Financial Analysis & Planning: Ratio Analysis- 1 | Financial Management & Economics Finance: CA Intermediate (Old Scheme) PDF Download

 Page 1


 
LEARNING OUTCOMES 
 
 
 
 FINANCIAL ANALYSIS AND 
 PLANNING– RATIO ANALYSIS  
 
? Discuss Sources of financial data for Analysis 
? Discuss financial ratios and its Types 
? Discuss use of financial ratios to analyse the financial 
statement. 
? Analyse the ratios from the perspective of investors, lenders, 
suppliers, managers etc. to evaluate the profitability and 
financial position of an entity. 
? Describe the users and objective of Financial Analysis:- A 
Birds Eye View 
? Discuss Du Pont analysis 
? State the limitations of Ratio Analysis  
CHAPTER 
3 
Page 2


 
LEARNING OUTCOMES 
 
 
 
 FINANCIAL ANALYSIS AND 
 PLANNING– RATIO ANALYSIS  
 
? Discuss Sources of financial data for Analysis 
? Discuss financial ratios and its Types 
? Discuss use of financial ratios to analyse the financial 
statement. 
? Analyse the ratios from the perspective of investors, lenders, 
suppliers, managers etc. to evaluate the profitability and 
financial position of an entity. 
? Describe the users and objective of Financial Analysis:- A 
Birds Eye View 
? Discuss Du Pont analysis 
? State the limitations of Ratio Analysis  
CHAPTER 
3 
 
 
3.2 FINANCIAL MANAGEMENT  
 
3.1 INTRODUCTION 
The basis for financial analysis, planning and decision making is financial 
statements which mainly consist of Balance Sheet and Profit and Loss Account. 
The profit & loss account shows the operating activities of the concern over a 
period of time and the balance sheet depicts the balance value of the acquired 
assets and of liabilities or in other words, financial position of an organization at a 
particular point of time. 
However, the above statements do not disclose all of the necessary and relevant 
information. For the purpose of obtaining the material and relevant information 
necessary for ascertaining the financial strengths and weaknesses of an 
enterprise, it is necessary to analyse the data depicted in the financial statement. 
 
RATIO ANALYSIS 
Types of Ratios 
Application of Ratio Analysis 
in decision making
?Liquidity Ratios/Short-
term solvency ratios 
?Leverage Ratio/Long 
term solvency Ratios 
? Activity Ratios/Efficiency 
Ratios/Performance 
Ratios/Turnover ratios 
Profitability Ratios 
Relationship of Financial 
Management with other 
disciplines of accounting. 
Page 3


 
LEARNING OUTCOMES 
 
 
 
 FINANCIAL ANALYSIS AND 
 PLANNING– RATIO ANALYSIS  
 
? Discuss Sources of financial data for Analysis 
? Discuss financial ratios and its Types 
? Discuss use of financial ratios to analyse the financial 
statement. 
? Analyse the ratios from the perspective of investors, lenders, 
suppliers, managers etc. to evaluate the profitability and 
financial position of an entity. 
? Describe the users and objective of Financial Analysis:- A 
Birds Eye View 
? Discuss Du Pont analysis 
? State the limitations of Ratio Analysis  
CHAPTER 
3 
 
 
3.2 FINANCIAL MANAGEMENT  
 
3.1 INTRODUCTION 
The basis for financial analysis, planning and decision making is financial 
statements which mainly consist of Balance Sheet and Profit and Loss Account. 
The profit & loss account shows the operating activities of the concern over a 
period of time and the balance sheet depicts the balance value of the acquired 
assets and of liabilities or in other words, financial position of an organization at a 
particular point of time. 
However, the above statements do not disclose all of the necessary and relevant 
information. For the purpose of obtaining the material and relevant information 
necessary for ascertaining the financial strengths and weaknesses of an 
enterprise, it is necessary to analyse the data depicted in the financial statement. 
 
RATIO ANALYSIS 
Types of Ratios 
Application of Ratio Analysis 
in decision making
?Liquidity Ratios/Short-
term solvency ratios 
?Leverage Ratio/Long 
term solvency Ratios 
? Activity Ratios/Efficiency 
Ratios/Performance 
Ratios/Turnover ratios 
Profitability Ratios 
Relationship of Financial 
Management with other 
disciplines of accounting. 
 3.3 
FINANCIAL ANALYSIS AND PLANNING RATIO ANALYSIS 
The financial manager has certain analytical tools which help in financial analysis 
and planning. One of the main tools is Ratio Analysis. Let us discuss the Ratio 
Analysis. 
 3.2 RATIOS AND RATIO ANALYSIS 
Let us first understand the definition of ratio and meaning of ratio analysis 
3.2.1 Definition of Ratio 
A ratio is defined as “the indicated quotient of two mathematical expressions 
and as the relationship between two or more things.” Here ratio means 
financial ratio or accounting ratio which is a mathematical expression of the 
relationship between two accounting figures. 
3.2.2 Ratio Analysis 
The term financial ratio can be explained by defining how it is calculated and 
what the objective of this calculation is 
a. Calculation Basis (Basis of Calculation) 
? A relationship expressed in mathematical terms; 
? Between two individual figures or group of figures; 
? Connected with each other in some logical manner; and 
? Selected from financial statements of the concern 
b. Objective for financial ratios is that all stakeholders (owners, investors, 
lenders, employees etc.) can draw conclusions about the 
? Performance (past, present and future); 
? Strengths & weaknesses of a firm; and 
? Can take decisions in relation to the firm. 
Ratio analysis is based on the fact that a single accounting figure by itself may 
not communicate any meaningful information but when expressed relative to 
some other figure, it may definitely provide some significant information.  
Ratio analysis is not just comparing different numbers from the balance sheet, 
income statement, and cash flow statement. It is comparing the number against 
previous years (intra-firm comparison) and, other companies (inter-firm 
Page 4


 
LEARNING OUTCOMES 
 
 
 
 FINANCIAL ANALYSIS AND 
 PLANNING– RATIO ANALYSIS  
 
? Discuss Sources of financial data for Analysis 
? Discuss financial ratios and its Types 
? Discuss use of financial ratios to analyse the financial 
statement. 
? Analyse the ratios from the perspective of investors, lenders, 
suppliers, managers etc. to evaluate the profitability and 
financial position of an entity. 
? Describe the users and objective of Financial Analysis:- A 
Birds Eye View 
? Discuss Du Pont analysis 
? State the limitations of Ratio Analysis  
CHAPTER 
3 
 
 
3.2 FINANCIAL MANAGEMENT  
 
3.1 INTRODUCTION 
The basis for financial analysis, planning and decision making is financial 
statements which mainly consist of Balance Sheet and Profit and Loss Account. 
The profit & loss account shows the operating activities of the concern over a 
period of time and the balance sheet depicts the balance value of the acquired 
assets and of liabilities or in other words, financial position of an organization at a 
particular point of time. 
However, the above statements do not disclose all of the necessary and relevant 
information. For the purpose of obtaining the material and relevant information 
necessary for ascertaining the financial strengths and weaknesses of an 
enterprise, it is necessary to analyse the data depicted in the financial statement. 
 
RATIO ANALYSIS 
Types of Ratios 
Application of Ratio Analysis 
in decision making
?Liquidity Ratios/Short-
term solvency ratios 
?Leverage Ratio/Long 
term solvency Ratios 
? Activity Ratios/Efficiency 
Ratios/Performance 
Ratios/Turnover ratios 
Profitability Ratios 
Relationship of Financial 
Management with other 
disciplines of accounting. 
 3.3 
FINANCIAL ANALYSIS AND PLANNING RATIO ANALYSIS 
The financial manager has certain analytical tools which help in financial analysis 
and planning. One of the main tools is Ratio Analysis. Let us discuss the Ratio 
Analysis. 
 3.2 RATIOS AND RATIO ANALYSIS 
Let us first understand the definition of ratio and meaning of ratio analysis 
3.2.1 Definition of Ratio 
A ratio is defined as “the indicated quotient of two mathematical expressions 
and as the relationship between two or more things.” Here ratio means 
financial ratio or accounting ratio which is a mathematical expression of the 
relationship between two accounting figures. 
3.2.2 Ratio Analysis 
The term financial ratio can be explained by defining how it is calculated and 
what the objective of this calculation is 
a. Calculation Basis (Basis of Calculation) 
? A relationship expressed in mathematical terms; 
? Between two individual figures or group of figures; 
? Connected with each other in some logical manner; and 
? Selected from financial statements of the concern 
b. Objective for financial ratios is that all stakeholders (owners, investors, 
lenders, employees etc.) can draw conclusions about the 
? Performance (past, present and future); 
? Strengths & weaknesses of a firm; and 
? Can take decisions in relation to the firm. 
Ratio analysis is based on the fact that a single accounting figure by itself may 
not communicate any meaningful information but when expressed relative to 
some other figure, it may definitely provide some significant information.  
Ratio analysis is not just comparing different numbers from the balance sheet, 
income statement, and cash flow statement. It is comparing the number against 
previous years (intra-firm comparison) and, other companies (inter-firm 
 
 
3.4 FINANCIAL MANAGEMENT  
comparison), the industry, or even the economy in general for the purpose of 
financial analysis. 
3.2.3 Sources of Financial Data for Analysis 
The sources of information for financial statement analysis are: 
1.  Annual Reports 
2.  Interim financial statements 
3.  Notes to Accounts 
4.  Statement of cash flows 
5.  Business periodicals. 
6.  Credit and investment advisory services 
3.3 TYPES OF RATIOS 
 
Classification of Ratios 
*Liquidity ratios should be examined taking relevant turnover ratios into 
consideration. 
Types of Ratios
Liquidity Ratios*/ 
Short-term Solvency 
Ratios
Leverage Ratios/ 
Long term Solvency 
Ratios
Capital Structure Ratios
Coverage Ratios
Activity Ratios/ 
Efficiency Ratios/ 
Performance  
Ratios/ Turnover 
Ratios*
Profitability Ratios
Realted to Sales
Related to overall Return 
on Investment (Assets/ 
Capital Employed/ Equity)
Required  for analysis 
from Owner's point of 
view
Related to Market/ 
Valuation/ Investors
Page 5


 
LEARNING OUTCOMES 
 
 
 
 FINANCIAL ANALYSIS AND 
 PLANNING– RATIO ANALYSIS  
 
? Discuss Sources of financial data for Analysis 
? Discuss financial ratios and its Types 
? Discuss use of financial ratios to analyse the financial 
statement. 
? Analyse the ratios from the perspective of investors, lenders, 
suppliers, managers etc. to evaluate the profitability and 
financial position of an entity. 
? Describe the users and objective of Financial Analysis:- A 
Birds Eye View 
? Discuss Du Pont analysis 
? State the limitations of Ratio Analysis  
CHAPTER 
3 
 
 
3.2 FINANCIAL MANAGEMENT  
 
3.1 INTRODUCTION 
The basis for financial analysis, planning and decision making is financial 
statements which mainly consist of Balance Sheet and Profit and Loss Account. 
The profit & loss account shows the operating activities of the concern over a 
period of time and the balance sheet depicts the balance value of the acquired 
assets and of liabilities or in other words, financial position of an organization at a 
particular point of time. 
However, the above statements do not disclose all of the necessary and relevant 
information. For the purpose of obtaining the material and relevant information 
necessary for ascertaining the financial strengths and weaknesses of an 
enterprise, it is necessary to analyse the data depicted in the financial statement. 
 
RATIO ANALYSIS 
Types of Ratios 
Application of Ratio Analysis 
in decision making
?Liquidity Ratios/Short-
term solvency ratios 
?Leverage Ratio/Long 
term solvency Ratios 
? Activity Ratios/Efficiency 
Ratios/Performance 
Ratios/Turnover ratios 
Profitability Ratios 
Relationship of Financial 
Management with other 
disciplines of accounting. 
 3.3 
FINANCIAL ANALYSIS AND PLANNING RATIO ANALYSIS 
The financial manager has certain analytical tools which help in financial analysis 
and planning. One of the main tools is Ratio Analysis. Let us discuss the Ratio 
Analysis. 
 3.2 RATIOS AND RATIO ANALYSIS 
Let us first understand the definition of ratio and meaning of ratio analysis 
3.2.1 Definition of Ratio 
A ratio is defined as “the indicated quotient of two mathematical expressions 
and as the relationship between two or more things.” Here ratio means 
financial ratio or accounting ratio which is a mathematical expression of the 
relationship between two accounting figures. 
3.2.2 Ratio Analysis 
The term financial ratio can be explained by defining how it is calculated and 
what the objective of this calculation is 
a. Calculation Basis (Basis of Calculation) 
? A relationship expressed in mathematical terms; 
? Between two individual figures or group of figures; 
? Connected with each other in some logical manner; and 
? Selected from financial statements of the concern 
b. Objective for financial ratios is that all stakeholders (owners, investors, 
lenders, employees etc.) can draw conclusions about the 
? Performance (past, present and future); 
? Strengths & weaknesses of a firm; and 
? Can take decisions in relation to the firm. 
Ratio analysis is based on the fact that a single accounting figure by itself may 
not communicate any meaningful information but when expressed relative to 
some other figure, it may definitely provide some significant information.  
Ratio analysis is not just comparing different numbers from the balance sheet, 
income statement, and cash flow statement. It is comparing the number against 
previous years (intra-firm comparison) and, other companies (inter-firm 
 
 
3.4 FINANCIAL MANAGEMENT  
comparison), the industry, or even the economy in general for the purpose of 
financial analysis. 
3.2.3 Sources of Financial Data for Analysis 
The sources of information for financial statement analysis are: 
1.  Annual Reports 
2.  Interim financial statements 
3.  Notes to Accounts 
4.  Statement of cash flows 
5.  Business periodicals. 
6.  Credit and investment advisory services 
3.3 TYPES OF RATIOS 
 
Classification of Ratios 
*Liquidity ratios should be examined taking relevant turnover ratios into 
consideration. 
Types of Ratios
Liquidity Ratios*/ 
Short-term Solvency 
Ratios
Leverage Ratios/ 
Long term Solvency 
Ratios
Capital Structure Ratios
Coverage Ratios
Activity Ratios/ 
Efficiency Ratios/ 
Performance  
Ratios/ Turnover 
Ratios*
Profitability Ratios
Realted to Sales
Related to overall Return 
on Investment (Assets/ 
Capital Employed/ Equity)
Required  for analysis 
from Owner's point of 
view
Related to Market/ 
Valuation/ Investors
 
 
 3.5 
 
FINANCIAL ANALYSIS AND PLANNING RATIO ANALYSIS 
3.3.1 Liquidity Ratios 
The terms ‘liquidity’ and ‘short-term solvency’ are used synonymously.  
Liquidity or short-term solvency means ability of the business to pay its short-
term liabilities. Inability to pay-off short-term liabilities affects its credibility as 
well as its credit rating. Continuous default on the part of the business leads to 
commercial bankruptcy. Eventually such commercial bankruptcy may lead to its 
sickness and dissolution. Short-term lenders and creditors of a business are very 
much interested to know its state of liquidity because of their financial stake. Both 
lack of sufficient liquidity and excess liquidity is bad for the organization. 
Various Liquidity Ratios are: 
(a) Current Ratio 
(b) Quick Ratio or Acid test Ratio 
(c) Cash Ratio or Absolute Liquidity Ratio 
(d) Basic Defense Interval or Interval Measure Ratios 
(e) Net Working Capital Ratio 
(a) Current Ratio: The Current Ratio is one of the best known measures of 
short-term solvency. It is the most common measure of short-term liquidity.   
The main question this ratio addresses is: "Does your business have enough 
current assets to meet the payment schedule of its current debts with a margin 
of safety for possible losses in current assets?" In other words, current ratio 
measures whether a firm has enough resources to meet its current obligations. 
Current Ratio = 
s Liabilitie  Current
Assets  Current
 
Where, 
 Current Assets  =  Inventories + Sundry Debtors + Cash and Bank  
  Balances + Receivables/ Accruals + Loans and  
  Advances + Disposable Investments + Any  
  other current assets.