Financial Analysis and Planning - Ratio Analysis
Ratio analysis converts financial statements into comparable diagnostics. The exam tests classification, formula integrity and interpretation, not blind calculation.
Core groups
- Liquidity: current ratio = current assets/current liabilities; quick ratio excludes inventory and prepaid expenses.
- Solvency: debt–equity uses interest-bearing debt; interest coverage = EBIT/interest.
- Efficiency: inventory turnover = COGS/average inventory; receivables days = 365/receivables turnover.
- Profitability: net margin, ROCE = EBIT/capital employed, ROE.
- Market: EPS, P/E, dividend payout. DuPont links ROE to net margin × asset turnover × equity multiplier, exposing whether leverage or operating performance drives returns.
Worked example
Current assets ₹300 lakh include inventory ₹120 lakh; current liabilities ₹200 lakh. Current ratio = 1.50; quick ratio = (300−120)/200 = 0.90. Debt ₹400 lakh and equity ₹500 lakh give D/E = 0.80. EBIT ₹150 lakh and interest ₹50 lakh give coverage = 3.0. Sales ₹1,000 lakh and capital employed ₹900 lakh give ROCE = 16.67%. The firm is liquid on a current basis but tight on quick assets and moderately geared.
Traps
Use average balances for turnover where available; do not mix year-end and average figures; do not compare ratios across unrelated industries; exclude prepaid expenses from quick assets; and remember window dressing can flatter year-end liquidity.