Ratio Analysis
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Ratio Analysis
Ratio analysis is the most popular ad widely used tool of financial analysis. Ratio analysis is the process determining and interpreting numerical relationships based on financial statements.
What is a Ratio? A ratio is simply one number expressed in terms of another it is calculated by dividing one items or groups in a simple and understandable form. It may be expressed dither as a percentage of a number.
A ratio by itself cannot by analyzed or interpreted unless it is compared with some standard or with some ratios in the past, called trend analysis. These two have already been discussed under types of analysis of financial statements. A standard for comparison may be internal or external. The need for standard arises to make the ratio analysis relative. The figures of financial statement are absolute in nature. The ratio makes it relative by comparing a figure with the other relevant figure. The ratio analysis, by comparing one ratio with the standard ratio, makes the concept of relative figures more meaningful.
Modes of Expressing Ratio
A ratio whether standard or not may be expressed in different modes such as :
(a) Pure Ratio or Projection
(b) Percentage
(c) Rate
(a) Pure Ratio. A ratio expressed by simple division of one number by another is called pure ratio. The denominator is generally kept at one while the numerator is expressed in relation to the denominator. The most commonly used pure ratio is current ratio, i.e.,
Current Assets / Current Liabilities say, Rs 4,00,000 / Rs 2,00,000
The current ratio expressed as pure ratio in the above case shall be 2 : 1. This means current assets are twice as those of current liabilities.
(b) Percentage. percentage expresses the relation in hundred. It is a special type of ratio. The Gross profit, Net profit, etc, are the ratios which are mostly expressed as percentages.
Net Profit Ratio = Net Profit / Net Sales x 100, say, Rs 20,000 / Rs 1,00,000
The Net Profit Ratio expressed as percentage in the above case shall be 20%. That means out of every Rs 100 sales, Rs 20 is the neyt profit. If expressed as pure ratio, it would be 0.2 : 1 which is not as effective as percentage in this case.
(c) Rate. Thee are certain ratios which can effectively be expressed as rate, i.e., number f times, etc. The most commonly used are turnover ratios like debtor turnover, Stock turnover, Creditor turnover, etc.
Stock Turnover Ratio = Cost of Sales / Average Stock say. Rs 1,00,000 / Rs 20,000
The Stock Turnover Ratio expressed as rate in the above case shall be 5 times a year. Presentation in pure of percentage form will not be meaningful in this case.
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What is a Ratio? A ratio is simply one number expressed in terms of another it is calculated by dividing one items or groups in a simple and understandable form. It may be expressed dither as a percentage of a number.
A ratio by itself cannot by analyzed or interpreted unless it is compared with some standard or with some ratios in the past, called trend analysis. These two have already been discussed under types of analysis of financial statements. A standard for comparison may be internal or external. The need for standard arises to make the ratio analysis relative. The figures of financial statement are absolute in nature. The ratio makes it relative by comparing a figure with the other relevant figure. The ratio analysis, by comparing one ratio with the standard ratio, makes the concept of relative figures more meaningful.
Modes of Expressing Ratio
A ratio whether standard or not may be expressed in different modes such as :
(a) Pure Ratio or Projection
(b) Percentage
(c) Rate
(a) Pure Ratio. A ratio expressed by simple division of one number by another is called pure ratio. The denominator is generally kept at one while the numerator is expressed in relation to the denominator. The most commonly used pure ratio is current ratio, i.e.,
Current Assets / Current Liabilities say, Rs 4,00,000 / Rs 2,00,000
The current ratio expressed as pure ratio in the above case shall be 2 : 1. This means current assets are twice as those of current liabilities.
(b) Percentage. percentage expresses the relation in hundred. It is a special type of ratio. The Gross profit, Net profit, etc, are the ratios which are mostly expressed as percentages.
Net Profit Ratio = Net Profit / Net Sales x 100, say, Rs 20,000 / Rs 1,00,000
The Net Profit Ratio expressed as percentage in the above case shall be 20%. That means out of every Rs 100 sales, Rs 20 is the neyt profit. If expressed as pure ratio, it would be 0.2 : 1 which is not as effective as percentage in this case.
(c) Rate. Thee are certain ratios which can effectively be expressed as rate, i.e., number f times, etc. The most commonly used are turnover ratios like debtor turnover, Stock turnover, Creditor turnover, etc.
Stock Turnover Ratio = Cost of Sales / Average Stock say. Rs 1,00,000 / Rs 20,000
The Stock Turnover Ratio expressed as rate in the above case shall be 5 times a year. Presentation in pure of percentage form will not be meaningful in this case.
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