SMART LEARN CA S.S.

RAJAGOPAL

Ratio analysis
Learning objective 1:
Balance Sheet Vertical Format

Particulars Amount Amount

I Sources of Funds
A. Shareholder’s Funds
Share capital XXX
+ Reserves and surplus XXX
- Misc exp (XXX)
TOTAL XXX
B. Borrowed funds
Secured loans XXX
Unsecured loans XXX
TOTAL XXX
C. Capital employed [A+B] XXX

II Application of Funds
A. Fixed assets [Cost-Depn]
Tangible Fixed assets XXX
Intangible Fixed assets XXX
Capital Work in Progress XXX
TOTAL XXX
B. Long term Investments XXX
C. Working capital
Current Assets XXX
- Current Liabilities (XXX)
TOTAL XXX
C. Capital Employed [A+B+C] XXX

Notes:
1. Share capital = Equity share capital + Preference share capital
2. Reserve and surplus = Free reserves + Capital reserves + Statutory reserves
3. Share holders funds also called as Equity, Net worth, Owners fund or Proprietor’s funds.
4. Misc expenses = Preliminary expenses, discount on issue, P&L account [Dr]

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Learning Objective 2:

Income Statement Vertical Format

Particulars Amount Amount

A. Sales XXX
B. Cost of goods sold
Opening stock XXX
+ Cost of production XXX
-Closing stock (XXX)
Total (XXX)
C. Gross profit [A-B] XXX
D. Operating income XXX
E. Operating exp[Admin and selling] (XXX)
F. Operating Profit [EBIT] [C+D-E] XXX
G. Non-operating income XXX
H. Non-Operating expenses (XXX)
I. Interest (XXX)
J. Profit before tax [PBT] [F+G-H-I] XXX
K. Provision for tax (XXX)
L. Profit after tax [PAT] [J-K] XXX
M. Opening Balance in P&L XXX
N. Appropriations
Proposed dividend XXX
Transfer to reserves XXX
Total (XXX)
O. Closing Balance P&L XXX

Note:
1. Sales = Sales – Sales return [Net sales]
2. Cost of production is the manufacturing cost of production seen in cost sheet.
3. Operating income = Discount received, royalty, commission received.
4. Non-operating income = rent received, profit on sale of assets, interest/dividend income
etc.
5. Non-operating expense = loss on sales of assets, write offs etc

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Learning Objective 3:
Types of Ratios

Liquidity Capital Structure Activity Profitability Miscellaneous

Ratios or short Ratios or Long Ratios or Ratios Ratios
term solvency Term Solvency Turnover
ratios Ratios ratios
a. Current Ratio a. Debt Equity a. Capital 1.Profitability a. EPS
b. Acid test Ratio turnover ratio on sales b. MPS
ratio or Quick b. Equity ratio b. Fixed a. Gross profit c. PE ratio
ratio or Liquid c. Debt ratio assets ratio d. DPS
ratio
d. Debt to Total turnover ratio b.Net profit ratio e. Dividend
c. Cash ratio
d. Defense assets ratio c. Working c. operating payout ratio
interval ratio e. Propriety ratio capital profit ratio f. Dividend yield
f. Capital gearing turnover ratio d. CGS to sales g. Retention
ratio d. Debtors ratio ratio
Coverage ratios turnover ratio e. Operating
g. Debt service e. Inventory expenses ratio
coverage ratio turnover ratio f. Operating ratio
h. Interest f. Creditors
coverage ratio 2 Profitability
turnover ratio
i. Preference div on Capital
coverage ratio a. Return on
h. Fixed charges capital employed
coverage ratio
b. Return on
Equity

Learning Objective 4:
Ratios Formula

Ratio Formula Remarks

1. Current ratio Current Assets/Current ➢ Current assets are intended to
Liabilities be kept for less than one year.
➢ Current liabilities become due
within a year.
2. Liquid ratio Liquid assets/Current ➢ Liquid Assets = Current assets
Liabilities – Stock – Prepaid expenses

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3. Cash ratio [Cash + Bank + Mkt

sec]/Current liabilities
4. Defense interval Cash + Bank + Mkt
ratio sec]/Operating exp per day
5. Debt Equity ratio Debt/Equity ➢ Debt means long term debt
➢ Equity = Share capital +
Reserves and surplus – Misc
exp not written off.
➢ Equity is also called as Net
worth, Shareholders funds or
Proprietors funds.
➢ Preference share capital forms
part of equity while calculating
debt equity ratio.
6. Equity ratio Equity/Capital employed ➢ Equity has same meaning as
point 5
7. Debt ratio Debt /Capital employed
8. Debt to Total assets Debt/Total assets
ratio
9. Proprietary ratio Equity/Total Asset ➢ Equity includes preference
share capital
10. Capital gearing [Debt + Preference share ➢ Equity does not include
ratio capital] / Equity preference share capital
11. Debt service FFO or CFO / [Interest + ➢ Income available to service
coverage ratio Installment] debt commitments.
➢ FFO = PAT+Depn+Profit/loss
on sale of assets
➢ CFO = FFO + Working capital
adjustment
12. Interest coverage EBIT/Interest ➢ Income available to service
ratio interest.
13. Preference PAT/Pref dividend ➢ Profit available to service
dividend coverage preference dividend.
ratio
14. Fixed charges [EBIT+Depn] /[Interest
coverage ratios +Inst/1-t]
15. Capital turnover Sales / Capital employed ➢ Capital employed = Debt +
ratio Equity
➢ Capital employed = Fixed
assets + working capital
16. Fixed assets Sales / Fixed assets
turnover ratio

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17. Working capital Sales / Working capital

turnover ratio
18. Debtors velocity Sales / Drs or Sales / ➢ Expressed in times
[Debtors turnover Average Drs ➢ Sales means credit sales
ratio]
19. Debtors velocity Debtors / Sales x 360 or 12 ➢ Expressed in period [months
[Debt collection or days]
period]
20. Stock velocity Cost of goods sold / ➢ Expressed in times
[Stock turnover ratio] Average stock or Stock
21. Stock velocity Average stock or stock / ➢ Expressed in period
[Inventory holding Cost of goods sold x 360 or
period] 12
22. Creditors velocity Purchases / creditors or ➢ Purchases means, credit
[Creditors turnover Average creditors purchases.
ratio]
23. Creditors velocity Creditors or Average ➢ Expressed in period
[Creditors payment creditors / Purchases x360
period] or 12
24. Gross Profit ratio Gross Profit / Sales x 100 ➢ Gross Profit = Sales- Cost of
goods sold
➢ Cost of goods sold means
manufacturing cost of goods
sold
➢ In case of trading firm COGS
= Opening stock + Purchases
– Closing stock
25. Net profit ratio Net profit / Sales x 100 or
PAT / Sales x 100
26. Operating profit Operating profit / Sales x
ratio 100 or EBIT / Sales x 100
27. COGS to Sales COGS / Sales x 100
ratio
28. Operating Operating expenses / Sales
expenses ratio x 100
29.Operating ratio COS/Sales COS = CGS + AOH + SOH
30. Return on Capital [PAT + Interest]/ Capital It can be pre -tax and post tax.
employed [ROCE] employed or
EBIT[1-t]/Capital Employed
or EBIT/Capital employed.
31. Return on Equity PAT / Equity
[ROE]

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Solution to Problem 1:
Balance Sheet Vertical Format

Particulars Amount Amount

I Sources of Funds
A. Shareholder’s Funds
Share capital
Equity share capital 400000
9% Preference share capital 200000 600000
+ Reserves and surplus
P&L account 28000
General reserve 200000 228000
- Misc exp
Preliminary expences 25000 (25000)
TOTAL 803000
B. Borrowed funds
Secured loans
12% Debentures 300000
Unsecured loans -
TOTAL 300000
C. Capital employed [A+B] 1103000

II Application of Funds
A. Fixed assets [Cost-Depn]
Tangible Fixed assets
Building 300000
Machinery 260000 560000
Intangible Fixed assets
Goodwill 30000 30000
Capital Work in Progress -
TOTAL 590000
B. Long term Investments -
C. Working capital
Current Assets [Incl loans and advances]
Stock 389000
Debtors 400000
Prepaid expenses 5000
Bank 1000 795000
- Current Liabilities [Incl provisions]
Bank OD 114000

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Creditors 78000
Provision for tax 30000
Proposed dividend 60000 (282000)
TOTAL 513000
C. Capital Employed [A+B+C] 1103000

Ratios
1. Current ratio = Current Assets / Current Liabilities = 795000/282000 = 2.82:1
2. Liquid ratio = Quick Assets / Quick Liability = [795000-389000-5000]/[282000-114000]
= 401000/168000 = 2.39:1
3. Capital gearing ratio = [Debt + Preference capital]/Equity = 500000/603000 = 0.83:1.
4. Proprietary ratio = Equity / Total assets = 803000/[590000+795000] = 0.58:1
5. Debt equity ratio= Debt/Equity = 300000/803000 = 0.37:1
6. Stock to working capital ratio = Stock / Working capital = 389000/[795000-282000] =
0.76:1.

Solution to Problem 2:

Income Statement Vertical Format

Particulars Amount Amount

A. Sales
Gross sales 1057000
- Sales return -57000 1000000
B. Cost of goods sold
Opening stock 225000
+ Purchases 835000
-Closing stock -460000
Total (600000)
C. Gross profit [A-B] 400000
D. Operating income -
E. Operating exp[Admin and selling]
Administration expenses
Rent 18750
Salaries 35750
Depreciation 36000
Printing and stationery 17500
Audit fees 12000
Selling expenses
Advertising 32750
Salesmen salaries 14250
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Depreciation 8000
Total (175000)
F. Operating Profit [EBIT] [C+D-E] 225000
G. Non-operating income
Dividend on shares 15000
Profit on sale of shares 25000
Total 40000
H. Non-Operating expenses
Loss on sale of assets (45000)
I. Interest -
J. Profit before tax [PBT] [F+G-H-I] 220000
K. Provision for tax (100000)
L. Profit after tax [PAT] [J-K] 120000
Ratios:
1. Gross profit ratio = Gross profit / Sales = 400000/1000000 = 40%
2. operating ratio = Total operating cost / Sales = CGS+ Adm exp + Sell exp/Sales =
600000 + 175000/1000000 = 77.5%
3. Operating profit ratio = EBIT/Sales = 225000/1000000 = 22.5%
4. Selling and distribution exp ratio = 55000/1000000 = 5.5%