FINANCIAL MANAGEMENT UNIT 3

Ratio Analysis- Meaning, definition, objectives and limitations of Ratio Analysis, Classification
of Ratios: Profitability ratios, liquidity ratios, solvency ratios and acid ratios.

RATIO ANALYSIS
Ratio: A ratio is a simple arithmetical expression of the relationship of one number to another.
Ratio Analysis: Ratio Analysis is a technique of analysis and interpretation of financial statements. It is the process of
establishing and interpreting various ratios for helping in making certain decisions.

USES & SIGNIFICANCE OF RATIO ANALYSIS

A) Managerial uses of Ratio Analysis
1. Helps in decision-making. Financial statements are prepared primarily for decision-making. But information provided in
financial statements is not an end in itself and no meaningful conclusion can be drawn from these statements alone. Ratio
analysis helps in making decisions from the information provided in these financial statements.
2. Helps in financial forecasting and planning. Ratio Analysis is of much help in financial forecasting and planning.
Planning is looking ahead and the ratios calculated for a number of years work as guide for the future. Meaningful
conclusions can be drawn for future from these ratios. Thus, ratio analysis helps in forecasting and planning.
3. Helps in communicating. The financial strength and weakness of a firm are communicated in a more easy and
understandable manner by the use of ratios. The information contained in the financial statements is conveyed in a
meaningful manner to the one for whom it is meant. Thus, ratios help in communication and enhance the value of the
financial statements.
4. Helps in co-ordination. Ratios even help in co-ordination which is of utmost importance in effective business
management. Better communication of efficiency and weakness of an enterprise results in better co-ordination in the
enterprise.
5. Helps in control. Ratio analysis even helps in making effective control of the business. Standard ratios can be based
upon proforma financial statements and variances or deviations, if any, can be found by comparing the actual with the
standards so as to take a corrective action at the right time. The weakness or otherwise, if any, come to the knowledge of
the management which helps in effective control of the business.

B) Utility to Shareholders/Investors: An investor in the company will like to assess the financial position of the concern
where he is going to invest. His first interest will be the security of his investment and then a return in the form of dividend
or interest. For the first purpose he will try to asses the value of fixed assets and the loans raised against them. The investor
will feel satisfied only if the concern has sufficient amount of assets. Long-term solvency ratios will help him in assessing
financial position of the concern. Profitability ratios, on the other hand, will be useful to determined profitability position.
Ratio analysis will be useful to the investor in making up his mind whether present financial position of the concern
warrants further investment or not.
C) Utility to Creditors: There are interested to know whether financial position of the concern warrants their payments at a
specified time or not. The concern pays short-term creditors out of its current assets. If the current assets are quite
sufficient to meet current liabilities then the creditors will not hesitate in extending credit facilities. Current and Acid-test
ratios will give an idea about the current financial position of the concern.
D) Utility to Employees: Employees wages and fringe benefits are related to the volume of profits earned by the concern.
The employees make use of information available in financial statements. Various profitability ratios relating to gross profit,
operating profit, net profits, etc., enable employees to put forwards their view point for the increase of wages and other
benefits.
E) Utility to Government: Government may base its future policies on the basis of industrial information available from
various units. The ratios may be used as indicators of overall financial strength of public as well as private sector. In the
absence of the reliable economic information, governmental plans and policies may not prove successful.

LIMITATIONS OF RATIO ANALYSIS

1. Limited Use of a Single Ratio. A single ratio, usually, does not convey much of sense. To make better interpretation a
number of ratios have to be calculated which is likely to confuse the analyst than help him in making any meaningful
conclusion.
2. Lack of Adequate Standards. There are no well accepted standards or rules of thumb for all ratios which can be
accepted as norms. It renders interpretation f the ratios difficult.
3. Inherent Limitations of Accounting. Like financial statements ratios also suffer from the inherent weakness of
accounting records such as their historical nature. Ratios of the past are not necessarily true indicators of the future.
4. Change of Accounting Procedure. Change in accounting procedure by a firm often makes ratio analysis misleading, e.g.,
a changed in the valuation of methods of inventories, from FIFO to LIFO increases the cost of sales and reduces
considerable the value of closing stocks which makes stock turnover ratio to be lucrative and an unfavorable gross profit
ratio.
5. Window Dressing. Financial statements can easily be widow dressed to present a better picture of its financial and
profitability position to outsiders. Hence, one has to be very careful in making a decision from ratios calculated from such
financial statements. But it may be very difficult for an outsider to know about the window dressing made by a firm.
6. Personal Bias. Ratios are only means of financial analysis and not an end in itself. Ratio have to be interpreted and
different people may interpret the same ratio in different ways.
7. Uncomparable. Not only industries differ in their nature but also the firms of the similar business widely differ in their
size and accounting procedures, etc. it makes comparison of ratios difficult and misleading. Moreover, comparisons are
made difficult due to differences in definitions of various financial terms used in the ratio analysis.
8. Absolute Figures Distortive. Ratios devoid of absolute figures may prove distortive as ratio analysis is primarily a
quantitative analysis and not a qualitative analysis.
9. Price Level Changes. While making ratio analysis, no consideration is made to the changes in price levels and this makes
the interpretation of ratios invalid.
10. Ratios no Substitutes. Ratio analysis is merely a tool of financial statements. Hence, ratio become useless if separated
from the statements from which they are computed.
 Significance of current ratio: Current ratio is a general
and quick measure of liquidity of a firm. It represents the
‘margin of safety’ or ‘cushion’ available to the creditors
and other current liabilities. It is most widely used for
making short-term analysis of the financial position or
short-term solvency of a firm.

Interpretation of current ratio: Standard norm of the

current ratio is 2:1 as considered to be satisfactory.
A high current ratio may not be favorable due to
the following reasons:
i. There may be show moving stocks. The stocks will
pile up due to poor sale.
ii. The figures of debtors may go up because debt
collection is not satisfactory.
iii. The cash or bank balances may be lying idle because
of insufficient investment opportunities.
On the other hand, a low current ratio may be
due to the following reasons:
i. There may not be sufficient funds to pay off
liabilities.
ii. The business may be trading beyond its capacity. The
resources may not warrant the activities.

2. QUICK OR ACID TEST OR LIQUID RATIO:

The term ‘liquidity’ refers to the ability of a firm
to pay its short-term obligations as and when they become
CLASSIFICATION OF RATIOS due. Quick Ratio may be defined as the relationship
 Liquidity Ratios between liquid assets and current liabilities. An asset is
 Activity Ratios said to be liquid if it can be converted into cash within a
short period without loss of value.
 Long term Solvency Ratios Liquid Assets
 Profitability Ratios Quick Ratio = ------------------------
Current Liabilities
Liquid Assets = Current Assets − (Inventories +
LIQUIDITY RATIOS: Prepaid Exp.)
liquidity refers to the ability of a concern to meet
its current obligations as and when these become due. The Significance of Quick Ratio: The quick ratio is very
short term obligations are met by realizing amounts from useful in measuring the liquidity position of a firm. It
current, floating or circulating assets. The current assets measures the firm’s capacity to pay off current obligations
should either be liquid or near liquidity. These should be immediately and is a more rigorous test of liquidity than
convertible into cash for paying obligations of short-term the current ratio. It is used as a complementary ratio to the
nature. To measure the liquidity of a firm, the following current ratio.
ratios can be calculated:
 Current Ratio Interpretation of Quick Ratio: Standard norm of the
 Quick or Acid Test or Liquid Ratio quick ratio is 1:1 as considered to be satisfactory. Usually,
 Absolute Liquid ratio or Cash position a high acid test ratio is an indication that the firm is liquid
ratio and has the ability o meet its current or liquid liabilities in
time and on the other hand a low quick ratio represents
that the firm’s liquidity position is not good.
1. CURRENT RATIO:
Current ratio may be defined as the relationship Significance of quick ratio: The quick ratio is very useful
between current assets and current liabilities. This ratio is in measuring the liquidity position of a firm. It measures
also known as working capital ratio. It is calculated by the firm’s capacity to pay off current obligation
dividing the total of current assets and total of current immediately and is a more rigorous test of liquidity than
liabilities. the current ratio. It is used as a complementary ratio to the
Current Assets current ratio.
Current Ratio = --------------------------------
Current Liabilities 3. ABSOLUTE LIQUID RATIO OR CASH RATIO:
It is the relationship between absolute liquid assets and
COMPONENTS OF CURRENT RATIO current liabilities.
CURRENT ASSETS CURRENT LIABILITIES Absolute liquid Assets
Cash in hand Outstanding expenses Absolute Liquid Ratio =
Cash at bank Bills payable -------------------------------
Marketable securities Sundry creditors Current
Bills receivable Short term advances Liabilities
Sundry debtors Income tax payable Absolute Liquid Assets = Cash + Bank + Marketable
Inventories Dividends payable Securities
Prepaid expenses Bank overdraft The acceptable norm for this ratio is 2 : 1
Accrued incomes
ACTIVITY RATIOS
Funds are invested in various assets in business 2
to make sales and earn profits. The efficiency with which Accounts Receivable = Trade debtors + Bills Receivables
assets are managed directly affects the volume of sales.  If opening debtors are not available then closing
The better the management of assets, the larger is the debtors and bills receivable are taken as average
amount of sales and the profits. Activity ratios measure the debtors.
efficiency or effectiveness with which a firm manages its  If net credit sales are not available then total sales
assets. The ratios are also called turnover ratios because are treated as credit sales.
they indicate the speed with which assets are converted or Significance: Debtors turnover ratio is an indication of the
turned over into sales. These ratios are expressed as speed with which a company collects its debts. The higher
‘times’ and should always be more than one. Some activity the ratio the better it is because it indicates that debts are
ratios are: being collected quickly. In general, a high ratio indicates
the shorter collection period which implies prompt
1. INVENTORY TURNOVER RATIO OR payment by debtors, land a low ratio indicates longer
collection period which implies delayed payments by
STOCK TURNOVER RATIO: debtors. To judge whether the ratio is satisfactory or not, it
This ratio establishes relationship between cost should be compared with own past ratios or with the ratio
of goods sold and average stock or inventory. The ratio of similar firms.
throws light on the efficient use of the stock. It also
indicates whether the required minimum amount has been
blocked in the stocks or not. This ratio provides guidelines
Debtor Velocity/Debt Collection Period:
to the management while framing stock management This period shows an average period for which
policy. It is calculated as under:- the credit sales remain outstanding and measures the
quality of debtors. It indicates the rapidity or slackness
Cost of goods sold
with which the money is collected from debtors. This
Stock Turnover Ratio = period may be calculated as under:
------------------------------ 12 months / 52 weeks / 365
Average days
Stock Debt Collection Period =
Costs of goods sold = Opening stock + Purchases + Direct
-------------------------------------------
expenses − Closing Stock Or Sales − Gross Profit
Opening Stock + Closing Debtors
Stock Turnover Ratio
Average Stock = 3. CREDITORS TURNOVER RATIO:
---------------------------------------- This ratio establishes a relationship between net
2 credit purchases and average trade creditors and bills
 If cost of goods sold is not given, the ratio is playable and is calculated as under:-
calculated from the sales. Net Credit Purchases
 If only closing stock is given, then that may be Creditors Turnover Ratio =
treated as average stock ---------------------------------
Significance: The ratio signifies the number of times on Average Accounts
an average the inventory or stock is sold during the period. Payable
The high ratio is indicative of efficiency and the low ratio Accounts Payable = Trade Creditors + Bills
is indicative of inefficiency of stock management. Payable
To judge whether the ratio is satisfactory or not Op. A.P +
it should be compared with its own past ratios or with the Cl. A. P
ratio of similar firms in the same industry or with
industry’s average.
Average Accounts Payable =
12 months / 52 weeks / -----------------------------------------
365 days 2
Creditor Velocity / Debt Payment Period: This period
Stock Velocity = shows an average period for which the credit purchases
--------------------------------------------- remain outstanding or the average credit period actually
Stock Turnover availed of:
Ratio 12 months / 52 weeks / 365
2. DEBTOR TURNOVER RATIO: days
This ratio establishes a relationship between net Debt Payment Period =
credit sales and average trade debtors and bills ---------------------------------------
receivable. The objective of computing this ratio is to Creditor Turnover
determine the efficiency with which the trade debtors are
managed. This ratio is also known as ‘ratio of net sales to
Ratio
average receivables’ it is calculated as under:-
Net Credit Sales ANALYSIS OF LONG-TERM
Debtors Turnover Ratio = FINANCIAL POSITION OR TESTS
------------------------------------
Average Accounts OF SOLVENCY
Receivables The term ‘solvency’ refers to the ability of a
Op. A.R + Cl. concern to meet its long term obligations. The long-term
indebtedness of a firm includes debenture holders,
A.R financial institutions providing medium and long-term
Average Accounts Receivable = loans and other creditors selling goods on installment
-------------------------------------- basis. The long-term creditors of a firm are primarily
interested in knowing the firm’s ability to pay regularly
interest on long-term borrowings, repayment of the Significance: This ratio indicates the extent to which
principal amount at the maturity and the security of their shareholders’ funds are sunk into the fixed assets.
loans. Accordingly, long-term solvency ratios indicate a Generally, the purchase of fixed assets should be financed
firm’s ability to meet the fixed interest and costs and by shareholders’ equity including reserves, surpluses and
repayment schedules associated with its long-term retained earnings. If the ratio is less than 100%, it implies
borrowings. The following ratios serve the purpose of that owner’s funds are more than total fixed assets and a
determining the solvency of the concern. part of the working capital is provided by the shareholders.
When the ratio is more than 100% it implies that owners’
1. DEBT-EQUITY RATIO funds are not sufficient to finance the fixed assets and the
Debt-Equity Ratio is calculated to measure the firm has to depend upon outsiders to finance the fixed
relative claims of outsiders and the owners against the assets. There is no ‘rule of thumb’ to interpret this ratio but
firm’s assets. This ratio indicates the relationship between 60% to 65% is considered to be satisfactory ratio in case
the external equities or the outsiders’ funds and the of industrial undertakings.
internal equities or the shareholders’ funds, thus:
Outsiders Funds 5. FIXED ASSETS LTO TOTAL LONG TERM
Debt-Equity Ratio = --------------------------- FUNDS OR FIXED ASSETS RATIO
Shareholders’ A variant to the ratio of fixed assets to net worth
Funds is the ratio of fixed assets to total long-term funds which is
Outsiders Funds = Long Term Debts + Short Term Debts calculated as:
Shareholders’ Funds = Equity Share Capital + Preference Fixed Assets (After
Share Capital + Reserves and Surpluses – Fictitious Assets Depreciation)
Significance: It indicates the extent of fixed interest Fixed Assets Ratio =
bearing funds being used in the business. A low debt- --------------------------------------------------
equity ratio implies the use of more equity than debt. This Total Long-term
means that business runs at low gear and is likely to earn Funds
less profit as compared to the situation when debt is more
Significance: This ratio indicates the extent to which the
than the equity in which case the business is likely to earn
totals of fixed assets are financed by long term funds of
a higher return on the equity after paying the interest. The
the firm. Generally, the total of the fixed assets should be
ideal Debt-Equity ratio is 1:1.
equal to the total of long-term funds or, say, the ratio
should be 100%. But in case the fixed assets exceed the
2. PROPRIETARY RATIO OR EQUITY RATIO total of the long-term funds it implies that the firm has
This ratio establishes the relationship between financed a part of the fixed assets out of current funds or
shareholders’ funds to total assets of the firm. The can be the working capital which is not a goods financial policy.
calculated as under: And if the total long term funds are more than total fixed
Shareholder’s Funds assets. It means that a part of the working capital
Equity Ratio = ---------------------------- requirements is met out of the long-term funds of the
Total Assets firms.
Total Assets = Fixed Assets + Current Assets
Significance: As equity ratio represents the relationship of 6. DEBT SERVICE RATIO OR INTEREST
owner’s funds to total assets, higher the ratio or the share COVERAGE RATIO
of the shareholders in the total capital of the company, Debt service ratio is used to test the debt
better is the long-term solvency position of the company servicing capacity of a firm. The ratio is also known as
ratio indicates the extent to which the assets of the interest Coverage Ratio of fixed Charges Cover or Times
company can be lost without affecting the interest of Interest Earned. This ratio is calculated by dividing the net
creditors of the company. profit before interest and taxes by fixed interest charges.
Net profit
3. SOLVENCY RATIO (EBIT)
This ratio indicates the relationship between the Debt-Service Ratio or Interest Coverage =
total liabilities to outsiders to total assets of a firm and can
be calculated as follows:
------------------------
Total Liabilities to Fixed
Outsiders Interest Charges
Significance: interest coverage ratio indicates the number
Solvency Ratio = of times interest is covered by the profits available to pay
--------------------------------------- the interest charges. Long-term creditors of a firm are
Total Assets interested in knowing the firms’ ability to pay interest on
Significance: Generally, lower the ratio of total liabilities their long term borrowing. Generally, higher the ratios,
to total assets, more satisfactory or stable is the long-term more safe are the long-term creditors because even if
solvency position of a firm. earnings of the firm fall, the firm shall be able to meet its
commitment of fixed interest charges. But a too high
4. FIXED ASSETS TO NET WORTH RATIO interest coverage ratio may not be good for the firm
The ratio establishes the relationship between because it may imply that firm is not using debt as a
fixed assets and shareholder’s funds, i.e., share capital plus source of finance so as to increase the earnings per share.
reserves, surpluses and retained earnings. The ratio can be
calculates as follows:
Fixed Assets (After
PROFITABILITY RATIOS
Profits are an index of economic progress.
dep.) Profitability ratios are calculated to measure the overall
Fixed Assets to Net worth Ratio = efficiency of the business. Generally, profitability ratios
------------------------------------ are calculated either in relation to sales or in relation to
Sharehold investment. The various profitability ratios are discussed
ers’ Funds below:
 Expenses ratios indicate the relationship of various
A. GENERAL PROFITABILITY expenses to net sales. The operating ratio reveals the
average total variations in expenses. But some of the
RATIOS expenses may be increasing while some may be falling.
1. GROSS PROFIT RATIO Hence, expense ratios are calculated by dividing each item
Gross profit ratio measures the relationship of of expenses or groups of expenses with the net sales to
gross profit to net sales and is usually represented as a analyze the causes of variation of the operating ratio. The
percentage. Thus, it is calculated by dividing the gross ratio can be calculated for each individual item of
profit by sales: expenses or a group of items of a particular type of
Gross Profit expense like cost of sales ratio, administrative expenses
ratio, selling expense ratio, material consumed ratio, etc.
Gross Profit Ratio = ----------------------- × The lower the ratio, the greater is the profitability and
100 higher the ratio, lower is the profitability. While
Net Sales interpreting the ratio, it must be remembered that for a
Significance: the gross profit ratio indicates the extent to fixed expense of rent, the ratio will fall if the sales
which selling prices of goods per unit may decline without increase and for a variable expense, the ratio in proportion
resulting in losses on operations of a firm. It reflects the to sales shall remain nearly the same.
efficiency with which a firm production its products. As Particular expense
the gross profit is found by deducing cost of goods sold Particular Expense Ratio = -------------------------------
from the net sales, higher the gross ratio (G.P Ratio) better
the result. There is no standard norm for gross profit ratio
× 100
and it may vary from business to business but the gross Net Sales
profit should be adequate to cover the operating expenses
and to provide for fixed charges, dividends and B. OVERALL PROFITABILITY
accumulation of reserves. A low profit ratio, generally
indicates high cost of goods sold due to unfavorable RATIOS
purchasing policies, lesser sales, lower selling prices, Profits are the measure of overall efficiency of a
excessive completion, over-investment in plant and business. The higher the profits, the more efficient are the
machinery, etc. business considered. Overall profitability or efficiency of a
business can be measured in terms of profit related to
2. NET PROFIT RATIO investments made in the business. Following are the
important overall profitability ratios or measure of Return
Net profit ratio establishes a relationship
on Investments.
between net profit (after taxes) and sales, and indicates the
efficiency of the management in manufacturing, selling, 1. RETURN ON SHAREHOLDER’S
administrative and other activities of the firm. This ratio is INVESTMENT OR NET WORTH
the overall measure of firm’s profitability and is calculated Return on Shareholders’ Investment, popularly
as: known as ROI or Return on Shareholder / Proprietors’
Net Profit after tax funds is the relationship between net profit (after interest
Net Profit Ratio = ----------------------------- × & tax) and the proprietors, funds. Thus,
100 Net Profit (after interest &
Net Sales tax)
Significance: This ratio also indicates the firm’s capacity Return on Shareholders’ Investment =
to face adverse economic conditions such as price --------------------- × 100
competition, low demand, etc. Higher the ratio, the better Sharehold
is the profitability. But while interpreting the ratio, it ers’ Funds
should be kept in mind that the performance of profits Significance: This ratio is one of the most important ratios
must also see in relation to investments or capital of the used for measuring the overall efficiency of a firm. This
firm and not only in relation to sales. ratio indicates the extent to which this primary objective
of business is being achieved. This ratio is of great
3. OPERATING PROFIT RATIO importance to the present and prospective shareholders as
This ratio is calculated by dividing operating profit well as the management of the company. As this ratio
by sales. Operating profit is calculated as: reveals how well the resources of a firm are being used,
Operating Profit = Net Sales – Operating Cost higher the ratio, better are the results. The return on
Operating Cost = Cost of Goods Sold + Administrative shareholders’ investment should be compared with the
and Office Expenses + Selling and Distribution expenses return of other similar firms in the same industry. The
Operating Profit inter-firm comparison of this ratio determines whether the
Operating Profit Ratio = investments in the firm are attractive or not as the
---------------------------- × 100 investors would like to invest only where the return is
Sales higher.
4. OPERATING RATIO
Operating ratio establishes the relationship 2. RETURN ON EQUITY CAPITAL
between cost of goods sold and the operating expenses on Return on equity capital is the relationship
the one hand and the sales on the other. On other words, it between profits of a company and its equity capital can be
measures the cost of operations per rupee of sales. The calculated as:
ratio is calculated by dividing operating costs with the net Net profit after tax – preference
sales and it’s generally represented as a percentage. dividend
Operating Cost Return on equity capital =
Operating Ratio = ----------------------- × 100 -------------------------------------- × 100
Net Sales Equity share capital
(paid up)
5. EXPENSES RATIOS
Significance: This ratio is more meaningful to the equity Dividend per share =
shareholders who are interested to know profits earned by ----------------------------------------
the company and those profits which can be made Number of
available to pay dividend to them. Interpretation of the shares
ratio is similar to the interpretation of return on
shareholders’ investments and higher the ratio, better it is.
7. DIVIDEND PAY OUT RATIO OR PAYOUT
3. EARNINGS PER SHARE (E.P.S) RATIO
Dividend pay-out ratio is calculated to find the
An earnings per share is calculated by dividing the
extent to which earnings per share have been related in the
net profit after taxes and preference dividend by the total
business. It is an important ratio because ploughing back
number of equity shares. Thus,
of profits enables a company to grow and pay more
Net Profit after Tax – Preference Dividend dividends in future.
E.P.S = Dividend per equity
------------------------------------------------------------------ share
No. of Equity Shares Dividend pay-out ratio =
4. RETURN ON CAPITAL EMPLOYED
-----------------------------------
Profits before Interest Earnings
and Tax per share
Return on Gross Capital Employed =
------------------------------- 8. PRICE-EARNING RATIO OR P/E RATIO
Gross Capital (EARNINGS YUIELD RATIO)
Employed Price-earning ratio is the ratio between market
price per equity share and earnings per share. The ratio is
calculated to make an estimate of appreciation in the value
Profit after Interest of a share of a company and is widely used by investors to
and Tax decide whether or not to buy shares in a particular
Return on Net Capital Employed = company. The ratio is calculated as:
----------------------------------- Market price per equity
Net Capital share
Employed Price earnings ratio =
Gross Capital Employed = Fixed assets + Current Assets -------------------------------------
Net Capital Employed = Fixed Assets + Current Assets – Earnings per
Current Liabilities share
Generally, higher the price-earning ratio, the
5. CAPITAL TURNOVER RATIO better it is. If the P/E ratio falls, the management should
Capital turnover ratio is the relationship between look into the causes that have resulted into the fall of this
Cost of Goods Sold and the capital employed. This ratio is ratio.
calculated to measure the efficiency or effectiveness with
which a firm utilizes its resources or the capital employed. 9. EARNINGS YIELD RATIO
As capital is invested in a business to make sales and earn This ratio also shows a relationship between
profits, this ratio is a good indicator of overall profitability earnings per share and market value of shares. It can be
of a concern. calculated as follows:
Cost of Goods Sold or Earnings per share
Sales Earning yield ratio = ----------------------------
Capital Turnover Ratio = × 100
------------------------------ Market price per
Capital share
Employed Problems:
1. The following is the balance sheet of
MARKET TEST OR VALUATION New India Ltd. for the year ending 31-
RATIOS 12-2006.
6. DIVIDEND YIELD RATIO Liabilities Rs. Assets Rs.
Shareholders are the real owners of a company Eq. share capital 10,00,000 Goodwill 1,00,000
and they are interested in real sense in the earnings 9% Pref. Sh. 5,00,000 Land & Building 6,50,000
distributed and paid to them as dividends. Therefore, Cap. 8% 2,00,000 Plant 8,00,000
dividend yield ratio is calculated to evaluate the Debentures 1,00,000 Furniture 1,50,000
relationship between dividend per share paid and the long-term loan 60,000 Bills Receivable 70,000
market value of the share. Bills Payable 70,000 Sundry debtors 90,000
Dividend per Sundry Creditors 30,000 Bank balance 45,000
share Bank Overdraft 5,000 Short-term 25,000
Dividend yield ratio = O/S Expenses invest. 5,000
---------------------------------- Prepaid 30,000
Market value per 1965000 expenses 1965000
stock
share
From the balance sheet calculate: Current ratio; Acid test
Dividend paid to ratio; Absolute liquid ratio; Comment on these ratios
shareholders [Ans: 1.61; 1.39; 0.42]
2. Following information is given to you: i) Current Credit sales Rs. 2, 70,000
Ratio = 205; ii)Working Capital = Rs. 90,000; Trade debtors at the end Rs. 45,000
Find out: a) Current assets and b) Current Liabilities. Returns inward Rs. 20,000
[Ans: Rs. 60,000; Rs. 1, 50,000] Provision for bad and doubtful debts Rs. 5,000
Calculate: 1) Debtors Turnover Ratio; 2) Average
3. The following information of a company given: Collection Period. [Ans: 5 times; 72 days]
Current ratio 2.5:1; Acid Test Ratio 1.5:1; Current 16. From the following information calculate Creditors
Liabilities Rs. 50,000. Find out: a) Current Assets; b) Turnover Ratio and Average Payment Period:
Liquid Assets; c) Inventory. [Ans: Rs. 1, 25,000; Rs. Total purchases Rs. 4, 00,000
75,000; Rs. 50,000] Bills Payable at the end Rs. 20,000
4. Given: Current Ratio = 2.8; Acid test Ratio = 1.5; Cash purchases Rs. 50,000
Working Capital = Rs. 1, 62,000. Reserve for discount on Creditors Rs. 5,000
Find out: a) current Assets; b) Current Liabilities; c) Purchase returns Rs. 20,000
Liquid Assets. [Ans: 2, 52,000; Rs. 90,000; Rs. 1, Take 365 days in a year
35,000] Creditors at the end Rs. 60,000
5. Find out Current Assets when Current Ratio is 2.4 and [Ans: 4.13 times; 88 days]
Working Capital is Rs. 1, 40,000.[Ans: Rs. 2, 40,000] 17. You are supplied with the following information from
6. Calculate: Current assets, Liquid assets and Inventory, the records of M/s. SAI Steel Ltd. For the year ending
when Current Liabilities are Rs. 80,000, Current Ratio 31-12-2006:
is 2:1, Liquid Ratio is 15:1, and Prepaid Expenses are Trade debtors at the end of the year Rs. 90,000
Rs. 2,000. [Ans: Rs. 1, 60,000; Rs. 1, 20,000; Rs. 38, Stock turnover ratio 5
000] times
7. Calculate Current Liabilities of a business concern Trade creditors in the beginning of the year Rs. 25,000
whose current ratio is 2.2:1; Liquid Ratio 1.4; Sales for the year 2006 Rs. 5, 00,000
Inventory Rs. 40,000 and prepaid expenses nil. [Ans: Trade creditors at the end of the year Rs. 45,000
50,000] Gross profit ratio 20% on sales
8. If Apple Company Ltd.’s Current Ratio is 5.5; quick Net working capital Rs. 1, 20,000
ratio is 4; Inventory is Rs. 30,000, what are its current Calculate: a) Average stock b) Purchases
liabilities?[Ans: Rs. 20,000] c) Average payment period d) Average Collection
9. If Orange Company Ltd.’s Inventory is Rs. 60000 total Period
current liabilities are Rs 12000; Quick ratio is 2; e) Creditors’ turnover ratio f) Work. Cap. Turnover
Calculate Current Ratio. [Ans: 2.5: 1] Ratio
10. If Banana Company Ltd.’s Current Liabilities are Rs. [Ans: Rs. 80,000; Rs. 4, 00,000; 32 days; 66 days; 11.4
25,000, Quick Ratio is 1.5:1. Inventory is Rs. 12,500, times; 3.33 times]
Calculate current assets. [Ans: 50,000] 18. Following is the profit and loss account to
11. M/s. Rakesh & Co. supplies you the following BHAGYASRI Ltd. For the year ended 31-12-
information for the year ending 31-12-2006: Credit
sales Rs 1, 50,000; Cash sales Rs. 2, 50,000 Returns 2006.
inward Rs. 25000; Opening stock Rs. 25000; Closing Particulars Rs. Particulars Rs.
stock Rs. 35,000; Gross Profit Ratio is 20%. Find out To Opening Stock 1,00,000 By Sales 5,60,000
inventory turnover and inventory velocity. [Ans: 10 To Purchases 3,50,000 By Closing 1,00,000
times; 37 days] To wages 9,000 Stock
12. If Inventory Turnover Ratio is 5 times and average To Gross Profit c/d 2,01,000
stock at cost is Rs. 75,000. Find out Cost of Goods 6,60,000 660000
Sold.[Ans: Rs. 3, 75,000] To Admn. expenses By G. P b/d
20,000 2,01,000
13. Simhadri Ltd. Supplies the following information for To S/D expenses By interest on
89,000 10,000
the accounting year, 2005-06: To Non-operating Investments
30,000 8,000
Total sales Rs. 3, exp. By Profit on
80,000
50,000 To Net Profit Sale of
2,19,000 Investment 2,19,000
Stock at the end of the year Rs. 26,000
Returns Inward Rs. 20,000 You are required to calculate: c) Operating Ratio
a) Gross Profit Ratio d) Operating Profit Ratio
Gross profit for the year Rs. 66,000 b) Net Profit Ratio e) Administration exp. Ratio
Stock in the beginning of the year Rs. 40,000 [Ans: 35.9%; 14.3%; 83.6%; 16.4%; 3.6%]
You are required to calculate: a) Inventory turnover ratio; 19. The capital of Mega Star Ltd. is as follows:
b) Inventory conversion period. [Ans: 8 Times; 45.6 days] 80000 Equity Shares of Rs. 10 each Rs. 8, 00,000
14. From the following information, calculate average 9% 30000 Preference Shares of Rs. 3, 00,000
collection period: The following information has been obtained
Total sales R. 1, 00,000 form the books of the company:
Depreciation Rs. 60,000, Profit after Tax at 60% Rs. 2,
70,000
Bills Receivable Rs. 4,000
Equity Dividend paid 20%, Mar. P. of equity share Rs.
Cash sales Rs. 20,000
40
You are required to calculate: a) Dividend yield on
Bad debts provision Rs. 1,000 equity share; b) Cover for the preference dividend;
Sales return Rs. 7,000 c) Cover for the equity dividend; d) Earnings per share; e)
The Price-earnings ratio.
Creditors Rs. 10,000 [Ans: 5%; 10 times; 1.52 times; Rs. 3.04; 13.1
Debtors at the end of the year Rs. 11,000 times]
[Ans: 75 days] 20. The current assets and current liabilities of your
15. Dragon Ltd. Provides the following information: company as at 31-12-2006 were Rs. 20, 00,000 and
Cash sales Rs. 1, 50,000 Rs. 10, 00,000 respectively. Calculate the effect of
Trade debtors in the beginning Rs. 55,000
 each of the following transactions individually and Current Liabilities 2,00,000 Stock
totally and on the current ratio of the company: 12,50,000 12,50,000
i. Purchase of new machinery for Rs. 5, 00,000 on
cash. 24. Complete the following balance sheet:
ii. Purchase of new machinery for Rs. 5, 00,000 on Liabilities Rs. Assets Rs.
short-term credit. Equity capital 3,00,000 Fixed Assets ----
iii. Purchase of new machinery for Rs. 5, 00,000 on a Retained 3,00,000 Inventories ----
medium term loan from your bank with 20% earnings - - - - - Debtors ----
margin. Creditors Cash ----
iv. Payment of dividend Rs. 2, 00,000 of which Rs. You are given further information: Total Debt is 2/3 of Net
50,000 was tax deducted at source. [Ans: 15:1; Worth; Total Assets Turnover is 1.8 times; 30 days Sales
1.33:1; 1.9:1; 0.8:1] are in the form of Debtors; Turnover of Inventory is 5
21. From the following information, make out a times; Cost of Goods Sold in a year is Rs. 9, 00,000; and
Statement of Proprietors’ Funds with as many the Acid Test Ratio is 1 : 1. [Ans: Creditors Rs. 4,00,000;
details at possible: Fixed Assets Rs. 4,20,000; Inventories Rs. 1,80,000;
Current Ratio 2.5 times Debtors Rs. 1,50,000; Cash Rs. 2,50,000]
25. From the following information you are required to
Working Capital Rs. 60,000 prepare balance sheet:
Liquid Ratio 1.5 times Current ratio 1.75
times
Reserves and Surplus Rs. 40,000 Reserves and Surplus to Capital 0.2
Proprietary Ratio 0.75 times times
Bank Overdraft Rs. 10,000 Liquid ratio 1.25
There is no long term loan or fictitious assets times
[Ans: Share Capital Rs. 2, 00,000; Fixed Assets Turnover to Fixed Assets 1.2
Rs. 1, 80,000; Stock Rs. 40,000; Other Current times
Assets Rs. 60,000; Current Liabilities Rs. 40,000] Stock turnover ratio 9 times
22. From the following details, make out the Balance
Sheet with as details as possible: Capital gearing ratio 0.6
Stock Velocity 6 times times
Gross profit ratio 25%
Gross Profit Turnover Ratio 20%
Capital turnover ratio 2 times
Fixed Assets to Net worth 1.25
times
Debtors Velocity 2 months Debt collection period 1.5
Fixed Assets Turnover 4 times months
Sales for the year Rs. 12,
Creditors Velocity 73 days 00,000
The gross profit was Rs. 60,000. Reserve & [Ans: Fixed Assets Rs. 7,50,000; Debtors
Surplus amounts To Rs. 20,000. Closing stock was 1,50,000; Cash Rs. 1,00,000; Stock Rs. 1,00,000;
Rs. 5,000 in excess of Opening stock. Share Capital Rs. 5,00,000; Reserves & Surplus
Rs. 1,00,000; Long-term Loan Rs. 3,00,000;
ANSWERS Current Liabilities Rs. 2,00,000]
Liabilities Rs. Assets Rs. Hint: Long- term Debt
Capital 1,00,000 Fixed 60,000 Capital Gearing Ratio =
Reserves & 20,000 Assets 42,500 -------------------------
Surplus 49,000 Stock 50,000 Equity Share
Creditors Debtors 16,500 Capital
1,69,000 Cash 1,69,000 26. With the following ratios and further information
(balance given below, complete the trading and Profit & Loss
figures) A/c and Balance Sheet of Real Star Ltd.
23. The following information is given bellow draw a Gross Profit Ratio 25%
Balance Sheet.
Net Working Capital Rs. 3,
00,000 Fixed Assets / Total Capital 3/2
Fixed Assets Turnover Ratio 2 times times
Current Ratio 2.5 Net Profit Ratio 20%
times
Average debt collection period 2 Capital / Total outside Liabilities 2/5
months times
Liquidity Ratio 1.5 Sales / Inventory Ratio 8 times
times
Fixed Assets to Shareholders 1:1 Fixed Assets Rs.
Stock Turnover Ratio 6 times 1500000
Fixed Assets / Current Assets ¾ times
Reserve to Share Capital 0.5 : 1
Gross Profit Ratio 20% Closing Stock Rs.
ANSWERS 200000
Liabilities Rs. Assets Rs. Proforma Trading and Profit &
Share Capital 5,00,000 Fixed Assets 7,50,000
Reserves 2,50,000 Liquid 3,00,000
Loss Account
Long-term Debts 3,00,000 Assets 2,00,000 Particulars Rs. Particulars Rs.
To Cost of Sales ---- By Sales ----
To Gross Profit ----
---- ----
To Expenses
---- ----
To Net Profit
----
---- ----

Proforma Balance Sheet

Liabilities Rs. Assets Rs.
Capital --- Fixed Assets ----
Add- Net Profit - - - - - - - Stock ----
Total outside - - - - Other Current Assets ----
Liabilities ---- ----
[Ans: C.G.S Rs. 12,00,000; Sales Rs 16,00,000; G.P Rs.
4,00,000; Expenses Rs. 80,000; Net Profit Rs. 3,20,000;
Other Current Assets Rs. 18,00,000; Capital Rs. 6,80,000;
Total outside Liabilities Rs. 25,00,000]
27. A factory engaged in an industry which is capital
intensive, has been in operation for ten years. The
capital employed is Rs. 170 lakhs out of which Rs. 100
lakhs cash credit from banks. The working capital of
the company is Rs. 85 lakhs made up of stocks Rs. 30
lakhs, Stores Rs. 14 lakhs, Debtors Rs. 35 lakhs, and
Deposits Rs. 6 lakhs. Annual sale is Rs. 80 lakhs.
Calculate six financial ratios from the above for the
use of the management. [Ans: C.R=4.25; L.R=2.05;
D.E.R=0.7; P.R=0.59; F/A to P.F=0.85; Fixed Assets
ratio =0.57]
28. GAMA Ltd. gives you the following
Balance Sheet for the year ending 31-12-
2006
Liabilities Rs. Assets Rs.
20000, Equity Capital Goodwill 50,000
Rs. 10 each 2,00,000 Plant 2,50,000
5000, Pref. Share Furniture 70,000
Capital Rs. 20 each 1,00,000 Investment 1,50,000
Reserve fund 50,000 Cash 20,000
Dividend Debtors 1,25,000
Equalization fund 60,000 Bills
Profit and Loss A/c 40,000 Receivable 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 following ratios: Debt Equity Ratio,
Funded Debt to Total Capitalization, Proprietor Ratio,
Solvency Ratio, and Fixed Asset to Net worth Ratio.
[Ans: 0.67; 0.33; 0.6; 0.4; 0.82]