CA Intermediate · Financial Management and Strategic Management

Financial Analysis and Planning - Ratio Analysis: formula sheet

Full chapter guide

Key formulas

Basic ratio: Ratio = Figure A ÷ Figure B (shown as x : 1, times, or %); Both figures must be related and on a consistent basis, for example both for the same period.
Liquidity group: Current ratio = Current assets ÷ Current liabilities; Example of the group. Others: quick ratio, cash ratio. Studied under Liquidity Ratios.
Leverage group: Debt-equity ratio = Debt ÷ Equity; Example of the group. Others: interest coverage, debt service coverage.
Activity group: Inventory turnover = Cost of goods sold ÷ Average inventory; Example of the group. Others: debtors, creditors and fixed asset turnover.
Profitability group: Net profit margin = Net profit ÷ Sales × 100; Example of the group. Others: gross profit margin, ROCE, return on equity.
Current ratio: Current ratio = Current assets ÷ Current liabilities; Current assets include stock, debtors, cash, bank, marketable securities, loans and advances (short-term) and prepaid expenses. Benchmark often quoted: 2:1.
Quick (liquid) assets: Quick assets = Current assets − Stock − Prepaid expenses; Some questions also exclude advance tax or other non-liquid items. Follow the question's data and state your assumption.
Quick ratio: Quick ratio = Quick assets ÷ Current liabilities; Also called liquid ratio or acid test ratio. Benchmark often quoted: 1:1.
Quick ratio with quick liabilities: Quick ratio = Quick assets ÷ Quick liabilities, where Quick liabilities = Current liabilities − Bank overdraft − Cash credit; Use this only when the question defines quick liabilities or says overdraft is a continuing source of finance.
Cash ratio: Cash ratio = (Cash + Bank + Marketable securities) ÷ Current liabilities; Also called absolute liquid ratio.
Working capital: Net working capital = Current assets − Current liabilities; Useful to back-solve missing figures from a given current ratio.
Debt-equity ratio: Debt-equity ratio = Long-term debt ÷ Shareholders' funds; Some treatments use total outside liabilities instead of long-term debt. State your definition. Shareholders' funds = equity share capital + preference share capital (if treated as equity) + reserves and surplus.
Debt to total assets ratio: Debt to total assets = Total debt ÷ Total assets; Shows the share of assets financed by borrowing. Use the same debt definition as in the other ratio. Often shown as a ratio or percentage.
Capital gearing ratio: Capital gearing ratio = (Preference share capital + Debentures + Long-term loans) ÷ (Equity share capital + Reserves and surplus); Fixed-return capital against equity funds. Here preference capital is treated as fixed-return capital, not as equity. A ratio above 1 means high gearing (fixed-return capital exceeds equity). A ratio below 1 means low gearing (equity dominates).
Interest coverage ratio: Interest coverage ratio = EBIT ÷ Interest on long-term debt; Answer in times. Use the interest figure the question specifies. A higher ratio means a safer cushion.
Debt service coverage ratio (DSCR): DSCR = Earnings available for debt service ÷ (Interest + Instalment of principal); Earnings available = net profit after tax + depreciation and other non-cash charges + interest on long-term debt. Use the version the question gives.
Equity multiplier link: Total assets ÷ Shareholders' funds = 1 + (Outside liabilities ÷ Shareholders' funds); Outside liabilities means all liabilities other than shareholders' funds, so total assets = shareholders' funds + outside liabilities. Useful when only some balance sheet figures are given.
Inventory (stock) turnover ratio: Cost of goods sold ÷ Average inventory; Average inventory = (Opening + Closing) ÷ 2. If cost of goods sold is not given, sales may be used only when the question says so.
Inventory holding period: Days in year ÷ Inventory turnover ratio; Use 365 days unless the question says 360 or another figure.
Debtors turnover ratio: Credit sales ÷ Average trade debtors (including bills receivable); If credit sales are not given, use total sales and state your assumption.
Average collection period: Days in year ÷ Debtors turnover ratio, or (Average debtors ÷ Credit sales) × Days; Compare it with the credit period allowed to customers.
Creditors turnover ratio: Credit purchases ÷ Average trade creditors (including bills payable); Credit purchases = Cost of goods sold + Closing stock − Opening stock, less cash purchases, if not given.
Average payment period: Days in year ÷ Creditors turnover ratio, or (Average creditors ÷ Credit purchases) × Days; A longer period means more supplier credit.
Fixed asset turnover ratio: Sales ÷ Average net fixed assets; Use net block, that is, after depreciation, unless told otherwise.
Total asset turnover ratio: Sales ÷ Average total assets; Shows sales generated per rupee of total assets.
Working capital turnover ratio: Sales ÷ Net working capital; Net working capital = Current assets − Current liabilities. Use average if given.
Gross Profit Ratio: Gross Profit ÷ Net Sales × 100; Gross Profit = Net Sales − Cost of Goods Sold. Also called gross margin.
Operating Profit Ratio: Operating Profit ÷ Net Sales × 100; Operating Profit = Gross Profit − Operating Expenses (administration, selling, distribution, depreciation). Excludes interest, tax and non-operating items.
Net Profit Ratio: Net Profit ÷ Net Sales × 100; Use net profit after tax unless the question asks for the pre-tax ratio. Say which one you used.
Operating Ratio: (Cost of Goods Sold + Operating Expenses) ÷ Net Sales × 100; Operating Ratio + Operating Profit Ratio = 100%.
Cost of Goods Sold Ratio: Cost of Goods Sold ÷ Net Sales × 100; COGS Ratio + Gross Profit Ratio = 100%.
Expense Ratio (individual): Particular Expense ÷ Net Sales × 100; Used for administration, selling, distribution, financial expenses and so on.
Cost of Goods Sold: Opening Stock + Purchases + Direct Expenses − Closing Stock; Use this when only trading account items are given.
Return on Investment (ROI) / ROCE: ROCE = EBIT ÷ Capital Employed × 100; Pre-tax version. Some questions use EBIT × (1 − t) for a post-tax return. Follow the wording of the question. Use average capital employed if opening and closing figures are given.
Capital Employed (liability side): Capital Employed = Equity Share Capital + Preference Share Capital + Reserves and Surplus + Long-term Debt (− fictitious assets, if any); Equals Net Fixed Assets + Working Capital (Current Assets − Current Liabilities).
Capital Employed (asset side): Capital Employed = Fixed Assets + Current Assets − Current Liabilities; Use as a cross-check. Non-trade investments may be added or excluded as the question directs.
Return on Equity (ROE): ROE = (PAT − Preference Dividend) ÷ Equity Shareholders' Funds × 100; Equity shareholders' funds = equity share capital + reserves and surplus. Use average funds if asked.
Earnings Per Share (EPS): EPS = (PAT − Preference Dividend) ÷ Number of Equity Shares; Use the weighted average number of shares if shares changed during the year.
Dividend Per Share (DPS): DPS = Equity Dividend ÷ Number of Equity Shares; Paid out per share.
Dividend Payout Ratio: D/P = DPS ÷ EPS × 100 = Equity Dividend ÷ Earnings available to equity × 100; Retention ratio = 100% − payout ratio.
Return on Total Assets: ROA = PAT ÷ Total Assets × 100; Some books add back interest (after tax) in the numerator. State your version.
Earnings per share (EPS): EPS = (Net profit after tax − Preference dividend) ÷ Number of equity shares; Use profit available to equity shareholders only.
Price-earnings ratio: P/E = Market price per share ÷ EPS; Expressed in times. Also equals Market capitalisation ÷ Earnings available to equity shareholders.
Dividend yield: Dividend yield = (Dividend per share ÷ Market price per share) × 100; Use the dividend per share for the year, not the payout ratio.
Earnings yield: Earnings yield = (EPS ÷ Market price per share) × 100 = (1 ÷ P/E) × 100; Inverse of P/E.
Dividend payout ratio: Payout = DPS ÷ EPS × 100; Dividend yield = Earnings yield × Payout ratio.
Market value to book value: MV/BV = Market price per share ÷ Book value per share; Book value per share = Equity shareholders' funds (net worth) ÷ Number of equity shares.
Q ratio: Q = Market value of the firm ÷ Estimated replacement cost of its assets; Market value of firm usually means equity plus debt at market value. Above 1 means market values assets above replacement cost.
Three-factor DuPont (ROE): ROE = Net profit margin × Total asset turnover × Equity multiplier; Net profit margin = PAT ÷ Sales; asset turnover = Sales ÷ Total assets; equity multiplier = Total assets ÷ Shareholders' equity.
Return on Assets (ROA): ROA = PAT ÷ Total assets = Net profit margin × Total asset turnover; ROE = ROA × Equity multiplier.
Equity multiplier: Equity multiplier = Total assets ÷ Equity = 1 + (Debt ÷ Equity); Here debt means all outside liabilities, if total assets = equity + outside liabilities.
Gross profit ratio: Gross profit ÷ Sales × 100; Use it to get cost of goods sold: COGS = Sales − Gross profit.
Stock turnover: COGS ÷ Average (or closing) stock; Use the base the question states. If it is silent, use closing stock.
Debtors collection period: Debtors ÷ Credit sales × 365 (or 360, as stated); Inverse: Debtors = Credit sales × Days ÷ 365.
Current ratio: Current assets ÷ Current liabilities; Quick ratio = (Current assets − Stock) ÷ Current liabilities, where prepaid expenses are also excluded if stated.
Fixed asset turnover: Sales ÷ Net fixed assets; Gives fixed assets when sales are known.

Quick revision

Current ratio = Current assets ÷ Current liabilities.
Quick ratio = Quick assets ÷ Current liabilities, where quick assets exclude stock and prepaid expenses.
Debt-equity ratio = Debt ÷ Equity, so check whether the question defines debt as long-term only.
Interest coverage ratio = EBIT ÷ Interest.
Stock turnover = Cost of goods sold ÷ Average stock.
Debtors turnover = Credit sales ÷ Average debtors, and collection period = 365 ÷ turnover (or the days the question gives).
Gross profit margin = Gross profit ÷ Sales × 100; net profit margin = Net profit ÷ Sales × 100.
Return on capital employed = EBIT ÷ Capital employed × 100.
Earnings per share = (Net profit after tax − Preference dividend) ÷ Number of equity shares.
P/E ratio = Market price per share ÷ EPS.
DuPont: ROE = Net profit margin × Total asset turnover × Equity multiplier.
State your assumptions whenever the question leaves the basis of a figure unclear.

Common mistakes

Writing only the formula and no interpretation Fix: After each ratio add one sentence on what it means and how it compares with a benchmark.
Placing ratios in the wrong group, such as return on capital employed under leverage Fix: Classify by purpose. If it measures earnings relative to investment, it is profitability.
Including stock in quick assets. Fix: Always write 'Quick assets = CA − Stock − Prepaids' as a separate line before dividing.
Ignoring prepaid expenses when finding liquid assets. Fix: Prepaid expenses cannot be converted to cash, so deduct them too, unless the question says otherwise.
Including current liabilities in debt when the question asks for long-term debt. Fix: Read the definition. Use long-term borrowings only unless the question says total outside liabilities.
Using net profit instead of EBIT in interest coverage. Fix: Interest coverage uses profit before interest and tax. Add back interest and tax if given profit after tax.
Using total sales for debtors turnover when credit sales are given. Fix: Underline 'credit' in the question. Use credit sales for debtors and credit purchases for creditors.
Dividing sales by inventory instead of cost of goods sold. Fix: Stock is valued at cost, so match it with cost of goods sold unless the question tells you to use sales.
Using gross sales instead of net sales as the denominator. Fix: Underline sales returns in the question and deduct them first. Write the net sales line before any ratio.
Including interest and tax in operating expenses. Fix: Operating profit is before interest and tax. Deduct only expenses of running the business.

Exam tips

Theory questions on this topic are usually 3 to 5 marks. Use numbered points so each idea is visible.
In MCQs, decide the group by what the ratio measures, not by the items in its formula.
In numerical questions, always add a short comment on the result. Interpretation often carries step marks.
Learn the limitations as a fixed list of five or six items so you can write them quickly.
Write ratio names exactly as ICAI uses them: for example 'Capital structure or leverage ratios' and 'Activity or turnover ratios'.
Most questions combine liquidity ratios with a balance sheet or with other ratios, so extract current assets and liabilities first.
In MCQs, check the sign: if stock is positive, the quick ratio must be lower than the current ratio.
Write ratios as x : 1 with two decimals and add a one-line comment. The comment often carries a mark.