International Journal of Commerce and Management Research
International Journal of Commerce and Management Research
ISSN: 2455-1627; Impact Factor: RJIF 5.22
Received: 02-01-2020; Accepted: 04-02-2020; Published: 02-03-2020
[Link]
Volume 6; Issue 2; 2020; Page No. 04-05
Ratio analysis in financial performance of a company: A review
Sardar Jaswanth Singh
Research scholar, Department of Commerce, Dr. APJ Abdul Kalam University, Arandia Jhalaria, Indore, Madhya Pradesh, India
Abstract
The ratio analysis is a key tool to determine the various external and internal factors of a company influencing the business. It
determines the earnings, functional capability and liquidity of a company by comparing the data available in financial
statements. The ratio analysis allows shareholders, investors or creditors to know the financial status and performance of a
company business. Even ratio analysis is an important tool for the management authorities to resolve various issues in
business.
Keywords: ratio analysis, key tool, business, financial statements, shareholders, investors
1. Introduction The current ratio analysis allows a company to liquidate
Ratio analysis is an approach to evaluate the business of a current liabilities for the payment pertaining to current
company through making an emphasis on company’s assets. In a company, 2:1 ratio of current assets to current
profits, functional efficiency and liquidity by an in-depth liabilities is preferred (Nuhu, 2014) [4].
comparative study of data obtained from its financial
statements. It allows investors, creditors, analysts and 2. Days sales outstanding: It estimates the capability of
shareholders to understand clearly about financial company to grant credit to customers and collect back the
statements of a company. The ratio analysis is a versatile same in a time frame. The following formula is used to
and significant tool which can be used to determine the calculate the day sales outstanding.
performance of a business organization (Adedeji, 2014) [1]. Days sales outstanding = (Accounts receivable ÷ Total
If ratio analysis of a company is performed with utmost care credit sales) x Number of days
by an analyst, it reveals the following outputs.
departments of company which require special attention It is useful to check the ability of a company’s credit and
the potent areas of the business to be improved with recovery procedures in giving credit to customers and also
proper guidance ability to recover from them.
profits, liquidity, solvency and efficiency levels of
company 3. Debt to equity ratio (D/E): It is the ratio of total
estimations for future business liabilities of a company to its equity of shareholders. The
formula used for debt to equity ratio is given below (Anuar
The ratio analysis is especially applicable for the following and Chin, 2016) [5].
two aspects.
Debt to equity ratio = (Long term debt + Short term debt +
Trend line: It is prepared for a company’s multiple
other fixed Payments) ÷ Shareholders Equity
financial reports over a period of time (Enyi and Enyi,
2019) [2]. The D/E ratio generates an output of financing operations of
Comparison of industry: It involves computing the a company (whether a company is functioning through debts
similar financial ratios of different companies or on owned funds)
belonging to the same sector on comparative basis. This
study allows us to determine the business performance 4. Dividend payout ratio: It is the ratio of total earnings of
of a company under study (Alia and Haqueb, 2014) [3]. a company paid to shareholders in the form of dividends to
net earnings (benefits) of the company. It is nothing but,
Types of ratios percentage of company’s earnings paid to its shareholders in
There are numerous types of ratios available to analyse the the form of dividends. The formulae to calculate dividend to
financial statements of a company. But in the following payout ratio is as follows.
section only those ratios which are genuinely useful for
financial performance of a company are discussed. Formula 1
1. Current ratio: It determines the existing assets of a Dividend payout ratio = Annual dividend paid to
company to clear the immediate liabilities. The formula to shareholders per share ÷ Earnings by company per share
calculate current ratio is given below.
Formula 2
Current ratio = current assets ÷ current liabilities Dividend payout ratio = total dividends paid out to
4
International Journal of Commerce and Management Research [Link]
Shareholder ÷ Net earnings of a company This ratio determines the ability of company management to
The dividend payout ratio estimates the part of earnings use its assets to create earnings. Hence, it is regarded as an
credited in terms of dividends to shareholders. This ratio of important measuring tool for investigating the performance
a company makes investors to know the amount of money of company management (Pandey, 2017) [10].
left with company for reinvestment after paying to its
shareholders (Manjunatha, 2013) [6]. Conclusion
The ratio analysis is an important tool for the analysis of
5. Gross profit ratio: It computes the proportion amount of financial statements. The ratio analysis tool involves various
earnings of a company achieved by selling products or by ratios to evaluate the financial status and ability of a
rendering services before administrative expenditure in company. The financial statements are the only sources to
added. The formulae used to calculate gross profit ratio are determine the business status of a company. Hence,
given below. thorough emphasis on financial statements can be achieved
through ratio analysis.
Formula 1
Gross profit ratio = (Sales of goods – (Direct materials used References
+ Direct labour + Overhead) ÷ Sales 1. Adedeji EJ. “A Tool for Measuring Organization
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This ratio can be used to estimate the present price of a
company’s share compared to earnings per share. The
higher ratio indicates that an investor is willing to pay more
amounts (Dutta et al., 2018) [9].
10. Return on assets: It is the ratio of net profits of a
company to total assets of the company. The below formula
is used to calculate the return on assets.
Return on assets = net profits of company ÷ total assets of
the company
