a writers copied report august 25
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1. FINANCIAL ANALYSIS ASSIGNMENT ROY
Article Body:
Useful to the outsiders:
Ratio analysis is indeed a well-widely accepted and widely used tool of supplying necessary
information method to gauge the management. In addition it is also considered as an important
technique even to the outside parties associated with any business or nonbusiness institution. The
performance of a company. Quantitative analysis of companys financial statements using the
information provided and comparing the same with the previous years data is an important
activity for any company. Evaluation of such relationships by comparing the financial statements
is further presented to the outsiders like potential investors depend a lotwho rely on the analyzed
information available through ratio analysis for setting up business relation, maintaining the link
with the firm, taking important decisions on different issues, etc. Even at present the researchers
on accounting and management fields take the help of ratiosuch data for theiranalysis for the
purpose of evaluation of performance, measurement of trends and projection ofand future
potentialsdecision making. Such ratios help identify the trend and compare with other companies
which reveal trivial data to make certain important financial decisions for current financial year
and also future projections.
From the foregoing discussion it is apparent that ratios have wide use not only in making Ratio
Analysis offinancial analysis but also for different other purposes. In fact the utility or
effectiveness of ratio analysis is dependent to a great extentstatements mainly focuses on the
purpose3 aspects ofusea company- profitability, solvency and the analytical aptitudeliquidity.
Profitability Ratios help measure the operating efficiency ofthea company.
Solvency Ratioshelp measure a companys potential long term risks.
Liquidity Ratiosas the name suggests measures the companys ability to repay short term debts
and its unexpected or immediate cash requirements.
It is of remarkable importance of recruit a financial analyst. At present the use of ratios is
common almost who is very proficient in working with financial data of current year and
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previous years in alldepth to provide timely and valuable information. Ratio Analysis has
become a day to day activity today for any company at a managerial activities.level as financial
decisions are made and changed almost everyday due to the frequently changing market
conditions. J.Batty has rightly stated that the ratios can help in executing the basic functions of
management like forecasting, planning, coordination, control and communication.
Return on Capital Employed:
(i) This ratio is a real test of the profitability and managerial efficiency. The higher the A
satisfactory return on any capitalbeing invested is perhaps the prime motive of an Investment.
Return on Capital employed (ROCE) helps establish the relationship between the higher is two
important factors of an investment- Profit and theprofitability and the sound is the managerial
ability. From the viewpoint of shareholders and the management a high return on capital
employed is always favorable.
(ii) A low. From the companys point of view, calculating this ratio is one ofthe best ways to
assess its overall performance as it helps indicate the efficiency of the management to manage
the investments made by the owners and also helps gauge its decisions. From a shareholders
point of view, this ratio informs them about theirreturn on capitalinvestments. High Return on
Capital employed in comparison to the industry standard reveals that the firm has not been able
to earn a reasonable profit. It also explains thatindicates high managerial efficiency implying
better profits ofthe managerial skill is not sound enough to increasecompany. This ratio also
shows theprofitability. A low return on capital employed is against the interest of the
shareholders and management.
(iii) If the cost of long-term borrowing is lower than the return on capital employed, return to
shareholders would increase.
(iv)companys trend in making profits over a period. A high return on capital employed achieved
for a few consecutive years indicates that the firm has a stable financialpositionstability and has
good futureprospectprospects.
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Net Profit or Net Margin Ratio
(i) The net profit ratio shows the net contributions made by sales of rupee 1 to the owners fund.
(ii) A higher net profit ratio indicates better overall profitability and managerial efficiency. It
expresses how much the total revenue earned is more than the total expenses incurred.
(iii) A low net profit ratio reveals that the net earning is insufficient and the profitability and
managerial efficiency are not up to the mark.
(iv) If a firm has a low net profit ratio in spite of having a high gross profit ratio, it seems that it
has excessive indirect expenses on which it has not been able to enforce control.
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Another important tool and one of the profitability ratios that provides the final output. It is a
ratio between net profits after taxes to net sales. Higher Net Profit Ratio denotes high profits to
the company. The Net Margin shows the money a company is left with for its equity and
preference shareholders who are the real owners. Any company will strive to keep a good Net
Profit Ratio to make sure it never defaults. This can be achieved when activities like pricing,
selling, financing, administration, production, taxation and likewise are carried on effectively
and efficiently as these factors have direct influence on Net Profit Ratio. It is always advisable
for a company to maintain a good balance between Gross Profits and Net Profits for that signifies
that both direct and indirect expenses are under control.
Dividend Yield Ratio
(i) It makes an analysis ofThis ratio measures the cash flow a company gets to investment made
in an equity position. It helps the investors secure their cash flow from their investment portfolio.
They can decide on investing in stocks whose dividends are relatively high and stable.It is the
ratio of Annual dividends per share over Price per share.
It helps analyse the return on equity shares not on the basis of the face value of the shares but on
their market value. So it which reflects on the true rate of return available to the equity
shareholders. Higher dividend yield ratio signifies more returns to the equity shareholders. It
indicates high/low rate of profit earned by the company.
(ii) The higher
Price - Earnings Ratio
As the dividend yield rationame suggests, the more is the return for equity shareholders. It
indicates the high ratecomparison ofprofit earned by the company.
(iii) If this ratio is low it indicates a low return on equityMarket value pershare capital and a low
profitability.
(iv) If the market price of the equity shares is too high the dividend yield ratio may be
considerably low. In such case, of course, the return of the equity shareholders may not be toolow. So a low dividend yield ratio in a situation of very high market price of equityto Earnings
pershare is not against the interest of the equity shareholders.
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gives Price Earnings Ratio
(i). It helps compare the earnings growth between two companies. A high price earnings ratio
indicates either a fall in earning per share or an increase in market price per share. A high price
earningsHigh Price - Earnings ratio resultingresults from increased market price per share and is
beneficial to the shareholders. It indicates high managerial efficiency, high profitability and good
market reputation. P/E Ratio is a great indicator of any problem or even an opportunity.
(ii) A low price earnings ratio not caused by an increased earning indicates reduced market price
per share. It also reveals a low level of managerial efficiency and profitability. It is against the
interest of the shareholders.
(iii) If the low price earnings ratio is caused by increased earnings per share it does not indicate
an unfavorable situation for the shareholders.
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Dividend Payout Ratio
(i) A highThis ratio helps conclude how well the company can support its dividendpayout ratio
indicatespayouts through its earnings. It is the percentage of companys earnings that the greater
portion of profit availablehas been paid out to the equity shareholders has been distributed while
a smaller portion has been retained.in the form of dividends. The shareholders like to get more
cash dividend, so a high dividend payout ratio is favorable to them.
(ii) A low dividend payout ratio reveals that the smaller portion of profit due to the equity
shareholders has been paid in cash, while is the greater portion has been retained.comparison of
dividends to Net Income of the company. The shareholders, keen to get cash dividend, do not
like this position.
(iii) From the viewpoint of the financial health of the company a high dividend payout ratio is
never desirable because in such case retentionpart ofprofit becomes less. A low dividend payout
ratio that indicates less distribution and more retentionearnings left after paying these dividends
is helpfulused for the sustainedfuture growth of the company. Paying up higher dividends is a
good option for companies with little room for growth whereas companies who need to allocate
funds for growth and expansion pay up lesser dividends as per the indication of the Dividend
Payout Ratio.
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Equity Dividend Coverage Ratio
(i) The higher the equity dividend coverage ratio the more is the security of the equity
shareholders to get dividend. It also indicates good financial stability of the firm because the firm
is in a position to pay equity dividend after meeting all fixed burdens and tax liability.
(ii) A low equity- dividend coverage ratio is against the interest of the equity shareholders as it
reduces the security of getting dividend by them. This situation does not indicate sound financial
base of the firm.
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This ratio helps decide the capacity of a company to pay the dividend to its shareholders. Equity
and Preference share holders have the first right over the companys dividends and hence, this
calculation becomes important for them. It is the comparison between Net Earnings and
Dividend. High Dividend coverage ratio signifies better security for equity and preference share
holders which in turn shows how stable a company is financially. Dividend payouts are
compulsory but can be postponed as per the discretion of the management. While Dividend
Payout Ratio is just a percentage shown by the management, Dividend Coverage Ratio is the
absolute value that is calculated.
Interest Coverage Ratio
(i) The earnings before interest and tax and the operating profit are same. So the interest
coverage ratio measures as to how many times the interest burden of the firm is covered by the
operating profit of the firm.
(ii) A The ratio ofhigher interest coverage ratio indicates betterpoint towards capacity of
superiordebt servicing capacity. It. So it is beneficial from the viewpoints of bothforthe firm
and as well as the lenders. From the viewpoint of prospective of firm it will be more helpful
while in the situations of low profit, as they will be having more absorbing power and it also
supports the firm it is beneficial because it indicates more shock absorbing capacity in case of
lower profit andwhile repaying the reduced risk of default in interestpayment. Fromamount.
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(iii) The ratio of low interest coverage shows that the lenders viewpoint it is welcome because it
indicates steady returnlenders which has low safety on their returns ofinvestment., even this
condition is not favorable for the firms.
(iii)
A low interest coverage ratio reveals that the lenders have a low safety of return on their
investment, it is also unfavorable to the firm because in such case the firms profitability in
relation to its interest payment commitment is low and it is not in a position to take recourse to
further debt financing in case of any need.
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Capital Gearing Ratio
(i) (i) The tern: gear Gear term is generally used to control the in controlling motorspeed of a motorwhich will be fitted to a car. The word speed has a close
relationship with the term risk. In accounting ratio theterm gear is used to
measure the financial risk involved in the capital structure of a company. In case of a
motor car using high gear means increasing the speed and using the risk term have a
shut relationship and everyone aware about the problems associated with it. In the
field of accounting the term gear is referred while measuring the financial risk
associated with companys capital structure. As the word high gear means speed
increasing and so as low gear means bringing downout the speed. Similarly at low
level. Same time a highly geared company (a company having awith high capital
gearing ratio) runs with will have more risk and a lowlythen geared company (a
company having a low capital gearing ratio)will have slow impact as it has to bears a
low risk, it means that a high gear Is rum- risky and vice versa.
(ii) The state ofhigh gearing state is favorable for while taking advantage of trading on
equity.equity trading. In inflationary situation condition high gearing is effective because at
this time the increased useful as the improvement in income helps to bear the in bearing
burden offixed interest burden..
(iii) In a deflationary market Low gearing situation low gearing is more effective because the
low income earned during favorable in the market as it helps at the time ofdeflationary period is
not sufficient to bear hugewhile it will easy in handling interest burden.
(iv) The management must try to draw up a perfectTo create a well balance in the use ofwhile
using risky capital and non-risky capital. the management plays vital role. A balanced capital
structureorganization is reflecteddazzling upon a modest capital gearing ratio. This situation is
moderate capital gearing ratio. It is that situation which is neither where the risk will not too
risky nor much ortoo conservative.less.
(v) InThe highly geared companies the provide high return of equity shareholders becomes highin the years ofon investment during theirhigh profit years,but it becomes low inwhen the
scenario get disturbs then the shareholders will have to bearthe yearloss on the value of their
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return on investment. So during the period of low profit. In a year of high profit it is possible for
the company to companies will declare a high rate of dividend even after paying off high cost of
debt. On the other hand in a year of low profit the major portion of profit earned is used up in
meeting loss and shareholder will get the amount which will be excluding the amount paid in
form ofinterest burden and only a small portion is left for equity shareholders.
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Current Ratio
1. (i) A comparatively higherHigh current ratio indicates a good indicated betterliquidityand it also indicates firms satisfactory debt repayment capacity. So at this moment ofthe
firm. It is also an indicator of safety of investment made bytime creditors. can take
advantage of the situation and go for safety investment.
(ii) A low2. Low current ratio than the is a standard indicates a indication ofbad liquidity, the
debt repayment capacity of the firm will be poor, over-trading, less and working capital and
unsatisfactory debt repayment capacity of the firm. The investment of creditors in a firm having
a low current ratio may not be too safe.
2. (iii) Current ratio expressed in terms of percentage is known as working capital ratio.This ratiowill also indicates the margin of safety or margin of caution of the creditors.be
less. So this type of situation will be good for creditors investment.
3. (iv) APercentage of current ratio is known as ratio of working capital. This ratio will helpcreditors to know the line of safety while investing into the firms.
4. While the high current ratio always indicates a soundstrong debt repayment capacity andathe low current ratio interprets this indicates the poorposition in an adverse manner
this proposition may not be universally trueof the firm in terms of their debt repayment
capacity, but it is not same in all cases. If the current assets do not have a
goodcircumstances, the quality, like they consist of more obsolete ofstock, slow paying
debtors, etc. the good also matters while judging the liquidity position as indicated by a
high current ratio may not be so good in reality. On the other hand. Concurrently, if the
current assets consist ofhigh quality stock and well-paying debtors even a stocks will be
the part of current asset then indication ofcurrent ratio lower than the standard may speak
of does play great role while indicating the sound solvencydebt repayment capacity of the
firm.
5. (v) InAt the time ofmeasuring the short- term liquidity or solvency current ratio shouldnot be takenconsidered as the sole parameter. Other however otherliquidity ratios are
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also to be calculated for this purpose.should be considered to understand the proper
position of the firm.
6. (vi) If there is a recession in a Recession inparticularindustry, all the firms belonging tothat industryindustries may have largeimpact on theirunsold inventory andwhich in turn
affects long outstanding debtors. These would increase This will add in current assets and
resultasset which helps in aboosting high current ratio. But in this case the trend indicated
by the high current ratio may not stand favorable for the firms.
Liquid or Quick or Acid Test Ratio
(e)
1. (i) A High current ratio along with high quick ratio along with is a high current ratioindicates a good short-term solvency or debtmere indication of better situation of the
firms repayment capacity of the firm.and also better short term solvency.
2. (ii) Even ifAt the time of high current ratio is high, a, low quick ratio doeswill notindicate ahave any kind of impact on firms good debt repayment capacity of the firm..
3. (iii) The authenticity of decision takenconclusion drawn on the basis of current ratiocanwill be verified through with the help ofquick ratio.
4. (iv) A The safety of creditors investment can be ensured with the help ofhigh quick ratioensures the safety of the investment of creditors..
5. (v) The While testing the better liquidity of the firm quick ratio is considered to be abetter test of liquidity more authentic than the current ratio. But However it is difficult to
come to the conclusion as the position of debtors mentioned by liquid asset orquickratio
itselfasset may not be takenin good practice, as a conclusive test of liquidity. Ifthe firm
which have shown quickasset or liquid assets consist of slow paying or defaulting
debtors the good liquidity position as indicated by a high quick ratioasset may notbe sogood in practice. Again if the inventories which are not included in quick assets are not
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so illiquid and have very good turnover the firm may enjoy aenjoying better liquidity
position.
6. So more rigorous or precise test should come in the practice ratherthan what isindicateddepending on the indication of current ratio maintained by a low quick ratio.
(vi) For verifying the trend indicated by the current ratio and supported by the quick ratio it is
required to adopt a more rigorous test of liquidity through the Absolute Liquid Ratio.
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Fixed Assets Turnover
1. (i) A high fixed assets turnover ratio is an indicator of efficient indicates fixed assetproficient utilization at the time offixed assets in generating sales. It revealsis disclosed
that use of less fixed assets made possible at the time ofhigher generation of sales.sales
less fixed asset can be made possible.
2. (ii) A The ratio oflow fixed assets turnover ratio indicates inefficient managerialasset isthe indication of ineffective marginal ability in utilization ofwhile utilizing the fixed
assetsbecause it reveals that use of as more fixed assets resulted inasset turn up in
generating lowergeneration ofsales.
3. (iii) If the value ofmajor portion ofa firms fixed assets have been depreciatedasset ofthe firm get depreciates its turnover ratio offixed assets turnover ratio may be more than
another firm which has recently purchased asset compare to the other firms with huge
fixed assets. In such case, and then it cannot be saidis considered that the formers
managerial efficiency is more than the latter. So a careful consideration is necessary for
measuring efficiency by using the fixed assets turnover ratio.will be more efficient in
future.
(iv) The While evaluating the activity level of any firm the comparisonbetween ratios ofa firms
fixed assetsasset turnoverratio with that of the compare topast years and also with the that of
industry standard maystandards will be a helpful tool to evaluate the activity level.
Current Assets Turnover
(i) If this ratio is high it indicates an efficient utilization of current assets in generating sales. It
reveals that use of less fixed assets has generated more sales.
(ii) If this ratio is low it is indicative of inefficiency in working capital management. It reveals
that use of more current assets resulted in lower generation of sales.
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(iii) A too high or too low current assets turnover is not a welcoming feature of a firms
management. If this ratio is nearer to the average or standard followed in the industry it is
considered as an indicator of an efficient activity level of the firm.
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Return on shareholders funds
(Same as return on capital employed)
Total shareholders return
(Same as return on capital employed)
Eps
Dps
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Comparative Financial Statement Analysisfinancial statement analysis
Comparative Financial Statement analysis providesIt gives information in order to
assessaccess the change direction ofchange in thea business. Financial statements arepresentedas onprepared for a particular date for a particular period. The financial statement duration oftime and presented on a fixed day. Balance Sheet indicates sheet is indicative of the financial
position as at the end of an accounting period and the financial statement Income Statementshows the operating and non-operating results for a period. But financial managers and topmanagement are also interested in knowing whether the of abusiness is moving in a favorable or
an unfavorable direction. For this purpose, figures of current year have to during a particularperiod of time and the Income statement shows the operation and the non-operating parameters
for a given period of time. However, the finance managers and the top management of a firm is
very eager to know if the business is heading in a right direction of success. In order tounderstand this, the results and statistics of this year shouldbe compared with thosethat of the
last orprevious years. In analyzingyear. For this waypurpose, comparative financial statementsare prepared.
Comparative Financial Statement Analysis which is also calledknown as Horizontal analysis.
The Comparative Financial Statement provides information about two or more years' figures as
well as any increase or decrease from the previous year's figure and it's percentage of increase
or decrease. This kind of analysisstatement provided the data or figures of two or more
years and also let us knows the differences in the form of increases or decreases which
eventually helps in identifyingfinding or discovering the majorbusiness weaknesses or
improvements and weaknesses.that may be needed. Forexampleinstance, ifthe net income
ofa particularthis year has decreased from its previousas compared to last year, despite anincrease in sales duringthroughout the year, is a matterit becomes an issue ofseriousgreat
concern. for the business. Comparative financial statement analysis in such situations
helpsstatements will certainly help to find outdiscoverwhere the costs havefactor
increased due to which has resulted in lower low net income than the previous year.situation
was faced by the business. Accountancy holds the roots of any business and financial
statements like the Balance sheet, Income statements and Profit and Loss accounts are an
indispensible part of accountancy and business.
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