Revision: Accountancy II : Financial Statement Analysis >> Accounting Ratios Accountancy Commerce (English Medium) Class 12 CBSE

• "Ratio analysis is a study of relationship among various financial factors in a business'' - Myres
• The use of different types of accounting ratios to evaluate the financial performance of business is called Ratio Analysis.

• "Liquidity is the ability of the firm to meet its current obligations as they fall due." - Saloman J. Flink
• "Liquidity is the ease with which assets may be converted into cash without loss." - Herbert B. Mayo

\[\text{Current Ratio}=\frac{\text{Current Assets}}{\text{Current Liabilities}}\]

1. Current Assets:

Current Assets = Current Investments + Inventories (Excluding Loose Tools and Stores and spares) + Trade Receivables (Bills Receivable + Sundry Debtors - Provisions for Doubtful debts) + Cash and Bank Balances + Short-term Loans and Advances + Other Current Assets.

                                        Or

Current Assets = Total Assets - Non-current Assets

                                        Or

Current Assets = Current Liabilities + Working Capital

Working Capital = Current Assets - Current Liabilities 

2. Current Liabilities:

Current Liabilities = Short-term Borrowings + Trade Payables + Other Current  Liabilities + Short-term Provisions

                                     Or

Current Liabilities = Current Assets - Working Capital

\[\text{Quick Ratio or Liquid Ratio}=\frac{\text{Quick Assets or Liquid Assets }}{\text{Current Liabilities}}\]

1. Quick or Liquid Assets:

Quick or Liquid Assets = Current Investments + Trade Receivables (i.e., Bills Receivable and Sundry Debtors less Provision for Doubtful Debts) + Cash and Bank Balances + Short-term Loans and Advances + Other Current Assets (Except Prepaid Expenses).

                                                   Or

Quick or Liquid Assets = Current Assets - Inventories - Prepaid Expenses and Advance tax. 

2. Current Liabilities:

Current Liabilities = Short-term Borrowings + Trade Payables (Sundry Creditors + Bills Payable) + Other Current Liabilities + Short-term Provisions

\[\text{Debt to Equity Ratio}=\frac{\text{Debt/Long-Term Debt}}{\text{Equity/Shareholders'Funds}}\]

1. Debt/Long-term Debts:

Debt/Long-term Debt = Long-term Borrowings + Long-term Provisions

2. Equity/Shareholders' Funds:

Equity/Shareholders' Funds = Share Capital + Reserves and Surplus

                                                             Or

Equity/Shareholders' Funds = Non-current Assets (Tangible Assets + Intangible Assets + Non-current Investments + Long-term Loans and Advances) + Working Capital* - Non-current Liabilities (Long-term Borrowings + Long-term Provisions).

                                                            Or

Equity/Shareholders' Funds = (Property, Plant and Equipment + Intangible Assets + Non-current Investments + Long-term Loans and Advances) + Working Capital* - Non-current Liabilities (Long-term Borrowings + Long-term Provisions)

\[\text{Debt to Total Assets Ratio}=\frac{\text{Debt/Long Term Debts}}{\text{Total Assets}}\]

1. Debt/Long Term Debts

Debt/Long Term Debts = Long Term Borrowings + Long Term Provisions

2. Total Assets:

Total Assets = Non-Current assets (Property, Plant and Equipment = Intangible Assets = Non-Current Investments + Long Term Loans & Advances) + Current Assets

\[\text{Proprietary Ratio}=\frac{\text{Shareholders' Funds/Equity}}{\text{Total Assets}}\]

1. Total Assets:

Total Assets = Non-current Assets + Current Assets

                                        Or

Total Assets = Property, Plant and Equipment + Intangible Assets + Non-current Investments + Long-term Loans and Advances + Current Investments + Inventories (Including Loose tools and Spare Parts) + Trade Receivable + Cash and Bank Balances + Short-term Loans and Advances + Other current Assets

2. Equity/Shareholders' Funds:

Equity/Shareholders' Funds = Share Capital + Reserves and Surplus

                                                    Or

Equity/Shareholders' Funds = Non-current Assets + Working Capital (Current Assets - Current Liabilities) – Non-current Liabilities

                                                   Or

Equity/Shareholders' Funds = Property, Plant and Equipment + Intangible Assets + Non-current Investments + Long-term Loans and Advances + Working Capital - Non-current Liabilities (Long-term Borrowings + Long-term Provisions).

\[\text{Total Assets to Debt Ratio}\ =\ \frac{\text{Total assets}}{\text{Long-term debts}}\]

\[\text{Interest Coverage Ratio}=\frac{\text{Net Profit before Interest and Tax}}{\text{Interest on Long-term Borrowings}}=.....\text{Times}.\]

\[\text{Inventory Turnover Ratio}=\frac{\text{Cost of Revenue from Operations or Cost of Goods Sold}}{\text{Average Inventory}}=...\text{Times}.\]

1. Cost of Revenue from Operations:

Cost of Revenue from Operations = Opening Inventory + Purchases + Carriage + Wages + Other Direct Charges - Closing Inventory

                                                     Or

Cost of Revenue from Operations = Cost of Materials Consumed + Purchases of Stock-in-Trade + Changes in Inventories of Finished Goods, Work-in Progress and Stock-in-Trade + Direct Expenses.

                                                     Or

Cost of Revenue from Operations = Net Revenue from Operations - Gross Profit

                                                     Or

Cost of Revenue from Operations = Revenue from Operations + Gross Loss

2. Average Inventory:

\[\text{Average Inventory}\quad=\quad\frac{\text{Opening Inventory }+\text{Closing Inventory}}{2}\]

\[\text{Trade Receivables Turnover Ratio}=\frac{\text{Credit Revenue from Operations (Credit Sales)}}{\text{Average Trade Receivables}}=.....\text{Times}.\]

1. Credit Revenue from Operations:

Credit Revenue from Operations (Credit Sales) = Revenue from Operations (Cash + Credit) – Cash Revenue from Operations

2. Average Trade Receivables:

\[\text{Average Trade Receivables}=\frac{\text{Opening Trade Receivables}+\text{Closing Trade Receivables}}{2}\]

Trade Receivable = Sundry Debtors + Bills Receivable

\[\text{Trade Payables Turnover Ratio}=\frac{\text{Net Credit Purchases}}{\text{Average Trade Payables}}=......\text{times}\]

1.Net Credit Purchases:

Net Credit Purchases = Net Purchases - Cash Purchases.

(When net credit purchases is not given, the amount of total purchases may be applied.)

2. Average Trade Payables:

\[\text{Average Trade Payables}=\frac{\text{Opening Trade Payables}+\text{Closing Trade Payables}}{2}\]

                                                        Or

\[\text{Average Trade Payables}=\frac{\text{Opening Creditors + Opening Bills Payable}+\text{Closing Creditors + Closing Bills Payable}}{2}\]

\[\text{Fixed asset turnover Ratio}=\frac{\text{Net Revenue from Operation}}{\text{Net Fixed Assets}}\]

\[\text{Net Assets or Capital Employed Turnover Ratio}=\frac{\text{Revenue from Operation}}{\text{Capital Employed}}\]

\[\text{Working Capital Turnover Ratio}=\frac{\text{Net Revenue from Operation}}{\text{Working Capital}}\]

\[\text{Gross Profit Ratio}\quad=\frac{\text{Gross Profit}}{\text{Revenue from Operations }i.e.,\text{Net~Sales}}\times100\]

1. Gross Profit:

Gross Profit = Revenue from Operations - Cost of Revenue from Operations

2. Cost of Revenue from Operations:

Cost of Revenue From Operations = Opening Inventory + Net Purchases + Direct Expenses ( Carriage, Wages, etc.) - Closing Inventory

                                          Or

Cost of Revenue from Operations = Revenue from Operations - Gross Profit

                                         Or

Cost of Revenue From Operations = Cost of Materials Consumed (including Direct Expenses) + Changes in Inventories of Work-in-Progress and Finished Goods

                                       Or

Cost of Revenue From Operations = Cost of Materials Consumed (including Direct Expenses) + Purchases of Stock-in-Trade + Changes in Inventories of Work-in-Progress, Finished Goods and Stock-in-Trade + Direct Expenses*

\[\text{Operating Ratio}=\frac{\text{Cost of Revenue from Operations}+\text{Operating Expenses}}{\text{Revenue from Operations}}\times100\]

                                                                        Or

\[\text{Operating Ratio}=\frac{\text{Cost of Revenue from Operations}+\text{Operating Expenses - Operating Income}}{\text{Revenue from Operations}}\times100\]

1. Cost of Revenue from Operations or Cost of Goods Sold:

Cost of Revenue from Operations = Opening Inventory + Net Purchases + Direct Expenses – Closing Inventory

2. Operating Expenses:

Operating Expenses = Employees' Benefit Expenses + Depreciation and Amortisation Expense + Selling and Distribution Expenses + Office and Administration Expenses, etc. + Discount + Bad Debts + Interest on Short-term Loans

3. Operating Income:

Operating Income = Commission Received + Cash Discount Received

\[\text{Operating Profit Ratio}=\frac{\text{Net Operating Profit}}{\text{Revenue from Operations}}\times100\]

Net Operating Profit:

Net Operating Profit = Net Profit after Tax + Non-operating Expenses - Non-operating Income

                                                    Or

Net Operating Profit = Gross Profit - Operating Expenses + Operating Income - Tax

a) Net Operating Expenses = Finance Cosr (Interest on Borrowings) + Loss on Sale of Non-current Assets

b) Non-operating Income + Interest and Dividend Received o Investment + Gain (Profit) on Sale of Non-current Assets

c) Operating Income = Sale of Scrap + Trading Commission Received + Cash discount Received + Revenue from Services Provided

\[\text{Net Profit Ratio}=\frac{\text{Net Profit after Tax}}{\text{Revenue from Operations}}\times100\]

Net Profit:

Net Profit = Gross Profit + Other Income - Indirect Expenses - Tax

                                                   Or

Net Profit = Revenue from Operations - Cost of Revenue from Operations - Operating Expenses - Non-operating Expenses + Non-operating Income - Tax

Indirect Expenses & Losses = Office Expenses + Selling Expenses + Interest on Long Term Borrowings + Accidental Losses

\[\text{Return on Investment (ROI)}=\frac{\text{Net Profit before Interest and Tax}}{\text{Capital Employed}}\times100=.....\%.\]

Capital Employed:

1. Liabilities Side Approach:

Capital Employed = Shareholders' Funds + Long Term Debts (Long Term Borrowings + Long Term Provisions) - Non Trade Investments

2. Assets Side Approach:

Capital Employed = Non-Current Assets + Working Capital

Non Current Assets = Property, Plant and equipment + Intangible Assets + Non Current Investments (except non-trade Investments) + Long Term Loans & Advances

\[\text{Return on Shareholders’ Fund}=\frac{\text{Profit after Tax}}{\text{Shareholders’ Funds }}\times100\]

\[\text{Earning Per Share (EPS)}=\frac{\text{Net Profit after Tax and Preference Dividend}}{\text{Number of Equity Shares}}\]

\[\text{Book Value per share}\ =\frac{\text{Equity Shareholders' Funds}}{\text{Number of Equity Shares}}\]

\[\text{Dividend Payout Ratio}\ =\frac{\text{Dividend per share}}{\text{Earning Per share}}\]

\[\text{Price Earning (P/E) Ratio}\ =\frac{\text{Market Price of the Equity Share}}{\text{Earning Per Share (EPS)}}\]

• Meaning: Ratio analysis studies financial relationships to assess a business’s performance and financial position.
• Objectives: It simplifies data, identifies weak areas, checks solvency and profitability, and supports planning.
• Advantages: Helps with decision-making, shows trends, and supports comparisons across firms and over time.
• Use in Comparison: Allows inter-firm and intra-firm comparisons to evaluate business efficiency.
• Limitations: Depends on data accuracy, may ignore qualitative factors, and is affected by policies and bias.
• Important Reminder: Use ratio analysis with care, considering its limitations and verifying data before conclusions.

• Meaning: Liquidity refers to a firm's ability to meet its short-term financial obligations as they become due.
• Purpose: Liquidity ratios assess the short-term financial position of a business and its ability to pay current liabilities using current assets.
• Also Known As: These are also called Short-term Solvency Ratios.
• Importance: They are useful for short-term creditors and banks to judge the firm's ability to repay short-term debts promptly.
• Types of Liquidity Ratios: The two main liquidity ratios are the Current Ratio and the Quick Ratio (Acid-Test Ratio).

• Solvency refers to a business's ability to meet its long-term financial obligations and debts.
• Purpose: Solvency ratios assess the firm’s capacity to repay long-term liabilities and interest payments on time.
• Insight Provided: These ratios show how much funding comes from owners versus external sources like loans.
• Importance: They help evaluate the business's financial stability and long-term risk from a lender’s or investor’s perspective.
• Key Solvency Ratios: Debt to Equity Ratio, Debt to Total Assets Ratio, Proprietary Ratio, and Interest Coverage Ratio.

• Meaning: Activity Ratios, also called Turnover or Efficiency Ratios, measure how efficiently a business uses its resources to generate sales.
• Basis of Calculation: These ratios are calculated using Revenue from Operations or Cost of Revenue from Operations.
• Purpose: They show the speed or number of times assets like inventory, trade receivables, or working capital are used or rotated during a period.
• Interpretation: A higher turnover ratio indicates better use of resources and generally leads to higher profitability.
• Key Activity Ratios: Inventory Turnover Ratio, Trade Receivables Turnover Ratio, Trade Payables Turnover Ratio, and Working Capital Turnover Ratio.

• Meaning: Profitability is a measure of a business's efficiency and its ability to earn profits relative to the capital invested.
• Purpose: Profitability ratios help assess how effectively a business generates profits from its operations and resources.
• Importance: These ratios are essential for evaluating a business's financial health, growth potential, and success.
• Also Known As: Profitability Ratios are also called Income Ratios.
• Key Ratios Included: Gross Profit Ratio, Net Profit Ratio, Operating Ratio, Operating Profit Ratio, Earnings Per Share, Price Earnings Ratio, and Return on Investment.