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What are the ratios used in analysing the stock?

Cash ratio: It tells about company’s ability to pay its current liabilities with the help of cash and cash equivalent and marketable securities. Higher the ratio better for the company.

Cash ratio = (Cash + cash equivalent + marketable securities) / Current liabilities

Example: Company A wants to start a new company and for that it borrowed a loan of Rs. 60, 000. The bank will grant a loan after considering the cash ratio with the help of following information:

Short term investment
Rs. 35, 000
Cash
Rs. 10, 000
Accounts payable
----
creditors
Rs.36, 000
Long term loan
Rs. 1, 25,000

Solution: Cash ratio = (10, 000 + 35, 000) / 36, 000
= 45, 000 / 36, 000
= 1.25
It shows that the cash ratio of company A is not so good so, the chance of getting approval on loan is very low.

Cash Conversion cycle: It shows how much time required by company to convert its inventory into cash sales. Higher the ratio better for the company.

Cash conversion cycle = Days inventory outstanding + Days receivable outstanding – Days payable outstanding

Days inventory outstanding = Average Inventory / (cost of goods sold / 365)

Days receivable outstanding = Average accounts receivable / (net credit sales / 365)

Days payable outstanding = Average accounts payable / (Net credit / 365)

Example: Find out the cash conversion cycle with the help of following information:

Particulars
Amount (Rs.)
Total Sales
5, 60,000
Gross profit
4, 36,800
Credit sales 36% of total sales
2, 01,600
Average B/P
58, 000
Average B/R
78, 000
Average Inventory
40, 000

Solution: Cost of goods sold = 5, 60,000 – 4, 36,800 = 1, 23,200
Days inventory outstanding = 40, 0000 / (1, 23,200 / 365)
= 40, 000 / 337.53 = 118 days
Days receivable outstanding = 78, 000 / (2, 01,600 / 365)
= 78, 000 / 552.33 = 141 days
Days payable outstanding = 58, 000 / (2, 01,600 /365)
= 105 days
Cash conversion cycle = 118 + 141 – 105
= 154 days

Interest coverage ratio: It tells about how much company’s earning cover the interest expenses of a company. Higher is better for the company if the ratio is lower than 1.0 it considers bad for company.

Interest coverage ratio = Earnings before tax / Interest expenses

Example: Company X has paid 30, 000 as bank loan and 45, 000 as interest on debenture. Mr Mehta as a shareholder wants to know that the company is earning enough money to cover its interest expenses or not. Profit before tax is Rs. 4, 65,200.

Solution: Interest coverage ratio = 4, 65,200 / (30, 000 + 45, 000)
= 6.2
It shows that the company is earning more than enough cash to cover its interest expenses.

Effective tax rate: It can be calculated for individuals and for company. If calculated for individual then,
Effective tax rate = tax paid / taxable income

If calculated for company then,

Effective tax rate = Income tax expenses / Earnings before interest and tax

Example: Find out the effective tax rate for individual and for company with the help of following information:


Particulars
Amount (Rs.)
Income tax paid
40, 000
Earning of a company
6, 20,000
Tax paid by company
1, 70, 000
Taxable income
62, 000

Solution: Effective tax rate for company = 1, 70,000 / 6, 20,000 = 27%
Effective tax rate for individual = 40, 000 / 68,000 = 58%

Revenue per employee ratio: This ratio measures how efficiently company pays revenue to its employees. So, that each and every employee gets rewarded according to their work. Higher the ratio better for the company.

Revenue per employee ratio = Company’s earnings / number of employees

Price to book ratio: This ratio compares market price of shares with the book value of each shares in a company. Lower the ratio shows undervalued stock.

Price to book ratio = Price per share / book value per share

Price to sales ratio: It tells about how much investor pay on share in relation to sales generated by company on each shares. Lower the ratio better will be the investment.

Price to sales ratio = Price per share / annual sales per share

PEG ratio (Price earnings to growth ratio): It shows the relation between market price and future growth of earnings of a company. If the ratio is more than 1.0 then it should not consider in good investment list. Lower the ratios better the investment.

PEG ratio = P/E ratio / earnings growth rate

P/E ratio = market price per share / earnings per share (EPS)

Earnings growth rate = (current year EPS / Previous year EPS) - 1

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