financial accounting - management accounting - financial management

1. Dr. Mohamed Kutty Kakkakunnan
Associate Professor
P G Dept. of Commerce
N A M College Kallikkandy
Kannur – Kerala - India

2. RATIO ANALYSIS
 A tool used for analysis and interpretation
 Refers to the analysis of financial statements with the
help of accounting ratios
 Ratio is a mathematical relationship between two
related items expressed in quantitative terms
 Shows the quantitative relationship
 Accounting ratios are the expression of quantitative
relationship between two accounting variables or items
or groups items contained in financial statements
 Ratio analysis refers to the process of computing,
determining and presenting the relationship of items
or group of items of financial statements

3. “the quantitative relationship between two or more
items of the financial statements connected with each
other’
Ratios (quantitative relationship) can be expressed in any
of the three ways:-
1. In proportions – in this form the amounts of the two
terms are being expressed in a common denominator.
Thus expression will be 2:1 or 1:2 etc
2. In rates or times or coefficients: in this form a
quotient is obtained by dividing one item by another.
When ratios are expressed in this way, it also known
as “turnover” or “times”
3. In Percentage: in this form, a quotient obtained by
dividing one item by another item is multiplied by 100

4. Utility or Uses of Ratio Analysis
Following are the general utility of ratio analysis
1. Trends in costs, sales, profit and other business
related facts can be ascertained and their future
events can be forecasted on the basis of the trend
2. Ideal (standard) ratios may constructed and can be
used for comparison
3. Can be used a managerial tool for control, especially
sales, costs etc
4. Can be used for measuring and evaluating
performance efficiencies of differ departments,
persons and divisions.
5. Helps to take important decisions on investment on
the basis of profitability

5. Advantages of Ratio Analysis
1. Simplifies comprehensive financial statements. Ratios
tell whole story of the financial position, profitability
and changes
2. Facilitates inter-firm comparison (absolute figures –
uniform)
3. Makes intra-firm comparison more meaningful
4. Helpful in ascertaining operational efficiencies
5. Helpful in forecasting and planning
6. Helpful in ascertaining the weak spots of the business
7. Very helpful in performance analysis and appraisal
8. Helps in discharging various managerial functions
efficiently and effectively.

6. Limitations of Ratio Analysis
1. Limited use of single ratios. A single ratio, usually will
not convey much meaning. To make better
interpretations, a number of ration have to be
calculated
2. Lack of adequate standards (ideal) for comparison
3. Inherent limitations of accounting
4. Change of accounting policies, methods etc
5. Window-dressing
6. Personal bias
7. Price level changes
8. Ratios are not substitutes for financial statements. Only
tools

7. Procedure (stages) for ratio analysis
1. Arrangement of data
2. Classification and calculation of ratios
3. Interpretation of calculated ratios
4. Projection through ratios
Arrangement Of Data
The items in the financial statements are to be
arranged in vertical or statement form so as
to enable calculation ratios easy

8. Classification and calculation of ratios and their
interpretation
Rearrangement of the data according to some
common characteristic features
Broadly classified on the basis of –
I. Statements
II. Users
III. Relative importance
IV. Accounting significance
V. Nature
VI. Purpose or function

9. 1. On the basis of statement
Balance sheet ratios
/ financial ratios
Profit /loss account
or income
statement ratios
Inter-statement
ratios
1. Liquidity
ratios
2. Current
ratio
3. Stock ratio
4. Proprietary
ratio
5. Capital
gearing ratio
Gross profit ratio
Expenses ratio
Net profit ratio
Profit cover
interest and
dividend
1. Return on capital
employed
2. Return on
shareholders fund
3. Stock turn over
4. Debtors turn over
5. Creditors turn over
6. Working capital turnover
7. Current asset turnover
8. Total capital turnover
9. Total turnover / total capital turnover
10. Fixed asset turnover

10. ON THE BASIS OF THE USERS
Management
1. Operating
ratios
2. Return on
capital
employed
3. Stock
turnover ratio
4. Debtors
turnover ratio
5. Solvency
ratios
Share holders
1. Return on
shareholders
fund
2. Capital gearing
ratio
3. Dividend cover
4. Yield rate
5. Proprietary
ratio
6. Dividend rate
7. Assets cover of
share
Creditors
1. Current ratio
2. Solvency ratio
3. Creditors
turnover
4. Fixed asset
ratio
5. Assets cover
6. Interest
coverage ratio

11. Classification by Purpose or Function or Test
I. Liquidity ratios
II. Solvency ratios
III. Profitability ratios
IV. Activity ratios
V. Market-test ratios
Classification is exhaustive. Classification
is difficult. Different ratios may belong to
the same category
Financial Ratios