Question

which combination of ratios do you feel present the most accurate and objective picture of an organizations performance?

minimum 150 words

Answer 1

Liquidity Ratios: Measures the ability of the firm to meet its short-term obligations. These ratios reflect the short-term financial solvency of a firm.

The various ratios that explains about the liquidity of the firm are

1. Current Ratio
2. Acid Test Ratio / quick ratio
3. Absolute liquid ration / cash ratio

1. CURRENT RATIO

The current ratio measures the short-term solvency of the firm. It establishes the relationship between current assets and current liabilities. It is calculated by dividing current assets by current liabilities.

Current Ratio = Current Asset/Current Liabilities

2. ACID TEST RATIO / QUICK RATIO

It establishes the relationship between quick assets and current liabilities. It is calculated by dividing quick assets by the current liabilities.

Acid Test Ratio = Quick Assets/Current liabilities

3. ABSOLUTE LIQUID RATION / CASH RATIO

Absolute liquid assets include cash, bank balances, and marketable securities.

Absolute liquid ratio = Absolute liquid assets/Current liabilities

Turnover ratios:

Turnover ratios are also known as activity ratios or efficiency ratios with which a firm manages its current assets. The following turnover ratios can be calculated to judge the effectiveness of asset use.

1. Inventory Turnover Ratio
2. Debtor Turnover Ratio
3. Creditor Turnover Ratio
4. Assets Turnover Ratio

1. INVENTORY TURNOVER RATIO

This ratio indicates the number of times the inventory has been converted into sales during the period. Thus it evaluates the efficiency of the firm in managing its inventory. It is calculated by dividing the cost of goods sold by average inventory.

Inventory Turnover Ratio = Cost of goods sold/Average Inventory

2. DEBTOR TURNOVER RATIO

This indicates the number of times average debtors have been converted into cash during a year. It is determined by dividing the net credit sales by average debtors.

Debtor Turnover Ratio = Net Credit Sales/Average Trade Debtors

3. CREDITOR TURNOVER RATIO

It indicates the number of times sundry creditors have been paid during a year. It is calculated to judge the requirements of cash for paying sundry creditors. It is calculated by dividing the net credit purchases by average creditors.

Creditor Turnover Ratio = Net Credit Purchases/Average Trade Creditor

4. ASSETS TURNOVER RATIO

The relationship between assets and sales is known as assets turnover ratio. Several assets turnover ratios can be calculated depending upon the groups of assets, which are related to sales.

1. Total asset turnover.
2. Net asset turnover
3. Fixed asset turnover
4. Current asset turnover
5. Net working capital turnover ratio

a. TOTAL ASSET TURNOVER

This ratio shows the firms ability to generate sales from all financial resources committed to total assets. It is calculated by dividing sales by total assets.

Total asset turnover = Total Sales/    Total Assets

b. NET ASSET TURNOVER

This is calculated by dividing sales by net assets.

Net asset turnover = Total Sales/Net Assets

c. FIXED ASSET TURNOVER

This ratio is calculated by dividing sales by net fixed assets.

Fixed asset turnover = Total Sales/Net Fixed Assets

d. CURRENT ASSET TURNOVER

It is divided by calculating sales by current assets

Current asset turnover = Total Sales/Current Assets

e. NET WORKING CAPITAL TURNOVER RATIO

A higher ratio is an indicator of better utilization of current assets and working capital and vice-versa. It is calculated by dividing sales by working capital.

Net working capital turnover ratio = Total Sales/Working Capital

Solvency ratios:

The solvency or leverage ratios throws light on the long term solvency of a firm reflecting it’s ability to assure the long term creditors with regard to periodic payment of interest during the period and loan repayment of principal on maturity or in predetermined instalments at due dates. The various solvency ratios are

1. Debt equity ratio
2. Debt to total capital ratio
3. Proprietary (Equity) ratio
4. Fixed assets to net worth ratio
5. Fixed assets to long term funds ratio
6. Debt service (Interest coverage) ratio

1. DEBT EQUITY RATIO

Debt equity ratio shows the relative claims of creditors (Outsiders) and owners (Interest) against the assets of the firm. Thus this ratio indicates the relative proportions of debt and equity in financing the firm’s assets. It can be calculated by dividing outsider funds (Debt) by shareholder funds (Equity)

Debt equity ratio = Outsider Funds (Total Debts)/Shareholder Funds or Equity

2. DEBT TO TOTAL CAPITAL RATIO

Debt to total capital ratio = Total Debts/Total Assets

3. PROPRIETARY (EQUITY) RATIO

This ratio indicates the proportion of total assets financed by owners. It is calculated by dividing proprietor (Shareholder) funds by total assets.

Proprietary (equity) ratio = Shareholder funds/Total assets

4. FIXED ASSETS TO NET WORTH RATIO

This ratio establishes the relationship between fixed assets and shareholder funds. It is calculated by dividing fixed assets by shareholder funds.

Fixed assets to net worth ratio = Fixed Assets X 100/Net Worth

5. FIXED ASSETS TO LONG TERM FUNDS RATIO

Fixed assets to long term funds ratio establishes the relationship between fixed assets and long-term funds and is calculated by dividing fixed assets by long term funds.

Fixed assets to long term funds ratio = Fixed Assets X 100/Long-term Funds

6. DEBT SERVICE (INTEREST COVERAGE) RATIO

This shows the number of times the earnings of the firms are able to cover the fixed interest liability of the firm. This ratio therefore is also known as Interest coverage or time interest earned ratio. It is calculated by dividing the earnings before interest and tax (EBIT) by interest charges on loans.

Debt Service Ratio = Earnings before interest and tax (EBIT)/Interest Charges

Profitability ratios:

The profitability ratio of the firm can be measured by calculating various profitability ratios.

1. GROSS PROFIT MARGIN OR RATIO

It measures the relationship between gross profit and sales. It is calculated by dividing gross profit by sales.

Gross profit margin or ratio = Gross profit X 100/Net sales

2. NET PROFIT MARGIN OR RATIO

It measures the relationship between net profit and sales of a firm. It indicates management’s efficiency in manufacturing, administrating, and selling the products. It is calculated by dividing net profit after tax by sales.

Net profit margin or ratio = Earning after tax X 100/Net Sales

3. OPERATING PROFIT MARGIN OR RATIO

It establishes the relationship between total operating expenses and net sales. It is calculated by dividing operating expenses by the net sales.

Operating profit margin or ratio = Operating expenses X 100/Net sales

4. EXPENSES RATIO

While some of the expenses may be increasing and other may be declining to know the behavior of specific items of expenses the ratio of each individual operating expenses to net sales should be calculated. The various variants of expenses are

Cost of goods sold = Cost of goods sold X 100/Net Sales

Administrative Expenses Ratio = Administrative Expenses X 100/Net sales

Selling and distribution expenses ratio = Selling and distribution expenses X 100/Net sales

5. OPERATING PROFIT MARGIN OR RATIO

Operating profit margin or ratio establishes the relationship between operating profit and net sales. It is calculated by dividing operating profit by sales.

Operating profit margin or ratio = Operating Profit X 100/Net sales

EARNINGS PER SHARE

IT measure the profit available to the equity shareholders on a per share basis. It is computed by dividing earnings available to the equity shareholders by the total number of equity share outstanding

Earnings per share = Earnings after tax – Preferred dividends (if any)/Equity shares outstanding

DIVIDEND PER SHARE

The dividends paid to the shareholders on a per share basis in dividend per share. Thus dividend per share is the earnings distributed to the ordinary shareholders divided by the number of ordinary shares outstanding.

Dividend per share = Earnings paid to the ordinary shareholders/Number of ordinary shares outstanding

DIVIDENDS PAY OUT RATIO (PAY OUT RATIO)

It measures the relationship between the earnings belonging to the equity shareholders and the dividends paid to them. It shows what percentage shares of the earnings are available for the ordinary shareholders are paid out as dividend to the ordinary shareholders. It can be calculated by dividing the total dividend paid to the equity shareholders by the total earnings available to them or alternatively by dividing dividend per share by earnings per share.

Dividend pay our ratio (Pay our ratio) = Total dividend paid to equity share holders/Total earnings available to equity share holders

DIVIDEND AND EARNINGS YIELD

While the earnings per share and dividend per share are based on the book value per share, the yield is expressed in terms of market value per share. The dividend yield may be defined as the relation of dividend per share to the market value per ordinary share and the earning ratio as the ratio of earnings per share to the market value of ordinary share.

Dividend Yield =               Dividend Per share/Market value of ordinary share

Earnings yield =                         Earnings per share/Market value of ordinary share

PRICE EARNING RATIO

The reciprocal of the earnings yield is called price earnings ratio. It is calculated by dividing the market price of the share by the earnings per share.

Price earnings (P/E) ratio = Market price of share/Earnings per share