Financial Statement Analysis: Ratio Analysis Assignment

This assignment delves into the core concepts of financial ratio analysis, providing a comprehensive overview of how to interpret financial statements using various ratios. It begins with a definition of ratio analysis, its importance, and its user-oriented approach, differentiating it from traditional meth...Read More

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Course Topics

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How to do ratio analysis for financial statements?
Financial statement analysis use ratio analysis formulas to draw a meaningful interpretation of
the data given in financial statements. This analysis helps investors to adopt a user-oriented
approach rather than traditional proprietary approach. Considering the various types of ratios
help investors to easily obtain the data from some ratios. This course aims to learn how to do
ratio analysis for the financial statement. This course first covers the meaning and definition of
ratio analysis in the introductory part and next to the various types of examples of financial
ratios.
A ratio measures the relationship between two financial figures. In this corporate finance world,
ratios specify the company's standard performance and help the investors and managers to
analyze the operations. The ratios may be classified according to the financial statement on the
basic leading categories from which the ratios are derived.
 Balance sheet ratios
 Revenue statement ratios
 Combined ratios
The ratio measures the relationship between two financial figures. Considering an example if
there are four cell phones and two calculators, now it can be said that cell phones and calculators
are in the ratio of 4:2. This shows that there are four cell phones for every two calculators. In the
corporate world of finance, ratios show the performance of companies. Ratio analysis helps the
investors and managers to analyze the various ratios and sustainability of the operations.
Ratios are used to simplify financial statement ratios. Without understanding the whole financial
statement ratio analysis helps the investor to obtain the information of a few data from the ratios.

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Detection of problematic trend the analysis can also forecast the future performance of a
company. The profile of the company's business based on the geographical location where the
company operates, the category of product and services it provides, target customers, etc. Next is
financial profile included the size of the company, the upper limit to lower limit, etc. the
comparison in between companies through the implication of the ratios and that ratios can be PE
ratio, PB ratio.
Types of financial statement ratios
Liquidity ratios:
Liquidity ratios indicate the cash available to business and its ability to meet current dues.
Liquidity ratios are an indicator of a company's capacity to clear its current liabilities (liabilities
need to be cleared in the year)
Liquidity ratio examples are discussed below
Quick ratio = Quick assets
Quick liabilities
Current ratio = Current Assets
Current liabilities
Formula: The addition of all the current assets and current liabilities shown in the balance sheet
comes to a quick ratio.
Solvency ratios

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Solvency ratios show companies feasibility on a long term basis. The comparison of debt
measures its earning, equity and assets.
Examples of solvency ratios are:
According to its name debt –to- equity ratio shows its relationship with debt taken by the
company to equity. The proportion of fundraising from banks and creditors compared to the fund
from the investors. Debt -equity = Debts
Equity shareholders fund
This ratio depicts that lower the ratio of debt-equity, higher the company's position. The fund
taken from the company's shareholders and investors is always better than the fund from banks
and creditors.
Efficiency ratios:
Efficiency ratio indicates the efficiency level of financial ratios. It shows the company uses
assets to derive profits or conversion of stock into cash. This ratio specifies the standard use
where the company collects the cash from the clients for credit goods and services. The main aim
of this ratio is to measure day to day performance of the company in its operation from trading
concern to the selling department to make profits.
Profitability ratios:
The profitability ratio shows the company's effective demonstration by using the assets to make a
profit. The example of this ratio is:
Return on asset= Net profit before tax
total assets ×100

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Valuation ratios
Valuation ratios are for the company's investors, it helps them to measure whether the share to be
purchase, hold or sell. Using these ratio investors can also be able to forecast the future of the
shares and stock and the expected returns from the stock.
The example of valuation ratio:
For the earning from the price paid for the shares price earning ratio should be used. It indicates
the appraisal investment in the stock market and the valuation of share-based on the value of
earning from the share.
Price earning ratio= Market value per equity share
earnings per share
The PE ratio shows the expected share price based on the earning of share. Generally, these
ratios are calculated at the time of the financial year-end.
Quiz
1) Category wise classification of financial ratios
 Liquidity, solvency, efficiency, profitability, valuation
 Solvency, liquidity, efficiency, valuation, profitability
 Efficiency, valuation, profitability, liquidity, solvency
 Any of the above
2) The quick ratio is also known as-

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 Acid test ratio
 Working capital ratio
 Current ratio
 All of the above
3) The working capital ratio is also known as
 Quick ratio
 Current ratio
 Working capital ratio
 Acid test ratio
4) Quick ratio formula -
 Current Assets
Current liabilities
 Quick assets
Quick liabilities
 Both (A) and (B)
 None of the above
5) Debt -equity ratio implies
 Debts
Equity shareholders fund
 Cur rent Assets
Current liabilities
 All of the above
 None of the above
Limitations of financial ratios are as follows:
 The primary data on which ratios are based must be reliable and non-manipulated.

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 The difference in accounting policies, interpretation of financial terms and accounting
periods make accounting data two firms noncomparable as also the accounting ratios.
Adjustments are needed to sort out such differences.
 There is no standard set of ratios.
 Seasonal factor may influence financial data.
 Window dressing can change the character of financial ratios.
 In the case of diversified product lines, aggregate data cannot be used for inter-firm
comparison.
 Financial data are badly distorted by inflation.
 Financial ratios are interrelated or not independent.
 Timely ratio analysis provides clues but not conclusions. These are tools in the hands of
experts for their interpretations.
Final quiz:
1) Limitation of financial ratios include following are:
 Seasonal factor may influence financial data.
 Window dressing can change the character of financial ratios.
 In the case of diversified product lines, aggregate data cannot be used for inter-firm
comparison.
 Financial data are badly distorted by inflation.
 All of the above
2) Current ratio formula -
 Current Assets
Current liabilities
 Quick assets
Quick liabilities

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 Both (A) and (B)
 None of the above
3) Return on asset=
 Net profit before tax
total assets ×100
 Net profit
total assets ×100
 Both (A) and (B)
 None of the above
4) Price earning ratio=
 Market value per equity share
earnings per share
 Earning per share
Market value per equity share ×100
 Longterm assets
¿ assets × 100
 None of the above
Reference
Liang, D., Lu, C. C., Tsai, C. F., & Shih, G. A. (2016). Financial ratios and corporate governance
indicators in bankruptcy prediction: A comprehensive study. European Journal of Operational
Research, 252(2), 561-572.

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Lecy, J. D., & Searing, E. A. (2015). Anatomy of the nonprofit starvation cycle: An analysis of
falling overhead ratios in the nonprofit sector. Nonprofit and Voluntary Sector Quarterly, 44(3),
539-563.
Flower, J., & Ebbers, G. (2018). Global financial reporting. Macmillan International Higher
Education.
Das, S. (2017). MEASURING THE PERFORMANCE THROUGH CASH FLOW RATIOS-A
STUDY ON CMC. Journal of Commerce & Accounting Research, 6(4).
Lewellen, J. (2004). Predicting returns with financial ratios. Journal of Financial
Economics, 74(2), 209-235.
Penman, S. H. (2015). Financial Ratios and Equity Valuation. Wiley Encyclopedia of
Management, 1-7.