1.

INTRODUCTION

A ratio shows the relationship between two numbers.

Accounting ratio shows the relationship between two accounting
figures. Ratio analysis is the process of computing and presenting
the relationship between the items in the financial analysis,
because it helps to study the financial performance and position
of a concern.
As aratio are simple to calculate and easy to understand
there is a tendency to employ them profusely. While such
statistical calculationstimulate be thinking and develop
understanding there is a danger of accumulation of a mass of
data that obscures rather than clarifies to steer a careful course.
His experience and objectives of analysis help him in determine
which of the ratios are more meaningful in a given situation.

The Parties Interested:- the person interested in the analysis

of financial can be grouped under three heads.
Owners Or Investor
Creditors And
Financial Executives.
Although all these three groups are interested in the financial
conditions and operating results of an enterprises the primary
information that each seeks to obtain forms these statement is to
serve. Investors desire a primary basis for estimating earning
capacity. Creditors (trade and financial) are concerned primarily
with liquidity and ability to pay interest and redeem loan within a
specific period. Management is interested in evolving analysis
tools that will measure costs,efficiency, liquidity and profitability
with a view to making intelligent decisions.

2.

FORMS

There are three different forms in which an accounting ratio can

be expressed.
1) Pure Ratio 2) Percentage and 3) Rate

1) PURE RATIO:-A pureratio a simple division of one

number by another. The relationship between current
assets & current liabilities is expressed in this way. If the
current assets are Rs.2,00,000 and current liabilities
Rs.1,00,000, the ratio is divided by dividing Rs.2,00,000
by Rs.1,00,000. It will be expressed as 2:1.
2) PERCENTAGE:-certain accounting ratios become more
meaningful if expressed as a percentage. The relationship
between profits and sales is expressed in this way. For
example, if sales are Rs.4,00,000 and gross profits is 50%
of sales.

3) RATE:- sometimes ratios are expressed as rates i.e.

number of times over a certain period. Relationship
between stock and sales is expressed in this way. If stock
turnover rate is said to be 8 times in a year. It means
that the stock is converted into sales 8 times in 12
months.3.

CLASSIFICATION

3.1. BASED ON FINANCIAL STATEMENT

Accounting ratios express the relationship figures taken from
financial statements. Figures may be taken from Balance sheet,
Profit & Loss Account or both. One way of classification of ratios is
based upon the source from which figures are taken. This is
known as the conventional classification.
1) BALANCE SHEET RATIOS: -If ratios are based on figures of
Balance sheet, they are called Balance sheet ratio e.g. ratio
of current assets to current liabilities or ratio of Debt to
Equity. While calculating these ratios, there is no need to
refer to the Revenue statement. These ratios judge the
liquidity. Solvency and capital structure of the concern. We
are going to study the following six balance sheet ratios in
this chapter. Ratio, capital Gearing Ratio, Debt-Equity Ratio
and stock working Capital Ratio.
2) REVENUE STATEMENT RATIOS:- Ratios based on the figures
from the Revenue statement are called revenue statement
ratios. These ratios study the relationship between the
profitability and the sales of the concern. We are going to
Gross Profit Ratio and Net Operating Profit Ratio and stock
Turnover Ratio.
3) COMPOSITE RATIOS:- These ratios indicate the relationship
between two items, of which one is found in the balance
sheet and the other in the revenue statement. There are two
types of composite ratios.
a) Same composite ratios study the relationship between the

profits and the investments of the concern. E.g. Return On

Capital Employed on Proprietors Funds, Return of Equity
Capital etc.
b) other composite ratios that we going to study are debtors
Turnover, Creditors Turnover, Dividend payout and debt
service.

3.2. BASED ON FUNCTION

Accounting ratio can also be classified according to their
functions (i.e. their purpose) into Liquidity ratios, Leverage ratios,
Activity ratios, Profitability ratios and Coverage ratios.
1. Liquidity ratios show the relationship between the current
assets and current liabilities of the concern.
Examples are Liquidity ratio and current ratio.
2. Leverage ratios show the relationship between proprietors
funds and debts used in financing the assets of the concern.
Examples are capital Gearing ratio, Debt-Equity ratio and
Proprietor ratios. These are also known as Capital structure
ratios or 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 ratios show the relationship between.
a) Profits and sales; for example, Operating ratio, Gross
profit ratio, Operating net profit ratio, Expenses ratio etc. OR
b) profits and investors; for example, Return on Investments
Return on equity Capital etc.
5. Coverage ratios show the relationship between the profits on
one hand the claims of outsiders (divided, interest etc.) to be
paid out of such profits. Examples are Dividend payout ratio,
Debt service and Debt service coverage ratio.

3.3. BASED ON USER

1. Ratios for Short Term Creditors: - Current Ratio, Liquidity Ratio

and Stock Working Capital.
2. Ratios for Share Holder: - Return on Proprietors Funds, Return
on Equity Capital.
3. Ratios for Management: - Return on capital Employed, Turnover
Ratio, Operating Ratio, Expense Ratios.
4. Ratios for Long Term Creditors: - debt Equity Ratio, Return on
Capital Employed, Proprietor Ratio.

4. BALANCE SHEET RATIOS

COMPUTATION OF BALANCE SHEET RATIOS AT A GLANCE
BALANCE SHEET

I
1
2
3
4
5
6
7

ITEM
SOURCE OF FUND
Equity Share Capital
Reserve & Surplus
Equity Shareholder Funds (1+2)
Preference Share Capital
Proprietors Funds (3+4)
Borrowed Funds
Capital Employed
(5+6)

II
1
2
3

ITEM
USE OF FUND
Fixed Assets
Debtors
Bills Receivable

Other Quick Assets

Total Quick Assets

Closing Stock

7
8

Pre-payments
Current Assets

AMOUNT
FC
RS
EF
PC
PE
BF
CE
AMOUNT
FA

(2+3+4)

(5+6+7)

DR
BR
OQ
A
QA
CS
T
PP
CA

9
10

Creditors
Bills Payable

11

Other Quick Liabilities

12
13
14
15
16

Total Quick Liabilities

(9+10+11)
Bank Overdraft
Current Liabilities (12+13)
Working Capital
(8-14)
Capital Employed
(1+15)

CD
BP
OQ
L
QL
OD
CL
WC
CE

Balance Sheet
Ratio

Equity/ Formula

Para

Current Ratio

CR=CA/CL

4.1

Quick/ Liquid Ratio

QR=QA/QL

4.2

Stock Working
Capital

SWC=

4.3

Proprietors Ratio

PR=PF/TA*100
[ TA= Total
Assets=FA+CA=CE+CL
=Total of Horizontal B/sfactious Assets]

Debt-Equity Ratio

DER=BF/PF

4.5

Capital Gearing
Ratio

CGR=PC+BF/EF

4.6

4.4

4.1. CURRENT RATIO

4.1.1. Meaning: - This ratio compares the current assets with
current Liabilities. It is expressed in the form of a pure Ratio e.g.
2:1.
4.1.2. Formula
Current Ratio= Current Assets =CA/CL
4.1.3. Components
Current Assets [CA] will include:
1) Sundry Debtors (Less Provision]
2) Loose Tools
3) Income Accrued/ due
4) Bills Receivable
5) Cash and Bank Balances
6) Marketable Investors
7) Closing Stock of Raw Material, WIP, FGs, Stores and
spares.
8) Pre-Payments (i.e. Pre-paid Expenses and Advance Tax)
9) Short Term Loans and Advances given current Liabilities
[CL] will include
a) sundry Creditors
b) Bills Payable
c) Outstanding Expense
d) Unclaimed Dividends and Prosed Dividend
e) Income Received in Advance
f) Bank Overdraft
g) Short Terms Loans

4.2. QUICK / LIQUID RATIO

4.2.1. Meaning: - Liquid ratio compares quick assets with the
quick Liabilities. It is expressed in the form of a pure ratio. It is
also known as Quick ratio or Acid test ratio.
4.2.2. FORMULA
Liquid Ratio = Quick Assets/Quick Liabilities = QA/QL
4.2.3. Components
Quick Assets [QA] = current Assets Less Closing Stock Less
Pre-payments i.e.
1. Debtors
2. Loose Tools
3. Income accrued/ due
4. Bills Receivable
5. Cash & Bank Balances
6. Marketable Investments
Quick Liabilities [QL] = Current Liabilities Less Bank
Overdraft/ Cash Credit i.e.
1) Sundry Creditors
2) Bills Payable
3) Outstanding expenses
4) Unclaimed dividend & proposed dividend
5) Provision for Taxation

4.3. STOCK TO WORKING CAPITAL RATIO

4.3.1. Meaning: - This ratio shows the relationship between the

Closing Stock and the working capital. It helps to judge the
quantum of inventories in relation to the working capital of the
business. It is expressed as a percentage. It is also known as
Inventory Working Capital Ratio.
4.3.2. FORMULA
Stock to Working Capital Ratio= stock/ working capital*100=
CST/WC*100
4.3.3. Components
Stock [CST] would mean closing stock.
Working Capital [WC] = Current Assets Less = Current
Liabilities (as in Para 4.1.3)

4.4. PROPRIETORY RATIO

4.4.1. Meaning: - Proprietary ratio compares proprietors funds
with total liabilities (or total assets) it is usually expressed in the
form of percentage. It is also known as Net Worth to Total Assets
Ratio. Equity Ratio, Net Worth Ratio or Assets Backing Ratio.
4.4.2. FORMULA
Proprietary Ratio = Proprietors Funds OR Shareholder
Equity/ Total Asset
OR Total Liabilities
=PF/TA or TL*100

4.4.3. Components
Proprietors Funds [PF] will include
1. Paid up Equity Capital (EC)
2. Reserve & Surplus (R&S) including, Capital Reserves, P&L
A/c cr.
Less:- Accumulated Losses (i.e. P&L A/c Dr. balance)
Less: - fictitious Assets Like Miscellaneous Expenditure not
Written Off.
3. Paid Up Preference Capital (PC)
Thus, PF=EC +RS+PC or EF+PC
Total Assets [TA] (Fixed Assets +Investments + current
Assets)
= Total Liabilities [TL] (Own Funds + Loans+ Current
Liabilities)
= Total of the (Horizontal) Balance Sheet excluding
Fictitious Assets &
Accumulated Losses (if any = Capital Employed
+current Liabilities)

4.5. DEBT EQUITY RATIO

Meaning: - this ratio compares the long - term debt with
shareholders funds. It is usually expressed as a pure ratio.
FORMULA
This ratio is calculated in two ways
1. Debt/Equity= Borrowed Funds/Proprietors funds =BF/PF OR

BF/BE+PF
Both ways are acceptable.

COMPONENTS
Borrowed Funds [BF] includes
1. Debenture, Loan, etc.
2. Interest accrued and due on such BF

Proprietors Funds [PF] includes

1. Equity Shares Capital (EC)
2. Reserve & Surplus (RS)
Less: - a) Profit & Loss A/c Dr. balance (Loss)
b) Miscellaneous Expenditure Not written of if any.
3. Preference Share Capital

4.6. CAPITAL GEARING RATIO

Meaning: - Gearing means the process of increasing the equity
shareholders return through the use of debt. Equity shareholders
earn more when the rate of return on total capital is more than
the rate of interest on debt. This is also known as Leverage or
trading an equity. The capital Gearing Ratio shows the
relationship between two types of capital viz. i. Equity Capital
including reserve and ii. Preference Capital and Long term

borrowings. It is usually expressed as a pure ratio. This is also

known as Capital Structure Ratio.

FORMULA
Capital Gearing Ratio =
1. = Capital Entitled to Fixed Rate of Interest OR Dividend/
Capital not So Entitled to Fixed Rate of Interest OR Dividend
2.

Preference Capital + Debentures/Equity Capital + Share

Premium A/c+ CR
Components
Capital entitled to fixed interest or dividend
1. Preference Capital (PC)
2. Debenture, Long term Loans, i.e. Borrowed funds (BF)
Capital not entitled to fixed interest or dividend (= Equity Funds)
1. Equity Capital (EC)
2. Reserve & Surplus (RS)
Less: - Profit & Loss A/c Dr. balance.
Less: - Fictitious Assets
thus, CGR= PC+BF/EF

5.REVENUE STATEMENT RATIOs

COMPUTATION OF PROFIT & LOSS RATIOs AT A
GLANCE
INCOME STATEMENT
ITEM
1.
2.
3.
4.

Credit Sales
cash Sales
Total Sales (1+2)
Opening Stock

5.

Credit Purchase

6.

Cash Purchase

7.
8.

Total Purchase (5+6)

Direct Expenses

9.

Less:- Closing Stock

10
.
11
.
12
.
13
.
14
.
15
.
16
.
17
.
18

Cost of Goods Sold

(4+7+8-9)

AMOUNT
CRS
CAS
S
OST
CR
P
CA
P
P
DE
(CS
T)
COG
S

Gross Profit
(3-10)

GP

Administration Expenses

AE

Selling expenses

SE

Finance Expenses (Excl. Interest)

FE

Operating Expenses

(12+13+14)

OE

Operating Profit(11-15)

OP

Net Non- Operating Income/ Expenses

NO

Profit before Interest & Tax (16+17)

PBIT

.
19
.
20
.
21
.
22
.
23
.
24
.
25
.
26
.

Interest On Loans

INT

Net Profit Before Tax(18-19)

NPA
T

Income Tax

IT

Net Profit After Tax (20-21)

NPA
T

Preference Dividend

PD

Profit Available for Equity Shareholders(2223)

PAE
S

Equity Dividends

ED

Retained Earning(24-25)

RET

Profit & Loss

Ratio

Equation / Formula

Par
a

1
.

Gross Profit Ratio

GPR=GP/S*100

5.1

2
.

Opening Ratio

OR=COGS+DE/S*100

5.2

3
.

Expenses Ratio

ER=AE or SE or FE/S*100

5.3

4
.

Operating Profit
Ratio

OPR=OP/S*100

5.4

5
.

Net Profit Ratio

NPR= NPBT/S*100

5.5

STR = COGS/OST + CST/2

OR
COGS/ Avg. Stock

5.6

6
Stock Turnover ratio
.

Average Stock

AS = Opening Stock + Closing

Stock/2

5.1 GROSS PROFIT RATIO

5.1.1. Meaning: - this ratio compares gross profit with net sales. It
is usually expressed in the form of percentage.
5.1.2. Formula
Gross profit = Gross Profit/Net Sales * 100 = GP/S * 100
5.1.3. Components
Gross profit [GP] = Sales Less Cost of goods Sold
Cost of goods sold [COGS] [In case of a Trading Concern]
1.
2.
3.
4.

Opening stock
Add: - Purchase
Add: - Direct Expenses
Less; - Closing Stock
= COGS

[In case of a Manufacturing Concern]

1. Opening stock of finished goods
2. Add: - Cost of goods produced
[Direct/ Price Cost (Materials + Labor + Expenses)]
3. Less: - Closing stock of finished goods
=COGS
Net Sales [S]
= Sales Less return Less Allowances.

5.2 OPERATING RATIO

5.2.1Meaning: -Operating ratio expenses the relationship between
total operating costs and net sales. It is expensed by way of
a percentage.
5.2.2Formula
Operating Ratio: - Cost of Goods Sold + Operating
Expenses/Net Sales*100
= COGS + OE/S * 100

5.2.3Components: - Cost of Goods Sold [COGS] [as per Para 5.1.3]

operating Expenses [OE] =
1. Office and Administration Expenses
2. Selling and Distribution Expenses
3. Finance Expenses Excluding Interest on Loans and
Debenture Net Sales [S] [as per Para 5.1.3]

5.3 EXPENSES RATIO

5.3.1Meaning: - this ratio expenses the relationship between each
item of expenditure and net sales. It is expressed as a
percentage. Total of all Expenses ratios will be each in
Operating Ratio.

5.3.2

FORMULA
Any Expenses Ratio = Expenditure/Net Sales*100
e.g. Administrative Expenses Ratio= Administration
Expenses/Net sales*100
Selling Expenses Ratio = Selling Expenses/Net Sales * 100
Finance Expenses Ratio = Finance Expenses/Net Sales*100
(Excluding Interest on Loans & Debentures)

5.4 OPERATING PROFIT RATIO

5.4.1Meaning: - Operating profit ratio indicates the relationship
between operating profit and the sales. It is usually
expressed in the form of a percentage. It is also known as
Net Operating Profit Ratio.

5.4.2

FORMULA
Operating Profit = Operating Profit/Net Sales * 100 = OP/S *
100

5.4.3

Components
Operating profit [OP]
1. Gross Profit

2. Less: - Operating expenses [OE] (as per Para 5.2.3)

(Net per Para 5.2.3)
Net Sales [S] =
Sales Less Returns Less Allowances.

5.5 NET PROFIT RATIO

5.5.1Meaning: - Net ratio indicates the relationship between net
profit and the sales. It is usually expensed in the form of a
percentage.
5.5.2FORMULA
Net Profit = Net Profit ( before Tax)/Net Sales * 100 =
NEPBT/S * 100
5.5.3Components: Net Profit before tax [NPBT] =
1. Operating net profit [as per Para 5.4.3]
2. Add: - Non Operating income
3. Less: - Non Operating Expenses = NPBT
Net Sales [S] = Sales Less Returns Less Allowances.

5.6 STOCK TURNOVER RATIO

5.6.1Meaning: - Stock turnover ratio shows the relationship
between the cost of Goods Sold and the average stock. This
ratio is normally expressed as a rate.
5.6.2FORMULA
A. Stock turnover Ratio = Cost of Goods Sold/Average Stock
= COGS/AS =
COGS/ OST + CST/2
If Stock is valued at sales price, formula will be
= Net Sales/Average Stock (at Selling Price)/2
Note: -In the absence of information, Closing Stock can be

used instead of average stock in the above formula.

B. Stock Velocity Stock [Stock Holding Period]
Stock velocity means the period (months or days) taken
for converting average stock into sales. It shows the Stock
Holding Period.
12/Stock Turnover Ratio = Number Of months production on
band or
Number of months it takes for
converting stock into sales
365/Stock Turnover Ratio = Number of days production on
band or
Number of days it takes for converting stock
into sales
5.6.3Components
Cost of Goods Sold [ COGS] = Sales Tess Gross Profit
Average Stock [AS] = Opening Stock + Closing Stock/2

6. COMPOSITE RATIO
COMOSEITE RATIOS AT A GLANCE
Composite Ratios

Formula / equation

Para

1
.

Return on Investment/
Capital Employed

ROI = PBIT/CE * 100

6.1

2
.

Return on proprietors Fund

RPF = NPAI / PF * 100

6.2

3
.

Return on Equity Capital

ROE = PAES / EF * 100

6.3

4
.

Dividend Payout

DP = ED / PAES * 100

6.4

5
.

Debt Service Ratio

DSR = PBIT/INT

6.5

6
.

Debt Service Coverage

Ratio

DSCR = Cash Profit/

Interest + Investments

6.6

7
.

Debtors Turnover Ratio

DTR = CRS / DR + BR

6.7

8
.

Credit Turnover Ratio

CTR = CRP/ CD + BP

6.8

6.1 RETURN ON CAPITAL EMPLOYED

6.1.1 Meaning: - This ratio measures the Relationship Between net
profit (before interest and tax) and the capital employed to earn
it. It is expressed as a percentage. This ratio is also known as
Return on Investment [ROI].
6.1.2. FORMULA
Return on Capital Employed: - Profit (before Interest & Tax *
100 / CE
6.1.3. Components
Profit (before Interest, Tax [PBIT =
1. Profit before interest on long term borrowing, tax &
dividends.
2. Less abnormal, non recurring items

1.
2.
3.
4.
5.

1.
2.
3.
4.

Capital Employed [CE]

Equity Capital
Add: - Preference Capital + Reserve & Surplus
Add: - Long term Borrowings ( Terms Loans + Debentures)
Less: - fictitious assets like Miscellaneous Expenses not
written Off
Less: -Profit & Loss A/c Dr. Balance (Loss)
note: -Capital employed may be taken to mean Assets
Employed, in which case.
Capital Employed [CE] can also be computed as
Fixed Assets (Less depreciation) (including investments)
Add: -Current Assets
Less: - Current Liabilities
Exclude Fictitious Assets.

6.2 RETURN ON PROPRITORS FUNDS

6.2.1 Meaning: - This ratio measures the relationship between net
profit (after interest and tax) and the Proprietors capital. It is

usually expressed as a percentage. It is also known as Return on

Proprietors Equity or Return on Net Worth.
6.2.2. FORMULA
Return Proprietors Funds: -Net Profit (after Tax)/ Proprietors
Funds *100
NPAT/PF * 100
6.23. Components
Net Profit [NPAT] = Profit after interest and tax proprietors
funds [PF] =
1. Equity Capital [EC]
2. Add: - Reserve & Surplus [RS]
Less: - Fictitious Assets like Miscellaneous Expenses not
written off
Less: - Profit & Loss A/c Dr. Balance (loss)
3. Add: -Preference Capital [PC]