The techniques that are used to do such proper comparative analysis are: (i)
common-sized statement, and (ii) financial ratio analysis.6.2. The common-size statement is prepared by expressing the items in the
Balance Sheet as percentages of total assets and the items in the P & L
Account as percentages of sales. The last two columns of Table 1 show
common – size statement for Shatabdi Industries. Once common-size
statements are prepared, straight comparison between two firms or between a
firm and industry averages is possible.
6.3. Financial ratio analysis is perhaps the most extensively used tool for
comparative analysis. The ratios which are useful for carrying out such
comparison depend upon the purpose of the analysis. For example, short-
term creditors would be interested in monitoring ratios that reflect the ability
of the firm to meet its short-term liabilities, while long-term creditors and
share-holders would in addition be interested in ratios that measure the long-
term performance of the firm. There are broadly four types of ratios that are
used for analyzing the performance of a firm :
- Liquidity ratios measure the firm’s ability to fulfill its short-term
obligations. - Leverage/Capital structure ratios measure the firm’s ability to meet its
short-term as well as long-term debt obligations. - Turnover/Activity ratios measure how effectively the firm is using its
assets. - Profitability ratio measure the return on sales and assets of the firm.
- Common stock ratios measure dividends, earnings and net worth on a per
share basis.
6.4. The reader is encouraged to evaluate Shatabdi Industries by computing and
interpreting the ratios defined in the Appendix. The authors’ summary
evaluation of the company is as follows :
Despite a substantial improvement in the performance of Shatabdi
Industries in 1991, the profitability ratios continue to be mediocre.
Though the profit margin on sales is good, low asset turnover
ratios have led to a low return on capital employed. Closer
analysis reveals that the turnover of current assets is reasonably
good and the low asset turnover ratio is due to fixed assets being
large in relation to sales. Shatabdi Industries has followed very
conservative financial policies as reflected in the high current ratio
of over 2, a relatively low long-term debt to equity ratio of 0.84
and a good interest coverage ratio of over 4. The company has
also been conservative in rewarding the shareholders. The payout
ratio is less than 20%. The large free reserves in relation to paid-
up capital indicate that the company is ripe for a bonus issue. In