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12 views

Sodapdf

ghfg

Uploaded by

shubhk908
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Accounting Ratios

Accounting Ratio: It is an arithmetical


relationship between two accounting
variables.
Ratio Analysis : It is a technique of analysis of
financial statements to conduct a
quantitative analysis of information of a
company’s financial statements.
Expression of ratio: Ratios are expressed in
following four ways:
1· Pure Ratio Like 2:1. All liquidity and
solvency ratios are expressed in pure form.
2· Percentage e.g. 15%. All profitability ratios
are presented in percentage form.
3· Times Like 4 times. All turnover ratios and
Interest Coverage Ratio are presented in this
form.
4· Fraction like 3/4.
Classification or Types of Ratios:
Ratios can be classified into following 4
categories:
1. Liquidity Ratios
2. Solvency Ratios
3. Activity Ratios also known as Turnover
Ratios or Performance Ratios.
4. Profitability Ratios.
Liquidity Ratios: These measure short term
solvency, i.e. the firm’s ability to pay its
current dues. In Liquidity Ratios the following
two ratios are included.
1. Current Ratio also called Working Capital
Ratio.
2.Liquid Ratio also called Quick Ratio or
Acid Test Ratio.
1. Current Ratio : It shows the relationship
of current assets with current liabilities

Current Assets
An asset shall be classified as current
when it satisfies any of the following
criteria:
(a) it is expected to be realized in, or is
intended for sale or consumption in, the
company’s normal operating cycle:
(b) it is held primarily for the purpose of
being traded:
(c) it is expected to be realized within
twelve months after the reporting date; or
(d) it is cash or cash equivalent unless it is
restricted from being exchanged or used
to settle a liability for at least twelve
months after the reporting date.
The following items are include under
Current Assets:
(a) Current investments
(b) Inventories
(c) Trade receivables (Debtors and Bills
Receivables) after deducting any
provision for Doubtful Debts)
(d) Cash and cash equivalents
(e) Short term loans and advances
(f) Other current assets (Restricted to
prepaid expenses, accrued incomes and
advance tax only)
Current Liabilities
A liability shall be classified as current
when it satisfies any of the following
criteria:
(a) It is expected to be settled in the
company’s normal operating cycle;
(b) It is held primarily for the purpose of
being traded .
(c) It is due to be settled within
twelve months after the reporting date;
or
(d) The company does not have an
unconditional right to defer settlement
of the liability for at least twelve months
after the reporting date. Terms of a
liability that could, at the option of the
counter party’ result in its settlement by
issue of equity instruments do not
affect its classification.
The following items are include under
Current Liabilities :
· Short term borrowings
· Trade payables (Creditors and Bills Payable)
· Other current liabilities
· Short terms provisions
Significance : It assesses the ability of a
business to pay its short term liability on
time.
... Ideal Ratio : 2:1 is considered as best.
· A Low ratio indicates that the company
cannot meet its short term liability on time.
· A High ratio indicates that funds have not
been used efficiently and lying idle.
Solvency Ratio : Solvency ratios convey an
enterprise’s ability to meet its long term
obligations as and when they become due.
1. Debt Equity Ratio
2. Total Assets to Debt Ratio
3. Proprietary Ratio
4. Interest Coverage Ratio
1. Debt Equity Ratio: It show relationship
between Debts (Long term Liabilities or Non
Current Liabilities) and Equity (Shareholders’
Funds).

Debt Equity Ratio = Debt/Equity

Debts = Long-term borrowing + Long-term


provisions
Equity/Shareholders’ Funds = Share Capital +
Reserves and Surplus – Non – Trading
Investments
OR
Equity/Shareholders’ Funds = Fixed Assets
(Tangible and Intangible) + Non Current
Investment (Excluding Non Trading
investment) +Long Terms Loans and
Advances + Current Assets – Current
Liabilities – Long –term borrowings – Long –
term Provision
Significance: It assesses the long term
soundness of financial position of a business.
... Ideal Ratio: 2:1 is considered as best but it
should not be more than this.

Total Assets to Debt Ratio : It shows the


relationship between Total Assets and Debts.
Total Assets To Debt Ratio
=Total Assets/Debt

Total Assets = Fixed Assets (Tangible and


Intangible) + Non Current Investment
(Excluding Non Trading Investment) + Long
Term Loans and Advances + Current Assets

Debts = Long-term borrowing + Long-term


provisions

Significance: It measures the safety margin


available to the providers of long term loans.

Ideal Ratio: No ideal ratio but a high ratio


indicates higher safety to lenders and low
ratio represents risky position.
Activity Ratios/Turnover Ratios/Performance
Ratios
These ratios measure the efficiency of asset
management and measure the effectiveness
with which an enterprise uses resources at
its disposal. These show rotation of a
concerned item within an accounting period.
Important Turnover ratios are :
1. Stock Turnover Ratio/Inventory Turnover
Ratio
2. Debtor Turnover Ratio/Trade Receivables
Turnover Ratio
3. Creditors Turnover Ratio/Trade Payables
Turnover Ratio
4. Working Capital Turnover Ratio
Working Capital Turnover Ratio : It
establishes the relationship between
Net Working Capital and Revenue from
Operations i.e., Net Sales.
Working Capital Turnover
ratio =Net Sales or Cost of goods
sold/Working Capital.

1. Net Working Capital = Current Assets


excluding Fictitious assets – Current
liabilities.
…. This ratio can also be calculated on the
basis of the Cost of Revenue from
Operations i.e., Cost of Goods Sold.
…. This Ratio is calculated in Times.
This ratio indicated the number of times the
working capital has been turned over in
relation to revenue form operations over a
year.
Generally a higher ratio indicates efficient
use of working capital.
Profitability Ratio:
These ratios are used to assess the
profitability or earning capacity of the
business.
These ratios are very important as
profitability is the measurement of the
overall performance and efficiency of the
management.
The important Profitability ratios are:
1. Gross Profit Ratio
2. Operating Ratio
3. Operating Profit Ratio
4. Net Profit Ratio
5. Return on Investment or Return on Capital
Employed.
All Profitability ratios are shown in
percentage form.
Return on Investment or Return on Capital
Employed:
It shows the relationship between Net profit
before interest, Tax and Divided and Capital
Employed of the business.
Return on Investment (ROI) =
Profit before interest and tax *100
Capital Employed

By Liability Approach:
Capital Employed = Share Capital + Reserves
and Surplus – Non Trading Investments +
Non Current Liabilities
OR
Capital Employed = Shareholders’ Funds +
Non Current Liabilities
By Assets Approach
Capital Employed = fixed Assets (Tangible
and Intangible) + Non Current Investment
(Excluding Non Trading Investment) + Long
Term Loans and Advances + Current Assets –
Current Liabilities.
OR
Capital Employed = Fixed Assets (Tangible
and Intangible) + Non Current Investment
(Excluding Non Trading Investment) + Long
Term Loans and Advances + Working Capital
OR
Capital Employed = Non Current Assets +
Working Capital
Capital Employed = Total Assets – Current
Liabilities.
Important Points
... This Ratio indicates the percentage of Net
profits before interest, tax and dividend in
relation to Capital Employed of the business.
.... This Ratio is considered as best
measurement of the overall performance of
the enterprise.
.... Generally a higher ratio indicates better
profitability.
.... As we are not including Non Trading
Investments as part of Capital Employed
therefore Income from Non Trading
Investments will not be taken into account
for calculation of Net Profits.

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