Ratio Analysis

Ratio: A ratio is a simple arithmetical expression of the relationship of one number to another. Ratio Analysis: Ratio Analysis is a technique of analysis and interpretation of financial statements. It is the process of establishing and interpreting various ratios for helping in making certain decisions. USES & SIGNIFICANCE OF RATIO ANALYSIS A)Managerial uses of Ratio Analysis 1. Helps in decision-making. Financial statements are prepared primarily for decision-making. But information provided in financial statements is not an end in itself and no meaningful conclusion can be drawn from these statements alone. Ratio analysis helps in making decisions from the information provided in these financial statements. 2. Helps in financial forecasting and planning. Ration Analysis is of much help in financial forecasting and planning. Planning is looking ahead and the ratios calculated for a number of years work as guide for the future. Meaningful conclusions can be drawn for future from these ratios. Thus, ratio analysis helps in forecasting and planning. 3. Helps in communicating. The financial strength and weakness of a firm are communicated in a more easy and understandable manner by the use of ratios. The information contained in the financial statements is conveyed in a meaningful manner to the one for whom it is meant. Thus, ratios help in communication and enhance the value of the financial statements. 4. Helps in co-ordination. Ratios even help in co-ordination which is of utmost importance in effective business management. Better communication of efficiency and weakness of an enterprise results in better co-ordination in the enterprise. 5. Helps in control. Ratio analysis even helps in making effective control of the business. Standard ratios can be based upon Proforma financial statements and variances or deviations, if any, can be found by comparing the actual with the standards so as to take a corrective action at the right time. The weakness or otherwise, if any, come to the knowledge of the management which helps in effective control of the business. B) Utility to Shareholders/Investors: An investor in the company will like to assess the financial position of the concern where he is going to invest. His first interest will be the security of his investment and then a return in the form of dividend or interest. For the first purpose he will try to asses the value of fixed assets and the loans raised against them. The investor will feel satisfied only if the concern has sufficient amount of assets. Long-term solvency ratios will help him in assessing financial position of the concern. Profitability ratios, on the other hand, will be useful to determined profitability position. Ratio analysis will be useful to the investor in making up his mind whether present financial position of the concern warrants further investment or not. C) Utility to Creditors: There are interested to know whether financial position of the concern warrants their payments at a specified time or not. The concern pays short-term creditors out of its current assets. If the current assets are quite sufficient to meet current liabilities then the creditors will not hesitate in extending credit facilities. Current and Acid-test ratios will give an idea about the current financial position of the concern. D) Utility to Employees: Employees wages and fringe benefits are related to the volume of profits earned by the concern. The employees make use of information available in financial statements. Various profitability ratios relating to gross profit, operating profit, net profits, etc., enable employees to put forwards their view point for the increase of wages and other benefits.

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E) Utility to Government: Government may base its future policies on the basis of industrial information available from various units. The ratios may be used as indicators of overall financial strength of public as well as private sector. In the absence of the reliable economic information, governmental plans and policies may not prove successful. LIMITATIONS OF RATIO ANALYSIS 1. Limited Use of a Single Ratio. A single ratio, usually, does not convey much of sense. To make better interpretation a number of ratios have to be calculated which is likely to confuse the analyst than help him in making any meaningful conclusion. 2. Lack of Adequate Standards. There are no well accepted standards or rules of thumb for all ratios which can be accepted as norms. It renders interpretation f the ratios difficult. 3. Inherent Limitations of Accounting. Like financial statements ratios also suffer from the inherent weakness of accounting records such as their historical nature. Ratios of the past are not necessarily true indicators of the future. 4. Change of Accounting Procedure. Change in accounting procedure by a firm often makes ratio analysis misleading, e.g., a changed in the valuation of methods of inventories, from FIFO to LIFO increases the cost of sales and reduces considerable the value of closing stocks which makes stock turnover ratio to be lucrative and an unfavorable gross profit ratio. 5. Window Dressing. Financial statements can easily be widow dressed to present a better picture of its financial and profitability position to outsiders. Hence, one has to be very careful in making a decision from ratios calculated from such financial statements. But it may be very difficult for an outsider to know about the window dressing made by a firm. 6. Personal Bias. Ratios are only means of financial analysis and not an end in itself. Ratio has to be interpreted and different people may interpret the same ratio in different ways. 7. Uncomparable. Not only industries differ in their nature but also the firms of the similar business widely differ in their size and accounting procedures, etc. it makes comparison of ratios difficult and misleading. Moreover, comparisons are made difficult due to differences in definitions of various financial terms used in the ratio analysis. 8. Absolute Figures Distortive. Ratios devoid of absolute figures may prove distortive as ratio analysis is primarily a quantitative analysis and not a qualitative analysis. 9. Price Level Changes. While making ratio analysis, no consideration is made to the changes in price levels and this makes the interpretation of ratios invalid. 10. Ratios no Substitutes. Ratio analysis is merely a tool of financial statements. Hence, ratio become useless if separated from the statements from which they are computed. CLASSIFICATION OF RATIOS Liquidity Ratios Activity Ratios Long term Solvency Ratios Profitability Ratios LIQUIDITY RATIOS: liquidity refers to the ability of a concern to meet its current obligations as and when these become due. The short term obligations are met by realizing amounts from current, floating or circulating assets. The current assets should either be liquid or near liquidity. These should be convertible into cash for paying obligations of short-term nature. To measure the liquidity of a firm, the following ratios can be calculated: Current Ratio Quick or Acid Test or Liquid Ratio Absolute Liquid ratio or Cash position ratio

RATIO ANALYSIS

Ratio Analysis
1. CURRENT RATIO: Current ratio may be defined as the relationship between current assets and current liabilities. This ratio is also known as working capital ratio. It is calculated by dividing the total of current assets and total of current liabilities. Current Assets Current Ratio = ------------------------Current Liabilities COMPONENTS OF CURRENT RATIO CURRENT ASSETS CURRENT LIABILITIES Cash in hand Outstanding expenses Cash at bank Bills payable Marketable securities Sundry creditors Bills receivable Short term advances Sundry debtors Income tax payable Inventories Dividends payable Prepaid expenses Bank overdraft Accrued incomes Significance of current ratio: current ratio is a general and quick measure of liquidity of a firm. It represents the margin of safety or cushion available to the creditors and other current liabilities. It is most widely used for making short-term analysis of the financial position or short-term solvency of a firm. Interpretation of current ratio: Standard norm of the current ratio is 2:1 as considered to be satisfactory. A high current ratio may not be favorable due to the following reasons: There may be show moving stocks. The stocks will pile up due to poor sale. The figures of debtors may go up because debt collection is not satisfactory. The cash or bank balances may be lying idle because of insufficient investment opportunities. On the other hand, a low current ratio may be due to the following reasons: There may not be sufficient funds to pay off liabilities. The business may be trading beyond its capacity. The resources may not warrant the activities. 2. QUICK OR ACID TEST OR LIQUID RATIO: The term liquidity refers to the ability of a firm to pay its short-term obligations as and when they become due. Quick Ratio may be defined as the relationship between liquid assets and current liabilities. An asset is said to be liquid if it can be converted into cash within a short period without loss of value. Liquid Assets Quick Ratio = -----------------------Current Liabilities Liquid Assets = Current Assets (Inventories + Prepaid Exp.) Significance of Quick Ratio: the quick ratio is very useful in measuring the liquidity position of a firm. It measures the firms capacity to pay off current obligations immediately and is a more rigorous test of liquidity than the current ratio. It is used as a complementary ratio to the current ratio. Interpretation of quick ratio: Standard norm of the quick ratio is 1:1 as considered to be satisfactory. Usually, a high acid test ratio is an indication that the firm is liquid and has the ability o meet its current or liquid liabilities in time and on the other hand a low quick ratio represents that the firms liquidity position is not good. Significance of quick ratio: The quick ratio is very useful in measuring the liquidity position of a firm. It measures the firms capacity to pay off current obligation immediately and is a more rigorous test of liquidity than the current ratio. It is used as a complementary ratio to the current ratio. 3. ABSOLUTE LIQUID RATIO OR CASH RATIO: It is the relationship between absolute liquid assets and current liabilities.

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Absolute liquid Assets Absolute Liquid Ratio = ------------------------------Current Liabilities Absolute Liquid Assets = Cash + Bank + Marketable Securities The acceptable norm for this ratio is 2 : 1 ACTIVITY RATIOS Funds are invested in various assets in business to make sales and earn profits. The efficiency with which assets are managed directly affects the volume of sales. The better the management of assets, the larger is the amount of sales and the profits. Activity ratios measure the efficiency or effectiveness with which a firm manages its assets. The ratios are also called turnover ratios because they indicate the speed with which assets are converted or turned over into sales. These ratios are expressed as times and should always be more than one. Some activity ratios are: 1. INVENTORY TURNOVER RATIO OR STOCK TURNOVER RATIO: This ratio establishes relationship between cost of goods sold and average stock or inventory. The ratio throws light on the efficient use of the stock. It also indicates whether the required minimum amount has been blocked in the stocks or not. This ratio provides guidelines to the management while framing stock management policy. It is calculated as under:Cost of goods sold Stock Turnover Ratio = -----------------------Average Stock Costs of goods sold = Opening stock + Purchases + Direct expenses Closing Stock Or Sales Gross Profit Opening Stock + Closing Stock Average Stock = ---------------------------------------2 If cost of goods sold is not given, the ratio is calculated from the sales. If only closing stock is given, then that may be treated as average stock Significance: The ratio signifies the number of times on an average the inventory or stock is sold during the period. The high ratio is indicative of efficiency and the low ratio is indicative of inefficiency of stock management. To judge whether the ratio is satisfactory or not it should be compared with its own past ratios or with the ratio of similar firms in the same industry or with industrys average. 12 months / 52 weeks / 365 days Stock Velocity = --------------------------------------------Stock Turnover Ratio 2. DEBTOR TURNOVER RATIO: This ratio establishes a relationship between net credit sales and average trade debtors and bills receivable. The objective of computing this ratio is to determine the efficiency with which the trade debtors are managed. This ratio is also known as ratio of net sales to average receivables it is calculated as under:Net Credit Sales Debtors Turnover Ratio = -----------------------------------Average Accounts Receivables Op. A.R + Cl. A.R Average Accounts Receivable = --------------------------------2 Accounts Receivable = Trade debtors + Bills Receivables If opening debtors are not available then closing debtors and bills receivable are taken as average debtors. If net credit sales are not available then total sales are treated as credit sales. Significance: Debtors turnover ratio is an indication of the speed with which a company collects its debts. The higher the ratio the better it is because it indicates that debts are being collected quickly. In general, a high ratio indicates the shorter collection period which implies prompt payment by debtors,

Ratio Analysis
land a low ratio indicates longer collection period which implies delayed payments by debtors. To judge whether the ratio is satisfactory or not, it should be compared with own past ratios or with the ratio of similar firms. Debtor Velocity/Debt Collection Period: This period shows an average period for which the credit sales remain outstanding and measures the quality of debtors. It indicates the rapidity or slackness with which the money is collected from debtors. This period may be calculated as under: 12 months / 52 weeks / 365 days Debt Collection Period = --------------------------------------Debtors Turnover Ratio 3. CREDITORS TURNOVER RATIO: This ratio establishes a relationship between net credit purchases and average trade creditors and bills playable and is calculated as under:Net Credit Purchases Creditors Turnover Ratio = -------------------------Average Accounts Payable Accounts Payable = Trade Creditors + Bills Payable Op. A.P + Cl. A. P Average Accounts Payable = ----------------------------------------2 Creditor Velocity / Debt Payment Period: This period shows an average period for which the credit purchases remain outstanding or the average credit period actually availed of: 12 months / 52 weeks / 365 days Debt Payment Period = ---------------------------------------Creditor Turnover Ratio ANALYSIS OF LONG-TERM FINANCIAL POSITION OR TESTS OF SOLVENCY The term solvency refers to the ability of a concern to meet its long term obligations. The long-term indebtedness of a firm includes debenture holders, financial institutions providing medium and long-term loans and other creditors selling goods on installment basis. The long-term creditors of a firm are primarily interested in knowing the firms ability to pay regularly interest on long-term borrowings, repayment of the principal amount at the maturity and the security of their loans. Accordingly, long-term solvency ratios indicate a firms ability to meet the fixed interest and costs and repayment schedules associated with its long-term borrowings. The following ratios serve the purpose of determining the solvency of the concern. 1. DEBT-EQUITY RATIO Debt-Equity Ratio is calculated to measure the relative claims of outsiders and the owners against the firms assets. This ratio indicates the relationship between the external equities or the outsiders funds and the internal equities or the shareholders funds, thus: Outsiders Funds Debt-Equity Ratio = --------------------------Shareholders Funds Outsiders Funds = Long Term Debts + Short Term Debts Shareholders Funds = Equity Share Capital + Preference Share Capital + Reserves and Surpluses Fictitious Assets Significance: It indicates the extent of fixed interest bearing funds being used in the business. A low debt-equity ratio implies the use of more equity than debt. This means that business runs at low gear and is likely to earn less profit as compared to the situation when debt is more than the equity in which case the business is likely to earn a higher return on the equity after paying the interest. The ideal Debt-Equity ratio is 1:1. 2. PROPRIETARY RATIO OR EQUITY RATIO This ratio establishes the relationship between shareholders funds to total assets of the firm. The can be calculated as under:

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Shareholders Funds Equity Ratio = ---------------------------Total Assets Total Assets = Fixed Assets + Current Assets Significance: As equity ratio represents the relationship of owners funds to total assets, higher the ratio or the share of the shareholders in the total capital of the company, better is the long-term solvency position of the company ratio indicates the extent to which the assets of the company can be lost without affecting the interest of creditors of the company. 3. SOLVENCY RATIO This ratio indicates the relationship between the total liabilities to outsiders to total assets of a firm and can be calculated as follows: Total Liabilities to Outsiders Solvency Ratio = --------------------------------------Total Assets Significance: Generally, lower the ratio of total liabilities to total assets, more satisfactory or stable is the long-term solvency position of a firm. 4. FIXED ASSETS TO NET WORTH RATIO The ratio establishes the relationship between fixed assets and shareholders funds, i.e., share capital plus reserves, surpluses and retained earnings. The ratio can be calculates as follows: Fixed Assets (After dep.) Fixed Assets to Net worth Ratio = -------------------------------Shareholders Funds Significance: This ratio indicates the extent to which shareholders funds are sunk into the fixed assets. Generally, the purchase of fixed assets should be financed by shareholders equity including reserves, surpluses and retained earnings. If the ratio is less than 100%, it implies that owners funds are more than total fixed assets and a part of the working capital is provided by the shareholders. When the ratio is more than 100% it implies that owners funds are not sufficient to finance the fixed assets and the firm has to depend upon outsiders to finance the fixed assets. There is no rule of thumb to interpret this ratio but 60% to 65% is considered to be satisfactory ratio in case of industrial undertakings. 5. FIXED ASSETS LTO TOTAL LONG TERM FUNDS OR FIXED ASSETS RATIO A variant to the ratio of fixed assets to net worth is the ratio of fixed assets to total long-term funds which is calculated as: Fixed Assets (After Depreciation) Fixed Assets Ratio = -------------------------------------Total Long-term Funds Significance: This ratio indicates the extent to which the totals of fixed assets are financed by long term funds of the firm. Generally, the total of the fixed assets should be equal to the total of long-term funds or, say, the ratio should be 100%. But in case the fixed assets exceed the total of the long-term funds it implies that the firm has financed a part of the fixed assets out of current funds or the working capital which is not a goods financial policy. And if the total long term funds are more than total fixed assets. It means that a part of the working capital requirements is met out of the long-term funds of the firms. 6. DEBT SERVICE RATIO OR INTEREST COVERAGE RATIO Debt service ratio is used to test the debt servicing capacity of a firm. The ratio is also known as interest Coverage Ratio of fixed Charges Cover or Times Interest Earned. This ratio is calculated by dividing the net profit before interest and taxes by fixed interest charges. Net profit (EBIT) Debt-Service Ratio or Interest Coverage = ---------------------Fixed Interest Charges

Ratio Analysis
Significance: interest coverage ratio indicates the number of times interest is covered by the profits available to pay the interest charges. Long-term creditors of a firm are interested in knowing the firms ability to pay interest on their long term borrowing. Generally, higher the ratios, more safe are the longterm creditors because even if earnings of the firm fall, the firm shall be able to meet its commitment of fixed interest charges. But a too high interest coverage ratio may not be good for the firm because it may imply that firm is not using debt as a source of finance so as to increase the earnings per share. PROFITABILITY RATIOS Profits are an index of economic progress. Profitability ratios are calculated to measure the overall efficiency of the business. Generally, profitability ratios are calculated either in relation to sales or in relation to investment. The various profitability ratios are discussed below: A. GENERAL PROFITABILITY RATIOS 1. GROSS PROFIT RATIO Gross profit ratio measures the relationship of gross profit to net sales and is usually represented as a percentage. Thus, it is calculated by dividing the gross profit by sales: Gross Profit Gross Profit Ratio = ----------------------- 100 Net Sales Significance: the gross profit ratio indicates the extent to which selling prices of goods per unit may decline without resulting in losses on operations of a firm. It reflects the efficiency with which a firm production its products. As the gross profit is found by deducing cost of goods sold from the net sales, higher the gross ratio (G.P Ratio) better the result. There is no standard norm for gross profit ratio and it may vary from business to business but the gross profit should be adequate to cover the operating expenses and to provide for fixed charges, dividends and accumulation of reserves. A low profit ratio, generally indicates high cost of goods sold due to unfavorable purchasing policies, lesser sales, lower selling prices, excessive completion, over-investment in plant and machinery, etc. 2. NET PROFIT RATIO Net profit ratio establishes a relationship between net profit (after taxes) and sales, and indicates the efficiency of the management in manufacturing, selling, administrative and other activities of the firm. This ratio is the overall measure of firms profitability and is calculated as: Net Profit after tax Net Profit Ratio = ----------------------------- 100 Net Sales Significance: This ratio also indicates the firms capacity to face adverse economic conditions such as price competition, low demand, etc. Higher the ratio, the better is the profitability. But while interpreting the ratio, it should be kept in mind that the performance of profits must also see in relation to investments or capital of the firm and not only in relation to sales. 3. OPERATING PROFIT RATIO This ratio is calculated by dividing operating profit by sales. Operating profit is calculated as: Operating Profit = Net Sales Operating Cost Operating Cost = Cost of Goods Sold + Administrative and Office Expenses + Selling and Distribution expenses Operating Profit Operating Profit Ratio = ---------------------------- 100 Sales 4. OPERATING RATIO Operating ratio establishes the relationship between cost of goods sold and the operating expenses on the one hand and the

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sales on the other. On other words, it measures the cost of operations per rupee of sales. The ratio is calculated by dividing operating costs with the net sales and its generally represented as a percentage. Operating Cost Operating Ratio = ----------------------- 100 Net Sales 5. EXPENSES RATIOS Expenses ratios indicate the relationship of various expenses to net sales. The operating ratio reveals the average total variations in expenses. But some of the expenses may be increasing while some may be falling. Hence, expense ratios are calculated by dividing each item of expenses or groups of expenses with the net sales to analyze the causes of variation of the operating ratio. The ratio can be calculated for each individual item of expenses or a group of items of a particular type of expense like cost of sales ratio, administrative expenses ratio, selling expense ratio, material consumed ratio, etc. The lower the ratio, the greater is the profitability and higher the ratio, lower is the profitability. While interpreting the ratio, it must be remembered that for a fixed expense of rent, the ratio will fall if the sales increase and for a variable expense, the ratio in proportion to sales shall remain nearly the same. Particular expense Particular Expense Ratio = ------------------------------- 100 Net Sales B. OVERALL PROFITABILITY RATIOS Profits are the measure of overall efficiency of a business. The higher the profits, the more efficient are the business considered. Overall profitability or efficiency of a business can be measured in terms of profit related to investments made in the business. Following are the important overall profitability ratios or measure of Return on Investments. 1. RETURN ON SHAREHOLDERS INVESTMENT OR NET WORTH Return on Shareholders Investment, popularly known as ROI or Return on Shareholder / Proprietors funds is the relationship between net profit (after interest & tax) and the proprietors, funds. Thus, Net Profit (after interest & tax) Return on Shareholders Investment = -------------------- 100 Shareholders Funds Significance: This ratio is one of the most important ratios used for measuring the overall efficiency of a firm. This ratio indicates the extent to which this primary objective of business is being achieved. This ratio is of great importance to the present and prospective shareholders as well as the management of the company. As this ratio reveals how well the resources of a firm are being used, higher the ratio, better are the results. The return on shareholders investment should be compared with the return of other similar firms in the same industry. The inter-firm comparison of this ratio determines whether the investments in the firm are attractive or not as the investors would like to invest only where the return is higher. 2. RETURN ON EQUITY CAPITAL Return on equity capital is the relationship between profits of a company and its equity capital can be calculated as: Net profit after tax preference dividend Return on equity capital = ---------------------------------- 100 Equity share capital (paid up) Significance: This ratio is more meaningful to the equity shareholders who are interested to know profits earned by the company and those profits which can be made available to pay dividend to them. Interpretation of the ratio is similar to the

Ratio Analysis
interpretation of return on shareholders investments and higher the ratio, better it is. 3. EARNINGS PER SHARE (E.P.S) An earnings per share is calculated by dividing the net profit after taxes and preference dividend by the total number of equity shares. Thus, Net Profit after Tax Preference Dividend E.P.S = ----------------------------------------------------No. of Equity Shares 4. RETURN ON CAPITAL EMPLOYED Profits before Interest and Tax Return on Gross Capital Employed = ---------------------------Gross Capital Employed Profit after Interest and Tax Return on Net Capital Employed = ------------------------------Net Capital Employed Gross Capital Employed = Fixed assets + Current Assets Net Capital Employed = Fixed Assets + Current Assets Current Liabilities 5. CAPITAL TURNOVER RATIO Capital turnover ratio is the relationship between Cost of Goods Sold and the capital employed. This ratio is calculated to measure the efficiency or effectiveness with which a firm utilizes its resources or the capital employed. As capital is invested in a business to make sales and earn profits, this ratio is a good indicator of overall profitability of a concern. Cost of Goods Sold or Sales Capital Turnover Ratio = -----------------------------Capital Employed MARKET TEST OR VALUATION RATIOS 6. DIVIDEND YIELD RATIO Shareholders are the real owners of a company and they are interested in real sense in the earnings distributed and paid to them as dividends. Therefore, dividend yield ratio is calculated to evaluate the relationship between dividend per share paid and the market value of the share. Dividend per share Dividend yield ratio = -------------------------Market value per share Dividend paid to shareholders Dividend per share = ---------------------------------------Number of shares 7. DIVIDEND PAY OUT RATIO OR PAYOUT RATIO Dividend pay-out ratio is calculated to find the extent to which earnings per share have been related in the business. It is an important ratio because ploughing back of profits enables a company to grow and pay more dividends in future. Dividend per equity share Dividend pay-out ratio = --------------------------------Earnings per share 8. PRICE-EARNING RATIO OR P/E RATIO (EARNINGS YUIELD RATIO) Price-earning ratio is the ratio between market price per equity share and earnings per share. The ratio is calculated to make an estimate of appreciation in the value of a share of a company and is widely used by investors to decide whether or not to buy shares in a particular company. The ratio is calculated as: Market price per equity share Price earnings ratio = ------------------------------------Earnings per share

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Generally, higher the price-earning ratio, the better it is. If the P/E ratio falls, the management should look into the causes that have resulted into the fall of this ratio. 9. EARNINGS YIELD RATIO This ratio also shows a relationship between earnings per share and market value of shares. It can be calculated as follows: Earnings per share Earning yield ratio = ---------------------------- 100 Market price per share Problems: 1. The following is the balance sheet of New India Ltd. for the year ending 31-12-2006. Liabilities Rs. Assets Rs. Eq. share capital 10,00,000 Goodwill 1,00,000 9% Pref. Sh. 5,00,000 Land & Building 6,50,000 Cap. 8% 2,00,000 Plant 8,00,000 Debentures 1,00,000 Furniture 1,50,000 long-term loan 60,000 Bills Receivable 70,000 Bills Payable 70,000 Sundry debtors 90,000 Sundry Creditors 30,000 Bank balance 45,000 Bank Overdraft 5,000 Short-term 25,000 O/S Expenses invest. 5,000 Prepaid 30,000 1965000 expenses 1965000 stock From the balance sheet calculate: a. Current ratio b. Acid test ratio c. Absolute liquid ratio d. Comment on these ratios [Ans: 1.61; 1.39; 0.42] 2. Following information is given to you: i) Current Ratio = 205; ii)Working Capital = Rs. 90,000; Find out: a) Current assets and b) Current Liabilities. [Ans: Rs. 60,000; Rs. 1, 50,000] 3. The following information of a company given: Current ratio 2.5:1; Acid Test Ratio 1.5:1; Current Liabilities Rs. 50,000. Find out: a) Current Assets; b) Liquid Assets; c) Inventory. [Ans: Rs. 1, 25,000; Rs. 75,000; Rs. 50,000] 4. Given: Current Ratio = 2.8; Acid test Ratio = 1.5; Working Capital = Rs. 162000. Find out: a) current Assets; b) Current Liabilities; c) Liquid Assets. [Ans: 2, 52,000; Rs. 90,000; Rs. 1, 35,000] 5. Find out Current Assets when Current Ratio is 2.4 and Working Capital is Rs. 1, 40,000.[Ans: Rs. 240000] 6. Calculate: Current assets, Liquid assets and Inventory, when Current Liabilities are Rs. 80,000, Current Ratio is 2:1, Liquid Ratio is 15:1, and Prepaid Expenses are Rs. 2,000. [Ans: Rs. 1, 60,000; Rs. 1, 20,000; Rs. 38, 000] 7. Calculate Current Liabilities of a business concern whose current ratio is 2.2:1; Liquid Ratio 1.4; Inventory Rs. 40,000 and prepaid expenses nil. [Ans: 50,000] 8. If Apple Company Ltd.s Current Ratio is 5.5; quick ratio is 4; Inventory is Rs. 30,000, what are its current liabilities? [Ans: Rs. 20,000] 9. If Orange Company Ltd.s Inventory is Rs. 60000 total current liabilities are Rs 12000; Quick ratio is 2; Calculate Current Ratio. [Ans: 2.5: 1] 10. If Banana Company Ltd.s Current Liabilities are Rs. 25,000, Quick Ratio is 1.5:1. Inventory is Rs. 12,500, Calculate current assets. [Ans: 50,000] 11. M/s. Rakesh & Co. supplies you the following information for the year ending 31-12-2006: Credit sales Rs 1, 50,000; Cash sales Rs. 2, 50,000 Returns inward Rs. 25000;

Ratio Analysis
Opening stock Rs. 25000; Closing stock Rs. 35,000; Gross Profit Ratio is 20%. Find out inventory turnover and inventory velocity. [Ans: 10 times; 37 days] 12. If Inventory Turnover Ratio is 5 times and average stock at cost is Rs. 75,000. Find out Cost of Goods Sold.[Ans: Rs. 3, 75,000] 13. Simhadri Ltd. Supplies the following information for the accounting year, 2005-06: Total sales Rs. 3, 50,000 Stock at the end of the year Rs. 26,000 Returns Inward Rs. 20,000 Gross profit for the year Rs. 66,000 Stock in the beginning of the year Rs. 40,000 You are required to calculate: a) Inventory turnover ratio; b) Inventory conversion period. [Ans: 8 Times; 45.6 days or 46 days] 14. From the following information, calculate average collection period: Total sales R. 1, 00,000 Bills Receivable Rs. 4,000 Cash sales Rs. 20,000 Bad debts provision Rs. 1,000 Sales return Rs. 7,000 Creditors Rs. 10,000 Debtors at the end of the year Rs. 11,000 [Ans: 75 days] 15. Dragon Ltd. Provides the following information: Cash sales Rs. 1, 50,000 Trade debtors in the beginning Rs. 55,000 Credit sales Rs. 2, 70,000 Trade debtors at the end Rs. 45,000 Returns inward Rs. 20,000 Provision for bad and doubtful debts Rs. 5,000 Calculate: 1) Debtors Turnover Ratio; 2) Average Collection Period. [Ans: 5 times; 72 days] 16. From the following information calculate Creditors Turnover Ratio and Average Payment Period: Total purchases Rs. 4,00,000 Bills Payable at the end Rs. 20,000 Cash purchases Rs. 50,000 Reserve for discount on Creditors Rs. 5,000 Purchase returns Rs. 20,000 Take 365 days in a year Creditors at the end Rs. 60,000 [Ans: 4.13 times; 88 days] 17. You are supplied with the following information from the records of M/s. SAI Steel Ltd. For the year ending 31-122006: Trade debtors at the end of the year Rs. 90,000 Stock turnover ratio 5 times Trade creditors in the beginning of the year Rs. 25,000 Sales for the year 2006 Rs. 5, 00,000 Trade creditors at the end of the year Rs. 45,000 Gross profit ratio 20% on sales Net working capital Rs. 1, 20,000 Calculate: a) Average stock b) Purchases c) Average payment period d) Average Collection Period e) Creditors turnover ratio f) Working Capital Turnover Ratio [Ans: Rs. 80,000; Rs. 4, 00,000; 32 days; 66 days; 11.4 times; 3.33 times] 18. Following is the profit and loss account to BHAGYASRI Ltd. For the year ended 31-12-2006. Particulars Rs. Particulars Rs. To Opening Stock 1,00,000 By Sales 5,60,000

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To Purchases To wages To Gross Profit c/d To Admn. expenses To S/D expenses To Non-operating exp. To Net Profit 3,50,000 9,000 2,01,000 6,60,000 20,000 89,000 30,000 80,000 2,19,000 By Closing Stock 1,00,000

You are required to calculate: a) Gross Profit Ratio Ratio b) Net Profit Ratio e) Administration exp. Ratio [Ans: 35.9%; 14.3%; 83.6%; 16.4%; 3.6%] 19. The capital of Mega Star Ltd. is as follows: 80000 Equity Shares of Rs. 10 each Rs. 8, 00,000 9% 30000 Preference Shares of Rs. 3, 00,000 The following information has been obtained form the books of the company: Depreciation Rs. 60,000, Profit after Tax at 60% Rs. 2, 70,000 Equity Dividend paid 20%, Market price of equity share Rs. 40 You are required to calculate: a) Dividend yield on equity share; b) Cover for the preference dividend; c) Cover for the equity dividend; d) Earnings per share; e) The Price-earnings ratio. [Ans: 5%; 10 times; 1.52 times; Rs. 3.04; 13.1 times] 20. The current assets and current liabilities of your company as at 31-12-2006 were Rs. 20, 00,000 and Rs. 10, 00,000 respectively. Calculate the effect of each of the following transactions individually and totally and on the current ratio of the company: a. Purchase of new machinery for Rs. 5, 00,000 on cash. b. Purchase of new machinery for Rs. 5, 00,000 on short-term credit. c. Purchase of new machinery for Rs. 5, 00,000 on a medium term loan from your bank with 20% margin. d. Payment of dividend Rs. 2, 00,000 of which Rs. 50,000 was tax deducted at source. [Ans: 15:1; 1.33:1; 1.9:1; 0.8:1] 21. The ratios relating to Power Star Ltd. are given as follows: [Ans:Gross Profit ratio 20% Find out: Sales Rs. 4, 00,000 Stock velocity 6 months Closing Stock Rs. 1, 70,000 Debtors velocity 3 months Debtors Rs. 1, 00,000 Creditors velocity 3 months Creditors Rs. 85,000] Gross Profit for the year ending 31-12-2006 amounts to Rs. 60,000. 22. From the following information, make out a Statement of Proprietors Funds with as many details at possible: Current Ratio 2.5 times Working Capital Rs. 60,000 Liquid Ratio 1.5 times Reserves and Surplus Rs. 40,000 Proprietary Ratio 0.75 times Bank Overdraft Rs. 10,000 There is no long term loan or fictitious assets [Ans: Share Capital Rs. 2, 00,000; Fixed Assets Rs. 1, 80,000; Stock Rs. 40,000; Other Current Assets Rs. 60,000; Current Liabilities Rs. 40,000] 23. From the following details, make out the Balance Sheet with as details as possible: Stock Velocity 6 times

660000 By G. P b/d 2,01,000 By interest on 10,000 Investments 8,000 By Profit on Sale of 2,19,000 Investment c) Operating Ratio d) Operating Profit

Ratio Analysis
Gross Profit Turnover Ratio Capital turnover ratio 20% 2 times

Unit - 2
Gross Profit Ratio 25% Fixed Assets / Total Capital 3/2 times Net Profit Ratio 20% Capital / Total outside Liabilities 2/5 times Sales / Inventory Ratio 8 times Fixed Assets Rs. 1500000 Fixed Assets / Current Assets times Closing Stock Rs. 200000 Proforma Trading and Profit & Loss Account Particulars Rs. Particulars Rs. To Cost of Sales - - - - By Sales ---To Gross Profit ---------To Expenses ------To Net Profit ---------Proforma Balance Sheet Liabilities Rs. Assets Rs. Capital --Fixed Assets ---Add- Net Profit - - - - - - Stock ---Total outside - - - - Other Current Assets ---Liabilities ------[Ans: C.G.S Rs. 12,00,000; Sales Rs 16,00,000; G.P Rs. 4,00,000; Expenses Rs. 80,000; Net Profit Rs. 3,20,000; Other Current Assets Rs. 18,00,000; Capital Rs. 6,80,000; Total outside Liabilities Rs. 25,00,000] 28. A factory engaged in an industry which is capital intensive, has been in operation for ten years. The capital employed is Rs. 170 lakhs out of which Rs. 100 lakhs cash credit from banks. The working capital of the company is Rs. 85 lakhs made up of stocks Rs. 30 lakhs, Stores Rs. 14 lakhs, Debtors Rs. 35 lakhs, and Deposits Rs. 6 lakhs. Annual sale is Rs. 80 lakhs. Calculate six financial ratios from the above for the use of the management. [Ans: C.R=4.25; L.R=2.05; D.E.R=0.7; P.R=0.59; F/A to P.F=0.85; Fixed Assets ratio =0.57] 29. GAMA Ltd. gives you the following Balance Sheet for the year ending 31-12-2006 Liabilities Rs. Assets Rs. 20000, Equity Capital Goodwill 50,000 Rs. 10 each 2,00,000 Plant 2,50,000 5000, Pref. Share Furniture 70,000 Capital Rs. 20 each 1,00,000 Investment 1,50,000 Reserve fund 50,000 Cash 20,000 Dividend Debtors 1,25,000 Equalization fund 60,000 Bills Profit and Loss A/c 40,000 Receivable 65,000 5% Debentures 1,50,000 Advance Tax 20,000 7% Mortgage Loan 70,000 Sundry Creditors 50,000 Bank Overdraft 30,000 7,50,000 7,50,000 Calculate following ratios: Debt Equity Ratio, Funded Debt to Total Capitalization, Proprietor Ratio, Solvency Ratio, and Fixed Asset to Net worth Ratio. [Ans: 0.67; 0.33; 0.6; 0.4; 0.82]

Debtors Velocity 2 months Fixed Assets Turnover 4 times Creditors Velocity 73 days The gross profit was Rs. 60,000. Reserve & Surplus amounts To Rs. 20,000. Closing stock was Rs. 5,000 in excess of Opening stock. ANSWERS Liabilities Rs. Assets Rs. Capital 1,00,000 Fixed Assets 60,000 Reserves & Surplus 20,000 Stock 42,500 Creditors 49,000 Debtors 50,000 Cash (bal. fig.) 16,500 1,69,000 1,69,000 24. The following information is given bellow draw a Balance Sheet. Net Working Capital Rs. 300000 Fixed Assets Turnover Ratio 2 times Current Ratio 2.5 times Average debt collection period 2 months Liquidity Ratio 1.5 times Fixed Assets to Shareholders 1:1 Stock Turnover Ratio 6 times Reserve to Share Capital 0.5 : 1 Gross Profit Ratio 20% ANSWERS Liabilities Rs. Assets Rs. Share Capital 5,00,000 Fixed Assets 7,50,000 Reserves 2,50,000 Liquid 3,00,000 Long-term Debts 3,00,000 Assets 2,00,000 Current Liabilities 2,00,000 Stock 12,50,000 12,50,000 25. Complete the following balance sheet: Liabilities Rs. Assets Rs. Equity capital 3,00,000 Fixed Assets --Retained 3,00,000 Inventories --earnings - - - - - Debtors --creditors Cash --You are given further information: Total Debt is 2/3 of Net Worth; Total Assets Turnover is 1.8 times; 30 days Sales are in the form of Debtors; Turnover of Inventory is 5 times; Cost of Goods Sold in a year is Rs. 9, 00,000; and the Acid Test Ratio is 1 : 1. [Ans: Creditors Rs. 4,00,000; Fixed Assets Rs. 4,20,000; Inventories Rs. 1,80,000; Debtors Rs. 1,50,000; Cash Rs. 2,50,000] 26. From the following information you are required to prepare balance sheet: Current ratio 1.75 times Reserves and Surplus to Capital 0.2 times Liquid ratio 1.25 times Turnover to Fixed Assets 1.2 times Stock turnover ratio 9 times Capital gearing ratio 0.6 times Gross profit ratio 25% Fixed Assets to Net worth 1.25 times Debt collection period 1.5 months Sales for the year Rs. 12, 00,000 [Ans: Fixed Assets Rs. 7,50,000; Debtors 1,50,000; Cash Rs. 1,00,000; Stock Rs. 1,00,000; Share Capital Rs. 5,00,000; Reserves & Surplus Rs. 1,00,000; Long-term Loan Rs. 3,00,000; Current Liabilities Rs. 2,00,000] Hint: Long- term Debt Capital Gearing Ratio = ------------------------Equity Share Capital 27. With the following ratios and further information given below, complete the trading and Profit & Loss A/c and Balance Sheet of Real Star Ltd.