Absolute numbers do not speak much. Ratios are calculated from absolute numbers of the financial statements bringing out the hidden meanings.
Haven’t we heard about the CBC report-a complete blood count report recommended for our health check-ups by doctors? There are various parameters in a CBC report that identifies problem areas or potential health problems. Ratio analysis does a similar thing. Ratios analyse the potential financial health of a company by measuring its efficiency, profitability and financial risks.
A healthy company must have efficient assets, profitable operations and long-term sustainability.
The benefits of ratio analysis are many
Forecasting: Ratios of the past years can be used to forecast and project the future after adjusting for the present variables in hand.
Ratios can be broadly classified based on
Growth ratios measure the progress of the company’s key business parameters like revenue, profits, dividend, earnings, assets etc. It helps in understanding the track record of a company. Growth should be analysed for a longer time. Given below are the growth parameters of a leading retailer. One can see the impact Covid-19 has had on the growth in sales and profits in March-21. One has to identify the cause of growth or de-growth in growth analysis.
Figures in Rs. Crores | Mar-13 | Mar-14 | Mar-15 | Mar-16 | Mar-17 | Mar-18 | Mar-19 | Mar-20 | Mar-21 |
Sales – | 3341 | 4686 | 6439 | 8584 | 11898 | 15033 | 20005 | 24870 | 24143 |
Sales Growth % | 51% | 40% | 37% | 33% | 39% | 26% | 33% | 24% | -3% |
Operating Profit | 215 | 341 | 456 | 664 | 969 | 1353 | 1633 | 2128 | 1745 |
Operating Profit Growth % | 56% | 59% | 34% | 46% | 46% | 40% | 21% | 30% | -18% |
Profit before tax | 141 | 245 | 323 | 492 | 747 | 1222 | 1422 | 1745 | 1483 |
PBT Growth % | 58% | 74% | 32% | 52% | 52% | 64% | 16% | 23% | -15% |
Net Profit | 94 | 161 | 212 | 320 | 479 | 806 | 903 | 1301 | 1099 |
Net Profit growth% | 57% | 71% | 32% | 51% | 50% | 68% | 12% | 44% | -16% |
EPS in Rs | 1.73 | 2.95 | 3.77 | 5.7 | 7.67 | 12.92 | 14.46 | 20.09 | 16.97 |
EPS Growth % | 53% | 71% | 28% | 51% | 35% | 68% | 12% | 39% | -16% |
The operating performance of a company can be classified into two categories; Profitability ratios and return ratios.
Gross margin = gross profit/net sales
Mar-17 | Mar-18 | Mar-19 | Mar-20 | Mar-21 | |
Net sales (a) | 265 | 297 | 271 | 264 | 228 |
Cost of goods sold (b) | 212 | 245 | 220 | 210 | 189 |
Gross profit (a-b) | 53 | 52 | 51 | 54 | 39 |
Gross margin % (gross profit/sales) | 20.00 | 17.67 | 18.78 | 20.50 | 16.89 |
Industry leader | 31.42 | 29.76 | 27.92 | 28.3 | 29.78 |
Interpretation: In the example, the company has tried to maintain its gross margin in the range of 18-21 per cent. Gross margins for March-21 were impacted due to covid-19.
Operating margin (%)- is the ratio of operating profit to sales. It is what a company earns on sales after deducting direct and indirect expenses like selling & distribution and administrative expenses. While the indirect expenses include depreciation it does not include interest and taxes.
Mar-17 | Mar-18 | Mar-19 | Mar-20 | Mar-21 | |
Net sales (a) | 265 | 297 | 271 | 264 | 228 |
Total expenses (a) | 244 | 281 | 251 | 247 | 215 |
Operating profit (a) – (b) | 21 | 16 | 20 | 17 | 13 |
Operating margin% (operating profit/sales) | 7.92 | 5.39 | 7.38 | 6.44 | 5.70 |
Industry leader | 17.16 | 16.40 | 13.38 | 12.08 | 15.73 |
Interpretation: The company has been able to maintain an operating margin of 6 per cent despite covid. The range of operating margin is 5-8 per cent and is currently stagnating. However, the industry leader has improved his margins during the same period.
Net margin = Net profit after taxes/total income
Mar-17 | Mar-18 | Mar-19 | Mar-20 | Mar-21 | |
Net sales (a) | 265 | 297 | 271 | 264 | 228 |
Net profit (d) | 7 | 3 | 8 | 4 | 2 |
Net margin % (net profit/sales) | 2.64 | 1.01 | 2.95 | 1.52 | 0.88 |
Industry leader | 10.45 | 8.05 | 6.49 | 6.52 | 8.97 |
Interpretation: The company is struggling at the net margins level. The net profit is trend is declining by 50 per cent since March-19. The industry leader has bettered his net margin.
RoE = (Net Profit / average shareholders’ funds) x 100
Mar-19 | Mar-20 | Mar-21 | |
Net profit (a) | 8 | 4 | 2 |
Equity capital (b) | 22 | 22 | 20 |
Reserves (c) | 67 | 67 | 64 |
Net worth (b)+(c) | 89 | 89 | 84 |
Average equity capital for the last two years | 89 | 86 | |
Return on equity (RoE)% | 4.49 | 2.31 | |
Industry leader | 14.62 | 16.20 |
Interpretation: The company’s net profit has been contracting. The net profit is trend is declining by 50 per cent since March-19. The industry leader has bettered his return on equity to 16.2%
RoCE = earnings before interest and tax (EBIT)/average capital employed.
Mar-17 | Mar-18 | Mar-19 | Mar-20 | Mar-21 | |
Operating profit (a) | 21 | 16 | 20 | 17 | 13 |
Depreciation (b) | 5 | 5 | 5 | 5 | 4 |
PBIT (a-b) | 16 | 11 | 15 | 12 | 9 |
Net worth (c) | 129 | 132 | 89 | 89 | 84 |
Borrowings (d) | 61 | 70 | 62 | 58 | 64 |
Capital employed (c) + (d) | 190 | 202 | 151 | 147 | 148 |
Average capital employed for last two years | 196 | 177 | 149 | 147 | |
Return on capital employed (RoCE)% | 5.61 | 8.50 | 8.05 | 6.10 | |
Industry leader | 17.51 | 16.77 | 14.11 | 18.95 |
Interpretation: The return on capital employed has declined as compared to last year. The industry leader is way ahead in terms of return on capital employed.
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