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Ratio Analysis

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Growth Ratios

Profit is vital for any company. We have learned several profitability ratios in our last unit. However, the growth of a company indicates how its business is growing from one period to another. Therefore, in this unit, we will discuss growth ratios. 

What are Growth Ratios?

Growth ratios indicate how fast a company or its business is growing. These ratios measure the rate at which the company is growing.

Net Sales Growth (%):

Net sales are the total sales of an organisation minus the return inwards, discounts etc. This ratio helps in checking whether the company is on a growth trajectory or not compared to the previous year. Consistent growth in sales is a measure of management’s quality and performance. Growing sales signifies a growth-oriented company.

Consistent net sales growth is a positive measure of a management’s performance. If the net sales growth over the years is consistent and there is no de-growth (apart from exceptional circumstances) it makes sense to invest in the company as a compounding story

Example - In 2016-17, the net sales of a company is ₹10 crores and in 2017-18 it is ₹11 crores then net sales growth % is (11-10)/10= 10%.

EBITDA Growth (%):

EBITDA stands for Earnings Before Interest, Tax, Depreciation and Amortisation. EBITDA is a measure of a company’s operating performance. It eliminates the effects of financing and accounting decisions. EBITDA is derived by subtracting expenses incurred from Sales and adding back interest cost + tax + depreciation and amortisation.

EBITDA growth percentage is an important barometer to measure the growth and future prospects of a company. The higher the EBITDA growth the better is the company’s growth potential. 

This is a better measure compared to net sales growth percentage. In the net sales growth percentage loss making transactions could also be accounted for like say an e-commerce company. Flipkart could be selling its goods below the cost price or at break even in order to boost sales. Hence EBITDA is a better margin. Growth in EBITDA signifies an improvement in the efficiency of a company. 

Example - In 2016-17, ABC Corporation reported sales of ₹50 crores and expenses excluding interest tax and depreciation or amortisation is ₹45 crores then EBITDA is ₹5 crores and similarly in 2017-18 the company sales is ₹57 crores and expenses excluding interest tax and depreciation or amortisation is ₹50 crores then EBITDA is ₹7 crores.

EBITDA Growth (%) = (7-5)/5= 40%

Net Profit Growth (%):

The net profit of the company is the profit that the company generates after accounting for all its expenses. It is a true reflection of the way the company has used its resources. Thus, consistent growth in net profit implies the financial strength of the company. 

Net profit growth percentage is an important tool to measure the growth and future prospects of a company. A growth in net profit enhances the dividend-paying capacity of a company and the company can use the profits to diversify its operations and expand the business.

Example - If a company made a net profit of ₹ 10 crores in first year  and ₹ 13 crores in second year  the net profit growth % is (13-10)/10= 30%

EPS Growth(%):

Where, EPS = Net Profit/Number of shares outstanding

EPS measures the amount of net income earned per share of stock outstanding. In other words, this is the amount of money each share of stock would receive if all of the profits were distributed to the outstanding shares at the end of the year.

Earnings per Share Growth (%) is reported after adjustment of extraordinary items (i.e. one-time income or expenses) and potential share dilution (i.e. increase in the number of potential shareholders due to an exercise of a stock option, conversion of a debenture or preference shares into equity, bonus issue, etc). Any bonus, split, conversion of debenture or preference share into equity, warrant issue, etc. must be reflected in the calculation of weighted average number of shares outstanding at the end of a period.

There are various kinds of EPS used under different circumstances for different kinds of calculations. Thus, we have Basic EPS, Diluted EPS and Cash EPS.

  • Basic EPS: It is a rough measurement of a company’s profit that can be allocated to one share of its stock. It does not factor in the diluted effect of convertible securities. Basic EPS is calculated as follows: 

Basic EPS = (Net income – Preference dividend) / Weighted average number of share outstanding

Example – ABC Corporation reported a net profit of ₹4 crores when the outstanding shares stood 40 lakh. Therefore,

EPS = (4 crores/40 lakh) = ₹10

  • Diluted EPS: If a company has a complex capital structure i.e. they have issued potentially dilutive securities then diluted EPS is considered to be a more precise metric than basic EPS. It takes into account all the outstanding diluted securities that could preferably be exercised and shows how such action would affect earnings per share. It can be calculated as:

Diluted EPS = {Net income – preference dividend (which are not convertible) + Interest on debenture (if such debenture is convertible)} / (Weighted average no of share outstanding + conversion of diluted securities)

  • Cash EPS: Cash EPS or more commonly operating cash flow per share measures financial performance of the company. Free from non-cash items like depreciation which is included in basic EPS calculation, cash EPS may prove to be a more reliable measure of financial and operational health of the company. Higher the company’s cash EPS, better it is considered to have performed over a period. The formula for calculating the company’s cash EPS is:

 Cash EPS = Operating cash flow / Diluted shares outstanding

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