9. How to Apply Key Ratios of P&L Statement

Curated By
Santosh Pasi
Options Trader and Trainer, SEBI registered Research Analyst

Skill Sheet: What You Will Learn Here 

  • Key ratios of P&L Statements
  • Their formulas and application
  • Analysis of carious rations
  • Observations based on the ratios

Every trader or investor aims to make fruitful trades or investments. However, the road to success is long and it takes systematic preparation, which is what you’ve been doing so far.

In this chapter, we look at key ratios from Profit and Loss Statements and their practical application. These ratios can be classified as:

  • Asset efficiency ratio
  • Collection efficiency ratio

Let’s take a detailed look:

Asset efficiency ratio

Asset efficiency ratio measures how efficiently assets are put to use to generate revenue. They are:

Total asset turnover:

This compares sales generated out of the total assets.

Formula: Sales/Total assets

Consolidated Profit and Loss Account

 

 

 

 

 

Period

Mar 21

Mar 20

Mar 19

Mar 18

Mar 17

Net Sales (Rs Cr)

17397

16350.2

17548.84

14840.52

13180.04

Consolidated Balance Sheet

 

 

 

 

 

Total Assets

19163.45

16481.99

13648.94

13142.58

9876.01

Average Total Assets

17822.72

15065.47

13395.76

11509.3

8697.78

Asset Turnover

0.98

1.09

1.31

1.29

1.52

Net fixed asset turnover:

This ratio measures the sales to net fixed assets.

Formula: Sales/Net fixed assets

Consolidated Profit and Loss Account

 

 

 

 

 

Period

Mar 21

Mar 20

Mar 19

Mar 18

Mar 17

Net Sales (Rs Cr)

17397

16350.2

17548.84

14840.52

13180.04

Consolidated Balance Sheet

 

 

 

 

 

Fixed Assets

11264.09

10557.26

7054.42

6385.65

5416.64

Average Fixed Assets

10910.68

8805.84

6720.035

5901.145

4566.42

Asset Turnover

1.59

1.86

2.61

2.51

2.89

A brief analysis:

A study of the tables above reveals a declining trend in both ratios since March 2019. This reveals may be due to the additional assets that were created. In the coming years, efficiency may improve as sales rise. This ratio is best suited for companies in the manufacturing industry.

Collection efficiency ratios

These are a set of ratios that measure how quickly, or efficiently current assets, such as debtors and inventories are into cash. It also measures how quickly creditors are paid off.

Receivables turnover

It measures the number of times sundry debtors are converted into cash, i.e., the frequency of collection.

Formula: Net sales/Average receivables

Along with this, we can calculate the receivable days, which tells us how many days receivables stay as receivables in the books on average before a customer pays.

Formula: No of days in a year (365 days)/Receivables days

Consolidated Profit and Loss Account

 

 

 

 

 

Period

Mar 21

Mar 20

Mar 19

Mar 18

Mar 17

Net Sales (Rs Cr)

17397

16350.2

17548.84

14840.52

13180.04

Consolidated Balance Sheet

 

 

 

 

 

Trade Receivables

732.04

445.08

779.49

550.15

386.49

Average Receivables

588.56

612.285

664.82

468.32

339.625

Receivables Turnover

29.56

26.70

26.40

31.69

38.81

Days in a Year

365

365

365

365

365

Receivables Days

12.35

13.67

13.83

11.52

9.41

A brief analysis:

The higher the receivable collection turnover, the higher the collection frequency, and this is evident from the above table. The receivables turnover ratio has come down from 38.81 to 29.56. The frequency has reduced. The receivables days have also increased from 9.41 days to 12.35 days. This means the collection period has increased, showing some lax in the collection.

Inventory turnover:

This refers to how many times inventory is replenished during the year. The more, the better, as it shows the demand for the product is high.

Formula: Cost of goods sold/Inventory

The inventory days are the time taken for the inventory to get replenished.

Formula: No. of days in a year (365 days)/Inventory turnover

Consolidated Profit and Loss Account

 

 

 

 

 

Period

Mar 21

Mar 20

Mar 19

Mar 18

Mar 17

Cost of goods sold (Rs Cr)

11907.88

11557.79

12567.84

10552.15

8817.03

Consolidated Balance Sheet

 

 

 

 

 

Inventories

2076.6

1808.25

2051.48

1721.49

1729.4

Average Inventories

1942.43

1929.87

1886.49

1725.45

1374.58

Inventory Turnover

6.13

5.99

6.66

6.12

6.41

Days in a Year

365

365

365

365

365

Inventory Bays

59.54

60.95

54.79

59.68

56.90

A brief analysis:

The number of times, or the frequency, of replenishing the inventory is stable in the range of around 6 times. The inventory days, i.e., the time taken to replenish the inventory is also more or less stable.

Payables turnover:

This ratio measures how frequently the sundry creditors are paid off. Credit purchases from suppliers are made regularly for manufacturing or trading activities. This ratio measures how fast a company sells its goods and receives cash to pay off its creditors.

Formula: Cost of goods sold/Total payables

We will use the cost of goods sold as many elements are bought on credit. Also, on the denominator, we will add trade payables and other current liabilities.
Payable days are the number of days within which creditors are paid off.

Formula: No. of days in a year/Payables turnover

Consolidated Profit and Loss Account

 

 

 

 

 

Period

Mar 21

Mar 20

Mar 19

Mar 18

Mar 17

Cost of goods sold (Rs Cr)

11907.88

11557.79

12567.84

10552.15

8817.03

Trade Payables (a)

1929.26

1610.72

1368.66

1512.57

1040.75

Other Current Liabilities (b)

2036.03

1127.55

741.55

553.52

625.54

Total Payables (a + b)

3965.29

2738.27

2110.21

2066.09

1666.29

Average Payables

3351.78

2424.24

2088.15

1866.19

1483.285

Payables Turnover

3.55

4.77

6.02

5.65

5.94

Days in a Year

365

365

365

365

365

Payable Days

102.74

76.56

60.64

64.55

61.40

A brief analysis:

In the above table, we can see that the payables turnover frequency has reduced from 6.02 in March 2019 to 3.55 times in March 2021. The number of days taken to pay off creditors has also increased substantially from around 61 to 103 days. While it is good for the company, it will impact its reputation. Many times, supplies are bought if the prices are expected to rise in future. This could also be one of the reasons for the increased number of days.

Working capital cycle:

This is the total of the receivable days, inventory days-payable days.

Working Capital Cycle Mar-21 Mar-20 Mar-19 Mar-18 Mar-17

Receivables Days (a)

12.35

13.67

13.83

11.52

9.41

Inventory Days (b)

59.54

60.95

54.79

59.68

56.90

Total Conversion Days (a + b)

71.89

74.61

68.62

71.20

66.31

Payable Days (c)

102.74

76.56

60.64

64.55

61.40

Working Capital Cycle in days
(a + b - c)

-30.85

-1.94

7.97

6.65

4.91

 
A brief analysis:

In March 2021, the payable days increased to 102.74, which could be a temporary effect. The receivable and inventory days are in a stable range.

Points to remember:

  • P&L Statements can throw light on various aspects of a company’s health
  • You must keep these efficiency ratios handy while studying the statement
  • Calculations will give you a clear idea about whether the company is worth investing in
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