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Ratio

# Ratio

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11/26/2012

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Naveen Rohatgi-9867451833 SYBMS- Management accounting
MEANING
A ratio shows the relationship between two numbers.
Accounting ratio
shows the relationship betweentwo accounting figures.
Ratio analysis
is the process of computing and presenting the relationships between the items in the financial statement. It is an important tool of financial analysis, because it helpsto study the financial performance and position of a concern.
Classification of ratios based on function
1.
Liquidity Ratios:
show the relationship between the current assets and current liabilities of theconcern. Examples are Liquid ratio and Current ratio.2.
Leverage Ratios:
show the relationship between proprietor’s funds and debts used in financingthe assets of the concern. Examples are Capital gearing ratio, Debt-Equity ratio and Proprietary ratio.These are also known as
Solvency ratios.
3.
Activity Ratios
(also known as
Turnover ratios
or
Productivity ratios
) show the relationship between the sales and the assets. Examples are Stock turnover ratio, Debtors turnover ratio etc.4.
Profitability ratio show
the relationship between
Profits and sales
; for example, Operatingratio, gross profit ratio, Operating net profit ratio, Expenses ratios etc.; or
Profits and investments
; for example, Return Return on capital employed., Return on investments, Return on equity capital etc.5.
Coverage ratios
show the relationship between the profit on one hand and the claims of outsiders (dividend, interest etc.) to be paid out of such profits. Examples are Dividend payout ratio andDebt services ratio.
Profit and loss account Ratio:GROSS PROFIT RATIOMeaning
This ratio compares gross profit with net sales. It is usually expressed in the form of percentage.
FormulaGross profit = Gross Profit x 100Net SalesFunction/Purpose
Gross profit is a
profitability ratio
, which shows the relationship between profits and sales. This ratiohelps to judge (i) how efficient the concern is in managing its production, purchase, selling and inventory;(ii) how good its control is over the direct costs; (iii) how productive the concern is; and (iv) how muchamount is left to meet other expenses and earn net profit.
OPERATING RATIO
The real opportunity for success lies within the person and not in the job .
1

Naveen Rohatgi-9867451833 SYBMS- Management accounting
Meaning
Operating ratio expresses the relationship between total operating costs and net sales. It is expressed byway of percentage .
FormulaOperating Ratio = Cost of Goods Sold + Operating Expenses x 100Net SalesFunction/Purpose
Operating ratio indicates cost of operations. Its purpose is to measure and to a

scertain the efficiency of themanagement as regards operations. This ratio helps to judge (i) how efficient the concern is in controllingits costs of production, administration, selling expenses; and (iv) how much amount out of sales revenue isused up in carrying out the operations of the concern.
EXPENSES RATIOMeaning
This ratio expresses the relationship between each item of expenditure and sales. It is expressed as a percentage. Total of all Expenses ratios will be equal to operating ratio.
FormulaExpense Ratio = Expenditure x 100Net Sales
e.g.Cost of goods Sold ( Factory cost) = COGS × 100Net salesAdministrative Expenses Ratio = Administrative Expenses x 100Net SalesFinance expenses= Finance expenses *100Net salesSelling Expenses Ratio = Selling Expenses x 100 Net Sales
OPERATING PROFIT RATIOMeaning
Operating profit ratio indicates the relationship between Operating profit and the sales.
Formula
The real opportunity for success lies within the person and not in the job .
2

Naveen Rohatgi-9867451833 SYBMS- Management accounting
Operating Profit = Operating Profit x 100 =Net SalesComponentsOperating profit [OP] =
1.Gross Profit2.Less: Operating expense [OE]
Function/Purpose
Operating profit ratio is a
profitability ratio
, which shows the relations

hip between profits and sales. Itindicates profits from operations. This ratio helps to judge (i) how efficient the concern is in managingall its operations of production, purchase, inventory, administration, selling, distribution etc.; and (ii)how much amount is left to meet non-operating expenses and earn net profits.
NET PROFIT RATIOMeaning
Net profit ratio indicates the relationship between net profit and the sales. It is usuallyexpressed in the form of a percentage.
Net Profit =Net Profit x 100Net SalesBalance Sheet RatioCURRENT RATIOMeaning
This ratio compares the current assets with the current liabilities. It is expressed in the form of a pure ratioe.g. 2:1
FormulaCurrent Ratio = Current Assets=CACurrent Liabilities CLFunction/Purpose
Current ratio is a
liquidity/solvency ratio
which indicates the ability of the concern to meet its short-termliabilities. It measures the short term solvency of the concern. It is used by a creditor to judge the safelymargin available and to decide the amount and the terms of the credit. The standard ratio is 2: 1.
LIQUID RATIOMeaning
The real opportunity for success lies within the person and not in the job .
3