Financial statement analysis using ratios

Financial ratio analysis is a systematic method of comparing line items from a company’s balance sheet, income statement and cash‑flow statement. By converting absolute numbers into relative measures, ratios remove the size effect and allow analysts to benchmark a firm against peers, industry norms, or its own historical performance.

In the NISM certification, candidates are expected to know the most commonly used ratios, the exact formula prescribed by SEBI‑recognised textbooks, and the interpretation of high or low values. The exam frequently presents a mini‑balance sheet and asks for one or more ratio calculations.

Remember that all ratios must be computed using figures from the same reporting period; mixing quarterly and annual data is a frequent source of error.

• Liquidity ratios assess short‑term ability to meet obligations.
• Solvency ratios gauge long‑term financial risk.
• Profitability, efficiency and market ratios reveal performance and valuation insights.

The Current Ratio measures a firm’s ability to cover its short‑term liabilities with its short‑term assets. It is a primary indicator of liquidity and is closely watched by banks and regulators in India.

A ratio above 1.0 generally suggests that the company can meet its current obligations, whereas a ratio far below 1.0 may signal potential cash‑flow problems. However, an excessively high ratio could indicate inefficient use of working capital.

In the NISM exam, you will be given Current Assets and Current Liabilities and asked to compute the ratio, then choose the correct interpretation from multiple‑choice options.

Debt‑to‑Equity (D/E) compares a company’s total debt to its shareholders’ equity, indicating the degree of financial leverage. In Indian corporate analysis, a D/E ratio higher than the industry average may raise concerns for investors and regulators.

A lower D/E ratio reflects a stronger equity base, but an extremely low ratio could imply that the firm is not optimising its capital structure for growth.

Exam questions often provide Total Debt and Shareholders’ Equity and ask you to compute D/E, then decide whether the firm is over‑leveraged based on typical Indian benchmarks (e.g., D/E > 2.0 is considered high).

Return on Equity measures the profit generated for each rupee of shareholders’ equity. It is a key performance indicator for equity investors and is heavily featured in SEBI‑mandated disclosures.

ROE is expressed as a percentage. A high ROE indicates efficient use of equity capital, but extremely high values may be the result of excessive leverage, which should be cross‑checked with the D/E ratio.

In the NISM exam, you will calculate ROE and then be asked to compare it with a peer group or a benchmark figure.

Inventory Turnover indicates how many times a company sells and replaces its inventory during a period. It reflects operational efficiency and inventory management, which are critical for manufacturing and retail firms in India.

A higher turnover suggests strong sales or efficient inventory control, whereas a low turnover may point to over‑stocking or obsolete inventory.

Exam questions provide Cost of Goods Sold (COGS) and opening/closing inventory figures; you must compute average inventory first, then the turnover ratio.

Earnings per Share measures the profit attributable to each ordinary share. It is a fundamental metric for equity valuation and is disclosed in quarterly and annual reports of Indian listed companies.

When preferred dividends are payable, they are deducted from net income before dividing by the weighted‑average number of ordinary shares. This adjustment ensures that EPS reflects only the earnings available to common shareholders.

In the NISM exam, you may be asked to compute EPS and then use it to calculate the Price‑to‑Earnings (P/E) multiple, though the latter is not covered in this sub‑topic.