A.

LIQUIDITY RATIO
It measures the ability of the firm to meet its short-term
obligations, that is capacity of the firm to pay its current
liabilities as and when they fall due.
Thus these ratios reflect the short-te.rm financial solvency of a
firm.
A firm should ensure that it does not suffer from lack of liquidity.
The failure to meet obligations on due time may result in bad
credit image, loss of creditors confidence, and even in legal
proceedings against the firm on the other hand very high
degree of liquidity is also not desirable since it would imply
that funds are idle and earn nothing.
So therefore it is necessary to strike a proper balance between
liquidity and lack of liquidity
 1.CURRENT RATIO
• The current ratio measures the short-term solvency
of the firm. It establishes the relationship between
current assets and current liabilities. It is calculated
by dividing current assets by current liabilities.
• Current Ratio = Current Asset
Current Liabilities
Current assets include cash and bank balances,
marketable securities, inventory, and debtors,
excluding provisions for bad debts and doubtful
debtors, bills receivables and prepaid expenses.
Current liabilities includes sundry creditors, bills
payable, short- term loans, income-tax liability,
accrued expenses and dividends payable
Interpretation
A generally acceptable current ratio is 2 to 1. But
whether or not a specific ratio is satisfactory
depends on the nature of the
business and the characteristics of its current
assets and liabilities
 2.ACID TEST RATIO / QUICK RATIO
• It has been an important indicator of the
firm’s liquidity position and is used as a
complementary ratio to the current ratio. It
establishes the relationship between quick
assets and current liabilities. It is calculated by
dividing quick assets by the current liabilities.
• Acid Test Ratio = Quick Assets
Current liabilities
Quick assets are those current assets, which can be
converted into cash immediately or within reasonable
short time without a loss of value. These include cash
and bank balances, sundry debtors, bill’s receivables and
short-term marketable securities.

Interpretation
An acid-test of 1:1 is considered satisfactory unless the
majority of “quick assets” are in accounts receivable, and
the pattern of accounts receivable collection lags behind
the schedule for paying current liabilities.
 B. TURNOVER RATIO
• Turnover ratios are also known as activity ratios
or efficiency ratios with which a firm manages
its current assets.
• The following turnover ratios can be calculated
to judge the effectiveness of asset use.
• Inventory Turnover Ratio
• Debtor Turnover Ratio
• Creditor Turnover Ratio
• Assets Turnover Ratio
 1. INVENTORY TURNOVER RATIO
• This ratio indicates the number of times the
inventory has been converted into sales during
the period. Thus it evaluates the efficiency of
the firm in managing its inventory. It is
calculated by dividing the cost of goods sold by
average inventory.
• Inventory Turnover Ratio = Cost of goods sold
Average Inventory
• The average inventory is simple average of the
opening and closing balances of inventory.
(Opening + Closing balances / 2).
In certain circumstances opening balance of the
inventory may not be known then closing
balance of inventory may be considered as
average inventory.

Interpretation
This ratio indicates that how fast inventory is
used or sold. A high ratio is good from the view
point of liquidity and vice versa. A low ratio
would indicate that inventory is not used/ sold/
lost and stays in a shelf or in the warehouse for a
long time.
 2. DEBTOR TURNOVER RATIO
• This indicates the number of times average debtors have
been converted into cash during a year. It is determined
by dividing the net credit sales by average debtors.
• Debtor Turnover Ratio = Net Credit Sales
Average Trade Debtors
• Net credit sales consist of gross credit sales minus sales
return. Trade debtor includes sundry debtors and bill’s
receivables. Average trade debtors (Opening + Closing
balances / 2)
• When the information about credit sales, opening and
closing balances of trade debtors is not available then the
ratio can be calculated by dividing total sales by closing
balances of trade debtor
Debtor Turnover Ratio = Total Sales
Trade Debtors

Interpretation
The speed with which these receivables are
collected affects the liquidity position of the firm.
The debtor’s turnover ratio throws light on the
collection and credit policies of the firm.
It measures the efficiency with which
management is managing its accounts
receivables
 3. CREDITOR TURNOVER RATIO
• It indicates the number of times sundry creditors have
been paid during a year. It is calculated to judge the
requirements of cash for paying sundry creditors. It is
calculated by dividing the net credit purchases by
average creditors.
• Creditor Turnover Ratio = Net Credit Purchases
Average Trade Creditor
• Net credit purchases consist of gross credit purchases
minus purchase return
• When the information about credit purchases, opening
and closing balances of trade creditors is not available
then the ratio is calculated by dividing total purchases
by the closing balance of trade creditors.
Creditor Turnover Ratio = Total purchases
Total Trade Creditors

Interpretation
The firm can compare what credit period it
receives from the suppliers and what it offers
to the customers. Also it can compare the
average credit period offered to the
customers in the industry to which it belongs.
 4. ASSETS TURNOVER RATIO
• The relationship between assets and sales is
known as assets turnover ratio. Several assets
turnover ratios can be calculated depending
upon the groups of assets, which are related to
sales.
• Total asset turnover.
• Net asset turnover
• Fixed asset turnover
• Current asset turnover
• Net working capital turnover ratio
a. TOTAL ASSET TURNOVER
This ratio shows the firms ability to generate sales from all financial
resources committed to total assets.
It is calculated by dividing sales by total assets.
Total asset turnover = Total Sales
Total Assets
b. NET ASSET TURNOVER
This is calculated by dividing sales by net assets.
Net asset turnover = Total Sales
Net Assets
Net assets represent total assets minus current liabilities.
Intangible and fictitious assets like goodwill, patents, accumulated losses,
deferred expenditure may be excluded for calculating the net asset turnover.
.
 c. FIXED ASSET TURNOVER
This ratio is calculated by dividing sales by net
fixed assets.
Fixed asset turnover = Total Sales
Net Fixed Assets
Net fixed assets represent the cost of fixed
assets minus depreciation.

Interpretation
A high fixed assets turnover ratio indicates
efficient utilization of fixed assets in generating sales.
A firm whose plant and machinery are old may show
a higher fixed assets turnover ratio than the firm
which has purchased them recently
 d. CURRENT ASSET TURNOVER
It is divided by calculating sales by current assets
Current asset turnover = Total Sales
Current Assets
e. NET WORKING CAPITAL TURNOVER RATIO
A higher ratio is an indicator of better utilization of current assets
and working capital and vice-versa
(a lower ratio is an indicator of poor utilization of current assets
and working capital).
It is calculated by dividing sales by working capital.
Net working capital turnover ratio = Total Sales
Working Capital
Working capital is represented by the difference between
current assets and current liabilities
 C. SOLVENCY OR LEVERAGE RATIOS
• The solvency or leverage ratios throws light on
the long term solvency of a firm reflecting it’s
ability to assure the long term creditors with
regard to periodic payment of interest during
the period and loan repayment of principal on
maturity or in predetermined instalments at
due dates. There are thus two aspects of the
long-term solvency of a firm.
• Ability to repay the principal amount when
due
• Regular payment of the interest.
The ratio is based on the relationship between
borrowed funds and owner’s capital it is
computed from the balance sheet,
the second type are calculated from the profit and
loss a/c. The various solvency ratios are
•Debt equity ratio
•Proprietary (Equity) ratio
•Fixed assets to net worth ratio
• Debt service (Interest coverage) ratio
 1. DEBT EQUITY RATIO
• Debt equity ratio shows the relative claims of creditors
(Outsiders) and owners (Interest) against the assets of the
firm. Thus this ratio indicates the relative proportions of debt
and equity in financing the firm’s assets. It can be calculated
by dividing outsider funds (Debt) by shareholder funds
(Equity)
• Debt equity ratio = Outsider Funds (Total Debts)
Shareholder Funds or Equity
• The outsider fund includes long-term debts as well as current
liabilities.
The shareholder funds include equity share capital, preference share
capital, reserves and surplus including accumulated profits. However
fictitious assets like accumulated deferred expenses etc should be
deducted from the total of these items to shareholder funds. The
shareholder funds so calculated are known as net worth of the
business.
Interpretation
A high debt to equities ratio here means less protection for creditors,
a low ratio, on the other hand, indicates a wider safety cushion (i.e.,
creditors feel the owner’s funds can help absorb possible losses of
income and capital).
This ratio indicates the proportion of debt fund in relation to equity.
This ratio is very often referred in capital structure decision as well as
in the legislation dealing with the capital structure decisions (i.e. issue
of shares and debentures).
Lenders are also very keen to know this ratio since it shows relative
weights of debt and equity. Debt equity ratio is the indicator of firm’s
financial leverage.
 2. PROPRIETARY (EQUITY) RATIO
• This ratio indicates the proportion of total assets financed
by owners. It is calculated by dividing proprietor
(Shareholder) funds by total assets.

• Proprietary (equity) ratio = Shareholder funds

Total assets
• Proprietary fund includes Equity Share Capital + Preference
Share Capital + Reserve & Surplus. Total assets exclude
fictitious assets and losses.
• Interpretation
It indicates the proportion of total assets financed by
shareholders.
 3 FIXED ASSETS TO NET WORTH RATIO
• This ratio establishes the relationship between fixed assets and
shareholder funds. It is calculated by dividing fixed assets by
shareholder funds.
• Fixed assets to net worth ratio = Fixed Assets X 100
Net Worth
• The shareholder funds include equity share capital, preference
share capital, reserves and surplus including accumulated profits.
• However fictitious assets like accumulated deferred expenses etc
should be deducted from the total of these items to shareholder
funds.
• The shareholder funds so calculated are known as net worth of
the business.
Interpretation
A high fixed assets turnover ratio indicates
efficient utilization of fixed assets in generating
sales. A firm whose plant and machinery are
old may show a higher fixed assets turnover
ratio than the firm which has purchased them
recently.
 4. DEBT SERVICE (INTEREST COVERAGE) RATIO

• This shows the number of times the earnings of

the firms are able to cover the fixed interest
liability of the firm. This ratio therefore is also
known as Interest coverage or time interest
earned ratio. It is calculated by dividing the
earnings before interest and tax (EBIT) by
interest charges on loans.
• Debt Service Ratio = Earnings before interest and tax (EBIT)
Interest Charges
• Interpretation
• Normally DSCR of 1.5 to 2 is satisfactory.
 D. Profitability Ratios
• The profitability ratios measure the
profitability or the operational efficiency of
the firm. These ratios reflect the final results
of business operations. They are some of the
most closely watched and widely quoted
ratios. Management attempts to maximize
these ratios to maximize firm value.
• The results of the firm can be evaluated in
terms of its earnings with reference to a given
level of assets or sales or owner’s interest etc.
The profitability ratios are broadly classified in four
categories:
1Profitability Ratios related to Sales
2Profitability Ratios related to overall Return on
Investment
3Profitability Ratios required for Analysis from Owner’s
Point of View
4Profitability Ratios related to Market/ Valuation/
Investors.
Profitability Ratios are as follows:
1.Profitability Ratios based on Sales
• Gross Profit Ratio
• Net Profit Ratio
• Operating Profit Ratio
• Expenses Ratio
2.Profitability Ratios related to Overall Return on
Assets/ Investments
Return on Investments (ROI)
• Return on Assets (ROA)
• Return of Capital Employed (ROCE)
• Return on Equity (ROE)
3.Profitability Ratios required for Analysis from Owner’s
Point of View
• Earnings per Share (EPS)
• Dividend per Share (DPS)
• Dividend Payout Ratio (DP)
4.Profitability Ratios related to Market/ Valuation/
Investors
• Price Earnings (P/E) Ratio
• Dividend and Earning Yield
Gross Profit (G.P) Ratio/ Gross Profit Margin: It measures the percentage of each
sale in rupees remaining after payment for the goods sold.
Gross Profit Ratio = Gross Profit ×100
Sales
Interpretation
Gross profit margin depends on the relationship between price/ sales, volume
and costs. A high Gross Profit Margin is a favourable sign of good management

Net Profit Ratio/ Net Profit Margin: It measures the relationship between net
profit and sales of the business. Depending on the concept of net profit it can be
calculated as:
(i)Net Profit Ratio = Net Profit×100
Sales
or Earnings after taxes (EAT)×100
Sales
(ii)Pre-tax Profit Ratio = Earnings before taxes (EBT)×100
Sales
Interpretation
Net Profit ratio finds the proportion of revenue that finds its way into profits. A
high net profit ratio will ensure positive returns of the business.
Operating Profit Ratio:
Operating profit ratio is also calculated to evaluate operating
performance of business.
Operating Profit Ratio = Operating Profit ×100
Sales
or,
Earnings before interest and taxes (EBIT) ×100
Sales
Where,
Operating Profit = Sales – Cost of Goods Sold(COGS) – Expenses
Interpretation
Operating profit ratio measures the percentage of each sale in
rupees that remains after the payment of all costs and expenses
except for interest and taxes. This ratio is followed closely by analysts
because it focuses on operating results. Operating profit is often
referred to as earnings before interest and taxes or EBIT.
 Expenses Ratio: Based on different concepts of expenses it can be
expresses in different variants as below:
(i) Cost of Goods Sold (COGS) Ratio = COGS×100
Sales

(ii) Operating Expenses Ratio = Admin. Exps. + Selling. & Dist. O.H. X 100
Sales

(III) Financial Expenses Ratio = Financial Expenses * x 100

Sales

*It excludes taxes, loss due to theft, goods destroyed by fire etc.
 Profitability Ratios related to Overall Return on
Assets/ Investments
Return on Investment (ROI): ROI is the most important ratio of all. It is the
percentage of return on funds invested in the business by its owners. In
short, this ratio tells the owner whether or not all the effort put into the
business has been worthwhile. It compares earnings/ returns/ profit with
the invest ent in the company. The ROI is calculated as follows:

Return on Investment = Return/Profit/Earnings×100

Investment

The concept of investment varies and accordingly there are three broad
categories of
ROI i.e.
• Return on Assets (ROA),
• Return on Capital Employed (ROCE) and
• Return on Equity (ROE).
• Return on Assets (ROA): The profitability ratio is measured in terms of
relationship between net profits and assets employed to
earn that profit. This ratio measures the profitability of the firm in terms of
assets employed in the firm. Based on various concepts
of net profit (return) and assets the ROA may be measured as follows:

ROA = Net Profit after taxes + Interest

Average Total Assets

OR
Net Profit after taxes+ Intereat
Average Tangible Assets

OR
Net Profit after taxes +Interest
Average Fixed Assets
•Return on Capital Employed (ROCE): It is another variation of ROI. The ROCE is
calculated as follows:
ROCE (Pre-tax) = Earnings before interest and taxes(EBIT)×100
Capital Employed
ROCE (Post-tax) = EBIT (1- t) ×100
Capital Employed

Sometime it is calculated as

=Net Profit after taxes(PAT/EAT)+Interest×100

Capital Employed
Where,
Capital Employed = Total Assets – Current Liabilities, or
= Fixed Assets + Working Capital

ROCE should always be higher than the rate at which the company borrows.
Intangible assets (assets which have no physical existence like goodwill, patents
and trade-marks) should be included in the capital employed. But no fictitious
asset should be included within capital employed. If information is available
then average capital employed shall be taken.
•Return on Equity (ROE): Return on Equity measures the profitability of equity
funds invested in the firm. This ratio reveals how profitably of the owners’ funds
have been utilised by the firm. It also measures the percentage return generated
to equity shareholders.
This ratio is computed as:

ROE = Net Profit after taxes-Preference dividend (ifany)×100

equity shareholders' fund

Return on equity is one of the most important indicators of a firm’s profitability

and potential growth.
Companies that boast a high return on equity with little or no debt are able to
grow without large capital expenditures, allowing the owners of the business to
withdraw cash and reinvest it elsewhere.
Many investors fail to realize, however, that two companies can have the same
return on equity, yet one can be a much better business. If return on total
shareholders is calculated then Net Profit after taxes (before preference
dividend) shall be divided by total shareholders’ fund includes preference share
capital.
Profitability Ratios Required for Analysis from
Owner’s Point of View
• Earnings per Share (EPS): The profitability of a firm from the point of view of
ordinary shareholders can be measured in terms of number of equity shares.
This is known as Earnings per share. It is calculated as follows:
Earnings per Share (EPS) = Net profit available to equity shareholders
Number of equity shares outstanding
• Dividend per Share (DPS): Earnings per share as stated above reflects the
profitability of a firm per share; it does not reflect how much profit is paid as
dividend and how much is retained by the business. Dividend per share ratio
indicates the amount of profit distributed to equity shareholders per share. It is
calculated as:
Dividend per Share (DPS) = Total Dividend paid to equity shareholders
Number of equity shares outstanding
• Dividend Payout Ratio (DP): This ratio measures the dividend paid in relation
to net earnings. It is determined to see to how much extent earnings per share
have been retained by the management for the business. It is computed as:
Dividend payout Ratio = Dividend per equity share(DPS)
Earning per Share (EPS)
 Profitability Ratios related to market/ valuation/
Investors
These ratios involve measures that consider the market value of the
company’s shares. Frequently share prices data are punched with the
accounting data to generate new set of information. These are (a)
Price- Earnings Ratio, (b) Dividend Yield
Price- Earnings Ratio (P/E Ratio): The price earnings ratio indicates the
expectation of equity investors about the earnings of the firm. It
relates earnings to market price and is generally taken as a summary
measure of growth potential of an investment, risk characteristics,
shareholders orientation, corporate image and degree of liquidity. It is
calculated as
Price-Earnings per Share (P/E Ratio)
= Market Price per Share(MPS)
Earning per Share(EPS)
Interpretation
• It indicates the payback period to the investors or prospective
investors
Dividend and Earning Yield:
Dividend Yield = Dividend±Change in share price ×100
Initial share price

Sometime it is calculated as
Dividend per Share (DPS)
Market Price per Share (MPS)
Interpretation
This ratio indicates return on investment; this may be on average investment or
closing investment. Dividend (%) indicates return on paid up value of shares. But
yield (%) is the indicator of true return in which share capital is taken at its
market value.
Earning Yield also can be calculated as
Earnings Yield = Earnings per Share(EPS) ×100
Market Price per Share (MPS)

Also known as Earning Price ( EP) Ratio.

The following are the summarized Profit & Loss A/c and B/s of Zenith Ltd. For the
year ended 31/03/2016.

Trading and Profit and Loss Account

Particulars Amount (Rs.) Particulars Amount (Rs.)

To Opening stock 99000 By Sales 950000

To Purchases 545000 By Closing stock 150000
To Freight Inward 16000
To Gross Profit 440000
1100000 1100000
To Operating Expenses 200000 By Gross Profit 440000
To Loss on sale of Assets 40000 By Non operating 60000
Income

To Net Profit 260000

500000 500000
 Balance Sheet
Liabilities Amount (Rs.) Assets Amount (Rs.)
Share Capital 200000 Land and Building 150000
Reserves and Surplus 260000 Plant and Machinery 180000
Bills Payable 40000 Stocks 150000
Other current liabilities 90000 Debtors 45000
Bills Receivable 5000
Cash and bank 60000
590000 590000

Calculate the following Ratios

1) Gross Profit Ratio 2) Operating Profit Ratio 3) return on capital
employed 4) Stock turnover ratio 5) Debtors turnover ratio
6)Current Ratio 7) Fixed Assets turnover ratio 8) Net Profit to Fixed
Assets ratio 9) Sales to Capital employed ratio 10) Total Assets
Turnover ratio.
 The following is the Balance Sheet as on 31/03/2016 of the company.

Liabilities Rs. Assets Rs

Equity shares of Rs10 each 600000 Fixed Assets 3500000
Reserve Fund 400000 Less :-Depreciation 500000 3000000
Profit & loss account 500000 Stock 600000
Long Term loans 2000000 Debtors 500000
Creditors 450000 Cash 100000
Other current liabilities 250000
Total 4200000 Total 4200000

Additional Information.
1) Profit earned during the year is Rs.450000
2) Market price of share is Rs.500
3) Ignore provision regarding taxation.
4) Calculate the following Ratios
a) Debt – Equity Ratio b) Current Ratio c) Acid Test Ratio
d) Earning Per Share e) Price Earning Ratio
 From the following Balance sheet of A Ltd. Prepare a statement showing sources
and application of funds. Balance Sheet of A Ltd.
Liabilities 31/03/17 31/3/18 Assets 31/3/17 31/3/18
(Rs.) (Rs.) (Rs.) (Rs.)
Share Capital 10,00,000 11,00,000 Goodwill 50,000 40,000

Debentures 5,00,000 3,00,000 Land & Building 4,20,000 6,60,000

General Reserve 2,00,000 2,00,000 Plant & machinery 6,00,000 8,00,000

Profit & Loss A/c 1,10,000 1,90,000 Stocks 2,50,000 2,10,000

Income tax 40,000 1,10,000 Debtors 3,00,000 2,40,000

Provision
Creditors 50,000 40,000 Cash 3,00,000 24,000

Bills Payable 20,000 30,000 Preliminary 30,000 20,000

Expenses
Provision for 30,000 24,000 ------- ------- --------
Doubtful debts
Total 19,50,000 19,94,000 Total 19,50,000 19,94000
Additional Information

1) During the year 2017-18 a part of machinery costing

Rs.7,500 (Accumulated depreciation on that Rs.2,500)
was sold for Rs.3000.

2) Dividend of Rs.1,00,000 was paid during 2017-18.

3) Income tax paid during the year 2017-18 Rs.50,000.

4) Depreciation for the year 2017-18 was provided as

under.
a) Land & Building Rs.10,000.
b) Plant & Machinery Rs.50,000.
 Following are the summarized Balance Sheet of Abhijit Ltd. As on
31/3/2014 & 31/3/2015. You are required to prepare a Fund Flow
Statement for the year ended 31/3/2015.
Balance Sheet
Liabilities Amt. Amt. Assets Amt. Amt.
(31.3.2014) (31.3.2015) (31.3.201 (31.3.201
4) 5)

Share Capital 1,00,000 1,25,000 Goodwill -------- 2,500

General Reserve 25,000 30,000 Land & Building 1,00,000 95,000

Profit & Loss 15,250 15,300 Plant & machinery 75,000 84,500
A/C
Long term bank 35,000 67,600 Stock 50,000 37,000
loan
Creditors 75,000 ---------- Debtors 40,000 32,100

Prov. For tax 15,000 17,500 Cash in Hand 250 4300

Total (Rs.) 2,65,250 2,55,400 Total (Rs.) 2,65,250 2,55,400

Additional Information

1) Depreciation written off on Plant & machinery

Rs.7,000 & on Land & Building Rs.5,000.

2) Provision for tax was made Rs.16,500.

3) Dividend of Rs.11,500 was paid.