Unit- II - RATIO ANALYSIS

1. CURRENT RATIO: -

The current ratio is the ratio of total current assets to total current liabilities. It is calculated by

= Current Assets

Current Liabilities

Current assets: Cash in hand, cash at bank, Debtors, Bills Receivable, Prepaid expenses, Money at call
and short notice, Stock, Sundry supplies, Other receivables within one year.

Current liabilities: Creditors, Bills payable, Bank overdraft, Expenses outstanding, Interest due or
payable, Reserve for unbilled expenses, Instalment payable on long term loans, Any other amount
which is payable in short period.

Current ratio = 2 : 1 indicates sound solvency position

2. Quick Ratio:-

Also known as liquid ratio or acid test ratio or near money ratio. It is the ratio between quick or liquid
assets and quick liabilities.

Quick or liquid Assets or current assets – (stock and prepaid expenses)

Liquid or current liabilities Current liabilities – Bank overdraft

Liquid ratio = 1 : 1 indicates sound financial position

3. Absolute Liquidity Ratio (Cash position ratio)

= cash + marketable securities

Current liabilities

If 1:1, then firm has enough cash on hand to meet all current liabilities

4. Proprietary ratio:

= Shareholders fund

Total assets or Total Resources

Shareholders fund: preference share capital + equity share capital + all reserves

Total assets: Includes all assets including goodwill.

1: 3 shows the general strength of the company.

Further analysed into: a) Fixed asset to proprietors fund ratio

b) Current assets to proprietors fund ratio

a) Fixed Asset to Proprietors fund ratio: Fixed assets

Proprietors fund

If ratio greater than 1, it means that creditors obligation have been used to acquire a part of the fixed
assets.

b) Current assets to Proprietors fund ratio: Current assets

Proprietors fund

If more than 75% shows lesser dependence on external sources (i.e sound financial position)

If less than 60% shows more dependence on external sources (i.e unsound financial position)

5. Capital Gearing Ratio:

Also known as Capitalisation ratio or Leverage ratio. Used to analyse the capital structure of a
company. It shows the mix of finance employed in the business. It indicates the proportion between
owners funds and non-owners funds.

= Fixed interest bearing funds

Equity share holders funds

If ratio high, the capital gearing is high and if the ratio is low, the gearing is said to be low.

6. Debt Equity Ratio:

It shows the relationship between borrowed funds and owner capital. Also known as
External-Internal equity ratio. To ascertain soundness of the long term financial policies of the
company.

= External equities or outsiders fund or Total long term debt

Internal equities shareholders fund Shareholders fund

It shows the extent to which debt financing has been used in the business. Acceptable norm is 2:1.
Sum 1:
The following is the Balance sheet of a firm
Share capital Rs.30000 Fixed Assets Rs.16500
Creditors Rs.8000 Cash Rs.1000
Bills payable Rs.2000 Book Debts Rs.6000
Provision for tax Rs.3500 Bills receivable Rs.2000
Stock Rs.17500
Prepaid expenses Rs.500
Rs.43500 Rs.43500
Solution:
1) Current ratio:
= Current Assets = 27000 = 2:1

Current Liabilities 13500

2) Liquid ratio =
Quick or liquid Assets = 9000 = 0.67 : 1

Liquid or current liabilities 13500

Comment: Current ratio is 2 : 1 which is considered satisfactory. But quick ratio is below the
optimum ratio is 1:1, indicating that the liquidity position of the firm is not satisfactory.

Note: Current assets: Cash + Book debts + B/R + Stock + Prepaid Exp.
Current liabilities: Creditors + B/P + Provision for tax

Sum 2:
The following figures are extracted from the balance sheet of X ltd as on 31st December.
2009 2010
Stock Rs.25000 Rs.40000
Debtors Rs.10000 Rs.16000
Cash at Bank Rs.5000 Rs.4000
Creditors Rs.8000 Rs.15000
Bills Payable Rs.2000 Rs.3000
Provision for Taxes Rs.5000 Rs.7000
Bank Overdraft Rs.5000 Rs.15000
Calculate the current ratio and Acid test ratio for the two years and commend on the liquidity
position of the company.

Solution:

Current assets = Stock + Debtors + Cash at Bank

2009 = 25000 + 10000 + 5000 = Rs.40000
2010 = 40000 + 16000 + 4000 = Rs.60000

Current liabilities = Creditors + Bills payable + Provision for Taxes + Overdraft

2009 = 8000 + 2000 + 5000 + 5000 = Rs.20000
2010 = 15000 + 3000 + 7000 + 15000 = Rs.40000

Liquid liabilities =
2009 = 8000 + 2000 + 5000 = Rs.15000
2010 = 15000 + 3000 + 7000 = Rs.25000

1) Current ratio:
2009 = Current Assets = 40000 = 2:1

Current Liabilities 20000

2010 = 60000 = 1.5 : 1

40000

2) Acid Test ratio =

Quick or liquid Assets

Liquid or current liabilities

2009 = 15000 = 1:1 2010 = 20000 = 0.8 : 1

15000 25000

Comment:

In 2009, the current ratio is 2:1. It is solvency position. The liquidity position also satisfactory

In 2010, the current ratio is not satisfactory, not able to meet its immediate commitments. The
liquidity position also fallen below the standard.

Sum: 3

Equity share capital Rs.1000000

10% preference share capital Rs.500000
18% Debentures Rs.800000
Loan at 15% (long period) Rs.140000
Current liabilities Rs.300000
General Reserve Rs.800000
Find out Capital Gearing from the above particulars.

Solution:

Capital Gearing Ratio:

= 10% Pref. cap. + 18% Deb. + Long Period Loan

Equity capital + General Reserve

= 500000 + 800000 + 140000 1440000

= = 0.8
1000000 + 800000 1800000

Comment: Since the ratio is less than one, it is low geared.

Sum: 4

Calculate debt-equity ratio from the following:-

Total Assets Rs.260000
Total Debt Rs.180000
Current Liabilities Rs.20000

Solution:

Share holders fund = Total Assets – Total debts = Rs.260000 – Rs.180000 = Rs.80000
Long term debt = Total Debt – Current liabilities = Rs.180000 – 20000 = Rs. 160000

Debt Equity Ratio = Long term debt 160000

= = 2:1
Shareholders funds 80000

Sum: 5

Preference share capital Rs.300000

Equity share capital Rs.1100000
Capital Reserve Rs.500000
Profit & Loss Account Rs.200000
6% debentures Rs.500000
Sundry creditors Rs.240000
Bills Payable Rs.120000
Provision for taxation Rs.180000
Outstanding creditors Rs.160000
Calculate Debt-equity ratio.
Solution:
External Equities 1200000
Debt-equity ratio = = 0.57 0r 4: 7
Internal Equities 2100000

It means that for every four rupees worth of the creditors investment, the shareholders have
invested seven rupees. External debts are equal to 57% of shareholders fund.
Sum: 6
The following is the balance sheet of a company as on 31st March:
Liabilities Rs. Assets Rs.
Share capital 200000 Land & Building 140000
P & L Account 30000 Plant & Machinery 350000
General Reserve 40000 Stock 200000
12% Debentures 420000 Sundry Debtors 100000
Sundry Creditors 100000 Bills Receivable 10000
Bills Payable 50000 Cash at Bank 40000
840000 840000

Calculate: 1) Current ratio 2) Quick Ratio 3) Inventory to working capital 4) Debt to equity ratio
5) Proprietary ratio 6) Capital Gearing Ratio 7) Current assets to fixed assets.
1) Current ratio:
= Current Assets = 350000 = 2.33 : 1

Current Liabilities 150000

2) Liquid ratio =
Quick or liquid Assets = 150000 = 1:1

Liquid or current liabilities 150000

3) Inventory to working capital =

Inventory 200000
= = 1:1
Working capital 200000

4) Debt to equity ratio =

Long term debt 420000
= = 1.56 : 1
Shareholders fund 270000

5) Proprietary ratio
Shareholders fund 270000
= = 0.32 : 1
Total Assets 840000

6) Capital Gearing ratio

Fixed interest Bearing Securities 420000
= = 2.1 : 1
Equity share capital 200000

7) Current assets to Fixed assets ratio

Current assets 350000
= = 0.71 ; 1
Fixed assets 490000
Revenue Statement Ratios (P& L a/c ratios)

1. Gross Profit Ratio = Gross Profit Sales – Cost of goods sold

X 100 or X 100
Net sales Net sales

2. Operating Ratio = Cost of goods sold + Operating expenses

X 100
Net sales

Cost of goods sold = Opening stock + Purchases – Closing stock

Operating expenses = Adm. Expenses + Financial expenses + Selling expenses

3. Expenses Ratio:

a) Factory expenses ratio = (Factory expenses / Net sales) X100

b) Administrative expense ratio = (Administrative expense / Net sales) X 100
c) Selling expense ratio = (Selling expense / Net sales) X 100

4. Net profit ratio = Net profit

X 100
Net sales

Sum: 7

Alpha Manufacturing Co. has drawn up the following profit and loss account for the year ended 31st
March
To opening stock Rs.26000 By sales Rs.160000
To Purchases Rs.80000 By closing stock Rs.38000
To wages Rs.24000
To Manufacturing expenses Rs.16000
To Gross Profit c/d Rs.52000
Rs.198000 Rs.198000

To selling expense Rs.4000 By gross profit b/d Rs.52000

To Administrative expense Rs.22800 By Compensation for
To General Expenses Rs.1200 acquisition of land Rs.4800
To Value of furniture lost by fire Rs.800
To Net Profit Rs.28000
Rs.56800 Rs.56800

You are required to find out: a) Gross profit ratio b) Net profit ratio c) Operating ratio
d) Operating net profit to net sales ratio.

a) Gross Profit Ratio = Gross Profit 52000

X 100 = X 100 = 32.5%
Net sales 160000
b). Net profit ratio = Net profit 28000
X 100 = X 100 = 17.5%
Net sales 160000

c) Operating Ratio = Cost of goods sold + Operating expenses

X 100
Net sales

= 108000 + 28000
--------------------- X 100 = 85%
160000
Note:

cost of goods sold = opening stock + Purchase + Direct expense – Closing stock
= 26000 + 80000 + 24000 + 16000 – 38000 = 108000
Operating expenses : Selling and distribution expense + administration expenses + General
Expenses (4000 + 22800 + 1200 = 28000)

d) Operating net profit to net sales ratio:

= Operating net profit

--------------------------- X 100
Net sales

= 28800 – 4800
--------------------- X 100 = 15%
160000
Profitability ratios related to investments

1) Return on assets =

Also known as profit-to-assets ratio. It can be measured in terms of relationship between net profit
and assets.
Net profit
X 100
Total assets

2) Return on Capital Employed:

Also known as ROI (Return on Investments) or Rate of return.

Operating profit
X 100
Capital employed

3) Return on shareholders equity: (profitability from shareholders point of view)

Net profit
X 100
Shareholders Fund

Sum: 8

From the following Balance sheet and additional information, you are required to calculate:
1) Return on Total resources
2) Return on Capital Employed
3) Return on Shareholders fund
Balance sheet as on 31st Dec
Rs. Rs.
Share capital (Rs.10) 800000 Fixed Assets 1000000
Reserves 200000 Current Assets 360000
8% Debentures 200000
Creditors 160000
1360000 1360000

Net operating profit before tax is Rs.280000. Assume tax rate at 50%. Dividend declared amounts to
Rs.120000.

1) Return on Total resources =

Profit after Tax 140000
-------------------- X 100 = ---------------- X 100 = 10.29%
Total Assets 1360000
 2) Return on capital employed =
Profit before tax and interest 296000
-------------------------------------- X 100 = ------------- X 100 = 24.7%
Capital employed 1200000

3) Return on shareholders fund

Profit after tax 140000
----------------------- X 100 = ------------ X 100 = 14%
Shareholders fund 1000000

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Sum: 9
Calculate Stock Turnover Ratio.
Opening stock Rs.20000, Closing stock Rs.10000, Purchases Rs.50000, Wages Rs.3000, Carriage
inward Rs.2000, Freight outward Rs.5000.
Solution:
Cost of goods sold = Opening stock + Purchases + Wages + Carriage inwards – Closing stock
20000 + 50000 + 3000 + 2000 – 10000 = Rs.65000

Average stock = Opening stock + Closing stock 20000 + 10000

--------------------------------------- = --------------------------- = Rs.15000
2 2

Stock turnover ratio = Cost of goods sold / Average stock

= Rs.65000 / Rs.15000 = 4.3 times

Sum: 10
Calculate opening debtors and closing debtors in the following case:
Cash sales Rs.100000
Cost of goods sold Rs.300000
Gross Profit Rs.100000
Debtors Turnover ratio 3 times
Closing debtors were Rs.100000 in excess of opening debtors.

Solution:

Total sales = Cost of goods sold + Gross profit

= Rs.300000 + Rs.100000
= Rs.400000

Credit sales = Total sales – Cash sales

= Rs.400000 – Rs.100000
= Rs.300000

Debtors turnover ratio = Net credit sales

--------------------- = 3
Average debtors

= Rs.300000
-------------- = 3
Average debtors

Average debtors = Rs.300000 / 3 = Rs.100000

Opening debtors + Closing debtors

--------------------------------------------- = Rs.100000
2

Opening debtors + Closing debtors = Rs.100000 X 2 = Rs.200000

OD + CD = Rs.200000 (A)
CD – OD = Rs.100000 (B)
Adding both (A) and (B), we get:
2 CD = Rs.300000
CD = 300000 / 2 = 150000
OD = 150000 – 100000 = 50000

Therefore, Opening Debtors = Rs.50000

Closing Debtors = Rs. 150000

Sum: 11
Calculate working capital turnover ratios from the following:
Current Assets Rs.600000
Current Liabilities Rs.120000
Credit sales Rs.1200000
Cash sales Rs.260000
Sales returns Rs.20000

Solution:

Net sales = Cash sales + Credit sales – Sales return

= 260000 + 1200000 – 20000
= 1440000

Working capital = Current assets – current liabilities

= 600000 – 120000
= 480000

Working capital turnover ratio = Net sales 1440000

--------------------- = -------------- = 3 times
Working capital 480000

Sum: 12

Calculate working capital turnover ratio from the following:

Capital Employed Rs.600000
Net fixed assets Rs.400000
Cost of goods sold Rs.2000000
Gross profit Rs.400000

Solution:

Net sales = Cost of goods sold + Gross profit

= 2000000 + 400000
= 2400000

Working capital = Capital employed – Net fixed assets

= 600000 – 400000
= 200000

Working capital turnover ratio = Net sales 2400000

--------------------- = -------------- = 12 times
Working capital 200000
Sum: 13

Calculate Fixed Assets Turnover ratio from the following:

Capital Employed Rs.200000
Working capital Rs.40000
Cost of goods sold Rs.640000
Gross profits Rs.160000

Solution:

Net sales = Cost of goods sold + Gross profit

= 640000 + 160000
= 800000

Net fixed assets = Capital employed – Working capital

= 200000 – 40000
= 160000

Fixed assets turnover ratio = Net sales 800000

--------------------- = -------------- = 5 times
Net fixed assets 160000

Sum: 14

Current Ratio – 2.8

Acid Test Ratio – 1.5
Working capital = Rs.162000

Find out: 1) Current Assets 2) Current Liabilities 3) Liquid Assets 4) Stock

Solution:
Current Assets
Current ratio = -----------------------
Current Liabilities
CA
2.8 = -----
CL

Working capital = Current assets – Current liabilities

162000 = 2.8 – 1
162000 = 1.8
162000
1. Current assets = ---------- X 2.8 = Rs.252000
1.8

2. Current liabilities = 162000

 ----------- X 1 = Rs. 90000
1.8

Liquid Assets
Acid Test Ratio = --------------------------
Current Liabilities

Liquid assets
1.5 = ----------------
90000

3. Liquid Assets = 90000 X 1.5 = Rs.135000

Liquid assets = Current assets – Stock

135000 = 252000 – Stock

4. Stock = 252000 – 135000 = 117000

Sum: 15

From the following figures calculate the Creditors Turnover Ratio and the Average payment period of
accounts payable:

Credit purchase in 2010 Rs.1000000

Creditors on 1.1.2010 Rs.200000
Creditors on 31.12.2010 Rs.100000
Bills payable on 1.1.2010 Rs.40000
Bills payable on 31.12.2010 Rs.60000

Solution
Net Credit Purchase 1000000
Creditors Turnover Ratio = ---------------------------------- = -------------- = 5 times
Average Accounts Payable 200000

Months in a year 12
Average Payment period = --------------------- ---------- = --------- = 2.4 months
Creditors Turnover ratio 5

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