### Ratio Analysis

**Financial statements:** The statement which provides us the financial position of a
Balance Sheet are called “Finance Statements”, which includes – Trading Account (in
case of Manufacturing concerns), Profit & Loss Account, Balance Sheet, Cash Flow
Statement and Funds Flow Statement. The analysis of Balance Sheet is a process of
bringing down the difficult matter into a simple and easily understandable one. To
have a clear understanding of the financial position of the Business concern, at least
three years financial statements are to be ascertained. They provide us treasure of
information. Balance Sheet of a business concern shows the strength of the concern
on a given date but not reveal the current state of affairs of the concerns. Balance
Sheet is having certain limitations, because it does not disclose the critical factors,
such as Managerial Efficiency, Technical competence, Marketing capabilities and
Competition in the market.

Ratio means a comparison of two items which are having cause and relationship. Ratios can be expressed in percentage or in number of times. Depending upon the nature, the ratios are broadly classified in to four categories viz., Liquidity Ratios, Leverage Or Solvency Ratios, Activity Ratios and Profitability Ratios.

**I. LIQUIDITY RATIOS:** These Ratios helps to find out the ability of the business
concern to pay the short term liability of its liquidity. Any adverse position in liquidity
leads to sudden fall of the unit.

**Current Ratio:** Current Ratio denotes the capacity of the business concern to meet
its current obligation out of the 50ttest50ed50 value of the Current Assets. Current
Ratio = Current Assets / Current Liabilities. Term Loan installments falling due for
payment in next 12 months are to be taken as Term Liability for the purpose of
calculation of Current Ratio /MPBF. Inter-corporate deposits are to be treated as
Non-Current Assets. Ideal Current Ratio is 2:1. Acceptable Ratio as per our Loan
Policy guidelines is 1.33:1 for the limits enjoying above Rs.6.00 crores and 1.15:1 for
the business concerns availing limits of below Rs.6.00 crores. Any deviation below the
required ratio requires ratification of Higher Authority.

**Quick Ratio Or Acid Test Ratio:** This ratio is a comparison of Quick Assets to
Current Liabilities. Quick Assets mean the assets which have instant liquidity of the
business concern. Though the Inventory and Prepaid expenses are part of Current
Assets, it may be difficult to sell and realize the inventory. Hence, Inventory and
Prepaid expenses are to be excluded for arriving the Quick Asset Ratio.
Current Assets – (Inventory+Prepaid Exp) Quick
Ratio or Acid Test Ratio = ----------------------------------------------
Current Liabilities
Ideal Quick Ratio is 1:1. Current Ratio is always to be read along with Quick Ratio. A
fall in the Quick Ratio in comparison to the Current Ratio indicates high inventory
holdings.

**II. LEVERAGE AND SOLVENCY RATIOS:** These Ratios helps to find out the Long
Term Financial stability of the business concern

**i)Debt Equity Ratio:** Long Term Debt / Equity – Here, Equity refers Tangible Net
worth. The Ideal ratio is 2:1 and the higher may also be considered as safe.

**ii) Debt Service Coverage Ratio:** It helps to know the capacity of the firm to
repay the Long Term Loan Instalment and Interest. Ideal DSCR is 2:1. The higher the DSCR, we may fix the lower repayment period. However, banks may also consider DSCR 1.20:1 where fixed income generation is assured, such as Rent Receivables etc.

**iii) Fixed Assets Coverage Ratio (FACR):** This ratio indicates the extent of Fixed
assets met out of long term borrowed funds. Ideal Ratio is 2:1

**iv) Interest Coverage Ratio:**

Where EBIDT is Earning Before Interest, Depreciation and Tax. This ratio indicates the interest servicing capacity of the unit. Higher the ratio has probability of nonservicing of interest and hence avoidance of slippage of asset.

**III. ACTIVITY RATIOS:**

**Inventory Turnover Ratio:** Inventory constitutes raw material, work in process,
finished goods etc. The ratio is arrived by dividing Inventory by average monthly Net
sales to arrive at inventory levels in number of months. Lower the ratio, the faster
the movement of inventories and Higher the ratio slower the movement of
inventories. It also indicates the time taken to replenish the inventories. Separate
parameters are laid down for fabrication units & seasonal industries (maintaining
peak level inventories as at March) where operating cycle is longer compared to
other businesses and others
Inventory x (RM+WIP+FG) x 12 (OR ) Cost of Goods Sold
Net Sales = Average Stock ((Opening Stock+Closing stock)/2)

**ii) Debtors Velocity Ratio:**

**iii) Creditors Velocity Ratio:**

**iv) Assets Turnover Ratio:**

**IV. PROFITABILITY RATIOS:**

**c) Gross Profit Ratio -> Gross Profit/Net Sales*100** – Gross Profit Ratio
indicates the manufacturing efficiency and Pricing policy of the concern. Higher
percentage indicates higher sales volume, better pricing of the product or lesser
cost of production.

**ii) Net Profit Ratio:**

**iii) Return on Equity:**

**Working Capital Assessment**

**i) Turnover Method:** (for WC limits up to & inclusive of Rs.6.00 Crore)

- Accepted Projected Sales Turnover
- 25% of Sales Turnover
- Margin @ 5 % of Sales Turnover
- Actual NWC available as per latest Audited Balance Sheet
- B-C
- B-D
- M.P.B.F = E or F, whichever is less.

**ii) Inventory Method** – For WC limits up to & inclusive of Rs.6.00 Crore

- Total Current Assets
- Current Liabilities (other than Bank Borrowings)
- Working Capital Gap = A – B
- Margin @ 13% of Projected Current Assets
- Actual NWC available as per latest Audited Balance Sheet
- C-D
- C-E
- M.P.B.F = F or G, whichever is less.

- Maximum Working Capital credit limit up to which Turn Over method can be extended is Rs.6 Crores. Where the limits of above Rs.6.00 Crore, the margin is to be taken as 25% projected current assets. If actual NWC is less than required margin, the borrower has to bring in the short fall.
- The minimum acceptable Current Ratio for working capital credit facility up to Rs.6 crore & above Rs.6 crore is 1.15 & 1.33 respectively.
- Maximum acceptable level of Total Debt- Equity Ratio is 4.
- Maximum permissible Gearing Ratio while assessing the eligibility for nonfunded limits is 10.
- Standard average DSCR specified for all Term Loans is 1.50 to 2.00. However, in case of assured source of income, it can be taken as 1.20. Lower DSCR can be accepted for Rural Godowns.