Posted on 19th Dec 2024 12:09:53 AM Banking, Finance
1.1. Background and statement of the problem
The purpose of the financial statements i.e. balance sheet and revenue statement is to show firstly, the result of operations for the period under review and secondly, the assets and liabilities of the firm as at the relevant date. But it is difficult to deduce any inference from the mass of figures included in the usual financial statements. So, in order to gauge accurately the financial health of the firm it is generally necessary to regroup and analyze the figures as disclosed by these conventional statements. The use of financial ratios enables conclusions to be drawn from the redrafted figures as to the earning capacity and financial condition of a concern.
1.2. Importance of the study
Being an MBA student, I am in need of acquiring the skill how to analyze financial statements of a business concern. Especially I have to assess the efficiency, profitability, and liquidity of a company/industry. Assessing the efficiency, profitability or otherwise of a concern can be ascertained through financial ratio analysis and evaluation of accounting data. Such analysis enables management to take prudent decisions in conduct of the business affairs, to promote efficiency and thereby increase profit. In particular, profitability ratios show the overall efficiency of a business concern. They are concerned with how effectively an organization has used its available resources. Like manner, liquidity ratios are concerned with the organization’s current financial position and in particular with its capacity to pay it's as they arise in the short term. Thus ratio analysis is the systematic process of financial analysis as well as the way to assess the strengths, weakness and financial position of a firm according to what management can decide what to do or not.
1.3. Objectives of the study
The objectives of the study are:
1.4. Methodology of the study
Ratio analysis is a complex process. Each ratio reveals a different aspect of a company’s condition, at the same time it must be remembered that these parts are interrelated. In interpreting the findings of ratio analysis, the analyst may rely on two types of comparison. First, the analyst can compare a present ratio with past ratio. The second method of comparison involves comparing the ratio of one firm with those of similar firms or with industry average at the same point in time. Such a comparison gives insight into the relative financial condition and performance of the firm.
However the present study has been undertaken only to compare the ratio of each firm with industry average at the same point in time:
Keeping in mind the objectives of the study annual reports of three financial years and other related secondary data of 27 companies of different industries had been collected and existing literature like books, journals and magazines had been used. As to the period, the study covers three financial years viz 2012 to 2010.
Necessary primary data had also been collected by inquiring the company officials.
1.5. Limitation of the study
2.1. Introduction
Financial analysis is the process of identifying the financial strengths and weakness of the firm by properly establishing relationships between the items of the balance sheet and the profit & loss account. Financial analysis can be undertaken by management of the firm, or by parties outside the firm, viz. owners, Creditors, investors and others. The nature of analysis depends on the purpose of the analyst.
Ratio analysis is the process of determining and interpreting numerical relationships based on financial statements. A ratio is statistical yardstick that provides a measure of the relationship between variable of figures. This relationship can be expressed as percent of as a time. Ratio analysis is based on the notion that the analysis of absolute figures may not be the best means available of assessing an organization performance and prospects. For example and annual profit of Tk. 20,000 represents a good level of performance for a local grocer with one shop but a poor achievement for a large company owing a chain of grocery stores. One possible reason for this is that two businesses may use very different amounts of capital. In brief, financial analysis is the process of selection, relation and evaluation.
2.2. Meaning and Rationale
Ratio analysis is a widely – used tools of financial analysis. It is defined as the systematic use of ratio to interpret the financial statements so that the strengths and weaknesses of a firm as well as its historical performance and current financial condition can be determined. The term ratio refers to the numerical or quantitative relationship between two items/variables. This can be expressed as:
These alternative methods of expressing items, which are related to each other rate, for purpose of financial analysis, referred to as ratio analysis. It should be noted that computing the ratio does not add any information not already inherent in the above figures of profit and sales. What the ratios do is that they reveal the relationship in a more meaningful way so as to enable us to draw conclusions from them.
The rationale of ratio analysis lies in the fact that it makes related information comparable. A single figure by itself has no meaning but when expressed in terms of a related figure, it yields significant inferences. Ratio analysis is a quantitative tool, enables analysis to draw quantitative answers to questions such as:
2.3. Nature of Ratio Analysis
Ratio analysis is a powerful tool of financial analysis. A ratio is defined as “the indicated quotient of two mathematical expressions” and as “the relationship between two of more things.” In financial analysis, a ratio is used as a benchmark for evaluating the financial position and performance of a firm. The absolute accounting figures reported in the financial statements do not provide a meaningful understanding of the performance and financial position of a firm. An accounting figure conveys meaning when it is related to some other relevant information. The relationship between two accounting figures, expressed mathematically, is known as a financial ratio (or simply as ratio). Ratios help to summarize the large quantities of financial data and to make qualitative judgement about the firm’s financial performance.
2.4. Basis of Comparison
Four types of comparisons are involved with the ratio analysis:
Trends ratios involve a comparison of the ratios of a firm over time i.e. present ratios are compared with past ratios for the same firm. The comparisons of the profitability of a firm. Trend ratios indicate the direction of change in the performance-improvement, deterioration or constancy- over the years.
The inter-firm comparison involving comparison of the ratios of a firm with those of others in the same line of business or for the industry as a whole reflects its performance in relation to its competitors.
Other type of comparison may relate to comparison of items within a single year’s financial statement of a firm and comparison with Idustry average.
2.5. Financial Statement
The financial statement that shows the financial position of the business concern.
There are three types of financial statements:
2.6. Importance of Ratio Analysis
As a tool financial management, ratios are of crucial significance. The importance of ratio analysis lies in the fact that it presents fact on a comparative basis and enables the drawing of inferences, regarding the performance of a firm. Ratio analysis is relevant in assessing the performance of a firm in respect of the following aspects:
2.6.1. Liquidity Position
With the help of ratio analysis conclusions can be drawn regarding the liquidity position of a firm. The liquidity position of firm would be satisfactory if it is able to meet its current obligations when they become due. A firm can be said to have the ability to meet its short-term liabilities if it has sufficient liquid funds to pay the interest on its short maturing debt usually within a year as well as to repay the principal. This ability is reflected in the liquidity ratios of a firm. The liquidity ratios are particularly useful in credit analysis by bank and other suppliers of short-term loans.
2.6.2. Long-term Solvency
Ratio analysis is equally useful for assessing the long-term financial viability of a firm. This aspect of the financial position of a borrower is of concern to the long-term creditors, security analysis and the present and potential owners of a business. The long-term solvency is measured by the leverage/capital structure and profitability ratios, which focus on earning power and operating efficiency. Ratio analysis reveals the strength and weaknesses of a firm in this respect. The leverage ratios, for instance, will indicate whether a firm has a reasonable proportion of various sources of finance or if it is heavily loaded with debt in which case its solvency is exposed to serious strain. Similarly, the various profitability ratios would reveal whether or not the firm is able to offer adequate return to its owners to owners consistent with the risk involved.
2.6.3. Operating Efficiency
Yet another dimension of the usefulness of the ratio analysis, relevant from the viewpoint of management, is that it throws light on the degree of efficiency in the management and utilization of its assets. The various activity ratios measure this king of operational efficiency. In fact, the solvency of a firm is, in the ultimate analysis, dependent upon the sales revenues generated by the use of its assets-total as well as its components.
2.6.4. Overall Profitability
Unlike the outside parties, which are interested in one aspects of the financial position of a firm, the management is constantly concerned about the over-all profitability of the enterprise. That is, they are concerned about the ability of the firm to meet its short-term as well as long-term obligations to its creditors, to ensure a reasonable return to its owners and secure optimum utilization of the assets of the firm. This is possible if an integrated view is taken and all the ratios are considered together.
2.6.5. Inter-firm Comparison
Ratio analysis not only throws light on the financial position of a firm but also serves as a stepping stone to remedial measures. This is made possible due to inter-firm comparison and comparison with industry averages. A single figure of a particular ratio is meaningless unless it is related to some standard or norm. One of the popular techniques is to compare the ratios of a firm with the industry average. It should be reasonably expected that the performance of a firm should be in broad conformity with that of the industry to which it belongs. An inter-firm comparison would be demonstrated the firm’s position vis-à-vis its competitors. If the results are at variance either with the industry average or with those of the competitors, the firm can seek to identify the probable reasons and in that light, take remedial measures.
2.6.6. Tend Analysis
Finally, ratio analysis enables a firm to take the time dimension into account. In other words, whether the financial position of a firm is improving or deteriorating over the years. This is made possible by the use of trend analysis. The significance of a trend analysis of ratios lies in the fact that the analysis can know the direction of movement, that is, whether the movement is favorable or unfavorable. For example, the ratio may be low as compared to the norm but the trend may be upward. On the hand, though the present level may be satisfactory but the trend may be a declining one.
2.7. Limitations of Ratio Analysis
Ratio analysis is a widely used tool of financial analysis. Yet, it suffers from various limitations. The operational implication of this is that while using ratios, the conclusions should not be taken on their face value. Some of the limitations that characterize ratio analysis are:
2.7.1. Difficulty in Comparison
One serious limitation of ratio analysis arises out of the difficulty associated with their comparability. One technique that is employed is inter-firm comparison. But such comparisons are vitiated by different procedures adopted by various firms. The differences may release to:
Secondly, apart from the different accounting procedures, company may have deferent accounting periods, implying differences in the composition of the assets, particularly current assets. For these reasons, the ratio of two firms may not be strictly comparable.
Another basis of comparison is the industry average. This presupposes the availability, on a comprehensive scale, of various ratios for each industry group over a period of time. If, however, as is likely, such information is not compiled and available, the utility of ratio analysis would be limited.
2.7.2. Impact of Inflation
The second major limitation of the ratio analysis as a tool of financial analysis is associated with price level changes, This, in fact, is a weakness of the traditional financial statements which are based on historical costs. An implication of this feature of the financial statements as regards ratio analysis is that assets acquired at different periods are, in effect, shown at different prices in the balance sheet, as they are not adjusted for changes in the price level. As a result, ratio analysis will not yield strictly comparable and, therefore, dependable results.
TABLE OF CONTENTS
Executive Summary
Chapter 1: Introduction
1.0. Name of the topic
1.1. Background and statement of the problem
1.2. Importance of the study
1.3. Objectives of the study
1.4. Methodology of the study
1.5. Limitation of the study
Chapter 2: Literature Review & Conceptual Framework
2.1. Introduction
2.2. Meaning and Rationale
2.3. Nature of Ratio Analysis
2.4. Basis of Comparison
2.5. Financial Statement
2.6. Importance of Ratio Analysis
2.6.1. Liquidity Position
2.6.2. Long-term Solvency
2.6.3. Operating Efficiency
2.6.4. Overall Profitability
2.6.5. Inter-firm Comparison
2.6.6. Trend Analysis
2.7. Limitations of Ratio Analysis
2.7.1. Difficulty in Comparison
2.7.2. Impact of Inflation
Chapter 3: Price Earnings Ratio (P/E)
Chapter 4: Debt Ratio
Chapter 5: Return on Equity
Chapter 6: Return on Assets
Chapter 7: Conclusion
Works Cited
Appendix
Research, Report, Financial, Performance, Analysis, Study, Ratios, Bangladeshi, Companies, Literature, Review, Conceptual, Framework, Comparison, Return, Equity, Assets
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