CHAPTER 10

CHAPTER 10 – RATIO ANALYSIS
More data presented in the different financial statements do not reveal the true picture of
a financial position of a firm. To extract the information from the financial statements, a
no of tasks are used to analyse such statements. The most popular tool is Ratio
Analysis.
Q1. Financial Ratios are classified into haw many groups. Name it?
Ans Financial Ratios are classified into three groups-
(i) Liquidity groups
(ii) Leverage /Capital structure ratio
(iii) Profitability ratios
Q2 What are liquidity ratios?

Ans
Liquidity refers to the ability of a firm to meet its financial obligations in short term,
which is less than a year.
Eg. 1.Current ratios 2. Acid test ratio 3. Turnover ratios
Q3.What is current ratio & Acid test Rate
Ans. Current ratio measures the ability of the form to meet its current liabilities out of
current assets. Higher the current ratio, greater the short term solvency
CR = CA/ CL
Acid Test Ratio = Quick Assets /Current liabilities
Quick assets = Current Assets (-) Inventories (-) Prepaid expenditure.
It measures firm's ability to convert its current assets quickly into cash in order to meet
its current liabilities. 1:1 is satisfactory
Q4. What is turnover ratio? Explain various -types of turnover ratios?

Ans. It measures how quickly certain Current assets are converted into cash or how
efficiently the assets are employed by a firm
1. INVENTORY TURNOVER RATIO - Cost of goods sold / Average Inventory
Cost of Goods Sold = Sales (-) Gross Profit
Average inventory = Opening inventory + Chasing Inventory
This ratios show the efficiency of inventory management. Higher the ratio more the
efficient of inventory management
2.DEBTORS TURNOVER RATIO = Net Credit / Debtors
This ratio shows how many times debtors turnover during the year. Higher the ratio
greater the efficiency of credit management.
3.AVERAGE COLLECTION PERIOD= 365 days /Debtors turnover
It shows the no. of days worth credit Sales that is locked in Debtors
4.FIXED ASSETS TURNOVER RATIO = Net Sales/ Net Fixed Asset
5. TOTAL ASSETS TURNOVER RATIO
Net Sales/Average Total Assets
Q5 What are leverage / Capital Statement ratios?
ANS. long-term financial strength or soundness of a firm is measured in terms of its
ability to pay interest regularly or repay principal on due dates. Some ratios ne
Computed from Balance sheet & certain ratios from Profit & loss A/C
(i) Debt Equity Ratio = Total Debt/ Total Equity
it reflects the contributions of creditors & owners to finance the business. It varies from
industry to industry.
(ii) Debt Asset Ratio = Total Debt / Total Assets

Total debt = Long term Debt to Current liabilities
Total Assets = Permanent Capital & Current liabilities
(iii) Interest Coverage Ratio - Earning before Interest & Taxes

Interest
Higher the interest coverage ratio better is the firm's ability to meet its interest burden.
The lenders use this ratio to assess debt servicing capacity of a firm.
(iv) Debt Service Coverage Ratio (DSCR).
It is a more comprehensive & apt to compute debt service capacity of a firm.
Profit after tax + Depreciation + Other non- cash expenditure + Interest on term loan
Interest on term loan + Repayment on Term Loan
Q26. What are profitability ratios?

Ans. Profitability & management efficient of a firm is judged by the following ratios;
i) Gross Profit Ratios = Gross Profit X100

Net Sales
ii) Net Profit Ratio = Net Profit X 100 / Net Sales

iii) Return of total Assets = Profit on Interest and taxes
Fixed Asset + Current Assets
(iv) Return on Capital employed=

Net profit after taxes
Total Capital Employed
Total Capital Employed - Total Fixed Assets (+) Total Current Assets (-) Current liabilities
(v) Return on Shareholders Equity=

Net Profit after tax
Avg Total Shareholders equity or Net
worth
Net worth = Equity Capital + Reserves and Surplus

(vi) A equity Shareholder has only residual claim on profits & assets of a firm i.e only
after claims of creditors & preference Shareholders are met, the equity shareholders
receive distribution of profits or assets on liquidation.
Earnings per share= Net profit / No. of ordinary shares outstanding
(vii) Price Earnings Ratio = P/E ratio =

Market price per share
EPS

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CHAPTER 10 – RATIO ANALYSIS

Q2 What are liquidity ratios?

Acid Test Ratio = Quick Assets /Current liabilities

Quick assets = Current Assets (-) Inventories (-) Prepaid expenditure.

Q4. What is turnover ratio? Explain various -types of turnover ratios?

(ii) Debt Asset Ratio = Total Debt / Total Assets

(iii) Interest Coverage Ratio - Earning before Interest & Taxes

Q26. What are profitability ratios?

i) Gross Profit Ratios = Gross Profit X100

ii) Net Profit Ratio = Net Profit X 100 / Net Sales

(iv) Return on Capital employed=

(v) Return on Shareholders Equity=

Net worth = Equity Capital + Reserves and Surplus

(vii) Price Earnings Ratio = P/E ratio =

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