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S.

no Terms and meanings


1

Accounting Ratios
Technique of expressing the relationship between one
accounting result and another to provided a useful
comparison

Liquidity Ratios
Used to measure the short term financial position f a
business firm

Solvency Ratios
To know the paying ability of a firm in the long run. To
assess long term financial position of the firm

Activity Ratios / Turnover Ratios


Represents the performance of the business to make more
sales / Turnover

Profitability Ratios
To analyse the profitability and earning capacity of the
business

Capital employed
Means long term funds employed in the business

Return on investment
Overall utilisation of funds by a business firm

Working Capital
Capital of the business used in its day to day activities

I
1

RATIOS
LIQUIDITY RATIOS
Current ratio

To assess whether current assets are sufficient enough to


meet current liabilities
2

Quick Ratio

To assess short term debt paying capacity of the company

II
1

SOLVENCY RATIOS
Debt Equity Ratio

To assess the long term financial position of the business


It indicates the relationship between long term external
equities and shareholders' funds
Computation of Equity
Method 1 : Liabilites approach

Share capital + Reserves and surplus + Money received


against share warrants + share application money
pending allotment ( only the part which is non refundable)
ADD Deferred tax Liabilities
LESS Deferred tax assets
LESS Unamortised Expenses (Fictitious Assets)
Method 2 : Assets Approach
Non current Assets (Fixed Assets + Investments) + Current
Assets LESS Current Liabilities LESS Long term borrowings
and other long term liabilities
2

Proprietary Ratio
Indicates the proportion of assets financed by proprietors'
funds
Compares proprietors' funds with total assets

Interest coverage ratio


To assess whether the firm can pay interest due on long
term debts within the due date.

III

ACTIVITY RATIOS / TURNOVER RATIOS


Represents the performance / capacity of the business to
make more sales or turnover
Higher turnover ratio indicates better utilisation of
resources

Stock Turnover / Inventory Turnover ratio


Expresses the relationship between 'Cost of goods sold'/
cost of revenue from operations and average inventory
during the year

Helps to assess the frequency of inventory purchased or


sold during the year
Computation of COGS
Method 1 : Op.Inventories + Purchases + Direct expenses
- Cl.Inventories
Method 2 : Revenue from operations (Net) LESS Gross
profit
Method 3 :Cost of materials consumed + Puchase of stock
in trade + Change in inventories of finished goods, WIP
and stock in trade + Direct Expenses

Debtors Turnover ratio / Trade receivables turnover


Indicates the relationship between net credit sales and the
debtors or book debts.
It is to measure the company's credit control and to assess
how much cash is tied up with the debtors

Debt collection period is the average time for collecting


the due amount from debtors
3

Creditors Turnover ratio


expresses relationship between credit purchase and Trade
payables
Higher ratio indicates that the firm pays its credit amount
efficiently

Average payment period


4

Working Capital Turnover ratio


To assess how business is utilising its working capital in
making sales
If COGS is not given then take Sales / Revenue instead of
COGS

IV

PROFITABILITY RATIOS

Gross profit Ratio


Used to measure profitability of a business
Helps in assessing margin available to cover the operating
and non operating expenses
Higher gross profit ratio is a good sign of profitability,
growth and development

Operating Ratio

To assess operational efficiency of the business

Low ratio is considered good for business

Net profit ratio


Indicates net profit margin in relation to sales
measures overall efficiency of the business
Higher ratio is considered very good

Return on investment

explains the overall utilisation of funds by a business firm


Capital employed computation
1 Liabities approach
Share holders' funds + share application money pending
allotment + non current liabilities + Deferred tax liabilities
(net) LESS Non trade investments LESS Deferred tax
assets (net)
Share holders' fund = share capital + Reserves and
surplus + money received against share warrants + shre
application money pending allotment LESS Fictitious
assets
2. Assets approach
Fixed Assets + Trade investments ( Non current) + Long
term loans and advances + Other non current assets
(except Unamortised expenses/Losses) + Working capital

Objectives of ratios

Limitations of ratios

1. To analyse efficiency, profitability, 1. Qualitative aspect / Non


solvency and liquidity
monetary aspect ignored
2. To know the areas which need
more attention

2. Ignores price level changes

3. Helps in forecasting and decision


making

3. Lack of accurate forecasting as


it is based on Historical data

4. Useful in inter firm and intra firm


comparison

4. Window dressing

5. Comparitive analysis of previous


years

CA - CL
FORMULAE

OTHER POINTS

CA/CL

*DO NOT include Unamortised


Expenses / Losses
*DEDUCT provision for doubtful
debts from 'Trade Receivables'
*DO NOT include Loose tools and
stores and spares

Quick assets / CL

Quick assets = CA LESS


Inventories LESS Prepaid expenses

Debt / Equity

Debts are liabilities payable to


outsiders after 12 months from B/s
date
Debt = Long term borrowings +
Long term provisions + Other long
term liabilities

Unamortised Expenses - Eg. Share


Issue expenses, Discount on issue
of shares, loss on issue of
debentures, Underwriters'
commission, Other unamortised
expenses

DO NOT Include Deferred tax


assets ( Net ) and unamortised
expenses / Loss (if any)

Proprietors' funds/Total Assets

Proprietors' fund means


Shareholders' funds
DO NOT include unamortised
expense / loss

Net profit before interest and tax


Interest payable (LTB)

Cost of Goods sold / Average


Inventory

Average inventory = (Op.Inventory


+ Cl.Inventory)
2

Inventories include RM, WIP and


FG

Direct expenses - Eg. Carriage


inwards, Freight inwards, wages,
Manufacturing or production
expenses

Net credit sales / Average Trade


receivables

Net credit sales = Total credit sales


LESS sales returns
Average trade receivables = (op. +
Cl.)/2
DEDUCT provision for doubtful
debts

(365 days/12 months/ 52 weeks) /


Debtors Turnover Ratio

Net credit Purchases / Average Trade Average trade payables = (op. +


payables
Cl.)/2
Net credit purchases = Total
purchase LESS cash purchases
LESS Purchase returns

(365 days/12 months/ 52 weeks) /


Creditors Turnover Ratio

Cost of Goods Sold / Working capital

Expressed as a percentage

Gross profit / Net Sales

Gross profit = Net sales LESS


COGS

Operating cost / Net sales

Operating cost = COGS +


Operating expenses

Operating expenses eg. Employee


benefit expenses and other
operating expenses like office and
admin expenses, selling and
distribution expenses, discount
allowed, bad debts
DO NOT Include non operating
expenses or non operating income

Net profit before tax/Net sales

Net profit = Revenue+Other


income LESS Operating and non
operating expenses

Net profit before interest, tax and


dividend
Capital employed
capital employed means long term
funds employed in the business

DO NOT include unamortised


expenses / losses

DO NOT Include non operating


assets