DIVIDEND YIELD

Any Investment must produce cash flow (returns). If we are owning either a Land or House we may be able to get money in the form of Renting or through Lease. Similarly in Stock investing it is termed as (Gains from stocks) Dividend. If we are being a long term investor the only term obtained as cash flow is Dividend.

                  

For each stock there is a Base value called Face value. In our country based in the face value dividend is announced. For example 10 rupees face value stock named “ Indian Bank ” up to the year ending March – 2011, has given 25% and 40% dividend , adding to a total of 65% (Rs. 6.50 /- )

                  

This dividend percentage is based on face value and announced. But, with the present stock price (or) with the price you have purchased , the gains obtained would be correct. It is called Dividend Yield. Let us again take Indian Bank.   

                  

This stocks present price  when taken as Rs.234 /- the March – 2010, Dividend yield is 2.78 % (6.50/234). Indian Bank which offered the public issue in 2007, if purchased then , the dividend yield may be (6.50/91) is 7.14 %. Among the various factors , the very important factor to be seen is dividend yield, while purchasing.

Generally the dividend yield being more is better. Sometimes, due to some problems in Organization the stock prices may have slashed. During these times the dividend yield seems to be large. The investors must be cautious while purchasing those stocks.   

                                               

The Indian Economy and the Organizations being in a Growth Track , the dividend yield is generally found low. The reason is the companies reinvest their profits in their Business itself. Our Nifty Index dividend yield is 1.07 % only. Banking like some sectors dividend yield may be somewhat greater.             

Generally, Middle and Small Cap Organizations dividend yield may be larger, when compared with Large Cap Organizations. Low risk taking persons can invest in dividend yield largely found stocks. Generally Old Economic Companies (other than New Economic companies ) dividend yield will be present more.    

Highest Price / Lowest Price :- 

Generally while analyzing various factors for purchasing a stock, the highest price/ lowest price and 52 weeks high / low can also be seen. This may indicate whether the stock is in Bullish phase or Bearish phase.

Stocks while costing nearest to Highest price, avoiding to purchase stocks is better. At the same time, either the lowest prices or the stock being in Bearish phase, we can buy a smaller Quantity.  

                  

Like the Sathyam Computers ( Present Mahindra Sathyam ) any large untoward incidents may happen. During those moments we must be cautious.

While the Entire stock market , being dragged (or) some stocks being dragged , the stocks may be available in very cheapest prices. During these periods , the other factors if found advantageous , we can utilize those golden moments definitely.      

Share Holding :-

The Stocks you ought to buy, before purchasing we can look a glance of the stock holding persons whom are belonging as partners. Efficiently managed Mutual Fund schemes, Government allied and private sector largest Organizations, Insurance Companies, I.F.C.( International Finance Corporation ) similar concerns being as Shareholders can be considered as positive points. It can be taken as a Filter.

Those people may have not purchased without Analyzing those stocks. F.I.I’s           ( Foreign Institutional Investors) being the investors, in one angle is considered better. The stock prices may rise.

On another side, Disadvantage is if money required for them in their country at any moment they may withdraw the amount invested from Indian stock market, which results in rapid downfall of the stock prices.

So, we must be cautious in that point. While compared with Large Organizations it may not be a problem. But for Mid Cap and Small Cap , the Downfall to be relieved may take a Larger period.        

Total Debts :- 

Several Organizations, thrown to the corner the reason is excessive presence of Debts. Debts can be termed as two faced coins. If the moment (period) is good it may lift a company to a greater level.

If it is in a struggle ( opposite ) it may push the company to the utter bottom of the valley. Similarly in India and in Foreign countries several Organizations were pushed to the bottom of the valley.

Without debts functioning a company is very much better. In some times the Debts being low , the Management may speed up their activities. The performance may be speedy in the Organization. After all the income from stocks may be considerably High.

The stocks you ought to buy , before purchasing, listen to the Total Debts of the Company. With regard to the Share Investment, listen to the ratio of the Debts received. For each sector it may differ.

Banking Organizations cannot function without Debts. Likewise the Organizations in service sector need not require debts largely. The stock you ought to buy,compare with the sector based best stocks. Doing those Analysis we can get a clear picture of Clarification about investing.    

Dividend Yield :-

Question: What is Dividend Yield and How is Dividend Yield Calculated

Answer: Dividend yield is an easy way to compare the relative attractiveness of     various dividend-paying stocks. It tells an investor the yield he / she can expect by purchasing a stock. This allows a basis of comparison between other investments such as bonds, certificates of deposit, etc.

To calculate the dividend yield, divide the annual dividend by the current stock price.

An Example: If company XYZ was trading for $10 per share and paid a $1 dividend, how much will the stock yield each year for the investor? Using our formula (Annual Dividend ÷ Current Stock Price = Dividend Yield), we find the answer is 10%.

The Dividend Yield 

Many investors like to watch the dividend yield, which is calculated as the annual dividend income per share divided by the current share price. The dividend yield measures the amount of income received in proportion to the share price.

If a company has a low dividend yield compared to other companies in its sector, it can mean two things:

(1) the share price is high because the market reckons the company has impressive prospects and isn't overly worried about the company's dividend payments, or

(2) the company is in trouble and cannot afford to pay reasonable dividends. At the same time, however, a high dividend yield can signal a sick company with a depressed share price. 

Dividend yield is of little importance for growth companies because, as we discussed above, retained earnings will be reinvested in expansion opportunities, giving shareholders profits in the form of capital gains (think Microsoft). 

Our Indian Companies are giving dividend based to the Face value. On seeing this either a company giving more or less dividend cannot be decided. If a company giving more dividend can be known from its dividend yield. The amount given as dividend is the percentage of present stock price, called as Dividend yield. 

          Yield = ( Dividend / Stock price ) x 100 

                   =  ( 10 / 1000 ) x 100

                   =     1 %  

Also we could have heard of 50 %, 195 %, 500 %, dividend giving companies. We need not be confused with those percentage. Except mentioning as dividend yield, if simply said in percentage is only meant as percentage to the Face value.  

For Example :-

                   Present stock price               Face value          Dividend

                                 100                                  10                      50 %

                   Dividend = ( 10 / 100 x 50 ) 

                                   = Rs.5 /-         

Past years dividend value can be utilized for present year dividend calculation also. But previously given dividend can now also be obtained is not guaranteed. Moreover we cannot expect the same also.

During Economic Crisis some large companies also never offered Dividend. Once in a year dividend must be given is not mandatory. Also yearly once is, not restricted.

In practice, many organizations are providing dividends more than once in a year. Interim dividends are also given. Continuous years to be given is not essential. The total number of dividends given, must be calculated for dividend yield for a certain year.  

                            

In dividend yield, highly earning companies growth may be slow. Since being already grown sectors , the P.E ratio may be low. Pay-out returns will be more due to the offer of dividend for the past years. Dividend yield scale can be a Better Shield for a Defensive Investor.

Management not swallowing the promoters money and distributing to all the share holders is an identity of Highest yield. At the same time it is also felt as the companies Balance Sheet being thick.  

Let us see 2 Companies, 

                                           ABC                       DEF   

          Stock price               50                         100    

          Dividend                 2 rupees                2 rupees 

          Dividend Yield =  ( 2 / 50 x 100 )       ( 2 / 100 x 100 ) 

                                   =           4 %                      2 %    

From the above example which company can be selected ? It’s a confusion in all the minds. Considering all the features as the same for both the companies ABC can be selected. Isn’t it ! 

                          

An Organization with its business transactions creating gains can be handled in 2 ways, 

1. Excessive gain can be Re-invested and Expanded.

2. Dividend can be given. 

3. Another type is the profit amount can be utilized for buy back of own stocks.

So that the number of stocks can be reduced. Moreover the share holders rights can be increased. 

                   

If the profits are not distributed to the share holders, and again Re-Invested for companies growth then the investment needs rapid growth. Shortly saying if the growth seems to be dull, then simply giving the Dividend to the Investors would be beauty to the Administration.

                                                         

Market Capitalization more than a limit grown up companies, the growth while they were smaller cannot be expected continuously. It means that Re-Investment need not be required continuously. After some period the profits must be returned to the Investors in the form of Dividend. 

                                                         

The best fact in dividend is cheating can’t be done. Only 2 facts,

1. Dividend will be given (or)

2. Dividend will not be given.        

Year- by – year the increase in dividend can be seen visibly. But in gains not like that. In the accounts statements and the Balance sheets portraying untrue EPS, due to Fraudulent actions with the help of Government Law and Auditors, can’t be committed in Dividend. Increasing the value of Dividend gradually indicates the identification of continuous Economic success.

                                                                            

Growth Organizations probably provide higher dividend. In the name of dividend sharing with the share holders is considered as a secondary part other than strengthening themselves. These types of actions must be felt prudent for both Administration and the Investor. Fair growth stocks after monitoring some years later ,apart from the price, the dividend rate will be increased considerably.

                                                           

Again analyzing in a certain angle, the dividend certifies the Managements stability and Decision capacity can be said. Without sharing the investors and the Company itself holding, may lead to Lavish spendthrift in the form of salary hike ,special benefits by the Top Officials of the company.

Instead if maintaining a stable policy of, the percentage of gain, the percentage of dividend, it testifies the managements honesty and Discipline. If failing the above , leads to distress, and the stock prices can get down.

                                                                                               

A stock in very low P.E  ratio with 3 – 4 % dividend ratio yield, chances to grow more than beating Inflation, if found by a value investor. Holding these stocks for several years will definitely produce better results than growth stocks. Moreover the acquired dividend can again be re-invested ( Dividend re-investment ) and enjoy the activity. Stocks like these criteria need not be a rapid growing stock instead need not be a vanishing stock must be noted in mind. 

                                               

Like Philip Fischer, a successful growth investor, rejects the dividend as a secondary Why ? Because new concepts , Plans , Technology, incorporates new companies may require largest capital requirement. During that time we can’t expect dividend from them. If expecting, investors in Future , may loss huge percentage of Organizations growth which may reflect in stock prices.

                                                                                               

Capital appreciation alone expecting investors may not give more importance to dividend. From his 40 year investment strategy , if considering dividend alone as an important fact , he would have lost several Huge profit investments, at a silly reason must be bared in mind. 

According to the statement by the finance ministry, the Tax Exemption for dividend even if it is a huge value, may be a relief for small investors. This statement reveals that the largest stock holder persons like promoters, and Directors may take advantage of Dividend. Even for small investors and for overall stock investors this can also be a suitable news.  

                                                                      

Most commonly other than Large, moderate and small companies are yielding and offering fair dividend yield. Very rare large companies are found in this List , investors must carefully access and select for investment , buying intermittently during the stock prices being low.

On today’s position the following features can be considered for selecting the stocks:- 

1. Stocks traded in national Stock Exchange.

2. Market capitalization being more than 500 crores.

3. Being in the industry for many years.

4. Quality Organizations.

5. Good dividend record history based Organizations.

6. Minimum 4 % dividend yield organizations.

7. Expected dividend in the forthcoming years also.     

      

BOOK VALUE VALUATION

What is Book Value Valuation ?

The accounting net worth of a business – total assets minus total liabilities is called book value valuation. Assets are valued at their adjusted cost basis minus depreciation. The book value does not take into consideration certain unrecorded assets and liabilities such as the current value of goodwill, customer lists or lease obligations.

In Valuation method we have seen a customer ready to give money only for Machineries with all Accessories including Building and Land. His prediction is nearest Book Value. In Book Value, he tried to buy that Industry. But the Owner refused. Companies or Stocks Book Value exactly calculating and with that Company / stocks value discovering is called Book Value Valuation Method.

                  

Calculating all Business with Book Value is not suitable. For Example, you are owning a Departmental store. You have started that store , nearly 10 years back. Your stores present Machineries with Accessories value can be taken as Rs.10 Lakhs. Your stores Annual Net Profit can be taken as roughly Rs10 Lakhs. If you will be ready to sell that share in Book     Value ? Just think!

                  

So, we can conclude that each valuation method is suitable for some sort of Business only. For service oriented Industries book value method doesn’t suit. Capital Intensive told as Large Capitalization Business can be calculated with the book value valuation method. ( Shipping, Electricity Production, Banking, and Finance sectors )   

                            

Likewise several Old Economic Business can be valued through Book Value Method. Which stocks can be bought lesser than the Book Value? Which Company stocks can be bought?

                            

Absence of more growth sectors / stocks , more debts present companies, can be available in less than book value. In our country

1)      During Economic problems felt (or)

2)      In, Good companies ,problems raised (or)

3)      The, Good companies when not familiar to the World.  

                            

During those times the companies / company stocks can be available less than book value. Even in those times, better Track record present, Quality Organizational stocks can be bought , which may be better. 

                            

Even several times companies portray their purchased asset value in book. In those stocks the value may be hidden. While Analyzing those stocks and purchasing we can yield attractive gains.

                  

In the past 10 to15 years in our country Real estate sector has raised well. Several organization even today predicting their real estate in the purchased rate as in older years in the book. Recently in north India some textile sectors based stocks are found  suddenly rising due to their vacant places. Residential blocks and trading buildings were built and sold (or) rented by way of creating income to the company

                  

Using book value valuation method must be handled carefully. After creating “PEER GROUP”, P/BV (stock market price/ book value) founded and compared with, which stock is suitable for investment can be worked out. Separately using a stocks book value or using P/BV alone don’t invest. Because some companies available very lower than the Book Value may be in a Horrible situation. So, using “PEER GROUP” comparing with some other stocks / Business execute the Investment.

Tangible book value.

Book value minus intangible assets (goodwill, covenant not to compete, etc.). This method only records the assets that can be collateralized. It is most often used  by financial institutions.

Adjusted tangible book value. 

Adjusts the tangible assets up or down to their fair market value. It tells what the liquidation value of a business is most likely to be.  It is sometimes used in place

of book value for buy/sell agreements.

                              

MARKET PRICE VALUATION METHOD ;-

Advantages :-

In Economy (or) specified sector / companies while occurring problems the demand of those stocks / companies will be low. So, in those times, from its real value the prices will be available in very low cost. 

For Example :-

1)      S.K.F. Bearings a Multinational Company, Rs.125 /- reduced in Year 2008. Now its value           is Rs.  

2)      Likewise 2008- 09, VOLTAS stocks reduced to Rs.33/-.( During 2007-2008, a maximum          of Rs.250/- )Now it cost is Rs.    

                             

So, even Market value is most Transparent value method, we have to know how Effectively use for our own.  

Disadvantages :-  

In valuation we have seen a person comparing the market price for buying a Residential House. In the market, persons buying / selling being ready cost is the calculation used for this method. In this method the positives and also the negatives (like any other method) are also present. First we can see the Negatives,

                  

Market price is derived with various factors. Among those the important one is Demand and Supply. Market rising to the Top and Touching the Bottom line are casual incidences. But many amateur people within us , buy in the Top of the Sensex and with scolding in the Bottom of the market position is found common. 

                  

While Market being in the Top several stocks / companies value, deand being more, the values will be at the Top. Similar instances are not alone common for small investing but even for Giant Companies like TATA.

                  

In 2007, TATA Steel Company purchased, Britain’s “CHORES” for 12.2 Billion Dollars while market was at its Top. Similarly TATA MOTORS Company purchased Britain’s “JAHUAR” in 2008 for 2.3 Billion Dollars. After the stock market crash both companies stocks crashed largely. Rattan Tata in an interview said that the companies can be bought in considerable low prices. So, the market price is Either True must be investigated before Acquiring.   

  

Market Price Method

Estimates economic values for ecosystem products or services that are bought and sold in commercial markets.

1.    Overview

2.    Why Use the Market Price Method?

3.    Application of the Market Price Method

4.    Summary of the Market Price Method

5.    Applying the Market Price Method

6.    Advantages of the Market Price Method

7.    Issues and Limitations of the Market Price Method

Overview

The market price method estimates the economic value of ecosystem products or services that are bought and sold in commercial markets. The market price method can be used to value changes in either the quantity or quality of a good or service.  It uses standard economic techniques for measuring the economic benefits from marketed goods, based on the quantity people purchase at different prices, and the quantity supplied at different prices. 

The standard method for measuring the use value of resources traded in the marketplace is the estimation of consumer surplus and producer surplus using market price and quantity data. The total net economic benefit, or economic surplus, is the sum of consumer surplus and producer surplus.

This section continues with an example application of the market price method, followed by a more complete technical description of the method and its advantages and limitations.

Hypothetical Situation: 

Water pollution has caused the closure of a commercial fishing area, and agency staff want to evaluate the benefits of cleanup.

Why Use the Market Price Method? 

The market price method was selected in this case, because the primary resource affected is fish that are commercially harvested, and thus market data are available. 
 

Application of the Market Price Method: 
  
The objective is to measure total economic surplus for the increased fish harvest that would occur if the pollution is cleaned up.  This is the sum of consumer surplus plus producer surplus.  Remember that consumer surplus is measured by the maximum amount that people are willing to pay for a good, minus what they actually pay.  Similarly, producer surplus is measured by the difference between the total revenues earned from a good, and the total variable costs of producing it.  Thus, the researcher must estimate the difference between economic surplus before the closure and economic surplus after the closure. 

Step 1: 
The first step is to use market data to estimate the market demand function and consumer surplus for the fish before the closure.  To simplify the example, assume a linear demand function, where the initial market price is $5 per pound, and the maximum willingness to pay is $10 per pound.  The figure shows the area that the researcher wants to estimate ? the consumer surplus, or economic benefit to consumers, before the area was closed. 

At $5 per pound, consumers purchased 10,000 pounds of fish per year.  Thus, consumers spent a total of $50,000 on fish per year.  However, some consumers were willing to pay more than $5.00 per pound and thus received a net economic benefit from purchasing the fish.  This is shown by the shaded area on the graph, the consumer surplus.  This area is calculated as ($10-$5)*10,000/2 = $25,000.  This is the total consumer surplus received from the fish before the closure.

Step 2: 
The second step is to estimate the market demand function and consumer surplus for the fish after the closure.  After the closure, the market price of fish rose from $5 to $7 per pound, and the total quantity demanded decreased to 6,000 pounds per year.

Thus, the economic benefit has decreased, as shown in the figure.  The new consumer surplus is calculated as ($10-$7)*6,000/2 = $9,000.

Step 3: 
The third step is to estimate the loss in economic benefits to consumers, by subtracting benefits after the closure, $9,000, from benefits before the closure, $25,000.  Thus, the loss in benefits to consumers is $16,000.

Step 4: 
Because this is a marketed good, the researcher must also consider the losses to producers, in this case the commercial fishermen.  This is measured by the loss in producer surplus.  As with consumer surplus, the researcher must measure the producer surplus before and after the closure and calculate the difference.  Thus, the next step is to estimate the producer surplus before the closure. 

Producer surplus is measured by the difference between the total revenues earned from a good, and the total expense of producing it.  Before the closure, 10,000 pounds of fish were caught per year.  Fishermen were paid $1 per pound, so their total revenues were $10,000 per year.  The variable cost to harvest the fish was $.50 per pound, so total variable cost was $5,000 per year.  Thus, the producer surplus before the closure was $10,000 - $5,000 = $5,000.

Step 5: 
Next, the researcher would measure the producer surplus after the closure.  After the closure, 6,000 pounds were harvested per year.  If the wholesale price remained at $1, the total revenues after the closure would be $6,000 per year.  If the variable cost increased to $.60, because boats had to travel farther to fish, the total variable cost after the closure was $3,600.  Thus, the producer surplus after the closure is $6,000 - $3,600 = $2,400.

Step 6:  
The next step is to calculate the loss in producer surplus due to the closure.  This is equal to $5,000 - $2,400 = $2,600.  Note that this example is based on assumptions that greatly simplify the analysis, for the sake of clarity.  Certain factors might make the analysis more complicated.  For example, some fishermen might switch to another fishery after the closure, and thus losses would be lower.

Step 7: 
The final step is to calculate the total economic losses due to the closure—the sum of  
lost consumer surplus and lost producer surplus.  The total loss is $16,000 + $2,600 = $18,600.  Thus, the benefits of cleaning up pollution in order to reopen the area are equal to $18,600.

How Can the Results be Used? 

The results of the analysis can be used to compare the benefits of actions that would allow the area to be reopened, to the costs of such actions.  

Summary of the Market Price Method

The market price method estimates the economic value of ecosystem products or services that are bought and sold in markets. The market price method can be used to value changes in either the quantity or quality of a good or service.  It uses standard economic techniques for measuring the economic benefits from marketed goods, based on the quantity people purchase at different prices, and the quantity supplied at different prices. 

For those resources for which markets exist, economists determine individuals’ values by observing their preferences and willingness to pay for the goods and services at the prices offered in the market.  The standard method for measuring the use value of resources traded in the marketplace is the estimation of consumer surplus  and producer surplus  using market price and quantity data.  The total net economic benefit, or economic surplus, is the sum of consumer surplus and producer surplus. 

Applying the Market Price Method

The market price method uses prevailing prices for goods and services traded in markets, such as timber or fish sold commercially.  Market price represents the value of an additional unit of that good or service, assuming the good is sold through a perfectly competitive market (that is, a market where there is full information, identical products being sold and no taxes or subsidies).

Application of the market price method requires data to estimate consumer surplus and producer surplus.  To estimate consumer surplus, the demand function must be estimated.  This requires time series data on the quantity demanded at different prices, plus data on other factors that might affect demand, such as income or other demographic data.  To estimate producer surplus, data on variable costs of production and revenues received from the good are required. 

Advantages of the Market Price Method

• The market price method reflects an individual's willingness to pay for costs and benefits of goods that are bought and sold in markets, such as fish, timber, or fuel wood.  Thus, people’s values are likely to be well-defined.
• Price, quantity and cost data are relatively easy to obtain for established markets.
• The method uses observed data of actual consumer preferences.
• The method uses standard, accepted economic techniques.

Issues and Limitations of the Market Price Method

• Market data may only be available for a limited number of goods and services provided by an ecological resource and may not reflect the value of all productive uses of a resource.
• The true economic value of goods or services may not be fully reflected in market transactions, due to market imperfections and/or policy failures. 
• Seasonal variations and other effects on price must be considered.
• The method cannot be easily used to measure the value of larger scale changes that are likely to affect the supply of or demand for a good or service.
• Usually, the market price method does not deduct the market value of other resources used to bring ecosystem products to market, and thus may overstate benefits.

RATIO ANALYSIS

Definition of 'Ratio Analysis' 

A tool used by individuals to conduct a quantitative analysis of information in a company's financial statements. Ratios are calculated from current year numbers and are then compared to previous years, other companies, the industry, or even the economy to judge the performance of the company. Ratio analysis is predominately used by proponents of fundamental analysis.

There are many ratios that can be calculated from the financial statements pertaining to a company's performance, activity, financing and liquidity. Some common ratios include the price-earnings ratio, debt-equity ratio, earnings per share, asset turnover and working capital.

Ratio Analysis is a widely used tool in Financial World. Not, alone for finance management ,even for day-to-day usage and for Business an efficient user. Let us see with an Example.  

                

Let us consider your salary as monthly Rs.35,000 / -.Your savings are monthly 15,000/- That means in ratio your savings are (12,000/35,000) is 34 %.We are comparing your savings with your salary. But your friend who is also earning the same salary is saving Rs.15,000/-, that is 42 %. After thorough analysis and research when comparing your expenses with your friend you can come to a conclusion that you can still save some amount larger than say 35%. So, in future your savings may be 35%. After this ratio analysis you are managing and improving yourself.  

                

Like the same manner, the stocks you ought to buy various ratios are compared with their competitors and you can assess the Efficiency of the purchased stock. Ratio Analysis is a very big ocean and here we are taking some important ratios. The ratios can be classified according to,

1)     Based on gain,

2)     Based on Operations,

3)     Based on Efficiency Management,

4)     Based on Company’s Debts ……etc..  

Let us see the Gain based ratio :-

        

The company BHEL accounts statement ending with the financial year March – 2010, is given below. It is a general format.

a)     Gross sales Turnover – 33226.25 Crores.

b)     Stock Adjustments     -   786.65    Cores.

c)     Total Expenses           -  27913.71 Cores.

d)     Operating Profit          -   6099.19   Cores.  ( 33226.25 + 786.65 – 27913.71)

Operating profit is termed as gain before Interest, Depreciation and Income Tax. It means 

Net sales minus Direct Expenses  = Net Profit.

Now we can see the Operating Profit Margin.

O.P.M      =      Operating Profit / Net Sales.   

According to the above the financial year ending March – 2010, Operating profit Margin is 18.4 % ( 6099.19 / 33226.25 )

        

Likewise Net Profit ( Net gain ) Margin is also very useful.

Net Profit Margin = Net Profit / Gross Income.

Net sales when added with other income with stock adjustments gross income may be obtained. 

For the BHEL Company other income ( Either through Investments, sale on assets, or any other income not connected to the business ) is 

a)     1085.73 Cores

b)     Stock Adjustments – 786.65 Cores,

c)     Total income in that year – 35098.63 Cores,

d)     Net gain  - 4310.64 Cores. 

                        

This ratio between Net gain Vs Total income is Net Profit Margin. BHEL March – 2010, net profit margin is 12.30 % (4310.64 / 35098.63 ) By this ratio for each and every rupee sales, how much gains obtained can be known to us,

Except this 

1)     Ratio between Raw Material Vs Sales

2)     Ratio between Sales, Management, & Common Expenses Vs Sales,

3)     Ratio between Electricity & Fuel Vs Sales.

Based on our Analysis we can going on add the ratios required. Merely calculating is not enough. With calculation, we have to compare with the companies competitors with the ratios. Then only the efficiency of the Organization can be worked out. Like your friend,  

Again some important ratios can be seen below,

1)     Small industries, with their raw materials ( Inventory ) present may consider their business as stronger.

2)     But medium and large scale industries don’t think like that. The main reason is we are talking about hundreds of Cores. (Products)

                        

Apart from these the Japanese people had climbed a step ahead and introduced the “Just in time Inventory Management” which is widely used today. Each and every Organization if try to calculate the rotational cycle (or sales) ten they may be able to work out their Organizations Efficiency in both sales and Gain. 

                

For Example if you are a Provision store Owner. Your daily sales is Rs.10,000/-. You are soling for Rs 36,00,000, assumed per year. At anytime Rs.3,00,000 worth materials are present in your shop. It means your materials (products0 rotation is 36/3 = 12% If you are able to measure this rotation your gain (profit) may definitely increase. Let us see the BHEL Company rotation rate as given below,  

(Inventory Turnover = Annual Sales / Year End Value of inventory products present )  

BHEL Companies

a)     Year end inventory is Rs.9235.46 Cores ( According to Balance Sheet)   

b)     That year net sales is Rs.33226.25 Cores.

So, BHEL Companies inventory turnover is 3.6 ( This inventory turnover being more is much better. It means those times the company had rotated its inventory (Products) 

Like above ratios, a company how much debts received, is very much important for investors like us. Conservative investors would think that the concerns should hold no debts within them. To analyze this a ratio Debt to Equity ratio is used. BHEL Concerns,

a)     Total debts ending March – 2010 – 127.75 Cores,

b)     That years share capital and reserves works out to 15917.36 Cores,

So, its Debt to Equity ratio is 0.008 (Less than 1 %) ( 127.75 / 15917.36) For some Organizations we have heard of even 100% or 200% present. Production based Organizations if debts are largely present , if an Economical Crisis occurs , those Organizations would be pushed to the bottom line.   

Debt to Equity Ratio = Total Debts / Share holders Capital. 

A point should be kept in mind while analyzing ratio Analysis. For each and every sector this ratios must be considered, separately. For Example,

1)     Finance based Organizations

2)     Retail sectors

3)     Production based Organizations

4)     Electricity producing Organizations etc…

For each and every sector the needs may differ. So, the ratios may also differ. 

For Example,

1)     In retail field the turn over ratio will be    -  more.

2)     Finance connected Organizations         -  Debts present will be more.

3)     Electricity Organizations                         -  Debts present will be more.      

So, while analyzing the ratios belonging to same sector with same size would be reasonable.

Traditional Classification of Ratios:

This is traditional method of classifying ratios. Under this category, ratios are classified into:

1. Balance Sheet or Position Statement ratios:

Balance sheet or position statement ratios are those ratios which are derived from two variables appearing in the balance sheet. For example, current ratio, debt equity ratio etc.

2. Profit and Loss Account or Income Statement Ratios:

Sometimes also known as operating ratios are derived from the variables appearing in the manufacturing, trading and profit and loss account. For example, inventory turnover ratio, gross profit ratio, expense ratio etc.

3. Inter Statement Ratios:

Inter statement ratios also known as combined or mixed ratios are such ratios which establish relationship between variables picked up from both the statements i.e. balance sheet and final account. For example debtors turnover, assets turnover, return on capital etc.

Functional Classification or Classification According to Test Specified:

Under this classification, ratios may be grouped in accordance with the type of test they are supposed to perform. Thus, ratios may be grouped as:

1. Liquidity Ratios:

Liquidity ratios are the ratios meant for testing short-term financial position of a business. These are designed to test the ability of the business to meet its short-term obligation promptly. For example, current ratio, quick ratio fall under this group.

2. Solvency Ratios: 

Solvency ratios are also known as leverage ratios. These are meant for testing long term financial soundness of any unit. Primarily these establish and study relationship between owned funds and loaned funds. For example, debt-equity ratio, capital gearing ratio etc., are covered under this group.

3. Efficiency Ratios:

Efficiency ratios are also known as activity ratios. These are meant to study the efficiency with which the resources of the unit have been used. These are also popularly known as turnover ratios. Examples are; inventory turnover ratio, return on investment etc.

Meanings, Nature and Usefulness of Ratios Analysis:

Meanings of Ratio:

According to J. Batty, "The term accounting ratios is used to describe significant relationships which exist between figures shown in a balance sheet, in a profit and loss account, in a budgetary control system or in any other part of the accounting organization"
In simple words, "Ratio" is the numerical relationship between two variables which are connected with each other in some way or the other. Ratios may be expressed in any one of the following manners
As a number the relationship between 500 and 100 may be expressed as 5(500 divided by 100).
As a fraction the above may alternatively be expressed as former being 5 times of the latter or latter being 1/5^thof the former.
As a percentage the relationship between 100 and 500 may be expressed as 20% of the latter (100/500 x 100) = 20%.
As a proportion the relationship between 100 and 500 may be expressed as 1 : 5. Ratio analysis facilitates the presentation of information of financial statements in simplified, concise and summarized form.

Nature of Ratio Analysis:

Ratios, by themselves, are not an end but only one of the means of understanding the financial health of a business entity. Ratio analysis is not capable of providing precise answers to all the problems faced by any business unit. Ratio analysis is basically a technique of:

1.   Establishing meaningful relationship between significant variables of financial
statements and

2.   Interpreting the relationships to form judgment regarding the financial affairs of the unit.

Usefulness of Ratio Analysis:

Usefulness of ratio analysis depends upon identifying:

1.   Objective of analysis

2.   Selection of relevant data

3.   Deciding appropriate ratios to be calculated

4.   Comparing the calculated ratios with norms or standards or forecasts; and

5.   Interpretation of the ratios

Important Factors For Understanding Ratios Analysis:

Quality of Financial Statements:

The reliability of ratios is linked with the quality of financial statements. Financial statements which have been prepared by faithful adherence to generally accepted accounting principles (GAAP). Generally accepted accounting principles are likely to contain reliable data. Calculation of ratios from such financial statements is bound to be more useful and trustworthy.

Purpose of Analysis:

Users of accounting information are different such as short-term and long-term creditors; owners and would be investors; trade unions; tax authorities; competitors etc., object of each group of interested parties is also different such as liquidity or solvency or profitability, etc. So, before undertaking the analysis, one should be clear about the object of analysis. It is the object of analysis which determines the area (liquidity, solvency, profitability, leverage, activity etc.) to be studied, analyzed and interpreted.

Selection of Ratios:

There is no end to the number of ratios which can be calculated. In 1919, Alexander Wall developed an elaborated system of ratio analysis. The same has been extended and modified over the period of time. So the ratios to be calculated should be selected judiciously taking into consideration the object of analysis. The ratios selected should serve the purpose of analysis. For example, short term creditors 'purpose is liquidity whereas owners' purpose may be served by solvency.

Standards to be Applied:

Any ratio in itself i.e. in isolation is meaningless. It must be compared with some standard to arrive at any logical conclusion. The analyst can choose the comparing standard from (a) Rule of thumb (b) past ratios (c) projected standards or (d) industry standards. Selection of standards for the purpose of interpretation will also depend upon the object of the analysis and the capacity of the analyst. For example, management (being the insider) can opt. for project standards whereas any outsider's choice shall be limited to the published information of the unit.

Capability of the Analyst:

Analysis is a tool in the hands of the analyst. Knife (as a tool) in the hands of a criminal may take the life but the knife (as a tool) in the hands of a surgeon may give new life to a patient. Interpretation depends on the educational background; professional skill; experience and intuition of the professional conducting it.

Ratios to be used only as Guide:

Ratios can provide, at the best, the starting point. The analyst, before arriving at the conclusion, should take into consideration all other relevant factors financial and non-financial; macro and micro. For example, general condition of economy; values of society; priorities of the government etc., are the important factors.

Significance and Usefulness of Ratio Analysis:

Ratios as a tool of financial analysis provide symptoms with the help of which any analyst is in a position to diagnose the financial health of the unit. Financial analysis may be compared with biopsy conducted by the doctor on the patient in order to diagnose the causes of illness so that treatment may be prescribed to the patient to help him recover. As, already hinted different groups of persons are interested in the affairs of any business entity, therefore, significance of ratio analysis for various groups is different and may be discussed as follows:

Usefulness to the Management:

1. Decision Making:

Mass of information contained in the financial statements may be unintelligible a confusing. Ratios help in highlighting the areas deserving attention and corrective action facilitating decision making.

2. Financial Forecasting and Planning:

Planning and forecasting can be done only by knowing the past and the present. Ratio help the management in understanding the past and the present of the unit. These also provide useful idea about the existing strength and weaknesses of the unit. This knowledge is vital for the management to plan and forecast the future of the unit.

3. Communication:

Ratios have the capability of communicating the desired information to the relevant persons in a manner easily understood by them to enable them to take stock of the existing situation:

4. Co-ordination is Facilitated:

Being precise, brief and pointing to the specific areas the ratios are likely to attract immediate grasping and attention of all concerned and is likely to result in improved coordination from all quarters of management.

5. Control is more Effective:

System of planning and forecasting establishes budgets, develops forecast statements and lays down standards. Ratios provide actual basis. Actual can be compared with the standards. Variances to be computed an analyzed by reasons and individuals. So it is great help in administering an effective system of control.

Usefulness to the Owners/Shareholders:

Existing as well as prospective owners or shareholders are fundamentally interested in the (a) long-term solvency and (b) profitability of the unit. Ratio analysis can help them by analyzing and interpreting both the aspects of their unit.

Usefulness to the Creditors

Creditors may broadly be classified into short-term and long term. Short-term creditors are trade creditors, bills payables, creditors for expenses etc., they are interested in analyzing the liquidity of the unit. Long-term creditors are financial institutions, debenture holders, mortgage creditors etc., they are interested in analyzing the capacity of the unit to repay periodical interest and repayment of loans on schedule. Ratio analysis provides, both type of creditors, answers to their questions.

Usefulness to Employees:

Employees are interested in fair wages: adequate fringe benefits and bonus linked with productivity/profitability. Ratio analysis provides them adequate information regarding efficiency and profitability of the unit. This knowledge helps them to bargain with the management regarding their demands for improved wages, bonus etc.

Usefulness to the Government:

Govt. is interested in the financial information of the units both at macro as well as micro levels. Individual unit's information regarding production, sales and profit is required for excise duty, sales tax and income tax purposes. Group information for the industry is required for formulating national policies and planning. In the absence of dependable information, Govt. plans and policies may not achieve desired results.

Limitations of Ratios Analysis:

Ratio analysis is a widely used and useful technique to evaluate the financial position and performance of any business unit but it suffers from a number of limitations. These limitations must be kept in mind by the analyst while using this technique.

Reliability is Linked with Accounting Data:

Ratios are calculated on the basis of accounting information. Accounting system has certain in built limitations like historical cost, going concern value, stable monetary value, etc. So, limitations of accounting data affect the quality of ratios also. After, all ratios can't be more reliable than the reliability of data itself.

Qualitative Factors are Ignored:

Ratio analysis is only a quantitative analysis. Sometimes qualitative factors may be  important. For example, management may be justified in making huge purchases of raw material in anticipation of large demand of its product for the coming period. But ratios are not capable of considering qualitative factors.

Isolated Ratios is Meaningless:

Ratios assume significance only when studied in proper context and if compared with norms or over a period. Ratio in itself does not convey any sense.

Ratio Analysis is Historical:

Ratios are based on the facts contained in financial statements. These statements contain
past records. Past may be less important or irrelevant for the management than present and future.

Different Accounting Practice Render Ratios Incomparable:

Accounting permits alternative treatment of many items like depreciation, valuation of tock, deferred expenses etc. Ratios based on statements prepared by following different practices are not comparable.

Price Level Changes Affect the Utility of Ratio Analysis:

Comparison of ratios over a period of time relating to same unit may be misleading. For example, sales may be static in quantity but higher in dollar value due to inflation.

Incompetence or Bias of Analyst:

Much depends upon the skill, integrity and competence of the analyst to use ratios judiciously.

Lack of Adequate Standards:

There are no well-accepted standards or rule of thumb for all ratios which might be expected as norms for comparison. It renders interpretation of ratios difficult and to some extent arbitrary.

Window Dressing:

Financial statements can easily be "window dressed" to depict better than real picture of the enterprise. Moreover the analyst depending only upon published financial statements will not be in a position to get inside information.