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Unit 4: Ratio Analysis




          Solution:                                                                             Notes

                           Long-term debt-equity Ratio  =  Debt  = 35/  = 6.

                                                    Net Worth


          Higher ratio indicates the riskier financial status of the firm which means that the firm has been


          financed by the greater outsiders’ fund rather than that of the owners’ fund contribution and
          vice versa.
               !
             Caution   Standard norm of the Debt-Equity Ratio:
             The ideal norm is 1:2 which means that every one rupee of debt finance is covered by two

             rupees of shareholders’ fund.

          The firm should have a minimum of 50% margin of safety in meeting the long-term fi nancial

          commitments. If the ratio exceeds the specification, the interest of the firm will be ruined by the

          outsiders’ during the moment at when they are unable to make the payment of interest in time as
          per the terms of agreement reached earlier. During the moment of liquidation, the greater ratio
          may facilitate the creditors to recover the amount due lesser holding held by the owners.
          Total Debt-equity Ratio

          The ultimate purpose of the ratio is to express the relationship total volume of debt irrespective
          of nature and shareholders’ funds. If the owners’ contribution is lesser in volume in general
          irrespective of its nature leads to worse situation in recovering the amount of outsiders’
          contribution during the moment of liquidation.

                       Total Debt-equity Ratio  =  Short-term  Debt  +  Long-term Debt
                                                     (
                                               Equity Shareholders Fundd)
                                                                '
                 Example:  The long-term debt of company ABC is ` 3 crores and the networth of the
          company is  ` 5 crores. If the company has a short term debt of  ` 1 crore, what is the total
          debt-equity ratio of ABC?

          Solution:

                                                                            :
                   Total Debt-equity Ratio   =  Short-term Debt + Long-term Debt  = =  1+3  = 45
                                           Equity(Shareholders' Fund)  5
          4.4.2 Proprietary Ratio

          The ratio illustrates the relationship in between the owners’ contribution and the total volume of
          assets. In simple words, how much funds are contributed by the owners in financing the assets

          of the fi rm. Greater the ratio means that greater contribution made by the owners’ in fi nancing
          the assets.
                    Proprietary Ratio  =  Owners' Funds or Equity or Shareholders' Funds
                                                   Total Assets

               !
             Caution   Standard Norm of the ratio: Higher the ratio, better is the position


          Higher ratio is better position for the firm as well as safety to the creditors.



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