Financial Ratio Analysis: Meaning Of Ratio Analysis

3.1 MEANING OF RATIO ANALYSIS

Ratio analysis is one of the most important and powerful tool in analyzing the financial position of the company where ratios are applied for evaluating the financial condition and act of the firm. Investigation and understanding of different accounting ratios gives a clear study and a better understanding of the financial position of the firm

Financial ratio analysis is the calculation and comparison of ratios which are derived from the information in a company's pecuniary statements. The stage and past trend of the ratios can be used to make inferences about a company's condition regarding its finances, its operations. 3.2 DEFINITION

According to Myers,” Ratio analysis of financial statements is the study

Capital gearing ratio is important to the company and the prospective investors. It must be carefully planned as it affects the company's capacity to maintain a uniform dividend policy during difficult trading periods. It reveals the suitability of company's capitalization

Fixed income securities include debentures and preference share capital.

A company is highly geared if this ratio is more than one. If it is less than one, it is low geared .If the ratio is exactly one, it is evenly geared. A highly geared company has the advantage of trading on equity. It may be noted that gearing is an inverse ratio to the equity share capital

3.5.3 PERFORMANCE RATIOS

This ratio is otherwise called as turnover ratio or activity ratio. This ratio used to indicate the efficiency with which assets and resources of the firm are being utilized. This ratio express the relationship between sales and various assets. A higher turnover ratio generally indicates better use of capital resources which in turn has a favorable effect on the profitability of the firm.

Types of performance ratios.

1. Inventory turnover ratio

2 .Debtors turnover ratio

3. Fixed assets turnover

Working capital ratio

5. Capital turnover ratio

3.5.3.1 INVENTORY TURNOVER RATIO

This ratio establishes the relationship between the cost of goods sold during a given period and the average amount of stock carried during the given period. This ratio indicates the efficiency of the firm’s inventory management. A low inventory turnover ratio is an indicator of dull business. Generally speaking, a high stock turnover ratio is considered better as it indicates that more sales are being produced by each rupee of investment in stock but a higher stock turnover ratio may not always be an indicator of favorable results. It may be the results of a very low level of stock which results in frequent out of stock positions. Such a situation prevents the company from meeting customers’ demands and the company cannot earn maximum profits.

Thus too high and too low inventory turnover ratio may not be good .A company should have a proper inventory turnover ratio so that it is able to earn a reasonable margin of profits

Cost of goods sold=opening stock+ purchases+ carriage inward and other direct expenses-closing stock.

Average stock =1/2(opening stock+ closing stock.).

3.5.3.2 DEBTORS TURNOVER