Meaning of Ratios
Objective of ratio analysis
Advantage or uses of Accounting Ratios
Limitations of Accounting Ratios
Classification of ratios :
i). Liquidity Ratio
ii). Solvency Ratio
iii). Activity/Turnover Ratio
iv). Profitability/Income Ratio
3. I would like to express my special thanks of
gratitude to my teacher (Pragya Bhargav
Ma’am (my mentor); assistant professor) who
gave me the golden opportunity to do this
wonderful project on the topic (Ratio
analysis),which also helped me in doing a lot
of Research and I came to know about so
many new things I am really thankful to
them.
Secondly I would also like to thank my
parents who helped me a lot in finalizing this
4. Content
Meaning of Ratios
Objective of ratio analysis
Advantage or uses of Accounting Ratios
Limitations of Accounting Ratios
Classification of ratios :
i). Liquidity Ratio
ii). Solvency Ratio
iii). Activity/Turnover Ratio
iv). Profitability/Income Ratio
6. Ratios may be expressed :
a. Proportion/pure ratio/simple ratio : it is expressed by
simple division of one number by other.
For e.g. – current assets = ₹1,00,000 & current liabilities
= ₹50,000 then the ratio is 2:1. (1,00,000 50,000)
b. Rate/so many times : in this type, it is calculated how
many times a figure is, in comparison to another figure.
For e.g. – credit sales = ₹4,00,000 and its trade
receivables = ₹40,000 at the end. So trade receivables
turnover ratio = 10 times. (₹4,00,000 ₹40,000)
c. Percentage : in this type, the relation between two figures
is expressed in hundredth.
For e.g. – capital = ₹10,00,000 & profit = ₹ 5,00,000.
Then ratio of profit to capital is 50% (5,00,000
10,00,000 × 100).
d. Fraction : say, net profit is one-fifth of capital.
7. Objective of Ratio analysis
To locate weak spots of business which
need more attention.
To provide deeper analysis of the liquidity,
solvency, activity and profitability of the
business.
To provide information useful for making
estimates and preparing the plans for the
future.
To provide information for making cross-
sectional & time series analysis.
8. Advantages or uses of Accounting Ratios
☺ Helpful in analysis of financial statements (helps
users to know about financial health of business).
☺ Helpful in comparative study(help in
comparison of profits of different firms).
☺ Simplification of accounting data (simplify the
long data of accounting).
☺ Helpful in locating the weak shots of the
business.
☺ Helpful in forecasting (helps in preparing plans
for future.)
☺ Fixation of ideal standard for comparison.
☺ Estimates about the trend of the business.
9. Limitations of Accounting Ratio
False accounting data gives false ratios.
Comparison not possible if different firms
adopt different accounting policies.
Window-Dressing (show high profit or low
profit to escape from high taxes.)
Ignores qualitative factors.
Lack of proper standards.
Limited use of a single ratio.
Ratios alone are not adequate for proper
conclusions.
10. Classification of ratios
Ratios may be classified into :
a. Liquidity Ratios
b. Solvency Ratios
c. Activity or turnover ratios
d. Profitability or income ratios
11. Liquidity Ratios
“Liquidity” refers to the ability of the firm
to meet its current liabilities.
It also called “Short-term Solvency”.
It is used to assess the short-term financial
position.
Liquidity ratios include two ratios :-
a). Current or Working capital ratios
b). Quick or liquid or acid test ratios
12. Current ratio
This ratio explains the relationship between current
assests and current liabilities of a business.
The formula =
𝑐𝑢𝑟𝑟𝑒𝑛𝑡 𝑎𝑠𝑠𝑒𝑡𝑠
𝑐𝑢𝑟𝑟𝑒𝑛𝑡 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
This is also called Working Capital Ratio.
This ratio is used to assess the firm’s ability to meet
its short-term liabilities on time.
According to accounting principles, a current ratio
of 2:1 is supposed to be an ideal ratio.
If current ratio is more than 2:1, show poor policies
of management .
if ratio is less than 2:1, show lack of liquidity and
shortage of working capital.
13. Continue…(Current assets)
• Current assets are those assets which are likely to
be converted into cash or cash equivalents within
12 months from the date of balance sheet.
• It includes :- current investments, inventories,
trade receivables
• (debtors and bills receivables), cash and cash
equivalents, short-term loans and
• advances and other current assets such as prepaid
expenses, advance tax and
• accrued income, etc.
14. Continue…(current liabilities)
• Current liabilities are the liabilities payable
within 12 months from the date of balance
sheet.
• Current liabilities include short-term
borrowings, trade payables (creditors and
bills payables), other current liabilities and
short-term provisions.
15. Example of current ratio :-
Q .Calculate Current Ratio from the following
information :
Inventories = 50,000
Trade receivables =50,000
Advance tax = 4,000
Cash and cash equivalents = 30,000
Trade payables = 1,00,000
Short-term borrowings (bank overdraft) =
4,000
16. Sol:-
Current Ratio =
Current Assets
Current Liabilities
Current Assets = Inventories + Trade receivables + Advance tax +
Cash and cash equivalents
Current Assets = ₹ 50,000 + ₹ 50,000 + ₹ 4,000 + ₹ 30,000
= ₹ 1,34,000
Current Liabilities = Trade payables + Short-term borrowings
Current Liabilities = ₹ 1,00,000 + ₹ 4,000
= ₹ 1,04,000
Current Ratio =
₹ 1,34,000
₹ 1,04,000
=1.29 :1
17. • It is the ratio of quick (or liquid) asset to current
liabilities.
• Quick ratio =
Quick Assets
Current Liabilities
• The quick assets are defined as those assets which
are quickly convertible into cash.
• While calculating quick assets we exclude the
inventories at the end and other current assets such
as prepaid expenses, advance tax, etc., from the
current assets. Because these are non-liquid current
assets.
• It also known as ‘Acid-Test Ratio’.
• A ideal quick ratio = 1:1.
Quick ratio
18. Example of quick ratio :-
Q .Calculate quick ratio from the information:-
Inventories = 50,000
Trade receivables =50,000
Advance tax = 4,000
Cash and cash equivalents = 30,000
Trade payables = 1,00,000
Short-term borrowings (bank overdraft) =
4,000
20. Solvency Ratio
• Solvency ratios are calculated to determine
the ability of the business to service its debt
in the long run.
• Solvency Ratio include four ratios :-
i. Debt-Equity Ratio
ii. Proprietary Ratio
iii. Total Assets to Debt Ratio
iv. Interest Coverage Ratio
21. • Debt-Equity Ratio measures the relationship between long-
term debt and equity.
• Normally, it is considered to be safe if debt equity ratio is 2
: 1.
• Debt-Equity Ratio =
Long − term Debts
Shareholders′ Funds
where:
• Shareholders’ Funds (Equity) = Share capital + Reserves
and Surplus
Share Capital = Equity share capital + Preference share capital
or
• Shareholders’ Funds (Equity) = Non-current assets +
Working capital – Non-current liabilities
• Working Capital = Current Assets – Current Liabilities
Debt-Equity ratio
22. Example of debt-equity ratio
• From the following, calculate the debt-equity
ratio:-
Equity Shares Capital = 1,00,000
General Reserve = 45,000
Accumulated Profits = 30,000
Debentures = 75,000
Sundry trade creditors = 40,000
Outstanding expenses = 10,000
23. Sol:-
Debt-Equity Ratio =
Long − term Debts
Shareholders′ Funds
• Shareholders’ fund = Equity share capital + Reserves +
Accumulated profits
= ₹ 1,00.000 + ₹45,000 + ₹ 30000
= ₹ 1,75,000
• Long term debt = Debentures = ₹75,000
Debt-Equity Ratio =
₹75,000
₹ 1,75,000
= 3 : 7.
24. • Proprietary ratio expresses relationship of
proprietor’s (shareholders) funds to net
assets.
• Proprietary ratio =
Shareholders′ funds
Total assets
• A high ratio shows that there is safety for
creditors.
Proprietary Ratio
25. Example of proprietary ratio
Q. From the following calculate the proprietary ratio
:-
• Equity share capital = 1,00,000
• Preference share capital = 50,000
• Reserves and surpluses = 25,000
• Debentures = 60,000
• Creditors = 15,000
• Fixed assets = 1,25,000
• Current Assets = 50,000
• Investment = 75,000
27. • This ratio measures the extent of the coverage of
long-term debts by assets.
• Total assets to Debt Ratio =
Total assets
Long−term debts
• The ideal ratio is 1:1.
Total Assets to Debt Ratio
28. Example of total assets to debt ratio:
Q . From the following information calculate
total assets to debt ratio:-
Share capital = 4,00,000
Reserves and surplus = 1,00,000
Long-term borrowings = 1,50,000
Current Liabilities = 50,000
Fixed assets = 4,00,000
Non-current investments = 1,00,000
Current Assets = 2,00,000
29. Sol:-
• Total Assets to Debt Ratio =
Total assets
Long−term debts
• Total Assets = Fixed assets + Non-current
investments + Current assets
= ₹ 4,00,000 + ₹ 1,00,000 +₹ 2,00,000
= ₹ 7,00,000
• Long-term Debt = ₹ 1,50,000
• Total Assets to Debt Ratio =
₹ 7,00,000
₹ 1,50,000
= 4.67 : 1
30. • It is a ratio which deals with the servicing of
interest on loan. It is a measure of security of
interest payable on long-term debts.
• It reveals the number of times interest on long-
term debts is covered by the profits available for
interest. A higher ratio ensures safety of interest
on debts.
• Interest Coverage Ratio =
profit before charging interest and income tax
fixed interest charges
Interest Coverage Ratio
31. Example of interest coverage ratio
Q .From the following details, calculate interest
coverage ratio:
profit after interest & tax = 1,98,000
Rate of income tax = 40%
15% Debenture = 2,00,000
Sol: profit before tax = ₹ 1,98,000 × 100
(100 - 40) = ₹ 3,30,000
Profit before interest and tax = 3,30,000 +
30,000 (2,00,000 × 15%) = 3,60,000
Interest coverage ratio =
₹ 3,60,000
₹ 30,000
= 12
times.
32. Activity or turnover ratios
• These ratios indicate the speed at which, activities of the
business are being performed. The activity ratios express
the number of times assets employed, or, for that matter,
any constituent of assets, is turned into sales during an
accounting period.
• Higher turnover ratio means better utilisation of assets and
signifies improved efficiency and profitability, and as such
are known as efficiency ratios.
The important activity ratios calculated under this category
are:
1. Inventory Turnover
2. Trade receivable Turnover
3. Trade payable Turnover
4. Working capital Turnover.
33. • It determines the number of times inventory is
converted into revenue from operations during the
accounting period under consideration.
• Inventory Turnover Ratio =
Cost of Revenue from Operations
average inventory
• Low turnover of inventory may be due to bad
buying, obsolete inventory, etc., and is a danger
signal. High turnover is good but it must be
carefully interpreted as it may be due to buying in
small lots or selling quickly at low margin to realise
cash.
Inventory Turnover Ratio
34. Example of inventory turnover ratio
Q. From the following items calculate inventory
turnover ratio:-
• Inventory in the beginning = 18,000
• Inventory at the end = 22,000
• Net purchases = 46,000
• Wages = 14,000
• Revenue from operations = 80,000
• Carriage inwards = 4,000
35. Sol:-
• Inventory Turnover Ratio =
Cost of Revenue from Operations
average inventory
• Cost of Revenue from Operations = Inventory in the
beginning + Net Purchases + Wages + Carriage inwards –
Inventory at the end
= ₹ 18,000 + ₹ 46,000 + ₹ 14,000
+ ₹ 4,000 – ₹ 22,000
= ₹ 60,000
• Average Inventory =
Inventory in the beginning + Inventory at the end
2
=
=
₹ 18,000 + ₹ 22,000
2
= ₹ 20,000
37. • It expresses the relationship between credit revenue from
operations and trade receivable.
• Trade Receivable Turnover ratio =
Net Credit Revenue from Operations
Average Trade Receivable
Where:-
Average Trade Receivable = (Opening Debtors and Bills
Receivable + Closing Debtors and Bills Receivable) 2.
• It needs to be noted that debtors should be taken before
making any provision for doubtful debts.
• Higher turnover means speedy collection from trade
receivable.
Trade receivable Turnover Ratio
38. Example of trade receivable turnover ratio
Q. Calculate the Trade receivables turnover ratio from the
following information:
• Total Revenue from operations 4,00,000
• Cash Revenue from operations 20% of Total Revenue from
operations
• Trade receivables as at 1.4.2014 40,000
• Trade receivables as at 31.3.2015 1,20,000
39. Sol:-
• Trade Receivable Turnover ratio =
Net Credit Revenue from Operations
Average Trade Receivable
• Credit Revenue from operations = Total revenue from operations – Cash
revenue from operations
• Cash Revenue from operations = 20% of ₹ 4,00,000 =
= ₹ 80,000
• Credit Revenue from operations = ₹ 4,00,000 – ₹ 80,000
= ₹ 3,20,000
• Average trade receivable =
=
₹ 40,000 + ₹1,20,000
2
= ₹ 80,000
• Trade Receivable Turnover ratio =
=
₹ 3,20,000
₹ 80,000
= 4 Times.
40. • Trade payables turnover ratio
indicates the pattern of payment of
trade payable.
• Trade Payable Turnover ratio =
net credit purchases
Average Trade Payable
• Lower ratio means credit allowed by
the supplier is for a long period or it
may reflect delayed payment to
suppliers which is not a very good
Trade payable Turnover Ratio
41. Example of trade payable turnover ratio
Q. Calculate the Trade payables turnover ratio from
the following figures:-
• Credit purchases during 2014-15 = 12,00,000
• Creditors on 1.4.2014 = 3,00,000
• Bills Payables on 1.4.2014 = 1,00,000
• Creditors on 31.3.2015 = 1,30,000
• Bills Payables on 31.3.2015 = 70,000
43. • Working Capital Turnover Ratio =
=
Net Revenue from Operation
Working Capital
• Higher turnover reflects efficient
utilisation resulting in higher liquidity
and profitability in the business.
Working capital Turnover Ratio
44. Example of working capital turnover ratio
Q. From the following information, calculate
working capital turnover ratio :-
Net revenue = ₹ 20,00,000
Working capital = ₹ 5,00,000
Sol:-
• Working capital turnover ratio =
=
₹ 20,00,000
₹ 5,00,000
= 4 times.
45. Profitability ratio
• Profitability ratios are calculated to analyse
the earning capacity of the business which
is the outcome of utilisation of resources
employed in the business.
• The following are profitability ratio :-
1. Gross profit ratio
2. Operating ratio
3. Operating profit ratio
4. Net profit ratio
5. Return on Investment
46. • Gross profit ratio as a percentage of revenue from
operations is computed to have an idea about gross
margin.
• Gross Profit Ratio =
=
Gross Profit
Net Revenue of Operations
× 100
• A low ratio may indicate unfavorable purchase and
sales policy. Higher gross profit ratio is always a
good sign.
Gross profit Ratio
47. Example of gross profit ratio
Q. Following information is available for the year
2014-15, calculate gross profit ratio:
• Revenue from Operations : Cash = 25,000
: Credit = 75,000
• Purchases : Cash = 15,000
: Credit = 60,000
• Carriage Inwards 2,000
• Salaries = 25,000
• Decrease in Inventory = 10,000
• Return Outwards = 2,000
• Wages = 5,000
50. • It is computed to analyse cost of operation in
relation to revenue from operations.
• Operating Ratio =
(Cost of Revenue from Operations +
Operating Expenses)
Net Revenue from Operations
× 100
• Operating expenses include office expenses,
administrative expenses, selling expenses,
distribution expenses, depreciation and employee
benefit expenses etc.
Operating Ratio
51. Example of operating ratio
Q. Given the following information:
• Revenue from Operations = 3,40,000
• Cost of Revenue from Operations =
1,20,000
• Selling expenses = 80,000
• Administrative Expenses = 40,000
Calculate Operating ratio.
53. • It is calculated to reveal operating margin.
• Operating Profit Ratio = 100 – Operating
Ratio
OR
• Operating Profit Ratio =
Operating Profit
Net Revenue from Operations
× 100
• Lower operating ratio is a very healthy sign.
Operating profit Ratio
54. • It relates revenue from operations to net profit after
operational as well as non-operational expenses and
incomes.
• Net Profit Ratio =
Net profit
Revenue from Operations
× 100
• Generally, net profit refers to profit after tax.
• It reflects the overall efficiency of the business,
assumes great significance from the point of view of
investors.
Net profit Ratio
55. Example of net profit ratio
Q. Gross profit ratio of a company was 25%.
Its credit revenue from operations was ₹
20,00,000 and its cash revenue from
operations was 10% of the total revenue from
operations. If the indirect expenses of the
company were ₹ 50,000; calculate its net
profit ratio.
56. Sol:-
• Cash Revenue from Operations = ₹ 20,00,000 × 10/90
= ₹ 2,22,222
• Hence, total Revenue from Operations are = ₹ 22,22,222
• Gross profit = 0.25 × ₹ 22,22,222
= ₹ 5,55,555
• Net profit = ₹ 5,55,555 – ₹ 50,000
= Rs.5,05,555
• Net Profit Ratio =
₹ 5,05,555
₹ 22,22,222
× 100 = 22.75%.
57. • It explains the overall utilisation of funds by a
business enterprise.
• Capital employed means the long-term funds
employed in the business and includes
shareholders’ funds, debentures and long-term
loans.
• Return on Investment (or Capital Employed)
=
Profit before Interest and Tax
Capital Employed
× 100
• It measures return on capital employed in the
business. It reveals the efficiency of the business in
utilisation of funds entrusted to it by shareholders,
debenture-holders.
Return on (capital employed) investments
58. Example of return on investments
Q. Calculate the return on investment :-
Net profit after interest but before tax = ₹ 1,40,000
15% Long-term debts = ₹ 4,00,000
Shareholders funds = ₹ 2,40,000
Tax rate = 50%
Sol:- net profit before interest and tax = ₹ 1,40,000 + (15%
on ₹ 4,00,000 = 60,000 ) = ₹ 2,00,000
Capital employed = shareholder funds + long-term debts
= 2,40,000 + ₹ 4,00,000 =
= ₹ 6,40,000
• Return on Investment (or Capital Employed)
= ₹ 2,00,000
₹ 6,40,000
× 100 = 31.25%
60. Q 1.Calculate current assets of a company from the following
information:
Inventory turnover ratio = 4 times
Inventory at the end is ₹ 20,000 more than the inventory in
the beginning.
Revenue from Operations ₹ 3,00,000 and gross profit ratio is
20% of revenue from
operations.
Current liabilities = ₹ 40,000
Quick ratio = 0.75 : 1
Q 2.The current ratio is 2.5 : 1. Current assets are Rs. 50,000
and current liabilities are Rs. 20,000. How much must be the
decline in the current assets to bring the ratio to 2 : 1
Q 3. Calculate debt-equity ratio from the following
information: Total Assets Rs. 15,00,000; Current Liabilities
Rs. 6,00,000; Total Debts Rs. 12,00,000
61. Q 4 .Following information is given by a company from its books of
accounts as on March 31, 2015:
Inventory = ₹1,00,000
Total Current Assets = ₹1,60,000
Shareholders’ funds = ₹ 4,00,000
13% Debentures =₹ 3,00,000
Current liabilities = ₹1,00,000
Net Profit Before Tax = ₹ 3,51,000
Cost of revenue from operations = ₹ 5,00,000
Calculate:
i) Current Ratio
ii) Liquid Ratio
iii) Debt Equity Ratio
iv) Interest Coverage Ratio
v) Inventory Turnover Ratio
62. Q 5. Calculate following ratios from the following information:
(i) Current ratio (ii) Liquid ratio (iii) Operating Ratio (iv) Gross
profit ratio :-
• Current Assets = ₹ 35,000
• Current Liabilities = ₹17,500
• Inventory = ₹ 15,000
• Operating Expenses = ₹ 20,000
• Revenue from Operations = ₹ 60,000
• Cost of Revenue from operation = ₹ 30,000
Q 6. Compute Gross Profit Ratio, Working Capital Turnover
Ratio, Debt Equity Ratio and Proprietary Ratio from the
following information:
Paid-up Share Capital = ₹5,00,000; Current Assets = ₹
4,00,000; Revenue from Operations = ₹10,00,000; 13%
Debentures = ₹2,00,000; Current Liabilities = ₹ 2,80,000; Cost
of Revenue from Operations = ₹6,00,000
63. Q 7. A trading firm’s average inventory is ₹ 20,000 (cost). If
the inventory turnover ratio is 8 times and the firm sells goods
at a profit of 20% on sales, ascertain the profit of the firm.
Q 8. Cost of Revenue from Operations is Rs. 1,50,000.
Operating expenses are ₹ 60,000. Revenue from Operations is
₹ 2,50,000. Calculate Operating Ratio.
Q 9. Quick ratio is also known as ........... ratio.
Q 10. Operating ratio of the company is 75%. Give reason
which transaction will i). Increase ii). Decrease iii). Not alter
the operating ratio:-
a. Purchase of goods ₹ 25,000
b. Office & selling expenses increase by ₹ 12,000
c. Revenue from operations ₹ 1,00,000.
