Accounting Ratios

Expression of Ratio

1. Pure ratio 2. Percentage 3. Times 4.

Fraction
Current ratio Proprietary ratio Interest coverage
Quick ratio Gross profit ratio Inventory turnover
Debt to equity Operating ratio Trade receivables turnover
Total input to debt Operating profit ratio Trade payable turnover
Proprietary ratio Net profit ratio Working capital turnover
Return on investment

Advantages of Ratio Analysis

1. Useful tool for analysis of financial statement.
2. Useful in accessing the operating efficiency of business.
3. Useful for forecasting.
4. Useful in locating the weak areas.
5. Useful in inter firm and intra firm comparison.

Limitation of Ratio Analysis

1. Qualitative factors are ignored.
2. False result as dependent on correctness of financial statement.
3. Ignore price level changes.
4. Window dressing.
5. Variations in account practice and may not be compatible.

Types of Accounting Ratio

Functional classification
1. Liquidity Ratio
 Short term financial obligation
1. Current ratio
2. Liquid ratio
2. Solvency Ratio
 Long term financial obligation
1. Debt equity ratio
2. Total Asset to debt
3. Proprietory ratio
4. Interest coverage ratio
3. Activity Ratios
 Efficiency of company
1. Trade receivable turnover ratio
2. Trade payable turnover ratio
3. Inventory turnover ratio
4. Working capital turnover ratio
4. Profitability ratio
 Profitability of firms
1. Gross profit ratio
2. Swag operating ratio
3. Net profit ratio
4. Operation profit ratio
5. Return on investment

Traditional classification
1. Statement of profit and loss ratios
 Both the variables are from P&L
o Ex- GP ratio.
2. Balance sheet ratios
 Both the variable are from Balance Sheet
o Ex- Current ratio
3. Composite ratios
 One variable from P&L and other from balance sheet
o Ex- Inventory turnover

IMPORTANT FORMULAS
1. Current assets:
Current investment + Inventories + Cash and cash equivalents + Trade receivables + Short term loans
& advances + Marketable securities + Prepaid expenses + Advance tax + Interest receivables.

2. Quick Assets = Current Assets – Inventories – Prepaid expenes – Advance taxes

3. Current liabilities:
Short term borrowings + Trade paybles + Short term provisions+ Interest accurred on borrowing +
Outstanding expenses + Calls in advance.
4. Long term Debt:
Long term borrowings like debentures, bank loan + long term provisions.

5. Shareholders fund:
Share Capital + Reserves and surplus + money received against share warrants.

6. Capital employed: Shareholders funds + Non current liability.

Or
Total assets - current liability.

7. Working capital: Current assets - current liabilities.

Or
Shareholders fund + non current liabilities - non current asset.
8. Non current assets:
Fixed assets (net) + non current investments + long term loan & advances.

9. Cost of revenue from operation:

Revenue from operation or cost of goods sold - gross profit.
Or
Revenue from operation + Gross loss.
Or
Opening inventory + purchase – closing inventory + Direct expenses.
Or
Cost of material consumed + purchase of stock in trade + change in inventories of finished goods,
work in progress, stock in trade + Direct expenses.

10. Direct expenses= Manufacturing expenses + wages + carriage inward.

11. Average inventory:(Opening inventory + closing inventory) / 2.

12. Average trade receivables: (Opening debtors + opening bills receivable + closing debtors + closing
bills receivable) / 2.

13. Debt collection period: (365 days or 12 months) / Trade receivables turnover ratio.

14. Average trade payable: (Opening creditors + opening bills payable + closing creditors + closing bills
payable) / 2.

15. Debt payment period: (365 days or 12 month) / trade payable turnover ratio.

16. Gross profit:

Revenue from operation - cost of goods sold.

17. Operating expenses:

Employee benefit expenses + depreciation & Amortization expense + administrative expensive +
salary & marketing expenses + office expenses.

18. Operating profit:

Gross profit - operating expenses.
Or
Net profit + non operating expenses - non operating income.

19. Operating ratio(%) + Operating profit ratio(%) = 100.

20. Net profit:

Revenue from operation - cost of revenue from operation - operating expenses - non operating expenses
+ non operating income – tax.
 RATIOS
1. Liquidity ratio

i. Current ratio = Current Asset / Current liabilities.

Ideal Ratio: 2:1
Important Points
1. Loose tools and stores & spares are not included in the inventory.
2. Trade receivables are taken after deducting provision for doubtful debts.
3. It should be neither be very high or very low.

ii. Liquid ratio or Quick ratio or Acid test ratio

Liquid ratio = Liquid assets / Current liabilities.
Ideal Ratio: 1:1
Important Points
1. Liquid Assets: Current asset - prepaid expenses - inventories - advance taxes.
2. Non-liquid assets are not considered & therefore it is better than current ratio.

2. Solvency ratio

i. Debt to equity ratio = Debt / shareholder funds.

Ideal ratio: 2:1
Important points
1. If debit balance of profit and loss is given, it will be deducted from shareholders fund.
2. Lower the better.

ii. Total assets to debt ratio = Total assets / long term debt.
Important points
1. Total assets include all the asset, including stores and spares and loose tools.
2. Higher the better.

iii. Property ratio = Shareholder funds / total asset.

Important point
1. It can be expressed in pure ratio or percentage.
2. High ratio is better.

iv. Interest coverage ratio = Profit before interest and tax / Interest on long term debt. Important point
1. Profit before interest and tax = Net profit + tax + interest.
2. Ratio in expressed in times.

3. Activity ratios / Performance ratios / Turnover ratios

i. Inventory turnover ratio= Cost of revenue from operation (COGS) / Average inventory
Important point
1.In case, COGS is not given and cannot be calculated, amount of revenue from
Operation can be used.
2. higher the better.
 ii. Trade receivables turnover ratio= (Credit revenue from operation / average trade receivable)
Important point
1.Provision for doubtful debt is not deducted from the trade receivables.
2.Higher the better.
3. Debt collection paid= 365 days or 12 months / trade receivables turnover ratio.

iii. Trade payable turnover ratio = Net credit for purchase / average trade payable
Important point
1.Higher the better.
2.Average payment period = 365 days or 12 month / trade payable turnover ratio

iv. Working capital turnover ratio = Revenue from operation / working capital
Important point
1.If revenue from operation is not given, it may be calculated on the basis of COGS.
2.Higher the better.

4. Profitability ratio

i. Gross profit ratios = (Gross profit / revenue from operations) * 100

Important point
Higher the better.

ii. Operating ratios: (Cost of revenue from operation + operating expenses / revenue
From operation) * 100
OR
(Operating cost/ revenue from operation) * 100
Important point
Lower the better.

iii. Operating profit ratios = (Operating profit / Revenue from operations) * 100
Important point
Higher the better.

iv. Net profit ratio = (Net profit after tax / Revenue from operations) * 100
Important point
Higher the better.

v. Return on investment (ROI) or return on capital employed:

(Net profit before Interest, Tax & Dividend / Capital employed) * 100
Important point
1.Non- trade investment is excluded from capital employed and income from non trade
investment is excluded from net profit.
2.Higher the better.