Chapter 9 Ratio Analysis1

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276 A Textbook of Financial Cost and Management Accounting

AlternativelySales

Fixed Assets Turnover Ratio =Net Fixed Assets

Net Fixed Assets = Total Fixed Assets - Depreciation= Rs. 6,25,000 - 25,000 =Rs. 6,00,000

5,00,000Fixed Assets Turnover Ratio =

6,00,000

= 0.83 timesIllustration: 31

Find out Fixed Assets Gross Profit and Cost of Sales from the following information :

Sales Rs. 5,00,000Gross Profit Ratio 20 %Fixed Assets Turnover Ratio (on cost of sales) 4 times

Solution:Gross Profit = Sales x Gross Profit Ratio

= Rs. 5,00,000 x 20 %20

= 5,00,000 x 100= Rs. 1,00,000

Cost of Sales = Sales - Gross Profit= Rs. 5,00,000 - 1,00 000 =Rs. 4,00,000

Cost of SalesFixed Assets Turnover = Fixed Assets

Rs. 4,00,0004 = Fixed Assets

Fixed Assets =4,00,000

=Rs. 1,00,0004

(6) Capital Turnover Ratio

This ratio measures the efficiency of capital utilization in the business. This ratio establishes therelationship between cost of sales or sales and capital employed or shareholders' fund. This ratio may illso

be calculated as :

(1) Capital Turnover Ratio =Capital Employed =

=(2) Capital Turnover Ratio =

Cost of a l e ~ Sales(or)

Capital Employed C!lpital Employed

Shareholders' Funds + Long-Term Loans(or)

Total Assets - Current Liabilities

Cost of Sales Sales

Shareholders' Fund(or)

Shareholders' Fund


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Ratio Analysis

Components of Capital Employed (Shareholders' Fund + Long-Term Loans)

(1) Equity Share Capital

(2) Preference Share Capital

(3) Debentures

(4) Long-Tenn Loans(5) Share Premium

(6) Credit Balance of Profit and Loss Account

(7) Capital Reserve

(8) General Reserve

(9) Provisions

(10) Appropriation of Profits

Illustration: 32

277

From the following infonnation find out (a) Cost of Sales (b) Capital Employed and (c) CapitalTurnover Ratio.

Solution:

Total AssetsBills PayableSundry CreditorsOpening StockPurchasesClosing Stock

(a) Cost of Sales

(b) Capital Employed


Illustration: 33

Equity Share CapitalGeneral ReservePreference Share CapitalLong-Term LoansProfit and Loss Account(Credit Balance)Total SalesGross Profit

=====

=

=

Rs.10,00,000

1,50,00075,00050,000

3,00,00060,000

Opening Stock + Purchases - Closing StockRs. 5,00,000 + 4,00,000 - 60,000Rs. 3,90,000Total Assets - Current LiabilitiesRs. 10,00,000 - 2,25,000 =Rs. 7,75,000

Cost of Sales

Capital Employed

3,90,000

7,75,000

= 0.50 times

Rs. 3,00,000Rs. 50,000Rs. 2,00,000Rs. 1,50,000Rs. 70,000

Rs. 10,00,000Rs. 80,000

From the above information find out Capital Turnover Ratio


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278

Solution:

Capital Turnover Ratio

Capital Employed


Alternatively


Cost of Sales


=

=

=

=

=

A Textbook o f Financial Cost and Management Accounting

Sales

Capital Employed

Shareholder fund + Long-Term Loans

Equity Share Capital + General Reserve+ Preference Share Capital + Long-Term Loans+ Credit Balance of P & L AlcRs. 3,00,000 + 50,000 + 2,00,000 + 1,50,000 + 70,000Rs. 7,70,000

10,00,000

7,70,000

1.29 times

Cost of SalesCapital Employed

Sales - Gross ProfitRs. 10,00,000 - Rs. 80,000Rs. 9,20,000

9,20,000

7,70,000

1.19 times

IV. SOLVENCY RATIOS

The term 'Solvency' generally refers to the capacity of the business to meet its short-term and longterm obligations. Short-term obligations include creditors, bank loans and bills payable etc. Long-termobligations consists of debenture, long-term loans and long-term creditors etc. Solvency Ratio indicatesthe sound financial position of a concern to carryon its business smoothly and meet its all obligations.Liquidity Ratios and Turnover Ratios concentrate on evaluating the short-term solvency of the concernhave already been explained. Now under this part of the chapter only the long-term solvency ratios aredealt with. Some of the important ratios which are given below in order to determine the solvency of theconcern :

(1) Debt - Equity Ratio

(2) Proprietary Ratio(3) Capital Gearing Ratio

(4) Debt Service Ratio or Interest Coverage Ratio

(1) Debt Equity Ratio

This ratio also termed as External - Internal Equity Ratio. This ratio is calculated to ascertain thefirm's obligations to creditors in relation to funds invested by the owners. The ideal Debt Equity Ratio is1: 1. This ratio also indicates all external liabilities to owner recorded claims. It may be calculated as


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Ratio Analysis

(a) Debt - Equity Ratio =

(b) Debt - Equity Ratio

=

External Equities

Internal Equities

(or)

Outsider's Funds

Shareholders' Funds

279

The term External Equities refers to total outside liabilities and the term Internal Equities refers to allclaims of preference shareholders and equity shareholders' and reserve and surpluses.

(c) Debt - Equity Ratio =

(d) Debt - Equity Ratio =

Total Long-Term Dept

Total Long-Term Funds

(or)

Total Long-Term Debt

Shareholders' Funds

The term Total Long-Term Debt refers to outside debt including debenture and long-term loans raisedfrom banks.

Illustration: 34

From the following figures calculate Debt Equity Ratio :

Preference Share CapitalEquity Share CapitalCapital Reserve

Profit and Loss Account6 % DebentureSundry CreditorsBills PayableProvision for taxationOutstanding Creditors

Solution:

(a) Debt Equity Ratio

External Equities

Internal Equities

=

=

===

==

Rs.

1,50,0005,50,0002,00,000

1,00,0002,50,0001,20,000

60,00090,00080,000

External Equities

Internal Equities

Debenture + Sundry Creditors+ Bills Payable + Provision for taxation+ Outstanding CreditorsRs. 2,50,000 + 1,20,000 + 60,000 + 90,000 + 80,000Rs.6,00,000Preference Share Capital + Equity Share Capital+ Capital Reserve + Profit and Loss AlcRs. 1,50,000 + 5,50,000 + 2,00,000 + 1,00.000Rs. 10,00,000


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280

Debt Equity Ratio

(b) Dept Equity Ratio

Total Long-Term DebtShareholders' Fund

Debt-Equity Ratio

(c) Debt Equity Ratio

(d) Debt Equity Ratio

Outsider's Fund

Debt Equity Ratio

=

=

==

=

A Textbook of Financial Cost and Management Accounting

6,00,000

10,00,000= 0.6 (or) 3 : 5


Shareholders' Funds

Rs. 2,50,000Rs. 10,00,000

Rs. 2,50,000

Rs. 10,00,000

= 0.25

==

=

Total Long-term Debt

Total Long-term Funds

2,50,000

12,50,000

= 0.2

=

==

=

Outsider's Fund

Shareholders' Fund

Total Outside LiabilitiesRs. 6,00, 000

6,00,000

10,00,000

= 0.6 (or) 3 : 5Significance: This ratio indicates the proportion of owner's stake in the bu.siness. Excessive liabilities

tend to cause insolvency. This ratio also tell the extent to which the firm depends upon outsiders for its existence.

(2) Proprietary Ratio

Proprietary Ratio is also known as Capital Ratio or Net Worth to Total Asset Ratio. This is one of thevariant of Debt-Equity Ratio. The term proprietary fund is called Net Worth. This ratio shows therelationship between shareholders' fund and total assets. It may be calculated as :

Proprietary Ratio =Shareholders' Fund =Total Assets =

Shareholders' Fund

Total AssetsPreference Share Capital + Equity Share Capital+ All Reserves and SurplusTangible Assets + Non-Tangible Assets+ Current Assets (or) All Assets including Goodwill

Significance : This ratio used to determine the financial stability of the concern in general.Proprietary Ratio indicates the share of owners in the total assets of the company. It serves as an indicatorto the ~ r e d i t o r swho can find out the proportion of shareholders' funds in the total assets employed in thebusiness. A higher proprietary ratio indicates relatively little secure position in the event of solvency of aconcern. A lower ratio indicates greater risk to the creditors. A ratio below 0.5 is alarming for the creditors.


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Ratio Analysis

Illustration: 35From the following infonnations calculate the Proprietary Ratio :

Preference Share CapitalEquity Share CapitalCapital Reserve

Profit and Loss Account9% DebentureSundry CreditorsBills PayableLand and BuildingPlant and MachineryGoodwillInvestments

Solution:

Proprietary Ratio

Shareholders' Fund

Total Assets

Proprietary Ratio

(3) Capital Gearing Ratio

=

==

==

==

Rs.2,00,0004,00,000

50,000

50,0002,00,00050,00050,000

2,00,0002,00,0001,00,0003,00,000

Shareholders' Fund

Total Assets

Preference Share Capital + Equity Share Capital+ Capital Reserve + Profit and Loss Accol,lntRs. 2,00, 000 + 4,00,000 + 50,000 + 50,000Rs.7,OO,OOOLand and Building + Plant and Machinery+ Goodwill + InvestmentsRs. 2,00,000 + 2,00,000 + 1,00,000 + 3,00,000Rs. 8,00,000

7,00,000

8,00,000

= 87.5% (or) 0.87

281

This ratio also called as Capitalization or Leverage Ratio. This is one of the Solvency Ratios. Thetenn capital gearing refers to describe the relationship between fixed interest and/or fixed dividend bearingsecurities and the equity shareholders' fund. I t can be calculated as shown below:

Capital Gearing Ratio =

Equity Share Capital =Fixed Interest Bearing Funds =

Equity Share Capital

Fixed Interest Bearing Funds

Equity Share Capital + Reserves and Surplus

Debentures+

Preference Share Capital+ Other Long-Tenn Loans

A high capital gearing ratio indicates a company is having large funds bearing fixed interest and/orfixed dividend as compared to equity share capital. A low capital gearing ratio represents preference sharecapital and other fixed interest bearing loans are less than equity share capital.


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282

Illustration: 36


From the following information, you are requited to find out Capital Gearing Ratio

Solution:

Preference Share CapitalEquity Share Capital

Capital ReserveProfit and Loss Account12% DebentureSecured loan

Capital Gearing Ratio



Capital Gearing Ratio

(4) Debt Service Ratio

==

===

==;::

Rs.

5,00,0006,00,000

3,00,0001,00,0003,00,0001,00,000



Equity Share Capital + Capital Reserve+ Profit and Loss AccountRs. 6,00,000 + 3,00,000 + 1,00,000Rs. 10,00,000Debenture + Preference Share Capital+ Secured LoansRs. 3,00,000 + 5,00,000 + 1,00,000Rs. 9,00,000

10,00,000

9,00,000

= 10 : 9 (Low Gear)

Debt Service Ratio is also termed as Interest Coverage Ratio or Fixed Charges Cover Ratio. Thisratio establishes the relationship between the amount of net profit before deduction of interest and tax andthe fixed interest charges. It is used as a yardstick for the lenders to know the business concern will be ableto pay its interest periodically. Debt Service Ratio is calculated with the help of the following formula :

Interest Coverage Ratio =Illustration: 37

Solution:

Calculate Interest Coverage Ratio :Profit before InterestIncome Tax PaidInterest On DebentureInterest on Long-Term Loan

Interest Coverage Ratio =Net Profit before Interest }and Taxes =

=

Net Profit before Interest and Income Tax

Fixed Interest Charges

: : Rs. 7,00,000

=Rs. 50,000

= Rs. 3,00,000= Rs. 1,00,000

Net Profit before Interest and Income Tax


Rs. 7,00,000 + 50,000Rs. 7,50,000

x 100

x 100


51/65

Ratio Analysis


Interest Coverage Ratio

==

=

Rs. 3,00,000 + 1,00,000Rs. 4,00,000

7,50,000x 100

4,00,000

= 187.5 % (or) 1.87 :1

283

Significance: Higher the ratio the more secure the debentureholders and other lenders would be withrespect to their periodical interest income. In other words, better is the position of long-term creditors and thecompany's risk is lesser. A lower ratio indicates that the company is not in a position to pay the interest butalso to repay the principal loan on time.

V. OVERALL PROFITABILITY RATIO

This ratio used to measure the overall profitability of a firm on the extent of operating efficiency itenjoys. This ratio establishes the relationship between profitability on sales and the profitability oninvestment turnover. Overall all Profitability Ratio may be calculated in the following ways:

Overall Profitability Ratio

=

Net Profit

Sales

DU Pont Control Chart (or) DU Pont Analysis

Salesx

Total Assets

ROI indicates the efficiency of the concern which depends upon the working operations of theconcern. Net Profit Ratio and Capital Turnover Ratio, as often called is usually computed on the basis ofthe chart represented by DU Pont. Thus it is known as "DU Pont Chart." This system of control wasapplied for the first time by DU Pont company of the United States of America. The DU Pont chart helpsto the management to identify the areas of problems for the variations in the return on investment so thatactions may initiated to improve the performance. The following chart can explain the ROI effect by anumber of factors.

Net Profit Ratio(Net Profit/Sales)

1Operating Ratio

(Operating Cost/Sales)

1Cost of Goods Sold

Return on Investment (ROI)

rOffice &

[Net Profit J

Capital Employed

~

~Fixed Asset Turnover Ratio

(Sales / Fixed Assets)

~Selling and

Administrative Expenses Distribution Expenses

~

Capital Turnover Ratio(Sales/Capital Employed)

k~

Working CapitalTurnover Ratio

(Sales/Working Capital)

1Working Capital

(Current Assets - Current Liabilities)


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284

Illustration: 38


The following are the Profit and Loss Account and Balance Sheet of Mrs. Sharma Ltd. for thepurpose of analysis and calculate (a) Liquidity Ratios (b) Profitability Ratios (c) Turnover Ratios(d) Solvency Ratios and (e) Overall Profitability Ratio.

Dr. Profit and Loss Account of Sharma Ltd. Cr.Particulars Rs. Particulars Rs.

To Opening Stock:Raw Materials 25,000 By Sales 5,00,000Finished goods 50,000 By Closing Stock:

To Purchases 1,50,000 Raw Materials 75,000To Wages 1,00,000 Finished Goods 50,000To Factory Expenses 50,000 By Profit on Sale of Investments 25,000To Administrative Expenses 25,000To SelJing & Distribution Expenses 25,000To Loss on Sale of Machinery 25,000To Interest on Debenture 5,000To Net Profit 1,95,000

6,50,000 6,50,000

Balance Sheet

liabili ties Rs. Assets Rs.

Equity Share Capital @ Rs. 10 each 50,000 Plant & Machinery 50,00010% Preference Share Capital 50,000 Land & Building 50,000Retained Earnings 50,000 Furniture 25,00012 % Debenture 1,00,000 Stock of raw material 75,000Sundry Creditors 50,090 Sundry Debtors 50.000BiIIs Payable 25,000 Bank Balance 25,000

Stock of finished goods 50,000

3,25,000 3,25,000

Solution:Profit and Loss Account of MIs Sharma Ltd.

Particulars Rs. Particulars Rs.

To Opening Stock: By Sales 5,00,000Raw Materials 25,000Add : Purchases 1,50,000

1,75,000Less: Closing Stock of Raw Materials 75,000

Raw Materials Consumed -1 1,00,000To Wages 1,00,000To Factory Expenses 50,000

Cost of Production - 2 2,50,000Add : Opening Stock of Finished Goods 50,000

3,00,000Less : Closing Stock of Finished Goods 50,000

Cost of Goods Sold - 3 2,50,000To Gross Profit c/d 2,50,000

5,00,000 5,00,000


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Ratio Analysis 285

To Administrative Expenses 25,000To Selling and Distribution Expenses 25,000 By Gross Profit bId 2,50,000

Operating Expenses - 5 50,000To Operating Profit cld - 6 2,00,000

2,50,000 2,50,000

To Loss on Sale of Plant 25,000 By Operating Profit bId 2,00,000

To Interest on Debenture 5,000 By Profit on Sale of investmentNon-operating Expenses - 7 30,000 (Non-operating income) 25,000

To Net Profit - 8 1,95,000

2,25,000 2,25,000

Balance Sheet

Particulars Rs. Rs.

Plant and Machinery 50,000Land and Building 50,000Furniture 25,000

Fixed Assets - I 1,25,000Bank Balances 25,000Sundry Debtors 50,000

Liquid Assets - 2 75,000Stock of Raw Materials 75,000Stock of Finished Goods 50,000

Current Assets - 3 2,00,000

Sundry Creditors 50,000Bills Payable 25,000

Current Liabilities - 4 75,000

Working Capital (3 - 4) = 5 1,25,000 1,25,000(Current Assets - Current Liabilities)Capital Employed ( 1+5) = 6 2,50,000(Fixed Assets + Working Capital)Less: Long-Term Debt:

12 % Debenture 1,00,000

Shareholders' Fund - 7 1,50,000Less: Preference Share Capital 50,000

Equity Shareholders' Fund or Net Worth - 8 1,00,000Net Worth Represented by : ,

Equity Share Capital 50,000Retained Earnings 50,000

Equity Shareholders' Net Worth 1,00,000

Gross Profit(1) Gross Profit Ratio = x 100

Sales

2,50,000= x 100 =50%5,00,000


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286 A Textbook of Financial Cost an d Management Accounting

Net Profit(2) Net Profit Ratio = x 100

Sales

1,95,000= x 100 =39%

5,00,000

Operating Costx 1003) Operating Ratio = Sales

50,000= x 100 = 10%

5,00,000

Operating Profit(4 ) Operating Profit Ratio = x 100

Sales

2,00,000= x 100 =40%

5,00,000

Net Profit after Interest and Tax(5) Return on Investment Ratio = x 100

Shareholders' Fund

Net Profit after Interest & = Net Profit - (Interest and Taxes)Tax Net Profit = Rs. 1,95,00012% on Debenture = Rs. 18,000Net Profit after Interest & Tax = Rs. 1,95,000 - 18,000

= Rs. 1,77.0001,77,000

Return on Investment Ratio = x 1001,50,000

= 118%(6) Return on Capital } Net Profit after TaxEmployed Ratio = x 100

Capital Employed

1,95,000= x 100

2,50,000

= 78%(7 ) Earning Per Equity } Net Profit after and Preference DividendShare Ratio =

No. of Equity Shares

1,95,000= =Rs. 39

5,000

Net Profit after Taxes(8) Net Profit to Net Worth Ratio = x 100

Shareholders' Net Worth

1,95,000= x 100 =Rs. 130%

1,50,000


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Ratio Analysis

(9) Stock Turnover Ratio (or) }Stock Velocity =

Average Stock

Stock Turnover Ratio

(10) Debtors' Turnover Ratio

(11) Creditors' Turnover Ratio

(12) Working Capital TurnoverRatio

( 13) Fixed Assets Turnover Ratio


(15) Current Ratio

=

=

=

=

=

=

=

=

=

=

=

=

=

=

=

=

=

Cost of Goods Sold

Average Stock

Opening Stock + Closing Stock

2

(25,000 + 50,000) + (75,000 + 50,000)

2

75,000 + 1,25,000

2

Rs. 2,00,000

2

2,50,000

1,00,000

= 1,00,000

= .5 times

Credit Sales

Average Receivables

5,00,000

50,000= 10 times

Credit Purchases

Average Payables

1,00,000= times

50,000

Net SalesWorking Capital

5,00,000=4 times

1,25,000

Cost of Goods Sold

Total Fixed Assets

2,50,000

1,25,000

Sales

= 2 times

Capital Employed

5,00,000= 2 times

2,50,000

Current Assets

Current Liabilities

2,00,000= 2.66 times

75,000

287


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288

(16) Liquid Ratio =

=

( 17 ) Absolute Liquid Assets =

=

(18) Debt Equity Ratio =

=

(19) Proprietary Ratio

(20) Capital Gearing Ratio =

Fixed Interest Bearing Funds =

=Capital Gearing Ratio =

(21) Overall Profitability Ratio =

=

A Textbook o f Financial Cost and Management Accounting

Liquid Assets

Current Liabilities

75,000

75,000= I time

Absolute Liquid AssetsCurrent Liabilities

25,000= 0.33 times

75,000


Shareholders' Fund

1,00,000

1,50,000= 0.66 times

Shareholders' FundTotal Assets

1.50,000

3,25,000= 0.46 times



Debenture + Preference Share Capital+ Other Long-Term LoansRs. 1,00,000 + 50,000 =Rs. 1,50,0001,00,0001,50,000

Net Profit

Sales

195000

500000

= 0.66 times

Salesx

Total Assets

500000x = 0.6 times

325000

SUMMARY OF RATIOS

I. Liquidity Ratios

S. No. Ratio to be Computed Formula ComponentsI Current Ratio Current Assets l . Current Assets

Current Liabilities 2. Current Liabilities

2 Quick Ratio (or) Liquid Assets l . Liquid Assets =Acid Test Ratio (or) Current Liabilines Current Assets -Liquid Ratio (Stock Liquid Ratio

& Prepaid Expenses)2. Current Liabilities


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Ratio Analysis

3 Absolute Liquid Ratio

(or) Cash Position Ratio

S. No. Ratio to be Computed

1 Gross Profit Ratio

2 Operating Ratio

3 Operating Profit Ratio

4 Net Profit Ratio

5 Return on InvestmentRatio

6 Return on CapitalEmployed Ratio

7 Earning Per ShareRatio

Absolute Liquid Assets

Current Liabilities

II. Profitability Ratios

Fonnula

Gross Profitx 100

Net Sales

Operating Costx 100

Net Sales

Operating Profitx 100

Net Sales

Net Profit after taxx 100

Net Sales

Net Profit after Interestand Taxes

x 100Shareholders' Funds or

Investments

Net Profit after taxesx 100

Gross Capital Employed

(or)

Net Profit after taxesbefore Interest

x 100Gross Capital Employed

(or)Net Profit after taxes

before Interestx 100

Average Capital Employedor Net Capital Employed

Net Profit after Tax andPreference Dividend

No. of Equity Shares

289

1. Absolute Liquid Assets =Cash in Hand + Cash at Bank+ Marketable Securities

2. Current Liabilities

Components

I. Gross Profit = Sales -Cost of goods sold)

2. Net Sales = Gross Sales- Sales Return)

1. Operating Cost =(Cost of goods Sold +Administrative Expenses+ Selling and DistributionExpenses)

2. Net Sales

I. Operating Profit =(Net Sales - Operating Cost)

2. Net Sales

I. Net Profit after tax =(Net Profit - Tax paid)

2. Net Sales

I. Net Profit =Net Profit -Interest and Taxes

2. Shareholders' Investment =(Equity Share Capital +Preference Share Capital +Reserves and Surplus -Accumulated Losses)

I. Net Profit after tax =(Net Profit - Tax Paid)

2. Gross Capital Employed =(Fixed Assets + Current Assets)

3. Average Capital EmployedOpening Capital Employed +Closing Capital Employed

2 (or)Average Capital Employed =Net Capital Employed + Y2 ofProfit after tax

4. Net Capital Employed =(Total Assets - Current Liabilities)

I. Net Profit after tax andpreference dividend =NetProfit - (Tax paid + PreferenceDividend)

2. No. of Equity Shares


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290 A Textbook of Financial Cost and Management Accounting

8 Dividend Equity Dividend 1. Equity Dividend =Pay Out Ratio x 100 (No. of Equity Shares x

Net Profit after tax and Dividend Per Equity Share)Preference Dividend 2. Net Profit after tax and

(or) preference dividend =

Dividend Per Equity Net Profit - (Tax Paid +

Share Preference Dividend)x 100

Earning Per Equity Share

9 Earning Per Net Profit after tax and 1. No. of Equity SharesEquity Share Preference Dividend 2. Net Profit after tax and

Preference DividendNo. of Equity Shares

10 Dividend Yield Ratio Dividend Per share 1. Dividend Per Sharex 100 2. Market Value Per Share

Market Value Per Share

11 Price Earning Ratio Market Price Per Share 1. Market Price Per Equity ShareEquity Share 2. Earning Per Share

x 100Earning Per Share

12 Net Profit to Net Net Profit after taxes 1. Net Profit after taxesWorth Ratio x 100 2. Shareholder Net Worth =

Shareholders Net Worth (Company's Net Assets -Long-Term Liabilities )(or)Total Tangible Net Worth =(Shareholders' fund + Profits

Retained in business)III. Thmover Ratios

S. No. Ratio to be Computed Fonnula Components

1 Inventory Ratio Cost of Goods Sold 1. Cost o f Goods Sold =(or) Stock Turnover Ratio (Opening Stock + Purchases +

Average Inventory at cost (or) Direct Expenses - Closing StockNet Sales

(or) Stock Velocity Average Inventory at cost 2. Cost of Goods Sold =

Net Sales (or) (Sales - Gross Profit)3. Average Stock =

Average Inventory at Opening Stock + Closing StockSeIling Price

(or) 2

Net Sales

Inventory


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Ratio Analysis 291

2 Debtors' Turnover Ratio Net Credit Sales 1. Net Credit Sales =Average Receivables (or)

(Total Sales - Cash Sales )2. Accounts Receivables =

Average Accounts Receivables (Sundry Debtors + Bills(or) Receivables)

Total Sales Average Accounts =Account Receivable

Opening Receivable + ClosingReceivable

2

3 Debt Collection Month or Days in a year 1. Months or Days in a yearPeriod Ratio 2. Net Credit Sales

Debtors Turnover (or) 3. Net Credit Sales =Average Accounts (Total Sales - Cash Sales )

Receivable x Months or Days 4. Average Accounts Receivablein a year

Net Credit Sales for the year

4 Creditors' Turnover Ratio Net Credit Purchases 1. Net Credit Purchases =Total Purchases - Cash Purchases

Average Accounts Payable 2. Average Accounts Payable =Opening Payable + Closing

Payable

2

5 Average Payment Period Month or Days in a year 1. Month or Days in a year2. Average Trade Creditors

Creditors' Turnover Ratio 3. Creditors' Turnover Ratio

. Average Trade Creditors 4 Net Credit Purchasex 100

Net Credit Purchases

6 Working Capital Net Sales 1. Net Sales = Gross Sales -Turnover Ratio Sales Return)

Working Capital 2. Working Capital =(Current Assets - CurrentLiabilities)

7 Fixed Assets Cost of goods sold 1. Cost of Goods SoldTurnover Ratio 2. Total Fixed Assets

Total Fixed Assets (or) 3. Sales

Sales4. Net Fixed Assets

Net fixed Assets

8 Capital Turnover Ratio Cost of Sales 1. Capital Employed =

Capital Employed(Total Assets - Current

(or) Liabilities ) (or)

Sales Capital Employed =

Capital Employed(Shareholders' Fund + Long-Term

(or) Loans)Cost of Sales or Sales 2. Cost of Sales (or) Sales

Shareholders' Fund


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292 A Textbook o f Financial Cost and Management Accounting

IV. Solvency Ratios

S. No. Ratio to be Computed Formula Components

1 Debt Equity Ratio External Equities 1. External Equities =Total Outside Liabilities

Internal Equities (or) 2. Internal Equities =Outsiders' Funds All claims of preference

Shareholders' Fundsshareholders + Equity

(or) shareholders + Reserves and

Total Long-Term Debt Surplus3. Total Long- Te.rm Debt =

Total Long-Term Funds (or) Outside Debt (Debenture and

Total Long-Term Debt Long-Term Loans)

Shareholders' Funds

2 Proprietary Ratio Shareholders' Fund 1. Shareholders' fund =

Total AssetsPreference Share Capital +

Equity Share Capital + AllReserves and surplus

2. Total Assets = TangibleAssets + Non-Tangible Assets+ Current Assets (or) All assetsincluding Goodwill

3 Capital Gearing Ratio Equity Share Capital 1. Equity Share Capital =Fixed Interest Bearing

Equity Share Capital +

Reserves and SurplusFunds 2. Fixed Interest Bearing Funds

= Debentures + PreferenceShare Capital + Other Long-TermLoans)

4 Debt Service Ratio Net Profit before 1. Net Profit before Interest andInterest and Taxes Taxes

2. Fixed Interest ChargesFixed Interest Charges

V. Over All Profitability Ratios

S. No. Ratio to be Computed Formula Components

V Overall Profit Net Profit X Sales 1. Net Profit

Ability Ratio Sales (or) Total Assets 2. Sales

Net Profit 3. Total Assets

Total Assets

QUESTIONS

1. What is meant by Ratio?2. What do understand by Accounting Ratio? Explain the Principles of ratio selection.3. What are the advantages of Ratio Analysis?4. What are the limitations of ratio analysis?5. What are the different categories of ratios? How are they classified?


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Ratio A1lIl1ysis

6. Write short notes on :(a) Liquidity Ratios. (b) Profitability Ratios. (c) Turnover Ratios.(d) Solvency Ratios. (e) Overall Profitability Ratios.

7. What do you understand by current ratio? What are it uses? What are its limitations?8. Ratio analysis is widely used as a tool of financial analysis, yet it suffers from various limitations. Explain.9. How can solvency of a firm be measured?

10. What you understand by Liquidity ratios? Discuss their significance.

11. Explain the importance of profitability Ratio. How they are worked out?12. Discuss the usefulness of the following ratios:

(a) Inventory Ratio. (b) Operating Ratio. (c) Price Earning Ratio.(d) Creditor's Turnover Ratio. (e) Debtor's Turnover Ratio.

EXERCISES

(1) From the following, compute both the purchases made during the year and the Stock Turnover Ratio:

Rs.Inventory (at cost price) :At the beginning 14,000At the end of the year 21,000Sales revenue 1,20,000

Sales return 6,000Gross profit 26,500

[Ans : Purchases Rs. 94,500; Stock Turnover Ratio = 5 times]

(2 ) From the following particulars, you are required to find out:

(a) Current Ratio, (b) Net Profit Ratio; and (c) Gross Profit Ratio.

Stock Rs. 50,000 Cash in HandDebtors Rs. 40,000 CreditorsBills Receivable Rs. 10,000 Bills PayableA d v ~ n c e s Rs. 4,000 Bank Overdraft

Sales (Net)Gross ProfitNet Profit

[Ans: Current Ratio = 1. 28:1; Net Profit Ratio = 4.29%; Gross Profit Ratio = 7.14%].

(3) Calculate: (a) Current Assets; (b) Liquid Assets; (c) Inventory.

Current Ratio = 2.6 : 1Liquid Ratio = 1.5 : 1Current Liabilities = Rs. 40,000

[Ans: Current Assets Rs. 1,04,000 ; Liquid Assets Rs. 60,000; Inventory Rs. 44,000]

(4) From the following details, you are required to find out:

Rs. 30,000Rs. 60,000Rs. 40,000Rs. 4,000Rs. 7,00,000Rs. 50,000Rs. 30,000

(a) Gross profit; (b) Purchases; (c) Opening Stock; (d) Closing Stock; (e) Debtors; (f ) Creditors; (g) Fixed Assets

(1 ) Stock Velocity = 6(2) Capital Turnover Ratio = 2(3) Fixed Turnover Ratio = 4(4) Gross Profit Turnover Ratio = 20%(5) Debtor's Velocity = 2 months(6) Creditor's Velocity = 73 days

293

The Gross Profit was Rs. 60,000. Reserve and surplus amount to Rs. 20,000. Closing stock was Rs. 5,000 in excess onopening stock.

[Ans : (a ) Rs. 60,000; (b) Rs. 2,45,000; (c) Rs. 37,500; (d) Rs. 42,500; (e) Rs. 50,000;(f ) Rs. 49,000; (g) Rs. 60,000].

(5) From the following Profit and Loss Account and Balance sheet, compute : (I) Current Ratio(2) Liquid Ratio (3) Fixed Asset to Net Worth Ratio (4) Proprietary Ratio (5) Debt Equity Ratio (6) Operating Ratio (7) StockTurnover Ratio (8) Fixed Assets Turnover Ratio (9) Creditors Turnover Ratio (10) Gross Profit Turnover Ratio (II) Net Profit to SalesRatio (12) Return on Investment Ratio.


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Dr. Profit an d Loss Account for the year ended 31.12.2002 Dr.

Particulars Rs. Particulars Rs.

To Opening Stock of By Sales 50,000Raw materials 5,000 Less: Return 1,000 49,000

To Purchases 32,000 By ClosingLess: Returns 2,000 30,000 Stock of Raw

To Factory Expenses 1,000 Materials 8,750To Gross profit cld 21,750

57,750 57,750

To Operating expenses 8,750To Interest on Debenture 400 By Gross Profit bId 21,750To Provision for income tax 6,300To Net Profit 6,300

21,750 21,750

Balance Sheet as on 31" Dec. 2003

Liabilities Rs. Assets Rs.

Equity Share Capital 12,500 Land & Building 10,000Capital Reserves 5,000 Plant & Machinery 6,000Profit and Loss Account 2,500 Stock 8,7508 % Debenture 5,000 Debtors 4,500Sundry Creditors 5,000 Cash 2,000Bank Overdraft 1,250

31,250 31,250

[Ans: (1) Current Ratio =2.44:1; (2) Liquid Ratio = 1.04 :1; (3) Fixed Asset Net Worth Ratio =80%; (4) Debt-EquityRatio = 25 :1; (5) Operating Ratio =0.74 :1; (6) Stock Turnover Ratio = 7.1 3times; (7) Fixed Asset Turnover Ratio =3.06 times; (or) 3.1 times; (8) Creditors' Turnover Ratio = 6 times; (9) Gross Profit Turnover Ratio = 44.39%; (10) NetProfit to Sales =25.71 %; ( i l ) Return on Investment Ratio =52%; (12) Proprietary Ratio =0.64].

(6) Ranjit Ltd. provides the following information for the year ending 31 March 2003 and request you to ascertain (a)Operating Ratio (b) Operating Profit Ratio and (c) Operating Profit:

SalesGross ProfitOffice ExpensesSelling Expenses

. Administrative ExpensesLoss on Sale of PlantInterest received on investments

Net Profit

Rs.1,00,0004,00,000

30,00020,00015,0002,0002,500

3,35,000

[Ans : Operating Ratio = 65 % (b) Operating Profit Ratio = 35% (c ) Operating ProfitRs. 3,35,000].

(7) From the following information find out (a) Sales (b) Closing Stock (c) Sundry Debtors and (d) Sundry Creditors

Gross Profit Ratio 25%Debtors' Turnover Ratio 2 monthsStock Turnover Ratio 2 timesCreditors' Turnover Ratio 3 months

Closing stock is Rs. 10,000 more than the opening stock. Bills receivable amount to Rs. 30,000 and Bills payable to Rs.40,000. Cost of goods sold for the year is Rs. 6,00,000

[Ans : (a) Sales = Rs. 8,00,000; (b) Closing Stock Rs. 3,05,000; (d) Sundry DebtorsRs. 93,333; (d) Sundry Creditors Rs. 71,666].


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Ratio Analysis 295

(8) Calculate the average collection period from the following details by adopting 360 days to an year.

Average Inventory Rs. 3,60,000Debtors Rs. 2,30,000Inventory Turnover Ratio = 6Gross Profit Ratio 10 %Credit Sales to Total Sales 20 %

[Ans : Average Collection Period = 172.5 days].

(9) You are required to calculate Return on Investment from the following details of Mary Ltd. for the year ending 31"March 2003.

Net Profit after tax Rs. 3,25,000Rate of Income tax 50 %12.5% Debenture of 100 each Rs. 4,00,000Fixed Assets Rs. 12,30,000Depreciation Rs. 2,30,000Current Assets Rs. 7,50,000Current Liabilities Rs. 3,50,000

[Ans : Return on Investment =50%].

(10) The following balance sheet is given to you:

Rs. Rs.Preference Share Capital 1,00,000 Fixed Assets 2,00,000Reserve for Contingencies 20,000 Sundry Debtors 30,000Term Loans 80,000 Inventories 30,000Sundry Creditors 50,000 Bills Receivable 10,000Profit & Loss N c 30,000 Cash at Bank 30,000Provision for Taxation 20,000

3,00,000 3,00,000

You are requIred to calculate :(a) Acid Test Ratio (b) Debit Equity Ratio and (c) Current Ratio.

(11) From the following particulars, you are required to calculate (a) Current Ratio (b) Gross Profit Ratio (c) Stock TurnoverRatio (d) Debt Equity Ratio (e) Proprietary Ratio (t ) Debtor's Turnover Ratio

Rs. Rs.

Annual Sales 74,40,000 Paid up Capital 15,00,000Gross Profit 7,44,000 Reserve & Surplus 6,00,000Fixed Assets 16,50,000 7% Debentures 5,00,000Inventories 9,10,000 Bank Overdraft 2,00,000Sundry Debtors 12,40,000 Sundry Creditors 12,00,000Short-Term Investments 1,60,000Cash Balances 40,000

(12) Calculate the current assets of a company from the following information:

(1) Stock turnover: 5 times(2) Stock at the end is Rs. 5,000 more than stock in the beginning(3) Sales (all credit) : Rs. 2,00,000(4) Gross Profit Ratio: 20%(5) Current liabilities = Rs. 60,000(6) Quick Ratio 0.75

[Ans: Current Assets Rs. 79,500]

(13) From the following details prepare statement of proprietary funds with as many details as possible:

(1) Stock Velocity - 6(2) Capital turnover ratio - 2(3) Fixed asset turnover ratio - 4(4) Gross Profit turnover ratio - 20%(5) Debtor's Velocity - 2 months(6) Creditor's Velocity - 73 days


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The Gross Profit was Rs. 60,000. Reserve and Surplus amounted to Rs. 20,000. Closing Stock was Rs. 5,000 in excessopening stock.

[Ans : Proprietary Fund Rs. 1,20,000]

(14) A company has an inventory of Rs. 7,20,000, debtors Rs. 4,30,000 and an inventory turnover ratio of 12. The grossprofit margin is 10% and its credit sales are 20% of the total sales. Calculate the average collection period.

[Ans: 81 days]

(15) From the following Balance Sheet and other information, you are required to calculate the following ratios: (a) GrossProfit Ratio (b) Operating Profit Ratio (c) Current Ratio and (d) Liquidity Ratio

Liabilities

Equity Share CapitalPreference Share CapitalGeneral ReservesProfit & Loss NcBank OverdraftSundry Creditors

[Ans: Gross Profit Ratio - 39.96%Operating Ratio - 17.38%Current Ratio - 8.54%Liquidity Ratio - 3.24%]

Balance Sheet

Rs. Assets Rs.

2,00,000 Land & Buildings 2,00,00080,000 Plant & Machinery 40,400

4,800 Inventories 78,40067,200 Sundry Debtors 36,000

2,800 Bank 10,00012,000 Cash Balances 2,000

3,66,800 3,66,800

(16) From the following information, calculate the following ratios: (a) Debt Equity Ratio(b) Interest Coverage Ratio (c) Debt to Total Fund Ratio (d) Return on Investment Ratio and (e) Capital Turnover Ratio

Dr.

Rs.

Share Capital 3,20,000General Reserve 1,20,000Profit and Loss Nc 2,00,000Loan @ 15% interest 4,00,000

Sales for the year 11,20,000Tax Paid during the year 80,000Profit for the year after interest and tax 1,60,000

[Ans: Debt Equity Ratio 1:16; Interest Coverage Ratio - 5 times; Debt to total Fund Ratio 1:2.6; Return on Investment- 28.84%; Capital Turnover Ratio 1.08 times]

(17) From the following particUlars, you are required to find out (a) Current Assets and (b) Stock:

(1) Current Ratio - 2.5(2) Quick Ratio - 1.5(3) Working Capital Rs. 75,000(4) Bank Overdraft Rs. 25,000(5) Cash in hand Rs. 1,000

[Ans: Current Assets 1,25,000; Stock Rs.50,ooo]

The following information relates to Gupta & Co. Ltd. for the year ended 31" December 2003 :

Trading an d Profit an d Loss Ale Cr.

Particulars Amount Particulars AmountRs. Rs.

To Opening Stock 1,50,000 By Sales 10,40,000To Purchases 6,50,000 Less: Returns 40,000 10,00,000To Gross Profit cld 4,00,000 By Closing Stock 2,00,000

12,00,000 12,00,000

By Gross Profit bId 4,00,000


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Ratio Analysis

To Operating Expenses:Administration 80,000

Selling & Distribution 50,000To Non-Operating Exp.

Loss on Sale of AssetsTo Net Profit

Liabilities

Share CapitalReservesCurrent LiabilitiesProfit and Loss Al e

Calculate:

(a) Gross Profit Ratio

By Non-Trading Income:Dividend 18,000

1,30,000 Profit on Sale of Shares 22,000

10,0003,00,000

4,40,000

Balance Sheet

AmountRs.

4,00,0001,80,0003,00,0001,20,000

10,00,000

Assets

Land and Buildinl!Plant and MachineryStockSundry DebtorsCash at Bank

(c) Expenses Ratio(f) Operating Ratio

297

40,000

4,40,000

AmountRs.

3,00,0001,60,0003,20,0001,60,000

60,000

10,00,000

(d) Return on Total Resources(g) Net Profit Ratio

(b) Operating Profit Ratio(e) Turnover to Total Assets(h) Stock Turnover Ratio (i ) Turnover of Fixed Assets

[Ans: (a) Gross Profit Ratio 40%(b) Operating Profit Ratio 27%(c) Expenses Ratio:

(I) Administrative Expenses Ratio 8%(II) Selling & Distribution Expenses Ratio 5%

(d) Return on Total Resources 30%(e )

(f)(g)(h)

Turnover to Total Assets I timeOperating Ratio 73%Net Profit Ratio 30%Stock Turnover Ratio 3.43 times

(i) Turnover of fixed Assets 1.30 times.]

(18) The Capital of Patel & Co. Ltd. is as follows:

9% Preference Shares of 10 eachEquity Shares of Rs. IO each

Additional InformationProfit (after tax at 60%) Rs. 2,70,000; Depreciation Rs. 60,000;

Rs.

3,00,0008,00,000

11,00,000

Equity dividend paid 20%; Market Price of Equity Shares Rs. 40. You are required to calculate the following:(a) Dividend yield on the Equity Shares(b) Cover for the Preference and Equity Dividends

(c) Earnings for Equity Shares(d) Price-Earnings Ratio

[Ans: (a) 5% (b) Preference IO times, Equity 1,52 times (c) Rs. 3.04 per Share

(d) 13 2 i ]

Documents

Chapter 9 Ratio Analysis1