CHAPTER Accounting Ratios LEARNING OBJECTIVES The study of this Chapter would enable students to understand: ‘@ Meaning of Ratio and Accounting Ratio 32 ‘ Meaning of Ratio Analysis 33 ‘¢ Objectives and Advantages of Ratio Analysis : 3.3 © Limitations of Ratio Analysis 34 Classification or Types of Accounting Ratios: 35 1. Liquidity Ratios: Current Ratio and Liquid Ratio 35 2. Solvency Ratios: Debt to Equity Ratio, Total Assets to Debt Ratio, Proprietary Ratio, 3.24 Interest Coverage Ratio and Debt to Capital Employed Ratio. 3. Activity Ratios: Inventory Turnover Ratio, Trade Receivables Turnover Ratio, 3.44 Trade Payables Turnover Ratio, Working Capital Turnover Ratio, Fixed Assets Turnover Ratio, and Net Assets Turnover Ratio 4, Profitability Ratios: Gross Profit Ratio, Operating Ratio, Operating Profit Ratio, 3.69 Net Profit Ratio and Return on Investment (RO!) IMPORTANT NOTE According to the CBSE Guidelines, accounting treatment of following will not be evaluated: (i) Reserves and Surplus: (Revaluation Reserve, Share Options Outstanding and Other Reserves are not to be evaluated. However, General Reserve can be evaluated); (i) Money Received against Share Warrants; (il) Share Application Money Pending Allotment; (iv) Deferred Tax Liabilities (Net); (v) Other Long-term Liabilities; (vi) Intangible Assets: (Masthead and Publishing Titles, Copyrights and Patents and Other Intellectual Property Rights, Services and Operating Rights and Licences and Franchise are not to be evaluated); (vil) Capital Work-in-Progress; (viii) Intangible Assets Under Development; (ix) Deferred Tax Assets (Net); (x) Other Non-current Assets; (xi) Cash and Cash Equivalents: (Earmarked Balance with Banks, Balances with Banks held as Margin Money ot Security against borrowings, guarantees, other commitments and Bank Deposits with more than 12 months maturity are not to be evaluated); and (xi) Treatment of Unamortised Expenses.onrinancial Statements. y Analys ctedto Prepaid Expenses, Acer - totes eA 7 idles means that astudent vill ot be amy, seine restatements Common sie Statement Reto tose rds, questions on Comparative Statements, Comming ea satement wllnot have entries or items from above heey i tefomulas straionsand questonsinhischapeg, Finanal Statements Analysis eis the most iggy ~ onehp betwen vo variables ofthe Financia tage Hi aveot ben technique of ysis ee ie srs soomaancaae MEA expression of relationship between two interdependent op a rel ai isan ait oe basis ofacounting information, are called Accoung! items. Ratios, when calcul ithmetical relationship bet n may be expressed as an ari Ratios. Acounting ratio. ing variables sing ais edo ecient relationship which exist beta aa «tac She, ina Statement of Profit & Loss, in a budgetary controt syst sion Bac Set, n Statement ny pat fe accountng organisation. . weer eM figures em or jn =I. Bety Bie eg} Accounting Ratios can be expressed in any of the following manner: 1. Pare Ratio nhs form the relationship bet to items is expressed in ratio, For exam ‘expresses the relationship between Current Assets and are % 100000 and Curtent Liabilities are @ 5,00,000, ple, Current Ratig Current Liabilities. If Current Asse then Current Ratio will be: a Current Assets _ %10,00,000 en Rao SES Pe = 20rd] 2. Peenage ‘urent Liabilities ~ %5,00,000 Tes expressed in rene naee: For example, Net Profit Ratio expresses the relat; : fe relati been Na Pott neat from Operation, ie, Net Sales It Net Profit =F a Prats = 250000, then Net Profit Ratio will be : Net Profit Ratio» —_Net Profit 00 = £50,000 oo Revenue rom Operations * *¥2,50,000°100= 20% "is expressed in numberof igure is when com, : re, imes a paticula example, Trade icme a Tate TIT Rao ov rani. ene Ne "Cu eet : eer ‘een Net Credit Purch : * ; ‘urchases and oy om Bae cs ae 1.0000 and Average Trade Payables Trade Pay Net Cre rh = : * Pyables Tumor Rao « _NetCredit Py ase _71,00,000 = Wrerage Tepe €1,00, im te : "erage Trade Payable 225,009, * 4 Times, Ran natn ample, ratio of, : "ae Taio of fixed asset | ‘a ‘ *S to share s me aa sidan “pial 15 (say) 3/4 (ie, 0.75). a imple, average collection Sty th ios bo | ting Rat accu! Ser WSL Oss MY pa ysis of financial statements with the help of ‘accounting ratios’ is termed 5 analysis an Aes ; Myers ran lysis is astudy of relationship among various financial actors in a busines —My' pt ysisis a process of determining and interpreting relationships between the items of ) pation ments to provide a meaningful understanding of the performance and Coe \ gnancial an enterprise. Thus, it is a technique of analysing the financial statements by i\ tin ratios. i com a kodiacaananee fe) alysis serves the Purpose of various users who are interested in the financial jo at 7 Ratio nts It simplifies, summarises and systematises the figures in the financial statements. Vi sate ectves of ratio analysis are: | ieee simplify the accounting information, i 1 | \ ine liquidity, i.e., Short-term solvency (Ability of the enterprise to meet its determine liquidity, y y of the . 2. Te eterm financial obligations) and Long-term solvency (Ability of the enterprise to my its long-term liabilities) of the business. 4, To assess the operating efficiency of the business. 44 To analyse the profitability of the business 5, To help in comparative analysis, ie, inter-firm and intra-firm comparisons. POUL a Ue REIS ‘The advantages of ratio analysis are as follows: 1, Useful Tool for Analysis of Financial Statements Accounting ratios are useful for understanding the financial position and financial performance of an enterprise. Bankers, investors, creditors, etc, all analyse Balance Sheet and Statement of Profit & Loss using ratios. 2, Simplifies Accounting Data Accounting ratio simplifies, summarises and systematises accounting data and making it understandable, Its main contribution lies in communicating precisely the interrelationships Which exist between various elements of financial statements. In the words of Biramn and Dribin, “Financial Ratios are useful because they summarise briefly the results of detailed and complicated computation.” 3. Useful in Assessing the Operating Efficiency of Business Operating efficiency can be assessed with the help of ratio analysis. Activity Ratios are dimed to evaluate the performance of the enterprise in utilising the resources, For exam Working Capital Turnover Ratio indicates the and Working Capital ple, relationship between Revenue from Operations« 34 , y OF i ‘i business even th he weak areas ofthe ough ea on ey nvm Comparison im ane wi at ote is of with the indy yy may compare f nterfiem Comparison or CrOSS-Sectionay ae is cle a jin the same firm is to be compared, Arai ‘The comparison J i ie tng rats make the comparing ae tong ‘Timeseries Analysis. rintatns of Ratio Analg , ee rm he fiancal statements, therefore, the reli ce aly depends ne cece financial statements. Ifthe fing a a ae awl ge 2 ale PCE OF the i, are not ‘considered ve analysis. It ignores qualitative factors, wig, are calculated 2, Qualitative Factors ati analysis is a technique of quantita my be important in decision-making. 5, Lack of Standard Ratios ‘Ther is no single standard ratio against 4, May not be Comparable Aang rics may notbe comparable different ims follow different accounting policig and penis For earl fim may follow Straight Line Method of Depreciation may fallow Diminishing Balance Method. 5. Price Level Changes are not considered lag in ie eels te compari of he ats, But price evel changes ae tatoo wg Yates om whi rate are computed Thi iste 6 Window Dressing Accounting ats may be 1 be afc by window , isa ay tocol vl ats pe tes: Manipulation of books of account Foe are il acs and resent he nan poston beter ha nat fi stin rence of para a reas ae io may not be a definite 7, Personal Bias ™ which accounting ratio can be compared. ‘Analysis of Financial Stat r mene 35 os : “ne ability ofthe enterprise to meet its short-term financis! obligations guid! 1, BAT ios show te ios are: () Current Ra iy Rais ate: () Coe Ra and (i) Quick Ratio. It ency Ratios p, SovERE, "gre calelated t0 assess ong term financial position of ios reg ability of the enterprise to meet its long- eM abilities. Important Solvency Ratios are: ( Debt to Equit Tassels to Debt Ratio, (if) Proprietary Ratio, (ic) Interest Coverage Ratio, a capital Employed Ratio (0) Oy Ratios of Turnover Ratios how efficiently a company is using its resources. Important umnover Ratio, (i) Trade Receivables Tumover Ratio, (i) () Fixed Assets Turnover f the enterprise. term financial ty Ratio, and Activity Ratios Trade Payables 3 eatios show Ratio, and apes 005 2, (e) Working Capit Tamover Ratio, a ‘sets Tumover Ratio (o ‘i (0 oaabity Ratios a A mpiity of a firm can be measured by its profitability ratios. Important Profitability profit. () Gross Profit Ratio, (i) ‘Operating Ratio, (if) Operating Profit Ratior (iv) Net patios a and (2) Return on Investment (ROM) profit Rat 1. LIQUIDITY (SHORT-TERM SOLVENCY) RATIOS sity of Busines" refers 10 the firm's ability to meet its current obligations, Mea short-term ancia Hit ality eatios are those ratios which are computed to evaluate the capability of the entity Heateet its short-term liabilities, Commonly used liquidity ratios are: and { Carrent Ratio; Quick Ratio or Acid Test Ratio. {jy Liquid Ratio or tet us discuss them in detail a Current Ratio Cent Ratio establishes the relationship between curent ase ‘and current liabilities. Tt is an Fafeator of whether the enterprise will be able to meet its short-term financial obligations te and when they become due for payment ‘The formula for calculating Current Ratio is: Computation: Current Assets Current Ratio = —-oen urrent Ratio Corrent Liabilities Ihis expressed as a ‘Pure Ratio’ say, 2: 1. id be noted that Current Ratio is calculated as at a particular date and not for a It shoul paticular period,“Garrent Liabilities’ are thy Cane onthe oF wha rating cycle from the date op They are shown under the Liabilities’ in the Balance Shoey wit 7 ‘They include: | short-term Borrowings (B, Cech Credit, Current Maturitn® Ove, Debts, etc.) of Long » Trade Payables (Bills Payable it Creditors), and 5, «+ Other Current Liabilities (Interesy “4 a cru ot due on borrowings, interest due on borrowings, outstandin Gnclaimed dividend, calls-in-aqe,°% and vance Say] « Short-term Provisions. cf, because they are “spares are excuded from Current ASSels wai ‘tose Toon fein Sheet they are shown as inventory 25'S required by Sche aan sy or ie ted 2nd July, 2013), Other Current Assets’ ex Pt Brea ‘acad-43/2013 43 nce tore notto be evauated Three the formulas He "ther than prepaid expenses, accrued incomes and ad, tS ang Vance Current Assets and Current Liabilities ‘the Companies Act, 2013) {As defined in Schedule Il of those asses which full any ofthe following criteria: vealsed in orisintendedforsale or consumption in, the company's normal opera, Current Assets are (@ itisexpected to be! cyclesor 1b) ised primary forthe purpose of (@ itis expected tobe realised within 12m {d) itis Cashand Cash Equivalents unlssitis es Feast 12 months after the reporting date, Curent Liabilities ae those lables whch fulfil any of the following criteria: (a) itisexpected tobe settled in companys normal operating cycle; or (0) tis held primary forthe purpose of being traded: or a bs eel be esentn '2months after the reporting date Ze, Balance Sheet Date; or ny does not have an - et eset woo right to defer settlement of the liability for at least being traded: oF ‘onths after the reporting date, ie, Balance Sheet Date; or trcted from being exchanged or used to settle a liability for “Anoperting clesthetimebetweent oe isthe time between the acquis ee Wie pea anton cases procesingandthetresation into Cashand Eaunclents be identified, itis assumed to be a period of 12 months." accounting Ratios ashe curent deal Ratio d. involve’ invol¥ ould be twice the current liabilities. it Ratio is 2 or more than 2, it means the firm is adequately Tiquic tits current financial obligations but if the Current Ratio is I may face difficulty in meeting its current financial obligations. assets # ne Curren! 0 mee! the firm High Cur ‘or manage™' to determine the effect be, rent Ratio of a company is 2: 1. State, giving ree it il 1 ssameamountsofurent Assets and Curent Lables as per given ratio. “ wre reduce of not change the ratio: 8 Feasons, which of the following will 1 Pace the eet of tansaction in assumed amounts of Curent Assets and Current Liabilities, ) Redemption of Debentures, ew amounts 2d cacy, ¢ £ Loose Tool 5 Cede en art Cae ee Je of fixed asset against cheque. 4 Compare the New Cunt Rat with ld Curent Ratio to determine (i 5 its effect on the Cu Jf cheque from a debtor. Met fgg (i) Receit 2. se, deoeae ono change the ati igterm loans repayable within 12 months, Ulustration 16 (o) Lon Curent Ratio of a company is 2 juded in the Trade Payables company is 2:1. Sate giving reasons, which of the fol (oe tag rete eh . change the ratio: lowing wouy solution: {j) Redemption of Debentures will improve the Current Ratio as both Current Assets ment of a current liability (Cash or Bank) and Current Liabilities (Other Current Liabilities) decrease by the same amount Note: ewes ° a aM cite ‘Companies Act, 2013, a liability that is due for payment within 12 months from the date of Balance Sheet or within the period of Operatin« ‘as Current Liability period of Operating Cycle is shown (i) Purchase of Loose Tools against cash/cheque will reduce Current Ratio as current asset (Cash/Bank) reduces while Loose Tools are not included in current asset for calculating,14 1h en eee ain unchanged . asset aga gt labilities emai iy a tnod a ‘ sue sw jange the Current Rati th » inerea® ror wil wot cm © Since cane vciyed om * age + current asset (Bank), © Ong \ gue y ? : % ot ee eetor) re within 12 months will ee Curent Rea \ tong Joans FP ent viability increases and lurrent Assets Femain 1 em ia ity woes # Current Liability and alse cu von maturil ' eo wit rayan ie me amount. Hence Current Ratio will increase, "Rt " ~ah/Bank) by Me (can pustation company i825 1 state, with reasons, Which Of the 4 rhe Current tao ame ort at ihesratio: by rai ee £00,000 at a premium of 10%. edesmesd 9 Detentures of € 1,00 i) eceived from debtors 17,000. ; @ sty Shares tothe vendors ‘of Machinery. i) sued © 190,000 Equity Share reitors ®7 0. a i) Accepted Bills cofexchange drawn by the crech b (0D 2015, egg Solution: er ae ee Sane ‘precton Current Ratio Reason SMe | —— cs Dabenture | +——prease _| lf redemption of debentures tak a in the current year where o 5 DAD ¢7,00,000ata premium tetas te debentures become Curent Liab "8 oie ‘a case Current Ratio will increase bers | both Current Assets and Current eee have decreased by the same amount, tig ii | Received from debtors ‘No change Tewillinrease cash and decrease debtors, lime cronies and Current Liabilities remain unchangeq Ti | issued € 2,00,000 Equity No change oth Current Assets and Current Liable Shares to the Vendors of are not affected. Machinery. {i | Accepted Bil of Exchange "No change it does not change Current Assets ang drawn by the Creditors Current Liabilities. Because increase iq 7,000. | ‘one Current Liability (Bils Payable) results in decrease in another Current Liability (Creditors) with the same amount. IMustration 19. ‘The Current Ratio ‘would (f) increase or (i) decrease or (ii) not change the ratio: (i) Included in the Trade Payables was a bills payable of€ 20,000 which was met on maturity i) Company issued 50,000 Equity Shares of € 10 each to the vendors of Machinery ‘purchased. (Dethi 2014) of X Lid. is 1:1 State, with reason, which of the following transactions in * improve the CHPEML Ratio sing, Ny ce %y 315 i festa the Coarene ane ton cd Nether io wlio aea Let Care het Cane ies Of Y Ltd. is 2: 1. State, with reason Ot, (i) AAcrease OF (ii) not change te rea Meceivables include debtors of ® 40,000 whch company rchased furiture of € 45000 The venioy new eect by fof € 10 each at par doe was paid by nue of st (Delhi 2014) snares following, transactions One Current Asset Debit | Cece ery st neta ren ity nd ao Guret Asets dono gE a. reason, Whether the Current Ratio of a company will improve of decline oF ese vin ‘ 2 e care = transactions if Current Ratio is (i) 1: 1, and (ii) 08 « E (a) Oe payable discharged () Be Receivable endorsed to a creditor, e ae purchased on red (0 Oo asad goods for cash. @ ce Receivable endorsed 0 a creditor dishonoured. (pent of dividend payable. @ = MF goods for € 25,000 (Cost € 20,000 e a of ld fumitae for 22,00 (Bok Valve € 25,00), @ sitO™ement showing the Efec of Various Transactions on Curent ato of 1:8 cons | teton Curent | —____ Reason wo Change | Botte Curent Assets and Coen Labs wil decease bythe [Both te Cent ses ond Curent nities wl decease byte same Te | ot the Curent set nd Curent abies wi ease by esa are | ot te Coent setsand Curent Lilie wiles tes amo ‘either the Curent Aes nor the Curent Labites are affected since its 2 Conversion of one Cunt Ase (Cas into another Curent Ase (Goods) “| ori the Curent Assets and Current Libis wiincrease by the same amount, se | Both the Current Assets and Curent Labs wil decrease by the same amount reser 000 Pot Curette nan + Gorant assets wl inerease by ® 72000 (ash or Bank but Current Lables Current Asset will remain unchanged. ame amount iCurrent jo or Quick Rati (a) Liquid Rati ; guid Ratio or tek ato or Acid Test Ratio tie enterpise to meets short: ‘he relationship betvee™ liquid ase Computation: {Quick Ratio is calcula ees Liquid Quick Ratio = Liquid itis expressed as a ‘Pure Ratio’ say 1k Liquid Quick Assets “Tiqud Assets’ are the assets that are either in the form of Cash and Cash Equivalents or con be | venvertd into Cash and Cash Equralents in 2 very Stow ie, ie are the mast iu sets They a shown under the head ‘Current Assets in the Balance ‘Sheet and include: Current Investments, Short-term Investments and Marketable Securities, «Trade Receivables Bills Receivable and \ Debtors less Provision for Doubtful Debts), «Cash and Cash Equivalents Short-term Loans and Advances, and "Other Curent Asets exept Prepaid Expenses “Assets eas and Curent Laities wil decease sets and current Liabilities will decrease by the oT Se the NY sas and Cent Biles wl ieee by p= ~ ‘Assets nar Current Liabilities are affected gj in ‘a conversion of ON Assets a 5 Current Ratio Cyrrent Liabilities x Current Ratio Current Assets = Current Liablit Current Assets = & 1,20,000 * 2.5 = € 3,00,000 Quick/Liquid Assets = Current Assets ~ Inventories = 300,000 - % 90,000 = % 2,10,000 Liquid Ratio = Mlustration 26, Calculate Liquid Ratio/Quick Ratio/Acid Test Ratio from the following: Working Capital @ 18,000; i ‘i Working pial 000; Total Outside Liabilities ® 3,90,000; Long-term Debts & 3,00,000, Solution: Liquid/Quick Ratio = Sd Ok Assets Asses , 190000 urrent Liabilities” @90,000 7 Current Liabilities = Total Outside Liabilities — Long-term Debts 390,000 & 300.00 = & 99,000, 231. Quick Ratio = Swick Assets __ £10,00,000 Current Liabilities ~ 5,00,000 =>"! 28. pilities of a company are € 3,00,000. Its Current Ratio is 3 and Liquid Ratio is 1. 3 Hal c a ‘value of Inventories. al ition: solution” erent Liabilities = & 3,00,000 a Liquid Ratio = —Said Assets __ Liquid Assets Current Liabilities %3,00,000 Liquid Assets = € 3,00,000 Current Assets = Current Ratio x Current Liabilities =3 x % 3,00,000 = @ 9,00,000 Inventories = Current Assets ~ Liquid Assets = T 9,00,000 ~ % 3,00,000 = & 6,00,000. iilustration 29- Current Ratio find its Current Let Current Liabilities be x Current Ratio is 4.5 : 1; ++ Current Assets = 4.5x Liguid Ratio is 3 : 1; + Liquid Assets oF Quick Assets = 3x Liquid Assets = Current Assets ~ Inventories 3x = 45x ~ & 3,00,000 1.5x = € 3,00,000 t Liabilities; Current Assets and Quick Assets. olution: or . p= 2 3:00,000 «= 209,000 7 15 of Star Ltd. is 4.5 : 1 and Liquid Ratio is 3:1. If its Inventories are € 3,00,000,Analysis of Financial Statement, « 3.20 ty nustration 3 ent Liabilities ® 40,000. Calcutay, ah Quick Ratio 5; Current inventories (100) Quick Assets_ = ick Rotio™ Curent Lables = qangn0 « 15 = € 60,000. Coren Assets ~ Quick Assets Coon «60.000 = € 40000 assets © 400,000; Cun ck Assets Quick Assets _ 1 5 Solution: 40,000 nventories * Iustation 31: 4 aa company is © 600000. IS Current Ratio is 25 : 1. Calculate value tal 600 io is 2 ries) Curent Ase and (i) Liquid Rato/Quick Ratio/Acid Test al € 400,000. a Current Ratio =25: 1 (Given) Let Current Liabilities = x Current Assets = 2.51 Solution: then, Working Capital = Curent Assets ~ Current Liabilities € 6,00,000 = 25x - x 1690000 = 154 ‘Therefore, %6,00,( 0 Current Liabilities (2) = = = € 400,000. (a) Current Assets = & 4,00,000 * 25 = & 10,00,000. (ii) Liquid Ratio/Aci Test Ratio Quick Assets __ 2600000 4.5 4, Current Liabilities %400,000 ~~ (Quick Assets = Current Assets ~ Inventories = 10,00,000 ~ & 4,00,000 = & 6,00,000. y ae 1700000. Its i Cm veg er ZH Ch ai Lg a Solution: : cS Assets 217, 00,000, Current Liabilities Current Liabilities Current Liaiites « £27.00,00, 25 CCurcent Ratio = 680,000. Liguid Assets Curse Liabilities" . Ee ibis ee cut tT 8S tory = Current Assets ~ Liquid / Gan ‘quid Asse 100" a sono Liquid Ratio = jos eotitd rai on 3 . | we owing ssormation, calculate Quick Ratio i oo t 2 de Deb 1440000 | Long term Bortowings 480,000 rot ge oe ‘Long-term Provisions 490,000 ott sets ‘Long-term Loans and Advances 1,20,000 {i poet St ard PT Prepaid Expenses 12,000 oe ie Ae) Inventories 228,000 | i investment 120000 ie \ " Quick Assets _ %7,20,000 i 5:1 i io __ golvtO™ Quick Ratio“ Current Liabilities € 4,80,000 Total Assets ~ Non-curent Assets (Fixed Assets + Nor-current 4 Investments + Long-term Loans and Advances) ! =e 19.2000 - ©6000 (7,20, 000 + & 120,000 + & 120.000) = © 9,60,000 quick Assets = Curent Assets = Inventories - Prepaid Expenses ‘= € 9,60,000 ~ & 2,28,000 — & 12,000 = & 7,20,000 ities = Total Outside Debts ~ Non-current Debts (Long-term Borrowings } current Assets = 1 Liabil curren + Long-term Provisions) = © 14,40,000 ~ T 9,60,000 (& 4,80,000 + & 4,80,000) = ¢ 4,80,000. tation 3 ion information, alee Quick Ratio and Current Ratio: t c | at +12,00,000 | Long-term Borrowings 4,00,000 i eset 1690.00 | Long term Provslons 490000 | Facd se 6,00,000 | Inventories 1,90,000 i fates 100000 | pepald Expenses 10000 tom arsan nes Oe) +0000 salution: ise an ick Ratio = —Quck ASSES = =15:1 ae Gorrent Liabilities | €4,00,000 * Current Assets _ €8,00,000 4 Current Ratio Gyrrent Liabilities €4,00,000 is = Total Assets ~ Non-current Assets = 16,00,000 — [ 6,00,00 (Fixed Assets) + < 1,00,000 (Non-current Investments) + € 100,000 (Long-term Loans ‘and Advances) = & 800,000. Quick Assets = Current Assets ~ Inventonice = Prepaid Expenses = = 8,00,000 — &1,90,000 ~ € 10,000 = © 6,00,000. Current Liabilities = Total Debt ~ Non-curzent Liabilities = © 12,00,000 ~ [& 4,00,000 (Long-term Borrowings) + € 400,000 (Long-term Provisions)] = 12,00,000 ~ & 8,00,000 = € 40,00. Current Assetanalysis of nana Statement, ste, 3 Ratio: ' Curent Fat pees ©2500 Working Capita yy, on 5 50000 _ 951, hy ing pen lO eo onet Ral * Curent Assets guts ©200 oat tories + Prepaid Expenses ar avert curent 808 * vial A oa + 2800 © 50,000. sgt ste tte, giving 260° which of the folowing jg 17 1 State, debtors; oot is centing € 1000) for € 60,0005 : + furiture (Book value © 10,000) for € 7,500; and Solution: {9 ood purchased for cash will Ratio will reduce. the total of quick assets b of quick asset tj Cash collected from debtors will not change the total O° cian (cre quik ase wil be replaced by another “Therefore, the Quick Ratio will not change (a Sale of goods for cash wil increase the total ofthe quick assets. Therefore, the Quicy Ratio will improve. (ey Sale of funiture for 87500 wil ineease the total of quick ass (Quick Ratio will improve. () Payment of Dividend will reduce the quick aes 28 well a5 current liabilities by the same amount. Therefore, the Quick Ratio will improve Illustration 37. Quick Ratio ofthe company is 15:1. State with reason which ofthe following transactions ‘would () increase, (i) decrease or (i) not change the ratio: { Paid rent & 3,000 in advance (i) Trade Receivables i a i a les included a debtor Shri Ashok who paid his entire amount due 1 reduce te total of quick assets: Therefore, the Quic, sets. Therefore, the nate 3.23 jon 35 3ti08 is 1:1. State, wit : 1 with reason, whether the lowing transactions eos not cage he ratio: . oe ec reno ee 00, i i) once 8 (je fal i yea 9% ‘Debentures of € 5,00,000 to the vendor for machinery purchased @ 1 ASSETS ods on credit % 8,000 1d equity shares of % 1,00,000 (CBSE 2019) ee ae se ea nee ‘Current Liblities will increase with no change in Quick Assets, ‘Wether Quid Asets nor Curent Labties ae changing palance Sheet of Venus Limited as at 3ist March, 2023: Wo a te goronings TO DEDENIES 7 abilities {@) Tade Payables (short-term Provisions otal 4, Non-Current Assets Property. plant and Equipment andintangibleAsets: propery, Plant and Equipment 2. Current Assets {a} Inventories (b) Trade! Receivables \ wo Cash and Cash Equivalents | Solution: (0D 2014) (ay Other Cues: Transactions Effect on Quick Ratio Prepaid Expenses: 0 Owcese | Quik sets = oe 2 aod sna Gece by ® 3,000 but Current Liabilities have not * w ase |Gceriea Quick Ratio will decrease, Calculate: Debtor — _i ee tei ce bnis. (Debtors is replaced by another Current Asset (cash ( Current Ratio, and (ii) Liquid Ratio. Ore What conclusions are drawn on the basis of these ratios?analysis of Financial Statemeny, SN Cas, aoe’ J 00+ sce te current labiiis. In this case ts sh0 ios. Hence: short-term financial position “">y a the cu eable to meet tS current liabilities pro, hy 2 de reseabes Cash and Cash aa com asses ee payables + Shor-term Provision’ sid ato * Gorsent Liabilities Lig 1112800 _ 947: 1 722800. onto S Ty * eA @ . ee “ position ca be said to be satisfactory, jy ar viguid Ratio is? a an riquaity postion nf the company is Not satis case, itis less as are not in slau ‘ese have been given for better understanding , vt pont 2, SOLVENCY | (LONG-TERM SOLVENCY) RATIOS in a position to meet tts long-term fnanig of business mens od when they become due are the ratios which show wh «jal obligations i, Fong-term Solvency ablations 0 ‘solvency Ratios’ its long-term finan’ (9 Debt to Equity Ratio: {ip Total Assets to Debt Ratio: ther the enterprise will be able to et portant solvency ratios ary liabilities. [mj (ii Proprietary Ratio; ¢) Itorest Coverage Ratio; and {o) Debt to Capital Employed Ratio. Let us discuss them in detail. (i) Debt to Equity Ratio Debt to Equity Ratio shows relations Funds) ofthe enterprise. It is compute Long-term Debts are external liabilities and inclu provisions They ae shown as non-curentLabilites inthe Equity and Liabilities part of ty o ip beeen long-term debls and equity (ie, Shareholders’ Ht assess long-term financial soundness of the enterprise, ide long-term borrowings and long-term the Balance Sheet. Major components of Lo nts of Long-term Borrowings are Debentures, Be hs poe res, Bonds, Mortgage Loan, Bank and Financial Institutions, Public Deposits, etc. oe 3.25 punes (CHEUOY NO. Acod-43/2013 dated and hy, 2013, accounting TOIT of cussed a "not inciuded in the 4 east ould ee Fee a cent een a Erp ne ge 1 meet © ablty amount of which a ag ane J is not determine i cries term provisions are in the nature af longterm HAHN in ex les, 1¢., external debts in spite of the fact that the amount ud Mt at the time of settlement of lability Se ce eae en # Jel ings undet Non-current Liabilities If hey are, jaths or after of ae pore 2 Eee ee a montane ‘Borrowings: Hot ng et er of orrowings payable within 12 months or within the period 1 fe from the date of he Balance ‘Sheet are shown as Short-term Borrowings under main a current liability, itis not considered while ‘computing Debt tO 4 but is provided months or after the 0. Non-current Liabilities if able after 12 ity at or shown as Liabilities if they are payable 1g Debt to Ea! are cS romthe date of Balance Sheet. They ce are considered while tannin eee oy a2 pe funds of the shareholders and it include Share Capital and Reserves and eqns, THUS jus: y ‘i Hpi THs polders’ Funds = Share Capital + Reserves an en sha a and Surplus = Non-current Assets (Tangible Assets + Intangible ASSO ++ Non-current (Trade) Investments + Long-term Loans 5% Advances) + Working Capital" - Non-current Liabilities (Long-term Borrowings + Long-term Provisions) r | = Total Assets - Total Debt (Non-cur! syyorking Capital = Current Assets ~ Current Liabilities plus, He, Balance in Statement of Profit & Loss has debit be it ote! wry shorenorders Funds. a Debt to Equity Ratio is computed as follows: Debt to Equity Ratio = eo reca Dee Tquity Ghareholders’ Funds) rent and Current Debts) deducted to compute computation: ois expressed as ‘Pure Ratio’ say 2: 1. ¢ to Equity Rati peb' Debt = Long-term Borrowings + Long-term Provisions Or = Total Liabilities - Current Liabilities Or = Capital Employed ~ Equity ote: capital Employed = Debt + Equity or = Non-current Assets + Working Capitalanalysis of Financial Statema,, | “ay, nd Ju, 2013), accounting yy, 13 dated 2m anrent Assets have nor 1, ah 27013 Sc rot ey 3.26 Acad pe 88 guiaetines (HO, eyaiuated “et Geter Norco" a ance Sheet under Non-current Labi [ feos se the aa nancial instieutions, and pubic day ings # an : Lange boron Balance Sheet under N-cutent gy ree cs To snow in eB casent payable on "ti Long,-teem Pro¥ for Cis depending more on long-term yo ye include liabilities S4* at the enterprise i ae vteseneel Yow Irae or Debs to Equity Rati sect, lenders are at high : eo : oa cee aity Ratio means that he Sn Pe Pending = ings or long- 65. In nd, -term borrowings ne ‘on the other hat jinst long-t! : fy on shade fd have higher safety cover: lowe lenders are at 8 / 1 is considered as an appropriate ratio 2: Ideal Ratio ; Normally, Debt to Equity Ratio of Objective and Significance rated to measure the ratio in which long-term borrow, : Debt to Equity Ratio is calcul re invested in the company, to assess long external funds and shareholders’ financial postion and soundness a extent to which the enterprise depends on funds at i of fong-erm financial policies of the enterprise ang 7 rowed funds for its business. Ilustration 40. . From the following information, calculate Debt to Equity Ratio: . z opt Debentures : ‘Share Ca 10,000 Equity Shares of 8 10 each 1,00,000 000 General Reserve a 70,000 | Long-term Provisions 25,009 30000 | Outstanding Expenses tae Surplus, Balance in Statement of Profit & Loss Solution: Debt (Long-term Debts) __% 1,00,000 Equity (Shareholders Funds) %2,00,000 ~ 9-59: 1. ‘Debt (Long-term Debts) = Debentures + Long-term Provisions = 75,000 + & 25,000 100,00, Faulty = Share Capital + General Reserve + Surplus i, Balance in Statement of Profit & Loss = 1,000 + & 70,000 + ® 30,000 = & 2,00,000, Debt to Equity Ratio = Mlustration 41, Calculate Debt to Equity Ratio from the following information: ( Total Assets : (i) Total External Liabilities ee 100,000 (i) Current Liat 500m ing ate 3.27 ee Debt (Long. jon cee t (Long-term Debts) 250,000 4.4 goiter ept to Equity Equity (Shareholders Funds) ~ 225,000 Total External Liabilities ~ Current Liabilities ppt (Lone 1,00,000 - 2 50,000 = 2 50,000 snolders’ Funds) = Total Assets — Total Debts or Liabilities | hare! 2 125,000 ~ % 1,00,000 = & 25,000. eq jon 42- fe trati following information, calculate Debt to Equity Ratio the z x s | ro — 2,00,000 | Non-current Assets seats ste 1,00,000 | Current Assets ee er 50,000 vend abies (Delhi 2014) curt a Debt (Long-term Debts) 3,00,000 Equity Ratio = emo iso Debt 1 BATT Equity (Shareholders Funds) — % 1,00,000 solu! spt (Long-term Debts) = Long-term Borrowings + Long-term Provisions Del = & 2,00,000 + % 1,00,000 = % 3,00,000. shareholders’ Funds) = Non-current Assets + Current Assets — (Long-term | gauity ¢ Borrowings + Long-term Provisions + Current Liabilities) = 3 3,60,000 + % 90,000 — (& 2,00,000 + & 1,00,000 + % 50,000) = & 4,50,000 ~ & 3,50,000 = & 1,00,000. ion 43. ration i . milus' te Debt to Equity Ratio from the following information: calcula z . 6,00,000 | Current Assets. 2,50,000 (G10ss) fa A rection 1.000000 | Current Liabilities 2,00,000 comet westnents 30,000 | Long-term Borrowings (10% Debentures) 3,00,000 Hore ans and AdvaNCES 20,000 | Long-term Provisions 1,00,000 von" ion: solutic Debt (Long-term Debts) %4,00,000 pebt to Equity Ratio = Equity (Shareholders Funds) ~ %2,00,000 Notes: 1, Debt (Long-term Debts) = Long-term Borrowings + Long-term Provisions 2. Equity **Non-current Liabilities “Non-current Assets = Fixed Assets (Gross) — = % 3,00,000 + ® 1,00,000 = & 4,00,000, Non-curtent Assets* + Current Assets - Current Liabilities ~ Non-current Liabilities** % 5,50,000 + & 2,50,000 ~ € 2,00,000 ~ & 4,00,000 = & 2,00,000. Accumulated Depreciation + Non-current Investments + Long-term Loans and Advances (6,00,000 - % 1,00,000) + % 30,000 + % 20,000 = ® 5,50,000.of Financial Statemen, analysts ty, \ tal Employed «400,000, CaP z 1209, ion 44 usta? rot Deg 1 calc golstiOr any RatiO™ Equity erent ‘pebt to Eau? pe Total Debt em 12,00,000 = sry capital Emp! savin. © pebt_ €8,00,000 _ 4.7, ty Ratio” Equity _ €2,00,000 _ Debt = Total Debt - Current Liabilities os Fg 12,00,000 - € 4,00,000 = & 8,00/ Debt sity = Total Assets ~ Total Equity * 400,000 ~ & 12,00,000 = € 2,00,000- lustration 46. Total Assets € 28,00,00 Debt to Equity Ratio. Solution: 0, Total Debt € 24,00000, Capital Employed € 20,00,000. Calcul ‘otal Assets - Total Debts :28,00,000 ~ % 24,00,000 = & 4,00,000 Debt = Capital Employed - Equity = % 20,00,000 - ¥ 4,00,000 = % 16,00,000. Mlustration 47. Sewak Ltd. has a Current Ratio of 3 : 1. Its Working Capital is © 5,00,000. Total Assets 875,000. Total Debt & 7,50,000. Calculate Debt to Equity Ratio. Soluti Current Assets ‘Current Liabilities ~ Current Assets = 3 Current Liabilities Working Capital = Current Assets - Current Liabilities %5,00,000 = 3 Current Liabilities - Current Liabilities 35, Current Ratio = Debt = Total Debt ~ Current Liabilities = 8 7,50,000 ~ & 2,50,000 2 5,00,000 3.29 10s g Rae equity ~ Total Assets ~ Total Debts = & 8,75,000 - % 7,50,000 = z 1,25,000, ___Debt__ %5,00,000 | equity Ratio Equity ~ €1,25,000 =437 to ei bt : ratio o Raja Ltd. is 1.5 : 1. Its Working Capital is < 3,00,000 and Inventories are ‘Total Assets % 9,50,000. Total Debts & 7,00,000. Calculate Debt to Equity Ratio. Quick Assets 0" Current Liabilities ck Assets = 15 Current Liabilities Qui capital ~ Current Assets (= Quick Assets + Inventories) - Current Liabilities worki"B 59,000 = 1.5 Current Liabilities + Inventories ~ Current Liabilities zt 3,00,000 = 1.5 Current Liabilities + = 2,00,000 - Current Liabilities ‘Liabilities ~ € 100,000; Current Liabilities = & 2,00,000 15:1 5 carsent PY" opt = Total Debts ~ Current Liabilities " = 7 7,00,000 — 2,00,000 = & 5,00,000 Equity = Total Assets ~ Total Debts = & 9,50,000 — % 7,00,000 = & 2,50,000 _ Debt _ %5,00,000 pt to Eauity RHO Eouity ~ %2,50,000 ~ tlustration Set Ratio is 2 : 1. State, giving reasons, whether this ratio will increase OF ee 10 fall not change in each one of the fllowing cases: purchase of a Fixed Asset by taking long-term loan. (0 ary of Fixed Asset (Book value & 40,000) at a loss of & 5,000. i See of Fixed Asset (Book value % 40,000) for & 50,000. ci) Jesue of New Shares for Cash. 4 jssue of Bonus Shares. H Redemption of Debentures for Cash. a Conversion of Debentures into Equity Shares. a Declaration of Final Dividend. (Delhi 2010) solution: Transactions | Effect on Debt to Reason Equity Ratio at Tacrease | Total Long-term Debts are increased but total Shareholders’ Funds remain unchanged. ‘As numerator (Long-term Debt) will increase and denominator (Equity) will not change, Debt to Equity Ratio will increase. a} Increase | Total Shareholders’ Funds will decrease by the amount of loss (% 5,000) but total Long-term Debts will remain unchanged, As numerator (long-term debt) will not ____| change and denominator (Equity) will decrease, Debt to Equity Ratio will inerease. a) Decrease | Total Shareholders’ Funds are increased by the amount of profit (@ 10,000) but total Long-term Debts remain unchanged. As numerator (Long-term Debt) will not (Equity) will increase, Debt to Equity Ratio will decrease.