Success of an industry largely depend upon its earning sufficient and earning its surplus. It helps to the expansion capacity of financing the resources and minimizes the needs for external funds. No technology is advanced if it doesn’t increase productivity. Ratio analysis is one of the most powerful tools of the financial statement analysis.
In place a vital roles in evaluation of the financial performance and condition of the company. Ratio analysis is a technique of analyzing and interpreting the financial statements. Thus, one can use ratio analysis for comparing the performance of a companies of comparable firms and of past years. With regard to organization for study. I prefer my self to work with a leading public sector enterprise, which has been growing potentially, Visakhapatnam Steel Plant is a continuously profit making organization operating under public sector.
Evaluation & Growth Of Steel In India
India has many intrinsic advantages in the production of steel. Some of the richest iron ore mines with highest iron content are found here. Also coal and iron are found in close proximity to each other. Infect, at one time the cost of production of steel in India was much lower then in other countries. Our Honorable First Prime Minister, Pt Jawaharlal Nehru said that the steel is the symbol of strength, of the economic activities, which cannot be overemphasized.
Birth Growth And Development Of Steel In India
Iron had occupied an important place in the service of mankind, not only in India but also abroad. From time immemorial steel is indispensable to modern civilization in peace and war. In other words to understand the background of the entry of iron and steel into the public sector in India, it would be desirable to trace briefly, the history of iron and steel in India through the centuries.
Need For The Study
Steel is a versatile and indispensable item. Iron and steel comprises some of the most important inputs in all sections of the economy. This industry is both basis and core industry.
The economy of any nation depends on a strong base of iron and steel industry in that nation and steel products have played a predominant role in the advancement of civilization. The great investment that has helped both directly and indirectly in many modern fields of today’s science and technology. The rapid growth and development of steel industry is indeed a logical corollary of any programmed of rapid industrialization. Steel form the backbone of the economy, especially of an industrial country. It has strong backward and forward linkages, which make steel indispensable.
The importance of steel in the economic activities cannot be over emphasized. Besides, steel employees, 15000 opportunities are created indirectly in the linkage industries.
Objectives Of Study
The major objectives of the study are as follows :
- To high light the organizational profile of Visakhapatnam Steel Plant.
- To analyses the ratio analysis of the Visakhapatnam Steel Plant.
- To evaluate the ratio analysis techniques adopted by the Visakhapatnam Steel Plant.
- To summarize and to suggest wherever necessary.
The methodology followed to complete the study successfully is basically from 2 sources, those are :
- Through the sources of primary data and
- Through the sources of secondary data
Primary data is collected by interviewing various persons relating to the departments.
Secondary data is collected from magazines of Visakhapatnam Steel Plant, present and previous annual report and cost sheets of the company.
Limitations Of Study
- The major limitation is the short span available for the study.
- Reliability on usage of secondary data is another limitation.
- Some aspects of financial information are held due to confidentially of the company.
- There was no scope of gathering current information as the auditing has not been done by the time of project work.
Future Plans Of The Indian Iron & Steel Industry
Future plans of iron & steel industry envisaged a production of 18. 6 million tons of hot metal. This requires an additional investment of 10,000 crore’s. The present per capital consumption of steel in India is around 15 kg compared to the figure of Indian population, which today stands about 800 million, even at 10 kg increase would need selling up of 8. million tons of steel per year generating capacity. Keeping this end in view, the government has been setting up different committees, agencies from the time to project to future demand for steel and their plans to fulfill the demand.
Swot Analysis Of The Indian Steel Industry Strengths
India has been bestowed with high resources of basic raw material for steel making. The country has about 12 billion tons of dolomite. Except high ash contents in coal, all minerals are of more suitable quality and hence India has been comfortable to any country in the world.
India has large number of experienced metallurgists, engineers and technicians who can engineer, adopt and assimilate cost effective technology for making and shaping of steel. Maintaining an edge in cost and quality, competitiveness in the export market, low labour cost (15% of steel) and well trained human resources as well as good quality inputs is one of the major strengths of India steel industry. India has the advantage if possessing large costal line. Future the geographical advantage of being in South east Asia for import of coking coal and export of finished steel add to the strengths.
- High capital, labour and energy intensive industry establishment long gestation period.
- Slow growth rate in domestic as well as international demand.
- Compulsion to import good quality metallurgical coking coal in spite of India possessing large coal resources, the reason being high ash content in India coal reserves.
- Total dependence on scrap, resulting in huge scrap inputs further up trend in scrap prices to reduce profitability.
- Poor capacity utilization of steel units due to inadequate infrastructure facilities and inadequate short-term and long-term planning. High and raising power costs and low availability of power are becoming a burden to the steel industry.
- Sponge-iron units mushrooms in India but it could not establish itself as a potential substitue to scrap in steel making.
- Per-capita consumption of steel in India is under 30 kg which is less than 1/5th of the world average, this means huge potential for steel consumption as well as latent demand.
- Presently the sector is almost entirely open with no licensing, pricing, distribution and improved deficiencies. Up-trend in average annual growth rate of steel production that was stagnant at 6. 7% since 1981 to 1983 is a noticeable opportunity. It is expected to touch 10% by the end of those decade. This means huge scope for capacities generation.
- With effect from Jan, 1992 the steel industry in India has been decontrolled and diligence. As apart of economic liberalization, various controls on pricing and distribution of iron and steel has been removed. All the producers are now free to determine their steel product prices. Further the trade policy announced in April 1992 has liberalized the import and export of steel products. It has been announced from 130% in 1990 to 85% in 1993 and it was further lowered to 20% by 1998.
- The government has made changes in the industrial policy. Steel production, which was earlier restricted for public sector has now been opened up for private sector also. Further there are no restrictions on capacities.
- In India there is considerable opportunity to use steel wherever require. Also there is a vast scope for agriculture mechanization.
World steel industry is plagued by recession due to the following reasons :
- Matured markets for user industries like automobiles, appliances continuously make efforts to control cost, minimize jobs and strive for more corporate export.
- Threat regarding dumping is very much persistent to Indian steel sector. Considering the fact that import barriers are being removed in Indian steel industry may be forced to remain under the cloud of cheap import.
- Severe threat of technological obsolescence due to rapid development in secondary steel making technology exists in Indian Steel industry. Diseconomies of scale of operations by various mini steel plants and inadequate investments opportunities for modernization and up-gradation due to high cost of inflation and financing rates posing a major threat to the industry as a whole.
Profile Of Visakhapatam Steel Plant Profile Of Visakhapatnam Steel Plant
Visakhapatnam Steel Plant is the biggest project in the country. Nesting in between the NH-5 and the Bay of Bengal lays a stretch of land strewn with hillocks, valleys a natural creek and green forest south west of Visakhapatnam harbor.
Taking full advantage of the natural bounty, plans were drawn up for setting up India’s 7th integrated steel plant in the government sector and the first shore based plant in Visakhapatnam. The company is trying its best to retain its market share and expand wherever possible, link up production to market demand and throttle the production if needed be and cut cost at all fonts to the maximum level. The company is thus passing through tough time with respect to managing financials both in terms of cash and profitability.
The department of steel in the ministry of steel and mines have approached financial relief to the company as in interim measure by conversion of outstanding government of Indian loans into non cumulative redeemable preference shares and directed the company to submit a comprehensive proposal; for rehabilitation of the company. Its sales turnover was Rs. 3,186 crore’s in 1997-98. Despite stiff competition from other steel majors, VSP’s domestic market share has risen from 16% in 1992-93 to 29%. On the quality front, its steel melt shop all finishing mills and a whole range of finished products have secured ISO-9002 certification.
It was decided to execute the project under a rationalized concept in 1986 with a view to reducing the capital investment by deleting some facilities, including a second steel melt shop, and upgrading some other. The rationalized concept aimed at working the plant at international levels of efficiencies with 30 to 35% of the manpower of the public sector steel mills of similar capacity.
It is located near Balacheruvu 28kms from visakhapatnam railway station, 15kms from airport and about 12kms South-West of vizag port.
It occupies 25,780 acres of land comprising of 6,400 acres for production facilities, 6,620 acres for township and 12,760 acres for other facilities.
Steel occupies the foremost place amongst the materials in use today and pervades all walks of life. All the key discoveries of the human genius – for instance, steam engine, railway, means of communication and connection, automobile, aeroplane and computers, are in one way or other, fastened together with Steel and with its sagacious and multifarious application.
Steel is a versatile material with multitude of useful properties making it indispensable for furthering and achieving continual growth of the economy be it construction, manufacturing, infrastructure or consumables. The level of steel consumption has long been regarded as an index of industrialization and economic maturity attained by a country. Keeping in view the importance of steel, the following integrated steel plants with foreign collaborations were set up in the Public Sector in the post independence era.
Construction Of Time Frame And Project Cost
The construction of the project was programmed to be carried out by the over lapping stages, the stage one is completed in four years and the stage 2 i. e. , the full capacity in 6 years from zero date (01/02/1982) on the fourth quarter 1981 price basis the project was estimated to cost Rs. 3,897. 28 crore’s. , the approved plant facilities at the ultimate stage were to give a yearly production of 3. met of liquid steel converted into 2. 983 met of saleable pig iron was to be produced per annum. However, due to continued constraint off funds and also inadequate initial mobilization there were some slippages in the progress of project. A proposal therefore emerged for commissioning tin 1988 and the full plant in 1991 the cost estimate of the project was accordingly updated at Rs. 7,500 crore’s approximately (on the first quarter 1985 price basis). In view of the continuing fund constraints it became necessary to review the project concept critically.
By deleting one mill and part of steel making facilities, rationalized concept with met of liquid steel capacity have been envisaged. Thus this concept has been basically possible due to higher levels of operational efficiency in VSP would be around 230 tons per man-year as against 60-70 tons per man year achieved as far in other steel plants in country. The rationalized concept has resulted in reduction in the capital costs by Rs. 1,500 crore’s. In the 1st quarter 1985 price basis. The total time was also shortened and the stage 1 was completed in 1988 and the stage 2 in 1990 instead of 1991 as earlier proposed.
Even though the liquid steel production in the rationalized concept is marginally reduced (3. 0 mt per year to 3. 4 mt per year in the original concept), the total saleable production in the rationalized concept is lightly higher.
The major inputs of the company are ore and coal along with flux materials and Ferro alloys. The iron ore supplies are linked from bailadila iron ore mines of NMDC while major requirements of metallurgical coal is being met through imports from Australia. Both these supplies from the sources are reliable and adequate supplies in future. The company has entered into contract with NMDC for committed supplies of iron ore as well as price fixation for the supplies. The company has also finalized long term contracts for supply of imported cooking coal where the price are linked to the international price parties of Australian coal.
- WATER SUPPLY Operational water requirement of 36 mgd is being met from the Yeleru Water Supply Scheme.
- POWER SUPPLY Operation power requirement of 180 to 200 MW is being met through Captive Power Plant. The capacity of the power plant is 286. 5MW. VSP is exporting around 60 MW power to APSEB. TECHNOLOGICAL
- HIGHLIGHTS OF VSP 7m tall coke oven batteries with coke dry quenching. Biggest Blast Furnace in the country. Bell less top charging system in Blast Furnace. 100% slag granulation at the BF cast house. Suppressed combustion-LD gas recovery system. 100% continuous casting of liquid steel. “Tempcore”and “Stelmor” cooling process in LMMM &WRM. Extensive waste heat recovery systems. Comprehensive pollution control measures.
- MAN POWER The steel plant has approximately 17,122 employees of which 4,002 are executives and the rest of them are non-executives. There are about 6000 contract workers in the organization. The manpower of this plant is very low when compared with the other existing public sector steel plants in the country.
- HRD POLICY OF VSP Identify development needs of the employees on a regular basis, provide the necessary training and continually evaluate and monitor the effectiveness of the training so that the quality of the training also gets upgraded. o Provide inputs to the employees for developing their attitude towards work and for matching their competencies with the organizational requirements. o Create an environment of learning and knowledge sharing by providing the means and facilities and also access to the relevant information and literature. o Facilitate the employees for continuous development of their knowledge base, skills, efficiency, innovativeness, self-expression and behaviour so that they contribute positively with commitment for the growth and prosperity of the organization while maintaining a high level of motivation and satisfaction. Prepare employees through appropriate development programs for taking up higher responsibilities in the organization. o Fulfill social obligations by providing training to the students of educational institutions and to the trainees of other organizations.
Vision of VSP
To be continuously growing world-class company. ? Harness our growth potential and sustain profitable growth. ? Deliver high quality and cost competitive products and be the first choice of customers. ? Create an inspiring work environment to unleash the creative energy of people. ? Achieve excellence in enterprise management. ? Be a respected corporate citizen, ensure clean and green environment and develop vibrant communities around us.
Visakhapatnam Steel Plant
Mission & Objectives Mission
To attain 16 million ton liquid steel capacity through technological up-gradation, operational efficiency and expansion; to produce steel at international standards of cost and quality; and to meet the aspirations of the stockholders.
Expand Plant capacity to 6. 3 Mt. by 2008-09 with the mission to expand further in subsequent phases as per the corporate plan. Sustain Gross margin to turnover ration >25%. Be amongst top five lowest cost steel producers in the world by 2009-10. Achieve higher levels of customer satisfaction than competitors. Be recognized as an excellent business organization by 2008-09. Instill right attitude amongst employees and facilitate them to excel in their professional, personal and social life. Be proactive in conserving environment, maintaining high levels of safety and addressing social concerns.
Hallmark Of Vizag Steel As An Organisation
Today, VSP is moving forward with aura of confidence and with pride amongst its employees who are determined to give their best for the company to enable it to reach new heights in organizational excellence.
At the same time, no single advantage accruing from a knowledge society if found wanting by the neighbourhod community with the growth & development of a phenomenon called VIZAG STEEL existing so close to its proximity. Futuristic enterprises, academic activity, planned & progressive residential localities but few of the plentiful ripple effects of this transformation and each one of us take immense pride to uphold the philosophy of mutual (i. e. , individual and societal) progress.
Theoritical Frame Work Of Ratio Analysis Ratio Analysis Introduction
Ratio Analysis is a widely used tool of financial analysis. A ratio is defined as the “ indicated quotient of two mathematical expressions” and “ a relations between two or more things”. A ratio is used as an index or yardstick for evaluating the financial position and performance of the firms.
The relationship between two accounting figures expressed mathematically, is known as financial ratio. Ratio helps to summarize the large quantities of financial data and to make qualitative judgement about the firm’s financial position. A rational ratio analysis lies in the fact that it makes related information comparable. A ratio may be expressed simple in one number as the result of the comparison between two figures. Ratios may be expressed in the following ways :
- In a pure ratio
- As a rate
- As a percentage
Nature Of Ratio Analysis
Ratio analysis is one of the powerful tools of the financial analysis. A ratio can be defined as “ the indicated quotient of wo mathematical quotients”, and as “the relationship between two or more things”. In financial analysis, a ratio is used as a benchmark of evaluating the financial position and performance of the firm. The absolute accounting figures reported in the financial statements do not provide a meaningful understanding of the performance and financial position of the firm. An accounting figure conveys meaning when it is related to some other relevant information. The relationship between two accounting figures, expressed mathematically, is known as a financial ratio (or simply as a ratio). Ratio help to summarize large quantities of financial data and to make qualitative judgement about the firm’s financial performance.
Significance Of Ratio Analysis
Ratios are significance in both the vertical and horizontal analysis. In vertical analysis ratios help the analyst to form a judgement whether the performance of the firm at a given point of time is in good position or not. Use of ratios in horizontal analysis indicates whether the financial condition of the firm is improving or deteriorating and whether the cost profitability of efficiency is showing an upward profitability or downward trend. Basis of comparison : The ratio analysis involves several types of comparison. They are below : A) A comparison of present ratio with the past and expected future ratios for same firm.
B) A comparison of the ratios of the firm with those of similar firm or with industry averages at the same point time. Such a comparison would provide considerable insight into a relative financial condition and performance of the firm. C) Trend series or analysis is also one of the comparisons. A financial ratio over a period of time is compared, it is known as trend analysis. Trend ratios involved a comparison of ratios of a firm over time. The analyst should not simply determine the change, but more important he should understand why ratios have changed. D) The other comparison may relate to comparison of items with a single year’s financial statement of a firm comparison with standards or plans.
Importance Of Ratio Analysis
The importance of ratio analysis lies in the fact that it presents facts on a comparative basis and enables the drawing of inferences regarding the performance of the firm. Ratio analysis is relevant in assessing the performance of a firm in respect of the following points.
- Liquidity positions :
With the help of ratio analysis conclusions can be drawn regarding the liquidity position of the firms. The liquidity position of a firm would be satisfactory if it is able to meet its current obligations when they become due. The liquidity ratios are particularly useful in credit analysis by banks and other suppliers of short-term loans.
- Long-term solvency:
Ratio analysis is equally useful for assessing the long term financial viability of the firm. The long-term solvency is measured by the leverage/capital structure and profitability ratios, which focus on earning power and operating efficiency. Ratio analysis reveals the strength and weakness of a firm in this respect.
- Operating efficiency :
It is relevant from the viewpoint of management and it throws light on the degree of efficiency in the management and utilization of its assets. The ultimate analysis depends upon the sales revenue generated by the use of its assets total as well as its components.
- Overall profitability :
In this the management is constantly concerned about the overall profitability of the enterprise. They are concerned about the ability of the firm to meet its short term as well as long term obligations to its creditors to ensure a reasonable return of its owners and secure optimum utilization of the assets of the firm.
- Inter firm comparison :
Ratio analysis is also stepping stone remedial measures. This is made possible due to inter-firm comparison and comparison with industry averages. One of the popular techniques is to compare the ratios of a firm with the industry average. An inter-firm comparison would demonstrate the relative position to its competitors.
- Trend analysis :
Ratio analysis enables a firm to take the time dimension into account. In other words whether the financial position of as firm improving or deteriorating over the years. This is made possible by the use of trend analysis. The significance of trend analysis of ratios lies in the fact that the analyst can know the direction of movement. The present level may be satisfactory but the trend may be declining one. Thus the trend analysis is of great significance.
Managerial Uses And Limitations
Helps in Decision-making : Financial statement is prepared primarily for decision-making. But the information provided in financial statements is not an end in itself and no meaningful conclusion can be drawn from these statements alone.
Ratio analysis helps in making decisions on the information provided in these financial statements. • Helping in financial forecasting and planning : Ratio analysis is of much help in financial forecasting and planning. Planning is looking ahead and the ratios calculated for a number of years work as a guide for the future. Meaningful conclusions can be drawn for future from these ratios. Thus, ratio analysis helps in forecasting and planning. • Helps in Communication : The financial strength and weakness of a firm are communicated in a more easy and understandable manner by the use of ratios. The information contained in the financial statements is conveyed in a meaningful manner to the one for whom it is meant.
Thus, ratios help in communication and enhance the value of the financial statement. • Helps in Co-ordination : Ratios even help in co-ordination, which is of utmost importance in effective business management. Better communication of the efficiency and weakness of an enterprise results in better co-ordination in the enterprise. • Other Users : There are so many other uses of the ratio analysis. It is an essential part of the budgetary control and standard costing. Ratios are of immense importance in the analysis and interpretation of financial statements as they bring out the strength or weakness of a firm.
Utility to shareholders / investors
An investor in the company will like to assess the financial position of the concern where he is going to invest. His first interest will be the security of his investment and then a return in the form of dividend or interest. For the first purpose he will try to assess the value of fixed loans raised against them. The investor will feel satisfied only if the concern as sufficient amount of assets. Long-term solvency ratios will help him in assessing financial position of the concern. Profitability ratios, on the other hand, will be useful to the investor in making up his mind whether present financial position of the concern warrants further investments or not.
Utility to creditors
The creditors or suppliers extent short-term credits to the concern. They are interested to know whether their payments at a specified time or not. The concern pays short-term creditors out of its current assets. Are quite sufficient to meet current liabilities then the creditor will nor hesitate in extending credit facilities. Current and quick ratios will give an idea about the current financial position of the concern.
Utility to employees
The employees are also interested in the financial position of the concern especially profitability. Their wage increases and amount of fringe benefits are related to the volume of profits earned by the concern.
The employees make use of information available, in financial statements. Various profitability ratios relating to gross profit, operation profit, net profit etc. , enable employees to put forward their viewpoint for the increase of wages and other benefits.
Utility to government
Government is interested to know the overall strength of the industry. Various financial statements published by industrial units are used to calculate ratios for determining short-term, long-term and overall financial position of the concerns. Profitability indexes can also be prepare with the help of ratios. Government may base its future policies on the basis of industrial information available from various units.
The ratios may be used as indicators of overall financial strength of public as well as private sectors. In the absence of the reliable economic information, governmental plans and policies may not prove successful.
Limitations Of Ratio Analysis
The various limitations of ratio analysis are given below : 1. A single ratio does not convert much of sense. To make better interpretation a number of ratios have to be calculated which is likely to confuse the analyst for interpretation. Financial statements can be easily widow dressed their figures. As a result, the correct picture cannot be drawn up by the ratio analysis, although certain structural defects can be detected.
Comparison between variables proves worth provided basis of valuation is identical. Ratios are computed on the basis of past results. It does not help properly to predict future, to prepare budgets and estimates.
Advantages Of Ratio Analysis
The various advantages of ratio analysis are given below :
- It becomes easier to analysis. a. Liquidity b. Solvency c. Profitability d. Efficiency
- It helps the management in evolution of the present health and future planning can based on the parameters.
- The efficient with which the firm is utilizing its various assets in generating sales revenue.
- The ratio analysis helps in decision-making process.
- The ratio analysis is also helps in security analysis.
- The details of cumbersome set of numbers are reduced to easily interpretable numbers.
Classification Of Ratios
Ratios may be classified in a number of ways keeping in view the particular purpose. Ratios indicating profitability are calculated on the basis of the profit and loss account; those indicating financial position are computed on the basis of the balance sheet and those which show operating efficiency or productivity or effective use of resources are calculated on the basis of figures in the profit and loss account and the balance sheet. Ratios may be classified
- Profitability ratios
- Coverage ratios
- Turnover ratios
- Financial ratios
- Leverage ratios
Profitability is the overall measure of the companies with regard to efficient and effective utilization of resources at their command. Profitability ratios are of utmost importance for a concern. These ratios are calculated to enlighten the end results of business activities which is the sole criterion of the overall efficiency of a business concern. The following are the important profitability ratios :
- Gross Profit Ratio
- Operating Ratio
- Cash Margin Ratio
- Operating Profit Ratio
- Net Profit Ratio
Gross Profit Ratio
This ratio express the relationship between gross profit and sales. The formula for computing this ratio is as under : Gross Profit Gross Profit ratio = X 100 Net Sales The gross profit ratio may interpreted by comparing this ratio of the same concern over a period of time or comparing this ratio of the two similar concerns or comparing the ratio of a year with some standard fixed by management. Normally a higher ratio is always considered good and serves as an index of higher profitability.
This ratio indicates the proportion that the cost of sales bears to sales. Cost of sales includes direct cost of goods sold as well as other operating expenses (i. e. administration, selling and distribution expenses) which have matching relationship with sales. Cost of goods sold + Operating Expenses Operating ratio = X 100 Net Sales Cost of goods sold = Opening Stock + Purchases + Direct Expenses + Manufacturing expenses – Closing stock or Sales – Gross Profit. Operating Expenses = Administrative Expenses + Selling and Distribution Expenses
Cash Margin Ratio
Cash profit excludes depreciation. It means Net profit after interests and taxes but before depreciation. This ratio indicates the relationship between the profit, which accrues in cash and sales. Greater percentage indicates better position and vice-versa as it shows the correct profit earned by the firm. This ratio is expressed as cash profit to sales. Cash Profit Cash Margin Ratio = X 100 Sales
Operating margin ratio is also known as Operating Net profit ratio. It is the ratio of operating profit to sales. This ratio establishes the relationship between the total cost incurred and sales. Operation profit is the Net profit after depreciation but Before Interests and Taxes. The purpose of computing this ratio is to find out the overall operational efficiency of the business concern. It measures the const of operations per rupee of sales. This ratio is expressed as operation profit to sales.
Operating Profit Operating Ratio = X 100 Net Sales Operating Profit = Net Profit + Non-Operating Expenses – Non- operating Income. (or) = Gross Profit – Operating Expenses
Net Profit Ratio
It is also called net profit to sales ratio. It measures relationship between net operating profit and sales and as such is expressed as percentage to sales. As indicated elsewhere, while ascertaining the net operating profit, items of non operating incomes and non operating expenses are not taken in to account.
The term investment refers to Total Assets. The funds employed in Net assets are known as Capital Employed. Net assets equal net fixed assets plus current assets minus Current liabilities excluding Bank loans. Alternatively, Capital employed in equal to Net worth plus total debt. The conventional approach of calculating return on investment (ROI) is to divide PAT by Investment.
Investment represents pool of funds supplied by shareholders and lenders, while PAT represents residual income of shareholders; therefore, it is conceptually unsound to use PAT in the calculation of ROI. Also, as discussed earlier, PAT is affected by capital structure. It is, therefore more appropriate to use one of the following measures of ROI for comparing the operating efficiency of firms. EBIT (1-T) ROI = ROTA = Total Assets EBIT (1-T) ROI = RONA = NET Assets Where ROTA and RONA respectively Return on Total assets and Return on Net assets. RONA is equivalent of Return on Capital Employed.
Return On Net Worth
NET Worth is also known proprietors Net Capital Employed. The Return should be calculated with reference to profits belonging to shareholders, and therefore, profit shall be Net profit after interest and tax. The profit for this purpose will include even non-trading profit. This is given as follows: Net profit after interest & tax RETURN ON NET WORTH = X 100 Shareholders funds RETURN ON CAPITAL: The ROCE is the second type of ROI. The term capital employed refers to long-term funds supplied by the creditors and owners of the fund. It can be computed in two ways. First, it is equal to non-current liabilities (long-term liabilities) plus owner’s equity.
Alternatively, it is equivalent to Net Working Capital plus Fixed Assets. Thus, the Capital Employed provides a basis to test the profitability related to the sources of long-term funds. A comparison of this ratio with similar firms, with the industry average and overtime would provide sufficient insight into how efficiency the long-term funds of owners and creditors are being used. The higher the ratio, the more efficient is the use of Capital Employed. NET PROFIT AFTER TAX/EBIT ROCE = X 100 Average Total Capital Employed
Return On Gross Block
This ratio establishes a relationship between net profit and gross fixed assets. This ratio emphasizes the profit on investment in Fixed Assets. This ratio is expressed as follows: Net profit RETURN ON GROSS BLOCK = X 100 Gross Block NET PROFIT is profit before Tax. Gross Block means Gross fixed assets i. e. , Fixed assets before deducting depreciation.
These ratios indicate the extent to which the interests of the persons entitled to get a fixed return (i. e. interest or dividend) or a scheduled repayment as per agreed terms are safe. The higher the cover, the better it is. Under this category the following ratios are calculated :
- Fixed Interest Cover
- Fixed Dividend Cover
Fixed Interest Cover
It really measures the ability of the concern to service the debt. This ratio is very important from lender’s point of view and indicates whether the business would earn sufficient profits to pay periodically the interest charges. It is calculated as under : Net Profit before interest and tax Fixed Interest Ratio = Interest charges FIXED DIVIDEND COVER : This ratio is important for preference shareholders entitled to get dividend at a fixed rate in priority to equity shareholders. It is calculated as follows. Net Profit before interest and tax Fixed Dividend Cover = Preference Dividend TURNOVER RATIOS
Turnover ratios also referred to as activity ratios or asset management ratios, measures how efficiently. The assets are employed by the firm. Activity efficiency refers to the profitable, efficient and judicious use of resources available to the concern in perfect consonance with clearly laid down financial policies relating to the operations. In order to examine the profitableness and efficiencies in making use of resources as well as wisdom and farsightedness in observing the financial policies laid down in this regard. Certain ratios are being used and they are collectively called as ‘Turnover Ratio’. In short, activity ratios are named as turnover or velocity.
The following ratios are the important turnover ratios which are commonly included in this category.
- Inventory turnover ratio
- Debtors turnover ratio
- Creditors turnover ratio
- Fixed assets turnover ratio
- Debtors Collection ratio
- Working Capital turnover ratio
Inventory Turnover Ratio
It is also called stock turnover ratio. This ratio can be computed dividing the cost of goods sold by the average inventory. Cost of goods Sold Inventory Turnover Ratio = Average Inventory (or) SALES / AVERAGE INVENTORY The inventory turnover ratio is deemed to reflect the efficiency of Inventory management. The higher the ratio, the more efficient the management of inventories and vice-versa.
A high inventory turnover ratio may be caused by a low level of inventory, which may result in frequent stock outs and loss of sales and customer good will.
Debtors Turnover Ratio
It is also called Receivable Turnover Ratio. This ratio can be calculated with the following formula. Credit Sales Debtors Turnover Ratio = Average Debtors CREDITORS TURNOVER RATIO It is also called Accounts Payable Ratio. This ratio gives the average credit period enjoyed from the creditors and is calculated under : Credit Purchases Creditors Turnover Ratio = Creditors + Bills Payable
Fixed Assets Turnover Ratio
This ratio measures the efficiency of the assets use. This ratio is calculated by establishing the relationship between sales and fixed assets. Net Sales Fixed Assets Turnover Ratio = Fixed Assets This ratio gives an idea about adequate investment or over-investment or under-investment in fixed assets. As a rule, over investments in unprofitable fixed assets should be avoided to the possible extent. Under investment is also equally bad effecting unfavourably the operating costs and consequently the profit. This ratio assumes added significance in the case of manufacturing concern. An increase in this ratio is indicator of efficiency in work performance and a decrease in this ratio speaks of unwise and improper investment in fixed assets.
Debtors Collection Period Ratio
This ratio indicates the extent to which the debts have been collected in time. The debt collection period indicates the average debt collection period. This ratio is a good indicator to the lenders of the firm, because it explains to them whether their borrower is collecting from its debt in time. An increase in this period indicates blockage of funds in debtors. Months/Days (in a year) DEBTORS COLLECTION PERIOD RATIO = Debtors turn over Debtors X Months/Days (in a year) (or) Sales WORKING CAPITAL TURNOVER RATIO: Working capital turnover ratio indicates the velocity of the utilization of net working capital.
This ratio indicates the number of times the working capital is turned over in the course of a year. This ratio measures the efficiency with which the working capital is being used by a firm. A higher ratio indicates efficient utilization of working capital and low ratio indicates otherwise. But a very high working capital turnover ratio is not a good situation for any firm and hence care must be taken while interpreting the ratio. Making of comparative and Trend Analysis can at best use this ratio for different firms in the same industry and for various periods. This can be calculated as follows: Sales WORKING CAPITAL TURNOVER RATIO = Net Working Capital
NET WORKING CAPITAL = Current Assets – Current Liabilities (Excluding short-term bank borrowings) FINANCIAL RATIOS These ratios are calculated to judge the financial position of the concern from long-term as well as short-term solvency point of view. These ratios can be divided into two broad categories :
- Liquidity Ratios
- Stability Ratios
Liquidity refers to the ability of the firm to meet its obligations in the short run. Usually one year. Liquidity ratios are generally based on the relationship between current assets and current liabilities. The ratios which indicate the liquidity of a firm are : a. Current Ratio b. Quick Ratio c. Super Quick Ratio
The current ratio is a very popular financial ratio, measures the ability of the firm to meet its current liabilities – current assets get converted into cash in the operational cycle of the firm and provide funds needed to pay current liabilities. There are two components of this ratio. The formula for calculating current ratio is : Current Assets Current Ratio = X 100 Current Liabilities a) Current Assets : Which mean the assets which are held for their conversion into cash within a year and include the following : Cash balance, Bank balances, Marketable Securities, Debtors less provisions, Prepaid expenses, Inventories, Short term loans and advances, tax reduced at source, Bills receivable. ) Current Liabilities : Which mean the liabilities which are expected to be metured with in a year and include the following : Creditors for expenses, Provision for tax. Creditors for expenses : Bank Overdraft, Income received in advance, Unclaimed dividend, Bills payable, Provision for taxation, Unexpired discounts, Outstanding expenses.
The ratio establishes the relationship between quick assets and current liabilities. Objective : The objective of computing this ratio is to measure the ability of the firm to meet it short term obligations as and when due without relying upon the realization of stock. There are two components in this ratio. a. Quick Assets : Which mean those Current Assets which can be converted into cash immediately (or) at a short notes without a loss of value and include the following Cash balances, Bank balances, Marketable subscribers debtors, bills receivable, short term loans and advances. b. Current Liabilities : Loans and advances, trade creditors, occurred and provisions, Quick ratio is also called as acid test ratio. Inventories are excluded from the numerator of this ratio because inventories are deemed to the least liquid component of current assets. The formula for quick ratio is Quick Assets Quick Ratio = Current Liabilities
This ratio shows the relationship between cash and current liabilities. This ratio presents the closest picture of all the above mentioned liquidity ratios about firm’s liquidity because be made within shortest span of time through these current assets. The cash can be calculated with the following formula : Cash + Marketable Securities Cash Ratio = Current Liabilities Cash includes cash and bank balances of the firm and current liabilities include all the items mentioned current ratio. This ratio is more meaningful liquid ratio. This ratio presents the firm’s ability to pay off current liabilities without time gap.
These ratios help in ascertaining the long term solvency of a firm which depends on firm’s adequate resources to meet its long term funds requirements, appropriate debt equity mix to raise long term funds and earnings to pay interest and instalment of long term loans in time. The following ratios can be calculated for this purpose : a. Fixed Assets Ratio b. Ratio of current assets to Fixed assets FIXED ASSETS RATIO This ratio explains whether the firm has raised adequate long term funds to meet its fixed assets requirements and is calculated as under : Fixed Assets Fixed Assets Ratio = Capital Employed RATIO OF CURRENT ASSETS TO FIXED ASSETS
This ratio is calculated as follows : Current Assets Ratio of Current Assets to Fixed Assets = Fixed Assets This ratio will differ from industry to industry and, therefore, no standard can be laid down. A decrease in the ratio may mean that trading is slack or more mechanisation has been put through. LEVERAGE RATIOS Financial leverage refers to the use of debt finance. While debt capital is a cheaper source of finance. Leverage ratios help in assessing the risk existing from the use of debt capital. Two types of ratios are commonly used to analyse financial leverage, structural ratios.
Structural ratios are based on the proportion of debt and equity in the financial structure of the firm ratio also called as coverage ratio. The important structural ratios are : a. Debt-equity ratio b. Proprietory ratio c. Interest coverage ratio Coverage ratios show the relationship between debt servicing commitments and the sources for meeting these burdens. DEBT-EQUITY RATIO This ratio can be calculated by this formula below : Debt Debt-Equity Ratio = Equity The numerator of this ratio consists of all liabilities, short term as well as long term and the denominator consists of net worth plus preferred capital. The general norm of this ratio is 2:1.
In general the lower the ratio the higher the degree of protection enjoyed by the creditors in using this ratio following points should be born in mind. ? The book value of equity may be an under statement of its true value in the period of rising prices. ? Some of debt are usually protected by specific collaterals and hence enjoy superior protection.
This ratio states relationship between share capital and total assets. Proprietors equity represents equity share capital, preference share capital and reserves and surplus. The latter ratio is also called capital employed to total assets. EQUITY SHARE CAPITAL PROPRIETORY RATIO = TOTAL TANGIBLE ASSETS PROPRIETORS EQUITY (OR) TOTAL TANGIBLE ASSETS INTEREST COVERAGE RATIO
Formula for calculating this ratio is EBIT Interest Coverage Ratio = Debt Interest It may be noted that EBIT (Earnings Before Interest and Tax) are used in the numerator of this ratio because the ability of a firm to pay interest is not affected by tax payment as interest on debt funds in tax-deductable expenses. A high interest coverage ratio measures that firm can easily meet its interest burdens even if earnings before interest and taxes suffer a considerable decline. A low interest coverage ratio may result in financial embarrassment when earnings before interest and taxes decline.