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INTRODUCTION

The analysis of the financial statements and interpretations of financial results of a particular period of operations with the help of 'ratio' is termed as "ratio analysis."

Ratio analysis used to determine the financial soundness of a business concern.

Alexander Wall designed a system of ratio analysis and presented it in useful form

in the year 199.

The term 'ratio' refers to the mathematical relationship between any two inter!

related ariables. #n other words$ it establishes relationship between two items

expressed in %uantitatie form.

According &. atty$ Ratio can be defined as "the term accounting ratio is used todescribe significant relationships which exist between figures shown in a balance

sheet and profit and loss account in a budgetary control system or any other part of

the accounting management."

PURPOSE OF FINANCIAL ANALYSIS

(or most of us$ accounting is not the easiest thing in the world to understand$ and

often the terminology used by accountants is part of the problem. )(inancial ratio

analysis* sounds pretty complicated. #n fact$ it is not. Thin+ of it as )battingaerages for business.*

The use of financial ratios is a time!tested method of analy,ing a business. Wall

-treet inestment firms$ ban+ loan officers and +nowledgeable business owners all

use financial ratio analysis to learn more about a companys current financial

health as well as its potential.

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LIQUIDITY #n accounting$ li%uidity /or accounting li%uidity0 is a measure of the ability of a

debtor to pay their debts as and when they fall due. #t is usually expressed as a ratio

or a percentage of current liabilities. i%uidity is the ability to pay short!term

obligations.

At the stoc+ leel2 i%uidity refers to how easy it is to buy or sell a large number of

shares without haing a big effect on share price.

At the company leel2 3hec+ the li%uidity of your companies to see if they would

be able to access cash %uic+ly if necessary$ for instance$ to ma+e a debt payment.

Are there enough cash and "cash e%uialents" on hand to coer the payment4

At the mar+et leel2 5ar+ets and economies in general need to hae li%uidity$ in

terms of a flow of money and credit$ otherwise operations are hindered$ as there's

no fuel$ no grease.

LIQUIDITY MANAGEMENT

The importance of li%uidity management is reflected in the fact that financial

managers spend a great deal of time in managing current assets and current

liabilities. The +ey issues in li%uidity management are as to how much must be

inested in each component of li%uidity management and how to manage these

components effectiely and efficiently.

6roper management of li%uidity is ery important for the success of an enterprise.

The manner of management of li%uidity to a ery large extent determines the

success of the operation of concern.

The failure of any enterprise is undoubtedly due to poor management and absence

of management s+ill. -hortage of li%uidity$ so often adance as the main cause of

failure is nothing but the clearest eidence of poor management$ which is so

common.

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LIQUIDITY RATIOS

i%uidity Ratios are also termed as -hort!Term -olency Ratios. The term li%uidity

means the extent of %uic+ conertibility of assets in to money for paying obligation

of short!term nature.

Accordingly$ li%uidity ratios are useful in obtaining an indication of a firm's ability

to meet its current liabilities$ but it does not reeal how effectiely the cash

resources can be managed.

DAYS SALES IN RECEIVABLES

ACCOUNTS RECEIVABLE TURNOVER

ACCOUNTS RECEIVABLES TURNOVER IN DAYS

DAYS SALES IN INVENTORY

INVENTORY TURNOVER

INVENTORY TURNOVER IN DAYS

OPERATING CYCLE

WORKING CAPITAL

CURRENT RATIO

ACID TEST RATIO

CASH RATIO

• SALES TO WORKING CAPITAL

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MILLAT TRACTORS LIMITED

The 5illat Tractors imited /5T0 was established in 1978 to introduce and

mar+et 5assey (erguson Tractors in 6a+istan. An assembly plant was set up in

197 to assemble tractors in semi!+noc+ed down /-:;0 condition.

The company was nationali,ed in 19< and started assembling and mar+eting

tractors on behalf of 6a+istan Tractor 3orporation /6T30 which was formed by the

=oernment for import of tractors in -:; condition. #n 19>$ the =oernment

decided on indigeni,ation of the tractors and entrusted this tas+ to 6a+istan Tractor

3orporation.

6a+istan Tractor 3orporation transferred this role of indigeni,ation in 19>1 to

5illat Tractors imited. &ust in one year's time$ the company too+ a giant step

towards self!reliance by setting up the first engine assembly plant in 6a+istan.

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AL-GHAZI TRACTORS LIMITED

The Al!=ha,i Tractors imited /A=T0$ was incorporated in 19>?$ its plant

located in ;era =ha,i :han$ 6un@ab$ 6a+istan. Al!=ha,i Tractors plant

manufacture ew Bolland tractors and generators in collaboration with (iat ew

Bolland. #n 1991$ Al!(uttaim =roup of ;ubai too+ oer the management control of

Al!=ha,i Tractors by ac%uiring CD of its shares. #ts corporate Bead Effice is in

:arachi$ 6a+istan.

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NUMBER OF DAYS SALES IN RECEIVABLES

DAYS SALES IN RECEIVABLES = GROSS RECEIVABLES/NET

SALES/365

The days' sales in accounts receiable ratio$ also +nown as the number of days of

receiables$ tells us the aerage number of days it ta+es to collect an account

receiable. -ince the days' sales in accounts receiable is an aerage$ you need to

be careful when using it.

;ue to the high importance of cash in running a business$ it is in a company's best

interest to collect outstanding receiables as %uic+ly as possible. y %uic+ly

turning sales into cash$ a company has the chance to put the cash to use again !ideally$ to reinest and ma+e more sales.

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ACCOUNTS RECEIVABLE TURNOVER

ACCOUNTS RECEIVABLE TURNOVER =NET SALES/AVERAGE

GROSS RECEIVABLES

The Accounts Receiable Turnoer Ratio measures the number of time accounts

receiable turned oer during a time period. A higher ratio indicates a shorter time

between ma+ing a sale and collecting the cash.

The ratio is based on et -ales and et Accounts Receiable. Remember$ et

-ales e%uals -ales less any allowances for returns or discounts. et Accounts

Receiable e%uals Accounts Receiable less any ad@ustments for bad debts.

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ACCOUNTS RECEIVABLE TURNOVER IN DAYS

A33EFT- RG3G#HAG- TFREHGR # ;AI- J AHGRA=G =RE--

RG3G#HAG-KGT -AG-K?7C

Accounts receiable turnoer measures the efficiency of a business in collecting its

credit sales. =enerally a high alue of accounts receiable turnoer is faorable

and lower figure may indicate inefficiency in collecting outstanding sales. #ncrease

in accounts receiable turnoer oertime generally indicates improement in the

process of cash collection on credit sales.

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DAYS SALES IN INVENTORY

;AI- -AG- # #HGTERI JG;#= #HGTERIK3E-T E(

=EE;- -E; K?7C

A financial measure of a company's performance that gies inestors an idea ofhow long it ta+es a company to turn its inentory /including goods that are wor+ in

progress$ if applicable0 into sales. =enerally$ the lower /shorter0 the ;-# the better$

but it is important to note that the aerage ;-# aries from one industry to another.

The days' sales in inentory tells you the aerage number of days that it too+ to sell

the aerage inentory held during the specified one!year period. Iou can also thin+

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of it as the number of days of sales that was held in inentory during the specified

year.

INVENTORY TURNOVER#HGTERI TFREHGR J3E-T E( =EE;- -E;KAHGRA=G

#HGTERI

The #nentory Turnoer Ratio measures the number of times inentory )turned

oer* or was conerted to sales during a time period. #t may also be called the 3ost

of -ales to #nentory Ratio. #t is a good indication of purchasing and production

efficiency.

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#n general$ the higher the ratio$ the more fre%uently the inentory turned oer. Iou

might expect a company with a perishable inentory$ such as a grocery store$ tohae a ery high #nentory Turnoer Ratio.

3onersely$ a furniture store might hae a low #nentory Turnoer Ratio.

INVENTORY TURNOVER IN DAYS

INVENTORY TURNOVER IN DAYS =AVERAGE INVENTORY/COST OF

GOODS SOLD/365

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Ence you hae calculated the #nentory Turnoer Ratio$ you can conert it to the

actual number of days of inentory you hae on hand. This +ey ratio combinedwith the Accounts Receiable ;ays on Band and Accounts 6ayable ;ays conert

to what is called the 3ash 3ycle.

OPERATING CYCLE

OPERATING CYCLE =ACCOUNTS RECEIVABLES TURNOVER IN

DAYS + INVENTORYTURNOVER IN DAYS

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The cash conersion cycle /333$ or Eperating 3ycle0 is the length of time between a firm's purchase of inentory and the receipt of cash from accounts

receiable. #t is the time re%uired for a business to turn purchases into cash receipts

from customers.

Eperating 3ycle represents the number of days a firm's cash remains tied up within

the operations of the business. A cash flow analysis using operating cycle also

reeals in$ an oerall manner$ how efficiently the company is managing its wor+ing

capital.

WORKING CAPITAL

WORKING CAPITAL = CURRENT ASSETS - CURRENT LIABILITIES

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Wor+ing capital is a measure of cash flow and is not a real ratio.

#t represents the amount of capital inested in resources that are sub@ect to

relatiely rapid turnoer /such as cash$ accounts receiable and inentories0 less

the amount proided by short!term creditors.

Wor+ing capital should always be a positie number. enders use it to ealuate a

companys ability to weather hard times. oan agreements often specify that the borrower must maintain a specified leel of wor+ing capital.

CURRENT RATIO

3FRRGT RAT#E J 3FRRGT A--GT- K 3FRRGT #A##T#G-

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The current ratio is a reflection of financial strength. #t is the number of times a

companys current assets exceed its current liabilities$ which is an indication of the

solency of the business.

A current ratio can be improed by increasing current assets or by decreasing

current liabilities.

3urrent ratio can be improed by increasing current assets or by decreasing current

liabilities.

-teps to accomplish an improement include2

L 6aying down debtL Ac%uiring a long!term loan /payable in more than 1 years time0

L -elling a fixed asset

L 6utting profits bac+ into the business

A high current ratio may mean cash is not being utili,ed in an optimal way. (or

example$ the excess

cash might be better inested in e%uipment.

ACID TEST RATIO

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ACID TEST RATIO =CASH EQUIVALENTS + MARKETABLE

SECURITIES + NET RECEIVABLES/CURRENTLIABILITIES

The %uic+ ratio is also called the )acid test* ratio. Thats because the %uic+ ratioloo+s only at a companys most li%uid assets and compares them to current

liabilities. The %uic+ ratio tests whether a business can meet its obligations een if

aderse conditions occur.

#n general$ %uic+ ratios between .C and 1 are considered satisfactory$ as long as

the collection of receiables is not expected to slow.

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CASH RATIO

3A-B RAT#E J 3A-B GMF#HAGT- N 5AR:GTAG -G3FR#T#G-K3FRRGT #A##T#G-

3ash Ratio is an indicator of company's short!term li%uidity. #t measures the abilityto use its cash and cash e%uialents to pay its current financial obligations.

3ash ratio measures the immediate amount of cash aailable to satisfy short!term

liabilities. A cash ratio of .C21 or higher is preferred.

3ash ratio is the most conseratie loo+ at a company's li%uidity since is ta+ing in

the consideration only the cash and cash e%uialents.

3ash ratio is used by creditors when deciding how much credit$ if any$ they would

be willing to extend to the company.

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SALES TO WORKING CAPITAL

SALES TO WORKING CAPITAL = SALES/AVERAGE

WORKINGCAPITAL

The relationship between et -ales and Wor+ing 3apital is a measurement of the

efficiency in the way wor+ing capital is being used by the business. #t shows how

wor+ing capital is supporting sales.

#n general$ a low ratio may indicate an inefficient use of wor+ing capitalO that is$

you could be doing more with your resources$ such as inesting in e%uipment.

A high ratio can be dangerous$ since a drop in sales$ which causes a serious cash

shortage$ could leae your company ulnerable to creditors.

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