Corporate Finance

Financial Statements and Firm Value 
 119

Sales/Working Capital
Computation: Net sales divided by (current assets minus current liabilities)

=

Net workin gcapital

Net sales

Meaning: It measures the efficiency with which working capital is employed. A low ratio may indicate
inefficiency and a high ratio may indicate efficient usage of working capital or over trading.

OPERATING RATIOS: HOW EFFICIENT IS THE COMPANY?

These are measures of financial efficiency, with which the firm employs capital—be it owner’s capital or
the total capital. Accordingly, there are two, commonly used measures: Return on Equity (ROE) and Return
on Investment (ROI), depending on whose viewpoint you are analyzing.

Return on Equity
Computation: Earnings available for shareholders divided by Net worth.

i.e., ROE =
Net worth

Profit after tax – Preference dividend(if any)

Meaning: This ratio measures the efficiency with which the firm employs owner’s equity. It estimates
profits per rupee of shareholder’s funds.

Return on Assets
Computation:
Variant 1: Earnings before interest and taxes divided by total assets.
Variant 2: Earnings before interest and taxes (1 – tax rate) divided by total assets.

PROFITABILITY RATIOS

These ratios relate profit to sales. Some of the profitability ratios are:

1. Operating profit margin = EBIT ÷ Sales


2. Net profit margin = PAT ÷ Sales

Coming back to HLL, the ratios for HLL are presented here along with their definitions:

2000 2001 Industry

A. Profitability ratios
Profit margin (PAT/net sales) 12.28 13.48
Return on assets (EBIT/total assets) 29.24 30.30
Return on equity 56.66 53.35

Table contd.