Lesson 3 of 5
Ratios, working capital and budgeting
2 min read
Ratio analysis
| Category | Ratio | Formula | Tells you |
|---|---|---|---|
| Liquidity | current ratio | current assets ÷ current liabilities | can short-term obligations be paid? (often about 1.5–2 is comfortable) |
| Liquidity | quick ratio | (current assets − inventory) ÷ current liabilities | liquidity without relying on selling stock |
| Profitability | gross, operating, net margin | profit ÷ revenue | how much of each rupee is kept |
| Profitability | ROE | net income ÷ shareholders' equity | return to shareholders |
| Profitability | ROCE | EBIT ÷ capital employed | how well all capital is used |
| Leverage | debt to equity | total debt ÷ equity | financial risk |
| Leverage | interest coverage | EBIT ÷ interest | ability to service debt |
| Efficiency | inventory turnover | COGS ÷ average inventory | how fast stock sells |
| Efficiency | receivable days (DSO) | receivables ÷ revenue × 365 | how fast customers pay |
| Valuation | P/E | price per share ÷ EPS | how much investors pay per rupee of earnings |
Ratios only mean something compared with the company's history, peers and industry norms. A supermarket's 3% net margin may be excellent; a software company's would be poor.
Working capital
Working capital = current assets − current liabilities. The cash conversion cycle = DIO (days inventory outstanding) + DSO (days sales outstanding) − DPO (days payables outstanding). A shorter cycle means less cash tied up.
Levers: collect from customers faster (clear invoicing, follow-ups, early-payment discounts), hold less inventory, negotiate longer supplier terms without damaging relationships.
Accounts payable and receivable
- AP: verify invoices (three-way match with PO and GRN), check GST details, schedule payments by due dates, deduct TDS where applicable, reconcile vendor statements.
- AR: raise accurate invoices, track ageing (0–30, 31–60, 61–90, 90+ days), follow up on overdue amounts, reconcile customer accounts, provide for doubtful debts.
- Bank reconciliation: match the bank statement with the books and explain differences (cheques not yet cleared, bank charges, direct deposits).
Budgeting and variance analysis
A budget is a financial plan. Compare actuals with the budget monthly:
- Variance = actual − budget; label it favourable or unfavourable.
- Investigate the why behind big variances (volume, price, timing, one-offs) and act.
- Forecasts update expectations during the year (rolling forecasts).
Check yourself
- Current assets ₹30 lakh, inventory ₹10 lakh, current liabilities ₹20 lakh: current and quick ratios?
- What does a rising DSO tell you?
- Revenue was ₹90 lakh vs a ₹100 lakh budget. What questions would you ask?
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