INTRODUCTION The term “ratio analysis” refers to the analysis of the financial statements in conjunction with the interpretations of financial results of a particular period of operations, derived with the help of 'ratio'. Ratio analysis is used to determine the financial soundness of a business concern.
MEANING OF RATIO ANALYSIS Ratio analysis is a conceptual technique which dates back to the inception of accountin, as a concept. !inancial analysis as a scientific tool is used to carry out the calculations in the area of accountin. "n order to appraise the valid and e#istent worth of an enterprise, financial tool comes handy, reularly. $esides, it also allows the firms to observe the performance spannin across a lon period of time alon with the impediments and shortcomins. !inancial analysis is an essential mechanism for a clear interpretation of financi fin ancial al sta statem tement ents. s. "t aid aidss the pro proces cesss of dis discove coverin rin, , the e#i e#iste stence nce of any cro cross% ss% sectional and time series linkaes between various ratios.
DEFINITION Ratio analysis is defined as. &The systematic use of ratio to interpret the financial stat statem ement ent so that that the the stre stren nth th and and weak weaknes nesss of the the firm firm as well well as its its hist histor oric ical al performance and current financial condition can be determined.
OBJECTIVES OF THE STUDY To know the financial performance based on ratios. To pinpoint the direction with which the oraniation is movin. •
To know the financial position of the $.(.). *rocess +ontrol *rivate td.
•
To know the liquidity position of the $.(.). *rocess +ontrol *rivate td.
•
To assess assess the lon%term viability of the firm.
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Research Research Methodolo!" - *rimary (ata / -nnual reports. 0 +ompany +ompan y 1e 1ebsite. bsite. $ 2econdary data3 2econdary data consists of readily available information in different financial te#ts and company database. da tabase. -nd also throuh annual reports of the company.
A#al!s$s o% Rat$o -nalysis usin ratios can be done in followin ways. •
-nalysis of an individual 4or 2inle Ratio
•
-nalysis of referrin to a 5roup of Ratio
•
-nalysis of ratios by Trend
•
-nalysis by inter%firm comparison
Ad&a#taes O% Rat$o A#al!s$s" A#al!s$s" Ratio analysis is widely used as a powerful tool of financial statement analysis. "t establishes establishes the numerical numerical or quantitati quantitative ve relationshi relationship p between two fiures fiures of a financial financial statement to ascertain strenths and weaknesses of a firm as well as its current financial position and historical performance. "t helps various interested parties to make an evaluation of certain aspect of a firm6s performance. performance.
2
'( Forecast$# a#d )la##$#"
The trend in costs, sales, profits and other facts can be known by computin ratios of relevant accountin fiures of last few years. This trend analysis with the help of ratios may be useful for forecastin and plannin future business activities.
*( B+det$#"
$udet is an estimate of future activities on the basis of past e#perience. -ccountin ratios help to estimate budeted fiures. !or e#ample, sales budet may be prepared with the help of analysis of past sales. ,( Meas+re-e#t o% O.erat$# E%%$c$e#c!"
Ratio analysis indicates the deree of efficiency in the manaement and utilisation of its assets. (ifferent activity ratios indicate the operational efficiency. "n fact, solvency of a firm depends upon the sales revenues enerated by utiliin its assets. /( Co--+#$cat$o#"
Ratios are effective means of communication and play a vital role in informin the position of and proress made by the business concern to the owners or other parties. 0( Co#trol o% )er%or-a#ce a#d Cost"
Ratios Ratios may also also be used used for control control of perfor performan mances ces of the differ different ent division divisionss or departments of an undertakin as well as control of costs. 1( I#ter2%$r- Co-.ar$so#"
+omparison of performance of two or more firms reveals efficient and inefficient firms, thereby enablin the inefficient firms to adopt suitable measures for improvin their efficiency. The best way of inter%firm comparison is to compare the relevant ratios of the oraniation with the averae ratios of the industry. 3( I#d$cat$o# o% L$4+$d$t! )os$t$o#"
3
Ratio analysis helps to assess the liquidity position i.e., short%term debt payin ability of a firm. iquidity ratios indicate the ability of the firm to pay and help in credit analysis by banks, creditors and other suppliers of short%term loans.
5( I#d$cat$o# o% Lo#2ter- Sol&e#c! )os$t$o#"
Ratio analysis is also used to assess the lon%term debt%payin capacity of a firm. on% term solvency position of a borrower is a prime concern to the lon%term creditors, security analysts and the present and potential owners of a business. "t is measured by the leverae7capital structure and profitability ratios which indicate the earnin power and operatin efficiency. Ratio analysis shows the strenth and weakness of a firm in this respect. 6( I#d$cat$o# o% O&erall )ro%$ta7$l$t!"
The manaement is always concerned with the overall profitability of the firm. They want to know whether the firm has the ability to meet its short%term as well as lon%term oblia obliatio tions ns to its creditor creditors, s, to ensure ensure a reason reasonabl ablee return return to its its owners owners and secure secure optimum optimum utilia utiliatio tion n of the assets assets of the firm. firm. This This is possib possible le if all the ratios ratios are considered toether. '8( S$#al o% Cor.orate S$c9#ess"
- company is sick when it fails to enerate profit on a continuous basis and suffers a severe liquidity crisis. *roper ratio analysis can ive sinal of corporate sickness in advance so that timely measures can be taken to prevent the occurrence of such sickness. ''( A$d to Dec$s$o#2-a9$#"
Ratio analysis helps to take decisions like whether to supply oods on credit to a firm, whether bank loans will be made available etc.
4
'*( S$-.l$%$cat$o# o% F$#a#c$al State-e#ts"
Ratio analysis makes it easy to rasp the relationship between various items and helps in understandin the financial statements.
LIMITATION OF RATIO ANALYSIS"2 Ratio analysis is a widely used tool of financial analysis. Thouh ratios are simple to calculate and easy to understand, u nderstand, they suffer from some serious limitations3
'( L$-$ted +se o% S$#le Rat$o"2 - sinle ratio usually does not convey much of a sense. To make a better interpretation a number of ratios have to be calculated which is likely to confuse the analyst than help him in makin any meaninful conclusion.
*( Lac9 o% Ade4+ate Sta#dards"2 Sta#dards"2 There are no well accepted standards or rules of thumb for all ratios which can be accepted as norms. "t renders interpretation of the ratio difficult.
,( Cha#e o% Acco+#t$# )roced+re"2 )roced+re"2 +hane in accountin procedure by a firm often makes ratio analysis misleadin e.. a chane in the valuation of methods of inventories, from !"!8 to "!8 increases the cost of sales and reduces considerably the value of closin stocks which makes stock turnover ratio to be lucrative and an unfavorable ross profit ratio.
/( :$#do; Dress$#"2
5
!inancial statements easily can be window dressed to present a better picture of its financial and profitability position to outsiders. 9ence one has to be very careful in makin a decision from ratios calculated from such financial statements. $ut it may be very difficult for an outsider to know about the window dressin made by a firm.
0( )erso#al B$as"2 Ratio is only means of financial analysis and not an end in itself. Ratios have to be interpreted and different people may interpret the same ratio in different ways.
1( I#co-.ara7le"2 :ot only industries differ in their nature but also the firms of the similar business widely differ in their sie and accountin procedure etc.. "t makes comparison of ratios difficult and misl mislea eadin din. . ;ore ;oreove over, r, comp compar aris ison onss are are made made diff diffic icult ult due to diff differ erenc ences es in definitions of various financial terms used in the ratio analysis.
3( A7sol+te F$+res D$stort$&e"2 Ratios devoid of absolute fiures may prove distortive as ratio analysis is primarily a quantitative analysis and not a qualitative ana lysis.
5( )r$ce Le&el Cha#es"2 1hile makin ratio analysis, no consideration is made to the chanes in price levels and this makes the interpretation of ratios invalid.
6( Rat$os No S+7st$t+tes"2 S+7st$t+tes"2 Ratio analysis is merely a tool of financial statements. 9ence, ratios become useless if separated from the statements from which they are computed.
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CLASSIFICATION OF RATIOS"
'< BALANCE BALA NCE SHEE SHEET T RATIO ♦
+urrent Ratio
♦
iquid Ratio
♦
2tock To 1orkin +apital Ratio
♦
*roprietary Ratio
♦
(ebt
♦
+apital 5earin Ratio
*< Re&e#+e Re&e #+e State-e#t Stat e-e#t Rat$o Rat$ o ♦
5ross *rofit Ratio
♦
8peratinratio.
♦
<#penses Ratio
♦
8peratin *rofit Ratio
7
♦ ♦
:et *rofit Ratio 2tock Turnover Ratio
,< Co-.os$t Co-. os$tee Rat$o" Rat$ o" ♦
Return 8n +apital
♦
Return 8n *roprietors6 !unds
♦
Return 8n
♦
(ividend *ayout Ratio
♦
(ebt 2ervice Ratio
♦
(ebt 2ervice +overae Ratio
♦
(ebtors Turnover
♦
+reditors Turnover
CURRENT RATIO RATIO " The current ratio is the ratio of current assets to the current liabilities ."t is calculated by dividin current assets by current liabilities. The current ratio of total current assets to total current liabilities.
C+rre#t Rat$o
=
C+rre#t Assets C+rre#t L$a7$l$t$es
>UIC?
RATIO" RATIO"
It is a measure of liquidity calculated dividin current assets minus inventory -nd
prepaid e#penses by current liabilities
8
.>+$c9 rat$o
=
>+$c9 assets >+$c9 l$a7$l$t$es
:OR?ING CA)ITAL CA)ITAL TURNOVER RATIO" "t represents the e#cess of current assets over current liabilities. "t is a measure of liquidity calculated by subtractin current liabilities from current assets.
1orkin 1orkin +apital Turnover Ratio
=
2ales :et 1orkin 1orkin +apital +apita l
)RO)RIETORY RATIO" RATIO" "t establishes relationship between the propitiator or shareholders funds > total tanible assets. The ratio indicates properties stake in total assets. 9iher the ratio lowers the risk and lowe lowerr the the rati ratio o hih hiher er the the risk risk.. (ebt (ebt ?equi ?equity ty rati ratio o > curre current nt rati ratio o affe affect ctss the the proprietary ratio. *roprietary Ratio
=
2hareholder6s !unds Total -ssets
DEBT2E>UITY RATIO
9
"t measures the relation between debt and equity in the capital structure of the firm. "n other words, this ratio shows the relationship between the borrowed capital and owner6s capital. (ebt (ebt%< %
=
Total (ebt (ebt :et 1orth 1orth
CA)ITAL CA) ITAL GEARING GEAR ING RATIO
REVENUE STATEMENT RATIOS GROSS )ROFIT RATIO 5ross profit ratiomeasures the relationship between ross profits profits > sales@ it is usually represented in percentae. 5R822 *R8!"T R-T"8 R-T"8
=
5ross *rofit 2ales
O)ERATING RATIO
10
A
/BB
"t is the relation between cost of oods sold > operatin e#penses on one hand > the sales on the other hand. "t measures the cost of operations per rupee of sales.
8peratin Ratio =
8peratin +ost
A /BB
2ales
STOC? TURNOVER RATIO @ITRSTR<( "t indicates the efficiency of firm in producin and sellin its products. 9ih Ratio is ood from the view point of liquidity and vice versa. - low ratio would sinify that inventory does not sell fast and stably in the warehouse for a lontime. +ost of 5oods 2old -v. -v. "nventory "nventor y
8R
2ales
a
+losin 2tock
NET )ROFIT )ROFI T RATIO" RATIO" This ratio is also known as net marin. This measures the relationship between net profit and sales of a firm. (ependin on the concept of net profit employed, it is calculated as follows
= *rofit 4loss after ta#
A /BB
:et 2ales This ratio indicates company6s capacity to withstand adverse economic conditions.
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RETURN ON CA)ITAL CA)ITAL EM)LOYED This ratio shows the return on capital employed 4share capital, reserve, retained earnin and lon term borrowins used in the oraniation. =
*$T +apital employed
INTEREST COVERAGE RATIO"2 This is a measure of the protection available to creditors for payment of interest chares by the company. The ratio shows whether the company has sufficient income to cover its interest requirements by a wide marin. The interest coverae ratio is computed by dividin profit before interest and ta# by the interest e#penses. *rofit before "nterest and Ta# 4<$"T "nterest
DEBTORS TURNOVER RATIO" RATIO" (ebtors constitute an important constituent of current assets and therefore the qua lity of debtors to reat e#tent determines that firm6s liquidity. liquidity. There are two ratios. They are3 / (ebt (ebtor orss turn turnove overr Rati Ratio o 0 (ebtor (ebtorss collec collectio tion n period period Rati Ratio o (ebtor6s turnover can be calculated by b y dividin total sales by balance of debtors. deb tors. (ebtors turnover
=
+redit 2ales
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-ccount Receivable
CREDITORS TURNOVER RATIO" RATIO"
+reditors turnover
=
+redit *urchase -ccount *ayable
COM)ANY COM)ANY )ROFILE( )ROF ILE( akshmi Cilas $ank 4C$ was founded eiht decades ao in /D0E by seven people of )arur under the leadership of C2: Ramalina+hettiar, mainly to cater to the financial needs of varied customer sements. The bank was incorporated on :ovember BF, /D0E under the "ndian companies act, /D/F and obtained the certificate to commence business on :ovember /B, /D0E, the bank obtained obtained its license from Reserve $ank of "ndia 4R$" in Gune /DHI and in -uust /DHI it became a scheduled commercial bank.
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(urin /DE/?EH C$ took over nine banks and raised its branch network considerably. To meet the emerin challenes in the competitive business world, the bank started e#pandin its boundaries beyond Tamil :adu from /DJK by openin branches in the neihborin states of -ndhra *radesh, )arnataka, )erala, ;aharashtra, ;adhya *radesh, 5ujarat, 1est 1est $enal, Lttar *radesh, (elhi and *ondicherry. ;echaniation was introduced in the head office of the bank as early as /DJJ. -t present, with a network of 0KD branches, F satellite branches and E e#tension counters, spread over /K states and the union territory of *ondicherry, the bank focus is on customer deliht, by maintainin hih standards of customer service and amidst all these new challenes, the bank is proressin admirably. C$ has a stron and wide base in the state of Tamil :adu, one of the proressive states in the country, which is politically stable and has a vibrant industrial environment. C$ has been focusin on retail bankin, corporate bankin and bank assurance. The bank business crossed Rs. /0,EBE crores as on ;arch F/, 0BBD. The bank earned a net profit of Rs. HB.FB crores. The net owned fund of the bank reaches Rs KHF.JB crore. 1ith a fairly ood quality of loan assets the ne t :*- of the bank was peed at /.0K M as on ;arch F/, 0BBD.
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Name of the Company
:
Laxmi Vilas Bank Limited
Chairman
:
Mr. Md. AshrafulMoqbul
CEO CEO & Ma Mana nagi ging ng Dir Direct ector
:
Mr. Mr. Md. Md. Obay Obaye edlla llah h Al Ma Mas sud
Company !ecretary
:
Mr. A.".M !a#edur$ahman "han
%egal !tatus
:
ublic %imited Company
'enesis
:
Date of 3ncorporation
:
Emerged as Nationalised Commercial (an) in *+,- follo/ing the (angladesh (an) 0Nationlisation1 Order No. *+,- 0O No.-2 of *+-21 45 No6ember *+-2
$egistered Office
:
5789- 99 Moti#heel Commercial Area Dha)a (angladesh
Authoried Capital
:
;a)a 2444.44 Crore
aid8up Capital
:
;a)a 5<54.44 Crore
Number of Employee
:
--992
Number of (ranches
:
*-4<
hone8A(=
:
+7749-285* 55 59 +77-+-9
>A=
:
<<84-8+72*9*4 +77-44,
!?3>;
:
(!ON(DD@
?ebsite
:
///.%ami6ilasban).com
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BALANCE SHEET OF LAMI VILAS BAN? AS ON ,'STMARCH *8'1
*arameter
;-R'/E
;-R'/H
4₹ +r.
4₹ +r.
M+han e
28LR+<2 8! !L:(2 2hare +apital
/JD.KE
/JD./J
B./EM
2hare warrants > 8ut standins
B.BB
B.BB
B.BBM
Total Reserve
/,HIK./F
/,FJE.DI
/H.BKM
2hareholder's !unds
/,JEF.HD
/,HHE./K
/F.FFM
(eposits
0H,KFB.D
0/,DEK.0
/H.JIM
E
/
$orrowins
J0F.B/
KHI./B
HJ.IFM
8ther iabilities > *rovisions
I/K.EB
J0E.DI
/0.BHM
T8T- "-$""T"<2
0I,JF0./
0K,JBH.K
/E.FBM
E
K
+ash and balance with Reserve $a $ank of "ndia
/,0IE.HB
/,/KF.KK
/0.H/M
$alances with banks and money at call and short
I0.//
/JH.0I
%HF./EM
"nvestments
E,HKH.KB
E,BH/./E
I./JM
-dvances
/D,EKF.J
/E,FH0.B
0B./FM
-**"+-T"8: 8! !L:(23
notice
16
K
0
5ross $lock
EBD.FJ
KKD./B
FH.EDM
ess 3 -ccumulated (epreciation
0K0.FI
0BH.ED
/J.IKM
ess 3 "mpairment of -ssets
B.BB
B.BB
B.BBM
:et $lock
FEJ.BB
0KF.K/
HB.JJM
ease -djustment
B.BB
B.BB
B.BBM
+apital 1ork in *roress
B.BB
B.BB
B.BBM
8ther -ssets
IBJ.K/
JKB./F
D.BDM
T8T- -22
0I,JF0./
0K,JBH.K
/E.FBM
E
K
+ontinent iability
F,EIJ.B/
0,DBF./0
0J.BBM
$ills for collection
IIK.KF
EF0.FI
FD.IEM
17
)ro%$t A#d Loss For The Year E#ded ,'st March *8'1
*arameter ". ":+8;< "nterest
oss )AT <#traordinary "tems *rofit brouht forward -djusted :et *rofit Total *rofit > oss -ppropriations
;-R'/E
;-R'/H
4₹ +r.
4₹ +r.
0,HEI.FB FBK.HF *53*(5,
0,0/K.HF 0IK.BF */65(01
/H.DJM J.00M /K.DIM
/,D00.DD HK0.J/ /83('* /JE.ID 0FB.0K HB.BB 0,ED0.EB
/,EIJ.II KK0.0I ,15(/' /IB.0B /II.0/ HH.D0 0,FEE.0I
/F.DFM 00.J/M /B.H/M %/.IKM 00.FFM %/B.HDM /F.JDM
'58(*/ B.BB B.BI B.BB /IB.0K /IB.F0 FB.BB /B.BK II.JB
',*(*6 B .B B B .B J B .B B /F0.0D /F0.FH 0B.BB J .F I I0.KI
FE.0HM B.BBM 0B.FHM B.BBM FE.0HM FE.0KM HB.BBM FE.B0M J.HHM
0,HEI.FB FBK.HF *53*(5,
0,0/K.HF 0IK.BF */65(01
/H.DJM J.00M /K.DIM
/,D00.DD HK0.J/ /83('* /JE.ID 0FB.0K HB.BB 0,ED0.EB
/,EIJ.II KK0.0I ,15(/' /IB.0B /II.0/ HH.D0 0,FEE.0I
/F.DFM 00.J/M /B.H/M %/.IKM 00.FFM %/B.HDM /F.JDM
18
+hane M
""". *rofit > oss )AT <#traordinary "tems *rofit brouht forward -djusted :et *rofit Total *rofit > oss -ppropriations
'58(*/ B.BB B.BI B.BB /IB.0K /IB.F0 FB.BB /B.BK II.JB
',*(*6 B .B B B .B J B .B B /F0.0D /F0.FH 0B.BB J .F I I0.KI
FE.0HM B.BBM 0B.FHM B.BBM FE.0HM FE.0KM HB.BBM FE.B0M J.HHM
LA?SHMI VILAS BAN? RATIOS :ame
Ratio
C+rre#t Rat$o @<
B.DD
>+$c9 Rat$o @<
0E.E D
D$&$de#d Y$eld @<
/.ID
5ood7:ot (escription 5ood N 0 is 5ood, - liquidity ratio that measures a company6s ability to O 0 i s : o t pay short%term obliations. ob liations. The hiher the current ratio, 5ood the mor oree ca capa pabl blee the co com mpa pany ny is of pa pay yin in its obliations. N / is 5ood, The quick ratio measures a company's ability to meet its O / i s : o t short%term obliations with its most liquid assets. !or 5ood this reason, the ratio e#cludes inventories from current assets N /.H is - financial ratio that shows how much a company pays 5ood, out in dividends each year relative to its share price. O /.H is :ot (iv (ivide idend nd yie yield ld is cal calcul culate ated d as ann annual ual div divide idends nds per
19
5ood
I#terest Co&erae Rat$o @<
De7t E4+$t! Rat$o @<
Ret+r# O# Asset @<
Ret+r# O# E4+$t! @<
/.0F
N 0 is 5ood, O 0 is :ot 5ood 4!o !orr $a $ank nkss > :$!+ this is not Calid /H.D O 0 is 5ood, I N 0 is :ot 5ood 4!o !orr $a $ank nkss > :$!+ this is not Calid /J.D N HM is J 5ood, O HM is :ot 5ood //.F0 N /IM is 5ood, O /IM is :ot 5ood
share divided by market price per share.
"t is used to determine how easily a company can pay interest on outstandin debt. "t is calculated by dividin a company6s <$"T by the interest e#penses.
- measure of a company6s financial leverae calculated by dividin its total liabilities by stockholders equity. The debt7equity ratio also depends on the industry in which the company operates.
-n indicator of how efficient manaement is at usin its assets ass ets to ene enerat ratee ear earnin nins. s. +al +alcul culate ated d by div dividi idin n a company6s annual earnins by its total assets -lso ca -lso callle led d Re Retu turrn on ne nett wo worrth th,, it mea eassur ures es a company6s profitability by revealin how much profit a company enerates with the money shareholders have invested, it is calculated by dividin the net profit after ta# by shareholder's fund !or hih rowth companies you should e#pect a hiher R8<.
SOLVED SOLVED >UESTIONS The followin illustration e#plains composition and quality of +urrent -ssets are more important to comment on adequacy of current ratio, not merely basin on crude fiures of current ratio. BALANCE SHEET as o# ,'st March *881
20
@Rs( $# tho+sa#ds< X
Z
X
Liabilities
Z
Assets
Share Capital
400
600
Fixed Assets
Sundry Creditors
600
400
1000
100
100
Cash
50
10
Stock
150
700
Debtors
700
190
100 0
100 0
1000
et us analye the current ratio of both the companies A and P.
+urrent -ssets +urrent Ratio
= +urrent iabilities +ash Q2tock Q (ebtors = +reditors
=
HB + /HB + JBB
+urrent Ratio of A
EBB
= /.H
21
+urr +urren entt Rat Ratio of P
= /B + JBB + /DB KBB = 0.0H
Ill+strat$o# ' 4- The only current current assets possessed possessed by a firm are cash Rs. /,BH,BBB, /,BH,BBB, inventories inventories Rs. H,EB,BBB H,EB,BBB and debtors Rs. K,0B,BBB. "f the current ratio for the firm is 03/, determine its current liabilities. liabilities.
4$ -t the close of the year, a company company has an inventory of Rs. /,HB,BBB /,HB,BBB and cost of oods sold Rs. D,JH,B D,JH,BBB BB.. "f the company company6s 6s turnover turnover ratio ratio is H, determ determine ine the openin openin balanc balancee of inventory. Sol+t$o#" Rs( @A< C+rre#t Assets
+ash
/,BH,BBB
"nventories (ebtors Total current -ssets
H,EB,BBB K,0B,BBB /B,IH,BBB
+urrent ratio of the firm is 03/. "f current assets are 0, +urrent liabilities are /.
+urrent -ssets +urr +urren entt Rati Ratio o = +urrent iabilities
=0
/B,IH,BBB +urrent iabilities = 0 /B,IH,B ,BBB BB +urrent liabilities = /B,IH 0 = H,K0,H H,K0,HBB BB
22
Ill+strat$o# *
The only current assets possessed by a firm are cash Rs. /,BH,BBB, inventories Rs. H,EB,BBB and debtors Rs. K,0B,BBB. "f the current ratio for the firm is 03/, determine its current liabilities.
-t the close of the year, a company has an inventory of Rs. /,HB,BBB and cost of oods sold Rs. D,JH,BBB. "f the company6s turnover turnover ratio is H, determine the openin balance of inventory.
Sol+t$o#" Rs( @A< C+rre#t Assets
+ash
/,BH,BBB
"nventories
H,EB,BBB
(ebtors
K,0B,BBB
Total current -ssets
/B,IH,BBB
+urrent ratio of the firm is 03/. "f current assets are 0, +urrent liabilities are /.
+urrent -ssets +urr +urren entt Rati Ratio o = +urrent iabilities
=0
/B,IH,BBB +urrent iabilities = 0 /B,IH, H,BB BBB B +urrent liabilities = /B,I 0 = H,K0 H,K0,H ,HBB BB
ILLUSTRATION NO( , The capital employed in a business has been financed, as below3
Rs.
E,BB,BBB
JM *reference 2hare +apital
K,BB,BBB
EM (ebentures
I,BB,BBB
Reserves and 2urplus
0,BB,BBB
0B,BB,BBB The company earns a profit of Rs. K,BB,BBB before interest. Ta# rate may be taken HBM. Sou Sou are required to3
4- <#plain the principles of “Tradin “Tradin on
Sol+t$o#"
@A< The .rocess o% +s$# the de7t $# ca.$tal e-.lo!ed to -a#$%! the ret+r# o% e4+$t! shareholders shareholders $s called Trad$# o# E4+$t!(
The e#tent of benefit benefit of debt depends depends on capital capital earin ratio. "f capital capital earin of the company is more than one, with the increase of <$"T, there would be a similar correspondin increase in R8+<. 2imilarly, R8< also increases. $ut, the important point is the M increase of R8< would be more than M increase of <$"T. The reverse also is true. To e#plain further, if <$"T increases by /BM, R8+< increases by /BM. $ut, R8< increases more than by /BM. "f <$"T falls by /BM, the R8+< also falls, similarly, by /BM. $ut, R8< falls more than /BM.
For th$s reaso# trad$# o# e4+$t! $s sa$d to 7e do+7le2eded s;ord(
The capital%earin ratio can be ascertained as under3
+apital 5earin Ratio = 4*reference 2hare +apital Q (ebentures 7 4
K,BB,BBB Q I, BB, BBB E,BB,BBB Q 0,BB,BBB =
/0,BB,BBB
I,BB,BBB
= /.H @B< I-.act o% Cha#e $# EBIT o# ROCE a#d ROE
+apital
E,BB,B E,BB,BBB BB Q 0,BB,B 0,BB,BBB BB Q K,BB,B K,BB,BBB BB Q I,BB I,BB,BB ,BBB B
=
0B,BB,BBB <$"T
Return on +apital
+apital
! /BB
Return on +apital
*rofits after Ta#?*reference (ividend
*rofits -vailable -vailable to
K,BB,BBB
<$"T ess "nterest on (ebentures EM on Rs. I,BB,BBB
KI,BBB
F,H0,BBB Ta# HBM
/,JE,BBB
*rofit after Ta#
/,JE,BBB
JM *reference (ividend on Rs. K,BB,BBB
0I,BBB
*rofits -vailable to equity 2hareholders
/,KI,BBB
Return on
= /I.HM
I,BB,BBB et us presume that there is a chane of <$"T by HBM.
I% EBIT $#creases 7! 08"
<$"T becomes Rs. E,BB,BBB.
E, BB, BBB ! Return on
+apital
/BB
= FBM
*rofits -vailable to
E,BB,BBB
ess "nterest on (ebentures EM on Rs. I,BB,BBB
KI,BBB
H,H0,BBB Ta# HBM
0,JE,BBB
*rofit after Ta#
0,JE,BBB
JM *reference (ividend on Rs. K,BB,BBB
0I,BBB
*rofits -vailable to to
0,KI,BBB
*rofits -fter Ta# ? *reference (ividend Return on
= F/M
I,BB,BBB 2o, if <$"T increases by HBM, R8+< also has increased by similar HBM 4from 0BM to !
/0.H FBM. $ut R8< has increased by EJ.HJM 4increased from /I.HM to F/M i.e. /I.H/BB
I% EBIT %alls 7! 08"
<$"T becomes Rs. 0,BB,BBB.
0, BB, BBB ! /BB
Return on +apital
= /BM
*rofits -vailable -vailable to
0,BB,BBB
ess "nterest on (ebentures EM on Rs. I,BB,BBB
KI,BBB /,H0,BBB
Ta# HBM
JE,BBB
*rofit after Ta#
JE,BBB
JM *reference (ividend on Rs. K,BB,BBB
0I,BBB
*rofits -vailable to to
KI,BBB
Return on
=
*rofits after Ta# ? *reference (ividend
KI,BBB
#
/BB
I,BB,BBB =
EM
ILLUSTRATION NO( / !rom the followin information of +herry > +herry +ompany td., prepare the balance sheet and compute the return on capital employed 4R8+<, Return on Total -ssets 4R8T- and Return on
+urrent -ssets
Rs. /,BB,BBB
"nvestments in Treasury $onds
/,BB,BBB
!i#ed -ssets
H,BB,BBB
2ales
H,BB,BBB
+ost of 5oods 2old
F,BB,BBB
/BM (ebentures
/,BB,BBB
"ncome from Treasury $onds
/B,BBB
"nterest on (ebentures
/B,BBB
/BM *reference 2hare +apital
/,BB,BBB
0,BB,BBB
+apital Reserve
/,BB,BBB
*rovision for Ta# at FBM of :et *rofits
Cherr! Cherr! Co-.a#! Ltd( )ro%$t a#d Loss Acco+#t %or the !ear e#ded ,' st March *880 Rs . To +ost of 5oods 2old
Rs.
To "nterest on (ebentures
F,BB,BB B /B,BBB
$y 2ales $y "ncome from
To *rovision for Ta#ation
EB,BBB
Treasury bonds
To :et *rofit after Ta#
/,KB,BB B H,/B,BB B
H,BB,B BB
/B,BBB
H,/B,B BB
Liabilities
Assets
Share Capital
600
Fixed Assets
Sundry Creditors
400
Cash
10
Stock
700
Debtors
190
1000
1000
<$"TUU +apital
100
+apital
<$"T = :et *rofits Q "nterest Q Ta# ? :on 8peratin "ncome
=
/,KB /,KB,B ,BBB BB Q /B,B /B,BBB BB Q EB,B EB,BBB BB ? /B,B /B,BBB BB
=
0,BB,BBB
+apital
H,BB H,BB,B ,BBB BB Q /,BB /,BB,B ,BBB BB ? EB, EB,BB BBB B
=
H,KB,BBB
Return on
= /,KB,BBB ? /B,BBB 0,BB,BBB Q/,BB,BBB Q/,KB,BBB
)ro&$s$o# %or ta $s calc+lated as +#der"
*rofits before Ta# Ta#
Ta# FBM
= H,BB,BBB Q /B,BBB ? 4 F,BB,BBB Q /B,BBB. = 0,BB,BBB = EB,BBB
EBIT does #ot $#cl+de $#co-e %ro- Treas+r! Bo#ds as $t $s #o#2o.erat$# $#co-e( So total assets also sho+ld #ot $#cl+de the rele&a#t assets Treas+r! Bo#ds( :he# $#co-e $s ecl+ded rele&a#t assets o%
that $#co-e are also to 7e ecl+ded %or .ro.er -atch$#(
