employed
(CE) or net assets (NA).
Total Debt
Debt Ratio = ----------------------------------------Total Debt +Net Worth
2. DEBT-EQUITY RATIO
The relationship between borrowed funds and owners capital is a popular measure of
the long-term financial solvency of a firm. This relationship is shown b the debt-equity ratios.
This ratio reflects the relative claims of creditors and shareholders against the assets of the
firm. The debt considered here is exclusive of current liabilities.
The debt equity ratio is an important tool of financial analysis to appraise the
financial structure of firm. The ratio reflects the relative contribution of creditors and owners
of business in is financing. A high ratio shows a large share of financing by the creditors
relatively to the owners and therefore a larger claim of creditors. The ratio is 1:2; it implies
that for every rupee of outside liability, the firm has two rupees of owners. There is therefore
a safety margin of 50% available to the creditors of the firm.
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Total Debt
Debt Ratio = ----------------------------------------------Share Holders equity
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C. ACTIVITY RATIOS
Activity ratio are employed to evaluate the efficiency with
which the firm manages and utilities its assets. These ratios are also called turnover ratios or
efficiency ratios. The efficiency with which the assets are used would be reflected in the
speed and rapidity with which assets are converted into sales. Such ratios are also designated
as turnover ratios. An activity ratio may, therefore, be defined as a test of the relationship
between sales and the various assets of the firm. We illustrate below the important activity
ratios.
1. Stock turnover ratio
2. Inventory turnover ratio
3. Debtors turnover ratio
4. Average collection period
5. Fixed Assets turnover ratio
6. Creditors turnover ratio
7. Current assets ratio
Average Stock
Average Inventory
The inventory turnover shows how rapidly is turning into receivable though sales. A
high inventory turnover is indicative of goods inventory management. A low inventory
turnover implies excessive inventory levels then warranted by production and sales
activities. A high level of sluggish inventory amounts to unnecessary tie-up of funds
reduced profit and increased costs.
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Average Debtors
FIXED ASSETS
Cash in hand
Machinery
Cash at bank
Buildings
Bills receivable
Plant
Inventories
Vehicles
Work-in-progress
Marketable securities
Short-term investments
Sundry debtors
Prepaid expenses
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D. PROFITABILITY RATIOS:
Profit is the difference between revenues and expenses over a
period of time. The profitability ratios are calculated to measure the operating efficiency of
the company. Generally two major types of profitability ratios are calculated i.e. profitability
in relate to sales and profitability relate to investment. Profitability ratios related on each
rupee of sales. Profitability ratios related to sales are classified below:
Gross profit ratio
Net profit ratio
Operating expense ratio
SHRI SAI INISTITUTE OF ENGINEERING AND TECHNOLOGY ATP
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Taxes are not controllable by the firm, and also, one may not
now the marginal corporate tax rate while analyzing the published data. Therefore, the ratio
may calculate on before tax basis.
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