Ratio analysisRatio analysis

Is a method or process by which the Is a method or process by which the relationship of items or groups of items in the relationship of items or groups of items in the financial statements are computed, and financial statements are computed, and presented. presented.

Is an important tool of financial analysis. Is an important tool of financial analysis. Is used to interpret the financial statements so Is used to interpret the financial statements so

that the strengths and weaknesses of a firm, its that the strengths and weaknesses of a firm, its historical performance and current financial historical performance and current financial condition can be determined.condition can be determined.

Ratio Ratio

‘‘A mathematical yardstick that measures A mathematical yardstick that measures the relationship between two figures or the relationship between two figures or groups of figures which are related to groups of figures which are related to each other and are mutually inter-each other and are mutually inter-dependent’. dependent’.

It can be expressed as a pure ratio, It can be expressed as a pure ratio, percentage, or as a ratepercentage, or as a rate

Words of cautionWords of caution A ratio is not an end in itself. They are only a A ratio is not an end in itself. They are only a

means to get to know the financial position of means to get to know the financial position of an enterprise.an enterprise.

Computing ratios does not add any information Computing ratios does not add any information to the available figures. to the available figures.

It only reveals the relationship in a more It only reveals the relationship in a more meaningful way so as to enable us to draw meaningful way so as to enable us to draw conclusions there from.conclusions there from.

Utility of RatiosUtility of Ratios

Accounting ratios are very useful in Accounting ratios are very useful in assessing the financial position and assessing the financial position and profitability of an enterprise. profitability of an enterprise.

However its utility lies in comparison of However its utility lies in comparison of the ratios. the ratios.

Utility of RatiosUtility of Ratios

Comparison may be in any one of the following Comparison may be in any one of the following forms:forms:

For the same enterprise over a number of yearsFor the same enterprise over a number of years For two enterprises in the same industryFor two enterprises in the same industry For one enterprise against the industry as a wholeFor one enterprise against the industry as a whole For one enterprise against a pre-determined standardFor one enterprise against a pre-determined standard For inter-segment comparison within the same For inter-segment comparison within the same

organisationorganisation

Classification of RatiosClassification of Ratios

Ratios can be broadly classified into four groups Ratios can be broadly classified into four groups namely:namely:

Liquidity ratiosLiquidity ratios Capital structure/leverage ratiosCapital structure/leverage ratios Profitability ratiosProfitability ratios Activity ratiosActivity ratios

Liquidity ratiosLiquidity ratios

These ratios analyse the short-term financial These ratios analyse the short-term financial position of a firm and indicate the ability of the firm position of a firm and indicate the ability of the firm to meet its short-term commitments (current to meet its short-term commitments (current liabilities) out of its short-term resources (current liabilities) out of its short-term resources (current assets). assets).

These are also known as ‘solvency ratios’. The These are also known as ‘solvency ratios’. The ratios which indicate the liquidity of a firm are:ratios which indicate the liquidity of a firm are:

Current ratioCurrent ratio Liquidity ratio or Quick ratio or acid test ratioLiquidity ratio or Quick ratio or acid test ratio

Current ratioCurrent ratio

It is calculated by dividing current assets by It is calculated by dividing current assets by current liabilities.current liabilities.

Current ratio = Current ratio = Current assets Current assets where where

Current liabilitiesCurrent liabilities

Conventionally a current ratio of 2:1 is Conventionally a current ratio of 2:1 is considered satisfactoryconsidered satisfactory

CURRENT ASSETSCURRENT ASSETSinclude –include –

Inventories of raw material, WIP, finished goods, Inventories of raw material, WIP, finished goods, stores and spares, stores and spares, sundry debtors/receivables, sundry debtors/receivables, short term loans deposits and advances, short term loans deposits and advances, cash in hand and bank, cash in hand and bank, prepaid expenses, prepaid expenses, incomes receivables and incomes receivables and marketable investments and short term securitiesmarketable investments and short term securities..

CURRENT LIABILITIESCURRENT LIABILITIES

include – include – sundry creditors/bills payable, sundry creditors/bills payable, outstanding expenses, outstanding expenses, unclaimed dividend, unclaimed dividend, advances received, advances received, incomes received in advance, incomes received in advance, provision for taxation, provision for taxation, proposed dividend, proposed dividend, instalments of loans payable within 12 months, instalments of loans payable within 12 months, bank overdraft and cash creditbank overdraft and cash credit

Quick Ratio or Acid Test RatioQuick Ratio or Acid Test Ratio

This is a ratio between quick current assets and current This is a ratio between quick current assets and current liabilities (alternatively quick liabilities). liabilities (alternatively quick liabilities).

It is calculated by dividing quick current assets by It is calculated by dividing quick current assets by current liabilities (quick current liabilities)current liabilities (quick current liabilities)

Quick ratio = Quick ratio = quick assetsquick assets where where

Current liabilities/(quick liabilities) Current liabilities/(quick liabilities)

Conventionally a quick ratio of 1:1 is considered Conventionally a quick ratio of 1:1 is considered satisfactory.satisfactory.

QUICK ASSETS & QUICK QUICK ASSETS & QUICK LIABILITIESLIABILITIES

QUICK ASSETSQUICK ASSETS are current assets (as stated are current assets (as stated earlier) earlier)

less prepaid expenses and inventories.less prepaid expenses and inventories.

QUICK LIABILITIESQUICK LIABILITIES are current liabilities (as are current liabilities (as stated earlier) stated earlier)

less bank overdraft and incomes received in less bank overdraft and incomes received in advance.advance.

Capital structure/ leverage ratiosCapital structure/ leverage ratios

These ratios indicate the long term solvency These ratios indicate the long term solvency of a firm and indicate the ability of the firm of a firm and indicate the ability of the firm to meet its long-term commitment with to meet its long-term commitment with respect to respect to

(i)(i) repayment of principal on maturity or in repayment of principal on maturity or in predetermined instalments at due dates and predetermined instalments at due dates and

(ii)(ii) periodic payment of interest during the periodic payment of interest during the period of the loan. period of the loan.

Capital structure/ leverage ratiosCapital structure/ leverage ratios

The different ratios are:The different ratios are: Debt equity ratioDebt equity ratio Proprietary ratioProprietary ratio Debt to total capital ratioDebt to total capital ratio Interest coverage ratioInterest coverage ratio Debt service coverage ratioDebt service coverage ratio

Debt equity ratioDebt equity ratio

This ratio indicates the relative proportion of debt and This ratio indicates the relative proportion of debt and equity in financing the assets of the firm. It is equity in financing the assets of the firm. It is calculated by dividing long-term debt by shareholder’s calculated by dividing long-term debt by shareholder’s funds.funds.

Debt equity ratio = Debt equity ratio = long-term debts long-term debts where where

Shareholders fundsShareholders funds

Generally, financial institutions favour a ratio of 2:1Generally, financial institutions favour a ratio of 2:1..

However this standard should be applied having regard However this standard should be applied having regard to size and type and nature of business and the degree of to size and type and nature of business and the degree of risk involved.risk involved.

LONG-TERM FUNDSLONG-TERM FUNDS are long-term loans whether are long-term loans whether secured or unsecured like – debentures, bonds, loans secured or unsecured like – debentures, bonds, loans from financial institutions etc.from financial institutions etc.

SHAREHOLDER’S FUNDSSHAREHOLDER’S FUNDS are equity share are equity share capital plus preference share capital plus reserves and capital plus preference share capital plus reserves and surplus minus fictitious assets (eg. Preliminary surplus minus fictitious assets (eg. Preliminary expenses, past accumulated losses, discount on issue expenses, past accumulated losses, discount on issue of shares etc.)of shares etc.)

Proprietary ratioProprietary ratio

This ratio indicates the general financial strength of the This ratio indicates the general financial strength of the firm and the long- term solvency of the business. firm and the long- term solvency of the business.

This ratio is calculated by dividing proprietor’s funds by This ratio is calculated by dividing proprietor’s funds by total funds.total funds.

Proprietary ratio = Proprietary ratio = proprietor’s fundsproprietor’s funds where where

Total funds/assetsTotal funds/assets

As a rough guide a 65% to 75% proprietary ratio is As a rough guide a 65% to 75% proprietary ratio is advisableadvisable

PROPRIETOR’S FUNDS PROPRIETOR’S FUNDS are same as are same as explained in shareholder’s fundsexplained in shareholder’s funds

TOTAL FUNDS TOTAL FUNDS are all fixed assets and all are all fixed assets and all current assets. current assets.

Alternatively it can be calculated as Alternatively it can be calculated as proprietor’s funds plus long-term funds plus proprietor’s funds plus long-term funds plus current liabilities.current liabilities.

Debt to total capital ratioDebt to total capital ratio

In this ratio the outside liabilities are related to In this ratio the outside liabilities are related to the total capitalisation of the firm. It indicates the total capitalisation of the firm. It indicates what proportion of the permanent capital of the what proportion of the permanent capital of the firm is in the form of long-term debt.firm is in the form of long-term debt.

Debt to total capital ratio =Debt to total capital ratio =long- term debt long- term debt

Shareholder’s funds + long- term debtShareholder’s funds + long- term debt

Conventionally a ratio of 2/3 is considered Conventionally a ratio of 2/3 is considered satisfactorysatisfactory..

Interest coverage ratioInterest coverage ratio

This ratio measures the debt servicing capacity of a firm This ratio measures the debt servicing capacity of a firm in so far as the fixed interest on long-term loan is in so far as the fixed interest on long-term loan is concerned. It shows how many times the interest concerned. It shows how many times the interest charges are covered by EBIT out of which they will be charges are covered by EBIT out of which they will be paid. paid.

Interest coverage ratio = Interest coverage ratio = EBITEBIT

InterestInterest

A ratio of 6 to 7 times is considered satisfactoryA ratio of 6 to 7 times is considered satisfactory. . Higher the ratio greater the ability of the firm to pay Higher the ratio greater the ability of the firm to pay interest out of its profits. But too high a ratio may interest out of its profits. But too high a ratio may imply lesser use of debt and/or very efficient operations imply lesser use of debt and/or very efficient operations

Debt service coverage ratioDebt service coverage ratio This is a more comprehensive measure to compute the This is a more comprehensive measure to compute the debt servicing capacity of a firm. It shows how many debt servicing capacity of a firm. It shows how many times the total debt service obligations consisting of times the total debt service obligations consisting of interest and repayment of principal in instalments are interest and repayment of principal in instalments are covered by the total operating funds after payment of covered by the total operating funds after payment of tax.tax.Debt service coverage ratio = Debt service coverage ratio = EAT+ interest + depreciation + other non-cash expEAT+ interest + depreciation + other non-cash exp Interest + principal instalmentInterest + principal instalmentEAT is earnings after tax.EAT is earnings after tax.Generally financial institutions consider 2:1 as a Generally financial institutions consider 2:1 as a satisfactory ratiosatisfactory ratio..

Profitability ratiosProfitability ratios

These ratios measure the operating efficiency of These ratios measure the operating efficiency of the firm and its ability to ensure adequate returns the firm and its ability to ensure adequate returns to its shareholders. to its shareholders.

The profitability of a firm can be measured by its The profitability of a firm can be measured by its profitability ratios.profitability ratios.

Further the profitability ratios can be determined Further the profitability ratios can be determined (i) in relation to sales and (i) in relation to sales and

(ii) in relation to investments(ii) in relation to investments

Profitability ratiosProfitability ratios

Profitability ratios in relation to sales:Profitability ratios in relation to sales: gross profit margingross profit margin Net profit marginNet profit margin Expenses ratioExpenses ratio

Profitability ratiosProfitability ratios

Profitability ratios in relation to investmentsProfitability ratios in relation to investments Return on assets (ROA)Return on assets (ROA) Return on capital employed (ROCE)Return on capital employed (ROCE) Return on shareholder’s equity (ROE)Return on shareholder’s equity (ROE) Earnings per share (EPS)Earnings per share (EPS) Dividend per share (DPS)Dividend per share (DPS) Dividend payout ratio (D/P) Dividend payout ratio (D/P) Price earning ratio (P/E)Price earning ratio (P/E)

Gross profit marginGross profit margin

This ratio is calculated by dividing gross This ratio is calculated by dividing gross profit by sales. It is expressed as a percentage. profit by sales. It is expressed as a percentage.

Gross profit is the result of relationship Gross profit is the result of relationship between prices, sales volume and costs.between prices, sales volume and costs.

Gross profit margin = Gross profit margin = gross profitgross profit x 100 x 100 Net sales Net sales

Gross profit marginGross profit margin

A firm should have a reasonable gross profit A firm should have a reasonable gross profit margin to ensure coverage of its operating margin to ensure coverage of its operating expenses and ensure adequate return to the expenses and ensure adequate return to the owners of the business ie. the shareholders. owners of the business ie. the shareholders.

To judge whether the ratio is satisfactory or To judge whether the ratio is satisfactory or not, it should be compared with the firm’s not, it should be compared with the firm’s past ratios or with the ratio of similar firms in past ratios or with the ratio of similar firms in the same industry or with the industry average.the same industry or with the industry average.

Net profit marginNet profit margin This ratio is calculated by dividing net profit by This ratio is calculated by dividing net profit by sales. It is expressed as a percentage. sales. It is expressed as a percentage. This ratio is indicative of the firm’s ability to This ratio is indicative of the firm’s ability to leave a margin of reasonable compensation to leave a margin of reasonable compensation to the owners for providing capital, after meeting the owners for providing capital, after meeting the cost of production, operating charges and the the cost of production, operating charges and the cost of borrowed funds.cost of borrowed funds.Net profit margin = Net profit margin = net profit after interest and taxnet profit after interest and tax x 100 x 100 Net salesNet sales

Net profit marginNet profit margin

Another variant of net profit margin is operating Another variant of net profit margin is operating profit margin which is calculated as:profit margin which is calculated as:

Operating profit margin = Operating profit margin =

net profit before interest and taxnet profit before interest and tax x 100 x 100

Net salesNet sales

Higher the ratio, greater is the capacity of the Higher the ratio, greater is the capacity of the firm to withstand adverse economic conditions firm to withstand adverse economic conditions and vice versaand vice versa

Expenses ratioExpenses ratio These ratios are calculated by dividing the various expenses by These ratios are calculated by dividing the various expenses by sales. The variants of expenses ratios are:sales. The variants of expenses ratios are: Material consumed ratio = Material consumed ratio = Material consumedMaterial consumed x 100 x 100 Net salesNet salesManufacturing expenses ratio = Manufacturing expenses ratio = manufacturing expensesmanufacturing expenses x x 100100 Net salesNet salesAdministration expenses ratio = Administration expenses ratio = administration expensesadministration expenses x 100 x 100 Net salesNet salesSelling expenses ratio = Selling expenses ratio = Selling expensesSelling expenses x 100 x 100 Net salesNet salesOperating ratio = Operating ratio = cost of goods sold plus operating expensescost of goods sold plus operating expenses x x 100100 Net salesNet salesFinancial expense ratio = Financial expense ratio = financial expensesfinancial expenses x 100 x 100 Net salesNet sales

Expenses ratioExpenses ratio

The expenses ratios should be compared over The expenses ratios should be compared over a period of time with the industry average as a period of time with the industry average as well as with the ratios of firms of similar type. well as with the ratios of firms of similar type. A low expenses ratio is favourable. A low expenses ratio is favourable.

The implication of a high ratio is that only a The implication of a high ratio is that only a small percentage share of sales is available for small percentage share of sales is available for meeting financial liabilities like interest, tax, meeting financial liabilities like interest, tax, dividend etc.dividend etc.

Return on assets (ROA)Return on assets (ROA)

This ratio measures the profitability of the total funds of This ratio measures the profitability of the total funds of a firm. It measures the relationship between net profits a firm. It measures the relationship between net profits and total assets. The objective is to find out how and total assets. The objective is to find out how efficiently the total assets have been used by the efficiently the total assets have been used by the management.management.Return on assets = Return on assets = net profit after taxes plus interestnet profit after taxes plus interest x 100 x 100 Total assetsTotal assetsTotal assets exclude fictitious assets. As the total assets Total assets exclude fictitious assets. As the total assets at the beginning of the year and end of the year may not at the beginning of the year and end of the year may not be the same, average total assets may be used as the be the same, average total assets may be used as the denominator.denominator.

Return on capital employed (ROCE)Return on capital employed (ROCE)

This ratio measures the relationship between net profit and This ratio measures the relationship between net profit and capital employed. It indicates how efficiently the long-term capital employed. It indicates how efficiently the long-term funds of owners and creditors are being used.funds of owners and creditors are being used.Return on capital employed = Return on capital employed = net profit after taxes plus interestnet profit after taxes plus interest x 100 x 100 Capital employedCapital employedCAPITAL EMPLOYEDCAPITAL EMPLOYED denotes shareholders funds and long- denotes shareholders funds and long-term borrowings.term borrowings.To have a fair representation of the capital employed, average To have a fair representation of the capital employed, average capital employed may be used as the denominator.capital employed may be used as the denominator.

Return on shareholders equityReturn on shareholders equity

This ratio measures the relationship of profits to This ratio measures the relationship of profits to owner’s funds. Shareholders fall into two owner’s funds. Shareholders fall into two groups i.e. preference shareholders and equity groups i.e. preference shareholders and equity shareholders. So the variants of return on shareholders. So the variants of return on shareholders equity are shareholders equity are

Return on total shareholder’s equity = Return on total shareholder’s equity = net profits after taxesnet profits after taxes x 100 x 100 Total shareholders equityTotal shareholders equity..

TOTAL SHAREHOLDER’S EQUITYTOTAL SHAREHOLDER’S EQUITY includes preference share capital plus equity includes preference share capital plus equity share capital plus reserves and surplus less share capital plus reserves and surplus less accumulated losses and fictitious assets. To accumulated losses and fictitious assets. To have a fair representation of the total have a fair representation of the total shareholders funds, average total shareholders shareholders funds, average total shareholders funds may be used as the denominatorfunds may be used as the denominator

Return on ordinary shareholders equity = Return on ordinary shareholders equity =

net profit after taxes – pref. dividendnet profit after taxes – pref. dividend x 100 x 100 Ordinary shareholders equity or net Ordinary shareholders equity or net worthworth

ORDINARY SHAREHOLDERS EQUITY ORDINARY SHAREHOLDERS EQUITY OR NET WORTHOR NET WORTH includes equity share capital includes equity share capital plus reserves and surplus minus fictitious assets.plus reserves and surplus minus fictitious assets.

Earnings per share (EPS)Earnings per share (EPS)

This ratio measures the profit available to the This ratio measures the profit available to the equity shareholders on a per share basis. This equity shareholders on a per share basis. This ratio is calculated by dividing net profit available ratio is calculated by dividing net profit available to equity shareholders by the number of equity to equity shareholders by the number of equity shares.shares.

Earnings per share = Earnings per share =

net profit after tax – preference dividendnet profit after tax – preference dividend

Number of equity sharesNumber of equity shares

Dividend per share (DPS)Dividend per share (DPS)

This ratio shows the dividend paid to the This ratio shows the dividend paid to the shareholder on a per share basis. This is a better shareholder on a per share basis. This is a better indicator than the EPS as it shows the amount of indicator than the EPS as it shows the amount of dividend received by the ordinary shareholders, dividend received by the ordinary shareholders, while EPS merely shows theoretically how much while EPS merely shows theoretically how much belongs to the ordinary shareholdersbelongs to the ordinary shareholdersDividend per share = Dividend per share = Dividend paid to ordinary shareholdersDividend paid to ordinary shareholders Number of equity sharesNumber of equity shares

Dividend payout ratio (D/P)Dividend payout ratio (D/P)

This ratio measures the relationship between the This ratio measures the relationship between the earnings belonging to the ordinary shareholders and the earnings belonging to the ordinary shareholders and the dividend paid to them.dividend paid to them.

Dividend pay out ratio = Dividend pay out ratio =

total dividend paid to ordinary shareholderstotal dividend paid to ordinary shareholders x 100 x 100

Net profit after tax –preference dividendNet profit after tax –preference dividend

OROR

Dividend pay out ratio = Dividend pay out ratio = Dividend per shareDividend per share x 100 x 100

Earnings per shareEarnings per share

Price earning ratio (P/E)Price earning ratio (P/E) This ratio is computed by dividing the market This ratio is computed by dividing the market price of the shares by the earnings per share. It price of the shares by the earnings per share. It measures the expectations of the investors and measures the expectations of the investors and market appraisal of the performance of the firm.market appraisal of the performance of the firm.

Price earning ratio = Price earning ratio = market price per sharemarket price per share

Earnings per shareEarnings per share

Activity ratiosActivity ratios

These ratios are also called efficiency ratios / asset These ratios are also called efficiency ratios / asset utilization ratios or turnover ratios. These ratios utilization ratios or turnover ratios. These ratios show the relationship between sales and various show the relationship between sales and various assets of a firm. The various ratios under this group assets of a firm. The various ratios under this group are:are:

Inventory/stock turnover ratioInventory/stock turnover ratio Debtors turnover ratio and average collection Debtors turnover ratio and average collection

period period Asset turnover ratioAsset turnover ratio Creditors turnover ratio and average credit Creditors turnover ratio and average credit

periodperiod

Inventory /stock turnover ratioInventory /stock turnover ratio

This ratio indicates the number of times inventory is This ratio indicates the number of times inventory is replaced during the year. It measures the relationship replaced during the year. It measures the relationship between cost of goods sold and the inventory level. between cost of goods sold and the inventory level. There are two approaches for calculating this ratio, There are two approaches for calculating this ratio, namely:namely:Inventory turnover ratio = Inventory turnover ratio = cost of goods soldcost of goods sold Average stockAverage stockAVERAGE STOCKAVERAGE STOCK can be calculated as can be calculated as Opening stock + closing stockOpening stock + closing stock 2 2 Alternatively Alternatively Inventory turnover ratio = Inventory turnover ratio = salessales__________________ Closing inventoryClosing inventory

Inventory /stock turnover ratioInventory /stock turnover ratio

A firm should have neither too high nor too A firm should have neither too high nor too low inventory turnover ratio. Too high a ratio low inventory turnover ratio. Too high a ratio may indicate very low level of inventory and a may indicate very low level of inventory and a danger of being out of stock and incurring high danger of being out of stock and incurring high ‘stock out cost’. On the contrary too low a ‘stock out cost’. On the contrary too low a ratio is indicative of excessive inventory ratio is indicative of excessive inventory entailing excessive carrying cost.entailing excessive carrying cost.

Debtors turnover ratio and average Debtors turnover ratio and average

collection periodcollection period This ratio is a test of the liquidity of the debtors This ratio is a test of the liquidity of the debtors of a firm. It shows the relationship between of a firm. It shows the relationship between credit sales and debtors.credit sales and debtors.

Debtors turnover ratio =Debtors turnover ratio =

Credit salesCredit sales Average Debtors and bills receivablesAverage Debtors and bills receivables

Average collection period = Average collection period =

Months/days in a yearMonths/days in a year

Debtors turnover Debtors turnover

Debtors turnover ratio and average Debtors turnover ratio and average collection periodcollection period

These ratios are indicative of the efficiency of These ratios are indicative of the efficiency of the trade credit management. A high turnover the trade credit management. A high turnover ratio and shorter collection period indicate ratio and shorter collection period indicate prompt payment by the debtor. On the prompt payment by the debtor. On the contrary low turnover ratio and longer contrary low turnover ratio and longer collection period indicates delayed payments collection period indicates delayed payments by the debtor.by the debtor.In general a high debtor turnover ratio and In general a high debtor turnover ratio and short collection period is preferableshort collection period is preferable..

Asset turnover ratioAsset turnover ratio

Depending on the different concepts of assets employed, there Depending on the different concepts of assets employed, there arearemany variants of this ratio. These ratios measure the efficiency many variants of this ratio. These ratios measure the efficiency of a firm in managing and utilising its assets.of a firm in managing and utilising its assets.Total asset turnover ratio = Total asset turnover ratio = sales/cost of goods soldsales/cost of goods sold Average total assetsAverage total assetsFixed asset turnover ratio = Fixed asset turnover ratio = sales/cost of goods soldsales/cost of goods sold Average fixed assetsAverage fixed assetsCapital turnover ratio = Capital turnover ratio = sales/cost of goods soldsales/cost of goods sold Average capital employedAverage capital employedWorking capital turnover ratio = Working capital turnover ratio = sales/cost of goods soldsales/cost of goods sold Net working capitalNet working capital

Asset turnover ratioAsset turnover ratio

Higher ratios are indicative of efficient Higher ratios are indicative of efficient management and utilisation of resources while management and utilisation of resources while low ratios are indicative of under-utilisation of low ratios are indicative of under-utilisation of resources and presence of idle capacity.resources and presence of idle capacity.

Creditors turnover ratio and average Creditors turnover ratio and average credit periodcredit period

This ratio shows the speed with which payments This ratio shows the speed with which payments are made to the suppliers for purchases made are made to the suppliers for purchases made from them. It shows the relationship between from them. It shows the relationship between credit purchases and average creditors.credit purchases and average creditors.

Creditors turnover ratio = Creditors turnover ratio =

credit purchasescredit purchases Average creditors & bills payables Average creditors & bills payables

Average credit period = Average credit period = months/days in a yearmonths/days in a year

Creditors turnover ratio Creditors turnover ratio

Creditors turnover ratio and average Creditors turnover ratio and average credit periodcredit period

Higher creditors turnover ratio and short credit Higher creditors turnover ratio and short credit period signifies that the creditors are being period signifies that the creditors are being paid promptly and it enhances the paid promptly and it enhances the creditworthiness of the firm.creditworthiness of the firm.