3.1 Concept of Ratio Analysis

CHAPTER 3
RATIO ANALYSIS
LEARNING OBJECTIVES
Aft er s t u dyin g t h is ch apt er, you will
be able t o :
l Appreciat e t h e con cept of rat io
an alys is ;
l Un ders t an d cros s -s ect ion al an d
t ime-s eries an alys es ;
l An a l ys e l i qu i d i t y, s ol ve n c y,
a ct ivit y a n d pr ofit a bilit y of a
bu s in es s en t er pr is e by u s in g
r elevan t r at ios .
In t h e pr eviou s ch a pt er you s t u died
a bou t t h e va r iou s t ools of fin a n cia l
a n a lys is a n d in t e r p r e t a t ion , viz. ,
comparat ive s t at emen t s , common -s ize
s t at emen t s an d rat io an alys is et c. Th is
ch apt er is devot ed t o t h e con cept an d
use of ratio analysis in the interpretation
of financial s t at ement s .
3 . 1 Concept of Rat io Analys is
Rat io an alys is in volves t h e met h od of
calcu lat in g an d in t er pr et in g fin an cial
r at ios in or der t o as s es s t h e s t r en gt h s
a n d we a k n e s s e s u n d e r l yi n g t h e
per for man ce of an en t er pr is e. In or der
t o c a l c u l a t e a r a t i o, a re le v a n t
relations hip betw een tw o numbers of
financial s tatements is es t ablis h ed an d
t h e r es u lt of t h e s ame is in t er pr et ed in
order to derive meaningfu l conclu sions.
Two n u mb e r s a r e n e e d e d t o
calcu lat e a rat io. One nu mber is pu t as
t h e n u mer a t or a n d t h e ot h er a s t h e
den omin at or. For example, if we wan t
t o kn ow t h e r elat ive mar ket s h ar e of a
br a n d of t oot h pa s t e (s a y X), we will
calcu late a ratio. This ratio will have the
n u mber of u n it s s old of Brand X in t h e
n u mer a t or a n d t h e t ot a l s ize of t h e
m a r k e t for t oot h p a s t e i n t h e
denominat or. Let u s as s u me t hat t hes e
n u mb e r s a r e 2 0 0 a n d 1 0 0 0
r es pect ively. So t h e r at io t u r n s ou t t o
be 20%, i.e.
100
1000
200
. It implies that the

mar ket s h ar e of Brand X is 20%.
A ver y impor t a n t a s pect of t h is
pr oces s is t h a t t h e n u mer a t or a n d
den omin at or mu s t be logically r elat ed
t o each ot h er. Ot h er wis e, t h e r at io will
RATIO ANALYSIS 107
not provide informat ion needed for decision-making. For example, in t he previou s
example, if we pu t 200 (n u mber of u n it s s old of Bran d X) in t h e n u merat or an d
2000 (n u mber of u s ers of was h in g mach in es ) in t h e den omin at or, we get a rat io
of 10%. Th ou gh it is a r at io,bu t it does n ot lead u s an ywh er e as n o mean in gfu l
con clu s ion cou ld be dr awn ou t of it . Th is is s o becau s e t h e n u mber s in t h e
nu merat or and denominat or were not logically relat ed s ince t wo members belong
t o differ en t pr odu ct cat egor ies . So, wh en ever a r at io is t o be calcu lat ed, an alys t
mu s t en s u r e t h at a logical r elat ion s h ip exis t s bet ween t h e t wo n u mber s . As a
corollary t o t his , we can des ign any nu mber of rat ios , t o analys e t he performance
of a bu siness enterprise, depending on the pu rpose at hand, so long as we observe
t h e con dit ion of logical r elat ion s h ip.
Rat io can be expr es s ed as :
i) percentage s ay, gr os s pr ofit r at io is 25% of s ales [calcu lat ed by dividin g
gros s profit (Rs . 10,000) by s ales (Rs . 40,000) an d mu lt iplyin g by 100];
ii) proportion s ay, cu r r en t r at io is 2:1 [calcu lat ed by dividin g cu r r en t as s et s
(Rs . 20,000) by cu r r en t liabilit ies (Rs .10,000)];
iii) fraction s ay, n et pr ofit is on e-t en t h of s ales [calcu lat ed by dividin g n et pr ofit
(Rs .4,000) by s ales (Rs .40,000)];
iv) times s ay, in ven t or y t u r n over r at io is 5 t imes [calcu lat ed by dividin g s ales
(Rs .40,000) by average in ven t ory (Rs .8,000)].
3 . 2 Cros s -s ect ional and Time-s eries Analys es
We began t he dis cu s s ion on rat io analys is by calcu lat ing market s har e of a brand
of t oot h pas t e, an d t h is r at io t u r n ed ou t t o be 20%. Th e pu r pos e was t o kn ow t h e
r elat ive mar ket s h ar e of t h e br an d. In or der t o in t er pr et t h e r at io on e h ave t o
an s wer a qu es t ion as : Is t h e market s h are of Bran d X h igh or low? To res pon d t o
t h is qu es t ion , we h ave t o compar e t h is r at io wit h t h at of ot h er br an ds or s ame
bran d over a period of t ime.
3 . 2 . 1 . Cros s -s ect ional Analys is
This comparison cou ld be made wit h ot her brands of t oot hpast e. We will calcu lat e
s imilar r at io for ot h er br an ds an d t h en compar e t h e s ame wit h Br an d X r at io of
20%. Th e dat a is pres en t ed h ere :
ACCOUNTANCY
108
Relat ive Market Share of different Brands of Toot hpas t e (2 0 0 2 )
Brand Y Brand Z Brand X
45% 35% 20%
On t h e bas is of t h e in for mat ion given above, on e can in fer t h at t h e mar ket
s h ar e of Br an d X is t h e lowes t on e. Th is t ype of an an alys is is called 'cr os s -
sectional analysis'. Cross-sectional analysis involves comparison with competitors
or in du s t r y aver ages at t h e s ame poin t of t ime. Th is t ype of an alys is h elps in
identifying the problems that exists. This will enable u s to enqu ire into the reasons
u nderlying the problems and which, in tu rn, will help to initiate corrective actions.
However, car e h as t o be exer cis ed r egar din g t h e s elect ion of t h e con s t it u en t s of
t h e cros s -s ect ion . Th ere mu s t be a common variable of s imilarit y. Th is s imilarit y
may be of en d pr odu ct (all pr ovidin g s imilar pr odu ct ), capit al mar ket at t r ibu t e
(all having similar equ ity price), produ ction process or raw material consu mption).
In t h e above example, bran d X is comparable t o bran d Y an d Z on ly if t h e t wo
pr odu ct s ar e of s imilar t ype an d cat er t o t h e s ame mar ket .
3 . 2 . 2 Time-s eries Analys is
Yet an ot h er way of examin in g t h e r elat ive market s h ar e of Bran d X is t o compar e
it s mar ket s h ar e over a per iod of t ime. Th is per iod h as t o be ch os en car efu lly s o
as t o permit comparis on acros s t h e period of t ime. Th is an alys is requ ires s imilar
dat a qu alit y over a per iod of t ime in or der t o der ive mean in gfu l con clu s ion s . So
car e mu s t be exer cis ed r egar din g ch an ge in accou n t in g policy, or an y s t r u ct u r al
ch an ge ar is in g ou t of ch an ge in gover n men t policy, t ech n ological developmen t
an d compet it ion , over t h e per iod of an alys is . For example, a compan y may h ave
ch an ged it s depr eciat ion policy fr om s t r aigh t lin e t o wr it t en down valu e. In t h is
case, the effect of change has to be ironed-ou t to make cross-sectional comparison
pos s ible. Similar will be t h e cas e wh en accou n t in g year is ch an ged fr om u s u al
12 mon t h s t o an ot h er per iod, s ay 15 mon t h s t h en 15 mon t h s per iod is t o be
divided s o as t o make it a per iod of 12 mon t h s , ot h er wis e dat a for t wo year s
wou ld be in comparable.
Let u s as s u me t h at t h is an alys is is bein g car r ied ou t for five year s an d t h e
mar ket s h ar e of br an d X for t h es e year s is s h own h er e :
RATIO ANALYSIS 109
Market Share of Brand X (19 97-20 02 )
1997 1998 1999 2000 2001 2002
40% 37% 30% 27% 25% 20%
Th e t able above clear ly in dicat es t h at t h e r at io is declin in g. It implies t h at
t he market s har e of Brand X is s hrinking over a period of t ime. We cou ld give t his
clear ju dgement becau se we observed t he behavior of t he same rat io over a period
of t ime. Th is t ype of an an alys is is called 'time-s eries analy s is '. Time-s er ies
analysis evalu at es t he performance of t he same bu siness ent erprise over a period
of t ime and helps in ident ifying pr oblem ar eas r equ iring corr ect ive meas u r es . We
can als o u s e bot h cr os s -s ect ion al an d t ime-s er ies an alys is t oget h er in or der t o
bet t er u n der s t an d a s it u at ion .
As dis cu s s ed earlier, depen din g on t h e pu rpos e at h an d, a rat io can be
calcu lat ed. So it becomes n eces s ar y t h at we u n der s t an d t h e expect at ion s of
different u sers of financial st at ement s. Credit ors, shareholders and management
have interest in the analysis of financial statements u sing ratio analysis. Creditors
cou ld be s h or t -t er m cr edit or s an d lon g-t er m cr edit or s . Sh or t -t er m cr edit or s ar e
primarily in t eres t ed in liqu idit y of t h e en t erpris e, as t h eir claims are t o be met in
t he short -ru n. Liqu idit y analysis means an analysis of t he abilit y of t he ent erprise
t o make paymen t s in t h e s h or t -r u n . Th e in t er es t s of t h e lon g-t er m cr edit or s ar e
differ en t . Th ey ar e mor e in t er es t ed in t h e abilit y of an en t er pr is e t o pay in t er es t
and t he principal. So s u ch credit ors are more int eres t ed in long-ru n profit abilit y,
cas h -flow gen er at in g abilit y an d t h e qu an t u m an d gr owt h of lon g-t er m debt t o
u nderstand the solvency position. The shareholders, both present and prospective,
ar e in t er es t ed in s h ar e pr ice an d in come in t h e for m of dividen d. Man agemen t is
con cern ed wit h all as pect s of workin g of an en t erpris es . Th erefore, man agemen t
may be in t er es t ed in t h e an alys is of en t ir e en t er pr is e en compas s in g liqu idit y,
s olven cy, act ivit y an d pr ofit abilit y.
3 . 3 Benchmarks
As dis cu s s ed ear lier, we calcu lat e r at ios becau s e in t h is way t h at we get a
compar is on t h at may pr ove mor e u s efu l. In or der t o commen t on t h e qu alit y of a
rat io on e h as t o make a comparis on wit h s ome s t an dard or ben ch mark. Th es e
ben ch marks cou ld be :
ACCOUNTANCY
110
i) Pas t ratio : A r at io cou ld be ben ch mar ked wit h t h e las t year s r at io. Th is
t ype of pr oces s was dis cu s s ed u n der t ime-s er ies an alys is ;
ii) Ratio of s imilar firms or indus try average : A rat io cou ld be compar ed wit h
t h e r at io of fir ms in t h e s ame in du s t r y or by in du s t r y aver age at t h e s ame
poin t of t ime. Th is t ype of pr oces s h as alr eady been dis cu s s ed u n der cr os s -
s ect ion al an alys is ; an d
iii) Rule of thumb : 'Ru le of t h u mb' h ave evolved over a per iod of t ime. For
example, r u le of t h u mb for cu r r en t r at io is 2:1, mean in g t h er eby cu r r en t
as s et s s h ou ld be t wo t imes t h e cu r r en t liabilit ies . However, t h es e r u le of
t h u mb ar e t o be cau t iou s ly u s ed.
3 . 4 Types of Rat io
Fin an cial r at ios can be gr ou ped in t o fou r t ypes :
(i) liqu idit y r at ios ,
(ii) s olven cy rat ios ,
(iii) act ivit y rat ios ,
(iv) pr ofit abilit y r at ios .
On ce we go ah ead wit h det ailed dis cu s s ion on differ en t r at ios wh ich fall
u n der each gr ou p, it will be r ealized t h at liqu idit y, s olven cy an d act ivit y r at ios
measu r e risks whereas pr ofit abilit y rat ios measu re r et u r n. Fu rt her, some of t hese
r at ios focu s s h or t -r u n wh ile ot h er s focu s lon g-r u n . Th e s olven cy r at ios h ave
lon g-t er m per s pect ive wh ile ot h er cat egor y r at ios ar e pr imar ily focu s s ed t o t h e
s h or t -r u n .
An impor t an t as pect of r at io an alys is is t h at it is s imilar t o per for min g ar t
endowed wit h lot of creat ivit y and imaginat ion. The choice of a set of rat ios t hou gh
con dit ion ed by t h e object ive a n d pu r pos e of a n a lys is yet t h e in t er pr et a t ion
depen ds on t h e in gen u it y of t h e fin an cial an alys t . Th ou gh we h ave cer t ain s et of
given r at ios yet t h er e is en ou gh fer t ile gr ou n d for des ign in g u n iqu e r at ios t o s u it
t h e n eeds of fin an cial an alys is keepin g in view t h e ever ch an gin g complexit ies
an d dimen s ion s of bu s in es s .
Now we dis cu s s differ en t rat ios u n der each of t h e fou r gr ou ps . We will be u s in g
t h e dat a of Pu n jab Tract ors Limit ed (PTL) wh os e an n u al accou n t s ar e lis t ed in
t h e pr eviou s ch apt er.
RATIO ANALYSIS 111
3 . 4 . 1 Liquidit y Rat ios
Th e liqu idit y mean s abilit y t o meet s h or t -t er m obligat ion s as t h ey become du e.
We h on ou r ou r obligat ion s t h r ou gh liqu id as s et s . A liqu id as s et is on e t h at can
be eas ily con ver t ed in t o cas h . If ou r liqu id as s et s ar e of poor qu alit y, mean in g
t h er eby t h at we fin d it difficu lt t o con ver t t h em in t o cas h wh en n eeded. Or if t h e
in ves t men t in liqu id as s et s is les s as compar ed t o ou r s h or t -t er m obligat ion s ,
t h en ou r abilit y t o h on ou r ou r s h or t -t er m liabilit ies will be impair ed.
Sh or t -t er m len der s ar e pr imar ily in t er es t ed in t h is t ype of an alys is . Th ey
wan t t o evalu at e t h e liqu idit y of t h e en t er pr is e wit h an in t en t ion t o as cer t ain
whet her t heir s hort -t erm credit will be s afe. Als o t he management is int eres t ed t o
kn ow wh et h er it will be able t o h on ou r it s commit men t s .
PTL h as cu rren t obligat ion s t o t u n e of Rs .18,231.40 lacs (2001) t o be paid
in an accou n t in g cycle. Will PTL be in a pos it ion t o s at is fy t h es e obligat ion s ? Th e
followin g liqu idit y r at ios h elp an s wer t h is qu es t ion .
3 . 4 . 1 . 1 Current Ra t i o
Cu r r en t r at io is t h e r elat ion s h ip bet ween cu r r en t as s et s an d cu r r en t liabilit ies .
Cu r r en t as s et s ar e as s et s h eld on a s h or t -t er m bas is . Th es e as s et s in clu de cas h
and bank balances, prepaid expenses, debtors, bills receivables, inventory (finished
goods , wor k-in -pr ogr es s an d r aw mat er ial), s h or t t er m in ves t men t in t r eas u r y
accou nts and accru ed income. Normally short-term refers to an accou nting period.
Cu r r en t liabilit ies ar e obligat ion s t h at ar e payable wit h in an accou n t in g per iod.
Cu rrent liabilit ies inclu de, credit ors, bills payable, cash credit and overdraft from
a ban k for a s h ort period an d liabilit y for expen s es , in come recorded in advan ce,
an d an y ot h er liabilit y du e for paymen t du r in g t h e cu r r en t accou n t in g per iod.
Cu r r en t r at io is calcu lat ed by dividin g cu r r en t as s et s by cu r r en t liabilit ies .
Cu rren t Rat io
s Liabilit ie Cu r r en t
As s et s Cu r r en t
ACCOUNTANCY
112
Punjab Tract ors Limit ed
Ext ract from t he Balance Sheet as at March 3 1 , 2 0 0 1
(Rs . in lacs )
Current As s ets , Loans 2001 2000
and Advances Rs . Rs . Rs . Rs .
In ven t or ies 9,687.87 11,968.50
Su ndry Debt ors 29,828.64 8,827.90
Cas h and Bank 419.64 1,839.79
Ba la n ces
Loan an d Advan ces 5,955.51 7,109.68
4 5 , 8 9 1 . 6 6 2 9 , 7 4 5 . 8 7
Les s :
Current Liabilities
and Provis ions 18,231.40 8462.47
Net Current As s et s 2 7 , 6 6 0 . 2 6 2 1 , 2 8 3 . 4 0
For PTL, t h is rat io is :
2001 2000
2. 5
18, 231. 40 Rs .
45, 891. 66 Rs .
3. 5
8, 462. 47 Rs .
29, 745. 87 Rs .

How t o in t er pr et t h is r at io? A cu r r en t r at io of 2:1 is gen er ally con s ider ed t o
be accept able. However, t h is r u le of t h e t h u mb var ies fr om in du s t r y t o in du s t r y.
High er t h e cu rren t rat io bet t er it is as it s ign ifies h igh er liqu idit y. An ot h er way of
in t er pr et at ion is t o obs er ve t h e beh aviou r of t h is r at io over a per iod of t ime. As
dis cu s s ed ear lier, it is called t ime-s er ies an alys is . We h ave cu r r en t r at ios of PTL
for t h e year 2000 an d 2001. A compar is on of t h e t wo r at ios s ign ifies t h at r at io
h as gon e down . It mean s t h at t h e liqu idit y pos it ion of PTL h as det er ior at ed over
a per iod of t ime. However, as dis cu s s ed ear lier t h at t h e r u le of t h u mb for t h is
r at io is 2:1, t h en on e can in fer t h at PTL is t r yin g t o r edu ce exces s ive in ves t men t
in cu r r en t as s et s an d br in gin g t h is r at io down .
On e can als o in t er pr et a r at io by compar in g it wit h a compet it or or in du s t r y
average. As discu ssed earlier, t his pr ocess of comparison is called cross-sect ional
an alys is . For example, t h e major compet it or of PTL h appen s t o Mah in dra an d
Mah in dra (M & M). Th e cu rren t rat io of M & M for t h e year 2001 is 1.4:1. If we
compare cu rren t rat io of PTL of 2001 wit h M & M, on e is led t o t h e con clu s ion
t h at t h e cu r r en t r at io of PTL is h igh er. It is r ou gh ly dou ble t h e M & M cu r r ent
r at io. So s t eps ar e r equ ir ed t o be t aken by PTL t o br in g it s cu r r en t r at io in lin e
RATIO ANALYSIS 113
wit h M & M, if PTL is benchmarking in liqu idit y management wit h t hat of M & M.
On e can look t o in du s t r y aver age als o for compar is on . Th e t r act or in du s t r y
cu r r en t r at io aver age was 1.4:1 in 2001. Th e fir ms in clu ded in t h e in du s t r y
gr ou p ar e: Mahindra and Mahindra Ltd., Eicher Ltd., Pu njab Tractors Ltd., Escorts
Lt d. and HMT Lt d. A comparis on wit h t his rat io als o res u lt s in s ame obs ervat ions
as given for t h e M & M ben ch mark rat io s in ce in du s t ry average an d M & M
cu rr ent rat io come ou t t o be s ame, i.e., 1.4:1. However, a t oo high cu rr ent rat io is
n ot good as exces s ive mon ey blocked in cu r r en t as s et s r edu ces pr ofit abilit y. If
t h e or gan izat ion car r ies h u ge in ven t or y, it mean s t h e or gan izat ion h as blocked
mas s ive fu n ds in in ven t or y an d t h e pr ofit abilit y ar is in g ou t of fas t er r ot at ion is
affect ed. Similar is t h e cas e wit h all ot h er cu r r en t as s et s . In s t ead of t h is , if t h e
fu n ds ar e in ves t ed in fixed as s et s , h igh er r et u r n is gen er at ed. So on e s h ou ld
keep in min d t h a t t h er e is a n in ver s e r ela t ion s h ip bet ween liqu idit y a n d
pr ofit abilit y. High er liqu idit y mean s lower pr ofit abilit y an d vice ver s a. So on e
h as t o s t rike a balan ce bet ween t h e t wo.
Th e above dis cu s s ion makes u s u n ders t an d t h at on e can in t erpret a rat io in
r elat ion t o t h e r u le of t h u mb, or obs er vat ion of t h e ph en omen on over a per iod of
t ime (t ime-s eries an alys is ), or in du s t ry average or compet it or ben ch mark (cros s -
s ect ional analys is ).
Rat io an alys is is a t ool an d like ever y t ool it h as t o be h an dled wit h car e by
t h e an alys t . Th e s oph is t icat ion in t h e u s e is depen den t u pon t h e pers on al s kills ,
experien ce an d ju dgemen t al power of t h e an alys t . Th e s u bt let ies h ave t o be born
in min d wh ile in t er pr et in g t h e r at io in lin e wit h t h e compos it ion of t h e r at io.
3 . 4 . 1 . 2 Li qui d Ra t i o
Th is r at io is als o r efer r ed t o as 'acid-t es t r at io' or 'qu ick-r at io'. Th e r at io s eeks t o
as cer t ain t h e liqu idit y pos it ion of a bu s in es s en t er pr is e. Liqu idit y implies t h e
abilit y t o con ver t cu r r en t as s et s in t o cas h . Liqu id r at io is expr es s ed as follows :
Liqu id Rat io =
s Lia bilit ie Cu r r en t
As s et s Liqu id
Th e t erm 'liqu id as s et s ' implies cu rren t as s et s min u s in ven t ory. Th e cu rren t
liabilit ies h ave alr eady been explain ed in t h e con t ext of cu r r en t r at io.
ACCOUNTANCY
114
Liqu id as s et s in clu de on ly t h os e cu r r en t as s et s wh ich ar e capable of bein g
con ver t ed in t o cas h accor din g t o t h e n eeds of t h e or gan izat ion ar is in g ou t of
paymen t s . Th er efor e, s ome as s et s s u ch as in ven t or y, pr epaid expen s es , n on -
realizable portion of receivables and non-saleable portion of marketable secu rities,
will be exclu ded fr om cu rrent as s et s t o obt ain t he valu e of liqu id as s et s . However,
in t h e abs en ce of an y in for mat ion t o t h e con t r ar y, debt or s an d mar ket able
s ecu r it ies ar e as s u med t o be r ealizable at t h eir s t at ed book valu es .
For PTL, following is t he amou nt of liqu id asset s (cu rrent asset s-invent ories).
(Rs . in lacs )
2001 2000
= Rs . 45,891.66 Rs . 9,687.87 = Rs . 29,745.87 Rs . 11,968.50
= Rs . 36,203.79 = Rs . 17,777.37
Liqu id Rat io 1. 98
18, 231. 40 Rs .
36, 203. 79 Rs .

1. 98
18, 231. 40 Rs .
36, 203. 79 Rs .

Generally, a qu ick rat io of 1:1 or more is cons idered t o be good for t he reas on
t h at it in dicat es availabilit y of fu n ds t o meet t h e liabilit ies 100%. However, t h is
r u le of t h u mb var ies fr om in du s t r y t o in du s t r y as in cas e of cu r r en t r at io an d
ot her rat ios .
In cas e of PTL t h is r at io is 1.98 for 2001. It mean s t h at t h e level of liqu idit y
of PTL is t oo h igh . As dis cu s s ed in t h e in t er pr et at ion of cu r r en t r at io, h igh er
liqu idit y mean s les s pr ofit abilit y. So PTL s h ou ld u s e s ome ben ch mar k level, or
in du s t r y aver age, t o fu r t h er it s liqu idit y pos it ion . Th e r at io h as s ligh t ly gon e
down wh en compared wit h las t year implyin g t h ereby t h at man agemen t h as
alr eady in it iat ed cor r ect ive act ion s t o main t ain liqu idit y in t h e opt imu m r an ge.
Ha vin g u n der s t ood t wo mea s u r es of liqu idit y a n d t h e ju s t ifica t ion a n d
proces s beh in d t h eir calcu lat ion , we can appreciat e t h at wh ile calcu lat in g liqu id
r at io, mor e impor t an t is t h e qu alit y of cu r r en t as s et s . If a bu s in es s en t er pr is e
h as a h igh ly liqu id block of in ven t or y bu t s low movin g debt or s , t h en we will
r edu ce debt or s (an d n ot in ven t or y) fr om t h e cu r r en t as s et s . So all t h os e cu r r en t
as s et s wh ich as per ou r ju dgemen t ar e les s liqu id ar e t o be r edu ced fr om t h e
cu r r en t as s et s . In ven t or y bein g t r adit ion ally t h e mos t liqu id as s et it h as been
r edu ced for t h e calcu lat ion of liqu id (qu ick) r at io.
Fr om t h e view poin t of man agemen t , t h e above met h od of calcu lat ion an d
in t erpret at ion is valid for t h e an alys is of balan ce s h eet , wh ich is s t at ic in n at u re,
RATIO ANALYSIS 115
as it is carried at a point in t ime. It is of not mu ch u s e t o management if t he focu s
of managerial decision-making is operat ions of t he ent erprise. At operat ions level,
liqu idit y h as t o be man aged on daily bas is an d wit h in t h e per iod of cr edit made
a va ila ble by t h e s u pplier s . Th er efor e, t h e ca s h gen er a t in g pot en t ia l of t h e
ent erprise has t o be mat ched wit h t he obligat ions t hat are du e for payment wit hin
t h e paymen t cycle.
3 . 4 . 2 Solvency Rat ios
Th e t er m s olven cy implies t h e abilit y of t h e en t er pr is e t o meet it s obligat ion s on
t h e du e dat e. Some paymen t s h ave s h or t -t er m mat u r it y an d s ome h ave lon g-
term matu rity. The firm has to plan for both short-term and long-term obligations.
We h ave an alyzed s h or t -t er m liqu idit y of a bu s in es s en t er pr is e in t h e pr eviou s
s ect ion . Now we ext en d an an alys is t o lon g-t er m liqu idit y. Lon g-t er m liqu idit y
mean s abilit y t o meet lon g-t er m commit men t s or obligat ion . Lon g-t er m len der s
ar e pr imar ily in t er es t ed in t h is t ype of an alys is .
A lon g-t er m len der of fu n ds is bas ically in t er es t ed in t wo t h in gs . Th e s afet y
of pr in cipal wh ich is t o be given by way of a loan , an d r egu lar s er vicin g of t h e
loan, in the form of payment of interest commitments and repayment of installment
of loan . For example, a loan is ext en ded for Rs . 1 cr or e for 5 year per iod wit h
10% in t er es t t o be paid an n u ally. On e wou ld like t o be s u r e t h at t h e pr in cipal
amou n t of Rs .1 crore is s afe for t h e du rat ion of loan an d t h e len der will regu larly
get Rs .10 lacs as in t er es t ever y year.
To capt u re t hes e t wo as pect s of long-t erm liqu idit y t wo rat ios are calcu lat ed,
debt t o equ it y rat io an d in t eres t coverage rat io. In t eres t coverage rat io deals wit h
t h e abilit y of t h e en t er pr is e t o h on ou r it s in t er es t paymen t ou t of t h e cas h
generat ed by it . It is expres s ed as nu mber of t imes t he operat ing net cas h inflows
ar e t o t h e in t er es t paymen t s . In ot h er wor ds , in t er es t cover age r at io = n et cas h
in flows fr om oper at ion s , in t er es t ch ar ges . Compu t at ion of n et cas h in flows fr om
oper at ion s will be dis cu s s ed in t h e ch apt er on cas h flow s t at emen t .
3 . 4 . 2 . 1 Debt -equi t y Ra t i o
Debt -equ it y r a t io r efer s t o t h e r ela t ion s h ip of t h e lon g-t er m debt a n d t h e equ it y
of t h e en t erpris e. Th e degree of in debt edn es s of an en t erpris e is capt u red by t h is
r at io. Lon g-t er m len der wan t s t o kn ow abou t t h e s t at u s of ou t s ider s lon g- t er m
fu n d s b ein g u s ed b y a b u s in es s en t er p r is e vis -a-vis own er s fu n d s . By
es t ablis h in g t h is r elat ion s h ip on e will come t o kn ow t h at at a poin t of t ime h ow
ACCOUNTANCY
116
mu ch is t h e s t ake of own er s as compar ed t o t h os e wh o h ave given lon g- t er m
loans.
Debt s ar e lon g-t er m liabilit ies h avin g mat u r it y aft er on e year. It in clu des
deben t u r e, lon g-t er m loan s fr om ban ks an d fin an cial in s t it u t ion s an d pu blic
depos it s . Equ it y (als o called s h ar eh older s fu n ds ) in clu des equ it y s h ar e capit al,
pr efer en ce s h ar e capit al, gen er al r es er ves , capit al r es er ves , s ecu r it ies pr emiu m
accou n t balan ce an d all ot h er r es er ves an d s u r plu s available for equ it y s h ar e
holders. For the compu tation of equ ity, miscellaneou s expenses and debit balance
of pr ofit an d los s accou n t , if an y, ar e t o be dedu ct ed.
Debt -Equ it y Rat io is expres s ed as
Equ it y
Debt
(Rs . in lacs )
Shareholders Funds 2001 2000
Ca pit a l 6,075.57 2,025.19
Res erves an d Su rplu s 37,356.31 4 3 , 4 3 1 . 6 8 35,176.32 3 7 , 2 0 1 . 5 1
Loan Funds
Secu red Loan 4.58
Uns ecu red Loans 1,310.00 1,314.58 1,275.32
4 4 , 7 4 6 . 4 6 3 8 , 4 7 6 . 8 3
2001 2000
Equ it y
Debt
0.030
43431.88
1314.58
0. 034
37201. 51
1275. 32
As alr eady dis cu s s ed, t h is r at io meas u r es t h e degr ee of in debt edn es s of a

bu s ines s ent erpris e. So it gives an idea t o a long-t erm lender regarding t he s afet y
of t h e prin cipal. If t h is rat io is h igh , t h en ris k is more in ext en din g a loan . Ru le of
t he t hu mb for t his rat io is 2 : 1. It means debt cou ld be t wice t he equ it y. However,
t h is r at io, like ot h er r at ios , var ies fr om in du s t r y t o in du s t r y. In du s t r ies wh ich
have inh erent s t abilit y of earnin gs like oil companies , have debt -equ it y s t andard
far h igh er t h an 2:1 In du s t r ies like h eavy equ ipmen t an d mach in er y man u fac-
t u r in g, wh os e ear n in gs an d cas h flows ar e les s s t able, t h is r at io h as t o be low.
PTL's debt -equ it y rat io is t oo low an d it h as remain ed s ame wh en compared
RATIO ANALYSIS 117
wit h 2000. It mean s t h at PTL h as mas s ive lon g-t er m debt r ais in g capacit y if it
ever plan s t o expan d it s oper at ion s in fu t u r e. PTL man agemen t h as a ver y
con s er vat ive appr oach t o fin an cin g as it fin an ces it s gr owt h pr imar ily fr om t h e
s ou r ces wh ich ar e r elat ed t o t h e own er s .
An ot h er way of lookin g at t h is r at io is fr om t h e per s pect ive of own er s . In
gen er a l, gr ea t er t h e u s e of debt in r ela t ion t o equ it y, t h e gr ea t er it s fin a n cia l
leverage. Financial leverage resu lt s from t he u se of fixed charge bearing secu rit ies
like deben t u r es . It h as a bear in g on own er s ' r et u r n an d r is k. An in cr eas e in
fin a n cia l lever a ge r es u lt s in h igh er pot en t ia l r et u r n a n d gr ea t er r is k.
Fr om t h is per s pect ive, PTL is n ot r eapin g t h e ben efit s of fin an cial lever age
for own er s as it s fin an cial lever age is qu it e low. PTL can magn ify t h e own er s '
ear n in gs by in cr eas in g debt -equ it y r at io.
3 . 4 . 2 . 2 Tot a l As s et s t o Debt Ra t i o
Th is r at io at t empt s t o meas u r e t h e pr opor t ion of t ot al as s et s fu n ded by lon g-
t er m debt . Th e lower t h e r at io, t h e r ole of loan ed fu n ds in fin an cin g t h e as s et s
en gaged in pr ofit gen er at in g act ivit ies of t h e or gan izat ion .
Th e rat io is calcu lat ed as : =
Debt
As s et s Tot a l
ACCOUNTANCY
118
(Rs . in lacs )
2 0 0 1 2 0 0 0
SOURCES OF FUNDS
Sh areh olders ' Fu n ds :
Ca pit a l 6,075.57 2,025.19
Res erves an d Su rplu s 37,356.31 43,431.88 35,176.32 37,201.51
Loan Fu n ds :
Secu red Loan s 4.58 -
Uns ecu red Loans 1,310.00 1,314.58 1,275.32
Tot al 4 4 , 7 4 6 . 4 6 3 8 , 4 7 6 . 8 3
APPLICATION OF FUNDS
Fixed As s et s :
Gros s Block 26,214.84 24,413.58
Les s : Depreciat ion 10,726.89 9,054.04
Net Block 15,487.95 15,359.54
Capit al Work-in -Pr ogr ess 758.26 664.59
/ Advan ce an d Con s t ru ct ion
Capit al Spares 66.53 16,312.74 84.38 16,108.51
In ves t men t s 773.46 1,084.92
Cu rren t As s et s ,
Loan s an d Advan ces :
In ven t or ies 9,687.87 11,968.50
Su ndry Debt ors 29,828.64 8,827.90
Cas h an d Ban k Balan ces 419.64 1,839.79
45,891.66 29,745.87
Tot al As s et s 6 2 , 9 7 7 . 8 6 4 6 , 9 3 9 . 3 0
Les s : Cu rren t Liabilit ies an d 18,231.40 8,462.47
Pr ovis ion s 44,746.46 38,476.83
RATIO ANALYSIS 119
Th e rat io for PTL h as been calcu lat ed below :
Rs . in lacs
2001 2000

47. 9
1, 314. 58 Rs .
62, 977. 86 Rs .

36. 8
1, 275. 32 Rs .
46, 939. 30 Rs .

The behaviou r of t his rat io s ignifies t hat t he role of ou t s iders ' fu nd in financing of
t h e t ot al as s et bas e of PTL is goin g down . On e can calcu lat e t h e per cen t age of
t ot al as s et s fu n ded by lon g-t er m len der s als o. Th es e per cen t ages for PTL will be
:
Rs . in lacs
2001 2000
2.1% 100
62, 977. 86 Rs .
1, 314. 58 Rs .

2.7% 100
46, 939. 30 Rs .
1, 275. 32 Rs .

Th is als o rein forces t h e con clu s ion drawn earlier t h at in 2001 t ot al as s et s of PTL
wer e fu n ded t o t h e t u n e of 2.1% on ly by t h e lon g-t er m len der s as compar ed t o
2.7% in 2000.
3 . 4 . 2 . 3 Prop ri et a ry Ra t i o
Th e pr opr iet ar y r at io is a var ian t of debt -equ it y r at io. It capt u r es r elat ion s h ip
bet ween equ it y an d t ot al as s et s . It at t empt s t o in dicat e t h e par t of t ot al as s et s
fu n ded t h r ou gh equ it y. Th e followin g is t h e for mu la:
Propriet ary Rat io =
As s et s Tot a l
Equ it y
Calculat ion of t his rat io for PTL
(Rs . in lacs )
2001 2000
69% or 0. 69
62, 977. 86 Rs .
43, 431. 88 Rs .

79% or 0. 79
46, 939. 30 Rs .
37, 201. 51 Rs .
Tot al as s et s block of PTL is fu n ded t o t h e t u n e of 69% by equ it y. Th is

per cen t a ge s t ood a t 79% in 2000. It mea n s t h a t du r in g on e yea r 34. 17%
ACCOUNTANCY
120
,
_
100
4693.30
46939.30 62977.86
gr owt h in t ot al as s et s h as been fu n ded by equ it y t o
t h e t u n e of on ly 16.75%
1
]
1
100
37201. 51
37201. 51 43431. 88
on ly. Res t of t h e gr owt h h as
been fu n ded primarily by cu rren t liabilit ies wh ich h ave grown over t h e period by
115.44%.
1
]
1
100
8462.47
8462.47 18231.40
. Th e s h ar e of lon g-t er m debt in t h e fu n din g
of t ot al asset s is meager. This is clear fr om t he previou s rat io (Tot al asset s t o Debt
r at io) als o.
3 . 4 . 3 Act ivit y Rat ios
Th es e r at ios h elp in commen t in g on t h e efficien cy of t h e fir m in man agin g it s
assets. The speed with which assets are converted into sales is captu red by activity
r at ios . Th e act ivit y of an y bu s in es s en t er pr is e is r eflect ed by t h e volu me of s ales
it is able t o generat e. All asset s are u sed by t he bu siness in t he qu est of generat ing
sales. So, one can comment on t he efficiency of different asset s in relat ion t o sales
gen er at ed du r in g a defin ed per iod. Let u s t ake a s imple example in or der t o
explain t h is .
Co. A Co. B
(Rs .) (Rs .)
Fixed As s et s 1,000 2,000
Sa les 10,000 18,000
On t h e bas is of t h es e figu r es , on e can opin e t h at Co. A is r elat ively efficien t
becau s e for ever y Re.1 in ves t men t in fixed as s et s it is able t o gen er at e s ale of
Rs .10 as compar ed t o Rs .9 in cas e of co.B. Th is leads on e t o in fer t h at fas t er t h e
rot at ion , great er is t h e efficien cy. Followin g are s elect act ivit y rat ios dis cu s s ed in
t his s ect ion.
3 . 4 . 3 . 1 Invent ory Tur nover Ra t i o
In ven t or y is an elemen t of cu r r en t as s et s . In ven t or y is n eeded for s moot h flow of
pr odu ct ion an d s ales . In ven t or y is of t h r ee t ypes , i.e., r aw mat er ial, wor k-in -
pr ogr es s an d fin is h ed goods . Raw mat er ial an d wor k-in -pr ogr es s in ven t or y is
main t ain ed for t h e u n in t er r u pt ed flow of pr odu ct ion . Fin is h ed goods in ven t or y
RATIO ANALYSIS 121
is kept for meeting the demands of cu stomers. Du e to u ncertain natu re of demand
flu ct u a t ion s a s a ls o t h e likelih ood of cr eepin g of logis t ics bot t len ecks for
u n for es een r eas on s . We u s u ally main t ain fin is h ed goods in ven t or y. In ven t or y
t u r n over r at io meas u r es t h e efficien cy wit h wh ich in ven t or y h as been con ver t ed
in t o s ales . Th e r at io cou ld be pu t like t h is :
In ven t ory Tu rn over Rat io =

In ven t or y Aver a ge
Sa les
In ven t or y is gen er ally valu ed at cos t . In or der t o h ave a logical r elat ion s h ip
wit h t he denominat or, t he nu merat or shou ld also be a cost variable. Sales inclu de
an elemen t of profit . By elimin at in g t h is elemen t , cos t of goods s old is calcu lat ed
an d t h en in ven t or y t u r n over r at io will be :
Sold Goods of Cos t
Average In ven t ory =
2
St ock Clos in g St ock Open in g +
Th e figu r e of cos t of goods s old is n ot s epar at ely available in t h e pu blis h ed
accou n t s of In dian compan ies . Th e ext er n al an alys t s do n ot h ave an acces s t o
cost of goods sold data. So, they u se sales in the nu merator. However, management
s h ou ld u s e cos t of goods s old dat a in or der t o calcu lat e t h is r at io. Fu r t h er, t h e
n u mer at or s h ou ld be n et of excis e du t y. So, s ales ar e always t o be u s ed n et of
excis e du t y wh ile calcu lat in g differ en t r at ios . However, if t h es e balan ces ar e n ot
available, on e can u s e t h e en d-of-year balan ce als o.
Ext ract from t he Balance Sheet and Profit and Los s Account
For t he year ended March 3 1 , 2 0 0 1
(Rs . in lacs )
2001 2000
Reven u e from operat ion s 1,11,946.37 1,17,020.86
Excis e Du t y 15,499.10 15,336.46
Revenue from operat ions 9 6 , 4 4 7 . 2 7 1 , 0 1 , 6 8 4 . 4 0
(Net of excis e dut y)
Inve nt orie s 9 , 6 8 7 . 8 7 1 1 , 9 6 8 . 5 0
ACCOUNTANCY
122
In ven t ory t u rn over rat io of PTL for t h e year 2001 h as been calcu lat ed below.
Rat io for 2000 can n ot be calcu lat ed as we n eed t o h ave t h e clos in g valu e of
in ven t ory for 1999 (This amount is not available in this annual report).
2
In ven t or y Clos in g In ven t or y Open in g
Du t y) Excis e of Sales (Net
+
=
2
9, 687. 87 11, 968. 50
96, 447. 27 Rs .
+

=
2
9,687.87 11,968.50
96,447.27 Rs .
+

= 8.9
Th is r at io of 8.9 s ign ifies t h at in ven t or y of PTL is get t in g r ot at ed over 8.9
t imes in a year. As we do n ot h ave s u fficien t dat a t o calcu lat e t h is rat io of PTL for
ear lier year s , s o t ime-s er ies an alys is can n ot be car r ied ou t . However, goin g by
t h e bas ic n at u r e of t h is r at io, h igh er t h e r at io, bet t er it is . If t h is r at io impr oves
an d r each es t h e level of 18 over t ime, t h en it implies t h at wit h t h e s ame level of
in ven t or y. PTL cou ld gen er at e dou ble t h e exis t in g level of s ales or by r edu cin g
t he inves t ment in invent ory t o a level which commens u rat e t o change in t he level
of s ales an d t h is is good for t h e or gan izat ion . Th er efor e, h igh er t h e r at io, t h e
bet t er it is . Th is is s u bject t o on e con dit ion t h at t h e in ven t or y t u r n over r at io
s h ou ld n ot t u rn s o h igh t h at it res u lt s in t o a s it u at ion of s t ock ou t . It mean s t h at
t h e in ven t or y bein g car r ied is s o les s t h at we migh t h ave t o r efu s e t h e s u pply of
goods t o t h e cu s t omer, i.e r edu ct ion in t h e level of in ven t or y wit h ou t s acr ificin g
t h e s moot h flow of goods t o cu s t omer s . Ca r r yin g h igh in ven t or y, cos t s t h e
or gan izat ion an d r edu ces it s pr ofit s . On t h e ot h er h an d, car r yin g in s u fficien t
in ven t or y s aves t h e cos t s an d cr eat es oppor t u n it y cos t for los t s ales becau s e of
s t ock ou t .
In ven t or y t u r n over r at io can als o be con ver t ed in t o n u mber of days , in t h e
followin g man n er.
Average Age of In ven t ory =
Rat io Tu r n over In ven t or y
yea r a in Da ys
=
41da ys =
8.8
365
RATIO ANALYSIS 123
In t h is cas e in ven t ory age of 41 days implies workin g capt ial in ves t emen t for
t h at per iod.
So, on an aver age, t h e mon ey blocked in in ven t or y get s con ver t ed in t o s ales
in 41 days . If t h e in ven t or y t u r n over r at io goes u p, t h e aver age age of in ven t or y
will go down an d vice vers a.
3 . 4 . 4 . 2 Debt ors Tur nover Ra t i o
Debt or s t u r n over r a t io mea s u r es t h e efficien cy wit h wh ich t h e debt or s a r e
con ver t ed in t o cas h . Th is r at io in dicat es bot h t h e qu alit y of debt or s an d t h e
collect ion effor t s of t h e bu s in es s en t er pr is e. Th is r at io is calcu lat ed as follows :
Debt ors Tu rn over Rat io =
Debt or s Aver a ge
Sa les

Average Debt ors =
2
Debt or s Clos in g Debt or s Open in g +
Th e n u mer at or of t h is r at io s h ou ld pr efer ably be cr edit s ales . Th is is s o
becau s e t he denominat or is logically relat ed t o credit s ales as it aris es from credit
sales only. Cash sales do not generate debtors. However, as the infor mation related
t o cr edit s ales is n ot s epar at ely available in cor por at e accou n t s , s o t ot al s ales
cou ld be t aken in t h e n u merat or. Average debt ors ar e calcu lat ed by dividin g t h e
s u m of begin n in g-of-year an d en d-of-year balan ce of debt or s by 2.
Punjab Trac t ors Limit e d
Ext rac t from t he Balanc e She e t and Profit and Los s Ac c ount
for t he ye ar e nde d Marc h 3 1 , 2 0 0 1
(Rs . in lacs )
2001 2000
Excis e Du t y 15,499.10 15,336.46
Revenue from operat ions (Net of excis e dut y) 9 6 , 4 4 7 . 2 7 1 , 0 1 , 6 8 4 . 4 0
Sundry Debt ors 2 9 , 8 2 8 . 6 8 8 , 8 2 7 . 9 0
Th e calcu lat ion of t h is r at io for PTL for t h e year 2001 is as follows :
ACCOUNTANCY
124
Debt ors Tu rn over Rat io
2
Debt or s Clos in g Debt or s Open in g
Sales
+
2
8,827.90 Rs . 29,828.64 Rs .
96,447.27 Rs .

+
5. 0
19, 328. 27 Rs .
96, 447. 27 Rs .

It mean s t h at debt ors of PTL are get t in g t u rn ed over on an average 5.0 t imes
in a year. As dis cu s s ed in 3.4.3.1, h igh er a t u r n over rat io, bet t er it is . However, a
t oo h igh debt or 's t u r n over r at io gen er ally mean s t igh t cr edit policy an d h en ce
den ial of oppor t u n it y t o in cr eas e s ales by offer in g liber al cr edit facilit y t o t h e
cu s t omer s .Con ver s ally t h e n at u r e of pr odu ct an d in du s t in g cu s t omer s may
war r an t ee n o cr edit , or ver y limit ed cr edit .
Th is r at io can als o be con ver t ed in t o t h e n u mber of days it t akes t o get cas h
collect ed fr om t h e debt or s in t h e followin g man n er :
Average Collect ion Period =
Rat io Tu r n over Debt or s
yea r a in Da ys
days 73
5.0
365

It mean s t h at t h e debt ors of PTL n ormally t ake 73 days t o get con vert ed in t o
cas h . A bet t er in s igh t in t o t h e qu alit y of t h is r at io cou ld be h ad by obs er vin g t h e
behaviou r of t his rat io over a period of t ime and als o by comparing t his rat io wit h
t h e bes t compan y in t h e in du s t r y or wit h in du s t r y-aver age.
3 . 4 . 3 . 3 Pa y a bl e Tur nover Ra t i o
Th is r at io r eflect s t h e efficien cy in makin g paymen t t o t h e cr edit or s . Pr u den ce
deman ds t h at on e s h ou ld n ot make paymen t t o cr edit or s at a pace wh ich is
faster than the pace of receiving payments from debtors. So, normally we compare
t h is rat io wit h debt ors t u rn over rat io t o obs erve ou r pace of dis ch argin g payable,
apar t fr om obs er vin g t h is r at io over a per iod of t ime an d in r elat ion t o ou r
compet it ors .
RATIO ANALYSIS 125
Payable Tu rn over Rat io =
Cr edit or s Aver a ge
Pu r ch a s es
Average Credit ors =
2
Cr edit or s Clos in g Cr edit or s Open in g +
Th e n u mer at or of t h e r at io car r ies t h e amou n t of pu r ch as es made du r in g
t h e year an d t h e den omin at or car r ies t h e aver age cr edit or s wh ich h ave emer ged
fr om t h e n u mer at or.
for t he year ended March 31, 20 01
(Rs . in lacs )
2001 2000
Raw Mat erials & Compon en t s Pu rch as ed (Sch edu le I) 63,645.56 69,589.05
Su n dry Credit ors (Sch edu le H) 11,356.56 2,714.60
Payable Tu rn over Rat io =
2
Cr edit or s Clos in g Cr edit or s Open in g
Pu r ch as es
+
9. 05
7, 035. 58 Rs .
63, 645. 56 Rs .

Payable t u r n over r at io cou ld be con ver t ed in t o n u mber of days by dividin g
t h e days in a year by t h is r at io.
Average Paymen t Period =

Rat io Tu r n over Cr edit or s
yea r a in Da ys
days 40.3
9.05
365

PTL is makin g paymen t t o it s credit ors as on average aft er 41 days .It is t o be
n ot ed t h at an y fr act ion of day wou ld, in pr act ice, mean n ext day. Hen ce, in t h e
pr es en t car e ar it h met ical r at io of 40.3 days wou ld imply 41 days . Aver age
collect ion per iod of PTL, as calcu lat ed ear lier, is 73 days . It implies t h at PTL is
makin g paymen t s t o it s cr edit or s mor e qu ickly t h an t h e paymen t .
ACCOUNTANCY
126
Th is r at io for PTL for t wo year s is :
2 0 0 1 2 0 0 0
4. 0
27, 660. 26 Rs .
37 1, 11, 946. Rs .
5. 5
21, 283. 40 Rs .
6 1, 17, 020. 8 Rs .

The ratio of two years leads one to the conclu sion that the tu rnover of working
capit al h as gon e down in 2001. PTL cou ld gen erat e les s er s ales reven u e in 2001
wit h t h e s ame amou n t of in ves t men t made in workin g capit al as compared t o
2000. Th is requ ires at t en t ion of t h e man agemen t .
3 . 4 . 3 . 4 Work i ng Ca p i t a l Tur nover
Wor kin g capit al r efer s t o in ves t men t in cu r r en t as s et s . Th is is als o kn own as
gr os s con cept of wor kin g capit al. Th er e is an ot h er con cept of wor kin g capit al
kn own as n et workin g capit al. Net workin g capit al is t h e differ en ce bet ween cu r -
r en t as s et s an d cu r r en t liabilit ies .
Analyst s int end t o est ablish a relat ionship bet ween working capit al and sales
as t h e t wo ar e clos ely r elat ed. Th r ou gh t h is r at io we ar e at t empt in g t o s ee t h at
on e r u pee blocked by t h e or gan izat ion in n et wor kin g capit al is gen er at in g h ow
mu ch s ales . High er t h e r at io t h e bet t er it is .
Workin g Capit al Tu r n over =
Capit al Wor kin g Net
Sa les
RATIO ANALYSIS 127
(Rs . in lacs )
2001 2000
Excis e Du t y 15,499.10 15,336.46
Revenue from operat ions (Net 9 6 , 4 4 7 . 2 7
of excis e dut y) 1 , 0 1 , 6 8 4 . 4 0
Cu rren t As s et s , Loan s &
Advan ces :
In ven t or ies 9,687.87 11,968.50
Su ndry Debt ors 29,828.68 8,827.90
Cas h an d Ban k Balan ces 419.64 1,839.79
45,891.66 29,745.87
Les s : Cu rren t Liabilit ies an d 18,231.40 8,462.47
Provis ion s
Net Current As s et s 2 7 , 6 6 0 . 2 6 2 1 , 2 8 3 . 4 0
(Net Working Capit al
Th is r at io for PTL for t wo year s is :
2001 2000
3. 5
27, 660
96, 447. 27
4.8
21,283.40
0 1,01,684.4

The ratio of two years leads one to the conclu sion that the tu rnover of working
capit al h as gon e down in 2001. PTL cou ld gen erat e les s er s ales reven u e in 2001
wit h t h e s ame amou n t of in ves t men t made in workin g capit al as compared t o
2000. Th is requ ires at t en t ion of t h e man agemen t .
3 . 4 . 4 Profit abilit y Rat ios
Pr ofit is impor t an t for ever y bu s in es s en t er pr is e. It is s o becau s e wit h ou t pr ofit s
a bu s in es s will fin d it difficu lt t o at t r act capit al, an d as s u r e it s cr edit or s an d
owners r egar ding t he s afet y of t heir fu nds . Fu rt her, pr ofit act s as a t ou chs t one t o
commen t on t h e s ou n dn es s (or ot h er wis e) of t h e policies an d decis ion s of t h e
ACCOUNTANCY
128
man agemen t . Th er e exis t s very man y meas u r es of pr ofit abilit y. However, we will
deliber at e on gr os s pr ofit r at io an d oper at in g r at io on ly.
3 . 4 . 4 . 1 Gros s Profi t Ra t i o
Gr os s pr ofit is t h e differ en ce bet ween s ales an d cos t of goods s old. Gr os s pr ofit
r at io is t h e r at io of gr os s pr ofit t o s ales . Th e gr os s pr ofit r at io r epr es en t s (in
per cen t age t er ms ) t h e exces s of wh at t h e con cer n is able t o ch ar ge as s ale pr ice
over t he cos t of pu rchas ing/ manu fact u ring t he goods . This exces s is available t o
meet other operating expenses (administrative, selling and distribu tion expenses),
in t er es t on bor r owin gs an d in come t ax. Th e amou n t r emain in g aft er meet in g
t h es e expen s es r epr es en t s n et pr ofit wh ich belon gs t o t h e s h ar eh older s .
Th e gr os s pr ofit r at io r epr es en t s t h e efficien cy of t h e con cer n in r es pect of
s ellin g a n d pu r ch a s in g/ ma n u fa ct u r in g oper a t ion s a s well a s t h e ma r ket
con dit ion s in wh ich it is oper at in g. Th u s , a con cer n can r ais e t h e gr os s pr ofit
rat io by redu cing t he cos t of pu rchas e of goods (in t he cas e of a t rading concern)/
t h e cos t of pu r ch as e of r aw mat er ials an d ot h er man u fact u r in g cos t s like wages
(in t h e cas e of a man u fact u rin g con cern ), or by in creas in g t h e s ale prices , or by a
combin at ion of bot h .
Gros s Profit Rat io 100
Sa les
Pr ofit Gr os s

In cas e of a trading concern
Cos t of Goods Sold = Open in g St ock + Pu rch as es + Expen s es
direct ly relat ed t o Pu rch as es * Clos in g St ock
In cas e of a manufacturing concern
Cos t of Goods Sold = Open in g St ock of Fin is h ed Goods + Cos t
of Goods Man u fact u red Clos in g St ock of
Fin is h ed Goods
It is t o be not ed t hat gros s profit rat io cannot be calcu lat ed from t he pu blicly
available from pu blished accou nt s becau se of it s high sensit ivit y compet it iveness
of t h e fir m. Hen ce, it is calcu lat ed by man agemen t for in t er n al decis ion -makin g,
s ales pricin g, et c.
In cas e of a pu blic limit ed compan ies like PTL, t h e an n u al accou n t s do n ot
pr ovide infor mat ion for Manu fact u ring Accou nt or Trading Accou nt . So, in or der
RATIO ANALYSIS 129
t o calcu lat e gr os s pr ofit , addit ion al in for mat ion is r equ ir ed t o be obt ain ed fr om
t h e books of accou n t s of PTL. In t h e ligh t of t h is , gr os s pr ofit r at io is n ot bein g
calcu lat ed for PTL. However, t o make t he concept clear, t he following dat a can be
u s ed.
R. and Bros . Rs .
Open in g St ock as on April 1, 2000 2,00,000
Pu rch as es made du rin g t h e year 15,00,000
Sales made du rin g t h e year 20,00,000
Freigh t In ward* 25,375
Wages (Loadin g/ Un loadin g Ch arges )* 2,585
Clos in g St ock as on March 31, 2001 2,25,000
Not e : Thes e are the expens es w hich are incurred in connection w hile mak ing purchas es s uch
as carriage inw ard, loading and unloading expens es , octroi etc.
Gros s Profit = Sales Cos t of Goods Sold
= Sales [Open in g St ock + Pu rch as es + Freigh t In ward
+ Wages Clos in g St ock]
= Rs . 20,00,000 [2,00,000 + 15,00,000 + 25,375 + 2,585
2,25,000]
= 20,00,000 [15,02,960]
Gros s Profit = Rs . 4,97,040
Gros s Profit Rat io =
100
Sales
Pr ofit Gr os s
=
24. 9% 100
20, 00, 000 Rs .
4, 97, 040 Rs .

Gross profit rat io (24.9%) signifies t hat ou t of Rs.100 sales revenu e, Rs.75.10
h ave been s pen t on cos t of goods s old. Th e balan ce of Rs . 24.90 is available t o
meet t h e in ciden ce of oper a t in g expen s es , viz., a dmin is t r a t ive, s ellin g a n d
dis t r ibu t ion expen s es , an d for paymen t of in t er es t ch ar ges an d in come t ax. Th e
amou nt remaining after meeting these expenses represents the earnings belonging
t o t h e own er s .
ACCOUNTANCY
130
3 . 4 . 4 . 2 Op era t i ng Ra t i o
It is t h e r at io of oper at in g expen s es t o s ales . Oper at in g expen s es in clu de cos t of
r a w ma t er ia l, fin is h ed a n d s emi-fin is h ed goods , ma n u fa ct u r in g expen s es ,
a dmin is t r a t ive, s ellin g a n d dis t r ibu t ion expen s es (in clu din g depr ecia t ion ).
Oper at in g expen s es do n ot in clu de in t er es t ch ar ges an d in come t ax. In ot h er
words , operat in g expen s es in clu de all t h os e expen s es wh ich relat e t o operat ion s
of a bu s in es s en t er pr is e bu t do n ot in clu de an y expen s es or ch ar ges r elat ed t o
fin an ce an d n on -oper at in g act ivit ies . If a man u fact u r in g or t r adin g con cer n h as
inves t ed s ome of it s fu nds ou t s ide (which wou ld be dis clos ed u nder 'inves t ment s '
in the balance sheet), any income arising therefrom is also not inclu ded in revenu e
fr om oper at ion s . Similar ly, an y cos t r elat in g t o t h e s ame, in clu din g dimin u t ion
in valu e, is n ot in clu ded in oper at in g expen s es .
Operat in g Rat io = 100
Sa les
Expen s es Oper a t in g
Ext ract from t he Profit and Los s Account
(Rs . in lacs )
2001 2000
Raw Mat erial, Fin is h ed an d Semi-fin is h ed
Produ ct s 65,126.87 69,643.81
Operat in g an d Admin is t rat ive Expen s es 13,047.32 12,508.45
(Schedule J)
Depr ecia t ion 1,691.90 1,598.17
Pr ovis ion for Dimin u t ion in Valu e of
Inves t ment s (Schedule J) 311.46 0
Excis e Du t y 15499.10 15,336.46
Revenue from operat ions
(Net of excis e duty ) 9 6 , 4 4 7 . 2 7 1 , 0 1 , 6 8 4 . 4 0
Sch edu le J (lis t ed in t h e pr eviou s ch apt er ) wh ich car r ies t h e det ails of
operat ing, adminis t rat ive and ot her expens es , makes it clear t hat all expens es in
t h e s ch edu le, except 'Pr ovis ion for Dimin u t ion in Valu e of In ves t men t s ', ar e
oper at in g expen s es . 'Pr ovis ion for Dimin u t ion in Valu e of In ves t men t s ' is n ot an
oper at in g ch ar ge. It does n ot r elat e t o oper at ion s of PTL. So, t h e amou n t t h is
fin an ce var iable, Rs .311.46 lacs , h as been dedu ct ed wh ile calcu lat in g oper at in g
RATIO ANALYSIS 131
expen s es for 2001. Hen ce, oper at in g expen s es of PTL for t h e t wo year s h appen
t o be :
Operat in g Expen s es = Cos t of Raw Mat erial, Fin is h ed Goods an d
Semi-fin is h ed Goods + operat in g, admin is t rat ive,
s ellin g an d dis t ribu t ion expen s es - Fin an ce
ch arges + Depreciat ion
2001 = 65,126.87+(10,347.32 - 311.46)+691.90
= 75,854.63
2000 = 69,643.81 + (12508.45 - 0) +1,598.17
= 83,750.43
2001 2000
Oper a t in g Ra t io =
100
96, 447. 27 Rs .
75, 854. 63 Rs .

=
100
101, 684. 40 Rs .
83, 750. 43 Rs .

= 78.6% = 82.4%
Th e operat in g rat io of PTL h as s h own a declin e in 2001. It is 78.6% in 2001.
Th is r at io s ign ifies t h at r ou gh ly 80% of s ales h ave been con s u med by cos t of
goods s old an d ot h er oper at in g expen s es . Th e r emain der (20%) is available t o
cover in t er es t ch ar ges , t axes an d ear n in gs available t o s h ar eh older s .
Th e lower t h e r at io, bet t er it is . As a h igh er oper at in g r at io will leave a s mall
amou nt of operat ing income t o meet int erest , t ax and dividends. This rat io shou ld
be s t u died over a per iod of t ime in or der t o h ave a bet t er u n der s t an din g of t h e
beh aviou r of t h is r at io.It is t o be n ot ed t h at in cas e of s ame en t er pr is es s u ch as
Xer ox compa n ies , compu t er h a r dwa r e compa n ies , in t er n et s er vice pr ovider
in it ially ear n t h eir r even u es by s ellin g t h e mach in es for min g par t of t h eir car e
s er vices act ivit ies bu t lat er on du e t o s at u r at ion of t h e mar ket , s u ch compan ies
des ir e lar ger compon en t s of t h eir r even u es fr om t h e an n u al main t ain con t r act s
and s ale of s pares . In s u ch a cas e, t he revenu e from s u ch act ivit ies will from part
of r even u e fr om operat ion s . However, wh ile makin g pr odu ct s egmen t an alys is
clas s ificat ion s bet ween s er vice an d pr odu ct s pr ovide deeper in s igh t in t o t h e
changing charact er and focu s abou t t he operat ions of t he ent erpris e. Somet imes
the firm experiences the initial core bu siness becoming non-profitable and chance
may t ake r ecou r s e t o h ir in g of s t r at egy.
ACCOUNTANCY
132
Illus tration
a) If cu r r en t r at io is 2.5 t imes an d cu r r en t liabilit ies ar e Rs . 27,000. Calcu lat e
cu rrent as s et s .
b) Calcu lat e cu r r en t liabilit ies , if cu r r en t as s et s ar e Rs .1,05,000 an d cu r r en t
r at io is 3 t imes .
c) If cu r r en t liabilit ies ar e Rs . 35,000, cu r r en t r at io is 3.25 t imes an d liqu id
rat io is 2.75 t imes , calcu lat e t he amou nt of cu rrent as s et s , liqu id as s et s and
invent ory.
Solut i on
a ) Cu r r en t Rat io =
2.5 (Given ) =
(Given ) 27, 000 Rs .

Cu rren t As s et s = Rs . 27,000 2.5
= Rs . 67, 500
b) Cu rren t rat io =
3 (Given ) =
(Given ) 1, 05, 000 Rs .
Cu r r en t Liabilit ies =
3
1, 05, 000 Rs .
= Rs . 35, 000
c) Cu r r en t Rat io =
3.25 (Given ) =
35,000 Rs .

Cu rren t As s et s = Rs . 35,000 3.25
= Rs . 1 , 1 3 , 7 5 0
RATIO ANALYSIS 133
Liqu id Ra t io =
As s et s Liqu id
2.75 (Given ) =
35, 000 Rs .
As s et s Liqu id
Liqu id As s et s = Rs . 35,000 2.75
= Rs . 96, 250
In ven t or y = Cu rren t As s et s Liqu id As s et s
= Rs . 1,13,750 Rs .96,250
= Rs . 1 7 , 5 0 0
Illus tration 2
Calcu lat e (i) Debt -Equ it y Rat io an d (ii) Pr opr iet ar y Rat io fr om t h e followin g dat a
:
Rs .
Equ it y Sh are Capit al 75,000
Res erves an d Su rplu s 20,000
Deben t u res 40,000
Loan from ICICI 30,000
Cu r r en t Liabilit ies 15,000
Fixed As s et s 82,000
Goodwill 48,000
Cu rren t As s et s 50,000
Solut i on
i ) Debt -Equ it y Ra t io
=
Equ it y
Debt
=
Su r plu s & Res er ve Capit al Sh a r e Equ it y
ICICI fr om Loa n Deben t u r es
+
+

=
95, 000 Rs .
7, 000 Rs .

= 0. 74 t imes
ACCOUNTANCY
134
ii) Propriet ary Rat io =
As s et s Tot al
Equ it y

Tot al As s et s = Fixed As s et s + Goodwill + Cu rren t As s et s
= Rs . 82,000 + 48,000 + 50,000
= Rs.1,80,000
Propriet ary Rat io =
1, 80, 000 Rs .
95, 000 Rs .

= 0. 53 t imes
Illus tration 3
In ven t or y t u r n over r at io is 3 t imes . Sales is Rs . 75,000. Open in g balan ce of
in ven t or y is Rs . 7,000 mor e t h an t h e clos in g balan ce of in ven t or y. Calcu lat e
open in g an d clos in g balan ces of in ven t or y.
Solut i on
Sa les
3 (Given ) =
75, 000 Rs .
Average In ven t ory = 25, 000 Rs .
3
75, 000 Rs .

Tot al In ven t ory = Rs . 25,000 2 = Rs . 50,000
Let t h e In ven t ory in t h e = X
begin n in g
In ven t ory at t h e en d = X Rs . 7,000
Tot al in ven t or y = X + (X Rs . 7,000)
Rs . 50,000 = X + (X Rs . 7,000)
2X = Rs . 57,000
X = Rs . 28,500
Th erefore, In ven t ory in t h e begin n in g = Rs . 28,500
In ven t ory in t h e en d = Rs . 28,500 Rs . 7,000
= Rs . 21,500
RATIO ANALYSIS 135
Illus tration 4
Calcu lat e Workin g Capit al Tu r n over Rat io fr om t h e followin g in for mat ion .
Liabilities (Rs .)
Sh are Capit al 2,00,000
12% Debent u re 1,60,000
Res erves an d Su rplu s 40,000
Cu r r en t Liabilit ies 1,40,000
Tot al 5 , 4 0 , 0 0 0
Assets
Fixed As s et s 3,40,000
Cu rren t As s et s 2,00,000
Tot al 5 , 4 0 , 0 0 0
Net s ales du rin g t h e year are Rs . 2,70,000
Solut i on
Workin g Capit al Tu r n over Rat io =
Ca pt ia l Wor kin g
Sa les Net
Workin g Capit al = Cu rren t As s et s Cu rren t Liabilit ies
= Rs . 2,00,000 Rs . 1,40,000
= Rs . 60,000
Workin g Capit al Tu r n over Rat io =
60, 000 Rs .
2, 70, 000 Rs .
= 4. 5 t imes
Illus tration 5
Calcu lat e : (i) Payable Tu rn over Rat io
(ii) Average Paymen t Period
ACCOUNTANCY
136
2000 2001
Rs . Rs .
Annu al Pu rchas es 25,840 28,500
Open in g Credit ors 3,040 2,800
Clos in g Credit ors 2,680 4,200
Solut i on
(i) Payable Tu rn over Rat io =
Pu r ch a s es
2000 2001
2
2,680) (3,040
25,840
+
2
4,200) (2,800
28,500
+
= 9.03 = 8.14
(ii) Average Paymen t Period =
Rat io Tu r n over Pa ya bles
yea r a in Da ys

2000 2001
=
9.03
365
= days 45
8.14
365

= 40.42 days = 44.80 days
i.e. 41 days i.e. 45 days
Illus tration 6
From t h e followin g in format ion , calcu lat e
i ) Debt ors Tu rn over Rat io
ii) Average Collect ion Period
iii) Payable Tu rn over Rat io
iv) Average Paymen t Period
Given :
(Rs . )
Sa les 8,75,000
Cr edit or s 90,000
Bills Receivable 48,000
RATIO ANALYSIS 137
Bills Payable 52,000
Pu rchases 4,20,000
Debt or s 59,000
Solut i on
i ) Debt ors Tu rn over Rat io = days 45
8.14
365

=
48,000 59,000
8,75,000
+
= 8. 18 t imes
*Th is figu re h as n ot been divided by 2, in order t o calcu lat e an average, as t h e figu res of
debt ors an d bills receivables in t h e begin n in g of t h e year are n ot available. So wh en on ly
year -en d figu r es ar e available u s e t h e s ame as it is .
(ii) Average Collect ion Period =
Rat io Tu r n over Debt or s
365
=
8.18
365
= 45 days
(iii) Payable Tu rn over Rat io =
Pu r ch a s es
=
pa ya ble Bills Cr edit or s
Pu r ch a s es
+
=
52,000 90,000
4,20,000
+
=
1,42,000
4,20,000
= 3 t imes
(iv) Average Paymen t Period =
Rat io Tu r n over Pa ya bles
365

=
3
365
= 122 days
ACCOUNTANCY
138
Illus tration 7
Given t h e followin g in for mat ion
(Rs .)
Sa les 3,40,000
Cos t of goods s old 1,20,000
Sellin g expen s es 80,000
Admin is t rat ive Expen s es 40,000
Calcu lat e Gr os s Pr ofit Rat io an d Oper at in g Rat io.
Solut i on
Gros s Profit = Sales Cos t of goods s old
= Rs . 3,40,000 Rs . 1,20,000
= Rs . 2,20,000
Gros s Profit Rat io = 100
Sa les
Pr ofit Gr os s
=
100
3, 40, 000 Rs .
2, 20, 000 Rs .
= 6 4 . 7 1 %
Operat in g Expen s es = Cos t of goods s old + Sellin g Expen s es +
Admin is t rat ive Expen s es
= Rs . 1,20,000 + 80,000 + 40,000
= Rs . 2,40,000
Oper a t in g Ra t io = 100
Sa les Net
Expen s es Oper a t in g
=
100
3,20,000
2,40,000
= 75%
Illus tration 8
Th e Pr ofit an d Los s Accou n t s an d Balan ce Sh eet s of Ar n old Co. Lt d. for t wo
year s ar e given below :
RATIO ANALYSIS 139
Profit and Los s Account of Arnold Co. Lt d.
for t he years ending March 3 1 , 2 0 0 0 and 2 0 0 1
(Rs . in lacs )
2000 2001
Net Sales 3,75,000 4,20,000
Les s :Cos t of Goods Sold 1,08,500 1,13,000
Admin is t r a t ive
Expen s es 42,000 65,500
Sellin g Expen s es 47,500 1,98,000 56,500 2,35,000
Profit before In t eres t 1,77,000 1,85,000
an d Tax
Les s : In t eres t 35,000 42,000
Profit before Tax 142,000 1,43,000
Les s : Provis ion for Tax 76,000 89,000
Profit aft er Tax 66,000 54,000
Balance Sheet s of Arnold Co. Lt d.
as at March 3 1 , 2 0 0 0 and 2 0 0 1
(Rs . in lacs )
2000 2001
LIABILITIES Rs . Rs .
Ca pit a l 8,00,000 8,00,000
Res erves an d Su rplu s 3,50,000 3,00,000
Lon g-t erm Loan 8,20,000 98,000
Cr edit or s 54,000 46,000
Bills Payable 23,500 26,000
Tot al 1 3 , 0 9 , 5 0 0 1 2 , 7 0 , 0 0 0
ASSETS
Fixed As s et s (Net ) 4,62,000 5,04,000
In ves t men t s 2,42,500 1,33,000
Debt or s 72,000 64,000
In ven t or ies 2,18,000 2,84,000
Cas h an d Ban k Balan ce 3,15,000 2,85,000
Tot al 1 3 , 0 9 , 5 0 0 1 2 , 7 0 , 0 0 0
ACCOUNTANCY
140
Calcu late the following ratios for both the years and comment on the solvency
pos it ion an d an alys e t h e efficien cy of oper at ion s man agemen t of t h e fir m.
1. Debt -Equ it y Ra t io
2. Propriet ary Rat io
3. In ven t ory Tu rn over Rat io
4. Debt ors Tu rn over Rat io
5. Workin g Capit al Tu r n over Rat io
6. Tot al As s et t o Debt Rat io
Solut i on
1. Debt -Equ it y Rat io =
Su r plu s a n d Res er ves Capt ial
Debt
Equ it y
Debt
+
2000 2001
=
350,000 80,000
82,000
+
=
3,00,000 8,00,000
98,000
+
=
11,50,000
82,000
=
11,00,000
98,000
= 0. 07 t imes = 0. 09 t imes
2. Propriet ary Rat io =
As s et s Tot al
Equ it y

2000 2001
=
13,09,500
11,50,000
=
12,70,000
11,00,000
= 0. 878 or 87. 8% = 0. 866 or 86. 6%
3. In ven t ory Tu rn over Rat io =
* In ven t or y Aver a ge
Sa les
* Year -en d figu r e of in ven t ory h as been u s ed in t h e den omin at or.
2000 2001
=
2,18,000
3,75,000
=
2, 84, 000
4, 20, 000
= 1. 72 t imes = 1. 47 t imes
RATIO ANALYSIS 141
4. Debt ors Tu rn over Rat io =
* Debt or s Aver a ge
Sa les

* Year -en d figu r e of debt ors h as been u s ed in t h e den omin at or.
2000 2001
=
72, 000
3, 75, 000
=
64, 000
4, 20, 000
= 5. 21 t imes = 6. 56 t imes
5. Workin g Capit al Tu r n over Rat io =
Capt ial Wor kin g Net
Sa les

Net Workin g Capit al = [Debt ors +In ven t ories +Cas h an d Ban k
Balan ce - (Credit ors +Bill Payable)]
Net Workin g Capit al
For the y ear 2000
=
23, 500) (54, 000 3, 15, 000 2, 18, 000 72, 000
3, 75, 000
+ + +
=
5,27,500
3,75,000
= 0. 71 t imes
Net Workin g Capit al
For the y ear 2001
=
26, 000) (46, 000 2, 85, 000 2, 84, 000 64, 000
4, 20, 000
+ + +
= 0. 75 t imes
Int erpret at ion
Debt-Equ ity ratio and Proprietary ratio relate to solvency position of an enterprise.
Debt -Equ it y rat io of Ar nold Co. Lt d. is t oo low. Fu rt her, it has not changed mu ch
in 2001 as compar ed t o last year. Slight incr ease in rat io signifies a small increase
in lon g-t er m loan s . It mean s t h at t h e compan y is n ot r eapin g t h e ben efit s of
financial leverage. By increas ing t he u s e of long-t erm loans and hence increas ing
financial leverage, Arnold Co. Lt d. can at t empt t o magnify t he earnings of owners.
Pr opr iet ar y r at io makes on e u n der s t an d abou t t h e par t of t ot al as s et s fu n ded
t h r ou gh equ it y. Th e r at io s t an ds at 86.6% in 2001 mean in g t h er eby t h at t h e
t ot al as s et s of Ar n old Co. Lt d. ar e fu n ded t o t h e t u n e of 86.6% by equ it y. Th is
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142
r at io s t ood at 87.8% in 2000. Th is r at io r ein for ces t h e commen t s made ear lier
r egar din g t h e u s e of low fin an cial lever age. It mean s t h at t h e as s et s of t h is
en t er pr is e ar e pr imar ily fu n ded t h r ou gh equ it y.
Inventory tu r nover ratio, Debtors tu r nover ratio and Working capital tu r nover
r at io belon g t o 'act ivit y r at ios ' cat egor y. Th es e r at ios h elp in commen t in g on t h e
efficien cy of differ en t as s et s in r elat ion t o s ales gen er at ed. In ven t or y Tu r n over
Rat io of t h e compan y h as got redu ced t o 1.47 t imes in 2001 as compared t o
1.72 t imes in 2000. It means t hat t he efficiency wit h regard t o u s e of invent ory t o
generat e s ales has det eriorat ed over t he period. Fu rt her, Invent ory t u r nover rat io
is qu it e low. Low Invent ory t u rnover rat io, and t hat t oo det eriorat ing over a period
of t ime, shou ld be int erpret ed as a signal of fort hcoming problems. Low Invent ory
t u r n over r a t io will r es u lt in s low-movin g a n d fin a lly n on -movin g in ven t or y
r es u lt in g in per man en t blockade of fu n ds . Debt or s t u r n over r at io h as impr oved
from 5.21 t imes in 2000 t o 6.56 t imes in 2001. This is reflect ive of bet t er handling
of debtors and their faster r otation. Working capital tu r nover ratio has also slightly
improved in 2001.
On t h e wh ole, Ar n old Co. Lt d. is advis ed t o u s e mor e of lon g-t er m debt an d
als o r ot at e it s wor kin g capit al at a fas t er pace.
Summary
1. Ra t i o Ana l y s i s
Rat io Analys is is a proces s of ident ifying t he financial s t rengt hs and weaknes s es
of t h e firm by logically es t ablis h in g relat ion s h ips bet ween t h e n u mbers given
in t h e balan ce s h eet an d profit an d los s accou n t , an d in t erpret in g t h e res u lt s
t h ereof in order t o derive mean in gfu l con clu s ion s .
2. Cros s -s ect i ona l a nd Ti me-s eri es Ana l y s i s
Cr os s -s ect ion a l a n a lys is in volves compa r is on of t h e fir m's r a t ios wit h t h e
compet it ors or in du s t ry averages at t h e s ame poin t of t ime.
Time-s eries analys is evalu at es t he per for mance of t he s ame bu s ines s ent erpris e
over a period of t ime.
Bot h t h es e a n a lys is h elp in iden t ifyin g pr oblem a r ea s r equ ir in g cor r ect ive
a ct ion s .
3. Us ers of Ra t i o Ana l y s i s
Th e t h ree main part ies in t eres t ed in t h e rat io an alys is of an en t erpris e are:
credit ors , s h areh olders an d man agemen t .
RATIO ANALYSIS 143
4. Ty pes of Ra t i os
Fin an cial rat ios can be clas s ified in t o fou r import an t cat egories :
l Liquidity Ratios : Liqu idit y rat ios h elp t h e u s ers in kn owin g t h e ext en t of s h ort -
t er m debt payin g abilit y of a fir m.
l Solvency Ratios : Solven cy rat ios an alys e t h e lon g-t erm debt payin g ca pa cit y
of t h e firm.
l Activity Ratios : Act ivit y rat ios h elp in commen t in g on t h e efficien cy of t h e firm
in man agin g it as s et s . Th e s peed wit h wh ich as s et s are con vert ed in t o s ales is
capt u red by act ivit y rat ios .
l Profitability Ratios : Profit abilit y rat ios are calcu lat ed t o meas u re t h e profit abilit y
of a bu s in es s en t erpris e.
Exe rc is e s
1. Object i ve t y p e Ques t i ons
I. Multiple Choice Ques tions
(i) Rat io provide a _______ meas u re of a compan y's performan ce an d con dit ion .
A. Defin it ive
B. Gr os s
C. Rela t ive
D. Qu a lit a t ive
(ii) ______ an alys is in volves t h e compar is on of differ en t fir ms ' fin an cial r at io at
t h e s ame poin t in t ime.
A. Time-s er ies
B. Cr os s -s ect ion a l
C. Ma r gin a l
D. Qu a n t it a t ive
(iii) ______ an alys is in volves comparis on of cu rren t t o pas t performan ce a n d t h e
evalu at ion of developin g t ren ds .
A. Time-s er ies
B. Cr os s -s ect ion a l
C. Ma r gin a l
D. Qu a n t it a t ive
(iv) Th e primary con cern of credit ors wh en as s es s in g t h e s t ren gt h of a fi r m i s
t h e firm's
A. Pr ofit a bilit y
B. Leverage
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144
C. Sh or t -t er m liqu idit y
D. Sh are price
(v) Time-s eries an alys is is oft en u s ed t o
A. as s es s developin g t ren ds
B. correct errors of ju dgemen t
C. reflect performan ce relat ive t o s ome n orms
D. s t an dardize res u lt s
(vi) In rat io an alys is , a comparis on t o a s t an dard in du s t ry rat io is made t o
is olat e_____ deviat ion s from t h e n orm.
A. pos it ive
B. n egat ive
C. s t andard
D. any
(vii) An an alys is in wh ich t h e firm's rat io valu es are compared t o t h os e of a key
compet it or or grou p of compet it ors , primarily t o iden t ify areas for improvemen t
is called
A. t ime-s eries an alys is
B. benchmarking
C. combin ed an alys is
D. n on e of t h e above
(viii) Cros s -s ect ion al rat io an alys is is u s ed t o
A. correct expect ed problems in operat ion s
B. is olat e t h e cau s es of problems
C. provide con clu s ive eviden ce of t h e exis t en ce of a problem
D. reflect t h e s ympt oms of a pos s ible problem
(ix) _____ eviden ce of t h e exis t en ce of a problem or ou t s t an din g
man agemen t performan ce is provided by rat io an alys is .
A. Con clu s ive
B. In con clu s ive
C. Complet e
D. Defin it ive
(x) In t h e n ear t erm, t h e import an t rat ios t h at provide t h e in format ion crit ical t o
t h e s h ort -ru n operat ion of t h e firm are
A. liqu idit y, act ivit y, an d pr ofit abilit y
B. liqu idit y, act ivit y, an d common s t ock
C. liqu idit y, act ivit y, an d debt
D. act ivit y, debt , an d profit abilit y
RATIO ANALYSIS 145
(xi) Th e followin g grou ps of rat ios primarily meas u re ris k
A. liqu idit y, act ivit y, an d pr ofit abilit y
B. liqu idit y, act ivit y, an d common s t ock
C. liqu idit y, act ivit y, an d debt
D. act ivit y, debt , an d profit abilit y
(xii) Th e _____ rat ios are primarily meas u res of ret u rn .
A. liqu idit y
B. a ct ivit y
C. debt
D. pr ofit a bilit y
(xiii) Th e _____ of a bu s in es s firm is meas u red by it s abilit y t o s at is fy it s s h ort -t erm
obligat ion s as t h ey come du e.
A. a ct ivit y
B. liqu idit y
C. debt
(xiv) _____ r a t ios a r e a mea s u r e of t h e s peed wit h wh ich va r iou s a ccou n t s a r e
con vert ed in t o s ales or cas h .
A. Act ivit y
B. Liqu idit y
C. Debt
D. Pr ofit a bilit y
(xv) Th e _____ is u s efu l in evalu at in g credit an d collect ion policies .
A. average paymen t period
B. cu rren t rat io
C. average collect ion period
D. cu rren t as s et t u rn over
(xvi) Net workin g capit al is defin ed as
A. t ot al as s et s les s cu rren t as s et s
B. t h e exces s of cu rren t as s et s over cu rren t liabilit ies
C. cu rren t liabilit ies les s cu rren t as s et s
D. market able s ecu rit ies an d cas h
(xvii)Th e _____ meas u res t h e act ivit y of a firm's in ven t ory.
A. average collect ion period
B. in ven t ory t u rn over
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146
C. liqu id r a t io
D. cu rren t rat io
(xviii) Th e t wo bas ic meas u res of liqu idit y are
A. in ven t ory t u rn over an d cu rren t rat io
B. cu rren t rat io an d liqu id rat io
C. gros s profit margin an d operat in g rat io
D. cu rren t rat io an d average collect ion period
(xix) Th e _____ is a meas u re of liqu idit y wh ich exclu des _____, gen erally t h e leas t
liqu id as s et .
A. cu rren t rat io, accou n t s receivable
B. liqu id rat io, accou n t s receivable
C. cu rren t rat ion , in ven t ory
D. liqu id r at io, in ven t or y
(xx) Th e ____ r a t io ma y in dica t e t h e fir m is exper ien cin g s t ock ou t s a n d los t
s a les .
D. qu ick
(xxi) Th e ____ rat io may in dicat e poor collect ion procedu res or a t ax credit policy.
D. qu ick
(xxii) ABC Co. ext en ds credit t erms of 45 days t o it s cu s t omers . It s credit collect ion
wou ld be con s idered poor if it s average collect ion period was
A. 30 days
B. 36 days
C. 47 days
D. 57 days
(xxiii) _____ are es pecially int eres t ed in t he average payment period, s ince it provides
t h em wit h a s en s e of t h e bill-payin g pat t ern s of t h e firm.
A. Cu s t omer s
B. St ockh older s
C. Len ders an d s u ppliers
D. Borrowers an d bu yers
RATIO ANALYSIS 147
(xxiv) If t h e in ven t ory t u rn over is divided in t o 365, it becomes a meas u re of
A. s ales efficien cy
B. t h e average age of t h e in ven t ory
C. s ales t u rn over
D. t h e average collect ion period
(xxv) Th e _____ is u s efu l in evalu at in g credit an d collect ion policies .
B. cu rren t rat io
D. cu rren t as s et t u rn over
(xxvi) Th e t wo cat egories of rat ios t h at s h ou ld be u t ilized t o as s es s a firm's t ru e
liqu idit y are t h e
A. cu rren t an d liqu id rat ios
B. liqu idit y an d pr ofit abilit y r at ios
C. liqu idit y an d debt rat ios
D. liqu idit y an d act ivit y rat ios
(xxvii) Th e _____ rat ios provide t h e in format ion crit ical t o t h e lon g-ru n operat ion
of t h e firm
A. liqu idit y
B. a ct ivit y
C. s olven cy
(xxviii) Th e _____ in dicat es t h e percen t age of each s ales ru pee remain in g a f t e r
t h e firm h as paid for it s goods
B. n et profit margin
C. operat in g profit margin
D. gros s profit margin
E. earn in gs available t o common s h areh olders
2. Short Ans wer Ty pe Ques t i ons
(i) Wh at do you mean by Rat io An alys is ?
(ii) Dis t in gu is h bet ween cros s -s ect ion al an d t ime-s eries an alys is .
(iii) Wh o are t h e u s ers of fin an cial rat io an alys is an d explain t h e s ign ifican ce of
rat io an alys is t o t h em.
(iv) Wh at are t h e variou s t ypes of rat ios ?
(v) Wh a t a r e liqu idit y r a t ios ? Dis cu s s br iefly t h e impor t a n ce of cu r r en t a n d
liqu id r a t io.
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148
(vi) How wou ld you s t u dy t h e s olven cy pos it ion of a firm?
(vii) Wh at relat ion s h ips will be es t ablis h ed t o s t u dy
a ) In ven t ory Tu rn over
b) Debt ors Tu rn over
c) Payable Tu rn over
d) Workin g Capit al Tu r n over
(viii) Wh at are t h e import an t profit abilit y rat ios ? How are t h ey worked ou t ?
(ix) Fin an cial rat io an alys is is con du ct ed by fou r grou ps of an alys t s :
man agers , equ it y in ves t ors , lon g-t erm credit ors , an d s h ort - t erm credit ors .
Wh at is t h e primary emph as is of each of t h es e grou ps in evalu at in g rat ios ?
(x) Wh y wou ld t h e in ven t ory t u rn over rat io be more import an t wh en an alyzin g a
grocery s t ore t h an an in s u ran ce compan y?
3. Comment on t he fol l owi ng s t a t ement s wi t h rea s on t hereon:
(i) Time-s eries an alys is is t h e evalu at ion of t h e fir m's fin an cial per for man ce in
comparis on t o ot h er firm(s ) at t h e s ame poin t in t ime.
(ii) As a ru le, t h e n eces s ary in pu t s t o an effect ive fin an cial an alys is in clu de, at
min imu m t h e in come s t at emen t an d t h e s t at emen t of cas h flow.
(iii) Th e cr os s -s ect ion a l r a t io a n a lys is in volves compa r in g t h e fir m's r a t ios t o
t h os e of firms in ot h er in du s t ries at t h e s ame poin t in t ime.
(iv) Ben ch ma r kin g is a t ype of cr os s -s ect ion a l a n a lys is in wh ich t h e fir m' s
rat io valu es are compared t o t h os e of firms in ot h er in du s t ries , primarily t o
iden t ify areas for improvemen t .
(v) Th e t ime-s eries an alys is evalu at es performan ce of firms at t h e s ame poin t in
t ime u s in g fin an cial rat ios .
(vi) Th e firm's credit ors are primarily in t eres t ed in t h e s h ort -t erm liqu idit y of t h e
compan y an d it s abilit y t o make in t eres t an d prin cipal paymen t s .
(vii) Ra t io a n a lys is mer ely dir ect s t h e a n a lys t t o pot en t ia l a r ea s of con cer n ; it
does n ot provide con clu s ive eviden ce as t o t h e exis t en ce of a problem.
(viii) Net wor kin g ca pit a l is u s efu l on ly in compa r in g t h e liqu idit y of t h e s a me
firm over t ime an d s h ou ld n ot be u s ed t o compare t h e liqu idit y of differen t
firms ; t h e cu rren t rat io s h ou ld be u s ed, in s t ead, for t h at pu rpos e.
(ix) Th e liqu idit y of a bu s in es s firm is meas u red by it s abilit y t o s at is fy it s lon g-
t erm obligat ion s as t h ey come du e.
(x) Th e cu rren t rat io provides a bet t er meas u re of overall liqu idit y on ly wh en a
firm's in ven t ory can n ot eas ily be con vert ed in t o cas h . If in ven t ory is liqu id,
t h e qu ick (liqu id) rat io is a preferred meas u re of overall liqu idit y.
RATIO ANALYSIS 149
(xi) Sin ce t h e differen ces in t h e compos it ion of a firm's cu rren t as s et s an d liabilit ies
can s ign ifican t ly affect t h e firm's "t ru e" liqu idit y, it is import an t t o look beyon d
meas u res of overall liqu idit y t o as s es s t h e liqu idit y of s pecific cu rren t as s et s .
(xii) The average age of invent ory is viewed as t he average lengt h of t ime invent ory is
h eld by t h e firm or as t h e average n u mber of days ' s ales in in ven t ory.
(xiii) Th e gros s profit margin meas u res t h e percen t age of each s ales ru pee left aft er
t h e firm h as paid for it s goods an d operat in g expen s es .
Problems
4. Calcu lat e t h e followin g rat ios from t h e det ails given below:
i ) Cu r r en t Rat io
ii) Liqu id Ra t io
iii) Oper a t in g Ra t io
iv) Gros s Profit Rat io
Det ails :
Cu rren t As s et s = Rs . 70,000 Sa les = Rs .1,40,000
Net workin g capit al = Rs . 30,000 Cos t of Goods Sold = Rs . 68,000
In ven t or ies = Rs . 30,000
5. Th e cu rren t as s et s of Mon arch Compan y are Rs .29745 an d t h e cu rren t rat io is
1.5. Th e in ven t ories s t ood at Rs .8827. Calcu lat e t h e liqu id rat io an d commen t
on t h e liqu idit y pos it ion of t h e compan y.
6. From t h e followin g in format ion , calcu lat e t h e s h areh older's fu n ds .
Cu r r en t Rat io 2.5
Liqu id Ra t io 1.5
Propriet ary Rat io 0.75
Wor kin g Capit al Rs . 60,000
Res erves an d Su rplu s Rs . 40,000
Loan Fu n ds Rs . 10,000
7. Fr om t h e followin g pa r t icu la r s , det er min e t h e a mou n t of gr os s pr ofit a n d
s a les .
Average In ven t ory Rs . 95,000
In ven t ory Tu rn over Rat io 3 t imes
Gros s Profit 25% of s ales
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150
8. On t h e bas is of t h e followin g rat ios derived from t h e accou n t s of compan y,
commen t on t h e efficien cy of man agemen t of t h e compan y.
Years Inventory Payable Operating
Turnover Turnover Ratio
(Times ) (Times ) (%)
1999 9.4 5.1 83.15
2000 9 4.7 82.56
2001 7.3 4.5 81.34
2002 6.5 3.7 82.93
9. Th e followin g figu r es h a ve been t a ken fr om t h e pu blis h ed a ccou n t s of G.
As s ociat es for t h e t wo s u cces s ive years .
2001 2002
Rs . Rs .
Reven u e from Operat ion s 2,10,000 4,20,000
Gros s Profit 52,500 84,000
Commen t on t h e profit abilit y for t h e t wo years .
10. Bh at ia Compan y h ad a liqu id (qu ick) rat io of 1.4, a cu rren t rat io of 3.0, an
in ven t ory t u rn over of 6 t imes , t ot al cu rren t as s et s of Rs .810,000, an d cas h
an d market able s ecu rit ies of Rs .120,000 in 2002. Wh at are an n u al s ales ?
11. On t h e ba s is of t h e followin g in for ma t ion ca lcu la t e: (i) Gr os s Pr ofit Ra t io
(ii) Debt -Equ it y Rat io (iii) Workin g Capit al Tu r n over Rat io.
(Rs .)
Net Sales 36,50,000
Cos t of Goods Sold 23,60,000
Cu r r en t Liabilit ies 7,80,000
Loan Fu n ds 6,25,000
Cu rren t As s et s 13,29,000
Equ it y Sh are Capt ial 17,80,000
Deben t u res 840,000
12. Calcu lat e Operat in g Rat io from t h e followin g in format ion .
(Rs . )
Net Sales 5,40,000
Net Pu rchas es 3,10,000
Open in g St ock 75,000
Direct Expen s es 32,000
Clos in g St ock 50,000
Sellin g Expen s es 25,000
Dis t r ibu t ion Expen s es 15,000
RATIO ANALYSIS 151
13.
Profit and Los s Account s of D. Co. Lt d.
(Rs . in lacs )
Rs .
Net s ales 20,00,000
Les s :Cos t of Goods Sold
Open in g St ock 2,50,000
Add : Pu rch as es 13,00,000 15,50,000
Les s : Clos in g St ock 5,50,000 1 0 , 0 0 , 0 0 0
Gros s Profit 10,00,000
Les s : Operat in g Expen s es 3,70,000
Oper at in g Pr ofit 6,30,000
Les s : In t eres t 2,10,000
Profit before Tax 4,20,000
Required : Calcu lat e Operat in g Rat io an d Gros s Profit Rat io.
14. In dicat e for each of t h e followin g rat ios t h e formu la for it s calcu lat ion an d
t h e kin ds of problems , if an y, t h e bu s in es s en t erpris es is likely t o h ave if t h es e
rat ios are t oo h igh relat ive t o t h e in du s t ry average. Wh at if t h ey are t oo low
relat ive t o t h e in du s t ry? Creat e a t able s imilar t o t h e on e t h at follows an d fill
in t h e empt y blocks .
Rat io Too high Too low
Cu rren t rat io =
In ven t ory t u rn over =
Gros s profit margin =
Debt -equ it y r a t io =
15. Su preme Paper compan y's t ot al cu rren t as s et s , n et workin g capit al,
an d in ven t ory for each of t h e pas t 4 years follow :
Item 1999 2000 2001 2002
Rs . Rs . Rs . Rs .
Tot al cu rren t as s et s 1,01,700 1,31,400 1,35,000 1,62,000
Net workin g capit al 47,700 55,800 59,400 57,600
In ven t or y 36,000 41,400 41,400 43,200
a . Calcu lat e t h e cu r r en t an d liqu id (qu ick) r at ios for each year. Compar e t h e
res u lt in g t ime s eries of each meas u re of liqu idit y (i.e., n et workin g capit al, t h e
cu rren t rat io, an d t h e liqu id (qu ick) rat io.
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152
b. Commen t on t h e firm's liqu idit y over t h e 1999-2002 period.
c. If you were t old t h at Su preme Paper Compan y's in ven t ory t u rn over for each
year in t h e 1999-2002 period an d t h e in du s t ry averages were as follows , wou ld
t h is s u pport or con flict wit h you r evalu at ion in b? Wh y?
Inventory turnover 1999 2000 2001 2002
Su preme Paper 6.3 6.8 7.0 6.4
In du s t ry average 10.6 11.2 10.8 11.0
16. Ca pit a l Ma n u fa ct u r in g Co. h a s s a les of Rs .1,60,00,000 a n d a gr os s pr ofit
margin of 40% . It s en d-of-qu art er in ven t ories are as follows :
Quart e r Inve nt ory
Rs .
1. 16,00,000
2. 32,00,000
3. 48,00,000
4. 8,00,000
a . Fin d t h e average qu art erly in ven t ory an d u s e it t o calcu lat e in ven t ory
t u rn over an d t h e average age of in ven t ory.
b. As s u min g t h at t h e compan y is in an in du s t ry wit h an average in ven t ory
t u r n over of 2 . 0 , h ow wou ld you eva lu a t e t h e a ct ivit y of Ca p it a l
Man u fact u rin g Co's in ven t ory?
17. Th e n ew own ers of Nat u ral Foods Co. h ave h ired you t o h elp t h em diagn os e
an d cu re problems t h at t h e compan y h as h ad in main t ain in g en ou gh workin g
capit al. As a firs t s t ep, you per for m a liqu idit y an alys is . You t h en do an
an alys is of t h e compan y's s h ort -t er m act ivit y rat ios . You r calcu lat ion s an d
appropriat e in du s t ry n orms are lis t ed.
Natural Foods Indus try norm
Cu rren t rat io 4.5 4.0
Liqu id r at io 2.0 3.1
In ven t ory t u rn over 6.0 10.4
Average collect ion period 73 days 52 days
Average payment period 31 days 40 days
a . Wh a t r ecommen da t ion s r ela t ive t o t h e a mou n t a n d t h e h a n dlin g of
in ven t ory cou ld you make t o t h e n ew own ers ?
b. Wh a t r ecommen da t ion s r ela t ive t o a mou n t a n d h a n dlin g of a ccou n t s
receivable cou ld you make t o t h e n ew own ers ?
c. Wh a t r ecommen da t ion s r ela t ive t o a mou n t a n d h a n dlin g of a ccou n t s
payable cou ld you make t o t h e n ew own ers ?
RATIO ANALYSIS 153
d. Wh a t r es u lt s , over a ll, wou ld you h ope you r ecommen da t ion s wou ld
achieve?
18. In du s t rial Fin an ce Limit ed h as been approach ed by t wo cu s t omers for a s h ort -
t erm loan of Rs .175000. Th e followin g s u mmarized fin an cial in format ion is
available from t h e lat es t fin an cial s t at emen t s
(Figures in Rs .)
Cons olidated Stores Golden Stores
Net Sales 31,85,000 26,25,000
Gros s Profit Margin 13,37,700 10,23,750
In t eres t Expen s e 70,000 28,700
Income Tax 2,62,500 1,75,000
Profit aft er Tax 2,87,000 1,96,875
In ven t or ies 3,15,000 2,28,200
Debt or s 2,45,000 1,96,000
Ca s h 21,000 63,000
Cu r r en t Liabilit ies 6,39,100 4,06,000
Lon g-t er m Liabilit ies 5,60,000 4,55,000
Sh areh olders ' Equ it y 6,30,000 4,90,000
In du s t rial Fin an ce Lt d. in t en ds t o accept on e of t h e t wo loan requ es t s .
On t h e bas is of you r u n ders t an din g of fin an cial rat io an alys is decide t h e loan
requ es t wh ich s h ou ld be accept ed by In du s t rial Fin an ce Lt d.
19. Calcu lat e s t ock t u rn over rat io if:
a . Open in g s t ock is Rs . 58,000
b. Clos in g s t ock is Rs . 62,000
c. Sales Rs . 6,40,000
d. Gros s profit 25% on s ales
(An s . 8 t imes )
20. Calcu lat e in ven t ories at t h e en d of year if Rs . 2,00,000 is t h e cos t of s ales of a
con cern du rin g t h e year 2002-2003. If in ven t ory is 8 t imes ; in ven t ories at t h e
en d is 1.5 t imes more t h an t h at in t h e begin n in g.
(An s . in ven t ories : Rs . 30,000)
ACCOUNTANCY
154
21. A fir m n or mally h as accou n t s r eceivables equ al t o t wo mon t h s cr edit s ale.
Du rin g t h e comin g years it expect s credit s ales of Rs . 7,20,000 s pread even ly
over t h e year (12 mon t h s ). Wh at is t h e es t imat ed amou n t of accou n t receivables
at t h e en d of t h e year?
(Accou n t s receivables : Rs . 1,20,000)
22. From t h e followin g, calcu lat e t h e debit equ it y rat io :
Rs .
a . 10,000 s h ares of Rs . 10 each 1,00,000
b. Gen eral res erve 45,000
c. Accu mu lat ed profit s 30,000
d. Deben t u res 75,000
e. Accou n t s payable 40,000
f. ou t s t an din g expen s es 10,000
(Debit equ it y r at io 3:10)
23. Th e debt -equ it y r a t io of a compa n y is 1:2. Wh ich of t h e followin g wou ld
in creas e, decreas e an d n ot ch an ge it .
1. Is s u e of equ it y s h ares
2. Cas h received from accou n t s receivables
3. Redempt ion of deben t u res
4. Pu rch as ed goods on credit .
(i) Decrease
(ii) No ch an ge
(iii) Decrease
(iv) No ch an ge
24. A Compan ys Ret u rn s on In ves t men t (ROI) in 25% before t ax. Tax is paid by
t h e compan y is 60%. Th e compan y h as a loan of Rs . 50 lakh s as part of t h e
capit al employed on wh ich in t eres t is paid at 15 p.a. Wh at is t h e amou n t by
wh ich s h areh olders gain from t h ere bein g t h e loan .
(An s . Net gain t o s h areh olders : Rs . 2,00,000)
Ans we rs
1. Object i ve Ty pe Ques t i ons
(i) C
(ii) B
(iii) A
RATIO ANALYSIS 155
(iv) A
(v) A
(vi) A
(vii) B
(viii) C
(ix) A
(x) C
(xi) D
(xii) B
(xiii) B
(xiv) A
(xv) C
(xvi) A
(xvii) B
(xviii) B
(xix) D
(xx) A
(xxi) C
(xxii) C
(xxiii) C
(xxiv) B
(xxv) A
(xxvi) A
(xxvii) C
(xxviii) D
4. (i) Cu rren t Rat io 7:4
(ii) Liqu id Rat io 1:1
(iii) Operat in g Rat io 48.57%
(iv) Gros s profit Rat io 51.42%
ACCOUNTANCY
156
5. Liqu id As s et s = Rs . 20,918
Cu rren t Liabit ies = Rs . 19,830
Liqu id Rat io = 1.05:1
7. Sales Rs . 2,85,000;
Gros s Profit Rs . 71,200
11. Gros s Profit Rat io 35.3%
Debt -Equ it y Rat io .82
Workin g Capit al Tu r n over Rat io 6.64 t imes
12. Operat in g Rat io 78.7%
13. Gros s Profit Rat io 50%

3.1 Concept of Ratio Analysis

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3.1 Concept of Ratio Analysis

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CHAPTER 3

. It implies that the

As alr eady dis cu s s ed, t h is r at io meas u r es t h e degr ee of in debt edn es s of a

Tot al as s et s block of PTL is fu n ded t o t h e t u n e of 69% by equ it y. Th is

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