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UNIT-II

SECTION A

1. A Ratio is a _______
a) Journal Entry b) Business Transaction
c) Relationship between two items d) Published document

2. The ideal Current Ratio is ____


a) 5 :1 b) 4:1
c) 3 :1 d) 2:1

3. The Safe level for Proprietary Ratio is ____


a) 0.50 b) 1
c) 2 d) 3

4. Net worth refers to owner’s _____


a) Funds b) Assets
c) Sales d) Liabilities
5. Operating Ratio is a ______ Ratio
a) Liquidity b) Profitability
c) Solvency d) Activity

6. A Ratio is expressed in
a) Rupees b) Weights
c) Proportion d) Numbers

7. Current Ratio indicates


a) Ability to meet short term b) Efficiency of Management
Obligations
c) Solvency Position d) Profitability
8. Liquid Ratio is otherwise called as_______ Ratio
a) Acid Test b) Profitability
c) Solvency d) Turnover
9. solvency ratios indicate
a) Profitability b) Activity
c) Credit worthiness d) Capital

10. The term current asset does not include


(a) Debtors (b) Bills receivables

(c) Building (d) Cash

SECTION – B

REASONING QUESTIONS

1. From the following information calculate

a) Current Liabilities (b) Current Assets c) and Liquid Assets

Current Ratio 2.8 Liquidity Ratio 1.5; Working Capital Rs.1,62, 000

Soultion:

a) CURRENT LIABILITY

Let us take CL as x

WC=CA-CL

162000=2.8x-1.0x

1 62000=1.8x

X=162000/1.8

= 90000

b) Current Assets = 90000*2.8 = 252000

c)LIQUID ASSET RATIO

=LIQUID ASSET/CL

1.5=LA/90000

= 90000*1.5

=1,35,000
2. . Following are the ratios to the trading activates of ABC limited, for the year ended
31.12.2014

Debtor’s velocity – 3 months Stock velocity – 6 months


Gross profit ratio - 25 % Creditors velocity– 2 months
Gross profit - Rs. 4, 00,000 Bills receivable – Rs.25, 000
Bills Payable – Rs.10,000
Closing stock of the year isRs. 10,000 above the opening stock.
Determine (a) sales (b)Purchases (c) sundry creditors d) sundry debtors e) Closing
stock
Soultion:

a)SALES =GP/SALES *100

25%=400000/SALES

SALES = 400000*100/25

=1600000

b) SUNDARY debtors

DEBTORS VELOCITY=TOTAL DEBTORS *NO: OF MONTHS /SALES

3=TOTSA DEBTORS *12/1600000

TOTAL DEBTORS = 1600000*3/12

=400000

TOTAL DEBTORS= SUNDARY DEBTORS –BILLS RECEIVABLES

=400000-25000

= 375000

c) CLOSING STOCK

STOCK VELOCITY=AVERAGE STOCK/COST OF GOODS SOLD *12

6 MONTHS = AVG STOCK /1200000*12

AVG STOCK * 12= 1200000*6

AVG STOCK=1200000*6/12

= 600000
AVG STOCK=OPENING STOCK +CLOSING STOCK /2

AVG STOCK |= OPENING STOCK+(OPENING STOCK +10000)/2

2*600000= 2 OPENING STOCK +10000

2 OPENING STOCK =1200000-10000

OPENING STOCK =1190000/2

= 595000

CLOSING STOCK = 595000+10000

=605000

3. The Directors of General Cloth Mills Limited are concerned at the persistent decline in their
gross profit rates for the last three years .You are required to list the possible reasons for the
decline.

Soultion:

The type of industry and market segments have a major impact on the gross profit margin of
businesses. The competitive environment within an industry segments influence the selling
price, cost of factors of production and the cost structure of businesses as discussed below.
Selling price is influenced by a number of factors such as:

 Product differentiation

 Bargaining power of customers

 Number of competitors

 Availability of substitute products and services

 Pricing strategies

Cost of factors of production can vary due to several reasons such as:

 Inflation

 Increment in salaries, wages and benefits

 Shortage in the supply of raw materials and labor

 Bargaining power of suppliers

 Availability of substitute materials


 Replacement of fixed assets causing an increase in depreciation or amortization

 Increase in the age of fixed assets resulting in a lower depreciation expense

Efficiency could be improved in the following ways:


 Economies of scale

 Lean management structure (flat organizations)

 Lower proportion of fixed costs and overheads in the organization's cost structure

 Optimization of workflows and supply chain

 Minimization of waste

 Automation

Debt to equity ratio The level of gearing directly affects the proportion of interest expense
deducted from profits. Taxation Tax expense is affected by the following factors:

 Change in tax rates

 Change in the applicable tax bracket

 Tax exemptions, credits and loss adjustments

 Group tax structure

 Prior period adjustments

Non-recurring
gains and losses GP Margin of specific accounting periods can be affected by non-recurring
gains and losses such as:

 Gain / Loss on disposal of fixed assets and investments

Discretionary expenditures Increase in discretionary expenditures such as research and


development costs may improve future profitability at the expense however of the current
period's NP margin. Accounting policies Variations in the accounting policies used by different
companies (e.g. historical cost vs. revaluation basis) can affect their respective NP margins. -
See more at: http://accounting-simplified.com/financial/ratio-analysis/net-profit-margin-
percentage.html#sthash.REQWG0DK.dpuf

4. Opening stock Rs.29, 000; Closing stock Rs.31000;Purchases Rs.2,42,000. Calculate Stock
Turnover Ratio
Soultion:

STOCK TUNROVER RATIO = COST OF GOODS SOLD/AVG STOCK

AVG STOCK =OPENING STOCK +CLOSING STOCK /2

29000+31000/2

= 30000

COST OF GOODS SOLD = OPENING STOCK +PURCHASES – CLOSING STOCK

=29000+242000-31000

=240000/30000

= 8 TIMES

5. Calculate Average collection period from the following

Credit Sales for the year Rs.30, 000


Debtors Rs.2,500
Bills Receivable Rs.3,000
Soultion:

AVG COLLECTION PERIOD =

DEBTORS TURNOVER RATIO = CREDIT SALES /AVG


ACCOUNTS RECEIVABLES

AVG ACCOUNTS RECEIVABLES =DEBTORS +B/R

=30000/5500

= 5.45 DAYS

AVG COLLECTION PERIOD = Days in a year

__________

Debtors turnover ratio

= 67 DAYS

DESCRIPTIVE QUESTIONS
1. What is Ratio Analysis? Explain the steps involved in Ratio Analysis?

Ratio Analysis. And the steps involved in Ratio Analysis:

A ratio analysis is a quantitative analysis of information contained in a company’s financial


statements. Ratio analysis is based on line items in financial statements like the balance
sheet, income statement and cash flow statement; the ratios of one item – or a combination of
items - to another item or combination are then calculated. Ratio analysis is used to evaluate
various aspects of a company’s operating and financial performance such as its
efficiency, liquidity, profitability and solvency

The first task of the financial analysis is to select the information relevant to the decision under
consideration from the statements and calculates appropriate ratios. To compare the calculated
ratios with the ratios of the same firm relating to the pas6t or with the industry ratios. It
facilitates in assessing success or failure of the firm. Third step is to interpretation, drawing of
inferences and report writing conclusions are drawn after comparison in the shape of report or
recommended courses of action.

2. Enumerate the limitations of ratio analysis.

Limitations of ratio analysis.

 Ratios are tools of quantitative analysis, which ignore qualitative points of view.

 2. Ratios are generally distorted by inflation.

 3. Ratios give false result, if they are calculated from incorrect accounting data.

 4. Ratios are calculated on the basis of past data. Therefore, they do not
provide complete information for future forecasting.

 5. Ratios may be misleading, if they are based on false or window-dressed accounting


information
3. From the following information calculate

a) Current Liabilities (b) Current Assets

Current Ratio 2.5; Working Capital Rs.90, 000

Solution:

Working capital= CA-CL

90000 = 2.5-1

90000 = 1.5

Current assets = 90000 * 2.5 / 1.5


=150000

Current liability = 90000 * 1 /1.5

=60000

4. Ram & co supplies you the following information regarding the year ended 31 st
December2015 Find out Debtors collection period.

Total sales……. Rs.5, 80, 000


Cash sales …..Rs.80, 000
Debtors ……… Rs.85, 000
Bills receivable… Rs. 5,000
Provision for bad Debts… Rs.6, 000

Solution:
Drs+B/R

Average collection period =>_______________________________ x No of working


days

Net credit sales in a year

I) Drs +B/R =85000+5000

= 90000

II) Total sales =580000

(-) cash sales =80000

Net credit sales =500000

90000

Average collection period => ____________ x 365

500000

= >66 days
5. Aruna Ltd. Furnish the following details for the year 2015. Calculate Gross profit ratio:

Particulars Rs.
Sales 2,00,000
Cost of production 80,000
Opening stock 50,000
Closing stock 31,000
Sales return 20,000

Solution:

Calculation of net credit sales

Sales = 200000

(-) sales return = 20000

Net credit sales = 180000

G/P = Sales – CGS

= 200000

CGS = OS+P-C

= 50000+80000-31000

CGS = 99000

99000

G/P = X 100

180000

G/P = 55

6. From the following information to find out a) Gross Profit Ratio andb) Operating Profit
Ratio:

Sales: Rs .8 crores;
Cost of goods sold : Rs.4 crores;
Selling and administrative overhead expenses: Rs.2crores
Solution:
Elastration of G/P(Rs in crores )

Gp => sales -CGS

 8 -4

G/P =>4

G/p

G/p ratio=> _________________ X 100

Net sales

 4/8

G/P ratio =>50%

operating profit

Operating profit ratio =>___________________ X 100

Net sales

Operating profit =>sales - ( cost selling & admission cpt)

 8 -(4+2)
 8 -6
 2 = operating profit

Operating profit ratio=>_________ X 100

=>25%
7. Calculate current ratio, when inventory is Rs.80, 000, prepaid expenses are Rs.2, 000; quick
ratio is 2.5 to 1 and current liabilities are Rs.50,000

Solution:

QR= QA/CL

QR= QA/50,000

2.5= QA/50,000

QA= 50,000 x 2.5

QA= 1,25,000

QA = CA – Sock + Prepaid Expenses

1,25,000 = CA – (80,000 + 2,000)

1,25,000 = CA – 82,000

1,25,000 + 82,000 = CA

2,07,000 = CA

CR = CA/CL

CR= 2,07,000/50,000

CR = 4.14
8. Current liability of a company is Rs. 3,00,000. If current ratio is 3: 1 and quick ratio is 1:1
calculate the value of stock in trade.

Solution:

CR = CA/CL

3 = CA/30,000

CA = 30,000 x 3

CA = 90,000

QR = QA/CL

1 = QA/30,000

QA = 30,000 x 1

QA = 30,000

QA = CA – Stock

30,000 = 90,000 – Stock

Stock = 90,000 – 30,000

Stock = 60,000

9. From the following information, calculate average collection period:

Particulars Rs.
Total Sales 1,00,000
Cash Sales (included in total sales) 20,000
Sales Returns 7,000
Total Debtors at the end of the year 11,000
Bills Receivable 4,000
Bad debts provision 1,000
Creditors 10,000

Solution:

Calculation of net credit sales

Total sales = 100000

(-) cashsales =20000

80000

(-) sales return =7000

Credit sales =>73000

Drs + B/R

Average collection period => _______________

Net credit sales

11000+4000

______________ X 365

73000

Average collection period =>75 days

10. From the following information calculate creditors’ turnover ratio and average payment period:

Particulars Rs.
Total Purchase 4,00,000
Cash purchases (included in above) 50,000
Purchase Returns 20,000
Creditors at the end 60,000
Bills Payable at the end 20,000
Reserve for discount on Creditors 5,000
Take 365 days in a year 5,000

Solution:
Calculation of net purchase

Total purchase 400000

(-) cash purchases 50000

Credit purchase 350000

(-) returns 20000

Net credit purchase 330000

Net credit purchase

Credit ratio turnover ratio =

Average trade creditors

330000

= = CTR = 4.13 times

80000

Average payment period Average trade creditors

= X No of working days

Net credit purchase

80000

= X 365

330000

APP = 88 days

SECTION – C

REASONING QUESTIONS

1. The following information is given about M/s. S.P. Ltd for the year ending Dec. 31, 2014

________________________________________________________________________
i. Stock Turnover ratio = 6 times
ii. Gross Profit Ratio = Rs.20% on sales
iii. Sales for 2014 = Rs. 3,00,000
iv. Closing stock is Rs. 10,000 more than the opening stock
v. Opening Creditors = Rs. 20,000
vi. Closing Creditors = Rs.30,000
vii. Trade Debtors at the end = Rs. 60,000
viii. Net working Capital = Rs.50,000
Find out the following:

(a) Average Stock (b) Purchases (b) Creditors Turnover Ratio (d) Average
Payment Period (e) Average Collection Period (f) Working Capital Turnover Ratio

Soultion:

1)

COST OF GOOD SOLD= SALES – GROSS PROFIT

300000-(20%OF SALES )

= 300000-60000

=240000

a)AVERAGE STOCK

STOCK TURNOVER RATIO= COST OF GOOD SOLD /AVG STOCK

6 =240000/AVERAGE STOCK

AVERAGE STOCK =240000/6

=40000

b) PURCHASE

COST OF GOODS SOLD =OPENING STOCK +PURCHASES – CLOSING STOCK

PURCHASES= COST OF GOODS SOLD +CLOSING STOCK- OPENING STOCK

AVG STOCK =OPENING STOCK+CLOSING STOCK /2

40000=OPENING STOCK+(OPENING STOCK+10000)/2

80000=2 OPENING STOCK +10000


OPENING STOCK =70000/2

= 35000

CLOSING STOCK = 35000+10000

=45000

PURCHASES= 240000+45000-35000

=250000

C)CREDITORS TURNOVER RATIO

= NET ANNUAL CREDIT PURCHASE/AVG


TRADERS CREDITORS

ALL PURCHASE ARE TAKEN AS CREDIT PURCHSE=250000/(250000+30000/2)

CREDITORS TURNOVER RATIO=250000/25000

=10 TIMES

D) AVG PAYMENT PERIOD =AVG TRADE CREDITORS * N0: OF WORKING DAYS /NET ANNUAL
PURCHASE

=25000/250000*365

=36.5 OR 37 DAYS

E)AVERAGE COLLECTION PERIOD = AVG TRADE DEBTORS *NO: OF WORKING DAYS /NET
ANNUAL SALES

60000*365/300000

=73 DAYS

F) WORKING CAPITAL

= COST OF GOODS SOLD /NET WORKING CAPITAL

=240000/50000=4.8 TIMES
2. With the following ratios and further information given below, prepare a Trading Account
Profit and Loss A/c and Balance sheet of Shree &co

Gross profit Ratio : 25% Fixed Assets /Total current Assets :5/7
Fixed Assets :Rs.10, 00,000 Closing Stock :1,00,000
Net profit /Sales :20% Stock turnover Ratio: 10
Net profit / Capital : 1/5 Capital to Total liabilities: 1/2
Fixed Assets / Capital :5/4

Soultion:

i) FA TO TOTAL CA= 5/7


100000/TOTAL CA =/7
5 TOTAL CA=7*1000000
TOTAL CA =7000000/5
=1400000-100000
OTHER CA = 1300000
ii) FIXED ASSET/CAPITAL=5/4
1000000/CAPITAL=5/4
5 CPITAL= 4*1000000
CAPITAL= 4000000/5
CAPITAL=800000
iii) CAPITAL TO TOTAL LAIBILITIES=1/2
800000/TOTAL LAIBILITY=1/2
TOTAL LAIBILITY=800000*2
TOTAL LAIBILITY =1600000
iv) NET PROFIT/CAPITAL =1/5
NET PROFIT /800000=1/5
800000=5*NET PROFIT
NET PROFIT =800000/5
NP=160000
v) NET PROFIT /SALES =20%
160000/SALES =20/100
20*SALES =160000*100
SALES =16000000/20
=800000
vi) GROSSPROFIT =SALES *25/100
= 800000*25/100
=200000
vii) STOCK TURNOVER RATIO=10 TIMES

STR=COST OF GOODS SOLD/AVG STOCK

10=60000/AVG STOCK
AVG STOCK =60000

OPENING STOCK +CLOSING STOCK/2=60000

OPENING STOCK = CLOSING STOCK =120000

OPENING STOCK= 120000-100000

=20000

TRADING PROFIT AND LOSS ACCOUNTS

PARTICULARS AMOUNT PARTICULARS AMOUNT


TO OPENING STOCK 20000 BY SALES 800000

TO PURCHASE (BF) 680000 BY CLOSING STOCK 100000

TO GROSS PROFIT 200000

900000 900000

BY GROSS PROFIT b/d 200000

TO EXPENSES (B.F) 40000

TO NET PROFIT 160000

200000 200000

LAIBILITY AMOUNT ASSET AMOUNT

CAPITAL 800000 OTHER CURRENT ASSETS 1300000

OTHER LAIBILITY 1600000 CLOSING STOCK 100000

FIXED ASSETS 1000000

2400000 240000

3. ‘Analysis without Interpretation is meaningless; Interpretation is not possible without


Analysis’- Comment

Soultion:
Analysis refers to the methodical classification of the data given the financial statement.the
term interpretation means explaining the meaning and signification of the data so arranged
.it is the the study of the relationship between various financial factors

Analysis and interpretation of financial statement the most important step in


accounting analysis and interpretation are closely related. Interpretation is not possible
without analysis and without interpretation analysis has no value .hence the terms analysis
is widely used to refer both analysis and interpretation.it is a process of evaluating the
relationship between the various components of a financial statement to obtain a clear
understanding of a firms position and performance.

4. From the following details prepare statement of proprietary funds with as many details as
possible.

Stock velocity: 6 Capital turnover ratio : 2


Fixed assets turnover ratio: 4 Gross profit turnover ratio 20 per cent
Debtors’ velocity :2 months Creditors Velocity : 73 days
The Gross profit was Rs.60, 000 ;Reserves and Surplus amount to Rs.20, 000.

Closing stock was Rs.5, 000 in excess of opening stock.

Soultion:

CALCULATION OF SALES:

GROOS PROFIT = GROSS PROFIT /SALES *100

SINCE G/P RATIO IS 20% AND GROOS PROFIT IS RUPEES 60000 , SALES ARE
400000

20/100 = 60000/SALES

300000

CALCULATION OF PURCHASE

PURACHASE = COST OF GOOD SOLD +CLOSING STOCK – OPENING STOCK

AS G/P RATIO IS 20% SO CSOT OF GOOD IS 100-20(OR) 80%

COST OF GODDS SOLD = 300000*80/100

= 240000

PURCHASE =240000+5000=245000
CALCULATION OF STOCK:

STOCK TURNOVER RATIO = COST GOODS SOLD / AVG STOCK

6= 240000/AVG STOCK

AVG STOCK= 40000

AVG STOCK = OPENIG STOCK +CLOSING STOCK /2

40000= OPENING STOCK +(OPENING STOCK+5000)/2

40000 =2OPENING STOCK +5000/2

80000-5000=2 OPENING STOCK

OPENING STOCK =75000/2

=37500

CLOSING STOCK = OPENING STOCK +5000

=37500+5000

=42500

CALCULATION OF DEBTORS =

DEBTORS VELOCITY = TOTAL DEBTORS /CREDIT SALES *NO OF MONTHS

2 =TOTAL DEBTORS /300000*12

(ALL HAVE BEEN TAKEN AS CREDIT SALES )

TOTAL DEBTORS *12=300000*2

TOTAL DEBTORS =300000*2/12

=50000

CALCULATION OF CREDITORS

CREDITORS VELOCITY =TOTAL CREDITORS/CERDIT PURCHAE*NO OF WORKING DAYS

73=TOTAL CREDITORS/245000*365

365*TOTAL CREDITORS=245000*73

TOTAL CREDITORS=245000*73/365

=49000
CALCULATIO OF FIXED ASSET

FIXED ASSET TURN OVERRATIO=CST OF GOODS SOLD/FIXED ASSET

4*FIXED ASSET =240000

FIXED ASSET =240000/4

=60000

CALCULATIN OF CAPITAL

CAPTIAL TURN OVER RATIO=COST OF GOODS SOLD/CAPITAL

2=24000/CAPITAL

2*CAPITAL=240000

CAPITAL=120000

NETWORTH=SHARE CAPITAL+RESERVES &SURPLUS

SHARE CAPITAL=NETWORTH-RESEVES &SURPLUS

=120000-20000

=100000

BALANSE SHEET

PARTICULARS AMT ASSET AMTT

CAPITAL 100000 FIXED ASSET 60000


RESERVES & 20000 STOCK 42500
SURPLUS 49000 DEBTORS 50000
CREDITORS CASH(BF) 16500

169000 169000

5. Following are the details relating to the activities of A ltd.


Stock velocity :8 months Debtors’ velocity: 3 months
Creditors Velocity: 2 months Gross profit Ratio: 25%
Gross profit for the year Rs.4, 00,000; Bills Receivable Rs.25,000; Bills Payable Rs.10,000;
Closing stock of the year is Rs.10,000 more than the opening stock. Find out

a) Sales b) Debtors c)Closing stock d) Creditors

Soultion:

1)SALES :

SALES IS 100%

GP IS 25%

100/25*400000

=1600000

2)DEBTORS :

DEBTORS TURNOVER RATIO= TOTAL DETORS / CREDIT SALES *NO:OF MONTHS

3=TOTAL DEBTORS /1600000*12

TOTAL DEBTORS *12=1600000*3

TOTAL DEBTORS =1600000*3/12

400000-B/R

=375000

COST OF GOODS SOLD = SALES –GP

=1200000

3) CLOSING STOCK:

STOCK VELOCITY =AVG STOCK/COST OF GOODS SOLD /12

8 MONTHS = AVG STOCK /1200000*12

12*AVG STOCK =1200000*8

AVG STOCK =1200000*8/12

=800000

AVG STOCK =OPENING+CLOSING STOCK/2


AVG STOCK= OPENING+(OPENING STOCK+10000)/2

2*800000=2 OPENING STOCK +10000

2 OPENING STOCK =1600000-10000

OPENING STOCK =159000/2

=795000

CLOSING STOCK =795000+10000

=805000

4)

CREDITORS VELOCITY = TOTAL CREDITORS /CREDIT PURCHASES /-*NO: OF MONTH

2*MONTHS =TOTAL CREDITS /CREDIT PURCHASE

PURCHASE= COST OF GOOD S SOLD+ CLOSING STOCK-OPENING STOCK

=1200000+805000-795000

=1210000

2 MONTHS =TOTAL CREDITS /1210000*12

=12*TOTAL CREDITORS =1210000*2

TOTAL CREDITORS =1210000*2/12

201667-10000(B.F) =191667

DESCRIPTIVE QUESTIONS

1. Explain briefly the different ratios that are commonly used in financial statement analysis.

Classification of financial ratios on the basis of function:


On the basis of function or test, the ratios are classified as liquidity ratios, profitability ratios,
activity ratios and solvency ratios.
Liquidity Ratios:
Liquidity ratios measure the adequacy of current and liquid assets and help evaluate the
ability of the business to pay its short-term debts. The ability of a business to pay its short-term
debts is frequently referred to as short-term solvency position or liquidity position of the
business.
Generally a business with sufficient current and liquid assets to pay its current liabilities as and
when they become due is considered to have a strong liquidity position and a businesses with
insufficient current and liquid assets is considered to have weak liquidity position.
Short-term creditors like suppliers of goods and commercial banks use liquidity ratios to know
whether the business has adequate current and liquid assets to meet its current obligations.
Financial institutions hesitate to offer short-term loans to businesses with weak short-term
solvency position.
Four commonly used liquidity ratios are given below:
1. Current ratio or working capital ratio
2. Quick ratio or acid test ratio
3. Absolute liquid ratio
4. Current cash debt coverage ratio
Unfortunately, liquidity ratios are not true measure of liquidity because they tell about the
quantity but nothing about the quality of the current assets and, therefore, should be used
carefully. For a useful analysis of liquidity, these ratios are used in conjunction with activity
ratios (also known as current assets movement ratios). Examples of activity ratios
are receivables turnover ratio, accounts payable turnover ratio and inventory turnover ratio etc.
Profitability ratios:
Profit is the primary objective of all businesses. All businesses need a consistent improvement in
profit to survive and prosper. A business that continually suffers losses cannot survive for a long
period.
Profitability ratios measure the efficiency of management in the employment of business
resources to earn profits. These ratios indicate the success or failure of a business enterprise
for a particular period of time.
Profitability ratios are used by almost all the parties connected with the business.
A strong profitability position ensures common stockholders a higher dividend income and
appreciation in the value of the common stock in future.
Creditors, financial institutions and preferred stockholders expect a prompt payment of interest
and fixed dividend income if the business has good profitability position.
Management needs higher profits to pay dividends and reinvest a portion in the business to
increase the production capacity and strengthen the overall financial position of the company.
Some important profitability ratios are given below:
Net profit (NP) ratio
Gross profit (GP) ratio
Price earnings ratio (P/E ratio)
Operating ratio
Expense ratio
Dividend yield ratio
Dividend payout ratio
Return on capital employed ratio
Earnings per share (EPS) ratio
Return on shareholder’s investment/Return on equity
Return on common stockholders’ equity ratio
Activity ratios:
Activity ratios (also known as turnover ratios) measure the efficiency of a firm or company in
generating revenues by converting its production into cash or sales. Generally a fast conversion
increases revenues and profits.
Activity ratios show how frequently the assets are converted into cash or sales and, therefore,
are frequently used in conjunction with liquidity ratios for a deep analysis of liquidity.
Some important activity ratios are:
 Inventory turnover ratio
 Receivables turnover ratio
 Average collection period
 Accounts payable turnover ratio
 Average payment period
 Asset turnover ratio
 Working capital turnover ratio
 Fixed assets turnover ratio
Solvency ratios:
Solvency ratios (also known as long-term solvency ratios) measure the ability of a business to
survive for a long period of time. These ratios are very important for stockholders and creditors.
Solvency ratios are normally used to:
 Analyze the capital structure of the company
 Evaluate the ability of the company to pay interest on long term borrowings
 Evaluate the ability of the the company to repay principal amount of the long term loans
(debentures, bonds, medium and long term loans etc.).
 Evaluate whether the internal equities (stockholders’ funds) and external equities
(creditors’ funds) are in right proportion.
Some frequently used long-term solvency ratios are given below:
 Debt to equity ratio
 Times interest earned (TIE) ratio
 Proprietary ratio
 Fixed assets to equity ratio
 Current assets to equity ratio
 Capital gearing ratio
Classification on the basis of financial statements:
Income statement/profit and loss ratios:
Income statement/profit and loss account ratios are those ratios that are calculated by using
the items of income statement/profit and loss account of a particular period only. Examples of
income statement/profit and loss account ratios are net profit ratio, gross profit ratio, operating
ratio, and times interest earned ratio etc.
Balance sheet ratios:
Balance sheet ratios are those ratios that are calculated by using figures from the balance
sheet only. The figures must be used from the balance sheet of the same period. Examples of
balance sheet ratios are current ratio, liquid ratio, and debt to equity ratio etc.
Composite ratios:
These ratios are calculated by using the items of both income statement and balance sheet for
the same period. Composite ratios are, therefore, also known as mixed ratios and inter-
statement ratios. Numerous composite ratios are computed depending on the need of analyst.
Some examples are inventory turnover ratio, receivables turnover ratio, accounts payable
turnover ratio, and working capital turnover ratio etc.
Classification on the basis of importance:
On the basis of importance or significance, the ratios are classified as primary ratios and
secondary ratios. The most important ratios are called primary ratios and less important ratios
are called secondary ratios. Secondary ratios are usually used to explain the primary ratios.
Examples of primary ratios for a commercial undertaking are return on capital employed ratio
and net profit ratio because the basic purpose of these undertakings is to earn profit.
Importance of ratios significantly varies among industries therefore each industry has its own
primary and secondary ratios. A ratio that is of primary importance in one industry may be of
secondary importance in another industry.
Classification of ratios on the basis of importance or significance is very useful for inter-firm
comparisons.

2. What is meant by Ratio Analysis? Discuss the Uses and Significance of Ratio analysis

Ratio Analysis and its Uses and Significance:

Usefulness to the Management:

1. Decision Making:

Mass of information contained in the financial statements may be unintelligible a confusing.


Ratios help in highlighting the areas deserving attention and corrective action facilitating
decision making.

2. Financial Forecasting and Planning:

Planning and forecasting can be done only by knowing the past and the present. Ratio help the
management in understanding the past and the present of the unit. These also provide useful
idea about the existing strength and weaknesses of the unit. This knowledge is vital for the
management to plan and forecast the future of the unit.

3. Communication:

Ratios have the capability of communicating the desired information to the relevant persons in a
manner easily understood by them to enable them to take stock of the existing situation:

4. Co-ordination is Facilitated:

Being precise, brief and pointing to the specific areas the ratios are likely to attract immediate
grasping and attention of all concerned and is likely to result in improved coordination from all
quarters of management.

5. Control is more Effective:

System of planning and forecasting establishes budgets, develops forecast statements and lays
down standards. Ratios provide actual basis. Actual can be compared with the standards.
Variances to be computed an analyzed by reasons and individuals. So it is great help in
administering an effective system of control.

Usefulness to the Owners/Shareholders:

Existing as well as prospective owners or shareholders are fundamentally interested in the (a)
long-term solvency and (b) profitability of the unit. Ratio analysis can help them by analyzing
and interpreting both the aspects of their unit.

Usefulness to the Creditors

Creditors may broadly be classified into short-term and long term. Short-term creditors are
trade creditors, bills payables, creditors for expenses etc., they are interested in analyzing the
liquidity of the unit. Long-term creditors are financial institutions, debenture holders, mortgage
creditors etc., they are interested in analyzing the capacity of the unit to repay periodical
interest and repayment of loans on schedule. Ratio analysis provides, both type of creditors,
answers to their questions.

Usefulness to Employees:

Employees are interested in fair wages: adequate fringe benefits and bonus linked with
productivity/profitability. Ratio analysis provides them adequate information regarding efficiency
and profitability of the unit. This knowledge helps them to bargain with the management
regarding their demands for improved wages, bonus etc.

Usefulness to the Government:

Govt. is interested in the financial information of the units both at macro as well as micro levels.
Individual unit's information regarding production, sales and profit is required for excise duty,
sales tax and income tax purposes. Group information for the industry is required for
formulating national policies and planning. In the absence of dependable information, Govt.
plans and policies may not achieve desired results.

3. From the following information make out a statement of proprietors funds with as
many details as possible.

Current Ratio 2.5: Liquid Ratio 1.5: Proprietary Ratio (Fixed assets /Proprietary fund): 0.75
Working Capital Rs.60,000 Reserves and surplus Rs.40,000Bank overdraft Rs.10,000
There is no long term loan or fictitious asset.

Solution:

Calculation of Current Assets and Current Liabilities

Current Ratio = 2.5(given)

CurrentRatio = Current Assets: Current Liabilities

Suppose, Current Liabilities areX

So, Current Assets will be 2.5X

Working Capital = Current Assets – Current Liabilities

60,000 = 2.5X – X (as working capital =Rs.60, 000)

60,000 = 1.5X

X = 60,000/1.5 = Rs.40, 000

Therefore, Current Liabilities are Rs.40, 000

and Current Assets = 2.5 x 40,000 = Rs.1,00,000

Calculation of Stock

Liquid Ratio = Liquid ,Quick Assets / Current Liabilites

= 1.5(given)

1.5 = Quick Assets/40,000

Quick Assets = Current Assets – Stock

60,000 = 1, 00,000 – Stock


Stock = 1, 00,000-60,000 = Rs. 40,000

Calculation of Proprietor’s Funds and Fixed Assets

Proprietary Ratio = 0.75:1

Fixed Assets: Proprietors’ funds =0.75:1

If Proprietor’s are X, Fixed Assets would be 0.75X

Since, Proprietors’ funds + Long term Loans + Current Liabilities

=Fixed Assets + Current Assets + Fictitious Assets

X+0+40,000 = 0.75X+1, 00,000+0

(As long-term loans and fictitious assets are nil)

or X - .75X = 1,00,000 – 40,000

.25X = 60,000

X = Rs.2, 40,000

So, proprietors’ funds are Rs.2, 40,000

And Fixed Assets are Rs.2, 40,000 x 75/100

or Fixed Assets are Rs.1,80,000

Calculation of Capital

Proprietors’ funds = Share capital + Reserves

or Rs.2,40,000 = Share capital + Rs.40,000

or Share capital= Rs.2,00,000

Statement of Proprietor’s Funds


Proprietors’ Funds
Share Capital 2,00,000
Reserve & Surplus 40,000
2,40,000
Investment of Funds
Fixed Assets 1,80,000
Current Assets:
Stock 40,000
Others 60,000

LessCurrent Liabilities 2,80,000


40,000
2,40,000

4. From the following information given below, You are required to prepare a Balance sheet of
Shree &co

Current Ratio =1.75 Liquid Ratio =1.25


Stock turnover Ratio = 9 Gross profit ratio = 25%
(Cost of sales /Closing stock) Debt collection period =1.5 months
Reserves and surplus to capital =0.2 Turnover to Fixed Assets =1.2
Fixed Assets to networth=1.25 Capital gearing ratio = 0.6
(Long term debt to equity capital)
Sales for the year = Rs. 12,00,000.

5.The following is the Balance Sheet of Bhubneshwara Ltd., as on 30 th June, 2015

Particulars Rs
I Equity and Liabilities
Equity share capital 3,00,000
9% Preference share capital 1,00,000
Reserves and surplus 50,000
Non Current Liabilities:
10% Debentures 2,00,000
Long Term Loans 25,000
Current Liabilities 2,25,000
Total 9,00,000
II Assets
Non-current Assets:
Fixed Assets 6,00,000
Investments 50,000
Current Assets 2,50,000
Total 9,00,000

You are required to calculate

(i)Debt - Equity Ratio - (Long - Term Debt to Equity)(ii) Proprietary Ratio (iii) Solvency Ratio
(iv) Fixed Assets to Proprietors Funds Ratio(v) Fixed Assets Ratio(vi) Current Assets to
Proprietors Funds Ratio

Solution:

a) Dept Equity Ratio

= Long-term Dept/ Shareholders’ Funds

Long –term Dept =10% Debentures + Long-term Loans

=Rs 2,00,000 + 25,000

=Rs 2,25,000

Shareholders’ Funds =Equity Share Capital+Preference Share


Capital+ Reserves and Surplus

=Rs 3,00,000+1,00,000+50,000

=Rs4,50,000

Dept-Equity Ratio =Rs2,25,000 / Rs4,50,000

=1: 2

B)Proprietory Ratio = Shareholders’ Funds/Total Assets

= Rs4,50,000/9,00,000
=0.50 or 50%

c)Solvency Ratio =Total liabilities to Outsiders/Total Assets

=Rs2,00,000+25,000+2,25,000/Rs
9,00,000

=Rs4,50,000/9,00,000

=0.50 or 50%

d)Fixed Assets to Proprietor’s Fund =Fixed Assets/ Shareholder’s Fund

=6,00,000/4,50,000

=1.33 or 1.33.33%

e) Fixed Assets Ratio =Fixed Assets/Total Long-term


Funds

=Fixed Assets/Shareholder’s Fund+Long-termBorrowings

=6,00,000/4,50,000+2,25,000=6,00,000/6,75,000

=0.888 or say 88.89%

f) Current Assets to Proprietor’s Funds =Current Assets/Shareholders’ Funds

=2,25,000/4,50,000

=0.555 or say 55.5%

6.Pearl Ltd gives you the following Balance Sheet for the year ending December 31, 2015
BALANCE SHEET

Liabilities Amount Assets Amount


Equity capital Goodwill 50,000
20,000 Shares of 10 each 2,00,000 Plant & Machinery 2,50,000
Preference Capital Furniture & Fittings 70,000
50,000 shares of Rs. 20 each 1,00,000 Trade Investments 1,50,000
Reserve Fund 50,000 Cash 20,000
Dividend Equalisation Fund 60,000 Sundry Debtors 1,25,000
Profit & Loss A/C 40,000 Bills Receivables 65,000
5% Debentures 1,50,000 Advance Tax 20,000
7% Mortgage Loan 70,000
Sundry Creditors 50,000
Bank Overdraft 30,000
7,50,000 7,50,000

Calculate the Following ratios:

(a) Debt - Equity Ratio (b) Funded Debt to Total Capitalization(c) Proprietary Ratio
(d) Solvency Ratio(e) Fixed Assets to Net worth Ratio(f) Current Assets to Proprietors Funds
Ratio.

Solution:

a)Debt equity ratio = outsider’s funds / shareholders funds

Outsider’s funds = 150000+70000+50000+30000

= 300000

Shareholders funds = 200000+100000+50000+60000+40000

= 450000

Debt equity ratio = 300000 / 450000

= 0.67

b) Funded Debt to total equilisation = funded debt (longterm debt)*100 / Total capitalization

funded debt = Debentures + Bonds + Other longterm loans

Total Capitalisation=Equity share capital + preference share capital + Reserve &


surplus +

Other reserves + Debentures + Bonds + Other longterm loans.

Funded debt = 150000+70000

= 220000

Total Capitalisation = 200000+100000+50000+60000+40000+150000+70000

= 670000

Funded Debt total capitalization = 220000 / 670000

= 0.33

c)Solvency Ratio = Total liabilities to the outsiders / Total Assets


Total liabilities to outsiders = 150000+70000+50000+30000

= 300000

Solvency Ratio = 300000 / 750000

= 0.4

d)Proprietory Ratio = shareholders funds / Total Assets

= 450000 / 750000

= 0.6

FA to net worth Ratio = FA / shareholders fund

FA = 50000+250000+70000

= 370000

= 370000 / 450000

FA to net worth ratio = 0.82

f) CA to proprietor’s fund

CA = 20000+125000+65000+20000

CA = 230000

CA to proprietor’s fund = 230000 / 450000

= 0.51

7. From the following particulars extracted from the financial statements of XYZ Ltd. compute

(a) Current Ratio (b) Liquid Ratio (c) Inventory Turnover Ratio (i) Net Sales/Average Inventory and(ii)
Cost of Goods Sold/Average Inventory (d) Debtors Turnover Ratio (e) Creditors Turnover Ratio

Particulars Amount Particulars Amount


(Rs) (Rs)
Opening Stock 47,000 Sundry Debtors 42,000
Closing Stock 53,000 Cash 10,000
Sales less returns 2,52,000 Bank 8,000
Provisions for bad debts 2,000 Bills receivables 15,000
Sundry Creditors 32,000 Bills payable 29,000
Purchase 1,80,000 Marketable Securities 8,000
Solution:

a)current ratio = CA / CL

CA = CS+Drs+Cash+Bank+BillsReceivable+Marketable securities

CA = 53000+42000+10000+8000+15000+8000

CA = 136000

CL = creditors+provision for bad debts+provision for tax+Bills payable

= 32000+2000+15000+29000

CL = 78000

Current Ratio = 136000 / 78000

= 1.74 times

b)QR = QA / CL

QA = CA-Stock

= 136000-53000

QA = 83000

QR = 83000 / 78000

LR (or) QR = 1.06

c) (i)Net sales/Average inventory

Average inventory = OS+CS / 2

= 47000+53000 / 2

Average inventory = 50000

Net Sales /Average inventory = 252000 / 50000

Net sales/Average inventory = 5.04

(ii) CGS/Average inventory


Cost of goods sold =OS+P-CS

= 47000+180000-53000

CGS= 174000

=174000 / 50000

CGS/Average inventory = 3.48

d)Debtors turnover ratio = Net credit sales / Average trade debtors

Average trade debtors = Debtor + BR

=42000+15000

Average trade debtors = 57000

= 252000 / 57000

DTR = 4.42

e) Creditors turnover ratio = Net credit purchase / Average trade creditors

Average trade creditors = Crs + BP

= 32000+29000

Average trade creditors = 61000

Calculation of credit purchase

CGS = OS+P-CS

174000 = 47000+P-53000

174000-47000+53000 = P

P = 180000

= 180000 / 61000

CTR = 2.95

8. Following is the Profit and Loss Account of Electro Matrix Ltd for the year ended 31 st
December 2015.
(Dr) Rs Rs (Cr)

To Opening Stock 1, 00,000 By Sales 5, 60,000


To Wages 3, 50,000 By Closing Stock 1, 00,000
Wages 9,000
To Gross Profit c/d 2, 01,000
6, 60,000 6, 60,000
To Administrative expenses 20,000 By Gross Profit b/d 2, 01,000
To Selling & Distribution Exp. 89,000 By Interest on Investment
(Outside business) 10,000
To Non-operating expenses 30,000 By Profit on Sale of
To Net Profit 80,000 Investments 8,000
2,19,000 2,19,000
You are required to calculate:
(i) Gross Profit Ratio (ii) Net Profit Ratio (iii) Operating Ratio
(iv) Operating Profit Ratio (v) Administrative Expenses Ratio

Solution:

1. Gross Profit Ratio =Gross Profit / Net Sales X 100

=2,01,100 / 5,60,000 X 100 = 35.9%

2.Net Profit Ratio =Net Profit(after tax) / Net Sales X 100

= 80,000 / 5,60,000 X 100 = 14.3%

Alternatively, Net Profit Ratio =Net Operating Profit / Net Sales X 100

=(80,000 + 30,000) – (10,000+8,000) / 5,60,000 X 100

= 92,000 / 5,60,000 X 100 = 16.4%

3. Operating Ratio =Cost of Goods Sold +OperatingExp/Net


Sales

Cost of Goods Sold =Op.Stock+Purchases+Wages-Closing Stock

=1,00,000+3,50,000+9,000-1,00,000=Rs 3,59,000

Operating Expenses =Administrative + Selling & Distribution Expenses

=Rs 20,000 + 89,000= Rs 1,09,000

Operating Ratio =3,59,000 + 1,09,000 / 5,60,000 X 100

= 4,68,000 / 5,60,000 X 100 = 83.6%


4. Operating Profit Ratio = 100 – Operating Ratio

=100 – 83.6% = 16.4%

5. Administrative Expense Ratio` = Administrative Expenses / Net Sales X


100

= 20,000 / 5,60,000 X 3.6%

9. Rearrange the following statement in a form suitable for analysis and calculate 5 significant
ratios to analyze the financial trend of the business.

Consolidated Balance Sheet

Particulars Year1 (Rs) Year II (Rs)

Bank 15,380 26,020


Debtors 11,260 11,210
Stock 56,160 50,460
Fixed Assets Less Depreciation 2,17,200 2,19,810
_______ _______
3,00,000 3,07,500
_______ _______
Creditors 20,000 16,500
Bills Payable 12,750 6,500
Debentures 1,00,000 1,00,000
Reserves 67,250 84,500
Paid up Capital 1,00,000 1,00,000
________ _______
3,00,000 3,07,500

Solution:

Current Ratio

CR = CA / CL

I Year

CA = Bank + Debtors + Stock

= 15380+11260+56160

CA = 82800
CL = Creditors + BP

= 20000+12750

= 32750

CR = 82800 / 32750

= 2.53:1

II Year

CA = 26020+11210+50460

CA = 87730

CL = 16500+6500

=23000

CR = 87730 / 23000

= 3.81:1 times

Current ratio of the firm for the first year and second year are satisfied when compare
with standard normal.

Liquid Ratio

LR = LA / CL

I Year

LA = CA-Stock

= 82800-56160

= 26640

LR = 26640 / 32750

LR = 0.81:1

II year

LA = 87730-50460

LA = 37270
LR = 37270 / 23000

= 1.62:1

The liquid ratio of the firm in the first year is not satisfied and the second year shows
good symptom.

Debt-equity ratio = Debt / equity

I Year

Debt (or) outsiders funds = Debentures + BP + Creditors

= 100000+12750+20000

Debt = 132750

Equity (or) shareholders funds = paidup capital + reserves

= 100000+67250

Shareholder funds = 167250

= 132750 / 167250

Debt equity ratio = 0.79

II year

Debt = 16500+6500+100000

= 123000

Equity = 84500+100000

= 184500

Debt-equity ratio = 123000 / 184500

= 0.67

Debt-equity ratio shows decreased when compare with I year. It shows poor situation

Proprietory ratio = Shareholders funds / Total Assests

I Year

= 167250 / 300000

Proprietory ratio = 0.56


II Year = 184500 / 307500

Proprietory ratio = 0.6

Proprietory ratio has increased compare with I Year

Fixed Assets Ratio = FA / Total longterm funds

I year = 217200 / 100000

FA ratio = 2.17

II year = 219810 / 100000

FA ratio = 2.20

FA ratio of the company has increased from the first year to second year.

10. Following is the Balance sheet of SonaLtd as on 31-12-2015

Liabilities (Rs) Assets (Rs)


Equity share Capital 1,00,000 Fixed Assets 3,60,000
7% Preference Capital 20,000 Less: Depreciation 1,00,000
Reserves and surplus 80,000 2,60,000
6% Debentures 1,40,000 Stock 60,000
Creditors 12,000 Debtors 40,000
Bills Payable 20,000 Trade investments 30,000
Outstanding expenses 2,000 Cash 10,000
Taxation provision 26,000
_________ __________
4,00,000 4,00,000
__________ __________
Additional Information:

i) Net Sales Rs 6, 00,000


ii) Cost of goods sold Rs.5, 16,000
iii) Net income before Tax Rs.40, 000
iv) Net income afterTax Rs.20, 000
Calculate Solvency Ratios

Solution:
CR = CA / CL

CA = Stock+Drs+Tradeinvestments+cash

= 60000+40000+30000+10000

=140000

CL = Crs +BP+Outstandingexpenses+Provision for tax

= 12000+20000+2000+26000

= 60000

CR = 140000 / 60000

CR = 2.33:1

LR = LA / CL

LA = CA-Stock

= 140000-60000

= 80000

LR = 80000 / 60000

= 1.33:1

Proprietory ratio = shareholder’s funds / Total Assets

Shareholder’s funds = ESR+PSR+R&S

=100000+20000+80000

= 200000

Proprietory ratio = 200000 / 400000

= 0.5:1

Debt equity ratio = Debt / Equity

Debt(outsider’s funds) = Debentures+crs+Bp+outstandingexp+Taxationprovison

= 140000+12000+20000+2000+26000

= 200000
Equity (or) proprietor’s funds = 200000

= 200000 / 200000

Debt-equity ratio = 1:1

FA to proprietor’s funds = FA / PF

= 260000 / 200000

FA to PF ratio = 1.3:1

Interest coverage ratio = N/P (before Interest and taxes) / Fixed interest charges

Fixed Interest charges = Debenture*interest rate

= 140000*6%

= 8400

Interest coverage ratio = 40000 / 8400

= 4.76 times

Solvency ratio = External liabilities / Total Assets

= 200000 / 400000

= 0.5:1