CHAPTER 4

ACCOUNTING RATIOS

Points to Remember :

1. Loose tools and stores & spares will be excluded from inventories while
calculating. Current ratio and inventories turn over ratio.
2. Provision for doubtful debt will be deducted from Trade receivables for

60
calculating current and liquid ratios. But it will not deduct while calculating
trade Receivables turnover ratio.
3. Non-trade Investment will be exclude from shareholder’s funds and Capital
employed and Total Assets for calculating solvency and Profitability ratios,

E3
and corresponding their income (i.e., interest on Non-trade Investment) will
exelucls from Net Profit.
4. Operating cost and operating expenses are reperate concept shouldn’t inter
change.

variables.
ID
Accounting Ratio: It is an arithmetical relationship between two accounting

Ratio Analysis: It is a technique of analysis of financial statements to conduct a

U
quantitative analysis of information in a company’s financial statements.
“Ratio analysis is a study of relationship among various financial factors in a
business.” –Myers
YG

io Pr
at % Debt op
R Equity rie
y
t or to
ry
D

r ie R
op at
Pr
Profitibility Solvency io
U

Fraction Times % Current

io D
at eb
R Liquidity Activity rs
to
er
ST

v Tu
no r rn
Tu Fraction ve o
y
or t R r
en at
io
nv I

`
RATIO ANALYSIS

[Class XII : Accountancy] 336

 Expression of ratios: Ratios are expressed in following four ways:

Pure Ratio Like 2:1. All liquidity and solvency ratios are expressed in pure
form.

Percentage e.g. 15%. All profitability ratios are presented in percentage

form.

Times Like 4 times. All turnover ratios and Interest Coverage Ratio are

60
presented in this form.

Fraction like 3/4.

E3
Classification or Types of Ratios:

ID
U
YG
D
U
ST

337 [Class XII : Accountancy]

 Liquidity Ratios
Current Ratio
Current Assets
Current Ratio =
Current Liabilities

Liquid or Quick or Acid Test Ratio

Current Assets
Liquid Ratio =
Current Liabilities

60
Supporting Formulae
1. Current Assets = Current Investments (also known as Market able
Securities or S.T. Investment)

E3
+ Inventories (except Loose Tools & Stores and
Spares)
+ Trade Receivables (Debtors and B.R.) Net after
provision for bdd.

ID+ Cash and Cash Equivalents (Cash and Bank

Balances)
+ Short Term Loans and Advances
U
+ Other Current Assets (Prepaid Expenses,
Accrued Income & Advance Tax)
2. Current Liabilities = Short Term Borrowings (Bank Overdraft and Cash
YG

Credit)
+ Trade Payables (Creditors and B.P.)
+ OtherCurrent Liabilities (O/s Expenses, Income
Received in Advance, Unpaid or Ui claimed
Dividend)
D

+ Short Term Provisions (Provision for Tax,

Proposed Dividend)
U

3. Liquid Assets = Current Assets

ST

- Inventory (closing)
- Other Current assets (Prepaid Expenses, Accrued
Inicome & Advance Tax)
4. Working Capital = Current Assets - Current Liabilities
5. Total Assets = Non-Current Assets + Current Assets
6. Total Liabilities = Non-Current Liabilities + Current Liabilities

[Class XII : Accountancy] 338

 7. Non-Current Assets = Fixed Assets (tangible and intangible)
+ Non-Current Investments
+ Long Term Loans & Advances (Capital Advances,
Security Deposits)
8. Non-Current Liabilities = Long Term Loans( Debentures, Bank Loans,
Bonds)
+ Long Term Provisions (Provision for employee
benefit & Warranties)

60
9. Capital Employed = Shareholders Fund
+ Borrowed Fund (Non-Current Liabilities)
10. Capital Employed = Total Assets - Current Liabilities
= Non-Current Assets + Working Capital

E3
11. Shareholders Fund = Share Capital
+ Reserves and Surplus
Non-Current Non Trade Investments

ID
Shareholders Fund = Total Assets - Non Current Liabilities - Current / liabilities
(Note: Total Assets wll include only Non-Current TRADE Investments for Capital
Employed)
U
Non Current: Investment will remain Non-Current TRADE Investments in Absence
of any other information.
YG

Solvency Ratios
• Debt - Equity Ratio
Debt (Non Current Liabilities)
Debt - Equity Ratio =
Equility (Shareholders Fund)
D

• Proprietary Ratio
Shareholders Fund
U

Proprietary Ratio = To tal Assets

ST

• Total Asset to Debt Ratio

To tal Assets
Total Asset to Debt Ratio =
Debt (Non Current Liabilities)

• Interest Coverage Ratio

Profit BEFORE Interest, Ta x and Dividend
Interest Coverage Ratio =
Interest on Long Te
erm Loans

339 [Class XII : Accountancy]

 Activity or Turnover Ratios
• Working Capital Turnover Ratio
Revenue from Operation
Working Capital Turnover Ratio =
Working Capital

• Inventory Turnover Ratio

Cost of Revenue from Operation

Inventory Turnover Ratio =

60
Average Inventory

• Receivable Turnover Ratio

E3
Net Credit Revenue from Operation
Receivable Turnover Ratio =
Average Debt ors+Average BR.

12 months or 365 days or 52 weeks

• Payable Turnover Ratio ID

Receivable Turnover Ratio = Debt or Average Collection
n Period
U
Net Credit Purchases
Payable Turnover Ratio =
Average Creditors + Average B.P.
YG

12 months or 365 days or 52 weeks

Payable Turnover Ratio =
Average Payment Period

Supporting Formulae
a) Revenue from Operation (Net Sales) = Total Revenue from Operation
D

Return of Revenue from Operation

b) Total Revenue from Operation = Cash Revenue from Operation
U

+ Credit Revenue from Operation

c) Net Credit Revenue from Operation = Credit Revenue from Operation
ST

- Return of Revenue from Operation

d) Cost Of Revenue From Operation (COGS) = Opening Inventory
+ Net Purchases + Direct Expenses
- Closing Inventory
e) Cost Of Revenue From Operation (COGS) = Revenue From Operation
- Gross Profit

[Class XII : Accountancy] 340

 f) Cost Of Revenue From Operation (COGS) = Cost of Raw Material Consumed
+ Purchases of Stock in Trade
+ Change in Inventory of Finished
Goods, WIP, Stock in Trade
+ Direct Expenses
Opening Inventory + Closing Inventory
g) Average Inventory =
2

60
Opening Debtors + Closing Debtors
h) Average Debtors =
2

Opening B.R. + Closing B.R.

E3
i) Average B.R. =
2

Opening Creditors + Closing Creditors

j) Average Creditors =
2

k) Average B.P. =
ID
Opening BP + Closing B. P.
2
U
I) Average Receivable = Average Debtors + Average B.R.
m) Average Payable = Average Creditors + Average B.P.
YG

In absence of Information
• Debtors = Opening Debtors = Closing Debtors = Average = Debtors
• B.R. = Opening B.R. = Closing B.R. = Average B.R.
• Creditors = Opening Creditors = Closing Creditors = Average Creditors
D

• B.P. = Opening B.P. = Closing B.P. = Average B.P.

U

Profitabiliy Ratio
Gross Profit Ratio
ST

Groos Profit
Gross Profit Ratio = × 100
Revenue from Operation
Net Profit Ratio
Net Profit After Ta x
Net Profit Ratio = × 100
Revenue from Operation

341 [Class XII : Accountancy]

 Operating Ratio or Operating Cost Ratio
Operating Cost
Operating Ratio = × 100
Revenue from Operation
Operating Profit Ratio
Operating Profit
Operating Profit Ratio = × 100
Revenue from Operation

Return on Investmetn or Return on Capital employed

Profit BEFORE Interest, Ta x and Dividend
ROI = × 100
Capital Employed

60
Supporting Formulae
• Net Profit = Gross Profit + Indirect Incomes - Indirect Expenses
= Gros profit + Non-Operating Income – (Operating Expenses + Non-

E3
Operating Expenses)
= Gross profit + Non-Operating Incomes – Operating Expenses - Non
Operating Expenses
= Gross profit – Operating Expeses + Non-Operating Incomes - Non
Operating Expenses

ID
= (Gross profit – Operating Expenses) + Non-Operatin, Incomes, non-
Operating Expenses
U
• Net Profit = Operating Profit + Non-Operating Incomes - Non Operating
Expenses
• Indirect Expenses = Operating Expenses + Non-Operating Expenses
YG

• Non-Operating expenses Example Interest Paid on loans a finance cost

• Operating Expenses = Office and Administrative Expenses
+ Selling and Distribution Expenses
+ General Expenses
D

+ Depreciation
• Operating Expenses = Employee Benefit Expenses + Other Operating
U

Expenses
• Indirect Incomes (also known Non-Operating Incomes)
ST

Example: Interest Received on Investment

• Operating Cost = Cost of Revenue from Operation + Operating Expenses
• Operating Profit = Gross Profit - Operating Expenses
= Revenue from Operation - Cost of Revenue - Operating Expenses
= Revenue from Operation - (Cost of Revenue + Operating Expenses)
• Operating Profit = Revenue from Operation-Operating Cost
• Operating Profit = Net Profit - Non Operating Incomes + Non-Operating
Expenses

[Class XII : Accountancy] 342

 60,000

payment

60
E3
ID ` 1,50,000
U
YG
D

A Ltd.
U
ST

- 1

24,000
24,000 - 2

343 [Class XII : Accountancy]

 60
E3
premium
20,000

divident

ID
U
will
YG

following:
Debt
D

4,00,000
2,00,000
Non Inventories 1,70,000
U

Advances 30,000
ST

Asset

[Class XII : Accountancy] 344

 60
receivable

were

E3
from

ID
U
from
YG
D
U

operations = Cash Revenue + Credit Revenue Operations

ST

Rs 3,00,000

345 [Class XII : Accountancy]

 CI × T|R

Rs 70,000

60
E3
6 times

ID
U
YG
D
U
ST

[Class XII : Accountancy] 346

 50,000
x=
3.5

Illustration 7:

60
E3
following ratio:

Proprietary ratio

ID
U
Mortgage
YG
D
U
ST

= 0.722 or 72.2 %
+ current Assets

Ratio
.
mortgage
347 [Class XII : Accountancy]
 50,000

60
E3
Investment ID
Depreciation 1,50,000 i.e., balance in
U
Asset
YG

– 1,50,000
D

Return
U
ST

[Class XII : Accountancy] 348

 Int.
(10% of 1,20000)

60
E3
16,20,000 – 10,20,000

(–) Surplus Balance

ID
U
YG

balance Davi

(b) Reserve & Surplus

D
U
ST

349 [Class XII : Accountancy]

 II ROI = Net profit before int & Tax * 100

60
E3
Surplus

ID
U
YG
D
U
ST

[Class XII : Accountancy] 350

 6=

60
E3
rs 9,000

ID
Administrative Expenses ` 22,000
U
YG

rs 80,000
rs 8,00,000 = 85%
D

+ stock in stock +
U
ST

Exp. =

Cost of

351 [Class XII : Accountancy]

 60
E3
ID –
U
operating Profit
10 = ×100
8,00,000
YG
D
U
ST

[Class XII : Accountancy] 352

 firm’s meet

60
Debtors)

E3
extends customers

ID it becomes
U
YG

(c) the
D

Earning
U
ST

operating

353 [Class XII : Accountancy]

 limitation

window
(c)

60
(c)

E3
(c)

ID
U
(d) If current ratio is 1.5 : 1.5
YG

(c)
D

÷
U

(c)
ST

Expenses

proprietary
current
[Class XII : Accountancy] 354
 (c)
(d)

Redemption

60
(c)

Ltd.

E3
(c)

ID
decrease
U
(c)
YG

(b) Liabilities
(c)
D
U

(c)
ST

are

In

(c) , i.e. balance

deducted to

355 [Class XII : Accountancy]

 times

– ___________ = Net profit

60
Exercise

E3
ID
U
YG
D
U

Non
ST

Creditors

rs 3,28,000

Calculate

[Class XII : Accountancy] 356

 funt 18,00,000
2,00,000

60
=

E3
operation

operating
ID following:
U
24,40,200
YG

theft
D

operating

Sales
U

Net
Intired
ST

(Gross)

357 [Class XII : Accountancy]

 (c) Quick Ratio

60
E3
inventory

ID
U
(c) Proprietary ratio
YG

9% Debentures
D

From
U

loan
ST

[Class XII : Accountancy] 358

 Things to Remember
• What is a Ratio?
It is an arithmetical relationship between 2 variables.
• What is Accounting Ratio?
It is an arithmetical relationship between 2 accounting variables.
• In how many ways a Ratio may be expressed
1. Pure

60
2. Times
3. %
4. Fraction

E3
• Give two objectives of Ratio Analysis
1. To find out the weak areas of business
2. To help in formulation of plans for future
•
1.
2.
ID
List two uses of Accounting Ratios
To Analyse the financial statements
To simplify the Accounting Data
U
• Write two limitations of Accounting Ratios
1. Ignoring Price level changes
YG

2. Ignoring qualitative aspect

• Liquidity Ratios are also known as short term solvency Ratios
• List two Ratios included in liquidity Ratios
2. Current Ratio
D

3. Quick Ratio

• Current Ratio is also known as – working capital Ratio

U

• Quick Ratio is also called as—Acid test Ratio or Liquid Ratio

Write formula for working capital Ratio
ST

Working capital Ratio =

• What are current Assets?

Assets which may be converted into cash or cash equivalent within, 12 months
from the date of Balance sheet or operating cycle.

359 [Class XII : Accountancy]

 • What are current liabilities?
Liabilities which are to be paid within 12 months from the date of Balance
sheet or operating cycle.
• Give examples of current liabilities?
Short term borrowing(including Bank overdraft), trade payables(Bills payables
and sundry creditors),other current liabilities.
• What are liquid Assets?
These assets which can be converted into cash or cash equivalents within

60
short period of time.
• Give examples of Liquid Assets
Current investments, trade receivables, cash and cash equivalents, short
term loans and advances.

E3
• What do you mean by solvency Ratios?
Those ratios which show whether the business will be able to pay its long
term commitment/ payments on time.
• How can we calculate debt?
Debt = long term borrowings
+long term provisions
ID
U
OR
= Total Debt-current liabilities
YG

• How to deal with debit balance of statement of P&L account?

It is to be deducted from equity /shareholders’ funds
• What are long term provisions?
Provisions for those liabilities to be paid after 12 months from the date of
D

balance sheet or after operating cycle.

• Give examples of long term provisions?
U

Employees benefit expenses like provision for gratuity, provision for warranty.
• Activity Ratios are also known as performance Ratios/ turnover Ratios.
ST

• How to deal with change in inventory Add change in inventory if opening

inventory>closing inventory.
Subtract change in inventory if opening inventory<closing inventory.
• Give a reason for ↑ or ↓ in gross profit Ratio.
↑Higher selling price with constant cost of revenue from operation results in
in gross profit ratio.
↓Higher cost of revenue from operation with constant selling price results in
gross profit ratio.

[Class XII : Accountancy] 360

 • Give examples of non-operating incomes: interest received, dividend received,
profit on sale of fixed assets.
• Give examples of non-operating expenses: Interest on long term loans, loss
on sale of non-current assets.

60
E3
ID
U
YG
D
U
ST

361 [Class XII : Accountancy]