A study of liquidity, productivity and financial efficiency through profitability is made by using the following tools and techniques and system.
[1] Ratio Analysis :
Ratios analysis is the process of determining and presenting in arithmetical terms the relationships figures and groups of figures drawn from these statements. A ratio expresses the results on the basis of comparison of two figures in numerical terms.
A ratio is a statistical yardstick that provides a measure of relationship between two accounting figures. Accordingiosdescribe thetosignificantBatty ―A relationship which exists between figures shows on a balance sheet in a profit and loss
account in a budgetary control or in The ratio is customarily expressed in following ways:
1. It may be obtained by dividing one value by other. This expression is known as ―Times‖
2. If hundred then the unit of multiply the above expression becomes percentage.
3. It may be expressed in the form ofas ―prop pure ratio.
4. It may also be depicted in the form of graphs like ratio graph.
Importance:
A ratio is known as symptom like blood pressure. The pulse rate of the temperature of an individual often ratio analysis is used as a devices to diagnose the financial position of an entreprise. It shall point out if the financial condition is very strong, good, partly good, and poor. As such the ratio analysis is a powerful tool of financial analysis through it economic and financial position of a business unit can be fully x-rayed.
Ratio analysis becomes meaningful to judge the financial condition and profitability. Performance of a firm only when there is comparison of present in fact analysis involves two types of comparision. First a comparison of present ratio with past and expected future ratios for the same firm, the second method of comparison involves comparing the ratio of the firm with those of similar firms of with industry average at the same point of time.
Further ―Ratio analysis‖es in which the net presents result of the financial the position and problems is concentrated. They provide a co-ordinate frame of reference for the financial manage. They tell the entire stor heap of financial date are buried them. They simplify the comprehensive of financial statistics.
On the basis of above it may be concluded that ratios are very important for interpretation as they give valuable and very useful information about business.
Limitations:
Every flower of rose has its own beauty in spite of numberless thorms in the same way ratio analysis has a variety of advantages, though it is not free from limitations, some of which are as below:
1. The formula for calculating each ratio is not well standardized.
2. No standard ratios are available for evaluating the significance of each ratio.
3. Ratio ignores non-monetary factors like general economic climate, government and management policies, which vitally affect the financial health of the enterprise.
4. If too many ratios are calculted, they are likely to confuse, Instead of revealing meaningful conclusions.
5. The ratios are generally calculated from the past financial statement and thus, are no indicators of future.
6. Ratios are not exact measure of financial situation as the balance sheet and profit and loss account are based on accounting conventoons, personal judgments and recorded facts.
As ratios are simple to calculate, there is a tendency to over employ them, which lead to accumulation of mass data. However significant the ratio may they cannot replace business efficiency and decision-making. They do not provide mechanical solution to business problems.
Classification of Ratio:
Some writes have described that there are as many 42-business ratios. First of all it is necessary to ascertain the ratios for a particular study. The financial ratios may be classified in the various ways. If the nature and objective of calculating each ratio is given then the customary and convenient classification from the point of view of management and investors will be:
[A] Liquidity Ratio
These ratios throw the light upon the liquidity position of a concern the main ratios
are:
1. Current Ratio,
2. Quick Ratio,
3. Absolute Liquidity Ratio,
4. Current assets to Total assets Ratio,
5. Debtors to Sales Ratio ,
6. Working Capital Turnover Ratio ,
7. Debt - Equity Ratio,
8. Propriety Ratio
[B] Profitability Ratio
These ratios X-ray the profit making ability of the enterprise. They may calculate either on the basis of operating profit of net profit. These ratios are of two types first related to sales and second profitability. The main efficiency ratios are
1. Net Profit Margin
2. Net profit ratio
3. Return on gross capital employed
4. Return on net capital employed
5. Return on net worth
6. Return on Shareholder's Equity
7. Return on Equity Capital
8. Earning Per Share,
9. Dividend Percentage,
10. Dividend Pay-out Ratio,
11. Dividend Yield Ratio
12. Total Assets Turnover
13. Fixed Assets Turnover
14. Current Assets Turnover
(C) Management of receivable
Management of trade credit is commonly known as Management of Receivables. Receivables are one of the three primary components of working capital, the other being inventory and cash, the other being inventory and cash. Receivables occupy second important place after inventories and thereby constitute a substantial portion of current assets in several firms. The capital invested in receivables is almost of the same amount as that invested in cash and inventories. Receivables thus, form about one third of current assets in India. Trade credit is an important market tool. As, it acts like a bridge for mobilization of goods from production to distribution stages in the field of marketing. Receivables provide protection to sales from competitions. It acts no less than a magnet in attracting potential customers to buy the product at terms and conditions favourable to them as well as to the firm. Receivables management demands due consideration not financial executive not only because cost and risk are associated with this investment but also for the reason that each rupee can contribute to firm's net worth. The import and commonly used receivable management ratios are as under:
1. Size of Receivables
2. Growth in Annual Sales and Receivables
3. Size of Debtors
4. Size of Receivables
5. Size of Loan and Advances
6. Average Receivables Turnover Ratio
7. Receivables of Sales Ratio
8. Average Collection Period
(D) Management of cash
The term cash management refers to the management of cash resource in such a way that generally accepted business objectives could be achieved. In this context the objectives of a firm can be unified as bringing about consistency between maximum possible profitability and liquidity of a firm. Cash management may be defined as the ability of a management in recognizing the problems related with cash which may come across in future course of action, finding appropriate solution to curb such problems if they arise, and finally delegating these solutions to the competent authority for carrying them out The choice between liquidity and profitability creates a state of confusion. It is cash management that can provide solution to this dilemma. Cash management may be regarded as an art that assists in establishing equilibrium between liquidity and profitability to ensure undisturbed functioning of a firm towards attaining its business objectives. The import and commonly used cash management ratios are as under:
1. Cash to Current Assets Ratio,
2. Cash to Safes Ratio,
3. Cash Turnover Ratio,
4. Cash Position Ratio,
5. Net Cash Flows to Current Liabilities Ratio,
6. Coverage of Current Liabilities 'Ratio,
[2] Trend Analysis
Trend analysis technique is useful to analyze the firm financial position and to put the absolute figures of financial statement in more understandable form over a period of years.
This indicates the trend of such variable as sales cost of production, profit assets and liabilities.
The different approaches of trend analysis are as follow:
1. COMMON SIZE VERTICAL ANALYSIS and
2. COMMON SIZE HORIZONTAL ANALYSIS
Trend analysis helps the analyst and management to evaluate the performance, efficiency and financial condition of an enterprise.
1.COMMON SIZE VERTICAL ANALYSIS
All the statement may be subject to common size vertical analysis a figure from the
same year‘s statement is comparedementwithshould the be converted in to percentage to some common base. The common size vertical income
statement and balance sheets of group of companies covered by this study are given in the study.
2.COMMON SIZE HORIZONTAL ANALYSIS
When asking horizontal analysis, a figure from the account is expressed in terms of same account figures from selected base year. It is calculation of percentage relation that each statement then bears to the same item in the base year. Horizontal analysis can help the analysis to determine how an enterprise has arrived at its current position.
The technique of common size statement is very useful when we wish to compare the performance of one company with that of another for presentation of the data in percentage form since it eliminates problems relating to differences in organization size.
[3] Comparative statement Analysis
Statement prepared in a form reflecting financial data for two or more periods are known as comparative statements. The data must first be properly set before comparison in the preparation of comparative financial statement uniformity is essential otherwise comparison will be vitiated. Comparative financial statement is very useful to the analyst because they contain not only the data appearing in a single statement but also information necessary for the study of financial and operating trends over a period of a year. They indicate the direction of the movement in respect of financial position and operating results. Comparision of absolute figures has no significance if the scale of operations of one company is much different from that of others.
1.comparative Balance-Sheet:
Increase and decrease in various assets or capital brought about by the conduct of a business can be observed by a comparison of balance sheets at the beginning and end of the period. Such observation often yield considerable information, which is of value informing an opinion regarding the progress of the enterprise and in order to facilitate comparison a simple device known as the ―comparative balance Sheet‖ may be used.
2.Comparative Income Statement:
As income statement shows the net profit or net loss resulting from the operations of a business for designated period of time. A comparative income statement shows the operating result for a number of accounting periods so that changes in absolute data from one period to another may be started in terms of money and percentage. The comparative income statement contains the same columns as the comparative balance sheet and provides the same type of information.
As the income statement presents the review of the operating activities of the business and the comparative balance sheet shows the effect of operation of its assets and liabilites. The latter contains a connecting link between the balance sheet and income statement. Income statement and balance sheet are contemporary documents and they highlight certain important facts.
[4] Cash Flow Analysis
The balance sheet is in the nature of a showing the position of a firm at a particular moment of time. The business process is very dynamic with transactions occurring regularly, each of which affects in some way, the immediately preceding financial position. A balance sheet therefore, merely provides the picture of a fleeting condition at a point of time and if balance sheets drawn at different time are compared any different pound between the closing and beginning figures would be the result of various transaction taking place during the interim period. The business process involves a continuous inflow and outflow of cash. This cash flow analysis helps the analysis to ap the business during a given period of time.
[5] Other Techniques of Analysis
Several other techniques like fund flow analysis and break-even analysis are also some time useful for analysis. The use of various statistical techniques is also used frequently for financial analysis, providing a more scientific analysis. The tools generally applied are
moving average, index number, range, Standard deviation, correlation, regression and analysis of time series. Diagrammatic and graph orientations are often used in financial analysis. Graphs provide a simplified way of presenting the data and often give much more vivid understandable of trends and relationships. Pie graphs bar diagrams and other simple graphs are often used for financial analysis.
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