Analysis of Financial Ratios

Transcription

1 Analysis of Financial Ratios CV.Alexander DGM &FM Version: 1

2 Definition The relationship between two accounting figures expressed mathematically is known as financial ratio Date: 2

3 Introduction What is the purpose of analysis of financial ratios It is for a meaningful study of information in the financial statements Ascertaining overall financial position of a business organisation Interpretation of key information in the financial statements Date: 3

4 Objective The objectives: Assess credit risk profile of the borrower Stipulation of terms and conditions Assess utilization of credit facility Establish sound well defined credit granting criteria Ensure safety of bank funds Date: 4

5 Factors that banks consider Credit worthiness of the borrower Integrity/reputation Credit risk profile Sensitivity to economic and market developments Liquidity Solvency Profitability of business Resource efficiency Date: 5

6 Financial Analysis Trends in the financial planning Analysis of projected financial statements Date: 6

7 Assets & Liabililities (Rs.crore) Liabilitiesm Assets Year 3 Year 2 Year 1 Category Category Year 1 Year 2 Year Current Liabilities Current Assets (436) (559) (619) Net Working Capital Deferred Liability Net Fixed Assets Net Worth Misc. Assets Intangible Assets Total Total Date: 7

8 Measures of Liquidity Net Working Capital Current Ratio Quick Ratio Net Working Capital/Net Assets Net Working Capital/Current Assets Date: 8

9 Net Working Capital Gross Working Capital ( GWC) is the investment required to be made by the borrower in Current Assets How From own contributions From creditors, borrowings Other short term resources Date: 9

10 Gross Working Capital Gross Working Capital How funded From own resources and other long term sources Short fall if any from short term resources Date: 10

11 Short Term Resources Short term resources constitute what are known as Current Liabilities Current Liabilities should be lower than Current Assets Excess o0f Current Assets over Current Liabilities is Net Working Capital Contribution from long term resources applied to financing of Current Assets ( excess of Current Assets) is owner s stake or margin money Date: 11

12 Financing of Current Assets (National Steel Corporation) 1.Current Assets = Current Liabilities + NWC or 3088 = NWC = Current Assets Current Liabilities or 436 = Current Assets = Current Liabilities + Contribution from Long Term Liabilities 3088 = [( )] = (i.e.nwc = 3088) Date: 12

13 Concept of NWC NWC represents the surplus long term funds applied towards financing of Current Assets Current assets are financed from two sources Surplus from Long Term Liabilities Current Liabilities Difference between Current assets and Current Liabilities should always be positive Date: 13

14 NWC Negative Net Working Capital What is the Implication Business has applied part of surplus Current Liabilities towards meeting shortfall in Long Term resources Date: 14

15 NWC Positive NWC means i.borrower has brought in his contribution ii.any fall in value of Current Assets will be cushioned by borrower s stake iii.loss in sale of Current Assets will not affect Short term creditors Date: 15

16 NWC Net Working Capital ( NWC ) is a measure of liquidity Sources for NWC Long Term Liabilities net of Long Term Assets ( LTLs including Net Worth less LTAs which includes Fixed Assets, miscellaneous assets and intangibles. Another measure of liquidity is the Current Ratio) Date: 16

17 Current Ratio Current Ratio: Current Assets/ Current Liabilities If Net Working Capital is to be of positive value the Current Ratio must be higher than 1. Ideally for calculating MPBF Current Ratio should be 1.33: 1 Date: 17

18 Liquidity Ratios Year 1 Year 2 Year 3 1. Current Assets Quick Assets Current Liabilities NWC (1-3) Current Ratio Quick Ratio Net Sales NWC/Net Sales (%) NWC/Current Assets(%) Date: 18

19 Quick Ratio From the gone concern approach inventory is the least liquid of Current Assets Quick Ratio or Acid Test Ratio = Current Assets- Inventory/Current Liabilities Norm the QR should not be less than 1. 1:1 is satisfactory Date: 19

20 NWC/Net Sales This percentage should be around 8-12 % NWC is lower: Business is growing too fast without building an adequate cushion in the form of NWC It indicates symptom of overtrading and Undue reliance on borrowed short term funds Date: 20

21 Falling NWC/Net Sales Indicative of overtrading and serious liquidity problems It needs to be investigated Date: 21

22 NWC/Current Assets This measures contribution of Long Term funds towards financing Current Assets Method of Lending 1 st Method Amt. 2 nd Method Amt. Current Assets (LTS) 370 Less CLs WCG % -55 MPBF CR 1.17 CR 1.33 Date: 22

23 Debt Equity Ratio DER = TLT Liabilitie/TNW Low ratio has a better leverage for borrowing Not more than 1.5 for providing finance by banks Date: 23

24 DSCR DSCR =( Net profit +Depcn+ Annual amount of int.on LTLs)/Interest + principal Indicative of funds available for servicing long term debt DSCR = 6+4+2/6 = 12/6= 2 This is comfortable Should not be less than 1.5:1 while considering projects Date: 24

25 Return on Assets RoA = PBIT/Total Assets To measure profitability and efficiency Higher the ratio, the more efficient is the firm in using resources Date: 25

26 Gross Profit Margin The surplus of sales over cost of goods sold Gross profit Margin= (Sales minus Cost of goods sold )x 100/Sales A higher ratio indicates better managerial efficiency and profitability Date: 26

27 Interest Coverage Ratio ICR = PBDIT/Annual Int.Obligation To find out whether business generates sufficient profit to service interest payment Interest Coverage Ratio of 3 is reasonable and below 2 is considered risk prone Date: 27

28 Summary Ratio analysis is used as a major tool for financial analysis For a meaningful study of information contained in the financial statements Ascertaining the overall financial position of a Business Organization Ratios are calculated from the past financial statements Ratios could also be worked out based on the projected financial statements of the same firm Easiest way of evaluating the performance of a firm is by comparing past and present ratios Used to judge operational efficiency, financial health, solvency or soundness To find out the liquidity position Major categories of ratios Liquidity ratios Leverage or solvency ratios Activity Ratios Profitability Ratios Date: 28

29 ANY???? THANK YOU Date: 29