Managerial

Economics
&
Financial Analysis
 Unit V

Financial Analysis
through Ratios
 MEFA SYLLABUS
UNIT – I Introduction to Business and Economics:
Business: Structure of Business Firm, Theory of Firm, Types of Business Entities,
Limited Liability Companies, Sources of Capital for a Company, Non-
Conventional Sources of Finance.
• Economics: Significance of Economics, Micro and Macro Economic Concepts,
Concepts and Importance of National Income, Inflation, Money Supply in
Inflation, Business Cycle, Features and Phases of Business Cycle. Nature and
Scope of Business Economics, Role of Business Economist, Multidisciplinary
nature of Business Economics.

UNIT – II Demand and Supply Analysis:

• Elasticity of Demand: Elasticity, Types of Elasticity, Law of Demand,
Measurement and Significance of Elasticity of Demand, Factors affecting
Elasticity of Demand, Elasticity of Demand in decision making, Demand
Forecasting: Characteristics of Good Demand Forecasting, Steps in Demand
Forecasting, Methods of Demand Forecasting.
• Supply Analysis: Determinants of Supply, Supply Function & Law of Supply.
UNIT- III Production, Cost, Market Structures & Pricing:

• Production Analysis: Factors of Production, Production Function, Production

Function with one variable input, two variable inputs, Returns to Scale.

• Cost analysis: Types of Costs. Market Structures: Nature of Competition, Features

of Perfect competition, Monopoly, Oligopoly, and Monopolistic Competition.
Pricing: Types of Pricing, Product Life Cycle based Pricing, Break Even Analysis, and
Cost Volume Profit Analysis.

UNIT - IV Financial Accounting:

Accounting concepts and Conventions, Accounting Equation, Double-Entry system of
Accounting, Rules for maintaining Books of Accounts, Journal, Posting to Ledger,
Preparation of Trial Balance, and Preparation of Final Accounts.
UNIT - V Financial Analysis through Ratios:

Concept of Ratio Analysis, Liquidity Ratios, Turnover Ratios, Profitability Ratios,

Proprietary Ratios, Solvency, Leverage Ratios (simple problems)
 UNIT - V Financial Analysis through Ratios
A Ratio is a simple mathematical expression. It is a number expressing the quantitative relationship
between the two.

Ratio analysis is a quantitative procedure of obtaining a look into a firm's functional efficiency, liquidity,
revenues, and profitability by analyzing its financial records and statements.

Ratio analysis is a very important factor that will help in doing an analysis of the fundamentals of
equity.

They help us to draw certain conclusions, comparison with related facts is the basis of ratio analysis.

ADVANTAGES OF RATIO ANALYSIS:

Ratio Analysis has the following advantages:
(1) It simplifies the understanding of financial statements.
(2) It brings out the inter relationship among various financial figures and bring to light their financial
significance.
(3) It Contributes significantly towards effective planning and forecasting.
(4) Ratios serve as effective control tools. They also facilitate establishment of a standard costing
system and budgetary control.
(5) Ratios cater to the particular information need of a particular person, depending on his interest in
the business.
 Ratio Analysis
LIMITATIONS OF RATIO ANALYSIS:
Ratio Analysis has the following Limitations:
(1) Ratios may not prove to be the ideal tool for inter – firm comparisons. The
two firms may adopt different accounting policies.
(2) A Study of ratios in isolation, without studying the actual figures, may lead to
wrong conclusions.
(3) Ratios can be only as correct as the data on which they are based. If the
original data is not reliable, then ratios will be misleading.
(4) Ratio analysis suffers from lack of consistency.
(5) Ratios fail to reflect the impact of price level changes, and hence can be
misleading.
(6) Ratios are based on past data. They cannot be a reliable guide to future
performance.
(7) Ratios are volatile and can be influenced by a single transaction with extreme
value.
 RATIO ANALYSIS
(1) LIQUIDITY RATIOS: The Liquidity ratios measure the short term solvency of the firm. The
following are the important liquidity ratios.

(A) CURRENT RATIO = CURRENT ASSETS

CURRENT LIABILITIES

WHERE
CURRENT ASSETS = CASH BALANCE + BANK BALANCE+ DEBTORS + BILLS RECEIVABLES +
CLOSING STOCK + PREPAID EXPENSES + SHORT TERM INVESTMENTS+
ACCRUED INCOMES

CURRENT LIABILITIES = CREDITORS + BILLS PAYABLE + BANK OVERDRAFT + SHORT TERM LOANS +
OUTSTANDING EXPENSES + DIVIDEND PAYABLE + PROPOSED DIVIDENDS + PROVISION FOR TAXATION

STANDARD RATIO = 2: 1

(B) QUICK RATIO / LIQUID RATIO / ACID TEST RATIO = QUICK ASSETS
CURRENT LIABILITIES
WHERE QUICK ASSETS = CURRENT ASSETS - (STOCK + PREPAID EXPENSES)
STANDARD RATIO = 1: 1
 RATIO ANALYSIS
2) ACTIVITY / TURNOVER RATIOS: It measure the efficiency or effectiveness with which a firm
manages its resources or assets. It calculate the speed with which various assets, in which funds
are blocked up get converted into sales. The significant activity or turnover ratios are

(A) DEBTORS TURNOVER RATIO = NET CREDIT SALES

AVERAGE DEBTORS
Where Net credit Sales = Total Sales – Cash Sales
Average Debtors = OPENING DEBTORS + CLOSING DEBTORS
2
Debtors Collection Period = Number of days in a Year
Debtors Turnover Ratio

(B) CREDITORS TURNOVER RATIO = NET CREDIT PURHCASES

AVERAGE CREDITORS

Where Net Credit Purchases = Total Purchases – Cash purchases

Average Creditors = OPENING CREDITORS + CLOSING CREDITORS
2
Debt Payment Period = Number of days in a Year
Creditors Turnover ratio
 RATIO ANALYSIS
NOTE: (1) IN ABSENCE OF OPENING DEBTORS VALUE CLOSING DEBTORS CAN BE TAKEN AS
AVERAGE DEBTORS IT ALSO INCLUDES BILLS RECEIVABLES VALUE
AVERAGE DEBTORS = CLOSING DEBTORS + BILLS RECEIVABLES
(2) IN ABSENCE OF OPENING CREDITORS VALUE CLOSING CREDITORS CAN BE TAKEN AS AVERAGE
CREDITORS IT ALSO INCLUDES BILLS PAYABLES VALUE
AVERAGE CRDITORS = CLOSING CREDITORS + BILLS PAYABLES

( C ) STOCK / INVENTORY TURNOVER RATIO = Cost of goods sold

Average Stock
Where Cost of goods sold ( COGS) = Sales – Gross profit
(or)
COGS = Opening Stock + Purchases + Direct Expenses – Closing Stock
Average Stock = Opening Stock + Closing Stock
2
STOCK CONVERSION PERIOD = Number of days in a Year
Stock Turnover Ratio

(D) FIXED ASSETS TURNOVER RATIO = NET SALES

FIXED ASSETS
Where
Fixed Assets = Land & Buildings + Plant & Machinery + Furniture + Investments
 RATIO ANALYSIS
(3) PROFITABILITY RATIOS :

(A) GROSS PROFIT RATIO = GROSS PROFT X 100

NET SALES
Where Gross Profit = Net Sales – Cost of goods sold
Net Sales = Total Sales - Sales returns
Cost of Goods sold = Opening Stock + Purchases + Manufacturing Expenses - Closing Stock

(B) NET PROFIT RATIO = NET PROFT X 100

NET SALES

( C ) OPERATING RATIO = COST OF GOODS SOLD + OPERATING EXPENSES X 100

NET SALES
WHERE OPERATING EXPENSES = ADMINISTRATION & SELLING & DISTRIBUTION EXPENSES

(D) OPERATING PROFIT RATIO = 100 - OPERATING RATIO

 Ratio Analysis
(4) LEVERAGE OR CAPITAL STRUCTURE RATIOS:
(i) Debt Equity Ratio = Long term Liabilities
Shareholders funds / Net worth
Where Long term liabilities = Debenture s+ Long term Loans
Share holders funds/ Net Worth = Equity share capital + Preference share capital
+ Reserves + Undistribute assets ( Profit & Loss Account) – Fictitious
assets( Goodwill & Preliminary expenses)

(ii) Proprietary Ratio = Shareholders fund / Net worth

Total Assets
Total Assets = Fixed Assets + Current Assets ( excluding fictitious assets)

(iii) Capital Gearing Ratio = Funds bearing fixed interest and Fixed dividend
Equity shareholders funds
Where
Funds bearing fixed interest and fixed dividend = Debentures + term loans +
preference share capital
 Ratio Analysis
(iv) INTEREST COVERAGE RATIO / DEBT SERVICE RATIO =
Profit before interest and taxes (PBIT)
Fixed interest charges
PBIT = PAT + Interest + Tax

(v) DIVIDEND COVERAGE RATIO = _______PAT_________

FIXED PREFERNCE DIVIDEND

(Vi) EARNINGS PER SHARE (EPS) = PROFIT AFTER TAX – PREFERENCE DIVIDEND
NUMBER OF EQUITY SHARES

(Vii) PRICE EARNING RATIO = EARNINGS PER SHARE

MARKET PRICE OF THE SHARE

(Viii) DIVIDEND YIELD RATIO = DIVIDEND PER SHARE______

MARKET PRICE OF THE SHARE
 (I) LIQUIDITY RATIO PROBLEMS
Eg: (1) From the following Balance Sheet Information, Calculate Liquidity ratios for
the Company A ? BALANCE SHEET

LIABILITIES
LIABILITIES AMOUNT ASSETS
AMOUNT ASSETS AMOUNT
AMOUNT
Creditors
Creditors 1,600
1,600 Cash
Cash Balance
Balance 360
360

Bills
Bills Payable
Payable 600
600 Debtors
Debtors 2,800
2,800
Bank
Bank Overdraft
Overdraft 200
200 Closing
Closing Stock
Stock 4000
4000
Short
Short term
term Loans Machinery
Machinery 2840
2840
Loans 1200
1200
Capital
Capital 6,400
6,400
________
________ ________
________
Total
Total 10,000
10,000 10,000
10,000

Quick assets ratio = Quick assets/cl

Quick Assets = Total Current assets – (Closing stock +prepaid expenses)
7,160 - 4000 + 0 = 3160
 LIQUIDTY RATIO PROBLEMS
Eg: (1) ANS: Liquidity ratios for the COMPANY A

(i) CURRENT RATIO = CURRENT ASSETS = 7,160 = 1.98

CURRENT LIABILITIES 3600

WHERE
CURRENT ASSETS = CASH + DEBTORS + CLOSING STOCK
= 360 + 2,800 + 4000
= 7,160
CURRENT LIABILITIES = CREDITORS + BILLS PAYABLE + BANK OVERDRAFT + SHORT TERM LOANS
= 1600 + 600 + 200 + 1200
= 3600

(ii) QUICK RATIO / LIQUID RATIO = Quick Assets = 3,160

Current liabilities 3,600

Quick assets = Total current assets – (closing stock & prepaid expenses)
= 7,160 – 4000 = 3,160

CURRENT ASSETS - ( CLOSING STOCK + PREPAID EXPENSES)

CURRENT LIABILITIES

= 7,160 - ( 4000 + 0 ) = 3,160 = 0.877

3600 3,600
 LIQUIDITY RATIO PROBLEMS
Eg: (2) From the following Balance Sheet information, Calculate Liquidity ratios for the Company B ?
LIABILITIES AMOUNT ASSETS AMOUNT
Creditors 10,000 Cash Balance 280

Bills Payable 2,000 Debtors 6,400

Bank Overdraft 250 Closing Stock 12,000
Short term Furniture 1,320
Loans 1,000
Capital 6,750
________ ________
Total 20,000 20,000

(a)Current Ratio = Current Assets = 18,680 = 1.40

Current Liabilities 13,250
Where Current Assets = Cash + Debtors + Closing stock = 280 +6400 +12000 = 18,680
Current Liabilities = Creditors+Billspayable+Bankoverdraft+shorttermloans = 13,250
= 10,000+2000+250+1000
(b)Quick Ratio = Quick Assets / Current liabilities
Where Quick Assets = Total Current Assets – (Closing stock + Prepaid exp)
 LIQUIDITY RATIO PROBLEMS
Eg: (2) From the following Balance Sheet information, Calculate Liquidity ratios for the Company B ?
LIABILITIES AMOUNT ASSETS AMOUNT
Creditors 10,000 Cash Balance 280

Bills Payable 2,000 Debtors 6,400

Bank Overdraft 250 Closing Stock 12,000
Short term Furniture 1,320
Loans 1,000
Capital 6,750
________ ________
Total 20,000 20,000

(a) Current ratio = Current assets = 18680 = 1.40

Current Liabilities 13250
Where Current assets = 280+ 6400+ 12000=18680
Current liabilities= 10000+2000+250+1000=13250
(b) Quick ratio = Quick Assets = 6,680 = 0.50
Current Liabilities 13250
Quick assets = total current assets – closing stock & prepaid exp
18680 - 12000 = 6680
 PROFITABILITY RATIO PROBLEM
Eg (3) you are given Trading and Profit & Loss Account of Maharshi Company Limited for the year ending
31st December 1993 Calculate (a) Gross Profit ratio (b) Net Profit ratio © Operating ratio (D)
Operating Profit ratio? TRADING & PROFIT AND LOSS ACCOUNT
PARTICULARS AMOUNT PARTICULARS AMOUNT
To Opening Stock 30,000 By Sales 1,10,000
To Purchases 60,000
To Wages 10,000 By Closing Stock 20,000
To Gross Profit 30,000
------------ -------------
1,30,000 1,30,000
------------ ------------
To By Gross Profit 30,000
Administrative 10,000 By Rent received 5,000
Expenses
To Selling &
Distribution 5,000
Expenses 20,000
To Net Profit ------------ -------------
2,95,000 2,95,000
------------ ------------
 PROFITABILITY RATIO PROBLEM
ANS: (i) Gross Profit ratio = Gross Profit X 100 => 30,000 X 100 = 22.27%
Net Sales 1,10,000

(ii) Net Profit ratio = Net Profit X 100 => 20,000 X 100 = 18.18%
Net Sales 1,10,000

(iii) Operating ratio = Cost of Goods sold + Operating Expenses X 100

Net Sales
Where
COGS = Opening Stock + Purchases + Direct Expenses - Closing Stock
= 30,000 + 60,000 + 10,000 - 20,000 => 1,00,000 – 20,000 = 80,000
Operating Expenses = Administration expenses + Selling & Distribution Expenses
= 10,000 + 5,000 = 15,000

Operating ratio = 80,000 + 15,000 X 100 = 95,000 X 100 = 86.36 %

1,10,000 1,10,000

(iv) Operating profit ratio = 100 – Operating ratio => 100 – 86.36 = 13.64%
 PROFITABILITY RATIO PROBLEM
Eg (4) you are given Trading and Profit & Loss Account of Savithri Company Limited for the year ending
31st December 1993 Calculate (a) Gross Profit ratio (b) Net Profit ratio © Operating ratio (D)
Operating Profit ratio? TRADING & PROFIT AND LOSS ACCOUNT
PARTICULARS AMOUNT PARTICULARS AMOUNT
To Opening Stock 50,000 By Sales 20,00,000
To Purchases 11,00,000
To Wages 3,00,000 By Closing Stock 6,00,000
To Factory expenses 2,00,000
To Gross Profit 5,00,000
------------ -------------
26,00,000 26,00,000
------------ ------------
To Administrative By Gross Profit 5,00,000
Expenses 75,000 By Discount received 10,000
To Selling & Distribution By Commission received 20,000
Expenses 50,000
To Depreciation 60,000
To Bad debts 5,000
To Net Profit 3,20,000
------------ -------------
5,30,000 5,30,000
------------ ------------
 Profitability ratios
(a) Gross profit ratio = Gross profit X 100 = 500000 X 100 = 25%
Net sales 20,00,000

(b) Net Profit ratio = Net profit X 100 = 320000 X 100 = 16%
Net Sales 20,00,000

© Operatio ratio = Cogs + Operating exp X 100 = 85000+125000X100 = 48.75%

Net sales 20,00,000
Where COST OF GOODS SOLD (COGS) = Opening stock + Purchases+ Direct exp –
Closing stock
COGS = 50,000 + 11,00,000 +3,00,000 – 600000= 8,50,000
OPERATING EXP = ADMINISTRATION + SELLING & DISTR EXP=
75000 + 50000= 125000

(D) Operating profit ratio = 100 – operating ratio ( C Bit answer )

= 100 – 48.75
= 51.25%
 Stock Turnover Ratio Problems
Eg (1) Given Opening Stock as R. 28,000 Closing stock as Rs. 32,000, Sales as Rs.
3,20,000, Gross Profit is 25% on sales, Calculate Stock Turn over ratio?
Ans:
STOCK / INVENTORY TURNOVER RATIO = Cost of goods sold = 2,40,000 = 8
Average Stock 30,000
Where Cost of goods sold ( COGS) = Sales – gross profit
= 3,20,000 – 80,000 = 2,40,000
Sales = 3,20,000
Gross profit = 3,20,000 x 25% = 80,000
Average Stock = Opening Stock + Closing Stock = 28000+ 32,000=60,000=30,000
2 2 2
 Stock Turnover Ratio Problems
Eg (1) Given Opening Stock as R. 28,000 Closing stock as Rs. 32,000, Sales as Rs. 3,20,000, Gross
Profit is 25% on sales, Calculate Stock Turn over ratio?
Ans:
STOCK / INVENTORY TURNOVER RATIO = Cost of goods sold
Average Stock
Where Cost of goods sold ( COGS) = Sales – Gross profit=> 3,20,000 – 80,000
COGS = 2,40,000

Where Gross Profit = Sales X 25% => 3,20,000 X 25% = 80,000

Average Stock = Opening Stock + Closing Stock = 28000+32000 = 30,000

2 2
STOCK / INVENTORY TURNOVER RATIO = Cost of goods sold = 2,40,000 = 8TIMES
Average Stock 30,000

STOCK CONVERSION PERIOD = Number of days in a Year = 365 = 45 DAYS

Stock Turnover Ratio 8
 Debtors Turnover Ratio Problems
Eg (2)Calculate the Debtors Turnover Ratio from the following information related to 2018 yr
Total Sales for the year = 1,00,000
Cash sales = 20,000
Debtors as on 01-01-2018 = 15,000 (opening Debtors)
Debtors as on 31-12-2018 = 10,000 ( closing Debtors)

Ans: DEBTORS TURNOVER RATIO = NET CREDIT SALES

AVERAGE DEBTORS
Given NET CREDIT SALES = Total Sales – Cash Sales => 1,00,000 – 20,000 = 80,000
Average Debtors = Opening Debtors + Closing Debtors = 15,000+10,000 = 12,500
2 2
Debtors Turnover Ratio = 80,000 = 6.4 Times
12,500
DEBTORS COLLECTION PERIOD = Number of days in a Year = 365 = 57 days
Debtors Turnover Ratio 6.4
(Answer)
 Creditors Turnover Ratio Problems
Eg (3)Calculate the Creditors Turnover Ratio from the following information related to 2017yr
Total Purchases = 7,00,000
Creditors as on 01-01-2017 = 1,20,000 (opening Creditors)
Creditors as on 31-12-2017 = 80,000 (closing Creditors)

Ans: CREDITORS TURNOVER RATIO = NET CREDIT PURCHASES

AVERAGE CREDITORS
Given NET CREDIT PURCHASES = 7,00,000
Average Creditors = Opening Creditors + Closing Creditors = 1,20000+80,000 = 1,00,000
2 2
Creditors Turnover Ratio =7,00,000 = 7 Times
1,00,000
DEBT PAYMENT PERIOD = Number of days in a year = 365 days = 52 days
Creditors Turnover Ratio 7
 ACTIVITY RATIOS
Eg: (1) Given below is the Profit & Loss Account and Balance Sheet . You are
required to Calculate Important Turnover Ratios
TRADING & PROFIT AND LOSS ACCOUNT
PARTICULARS AMOUNT PARTICULARS AMOUNT

To Opening Stock 80,000 By Sales 10,40,000

To Purhcases (-) Sales returns – 40,000 10,00,000
Cash 96,000
Credit 7,00,000 7,96,000 By Closing Stock 1,20,000

To Administration expenses 1,69,000

To Net Profit 75,000
------------- ------------
11,20,000 11,20,000
------------ ------------
 ACTIVITY RATIOS
Eg: (1) Q. BALANCE SHEET

LIABILITIES AMOUNT ASSETS AMOUNT

SHARE CAPITAL 3,00,000 BUILDINGS 2,50,000

RESERVES 1,50,000 PLANT 2,10,000
DEBENTURES 2,00,000 INVESTMENTS 80,000
CREDITORS 1,30,000 STOCK 1,20,000
BILLS PAYABLE 70,000 DEBTORS 50,000
PROVISIONS 60,000 40,000
LESS (-) PROVISIONS(-) 10,000
BILLS RECEIVABLES 1,60,000
1,75,000 50,000
------------ LESS (-) PROVISIONS(-) 15,000 --------------
9,10,000 CASH 9,10,000
------------ -------------
 ACTIVITY RATIOS
Eg: (1) Ans: (a) STOCK TRUNOVER RATIO = Cost of goods sold (COGS)
Average Stock
Where COGS = OPENING STOCK + PURHCASES + MANUFACTURING EXPENSES –
CLOSING STOCK
= 80,000 + 7,96,000 - 120,000
COGS = 7,56,000

AVERAGE STOCK = Opening Stock + Closing Stock = 80,000 + 1,20,000 = 1,00,000

2 2

STOCK TURNOVER RATIO = COGS_________ = 7,56,000 = 7.56 Times

AVERAGE STOCK 1,00,000

STOCK CONVERSION PERIOD = Number of days in a Year = 365 days = 48.28 => 48 days
Stock Turnover Ratio 7.56
 ACTIVITY RATIOS
Eg: (1) Ans: (b) DEBTORS TURNOVER RATIO = NET CREDIT SALES
AVERAGE DEBTORS
Given NET CREDIT SALES = 1,00,0000
Since Average Debtors cannot be calculated, Closing debtors should be taken as Average
Debtors including the Bills Receivables.
AVERAGE DEBTORS = Debtors + Bills Receivables = 50,000 + 1,75,000 = 2,25,000

Debtors Turnover Ratio = 10,00,000 = 4.44 Times

2,25,000
DEBTORS COLLECTION PERIOD = Number of days in a Year = 365 = 82.125 => 82 days
Debtors Turnover Ratio 4.44

(c ) CREDITORS TURNOVER RATIO = NET CREDIT PURCHASES

AVERAGE CREDITORS
Where Net Credit Purchases = 7,00,000
Since Average Creditors cannot be calculated, Closing Creditors should be taken as Average
Creditors including the Bills Payables.
AVERAGE CREDITORS =CREDITORS + BILLSPAYABLES =1,30,000 + 70,000 = 2,00,000
CREDITORS TURNOVER RATIO = 7,00,000 = 3.5
2,00,000
 ACTIVITY RATIOS
Eg: (1) Ans: DEBT PAYMENT PERIOD = Number of days in a year = 365 days = 104 days
Creditors Turnover Ratio 3.5

(D) FIXED ASSETS TURNOVER RATIO = NET SALES___=

FIXED ASSETS
Where Net Sales = 10,00,000
Fixed Assets = Buildings + Plant + Investments = 2,50,000 + 2,10,000 + 80,000 = 5,40,000

Fixed Assets Turnover Ratio = 10,00,000 = 1.85

5,40,000
 DEBT EQUITY RATIOS
Eg: (1) Calculate the Debt Equity ratio from the Balance sheet given below:
BALANCE SHEET
LIABILITIES AMOUNT ASSETS AMOUNT
EQUITY 1,00,000 GOOD WILL 60,000
SHARE (FICTITIOUS
CAPITAL ASSETS)
RESERVES 20,000 MACHINERY 1,40,000

P & L A/C 30,000 CLOSING 30,000

STOCK
LONG TERM 80,000 DEBTORS 10,000
LOANS
CREDITORS 50,000 CASH
BALANCE 30,000
PROVISION 20,000 BANK
FOR BALANCE 30,000
TAXATION

TOTAL 3,00,000 TOTAL 3,00,000

 DEBT EQUITY RATIO
ANS: Debt Equity Ratio = Long term Liabilities
Shareholders funds / Net worth

Where Long term liabilities = Debentures+ Long term Loans

+ 0 + 80,000 = 80,000

Share holders funds/ Net Worth = Equity share capital + Preference share capital
+ Reserves + Undistribute assets ( Profit & Loss Account) – Fictitious
assets
=1,00,000 + 0 + 20,000 + 30,000 -
60,000
= 90,000

Debt Equity Ratio = Long term Liabilities = 80,000 = 0.888

Shareholders funds 90,000
 DEBT EQUITY RATIOS
Eg: (2) Calculate the Debt Equity ratio from the Balance sheet given below:
BALANCE SHEET
LIABILITIES AMOUNT ASSETS AMOUNT
EQUITY 1,00,000 PRELIMINARY 5,000
SHARE EXPENSES
CAPITAL (FICTITIOUS
ASSETS)
RESERVES MACHINERY 1,25,000
AND
SURPLUS 65,000 CLOSING 50,000
STOCK
5% 1,00,000 DEBTORS 10,000
DEBENTURES BILLS
RECEIVABLE 5,000
LONG TERM 18,000 CASH
LOANS BALANCE 20,000
BILLS PAYABLE 7,000
TOTAL 2,90,000 TOTAL 2,90,000
 DEBT EQUITY RATIO
ANS: Debt Equity Ratio = Long term Liabilities
Shareholders funds / Net worth

Where Long term liabilities = Debentures+ Long term Loans

+ 1,00,000 + 18,000 = 1,18,000

Share holders funds/ Net Worth = Equity share capital + Preference share capital
+ Reserves + Undistribute assets ( Profit & Loss Account) – Fictitious
assets
=1,00,000 + 0 + 65,000 + 0 - 5,000
= 1,60,000

Debt Equity Ratio = Long term Liabilities = 1,18,000 = 0.737

Shareholders funds 1,60,000
 INTEREST COVERAGE RATIO
Eg(1) FROM THE FOLLOWING INFORMATION CALCULATE THE INTEREST COVERAGE RATIO
The earnings before interest and taxes (PBIT) of a company is Rs. 5,60,000. Its fixed
commitments include payment of 10% on 7,00,000 debentures . It is subject to tax of
30% per annum?
ANS:
CALCULATE INTEREST COVERAGE RATIO
Profit before interest and taxes = 5,60,000
Fixed interest charges on debentures = 7,00,000 X 10% = 70,000

INTEREST COVERAGE RATIO / DEBT SERVICE RATIO =

Profit before interest and taxes (PBIT) = 5,60,000 = 8 times
Fixed interest charges 70,000
Where
PBIT = PAT + Interest + Tax
Interest coverage ratio of 8 times means that the net profit earnings are 8 times to the fixed
interest charges payable during the year.
 EARNING PERSHARE RATIO
EG(1) GIVEN THAT THE NUMBER OF SHARES IS 10,000 AND THE NET
PROFIT AFTER TAXES FOR A GIVEN ACCOUNTING PERIOD IS RS.
4,50,000 . CALCULATE THE EPS?

ANS:
EARNINGS PER SHARE (EPS) = PROFIT AFTER TAX – PREFERENCE DIVIDEND
NUMBER OF EQUITY SHARES

EPS = 4,50,000 – 0 = 45
10,000
 PRICE EARNING RATIO
EG(1) GIVEN THAT MARKET PRICE OF A SHARE IS RS. 340 AND EPS IS 10,
CALCUALTE THE PRICE EARNING RATIO?
ANS:
PRICE EARNING RATIO = MARKET PRICE PER SHARE = 340 = 34
EARNING PER SHARE 10
 Exam based problem
Eg(1) The following is Balance sheet of A limited as on 31-12-1990

LIABILITIES AMOUNT ASSETS AMOUNT

SHARE 1,00,000 LAND AND 1,25,000
CAPITAL BUILDINGS
RESERVES & 65,000 PLANT &
SURPLUS MACHINERY 75,000
DEBENTURES 1,00,000 STOCK 50,000
CREDITORS 18,000 DEBTORS 10,000
BILLS PAYABLE 7,000 BILLS 5,000
RECEIVABLE
CASH
BALANCE 20,000
PRELIMINARY
EXPENSES 5,000

TOTAL 2,90,000 TOTAL 2,90,000

 Exam based problem
SALES FOR THE YEAR RS. 6,00,000
Calculate the following ratios and offer your comments
(a) Current Ratio
(b) Debtors Turnover Ratio & Debtors Collection Period
(c) Debt / equity Ratio ?
Ans:
(a) CURRENT RATIO = CURRENT ASSETS = 85,000 = 3.4
CURRENT LIABILITIES 25,000

WHERE
CURRENT ASSETS = CASH + DEBTORS + STOCK + BILLS RECEIVABLE
= 20,000 + 10,000 + 50,000 + 5,000
= 85,000
CURRENT LIABILITIES = CREDITORS + BILLS PAYABLE
= 18,000 + 7,000
= 25,000
 Exam based problem
(b) DEBTORS TURNOVER RATIO = NET CREDIT SALES
AVERAGE DEBTORS
Given NET CREDIT SALES = 6,00,000
Average Debtors = Opening Debtors + Closing Debtors =
2
As opening debtors value not given we are considering Closing debtors + Bills
Receivables value as average debtors here.
CLOSING DEBTORS + BILLS RECEIVABLES
10,000 + 5,000 = 15,000
Debtors Turnover Ratio = 6,00,000 = 40 Times
15,000
DEBTORS COLLECTION PERIOD = Number of days in a Year = 365 = 9 days
Debtors Turnover Ratio 40
 Exam based problem
(3) Debt Equity Ratio = Long term Liabilities = 1,00,000 = 0.625
Shareholders funds / Net worth 1,60000

Where Long term liabilities = Debentures+ Long term Loans = 1,00,000

= 1,00,000 + 0

Share holders funds/ Net Worth = Equity share capital + Preference share capital
+ Reserves + Undistribute assets ( Profit & Loss Account) – Fictitious
assets
= 1,00,000 + 0 + 65000 + 0 - 5000 = 1,60,000
 Exam based question
3(Q). Given below is the Profit & Loss Account and Balance Sheet . You are
required to Calculate (i) Gross Profit Ratio (ii) Current Ratio (iii) Stock Turn over
ratio? TRADING & PROFIT AND LOSS ACCOUNT
PARTICULARS AMOUNT PARTICULARS AMOUNT

To Opening Stock 25,000 By Sales 1,80,000

To Purhcases 1,05,000 By Closing Stock 15,000
To Gross Profit c/d 65,000
------------ ------------
1,95,000 1,95,000
------------ ------------
To Administration expenses 23,000 By Gross Profit b/d 65,000
To Selling & Distribution 10,000 By Profit on Sale of shares 5,000
expenses
To Financial expenses 2,000
To Net Profit 35,000
------------- ------------
70,000 70,000
------------ ------------
 Exam based question
BALANCE SHEET

LIABILITIES AMOUNT ASSETS AMOUNT

SHARE CAPITAL 50,000 LAND & BUILDINGS 50,000

RESERVES & SURPLUS 40,000 PLANT & MACHINERY 20,000
PROFIT & LOSS A/C 15,000 STOCK 15,000
CREDITORS 12,000 DEBTORS 20,000
BILLS PAYABLE 8,000 BILLS RECEIVABLES 5,000
CASH 15,000

------------ --------------
1,25,000 1,25,000
------------ -------------
 Exam based problem
(i) Gross Profit ratio = Gross Profit X 100 => 65,000 X 100 = 36.11%
Net Sales 1,80,000

(ii) CURRENT RATIO = CURRENT ASSETS = 55,000 = 2.75

CURRENT LIABILITIES
20,000

WHERE
CURRENT ASSETS = CASH + DEBTORS + STOCK + BILLS RECEIVABLE
= 15,000 + 20,000 + 15,000 + 5,000
= 55,000
CURRENT LIABILITIES = CREDITORS + BILLS PAYABLE
= 12,000 + 8,000
= 20,000
 EXAM BASED PROBLEM
Eg: (2) Ans: (iii) STOCK TRUNOVER RATIO = Cost of goods sold (COGS)
Average Stock
Where COGS =SALES – GROSS PROFIT
= 1,80,000 - 65,000
COGS = 1,15,000

AVERAGE STOCK = Opening Stock + Closing Stock = 25,000 + 15,000 = 20,000

2 2

STOCK TURNOVER RATIO = COGS_________ = 1,15,000 = 5.75 Times

AVERAGE STOCK 20,000

STOCK CONVERSION PERIOD = Number of days in a Year = 365 days = 63 days

Stock Turnover Ratio 5.75
 Du Pont Chart
• The Du Pont Control Chart is called as such because Du Pont Company of the
USA first used it. The Du Pont Company of US pioneered a system of financial
analysis which has received widespread recognition. As a useful tool for
financial analysis, it has been adopted by many firms in some form or the
other. The various factors affecting the Return on Investment (ROI) are
illustrated through this chart. ROI represents the earning power of the
business.
It depends on two ratios:
• (a) Net Profit ratio and
• (b) Capital Turnover Ratio.

• A change in any one of the two ratios will change the business earning power
(i.e., ROI), and they are affected by many factors. The chart shown below
exhibits that ROI is affected by a number of factors.
• Any change in these factors will affect the return on capital employed. For
example, if the cost of goods sold decreases without any corresponding
decrease in selling price, the net profit will increase and therefore, ROI will
also increase.
Du Pont Chart
 Dr. Trading Account Cr.
Particulars Amount Amount Particulars Amount Amoun

To Opening Stock XXXXXX By Sales XXXXXX

Less: Sales
To Purchases XXXXXX returns (-) XXX XXXXXX
Less: Purhcase returns (-) XXX XXXXXX
By Closing Stock XXXXXX
To Carriage inwards XXXXXX
To Wages XXXXXX

To All Factory Expenses XXXXXX

To Import, Customs & Excise duty XXXXXX

To Gross Profit C/d XXXXXX By Gross Loss xxx

C/d
XXXXXX XXXXXX
 Dr. Profit & Loss Account Cr.
Particulars Amount Amount Particulars Amount Amount

To Gross Loss b/d XXXXXX By Gross Profit b/d XXXXX

By Commission
To Salaries Paid XXXXXX received XXXXXX
By Rent received XXXXXX
To Advertisement XXXXXX
expenses
By Interest received XXXXXX
To Carriage Outwards XXXXXX

To All Office & selling & XXXXXX By Discount received XXXXXX

Distribution expenses
To Discount allowed XXXXXX

To Net Profit C/d XXXXXX By Net Loss C/d XXXXXX

XXXXXX XXXXXX
----------- -----------
 BALANCE SHEET
LIABILITIES AMOUNT AMOUNT ASSETS AMOUNT AMOUNT

Creditors XXXXXX Cash in Hand XXXXXXX

Cash at Bank XXXXXXX
Bills Payable XXXXXX Debtors XXXXXXX
Closing Stock XXXXXXX
Bank Loan XXXXXX
Land & Buildings XXXXXXX
Furniture XXXXXXX
Plant & Machinery XXXXXXX
Capital XXXXXX Computer XXXXXXX
Add: Net Profit (+) XX Motor Vehicle XXXXXXX
(or)
Less: Net Loss (-) XXXX

Less: Drawings (-) XXXX XXXXXX

------------- ________ --------------

TOTAL 1,00,000 1,00,000

________ --------------
 REVISION Final Account Problem
Eg(1) From the following information Prepare Trading and Profit & Loss Account & Balance Sheet
PARTICULARS AMOUNT AMOUNT TRIAL BALANCE
PARTICULARS AMOUNT AMOUNT

Cash Balance 10,000 Sales 20,000

Bank balance
PARTICULARS AMOUNT 20,000
AMOUNT Purchase returns
PARTICULARS AMOUNT 10,000
AMOUNT
Machinery 50,000 Interest received 10,000
Furniture 20,000 Creditors 50,000
To Opening
Opening Stock
Stock 20,000
10,000 By
BankSales
loan 1,00,000
50,000
To Purchases
Purchases 20,000
30,000 Capital 40,000
To Carriage
Sales inward
returns 10,000
10,000 By Closing Stock 50,000
To Gross Profit C/d
Wages 1,00,000
5,000
Salaries -------------
5,000 ------------
Office Expenses 1,50,000
10,000 1,50,000
Carriage Outward ------------
10,000 -----------
------------- -------------
To Salaries 20,000
1,80,000 By Gross Profit b/d 1,00,000
1,80,000
To Advertisement 5,000
------------ By Interest received 5,000
------------
Expenses
Closing Stock 60,000
To Carriage Outward 10,000
To Net Profit C/d 70,000
------------- -------------
1,05,000 1,05,000
-------------- -------------
 Trading and Profit & Loss Account
ANS: Dr. TRADING AND PROFIT & LOSS ACCOUNT of ____________ Cr.
For the year ending _______________

PARTICULARS
PARTICULARS AMOUNT
AMOUNT AMOUNT
AMOUNT PARTICULARS
PARTICULARS AMOUNT
AMOUNT AMOUNT
AMOUNT
To
To Opening
Opening Stock
Stock 10,000
20,000 By
By Sales
Sales 20,000 1,00,000
To Purchases
To Purchases 30,000 20,000 (-) Sales returns (-) 10,000 10,000
(-)
To Purchase returns
Carriage inward (-) 10,000 20,000
10,000 By
By Closing
Closing stock
Stock 60,000
50,000
To
To wages
Gross Profit C/d 5,000
1,00,000
------------- ------------
To Gross Profit c/d _35,000_
1,50,000 _______
1,50,000
70,000
------------ 70,000
-----------
To
To Salaries
Salaries 5,000
20,000 By
By Gross
GrossProfit
Profitb/d
b/d 35,000
1,00,000
To
To Office expenses
Advertisement 10,000
5,000 By
By Interest
Interestreceived
received 10,000
5,000
To Carriage outward
Expenses 10,000
To Carriage Outward 10,000
To Net Profit C/d 70,000
To Net Profit c/d 20,000
------------- ________
-------------
45,000
1,05,000 45,000
1,05,000
-------------- -------------
 BALANCE SHEET

ANS: Balance Sheet of _______________as on ____________

LIABILITIES AMOUNT AMOUNT ASSETS AMOUNT AMOUNT

Creditors 50,000 Cash Balance 10,000

Bank loan 50,000 Bank balance 20,000
Machinery 50,000
Capital 40,000 Furniture 20,000
Add Net profit +20,000 60,000 Closing stock 60,000
-------------

------------- -----------
1,60,000 1,60,000
------------- -----------
 Exam based problem BEP PER UNIT
Q. (1) FIND OUT THE BEP per unit and BEP (in Sales) from the following
information, given Fixed cost 40,000 and Selling price p.u. Rs.10, Variable cost
per unit Rs.5p.u.?
A: (i) BEP (per unit)= Fixed cost = 40,000 = 8,000
Contribution margin per unit 5
Where
Contribution margin per unit = Selling Price – Variable cost= 10 – 5= Rs.5
BEP per unit = 8000

(ii) BEP (Sales)= Fixed cost = 40,000 = 40,000

Contribution margin ratio 1
Where
Contribution margin ratio = Selling Price – Variable cost = 10 -5= 5= 1
Selling price 5 5
 Exam based problem BEP PER UNIT
Q. (2) Find out the BEP FROM THE FOLLOWING INFORMATION GIVEN FIXED COST
1,00,000 SALES 60,000 AND VARIABLE COST 20,000?
A: BEP (sales) = Fixed cost
P/v ratio
Where P/v ratio = contribution X 100 = 40,000 X 100 = 66.67%
Sales 60,000

Contributioin = Sales – Variable cost = 60,000 – 20,000 = 40,000

BEP (sales) = Fixed cost = 1,00,000 = 1,500

P/v ratio 66.67
 Exam based problem
(i) Gross Profit ratio = Gross Profit X 100 => 65,000 X 100 = 36.11%
Net Sales 1,80,000

(ii) CURRENT RATIO = CURRENT ASSETS = 55,000 = 2.75

CURRENT LIABILITIES
20,000

WHERE
CURRENT ASSETS = CASH + DEBTORS + STOCK + BILLS RECEIVABLE
= 15,000 + 20,000 + 15,000 + 5,000
= 55,000
CURRENT LIABILITIES = CREDITORS + BILLS PAYABLE
= 12,000 + 8,000
= 20,000
 Accounting Equation
• The accounting equation is considered to be the foundation of the
double-entry accounting system.

• On a company's balance sheet, it shows that a company's total assets are

equal to the sum of the company's liabilities and shareholders' equity.

• Based on this double-entry system, the accounting equation ensures that the
balance sheet remains “balanced,” and each entry made on the debit side
should have a corresponding entry (or coverage) on the credit side.

• Accounting Equation Formula and Calculation

• Assets = Liabilities + Owner’s Equity (Capital)

The balance sheet holds the basis of the accounting equation:

Accounting Equation