Useful ratios to know in the balance sheet of a company

Most of you would have already received the balance sheets of companies you are invested in.

ET Wealth explains how to compute a few useful ratios from the available data.

VALUATION

PBV RATIO
The formula: Share price/book value per share (or market cap net worth)

What does it mean?
It compares the market value of a stock to its net worth, or assets minus liabilities. A low PB ratio means the stock is undervalued.

Useful for: All sectors, particularly for banking where assets (i.e. loans) are close to market value.

Firms with high PB ratios (PB (times))
Hindustan Unilever: 36.92
Bajaj Finserve Ltd: 23.73
Colgate Palmolive India: 23.04
EFFICIENCY

Inventory Turnover ratio
The formula: Cost of goods sold/Average inventory
What does it mean?
Indicates how many times a company's inventory is sold and replaced in a year’s time (more the better). Since this ratio varies across industries, compare it against company's previous values or with similar company.

Useful for: Most manufacturing sectors that have large supply chains.

Most auto companies are managing inventory well (Inventory turnover (times))
Hero MotoCorp: 46.41
Bajaj Auto: 31.90
Mahindra & Mahindra: 17.43

Account Receivables Turnover ratio
The formula: Total sales / Average accounts receivable (Total sales considered because total credit sales not available)

What does it mean?
Indicates the number of times the average account receivable is collected in a year. Since this ratio indicates the ability of a company to collect funds from debtors in a timely manner, higher the ratio, the better. This ratio also varies across industries.

Useful for: Most manufacturing sectors that have large supply chains.

Figures should be compared with similar companies (Receivable turnovers (times))
Reliance Industries: 59.11
Colgate Palmolive India: 39.06
Bharti Infratel: 35.07

FINANCIAL STRENGTH

Current ratio
The formula: Current assets / Current liabilities

What does it mean?
Determines a company’s ability to pay back short-term liabilities. A high ratio means the company is not utilising enough current liabilities. Be careful if ratio is below 1.

Useful for: Sectors with large supply chains.

Ratio is high for cash-rich businesses (Current ratio (times))
Tata Consultancy Services: 6.41
Infosys: 4.05
Zee Entertainment Enterprises: 3.68

Quick ratio (Acid test ratio)
The formula: (Current assets - inventories) / Current liabilities

What does it mean?
Tests the company’s ability to pay off current liabilities at short notice. Inventories are not considered as they take time to liquidate. Ratio above 0.5 times is considered good.

Useful for: Most manufacturing sectors that have large supply chain on both sides.

Cash-rich businesses have high ratio (Quick ratio (times))
Tata Consultancy Services: 6.41
Infosys: 4.05
Wipro: 3.50

Debt-Equity ratio
The formula: Long-term debt / Net worth (or shareholders’ equity)

What does it mean?
A high debt-equity ratio indicates that most assets are funded by debt. While zero debt companies are best, investors should be careful if this ratio is above 2.

Useful for: Most sectors except financials.

Investors should be wary of ratio above 2 (Debt/equity (times))
Idea Cellular: 2.33
JSW Steel: 1.60
Piramal Enterprises: 0.71

PROFITABILITY

Return on equity (ROE)
The formula: Profit after tax / Net worth (or shareholders’ equity)

What does it mean?
It measures the returns the company is generating on shareholders’ equity. More the better. This ratio should be significantly higher than the returns available in the market.

Useful for: Most sectors.

Concentrate on companies with very high ROE (ROE %)
Hindustan Unilever: 70.73%
Colgate-Palmolive (India): 50.48%
Hero MotoCorp: 35.66%

Return on capital employed (ROCE)
The formula: Profit before interest and tax / Total capital employed

What does it mean?
The comparison here is between operating profit and total capital employed, including debt. More useful than ROE to evaluate the longevity of a company.

Useful for: Most sectors other than financials.

Companies should match your cost of capital (ROCE %)
Hindustan Unilever: 100.52%
Colgate-Palmolive (India): 73.88%
Hero MotoCorp: 49.24%

Return on assets (ROA)
The formula: Profit after tax / Total assets

What does it mean?
Measures the efficiency with which the management is utilising assets. Since this ratio varies across industries, one needs to compare it against the company’s previous values or ratio of a similar company.

Useful for: Banking sector.

Bet on companies with high ROA (ROA %)
Hindustan Unilever: 31.68%
Tata Consultancy Services: 29.08%
Hero MotoCorp: 23.04%

Source: ETIG Database; Data based on BSE 100 companies whose balance sheet of 2016-17 available