ANALYSIS AND INTERPRETATION OF FINANCIAL STATEMENTS : RATIO ANALYSIS NOTES

An analysis of financial statements is the process of critically examining in detail accounting information given in the financial statements. For the purpose of analysis, individual items are studied, their interrelationships with other related figures are established, the data is sometimes rearranged to have better understanding of the information with the help of different techniques or tools for the purpose. Analysing financial statements is a process of evaluating relationship between component  parts of financial statements to obtain a better understanding of firm’s position and performance. The analysis of financial statements thus refers to the treatment of the information contained in the financial statements in a way so as to afford a full diagnosis of the profitability and financial position of the firm concerned. For this purpose financial statements are classified methodically, analysed and compared with the figures of previous years or other similar firms.

The term ‘Analysis’ and ‘interpretation’ though are closely related, but distinction can be made between the two. Analysis means evaluating relationship between components of financial statements to understand firm’s performance in a better way. Various account balances appear in the financial statements. These account balances do not represent homogeneous data so it is difficult to interpret them and draw some conclusions. This requires an analysis of the data in the financial statements so as to bring some homogeneity to the figures shown in the financial statements. Interpretation is thus drawing of inference and stating what the figures in the financial statements really mean. Interpretation is dependent on interpreter himself. Interpreter must have experience, understanding and intelligence to draw correct conclusions from the analysed data.

  • MEANING OF RATIO ANALYSIS

A ratio is a simple arithmetical expression of the relationship of one number to another. According to Accountant’s Handbook by Wixon, Kelland bedbord, “a ratio” is an expression of the quantitative relationship between two numbers”. In simple language ratio is one number expressed in terms of the other and can be worked out by dividing one number into the other. This relationship can be expressed as (i) percentages, say, net profits are 20 per cent of sales (assuming net profits of Rs. 20,000 and sales of Rs. 1,00,000), (ii) fraction (net profit is one-fourth of sales) and (iii) proportion of numbers (the relationship between net profits and sales is 1:4).

The rational  of ratio analysis lies in the fact that it makes related information comparable. A single figure by itself has no meaning but when expressed in terms of a related figure, it yields significant inferences. Ratio analysis helps in financial forecasting, making comparisons, evaluating solvency position of a firm, etc. For instance, the fact that the net profits of a firm amount to, say, Rs. 20 lakhs throws no light on its adequacy or otherwise. The figure of net profit has to be considered in relation to other variables. How does it stand in relation to sales? What does it represent by way of return on total assets used or total capital employed? In case net profits are shown in terms of their relationship with items such as sales, assets, capital employed, equity capital and so on, meaningful conclusions can be drawn regarding their adequacy. Ratio analysis, thus, as a quantitative tool, enables analysts to draw quantitative answers to questions such as : Are the net profits adequate ? Are the assets being used efficiently? Can the firm meet its current obligations and so on ? However, ratio analysis is not an end in itself. Calculation of mere ratios does not serve any purpose, unless several appropriate ratios are analysed and interpreted. The following are the four  steps involved in the ratio analysis :

  • Selection of relevant data from the financial statements depending upon the objective of the analysis.
  • Calculation of appropriate ratios from the above data.
  • Comparison of the calculated ratios with the ratios of the same firm in the past, or the ratios developed from projected financial statements or the ratios of some other firms or the comparison with ratios of industry to which the firm belongs.
  • Interpretation of the ratio.

13.3  INTERPRETATION OF RATIOS

The interpretation of ratios is an important factor. Though calculation is also important but it is only a clerical task whereas interpretation needs skills, intelligence and foresightedness. The interpretation of the ratios can be done in the following ways :

  1. Single Absolute Ratio: Generally speaking one cannot draw meaningful conclusions when a single ratio is considered in isolation. But single ratios may be studied in relation to certain rules of thumb which are based upon well proven contentions as for example 2:1 is considered to be a good ratio for current assets to current liabilities.
  2. Groups of Ratio : Ratios may be interpreted by calculating a group of related ratios. A single ratio supported by related additional ratios becomes more understandable and meaningful.
  3. Historical Comparisons : One of the easiest and most popular ways of evaluating the performance of the firm is to compare its present ratios with the past ratios called comparison over time.
  4. Projected Ratios : Ratios can also be calculated for future standard based upon the projected financial statements. Ratio calculation on actual financial statements can be used for comparison with the standard ratios to find out variance, if any. Such variance helps in interpreting and taking corrective action for improvement in future.
  5. Inter-firm Comparison : Ratios of one firm can also be compared with the ratios of some other selected firms in the same industry at the same point of time.

13.4  MANAGERIAL USES OF RATIO ANALYSIS

The following are the important managerial uses of ratio analysis –

  1. Helps in Financial Forecasting : Ratio analysis is very helfpful in financial forecasting. Ratios relating to past sales, profits and financial position form the basis for setting future trends.
  2. Helps in Comparison : With the help of ratio analysis, ideal ratios can be composed and they can be used for comparing a firm’s progress and performance. Inter-firm comparison or comparison with industry averages is made possible by the ratio analysis.
  3. Financial Solvency of the Firm : Ratio analysis indicates the trends in financial solvency of the firm. Solvency has two dimensions-long-term solvency and short-term solvency. Long-term solvency refers to the financial viability of a firm and it is closely related with the existing financial structure. On the other hand, short-term solvency is the liquidity position of the firm. With the help of ratio analysis conclusions can be drawn regarding the firm’s liquidity and longterm solvency position.
  4. Evaluation of Operating Efficiency : Ratio analysis throws light on the degree of efficiency in the management and utilisation of its assets and resources. Various activity ratios measure this kind of operational efficiency and indicate the guidelines for economy in costs, operations and time.
  5. Communication Value : Different financial ratios communicate the strength and financial standing of the firm to the internal and external parties. They indicate the over-all profitability of the firm.
  6. Others Uses : Financial ratios are very helpful in the diagnosis of financial health of a firm. They highlight the liquidity, solvency, profitability and capital gearing etc. of the firm.

13.5  DRAW BACKS OF RATIO ANALYSIS

  1. Limited use of a single ratio : Ratio can be useful only when they are computed in a sufficient large number. A single ratio would not be able to convey anything. A the same time, if too many ratios are calculated, they are likely to confuse instead of revealing any meaningful conclusion.
  2. Effect of inherent limitations of accounting : Because ratios are computed from historical accounting records, so they also possess those limitations and weaknesses as accounting records possess.
  3. Lack of proper standards : While making comparisons, it is always a challenging job to find out an adequate standard. It is not possible to calculate exact and well accepted absolute standard, so a quality range is used for this purpose. If actual performance is within this range, it may be regarded as satisfactory.
  4. Past is not indicator of future : It is not always possible to make future estimates on the basis of the past as it always does not come true.
  5. No allowance for change in price level : While making comparisons of ratios, no allowance for changes in general price level is made. A change in price level can seriously affect the validity of comparisons of ratios computed for different time periods.
  6. Difference in definitions : Comparisons are also made difficult due to differences in definitions of various financial terms. The terms like gross profit, net profit, operating profit etc. have not precise definitions and an established procedure for their computation.
  7. Window Dressing : Financial statements can easily be window dressed to present a better picture of its financial and profitability position to outsiders. Hence one has to be careful while making decision on the basis of ratios calculated from such window dressing made by a firm.
  8. Personal Bias : Ratios are only means of financial analysis and is not an end in itself. Ratios have to be Interpreted carefully because the same ratio can be looked at, in different ways.

13.6  CLASSIFICATION OF RATIOS

Ratios can be classified into five broad groups : (i) Liquidity ratios (ii) Activity ratios (iii) Leverage/Capital structure ratios (iv) Coverage ratios (v) Profitability ratios.

13.6.1Liquidity Ratios : Liquidity refers to the ability of a firm to meet its current obligations as and when they become due. The importance of adequate liquidity in the sense of the ability of  a firm to meet current/short-term obligations when they become due for payment can hardly be overstressed. In fact, liquidity is a prerequisite for the very survival of a firm.

The ratios which indicate the liquidity of a firm are (i) net working capital, (ii) current ratio, (iii) acid test/quick ratio, (iv) super quick ratio, (v) basic defensive interval.

  1. Net Working Capital : The first measurement of liquidity of a firm is to compute its Net Working capital (NWC). NWC is really not a ratio, it is frequently employed as a measure of a company’s liquidity position. NWC represents the excess of current assets over current liabilities. A firm should have sufficient NWC in order to be able to meet the claims of the creditors and the day-to-day needs of business. The greater the amount of NWC, the greater the liquidity of the firm. Inadequate working capital is the first sign of financial problems for a firm. It is useful for purposes of internal control also.

Current Ratio : Current ratio is the most common ratio for measuring liquidity. Being related to working capital analysis, it is also called the working capital ratio. The current ratio is the ratio of total current assets to total current liabilities.

As a measure of short-term financial liquidity, it indicates the rupees of current assets available for each rupee of current liability. The higher the current ratio, the larger the amount of rupees available per rupee of current liability, the more the firm’s ability to meet current obligations and the greater the safety of funds of short-term creditors. If the result is greater than 1, the firm presumably has sufficient current assets to meet its current liabilities. A ratio of 2:1 (two times current assets of current liabilities) is considered satisfactory as a rule of thumb. Thus, a good current ratio, in a way, provides a margin of safety to the creditors.

  1. Acid-Test/Quick Ratio : One defect of the current ratio is that it fails to convey any information on the composition of the current assets of a firm. A rupee of cash is considered equivalent to a rupee of inventory or receivables. But it is not so. A rupee of cash is more readily available to meet current obligations than a rupee of, say, inventory. This impairs the usefulness of the current ratio. The acidtest ratio is a measure of liquidity designed to overcome this defect of the current ratio. It is often referred to as quick ratio because it is a measurement of a firm’s ability to convert its current assets quickly into cash in order to meet its current liabilities. Thus, it is a measure of quick or acid liquidity.

The term quick assets refers to current assets which can be converted into cash immediately or at a short notice without diminution of value. Included in this category of current assets are (i) cash and bank balances; (ii) short-term marketable securities and (iii) debtors/receivables. Thus, the current assets which are excluded are : prepaid expenses and inventory. The exclusion of inventory is based on the reasoning that it is not easily and readily convertible into cash. Prepaid expenses by their very nature are not available to pay off current debts. An acid-test ratio of 1:1 or greater is recommended.

Cash-Position Ratio or Super-Quick Ratio : It is a variant of Quick ratio. When liquidity is highly restricted in terms of cash and cash equivalents, this ratio should be calculated. It is calculated by dividing the super-quick current assets by the current liabilities of a firm. The super-quick current assets are cash and marketable securities

Activity Ratios

Activity ratios which are also called efficiency ratio or asset utilisation ratios are concerned with measuring the efficiency in asset management. The efficiency with which the assets are used would be reflected in the speed and rapidity with which assets are converted into sales. The greater is the rate of turnover or conversion, the more efficient is the utilisation/management, other things being equal. For this reason, such ratios are also designated as turnover ratios.

  1. Inventory Turnover Ratio : :

 

The cost of goods sold means sales minus gross profit. The average inventory refers to the simple average of the opening and closing inventory. The ratio indicates how fast inventory is sold. A high ratio is good from the viewpoint of liquidity and vice versa. A low ratio would signify that inventory does not sell fast and stays on the shelf or in the warehouse for a loan time.

  1. Debtors Turnover Ratio : This ratio is determined by dividing the net credit

sales by average debtors outstanding during the year. Thus,

 

Net credit sales consist of gross credit sales minus sales returns, if any, from customers. Average debtors is the simple average of debtors at the beginning and at the end of year. The ratio measures how rapidly debts are collected. A high ratio is indicative of shorter time-lag between credit sales and cash collection. A low ratio shows that debts are not being collected rapidly.

  1. Creditors Turnover Ratio : It is a ratio between net credit purchases and the average amount of creditors outstanding during the year. It is calculated as follows:

Net credit purchases Creditors turnover ratio =

Average creditors

Net credit purchases = Gross credit purchases less returns to suppliers

Average creditors = Average of creditors outstanding at the beginning and at the end of the year.

A low turnover ratio reflects liberal credit terms granted by suppliers, while a high ratio shows that accounts are to be settled rapidly.

  1. Average Age of Sundry Debtors : The average age of sundry debtors (or accounts receivable), or average collection period is more meaningful figure to use in evaluating the firm’s credit and collection policies. The main objective of calculating average collection period is to find out cash inflow rate from realisation from debtors. It is found by a simple transformation of the firm’s accounts receivable turnover :

 

The average of collection period should not exceed the standard or stated credit period in sales terms plus 1/3 of such days. If it happens, it will indicate either liberal credit policy or slackness of management in realising debts or accounts receivable.

Assets Turnover Ratio : This ratio is also known as the investment turnover ratio. It is based on the relationship between the cost of goods sold and assets/ investments of a firm. A reference to this was made while working out the overall profitability of a firm as reflected in its earning power. Depending upon the different concepts of assets employed, there are many variants of this ratio.

3Leverage/Capital Structure Ratios : The second category of financial ratios is leverage ratios. The long-term creditors would judge the soundness of a firm on the basis of the long-term financial strength measured in terms of its ability to pay the interest regularly as well as repay the instalment of the principal on due dates or in lump sum at the time of maturity. The long-term solvency of a firm can be examined by using leverage or capital structure ratios. The leverage ratios may be defined as financial ratios which throw light on the long-term solvency of a firm as reflected in its ability to assure the long-term creditors with regard to (i) periodic payment of interest during the period of the loan and (ii) repayment of principal on maturity or in predetermined installments at due dates.

The Debt-equity Ratio – This ratio establishes the relationship between the long-term funds provided by creditors and those provided by the firm’s owners. It is commonly used to measure the degree of financial leverage of the firm.

Proprietary Ratio : This ratio is also known as Shareholders’ Equity to Total Equities Ratio or Net Worth to Total Assets Ratio. It indicates the relationship of Shareholders’ equity to total assets or total equities

  1. The Solvency Ratio – It is also known as Debt Ratio. It is a difference of 100 and proprietary ratio. It measures the proportion of total assets provided by the firm’s creditors. This ratio is calculated as follows :

Total Liabilities Solvency Ratio (or Debt Ratio) = Total Assets Interpretation :

Generally, lower the rate of total liabilities to total assets; more satisfactory or stable is the long-term solvency position of a firm.

  1. Fixed Assets to Net Worth Ratio – One of the important aspects of sound financial position of a firm is that its fixed assets are totally financed out of shareholders’ funds. If aggregate of fixed assets exceeds the net worth (or proprietors’ funds), it proves that fixed assets have been financed with outsiders’ funds (or creditors’ funds). It may create difficulty in the long-run. This ratio is calculated as follows :

Fixed Assets (after depreciation)

 

Proprietors’ Funds

This ratio should not exceed 1:1. On the contrary, lower the ratio, better the position. Usually, a ratio of 0.67 : 1 is considered satisfactory.

  1. Proprietors’ Liabilities Ratio : This ratio indicates the relationship of proprietors’ funds to total liabilities. It is calculated as follows :

Proprietros’ Funds Proprietors’ Liabilities Ratio = Total Liabilities

Higher the ratio, better is the position of creditors.

  1. Fixed Assets Ratio

 

Total long-term funds Interpretation :

This ratio indicates the extent to which the total of fixed assets are financed by logterm funds of the firm. Generally, the total of the fixed assets should be equal to total of the long-term funds or say the ratio should be 100%. And if total long-term funds are more than total fixed assets, it means that part of working capital requirement is met out.

  1. Ratio of Current Assets to Proprietary’s Funds

The ratio is calculated by dividing the total of current assets by the amount of shareholder’s funds.

Debt-Service Ratio

Net income to debt service ratio or simply debt service ratio is used to test the debt-servicing capacity of a firm. The ratio is also known as interest coverage ratio or fixed charges cover or times interest earned. This ratio is calculated by dividing the net profit before interest and taxes by fixed interest charges.

Net Profit (before interest and tax)

Debt Service or Interest Coverage Ratio =

Fixed Interest Charges

Interpretation

Interest coverage ratio indicates the number of times interest is covered by the profits available to pay the interest charges. Long-term creditors of a firm are interested in knowing the firm’s ability to pay interest on their long-term borrowings. Generally, higher the ratio, more safe are long term creditors because even if earnings of the firm fall, the firm shall be able to meet its commitment of fixed interest changes. But a too high interest coverage ratio may not be good for the firm because it may imply that firm is not using debt as a source of finance so as to increase the earnings per share.

4Coverage Ratios : The another category of leverage ratios are coverage ratios. These ratios are computed from information available in the profit and loss account.  The coverage ratios measure the relationship between what is normally available from operations of the firms and the claims of the outsiders. The important coverage ratios are as follows :

  1. Interest Coverage Ratio : This ratio measures the debt servicing capacity of a firm insofar as fixed interest on long-term loan is concerned. It is determined by dividing the operating profits or earnings before interest and taxes (EBIT) by the fixed interest charges on loans. Thus,

 

From the point of view of the creditors, the larger the coverage, the greater is the ability of the firm to handle fixed-charge capabilities and the more assured is the payment of interest to the creditors. However, too high a ratio may imply unused debt capacity.

  1. Dividend Coverage Ratio : It measures the ability of a firm to pay dividend on preference shares which carry a stated rate of return. This ratio is computed as under :

 

The ratio, like the interest coverage ratio, reveals the safety margin available to the preference shareholders. As a rule, the higher the coverage, the better it is from their point of view.

  1. Total Coverage Ratio : The total coverage ratio has a wider scope and takes into account all the fixed obligations of a firm, that is, (i) interest on loan, (ii) preference dividend, (iii) Lease payments, and (iv) repayment of principal.

 

  1. Debt-Services Coverage Ratio (DSCR) : This ratio is considered more comprehensive and apt measure to compute debt service capacity of a business firm. It provides the value in terms of the number of times the total debt service obligations consisting of interest and repayment of principal in installments are covered by the total operating funds, available after the payment of taxes.

 

The higher the ratio, the better it is. In general, lending financial institutions consider 2:1 as satisfactory ratio.

13.6.5Profitability Ratios : Apart from the creditors, also interested in the financial soundness of a firm are the owners and management or the company itself. The management of the firm is naturally eager to measure its operating efficiency. Similarly, the owners invest their funds in the expectation of reasonable returns. Profitability ratios can be determined on the basis of either sales or investments.

  1. Profitability Ratios Related to Sales : These ratios are based on the premise that a firm should earn sufficient profit on each rupee of sales. These ratios consist of (1) profit margin, and (2) expenses ratio.
  1. Rate of Return on Equity Share Capital : This ratio is calculated by dividing the net profits (after deducing income-tax and dividend on preference share capital) by the paid up amount of equity share capital. It is usually expressed in percentage as below :

 

This ratio examines the earning capacity of equity share capital.

  1. Return on Proprietors Funds on Return on Net Worth : Some experts suggest to calculate return on net worth instead of calculating return on equity share capital. The proprietors funds or net worth represents the total interest of shareholders which include share capital (whether equity or preference) and all accumulated profits. Alternatively, proprietors’ funds may be taken equal to fixed assets plus current assets minus all outside liabilities both long-term and current.

 

This ratio helps the proprietors and potential investors to judge the earning of the company in relation to others and the adequacy of the return on proprietors’ funds.

  1. Return on Investment (ROI) Ratio : This is one of the key profitability ratios. It examines the overall operating efficiency or earning power of the company in relation to total investment in business. It indicates the percentage of return on the capital employed in the business. It is calculated on the basis of the following formula :

Operating Profit

 

The term capital employed has been given different meanings by different accountants. Some of the popular meanings are as follows : (i) Sum-total of all assets whether fixed or current.

 

In management accounting the term capital employed is generally used in the meaning given in the point third above.

The term Operating Profit means Profit before Interest and Tax. The term Interest means Interest on long-term Borrowings. Interest on short-term borrowings will be deducted for computing operating profit. Non-trading incomes such as interest on Government securities or non-trading losses or expenses such as loss on account of fire, etc. will also be excluded.

The computation of ROI can be understood with the help of the following illustration:

Significance of ROI :  The Return on Capital invested is a concept that measures the profit which a firm earns on investing a unit of capital. Yield on capital is another term employed to express the idea. It is desirable to ascertain this periodically. The profit being the net result of all operations, the return on capital expresses all efficiencies or inefficiencies of a business collectively and thus is a dependable basis for judging its overall efficiency or inefficiency. On this basis, there can be comparison of the efficiency of one department with that of another or one plant with that another, one company with that of another and one industry with that of another. For this purpose, the amount of profits considered is that before making deductions on account of interest, income-tax and dividends and capital is the aggregate of all the capital at the disposal of the company, viz., equity capital, preference capital, reserve, debentures, etc.

Limitations of ROI : ROI is one of the very important measures for judging the overall financial performance of a firm. However, it suffers from certain important limitations. These limitations are :

  • Manipulation is possible : ROI is based on earnings and investments. Both these figures can be manipulated by management by adopting varying accounting policies regarding depreciation, inventory valuation, treatment of provisions, etc.

The decision in respect of most of these matters is arbitrary and subject to whims of the management.

  • Different bases for computation of Profit and Investments : There are different bases for calculating both profit and investment as explained in the preceding pages. For example, fixed assets may be taken at gross or net values, earnings may be taken before or after tax, etc.
  • Emphasis on short-term profit : ROI emphasises the generation of shortterm profits. The firm may achieve this objective by cutting down cost such as those on research and development or sales promotion. Cutting down of such costs without any justification may adversely affect the profitability of the firm in the long run, though ROI may indicate better performance in the shortrun.
  • Poor Measure : ROI is a poor measure of a firm’s performance since it is also affected by many extraneous and non-controllable factors.
  1. Return on Capital Employed (ROCE) : The ROCE is the second type of ROI. It is similar to the ROA except in one respect. Here the profits are related to the total capital employed. The term capital employed refers to long-tern funds supplied by the creditors and owners of the firm. The higher the ratio, the more efficient is the use of capital employed.

Earning Per Share (EPS) measures the profit available to the equity shareholders on a per share basis, that is, the amount that they can get on every share held. It is calculated by dividing the profits available to the shareholders by the number of the outstanding shares. The profits available to be the ordinary shareholders are represented by net profits after taxes and preference dividend.

 

Number of ordinary shares outstanding

  1. Divided Per Share (DPS) is the dividends paid to shareholders on a per share basis. In other words, DPS is the net distributed profit belonging to the shareholders divided by the number of ordinary shares outstanding. That is, Dividend paid to ordinary shareholders

 

Number of ordinary shares outstanding

The DPS would be a better indicator than EPS as the former shows what exactly is received by the owners.

  1. Divided-Pay Out (D/P) Ratio : This is also known as pay-out ratio. It measures the relationship between the earnings belonging to the ordinary shareholders and the dividend paid to them. In other words, the D/P ratio shows what percentage share of the net profits after taxes and preference dividend is paid out as dividend to the equity holders.

 

If the D/P ratio is subtracted from 100, it will give that percentage share of the net profits which are retained in the business.

  1. Earnings and Dividend Yield : This ratio is closely related to the EPS and DPS. While the EPS and DPS are based on the book value per share, the yield is expressed in terms of the market value per share.

 

Price Earnings (P/E) Ratio is closely related to the earnings yield/earnings price ratio. It is actually the reciprocal of the latter. This ratio is computed by dividing the market price of the shares by the EPS. Thus,

 

The P/E ratio reflects the price currently being paid by the market for each rupee of currently reported EPS. In other words, the P/E ratio measures investors’ expectations and the market appraisal of the performance of a firm.

  • SUMMARY

Ratio analysis is a widely- used tool of financial analysis. The rational  of ratio analysis lies in the fact that it makes related information comparable. A single figure by itself has no meaning but when expressed in terms of a related figure, it yields significant inferences. Ratio analysis helps in financial forecasting, in making comparisons, in evaluating solvency position of a firm, etc.

Ratios can be classified into five broad groups : (i) Liquidity ratios (ii) Activity ratios (iii) Long-term solvency/capital structure/leverage ratios (iv) coverage ratios (v) Profitability ratios. In life insurance area, the ratios are calculated for each operating unit i.e. each branch office, each divisional office (consolidated for division as a whole), each zonal office (consolidated for zone as a whole) and for the corporation as a whole. Ratios are calculated for two or more than two years and compared; then they are compared with other units, and even with the corporate ratios , and interpreted and based on the indications received, corrective action is taken. Sometimes some of the ratios are calculated monthly for observing the trend of movement in various indices, and for taking remedial action promptly.

  • KEYWORDS

Ratio: A ratio is simply one number expressed in terms of another.

Liquidity ratios: Liquidity ratios are used to test the short-term solvency position of the business.

Activity ratios: Activity ratios are concerned with measuring the efficiency in asset management.

Profitability ratios: These indicate the profit earning capacity of a business.

Leverage ratios: There are financial ratios which throw light on the long-term solvency of a firm as reflected in its ability to assure the long-term creditors with respect to periodic payment of principal as well as interest.

  • SELF ASSESSMENT QUESTIONS
  1. Discuss the significance of any three of the following ratios to financial analyst :
    • Current Ratio
    • Liquidity Ratio
    • Net Profit to Capital Employed Ratio
    • Debt Equity Ratio
  2. State the meaning of expression “Return on Capital Employed” and point out the advantages the business would derive from its use.
  3. Ratios like statistics have a set of principles and finality about them which at times may be misleading.” discuss with illustrations.
  4. Discuss the importance of ratio analysis for inter-firm and intra-firm comparison including circumstances responsible for its limitations, if any.
  5. “The study of financial analysis is simply memorising a bunch of ratios and gives the students very little opportunity for creative problem solving.” Do you agree with it ? Explain.
  6. Discuss in detail and with illustrations the limitations of ratio analysis.
  7. What do you understand by ‘Ratio Analysis’? What are its objects? Discuss the role of three important ratios to the management.
  8. Discuss some of the important ratios usually worked from financial statements showing how they would be useful to higher management.
  9. What is Profitability and how is it measured? Which of the accounting ratios serve as indication of profitability and how are they computed ?
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