Financial Analysis

3. FINANCIAL ANALYSIS & PLANNING

Learning Objective

Inter-Firm and Intra-Firm analysis

Brief note on use of Ratios in Cash Flow Statements

Financial Forecasting Technique

Tools of Financial Forecasting

Implementation

Functional management

Types of Financial Statement analysis

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Topper’s Institute Financial Analysis 3.2

Q.1 Who are the entities interested in Financial Statements Analysis?

Financial Statement Analysis is a meaningful interpretation of financial statements, in order to meet the information

requirements of the parties who use such financial information.

The users of financial information include:

(a) Management- for day to day decision making and also for performance evaluation.

(b) Proprietor / Shareholders -for analysing performance, profitability and financial position. Prospective

investors need to know track record of performance.

(c) Lenders -Banks and Financial Institutions -for determining financial position of the company, debt service

coverage etc.

(d) Suppliers -to determine the credit worthiness of the company in order to grant credit.

(e) Customers -to know the general business viability before entering into long-term contracts and

arrangements.

(f) Government -to ensure prompt collection of direct and indirect tax revenues, to evaluate performance and

contribution to social objectives.

(g) Research Scholars -for study, research and analysis purposes.

Q.2 What are the types of financial statement analysis?

Financial Statement Analysis may be of the following types:

(1) Internal and External Analysis :

Internal Analysis External Analysis

It is done within the Company, i.e. by the Corporate

Finance Department.

It is done by outside parties e.g. bankers, investors, suppliers

etc.

It is more extensive and detailed. It looks into all

aspects of functioning and performance.

It is restricted according to the requirements of the user. For

example, a trade creditor may be interested in the general

profitability and financial standing. A lender may be

interested in debt-service coverage etc.

(2) Horizontal and Vertical Analysis:

Horizontal Analysis Vertical Analysis

It involves comparison of financial statements of one

year with other years.

It involves analysis of relationship between various items

in the financial statements of one year.

Items are compared on a one-to-one basis, e.g. sales

increase, comparative net profit for two years etc.

Relationship between items i.e. ratios or percentages are

considered under this analysis.

(3) Inter-Firm and Intra-Firm analysis:

Inter-Firm Analysis Intra-Firm Analysis


firm with other firms.


firm for different time periods or different divisions of

the firm for the same year.

Q.3 Ratios are not everything in financial analysis. Outline the limitations of Financial Ratio Analysis.

Ratios are useful tools for financial analysis. However the following limitations do exist.

(a) Window Dressing: Ratios depict the picture of performance at a particular point of time. Sometimes, a business

can make year-end adjustments in order to result in favourable ratios (e.g. current ratio, operating profit ratio,

debt-equity ratio etc.)


(b) Impact of Inflation: Financial Statements are affected by inflation. Ratios may not depict the correct picture. For

example, fixed assets are accounted at historical cost while profits are measured in current rupee terms. In

inflationary situations, the Return on Assets or Return on Capital Employed may be very high due to less

investment amount of fixed assets. Ratios may not indicate the true position in such situations.

(c) Product Line diversification: Detailed ratios for different divisions, products and market segments etc. may not be

available to the users in order to make an informed judgement. For example, loss in one product may be set off

by substantial profits in another product line. But, the overall net profit ratio may be favourable.

(d) Impact of Seasonal Factors: When the operations do not follow a uniform pattern during the financial period,

ratios may not indicate the collect situation. For example, if the peak supply season of a business is between

February to June, it will hold substantial stocks on the balance sheet date. This will lead to a very favourable

current ratio on that date. But the position for the rest of the year may be entirely different.

(e) Differences in Accounting Policies: Different firms follow different accounting policies) e.g. rate and methods of

depreciation. Straight-jacket comparison of ratios may lead to misleading, results.

(f) Lack of Standards: Even though some norms can be set for ratios there is no uniformity as to what an "ideal" ratio

is. Generally it is said that Current Ratio should be 2:1. But if a firm supplies mainly to Government

Departments where debt collection period is high, the Current Ratio of 4:1 or 5:1, may also be considered

normal.

(g) High or Low: A number by itself cannot be 'high" or "low". Hence, a ratio by itself cannot become "good" or

"bad". The line of difference between "good ratio" and "bad ratio" is very thin.

(h) Interdependence: Financial Ratios cannot be considered in isolation. Decision taken on the basis of one ratio may

be incorrect when a set of ratios are analysed.

Q.4 Write a brief note on use of Ratios in Cash Flow Statements.

Cash Flow Statement can be prepared by reference to the Direct and Indirect Methods, as prescribed by the

Accounting Standard - 3 issued by the ICAI.

The ratios used in cash flow Statement Analysis are:

(a) Cash Generating Efficiency Ratios: It is the ability of the firm to generate cash from its current or continuing

operations. This may be measured by any of the following ratios:

Net Cash Flow from Operating Activities

(i) Cash flow yield = –––––––––––––––––––––––––––––––––


(ii) Cash flow Sales = –––––––––––––––––––––––––––––––––

Net Sales


(iii) Cash flow yield = –––––––––––––––––––––––––––––––––

Average Total Assets

(b) Free Cash Flow Ratios : Free cash flow represents the amount of cash that remains after deducting current

commitments and outflows. It is equal to the cash flow that remains after meeting current operating expenses,

interest, instalments (if any), income-tax, dividends and net capital expenditure. A positive free cash flow will

indicate that surplus funds are available for investment or repayment of debt. A negative free cash flow will

require sale of investments or raising of finance through loans or equity. The ratios based on free cash Flow are:

Price per share

(i) Price to Free Cash Flow = –––––––––––––––––––––––

Free cash Flow per Share

Operating Cash Flow

(ii) Operating Cash Flow to Profit = ––––––––––––––––––

Operating profit

Internal funding

(iii) Self financing investment ratio = –––––––––––––

Net Investment


Q.5. What is Financial Forecasting? Describe in brief, its utility and how it is affected.

Forecasting is the first stage in the financial planning process. This refers to the formal process of predicting future

events technique of determining in advance the requirements and utilisation of funds for a future period. It

While forecasting refers to finding the most profitable course of events or at best a range of probabilities, planning is

deciding what one will do about it. Planning deals with the futurity of present decisions in terms of (a) setting goals

and developing strategies to achieve them and (b) translating strategies into detailed operational programmes and

assuring that plans are carried out. The former one can be called as strategic planning, the other is termed as

programming.

Financial forecasting aims at pre-determining the demand for funds and the avenues wherein the funds are to be

utilised. Thus, a systematic projection of financial data is made in the form of projected financial statements with the

help of fund flow statements, ratio analysis etc. These projections are based on past record of the organisation with a

view to predict the future financial performance. Forecasting generates information which is utilised by the

management of an enterprise, for making proper decisions and for judging the financial efficiency of the funds and

projecting a scale of standards to be followed in the future course. Another objective of financial forecasting is to use

it as control device. Standards of financial performance of an enterprise could bc laid down through financial

forecasting for evaluating the results and assuring its growth. Optimum utilisation of funds can be achieved through

forecasting. A pre-testing of financial feasibility of implementation of production prospects or programmes can also

be made by rupees forecasting.

Through use of computers, financial forecasting has scaled new heights. Financial forecasting has utility for a

business organisation because

(i) It generates useful information for decision making.

(ii) It provides significant information for successful financial planning.

(iii) It facilitates the organisation to plan its growth and its financial needs.

(iv) It functions as a control device by providing a standard of financial performance for the future.

(v) It enables the organisation to make optimum utilisation of available funds/resources.

(vi) It makes the organisation to adopt appropriate financial policies.

(vii) It updates the financial plans periodically and make them relevant according to changing circumstances.

Financial forecasting uses the following tools: (a) Day's sales method (b) Percentage of sales method (c) Simple

regression method (d) Multiple regression method.

Financial forecasting helps an organisation in the preparation of statements like proforma income statement,

proforma balance sheet, funds flow statement, cash budget etc. as tools for long and medium term financial planning.

Q.6. Write a short note on Financial Forecasting Technique.

Financial forecasting is the starting point in a planning process. It facilitates pre-testing of the financial feasibility of

various programmes, acts as a control device, helps in funds, and improves utilisation of surplus cash.

A few forecasting techniques are briefly discussed as under:

(i) Percentage of Sales Method

It is the simplest approach to forecasting financial requirements of a firm. This method expresses the firm's financial

needs ill terms of the percentage of annual sales invested in each individual item of Balance Sheet. Under this

method, the forecaster computes past relationship between assets and liabilities on one hand and sales on the other on

the assumption that the same relationship will continue, he app lies new sales forecast figure to get an estimate the

financial requirements. This method is more suitable for short-term forecasting.

(ii) Simple Regression Method

An alternative method used to forecast financial requirements is the simple regression scatter diagram method. With

the sales forecast as the starting point and based on the past relationship between sales and Balance sheet items, it is possible to construct a line-of best it or the regression line. It is possible to link sales with one item of asset at a time.

This method is more suitable for long-term forecasting.

(iii) Multiple Regression Method


A more sophisticated approach to financial forecasting calls for the use of multiple regression analysis. Unlike simple

regression method, here sales are assumed to be a function of several variables. It is, therefore, a superior method.

Q.7 Write a short note on the Tools of Financial Forecasting:

(1) Days' sales method is a traditional method under which an attempt is made to calculate the number of. days sales

and tie it up with the balance sheet items. As different components of the balance sheet are forecasted in terms of

days's sale, this method measures the resources that are to be financed.

(2) Percentage of sales method is another tool of financial forecasting in which the balance sheet items are expressed

as percentages of sales. This will clearly (to some extent) show the financial needs caused by increase in sales.

(3) Simple regression method: On the basis of past relationship between sales and different items, a line of the best

fit is drawn. This method requires linking sales with one item at "a time. Thus data about different items can be

projected with changes in sales level for study and evaluation.

(4) Multiple regression method: In the case of simple regression method sales are considered as a function of one

variable. Multiple regression line is drawn considering the sales as a function of several variables.

A financial analyst may adopt any of the above techniques depending upon the availability of data and purpose of

forecasting.

Q.8 Mention a few symptoms which might indicate that industrial sickness lies ahead.

As far as the case of industrial sickness in India is concerned, the Tiwari Committee had identified certain symptoms

which would be quite helpful in the detection of sickness at the incipient stage. Such symptoms of sickness are

continuous irregularity in cash credit accounts, low capacity utilisation, profit fluctuations, downward trends in sales

and stagnation or fall in profits followed by contraction in the share of the market, high rate of rejection of goods

manufactured, reduction in credit summations failure to pay statutory liabilities, larger and longer outstanding in the

bill accounts, longer period of credit allowed on sale documents negotiated through the bank and frequent returns by

customers of the same, constant utilisation of cash facilities to the maximum and failure to pay timely instalment of

principal and interest on term loans and instalment credits non-submission of periodical financial data/stock

statements, etc. in time, financing capital expenditure out of funds provided for working capital purpose, rapid

turnover of key personnel, existence of a large number of law suits against the company rapid expansion and too

much diversification within a short time, sudden/frequent changes in management – whether professional or

otherwise and/ or dominated by on man/few individuals, diversion of funds for purposes other than running the unit,

any major change in the shareholdings.

Q.9 Briefly indicate the cause of industrial sickness in India.

Causes of Industrial sickness: The causes of industrial sickness in India may be broadly classified as follows:

A. Internal causes: Under this category, the following causes arc generally responsible' the industrial sickness in India.

(1) Planning

(a) Technical feasibility: Viz. Inadequate technical know- how, locational disadvantage, outdated production

process.

(b) Economic viability: High cost of inputs, break-even point too high, uneconomic of project, under-estimation of

the financial requirements, unduly large investment in fi assets, over-estimation of demand, poor labour

relations, lack of trained/skilled labour technically competent personnel.

(c) Marketing management: Dependence on a single customer or a limited number customers/single or a limited

number of products, poor sales realisation, defective pricing policy, booking of large orders at fixed prices in

an inflationary market, weak market feed back and market research. Lack of knowledge of marketing

techniques, unscrupulous sales/purchase practices.

(d) Financial management: Poor resources management and financial planning, faulty costing, liberal dividend

policy, general financial indiscipline and application of funds unauthorised purposes, deficiency of funds,

over-trading, unfavourable gearing or keeping adverse debt Equity-ratio, inadequate working capital, absence

of cost consciousness, lack of effective collection machinery.


(e) Administrative management: Over centralisation, lack of professionalism, lack of feed-back to management.

(2) Implementation: Cost over-runs resulting from delays in getting licences/sanctions, inadequate mobilisation of

finance.

(3) Functional management:

(a) Production management: Inappropriate product-mix, poor quality control, high of production, poor inventory

management, inadequate maintenance and replacement, of timely and adequate modernisation, etc., high

wastage, poor capacity utilisation.

(b) Labour-management relations: Excessively high wage structure, inefficient had of labour problems, excessive

manpower, poor labour productivity,

(c) Lack of proper manage information system and controls, lack of timely diversification, excessive expenditure

Research & Development, divided loyalties (where the same management has interest in than one unit, cases

are known where promoters of limited companies who also have own private interests first tend to look after

the interest of the latter, often at the cost former), dissension within the management, incompetent and

dishonest management. ,

B. External causes and other factors:

The following factors may be mentioned in this respect

(a) Government controls and policies, etc.: Government price controls, fiscal abrupt changes in Government

policies affecting costs/prices/imports/exports/licensing.

(b) Procedural delays on the part of financial/licensing/other controlling or regulation authorities like Banks,

Financial Institution, Government departments, Lice Authorities, MRTP authorities, etc.

(c) Market constraints : Market saturation, Revolutionary technological advances rendering the products

absolute, and Recession – fall in domestic/export demand.

Extraneous factors: Natural calamities, Political situation (domestic as well as international) and strikes and

multiplicity of labour unions etc.

Profitability Ratios Income statement

Sales

Material Consumed

Opening stock

Add. : Purchase

Less : Closing Stock

Wages

Carriage

Other direct exps.

Cost of sales

Gross profit

Admin. exps.

Selling exps.

Operating profit

non - operating Income

Non operating exps.

Net profit

Capital employed: Return

Equity share cap. Operating Profit Reserves & surplus Add: Non operating Income

Less: Fictitious assets: - Less: Non operating Exps.

Preliminary exps.

P/L A/C (Dr.) Profit before interest and tax (PBIT)

Equity Shareholder’s fund less: interest on long term fund

Add: Preference Share Capital Profit before tax (PBT)

Shareholder's fund Less: Provision for tax

Add: Debentures Profit after tax (PAT)


Long Term Loan Less: Preference Dividend

Gross Cap. employed Less: Non trading investment

Net capital employed (investment) Earnings available to Eq. Sh. holder

RATIO ANALYSIS

A. PROFITABILITY RATIOS BASED ON SALES

Ratio FORMULA NUMERATOR DENOMINATOR USEFULNESS 1. Gross Profit Ratio Gross Profit

Sales

Gross Profit as per Trading

Account

Sales net of returns Indicator of Basic

Profitability

2. Operating Profit ratio Operating

Profit

Sales

Sales Less : Cost of Sales

Sales net of returns Indicator of

Operating

Performance of

business.

3. Net Profit Ratio Net Profit

Sales

Net Profit Sales net of returns Indicator of

overall

profitability

B. PROFITABILITY RATIOS- OWNER'S VIEW POINT

1. Return on

Investment (ROI)

or Return on

Capital Employed

(ROCE)

Total

Earnings

Total

Capital

Employed

PBIAT Assets Route:

Net Fixed Assets (including

intangible assets like patents, but

not fictitious assets like

miscellaneous expenditure not

w/off)

+ Net working Capital

Liability Route:

Equity Share Capital

+ Preference Share Capital

+ Reserves & Surplus

+ Debentures and Long Term

Loans

Less: Accumulated Losses

Less: Non-Trade Investments

Overall profitability of the

business for the capital

employed; Indicates the

return on the total capital

Employed Comparison of

ROCE with rate of interest

of debt leads to financial

leverage. If ROCE >

interest Rate, use of debt

funds is Justified.

2. Return on Equity

[ROE]

Earnings

after Taxes

Net Worth

Profit After

Taxes

Net Fixed Assets

+ Net Working Capital invested

Less: External Liabilities (long

term

Profitability of Equity

Funds in the business.

3. Earnings Per

Share [EPS]

[PAT-Pref.

Divid.]

Number of

Equity

Shares

Profit After

Taxes Less

Preference

dividend

Number of Equity Shares

outstanding

Return or income per

share, whether or not

distributed as dividends.

4. Dividend per

Share [DPS]

Dividends

Number of

Equity

Share

Profits

distributed to

Equity

Shareholders


Face Value per share

Amount of Profits

distributed per share

5. Return on Assets

[ROA]

Net Profit

after taxes Average

Total

Assets

Net Profit

after taxes

Average Total Assets i.e. ½ of

opening and closing Balance

Net Income per rupee of

average fixed assets.

C. TURNOVER / ACTIVITY / PERFORMANCE RATIOS


1 Capital

Turnover Ratio

Sales

Capital Employed

Sales net of

returns

Assets Route : Net

fixed asset

+ Net working

capital

Liability Route:


+ Preference Share

Capital

+ Reserves &

Surplus

+ Debentures and

Long Term Loans

Less: Accumulated

Losses

Less: Non- Trade

Investments

Ability to generate sales per rupee of long-

term investment.

The higher the turnover ratio, the better it

is.

2. Fixed Assets

Turnover Ratio

Turnover

Fixed Assets

Sales net of

returns

Net Fixed Assets Ability to generate sales per rupee of

Fixed Asset.

3. Working

Capital

Turnover Ratio

Turnover

Net Working

Capital

Sales net of

returns

Current Assets Less

Current Liabilities

Ability to generate sales per rupee of

Working Capital.

4. Finished

goods or Stock

Turnover Ratio

Cost of Goods

sold

Average stock

For

Manufacturers

:

Opening

Stock

+ Cost of

Production

Less: Closing

Stock

For Trader:

Opening

Stock

+ Purchases

Less: Closing

Stock

(Opening stock +

Closing Stock)

2

or

(Max. stock + Min.

Stock)

2

Indicate how fast inventory is used/ sold.

A high turnover ratio generally indicates

fast moving material while low ratio may

mean dead or excessive stock.

5. Raw Material

Turnover ratio

Cost of Material

Consumed

Average stock of

RM

Opening stock

of RM

+ Purchases

Less: Closing

stock

(Opening stock +

Closing Stock)

2

Indicates how fast raw materials are used

in production.

6. Debtors

Turnover ratio

Credit Sales

Average A/c

Receivable

Credit Sales

net of returns

A/c Receivables =

Debtors + B/R

Average A/c

Receivable =

(Opening Bal. +

Closing Bal. )

2

Indicates speed of collection of credit

sales.

7. Creditor

Turnover ratio

Credit Purchases

Average A/c

Payable

Credit

Purchases net

of returns, if

any

A/c Payable =

Creditors + B/P

Average A/c

Payable =

(Opening Bal. +

Closing Bal. )

2

Indicates velocity of debt payment.

Note : The turnover ratios can also be computed in terms of days as 365 / Turnover Ratio. For example, Number of

days average stock is held = 365 / Stock Turnover Ratio

D. LIQUIDITY RATIOS - Short Term Solvency


Ratio Formula Numerator Denominator Significance I Indicator

1. Current

Ratio

Current Assets

Current Liabilities

Inventories

+ Debtors

+ Cash & Bank

+ Receivables /

Accruals

+ Short terms Loans

+ Marketable

Investments

Sundry Creditors (for

goods)

+ Outstanding Expenses

(for services)

+ Short Term Loans &

Advances (Cr.)

+ Bank over draft / Cash

Credit

+ Provision for taxation

+ Purpose or Unclaimed

Dividend

Ability to repay

short-term

commitments

promptly. (Short-

term Solvency)

Ideal Ratio is 2:1.

High Ratio

indicates existence

of idle current

Assets.

2. Quick

Ratio or Acid

Quick Assets

Quick Liabilities

Current Assets

Less: Inventories

Less: Prepaid Expenses

Current Liabilities

Less: Bank Overdraft

Less: Cash Credit

Ability to meet

immediate test ratio

liabilities. Ideal

Ratio is 1: 33: 1

3. Absolute

Cash Ratio

(Cash + Marketable

Securities)

Current Liabilities

Cash in Hand

+ Balance at Bank

(Dr.) + Marketable

Securities & short term

investments

Sundry Creditors (for

goods)

+ Outstanding Expenses

(for services)

+ Short Term Loans

&Advances (Cr.)

+ Bank Overdraft / Cash

Credit + Provision for

taxation

+ Proposed or Unclaimed

Dividend

Availability of cash

to meet short term

commitments.

4. Interval

Measure

Quick Assets

Cash Expenses Per Day

Current Assets

Less: Inventories

Less: Prepaid Expenses

Annual Cash Expenses

365

Cash Expenses = Total

Expenses less Depreciation

and write offs.

Ability to meet

regular cash

expenses.

E. CAPITAL STRUCTURE RATIOS - Indicator of Financing Techniques & long - term

solvency

1. Equity to

Total

Funds Ratio

Shareholde

r's Funds

Total

Funds

Equity Share

Capital

+ Preference

Share Capital

+ Reserves &

Surplus

Less:

Accumulated

Losses

Total Liabilities

(including Current

Liabilities & Provisions)

Indicates Long Term Solvency; mode of

financing; extent of own funds used in

operations.

2. Debt Equity

Ratio

Debt

Equity

Long Term

Borrowed

Funds, i.e.

Debentures,

Long Term

Loans from

institutions


+ Preference Share

Capital


Indicates the relationship between Equity

debt & equity; Ideal ratio is 2: 1.

3. Capital

Gearing Ratio

Fixed

Charge

Bearing

Capital

Equity

Shareholde

r's Funds

Preference

Share Capital

+ Debentures

+ Long Term

Loans



Less: Accumulated

Losses

Shows proportion of fixed charge

(dividend or interest) bearing capital to

equity funds; the extent of advantage or

leverage enjoyed by Equity shareholders.


4. Fixed

Assets to

Long Term

Fund Ratio

Fixed

Assets

Long Term

Fund

Net Fixed

Assets i.e.

Gross Block

Less:

Depreciation

Long Term Funds =

Shareholder's funds (as in

BI) + Debt funds (as in

B2)

Shows proportion of fixed assets (long-

term assets) financed by long term funds.

Indicates the financing approach followed

by the firm i.e. conservative, matching or

aggressive;

Ideal Ratio is less than one.

5. Proprietary

Ratio

Proprietary

Funds

Total

Assets

Equity Share

Capital

+ Preference

Share Capital

+ Reserves &

Surplus

Less:

Accumu1ated

losses

Net Fixed Assets

+ Total Current Assets

Less: Accumulated

Losses

Shows extent of owner's funds utilised in

financing assets.

Note: Proprietary Funds can be computed through two ways from the Balance Sheet:

Liability Route : [Equity Share Capital + Preference Share Capital + Reserves & Surplus] Less: Accumulated

losses

Assets Route: (Net Fixed Assets + Net Working Capital] Less: Long Term Liabilities.

F. COVERAGE RATIOS - Ability to Serve Fixed Liabilities

1. Debt

Service

Coverage

Ratio

Earnings for

Debt Service

(Interest +

Instalment)

Net Profit after

taxation

Add : Taxation

Add: Interest on

Debt Funds

Add: Non-cash

operating

Expenses (e.g.

depreciation and

amortization's)

Add: Non-operating

adjustment

(e.g. loss on sale of

fixed assets )

Interest on

Debt

Add:

Instalment of

Debt

(Principal

repaid)

Indicates extent of current earnings

available for meeting commitments and

outflow towards interest instalment. Ideal

ratio must be between 2 to 3 times

2. Interest

Coverage

Ratio

Earnings before

Interest & Tax

Interest

Earnings before

Interest and Taxes

=Sales Less Variable

and Fixed Costs

(excluding interest)

(or) EAT + Taxation

+ Interest

Interest on

Debt Fund

Indicates ability to meet Interest obligations

of the current year Should generally be

greater than 1.

3. Preference

Dividend

coverage

Ratio

Earnings after

Tax

Preference

Dividend

Earnings after Tax =

EAT

Dividend on

Preference

Share Capital

Indicates ability to pay dividend on

preference share capital.

Theory

Q.1. Indicate the important accounting ratios that would be used by each of the following : -

(i) A long term creditor interested in determining whether his claim is adequately secured.

(ii) A bank who has been approached by a company for short term loan / overdraft.

A shareholder who is examining his portfolio and who is to decide whether he should hold or sell his

shares in a company.


PRACTICAL PROBLEMS

Calculation of Ratios

Problem 1.

Following figures have been extracted from the final accounts of Sumant Ltd.:

Rs.

Sundry Creditors as on 31.3.1996 30,000 Bills Payable as on 31.3.1996 20,000

Purchases for the year ended 31.3.1996 3,00.000 Purchase Return for the above period 10,000

Sundry Creditors as on 31.3.1995 26,000 Bills Payable as on 31.3.1995 4,000

Taking year for 360 days, calculate: (i) Creditors Turnover Ratio (ii) Average Payment Period.

Solution

25.7000,40

000,90,2

/:

PBandCreditorsAverage

purchaseCreditRatioTurnoverCreditors

dayspurchasescreditdialyAverage

PBandCreditorsAveragePaymentAverage 50

000,90,2

360000,40/:

Working Notes:

1. Average creditors and B/P:

Opening Balance of creditors and B/P + Closing Balance of creditors and B/P

2

30,000 + 50,000

2 = Rs. 40,000.

2. Purchases less returns (net purchases) will be taken.

3. In the absence of information total purchases have been treated as credit purchases.

Problem.2.

The balance sheets of Pilcom Ltd. For the last 3 years read as below; (Rs. In lakh)

1994 1995 1996

Sources

Share Capital 2,000 2,000 3,000

(shares of Rs. 10 each)

Share Premium 1,500 1,500 500

Reserves 1,500 1,700 1,800

(after 10%dividend)

Long Term Loan 1,000 800 800

6,000 6,000 6,100

Represented by

Fixed Assets 2,000 2,500 3,000

Less : Depreciation 700 950 1,250

1,300 1,550 1,750

Capital Work-in-progress 800 900 700

Investments 200 200 200

2,300 2,650 2,650

Net Current Assets : Current Assets :

Debtors 1,700 1,800 1,850

Stocks 1,800 1,900 2,400

Cash & Bank 500 500 500


Others 400 600 1,400

4,400 4,800 6,150

Current Liabilities 700 1,450 2,700

3,700 3,350 3,450

Total Assets 6,000 6,000 6,100

Sales 3,900 4,000 5,000

Sales excludes excise duty and sales tax at 20%. Calculate for the years 1995 & 1996:

(i) Fixed Assets Turnover Ratio.

(ii) Stock Turnover Ratio

(iii) Debtors Turnover ratio in terms of number of days sales

(iv) Earnings per share.

Briefly comment on the performance of the company.

Solution 1995 1996

(i) 2.80 times 3.03 times

(ii) 2.16 times 2.33 times

(iii) 133 days 111 days

(iv) Rs. 2.00 Rs. 1.33

Problem 3.

The following extracts of financial information relate Curious Ltd. (Rs. In lakhs)

Balance Sheet as at 31st

December 1995 1994

Share Capital 10 10

Reserves and Surplus 30 10

Loans funds 60 70

100 90

Fixed Assets (Net) (A) 30 30

Current Assets

Stock 30 20

Debtors 30 30

Cash and Bank Balances 10 20

Other Current Assets 30 10

100 80

Less : Current Liabilities 30 20

Net Current Assets (B) 70 60

Total Assets 100 90

Sales (Rs. Lakhs) 270 300

(i) Calculate for two years, Debt-equity Ratio, quick Ratio, and Working Capital Turnover Ratio and

(ii) Find the sales volume that would have been generated in 1995 if the company has maintained

its Working Capital Turnover Ratio.

Solution

Debt Equity Ratio [1.5 times 3.5 times]; Quick Ratio [1.33 : 1], 2.5 : 1 ; Working Capital Turnover Ratio [3.86

Times, 5 times.]

Problem4.

The Balance Sheet of Y Ltd. Stood as follows:


Liabilities 31.3.95 31.3.94 Assets 31.3.95 31.3.94

Capital

Reserves

Loans

Creditors and

Other Current

Liabilities

250

116

100

129

250

100

120

25

Fixed Assets

Less: Depre.

Investment

Stock

Debtors

Cash/Bank

Other Current Assets

Misc. Expenditure

400

140

260

40

120

70

20

25

60

300

100

200

30

100

50

20

25

70

595 495 595 495

You are given the following information for the year 1994—95.

Sales 600 PBIT 150

Interest 24 Provision for tax 60

Proposed Dividend 50

From the above particulars calculate for the years 1994—95;

(a) Return on Capital Employed Ratio. (d) Stock Turnover Ratio

(b) Return on Net Worth Ratio. (e) Current Ratio

(c) Proprietory Ratio [CA Final]

[Ans. Return on capital employed 22.33%; Stock turnover ratio—5.45 times ; Return on net worth 22.53%; Current

ratio = 1.82 times; Proprietory ratio – 0.57.]

Problem 5.

Mr. T. Munim is made an offer by the promoters of Siva Enterprises Ltd. to invest in the project of the company by

purchasing a substantial portion of the share capital. He is promised good returns by way of dividends and capital

appreciation.

Mr. Munim desires that you compute the following ratios for the financial analysis. Workings should form part of

your answer.

1. Return on Investment Ratio; 2. Net Profit Ratio;

3. Stock Turnover Ratio; 4. Current Ratio;

5. Debt Equity Ratio;

The figure given to him are as under : (Rs. ‗000s)

Sales 16,000 Raw Materials Consumed 7,800

Consumables 800 Direct Labour 750

Other Direct Expenses 480 Administrative Expenses 1,200

Selling Expenses 260 Interest 1,440

Fixed Assets 14,000 Income – Tax 50%

Depreciation 700 Share Capital 5,000

Reserves & Surplus 1,500 Secured Term Loans 12,000

Unsecured Term Loans 1,500 Trade Creditors 3,350

Investments 400 Inventories 6,000

Receivables 3,700 Cash at hand & bank 100

Provisions 650 Other Current Liabilities 200

[CA Inter]

[Ans. (1) 13.625 % (2) 8.03 % (3) 1.64 times (4) 2.33 : 1 (5) 2.08 times.]


Problem 6. The following are the summarised Profit and Loss A/c of Hind Products Limited for the year ending 31s1 March

1994 and the Balance Sheet as on that date.

PROFIT AND LOSS ACCOUNT

Rs. Rs.

To Opening Stock 99,500 By Sales(Credit) 8,50,000

To Purchases 5,45,250 By Closing Stock 1,49,000

To Incidental Expenses 14,250

To Gross Profit 3,40,000

9,99,000 9,99,000

To Operating Expenses 1,95,000 By Gross Profit 3,40,000

To Non-Operating Expenses 4,000 By Non-Operating Income 9,000

To Net Profit 1,50,000

. 3,49,000 3,49,000

BALANCE SHEET

Liabilities Rs. Assets Rs.

Share Capital - Land and Building 1,50,000

2,000 Equity Share of Rs. 10 Plant and Machinery 80,000

each 2,00,000 Stock in Trade 1,49,000

Reserves 90,000 Sundry Debtors 41,000

Other Current Liabilities 90,000 Cash and Bank Balance 30,000

Profit and Loss A/c 60,000 Bills Receivable 30,000

Bills Payable 40,000

4,80.000 4,80.000

From the above statements you are required to calculate the following ratios:

(i) Gross Profit Ratio,

(ii) Net Profit Ratio,

(iii) Operating Profit Ratio,

(iv) Operating Ratio,

(v) Return on Capital Employed,

(vi) Net Profit to Fixed Assets Ratio,

(vii) Stock Turnover Ratio,

(viii) Receivable Turnover Ratio,

(ix) Creditors Turnover Ratio,

(x) Sales to Working Capital,

(xi) Sales to Fixed Assets,

(xii) Sales to Capital Employed,

(xiii) Return on Total Resources,

(xiv) Turnover of Total Assets.

Additional Information

Average Receivables Rs. 85,000

Average Payables Rs. 80,000


Solution

(i) Gross Profit Ratio 100Sales

ofitPrGross

= %,,

,,40100

000508

000403

(ii) Net Profit Ratio 100Sales

ofitPrGross %.

,,

,,6517100

000508

000501

(iii) Operating Profit Ratio 100Pr

Sales

ofitOperating %06.17100

000,50,8

000,45,1

(iv) Operating Ratio Sales

ensesexpOperatinggoodsofCost 100

%.,,

,,,,9482100

000508

000951000105

(v) Return on capital Employed 100Pr

EmployeedCapital

ofitoperting %43.41100

000,50,3

000,45,1

(vi) Net Profit to F A 100AssetsFixed

ofitPrNet %.

,,

,,2265100

000302

000501

(vii) Stock turnover Ratio InventoryAverage

soldgoodsofCost

2

gStocksinCloStockOpening

ofitPrGrossSales

times.,,

,,

,,,

,,,,14

250241

000105

2

000491500099

000403000508

(viii) Receivables Turnover Ratio ceivableReAverage

SalesCreditNet times

,

,,10

00085

000508

(ix) Creditors Turnover Ratio payableAccountAverage

PurchaseCredit times.

,

,,86

00080

200455

(x) Sales to Working Capital CapitalWorking

Sales 1087

000201

000508:.

,,

,,

(xi) Sales to Fixed Assets AssetsFixed

Sales 173

000302

000508:.

,,

,,


(xii) Sales to Capital Employed EmployedCapital

Sales 1432

000503

000508:.

,,

,,

(xiii) Return on total Resources 100AssetsTotal

ofitPrNet %.

,,

,,2531100

000804

000501

(xiv) Turnover on total Assets AssetsTotal

SalesNet 1771

000804

000508:.

,,

,,

Problem 7.

The following Balance Sheet of Rim Zim Ltd. as on 31st March, 1994 calculate (i) Current

Ratio, (ii) Quick Ratio (iii) Absolute Liquidity Ratio, (iv) Ratio of Inventory to Working Capital, (v) Ratio of Current

Assets to Fixed Assets (vi) Debt to Equity Ratio, (vii) Proprietary Ratio, (viii) Capital Gearing Ratio and (ix) Fixed

Assets Ratio.

BALANCE SHEET


Equity Share capital 10,00,000 Goodwill (At cost) 5,00,000

6% Preference Share Capital 5,00,000 Plant and Machinery 6,00,000

General Reserve 1,00,000 Land and Building 7,00,000

Profit and loss A/c 4,00,000 Furniture and fixtures 1,00,000

Provision for Tax 1,76,000 Stock-in-trade 6,00,000

Bills payable 1,24,000 Bills Receivable 30,000

Bank Overdraft 20,000 Debtors 1,50,000

Creditors 80,000 Bank 2,00,000

12%debentures 5,00,000 Marketable Securities 20,000

29,00,000 29,00,000

Solution

(i) Current Ratio 152000004

0000010:.

,,.Rs

,,.Rs

sLiabilitieCurrent

AssetsCurrent

(ii) Quick Ratio 1051000803

000004:.

,,.Rs

,,.Rs

sLiabilitieLiquid

AssetsLiquid

(iii) Absolute Liquidity ratio 1550000004

000202:.

,,

,,

sLiabilitieCurrent

SecuritiesMarketableankBatCash

(iii) Inventory to Working Capital 11000006

000006:

,,

,,

CapitalWorking

Inventory

(iv) Current Assets to Fixed Assets 1:526.019:10000,00,19.

000,00,10.or

Rs

Rs

AssetsFixed

AssetsCurrent

(vi) Debt to Equity Ratio 12500000020

000005:.

,,

,,

fundss'rShareholde

DebtstermLong

or


(vii) Proprietary Ratio 169029200000029

0000020:.or:

,,

,,

AssetsTotal

fundss'rShareholde

(viii) Capital Gearing Ratio Surplus&servesReCapitalShareEquity

SecuritiesBearingerestintFixed

5110000015

0000010.:

,,

,,

(ix) Fixed Assets Ratio 1:76.0000,00,25.

000,00,19.

Rs

Rs

EmployedCapital

AssetsFixed

Problem 8.

From the following Balance sheet and the sub-joined information of a Company, you are required to calculate.

1. Current ratio

2. Quick ratio

3. Inventory turnover

4. Average collection period presuming 360 days in a year.

5. Owned funds to liabilities ratio.

Balance Sheet


Share capital 2,00,000 Goodwill 1,20,000

Reserves and surplus 58,000 Plant and machinery 1,50,000

Debentures 1,00,000 Stock 80,000

Creditors 40,000 Debtors 45,000

Bills payable 20,000 Cash 17,000

Other current liabilities 2,000 Misc. Current assets 8,000

4,20,000 4,20,000

Sales (credit) for the year Rs. 4,00,000

Gross profit Rs. 1,60,000 [CS Dec. 98]

Solution Current Assets Rs. 1,50,000

(i) Current Ratio = –––––––––––––––– = –––––––––––– = 2.41 : 1

Current Liabilities Rs. 62,000

Current Assets = Stock + Debtors + Cash + Misc. current Assets

= Rs. (80,000 + 45,000 + 17,000 + 8,000) = Rs. 1,50,000

Current Liabilities = Creditors + Bills payable + other current Liabilities

= Rs. (40,000 + 20,000 + 2,000) = Rs. 62,000

(ii) Quick Ratio = sLiabilitieCurrent

Stock Closing - AssetsCurrent

1:129.1000,62

000,80000,50,1


Cost of goods sold Rs. 2,40,000

(iii) Inventory turnover = –––––––––––––––– = –––––––––––– = 3

Average Inventory Rs. 80,000

Cost of goods sold = Sales – Gross profit

= Rs. 4,00,000 – Rs. 1,60,000 = Rs. 2,40,000

Average Inventory = Rs. 80,000

Note: Opening inventory has not been given

(iv) Average collection period

Days in a year 360

= ––––––––––––– = –––––– = 40 days

Debtors turnover 9

Net credit sales Rs. 4,0,000 4,00,000

Debtors turnover = ––––––––––––––– = –––––––––– = –––––––– = 8.88 = 9 (approx)

Sundry debtors + B/R 45,000 + 0 45,000

2. Owned funds to Liabilities Ratio

Owned funds Rs. 2,58,000

= ––––––––––––– = –––––––––––– = 1.6 : 1

Liabilities Rs. 1,62,000

Own funds = Share capital + Reserve & Surplus

= Rs. 2,00,000 + Rs. 5,800

= Rs. 2,58,000

Liabilities = Debentures + Creditor + B/P + Other Current Liabilities

= Rs. (1,00,000 + 40,000 + 20,000 + 2,000) = Rs. 1.62,000

Problem 9.

The AB Company ‘s financial statements contain the following information:

31st March, 98 31

st March, 99

Cash 2,00,000 1,60,000

Sundry debtors 3,20,000 4,00,000

Temporary investments 2,00,000 3,20,000

Stock 18,40,000 21,60,000

Prepaid expenses 28,000 12,000

Total current assets 25,88,000 30,52,000

Total assets 56,00,000 64,00,000

Current liabilities 6,40,000 8,00,000

10% Debentures 16,00,000 16,00,000

Equity share capital 20,00,000 20,00,000

Retained earnings 4,68,000 8,12,000

Statements of Profit for the year ended 31st March, 1999

Rs.

Sales 40,00,000

Less: Cost of goods sold 28,00,000

Less: interest 1,60,000 29,00,000

Net profit for 1999 10,40,000

Less: Taxes @ 50% 5,20,000

5,20,000

Dividend declared on equity shares Rs. 2,20,000.

From the above figures, appraise the financial position of the Company from the points of view of (I) liquidity; (ii)

solvency; (iii) profitability and (iv) activity. [June-96]


Solution

I. Liquidity Ratios Current Assets

a. Current Ratio = ––––––––––––––

Current Liabilities

Rs. 25,88,000 Rs. 30,52,000

1998 = –––––––––––––––– = 4.04 1999 = –––––––––––– = 3.82

Rs. 6,40,000 Rs. 8,00,000

Quick Assets

b. Acid Test Ratio = ––––––––––––––

Current Liabilities

Rs. 7,20,000 Rs. 8,80,000

1998 = –––––––––––––– = 1.12 1999 = –––––––––––– = 1.1

Rs. 6,40,000 Rs. 8,00,000

II. Solvency Ratios Long-term Debts

a. Debt Equity Ratio = –––––––––––––––––

Shareholder‘s Funds

Rs. 16,00,000 Rs. 16,00,000

1998 = –––––––––––––– = 0.65 (approx) 1999 = –––––––––––– = 0.57(approx)

Rs. 24,68,000 Rs. 28,12,000

Profit before interest + Taxes

b. Interest Coverage Ratio = ––––––––––––––––––––––

Interest charges

Rs. 12,00,000

1999 = ––––––––––––– = 7.5 times

Rs. 1,60,000

III Profitability Ratios Net Profit

a. Net Profit Ratio = ––––––––––––– 100

Sales

Rs. 5,20,000

1999 = –––––––––––––– 100 = 13 %

Rs. 40,00,000

Net Profit before interest + taxes

b. Returns on capital employed = –––––––––––––––––––––––––––––– 100

Average capital employed

Rs. 12,00,000

1999 = –––––––––––– 100 = 28.3 %

Rs. 42,40,000

IV Activity Ratios Cost of goods sold Rs. 28,00,000

a. Stock turnover ratio = ––––––––––––––––– = –––––––––– = 1.4 times

Average Stock Rs. 20,00,000

Sales Rs. 40,00,000

b. Total assets turnover ratio = ––––––––––––– = –––––––––––– = 0.625 times

Total Assets Rs. 64,00,000


Comments: Company ‗s position is sound from the point of view of (i) Liquidity (ii) Solvency (iii) Profitability.

However its activity ratios do not seem to be adequate.

Problem 10.

Particulars 1st Case 2nd Case 3rd Case

Return 75,000 80,000 60,000

Sales 3,00,000 3,00,000 3,00,000

Capital Employed 2,00,000 2,25,000 1,75,000

Compute capital turnover Ratio, Net operating Profit ratio and applying Dupont analysis stat the relationship

between the two.

Solution

Case I Case II Case III

1. Capital Turnover Ratio

Turnover

Capital

31.5 Times

2

1.33 Times

1.71 Times

2. Net operating Profit Ratio

100Return

sales

75100 25%

300

= 26.67%

20%

3. ROI (1 × 2) 37.5% 35.47% 34.2%

Problem 11.

The profit margin of a company is 10% and the capital turnover is 3 times. What is the return on investment (ROI) of

the company? Applying Du Pont analysis, state by what percentage will the company's return on investment increase

or decrease if

(i) the profit margin increases by 2% (ii) the profit margin decreases by 2%;

(iii) the capital turnover increases by 1: and (iv) the capital turnover decreases by I?

[Ans.: ROI - 36%, 24%, 40%, 20%] [Increase/Decrease in ROI +6%, -6%, +10%, -10%]

Problem 12.

Compute the return on capital employed from the following data relating to company A and B applying Du Pont

analysis:-

A Company B Company

Net Sales for the year Rs.5,00,000 Not known

Capital Employed Not known Rs.1,00,000

Operating Profit on Sales 5% 6%

Turnover on Capital Employed 5 Times Not known

Gross Profit margin 30% Rs.90,000(15%)

[Ans: ROI: A- 25%; B-36%

Problem 13.

Calculate Absolute Cash Ratio from following information.

Yr.1 Yr.2

Rs. Rs.

Bank Balance 50,000 70,000

Cash 15,000 5,000

Investments (Total) 1,50,000 1,20,000

Current Liabilities 4,00,000 5,00,000

Trade Investments 20,000 30,000

Market value of quoted Total investments 1,35,000 96,000


Solution

Only Non-Trade Investments at its market value will be taken.

Yr.1 Yr.2

Total Investments 1,50,000 1,20,000

Less: Trade Investments 20,000 30,000

Non- Trade Investments 1,30,000 90,000

000201

0009000096

000501

000301000351ValueMarket

,,

,,

,,

,,,,

= Rs. 1,17,000 = Rs. 72,000

Comment: Absolute cash ratio has declined from .46 to .29. This indicates that availability of cash to pay firm‘s current

liabilities has sharply declined.

Problem 14.

Relevant figures derived from the Balance sheet of A Ltd. as on 31.3.1996 are as under: Total Assets (including

preliminary Expenses of Rs. 10 lacs) = Rs. 190 Lacs

Cash in hand. = Rs. 5 Lacs

Bank Balance. = Rs. 12 Lacs

Total Investments. = Rs. 6 Lacs.

Details of Investments: Trade -Rs. 4 Lacs, Non- Trade Rs. 2 Lacs, Quoted Rs. 3 Lacs out of which Non- Trade is Rs.

1.50 Lacs. Market quotations are Rs. 4.50 Lacs of which Rs. 1.75 Lacs are ) for Non- Trade Investments. Other

investments are not readily marketable. Calculate Cash Position to Total Assets Ratio. Industry average of the ratio is

.18.

Solution

Cash position to Total Assets Ratio = Cash Reservoir

Total Assets

Cash Reserve:

Rs. (in Lacs) Cash in hand 5.00

Bank Balance 12.00

Non- Trade Investments in marketable securities. 1.75

18.75

Total Assets:

Assets as given. 190.00

Less: Preliminary Expenses. 10.00

180.00

Add: Increase in value of marketable non-trade investments. 0.25

180.25

Cash position to Total assets Ratio = 18.75 / 180.25 =.10

Comment: Industry average of the ratio is .18, where as ratio of the firm is only .10. This shows firm is maintaining

low cash balance. This may adversely affect firm's capacity to pay its current liabilities and meet day to day

expenses.

Absolute Cash Ratio =Cash + Non - Trade marketable securities

Current Liabilities


Problem 15.

The following data is available from the records of X Ltd. and Y Ltd. in the same industry the year ended 31st

March, 2000: (Rs. '000)

X Ltd. Y Ltd.

Assets

Plant and machinery 6,780 9,600

Stock 4,920 3,800

Debtors 1,320 2,520

Cash 840 1,280

13,860 17,200

Liabilities

Equity share capital 4,400 7,000

Retained earnings 3,860 2,000

10% debentures 2,000 4,000

Sundry Creditors 3,600 4,200

13,860 17,200

Sales 22,400 32,800

Cost of goods sold 16,000 25,800

Other operating expenses 3,200 3,440

Interest expenses 200 400

Income tax 1,500 1,580

Dividend . 400 720

You are required to calculate the relevant ratios and answer the following questions:

(i) Which of the companies is able to meet its current debts in a better way?

(ii) Which of the companies collects its receivables faster, assuming all sales are on credit basis?

(iii) Which of the companies is making more profitable use of the shareholders' money?

(iv) If you have to purchase the debentures of one of the companies, which company would be preferred by you?

(v) Which of the companies retains a larger proportion of its income in the business?

[Ans.: X Ltd.]

Problem 16.

Following is Profit and Loss account of A. B. C. Ltd. for the year ended 31st March. 1996,

Rs. Rs.

To Opening stock 4,00,000 By Sales 24,00,000

To Purchases 16,00,000 By Closing stock. 8,00,000

To Gross Profit 12.00.000

32.00.000 32,00,000

To salaries, allowance and bonus 3,20,000 By Gross Profit 12,00,000

To Stationery 32,000

To Telegrams, Postage Telephones 8,000

To Advertisements 8,000

To Commission 4,000

To Depreciation 16,000

To Preliminary expenses written off 4,000

To Loss on sale of fixed assets 8,000

To Provision for taxation 4,00,000

To Net Profit 4,00,000

12,00,000 12,00,000

Advance tax paid Rs. 3,40,000, Cash Reservoir Rs. 1,40,000. Find out average daily cash expenses and calculate

cash interval.


Solution

Average daily cash expenses: Rs.

Expenses as per Profit and Loss Account excluding non-cash items:

Purchases 16,00,000

Salaries, allowances, bonus 3,20,000

Stationery 32,000

Telegrams, postage, telephones 8,000

Advertisements 8,000

Commission 4,000

19,72,000

Add Advance tax. 3,40,000

23,12,000

-Average daily expenses = 23,12,000 / 365 = Rs. 6.334

Cash Interval = Cash Reservoir

Average daily cash expenses = 1,40,000/ 6,334 = 22 days.

Problem 17.

A business furnishes you with the following details:

(i) Opening Stock Rs. 50,000

(ii) Closing Stock Rs. 70,000

(iii) Sales:

Credit Rs. 2,10,000

Cash Rs. 1,50,000

(iv) Gross profit Rs. 60,000

(v) Year end debtors Rs. 20,000

Less: Provision Rs. 2,000

For bad debts 18,000

(iv) Year end bills receivable Rs. 15,000

A year may be taken to be of 360 days. You are asked to:

(i) Work out stock turnover and debtors turnover ratios.

(ii) Calculate the operating cycle and state its significance. [CA Nov'99]

Analysis of Ratio

Problem 18.

You have the following information on the performance of Prosper Co., as also industry averages:

(i) determine the indicated ratios for the Prosper Co. ; and

(ii) indicate the company's strengths and weaknesses as shown by your analysis.

Balance Sheet as on 31st December, 1998

Liabilities Rs. Assets Rs. Equity share capital 24,00,000 Net fixed assets 12,10,000

10% debentures 4,60,000 Cash 4,40,000

Sundry creditors 3,30,000 Sundry debtors 5,50,000

Bills payable 4,40,000 Stock 16,50,000

Other current liabilities 2,20,000

38,50,000 38,50,000


Statement of Profit for the year ending 31st December, 1998

Rs. Sales 55,00,000

Less: Cost of goods sold:

––Materials 20,90,000

––Wages 13,20,000

––Factory overheads 6,49,000 40,59,000

Gross Profit 14,41,000

Less: Selling & distribution cost 5,50,000

Administration and general

expenses 6,14,000 11,64,000

Earning before Interest and taxes 2,77,000

Less: Interest charges 46,000

Earnings before taxes 2,31,000

Less: Taxes (50%) 1,15,500

Net Profit 1,15,500

Ratios considered: Industry

Current assets/current liabilities 2.4

Sales/debtors 8.0

Sales/stocks 9.8

Sales/total assets 2.0

Net profit/sales 3.3%.

Net profit/total assets 6.6%

Net profit/net worth 10. 7%

Total debts/total assets 63.5%

[CS June-91]

Solution

Company strength:

(a) Current ratio is better than that of industry.

(b) Sales / Debtors ratio indicates that the debts collection period of the company is better than that of industry.

Company's weakness:

(a) As for the industry's standard the stock should have been Rs. 5,61,224 (55,00,000/9.8). But the company's

stock was Rs. 16,50,000 i. e. three times more. Thus it is seen that the greatest weakness of the company is

the high level of inventories.

(b) The high level of inventory leads 10 a decline in the Sales / Total assets Ratio.

(c) The cost of high level of inventory affects the profitability in an adverse manner.

(d) Due to low profitability the ratio at 5,6 &7 are also lower than those of the industry.

(e) The Net Profit / Net Worth is low because1he company is using less amount of debts i.e. 37.7 % as

compared to the industry's figure of 63.5%.

Remedial Action

The stock should be maintained at Rs. 5,50,000 i. e. stock should be reduced by Rs. 11,00,000. If it is reduced the

ratios at 3 & 4 will be as follows:

Sales Rs. 55,00,000

–––––––– = –––––––––––––– = 10.0

Stock Rs. 5,50,000

Sales Rs. 55,00,000

–––––––––– = ––––––––––– = 2.0

Total Assets Rs. 27,50,000


Due to reduction in stock level the profitability of the company will improve. Further debentures can be obtained.

This will improve the ratio of Net Profits / Net Worth. To sum up reduction of stock and increase of debt will be

highly beneficial to the company.

Problem 19.

Given below are cash position ratios of MRD Ltd. and the Industry Average. Industry Average is arrived at by taking

average position of 25 companies of the similar trade :

Absolute Cash ratio Cash Position to total Cash interval

Assets ratios

MRD. Ltd. 0.36 12.50% 25 days

Industry Average 0.30 15% 33 days

How do you feel about the cash position of MRD Ltd.?

[Ans. (i) Absolute cash ratio is better than industry average.

(ii) Cash position to total assets ratio of MRD Ltd. is lower than that of industry.

(iii) Overall assessment: it can be concluded that MRD Ltd. is maintaining low cash position.]

Problem 20.

On the basis of the following figures derived from the accounts of a company; prepare a report on the level of

efficiency of financial and operational management of the company:

Years Capital Net Profit ROI Current

Turnover on Sales (%) Ratio

Ratio (%)

1 1.0 8 8 6.0

2 2.0 10 20 4.0

3 3.0 11.5 34.5 2.0

4 5.0 13 65 0.5

[June 86]

Solution To,

The Managing Director

Sub.:- Level of efficiency of financial and operational management

Sir,

After analysing the figures derived from the accounts of our company I have come on the point that the level of

efficiency on financial and operational management of the company are as follows.

1st year

In the first year there is poor utilisation of the available capital as the capital turnover ratio is very low. While the

current ratio is too high which also indicates that company did not utilised its funds. Considering these two ratios, it

can be concluded that there is a case of over capitalisation. The percentage of net profit on sales and ROI are also not

upto mark.

2nd

year

In the second year though there is improvement in all the ratios so there is very much scope for reduction in current

ratio and improvement in the capital turnover ratio.

3rd

year

In the third year the capital turnover ratio has gone upto 3:0 and current ratio has come down to 2:0 which indicates a

good situation in this year. ROI is also excellent at 34.5 %.

4th

year

In the fourth year as the capital turnover ratio, percentage of net profit on sales and ROI are very high. i.e. 5.0, 13,

65. As current ratio has come down to 0.5 this shows that there was no sufficient working capital to meet the


financial liabilities of the company, which is not a good situation. So efforts should be made to improve the current

ratio to 2.

Final conclusion

It is advised to maintain these ratios in the fourth year and improve the current ratio to 2 by ploughing back profits

for meeting the working capital requirement.

Yours faithfully

Date Sd/-

Management Accountant

Problem 21.

A Ltd. and B Ltd. are two Companies belonging to the same industry. In 1988—89 each of them has maintained the

inventory almost at the same level at which its inventory stood at the beginning of the year. The industry has

developed the following accounting ratios for inter firm comparison.

Current Ratio 1.8‘ Liquid Ratio 1.1 (liquid liability is taken after excluding overdraft); Gross Profit Ratio to sales .25

(after considering only material cost) Return on own capital 40; Debtors velocity 80 days Creditors Velocity 75 days

and stock Velocity 4.

From the following details of A Ltd. and B Ltd. relating to 1988—89, comment upon the financial management and

operational efficiency of the two companies in terms of the norms for the industry as stated above.

A Ltd. B Ltd

Sales Rs. 250 lakhs Rs. 200 lakhs

Bank overdraft Rs. 25 lakhs Rs. 10 lakhs

Debtors velocity 3 months 2 months

Gross profit % on sales (considering only material cost) 20% 30%

Stock Rs. 35 lakhs Rs. 40 lakhs

Expenses Rs. 30 lakhs Rs. 25 lakhs

Own capital velocity (with respect to sales) 8 2

Trade creditors Rs. 65 lakhs Rs. 28 lakhs

Expenses creditors Rs. 3 lakhs Rs. 2 lakhs

Liquid assets (other than Book Debts) Rs. 4 lakhs Rs. 8 lakhs

Note : For calculation of velocity in days 365 days in a year have been considered in all the cases.

[CA May 1989]

Solution A Ltd. Profit & Loss Account

To Cost of Sales (80%) of sales 200.00 By Sales 250.00

(Material consumed)

To Gross Profit (20%) of sales 50.00

250.00 250.00

To Expenses (12%) of sales 30.00 By Gross Profit 50.00

To Profit before Interest and Tax

(8% ) of sales 20.00

50.00 50.00

Balance Sheet as on

(Rs. in Lakhs)

Liabilities Amount Assets Amount

Own Capital

Bank Overdraft

Trade Creditors

Expense Creditors

31.25

25.00

65.00

3.00

Fixed Assets

(balancing figure)

Stock

Liquid Assets

Debtors

22.75

35.00

4.00

62.50

124.25 124.25


B Ltd.

Profit & Loss Account

To Material consumed 140.00 By Sales 200.00

To Gross Profit (30%) of sales 60.00

200.00 200.00

To Expenses (12.5%) of sales 25.00 By Gross Profit 60.00

To Profit before Tax

(17.50% ) of sales 35.00

60.00 60.00

Balance Sheet as on (Rs. in Lakhs)

Liabilities Amount Assets Amount

Capital own

Bank Overdraft

Creditors

Expense for Creditors

100.00

10.00

28.00

2.00

Fixed Assets

(balancing figure)

Stock

Liquid Assets

Debtors

58.67

40.00

8.00

33.33

140.00 140.00

Notes:

(i) It has been assumed that expenses include interest cost.

(ii) In the absence of information about tax, it has been assumed that return on capital computed is before tax.

Statement showing relevant ratios of industry Averages, A Ltd. and B Ltd. and comments thereon

Ratio Industry

Average

A Ltd. B Ltd.

Current Ratio: Current Assets/Current Liabilities

1.8 101.50

1.0993

81.33

2.0340

Liquid Ratio: Quick Assets / Quick Liabilities

(CL-Bank overdraft)

1.1 66.50

.9968.00

41.33

1.3830

Gross Profit Ratio: Gross Profit/Sales × 100

Return on Own Capital

Profit / own capital × 100

25%

40%

50100 20%

250

20100 64%

31.25

60100 30%

200

%35100100

35

Debtors’ velocity (in days): 365/credit sales × closing debtors

80 days 365

62.50 91 days250

365

33.33 61 days200

Creditors’ Velocity (in days): 365/credit purchase × closing creditors

75 days 365

65 119 days200

365

28 73 days140

Stock Velocity (time): Cost of Goods sold/Closing stock or

Average stock

4

2005.71

35

1403.5

40

Current ratio indicates short term financial position of a firm. A Ltd‘s current ratio (1.09) is much below the industry

average of 1.8 indicating weak short term financial position, whereas B Ltd. s‘ current ratio of 2.03 above the

industry average points towards its sound short-term financial position. It may be noted that the generally accepted

current ratio is 2 : 1

Liquid ratio of 0.98 (taking current liability without bank overdraft) of A Ltd, is also below industry average of 1.1,

indicating that the company does not possess adequate liquidity to pay current liabilities at a given point of time even

after excluding overdraft. The liquidity ratio of B Ltd (1.38) is better than industry average of 1.1, showing much

better short term solvency position than that of A Ltd. and also in comparison to industry as a whole.


A Ltd. is earning 5% less gross profit than industry average whereas B Ltd. is earning 5% more than industry

average. It shows that operational efficiency, particularly management of purchase of B Ltd. is higher than that of A

Ltd. and also better than industry average.

A Ltd. ‗s debtors‘ velocity is lower than industry average. However, debtors‘ velocity of B its is slightly better than

that of A Ltd. and in comparison to industry average.

A Ltd. shows much higher return on own investments i.e. 64% in spite of lower net profit ratio. It has been possible

mainly because of higher fixed assets turnover ratio, apart from higher stock Velocity. B Ltd. ‗s return on investment

is lower than industry average. It may be explained by lower fixed assets turnover and lower stock velocity.

A Ltd. is taking 119 days to pay its creditors against the industry average of 75 days. It may partly responsible for

paying higher purchase price resulting in lower GP ratio. B Ltd. is taking 73 days to pay its creditors four days less

than industry average. It may be said that it is making timely payment to its creditors enjoying better credit

worthiness.

Higher stock velocity of A Ltd. (5.71) as compared to industry average of 4, shows comparatively less investment in

stock. B Ltd.‘s stock velocity of 3.5 is below industry average indicating relatively more investment in stock.

In conclusion, it may be said that B Ltd. has better financial management and operational efficiency in comparison to

A Ltd. It is also surprising why it has heavy investment in fixed assets

Problem 22.

The Balance Sheets of A Ltd. and B Ltd. as on 31st March 1994 are as follows:

Liabilities A Ltd. B Ltd.

Share Capital 40,00,000 40,00,000

Reserves & Surplus 32,30,000 25,00,000

Secured Loans 25,25,000 32,50,000

Current Liabilities & Provisions :

Sundry Creditors 15,00,000 14,00,000

Outstanding Expenses 2,00,000 3,00,000

Provision for Taxation 3,00,000 3,00,000

Proposed Dividend 6,00,000

Unclaimed Dividend 15,000 —

1,23,70,000 1,17,50,000 Assets

Fixed Assets Less Depreciation 80,00,000 50,00,000

Investments 15,00,000 —

Inventory at cost 23,00,000 45,00,000

Sundry Debtors — 17,00,000

Cash and Bank 5,70,000 5,50,000

1,23,70,000 1,17,50,000

Additional information available:

(i) 75% of the Inventory in A Ltd. readily saleable at cost plus 20%

(ii) 50% of Sundry Debtors of B Ltd. are due from C Ltd. which is not in a position to repay the amount B Ltd.

agreed to accept 15% debentures of C Ltd.

(iii) B Ltd. had also proposed 15% dividend but that was not shown in the accounts.

(iv) At the year end, B Ltd. sold investments amounting to Rs. 1,20,000 and repaid Sundry Creditors.

On the basis of the given Balance Sheet and the additional information, you are required to evaluate liquidity of the

companies. All working should form part of the answer.

Solution Particulars A B

CA. Stock (23,00,000 × 75%) + 20%

Debtor (17,00,000 × 50%)

Cash & Bank

20,70,000

-

5,70,000

-

8,50,000

5,50,000


Liquid Assets

Stock(23,00,000 × 25%) 26,40,000

5,75,000 14,00,000

45,00,000

Total CA 32,15,000 59,00,000

CL

Proposed Dividend

Creditor

Out Exp.

Provision for tax

Unclaimed Dividend

6,00,000

15,00,000

2,00,000

3,00,000

15,000

6,00,000

15,20,000

3,00,000

3,00,000

-

26,15,000 27,20,000

Evaluation of Liquidity

A B

1. CL

CARatioCurrent

32,15,0001.23

26,15,000

59,00,0002.17

27,20,000

2. CL

LARatioLiquid 009.1

000,15,26

000,40,26 51.

000,20,27

000,00,14

Problem 23.

Mr. Smarty intends to supply goods on credit to Surya Ltd. and, Chandra Ltd. The relevant financial data relating to

the companies for the year ended 31st December; 1998 are as follows:

Surya Ltd. Chandra Ltd.

Terms of payment 3 months 3 months

(Started) (Rs.) (Rs.)

Stock 8,00,000 1,00,000

Debtors 1,70,000 1,40,000

Cash 30,000 60,000

Trade creditors 3,00,000 1,60,000

Bank overdraft 40,000 30,000

Creditors for expenses 60,000 10,000

Total purchases 9,30,000 6,60,000

Cash purchases 30,000 20,000

Advise with reasons, as to which of the companies he should prefer to deal with. [CS Dec.-87]

Solution

First of all Let us find out current ratio, liquid ratio, creditors velocity and average credit period as follows.

Surya Ltd. Chandra Ltd.

Rs. Rs.

Debtors 1,70,000 1,40,000

Cash 30,000 60,000

Liquid Assets 2,00,000 2,00,000

Stock 8,00,000 1,00,000

Current Assets 10,00,000 3,00,000

Trade creditors 3,00,000 1,60,000

Bank overdraft 40,000 30,000

Creditors for expenses 60,000 10,000

Current liabilities 4,00,000 2,00,000

(i) Current ratio: Surya Ltd. Chandra Ltd.

Rs. Rs.

Current Assets 10,00,000 3,00,000

Current Liabilities 4,00,000

2,00,000

= 2.5 = 1.5

(ii) Liquid Ratio (Including Bank overdraft)


Liquid Assets Rs. 2,00,000 Rs. 2,00,000

= –––––––––––––– = ––––––––––– = ––––––––––––

Current Liabilities Rs. 4,00,000 Rs. 2,00,000

= 0.50 = 1.00

(iii) Creditor's Turnover Ratio

Credit purchases Rs. 9,00,000 Rs. 6,40,000

= –––––––––––––– = –––––––––––– = ––––––––––––

Trade creditors Rs. 3,00,000 Rs. 1,60,000

= 3 times = 4 times.

(iv) Average Credit Period:

Days in a year 365 365

–––––––––––––––––––– –––– ––––

Creditor's Turnover Ratio 3 4

= 122 days = 91 days

After calculating all above ratio we see that liquid ratio, creditors velocity and average credit period are better in case

of chandra Ltd.

Terms of payment: 3 months chandra Ltd. is following this as the average credit period in this case is 91 days.

Though Current Ratio is better, Surya Ltd. is not reliable in regard to liquidity, creditors velocity and Average credit

period which is of 4 months instead of 3 months. That means Surya Ltd. is discharging liabilities in an average period

of 4 months.

So my advise is to deal with chandra Ltd. due to above reasons.

Problem 24.

Assuming the current ratio is 2, state and explain in each of the following cases whether the current ratio will

improve or decline or will have no change:

(i) Payment of a current liability;

(ii) purchase of fixed assets;

(iii) cash collected from customers;

(iv) bills receivable dishonoured; and

(v) issue of new shares. [CS Dec. 90]

Solution

Current Ratio = 1:2sLiabilitieCurrent

AssetsCurrent

Let us assume current assets are Rs. 21akhs and current liabilities are Rs. 1 lakh.

(i) Payment of a current liability: Current ratio will improve:- When current ratio is 2 : 1, payment of current liabilities will

reduce in the same amount in the numerator and denominator. Hence current ratio will improve. Exp. Payment of

current liability = Rs. 10,000

then current asset = Rs.1 ,90,000

current liability = Rs. 90,000

Current Ratio = 1:2000,90.

000,90,1.

Rs

Rs

(ii) Purchase of fixed assets

(a) On Cash for Rs. 10,000

Current liabilities = Rs. 1,00,000

Then Current Asset = Rs. 1,90,000


Current Ratio = 9.1000,06,1.

000,90,1.

Rs

Rs

Current ratio will decline.

(b) On Credit for Rs. 10,000


Then Current Asset = Rs. 2,00,000

Current Ratio = 82.1000,10,1.

000,00,2.

Rs

Rs

Current ratio will decline

Note: In both the cases i.e. purchase of fixed asset on cash or on credit current ratio will decline.

(iii) Cash collected from customers: Current ratio will not change.

Reason: Cash will increase and debtors will decrease. Hence no change in current assets.

(iv) Bills receivable dishonoured: Current ratio will not change. Reason: Bills receivable will come down and debtors will

increase. Hence no change in current assets.

(v) Issue of new shares: Current ratio will improve.

Example: Issue of new shares for Rs. 20,000 cash. Cash will increase by Rs. 20,000 and consequentially increase in

current assets.

Current ratio = 2.2000,00,1.

000,20,2.

Rs

Rs

Problem 25.

Following figures are available from the accounts of a large industrial unit. Compute relevant ratios to assess the

efficiency of working capital management for 1999-2000 and 2000-01.

(Rs. crores)

Particulars 1998-99 1999-2000 2000-2001

Inventories 50.0 52.5 65.0

Debtors 67.0 57.0 77.0

Other current assets 5.0 15.0 20.0

Cash and bank balances 30.0 10.0 15.0

Total 152.0 134.5 177.0

Current liabilities 52.0 54.5 72.0

Net working capital 100.0 80.0 105.0

Sales 300.0 300.0 340.0

Total assets 220.0 200.0 240.0

(CWA Dec., 1994)

Solution Working Notes:

(Rs. crores)

1. Average Inventory (Op. Stock + Closing Stock)/2

1999-2000 (50 + 52.5)/2 51.25

2000-2001 (52.5 + 65)/2 58.75

2. Average Debtors (Op. Balance + Closing Balance)/2

1999-2000 (67 + 57)/2 62

2000-2001 (57 + 77)/2 67

3. Average Working Capital (Op. Balance + Closing Balance)/2

1999-2000 (100 + 80)/2 90


2000-2001 (80 + 105)/2 92.5

4. Average Current Assets (Op. Balance + Closing Balance)/2

1999-2000 (152 + 134.5)/2 143.25

2000-2001 (134.5 + 177)/2 155.75

Computation of Ratios for assessment of Working Capital (Rs. crores)

Particulars 1999-2000 2000-2001

1. Current Ratio (Current assets/Current liabilities) (134.5/54.5) (177 /72)

= 2.47 = 2.46

2. Liquid Ratio (Current Assets -Inventory/Current Liabilities) (134.5- 52.5)/54.5 (177- 65)/72

= 1.50 = 1.56

3. Current Assets to Total Assets (Current assets/Total assets) (134.5/200) (177/240)

= 0.67 = 0.74

4. Inventory turnover ratio (Sales/Average inventory) (300/51.25) (340/58.75)

= 5.85 = 5.79

5. Debtors Turnover Ratio (Sales/Average debtors) (300/62) (340/67)

6. Current Assets Turnover Ratio (Sales/ Average current assets) (300/143.25) (340/155.75)

= 2.09 = 2.18

7. Working Capital Turnover Ratio (Sales/ Average net working capital) (300/90) (340/92.5)

= 3.33 = 3.68

B. Financial Statement

Problem 26.

Assume that a firm has owners' equity of Rs. 1,00,000. The ratios for the firm are:

Current debt to total debt .40

Total debt to owners' equity .60

Fixed assets to owners' equity .60

Total assets turnover 2 times

Inventory turnover 8 times

Complete the following balance sheet, given the above information.

Liabilities Rs. Assets Rs. Current debt ………. Cash ……….

Long-term debt ………. Inventory ……….

Total debt ………. Total current assets ……….

Owners' equity ………. Fixed assets ……….

Total Capital ………. Total assets ……….

Solution

Equities Rs. Assets Rs Current debt 24,000 Cash 60,000

Long-term debt 36,000 Inventory 40,000

Total debt 60,000 Total current assets 1,00,000 Owners' equity 1,00,000 Fixed assets 60,000

Total Capital 1,60,000 Total assets 1,60,000

Total Debt = 1,00,000 X 0.6 = 60,000

Current Debt = 60,000 X 0.4 = 40,000


Fixed Assets = 1,00,000 X 0.6 = 60,000

Problem 27.

Complete the following annual financial statements on the basis of ratios given below :-

Profit and loss account for the year ended 30th

June, 1990

Dr. Rs. Cr. Rs. To cost of goods sold 6,00,000 By Sales 20,00,000

― Operating Expenses ---

― Earning before interest

and Tax ---

-----

To Debenture Interest 10,000 By Earnings before

― Income – tax --- Interest & tax

― Net Profit ---

--- -----

Balance Sheet as at 30th

June, 1990

Rs. Rs.

Net Worth : Fixed Assets ----

Share Capital ----- Current Assets:

Reserve & Cash -----

Surplus ----- Stock -----

10% Debentures ----- Debtors 35,000

Sundry Creditors 60,000 _______

Net Profit to sales 5% Current Ratio 1.5 times

Return on net worth 20% Inventory turnover (based on cost of goods sold) 15 times

Share capital to reserves 4:1 Rate of Income- tax 50

Solution P/L Account

To Cost of good sold

To Operating Exp

EBIT

6,00,000

11,90,000

2,10,000

By Sales

20,00,000

20,00,000 20,00,000

To Debt Int.

To Income Tax

To N.P

10,000

1,00,000

1,00,000

EBIT 2,10,000

2,10,000 2,10,000

Balance Sheet

S. Capital

Reserve

N. W.

10% Deb

Creditors

4,00,000

1,00,000

5,00,000

1,00,000

60,000

Fixed Assets

CA

Cash

Stock

Deb

5,70,000

15,000

40,000

35,000

90,000

6,60,000 6,60,000

Problem 28.

Working capital of a company is Rs. 1,35,000 and currant ratio is 2.5 Liquid ratio is 1.5 and proprietary ratio is 75%.

Bank overdraft is Rs. 30,000. There are no long term loans and fictitious assets. Reserves and surplus amount to Rs.

90,000 and the gearing ratio (equity Capital/Preference Capital) is 2.

From the above draw the statement of proprietary fund.


Solution

Computation of Net Block and Proprietary Fund:

Proprietary Ratio = Proprietary Fund / Total Assets

= Proprietary Fund / Net Block + Current Assets = 0.75

i.e. Proprietary Fund = 0.75 Net Block + .75 2,25,000

= .75 Net Block + 1,68,750

Since there in no long term loan,

Hence, Proprietary funds = Net Block + Working Capital

= Net Block + 1,35,000

= 0.75 Net Block + 1,68,750

or, 0.25 Net Block = Rs. 33,750

Net Block = Rs. 1,35,000

Proprietary Funds Statement

Particulars Rs. Rs.

Sources: Equity Capital 1,20,000

Preference Capital 60,000

Reserve and Surplus 90,000

2,70,000

Applications: Net Block 1,35,000

Current Assets:

Stock 1,35,000

Other Current Assets 90,000 2,25,000

3,60,000

Less: Current Liabilities

Bank Overdraft 30,000

Other Current Liabilities 60,000 90,000

2,70,000

Problem 29.

Important ratios of a firm for the year ended 1999 are given below:

Stock velocity (stock holding period) 4 months Debt collection period 2 months

Creditors payments period 73 days Gross profit Rs. 2,00,000

Gross profit margin 20% Cash and Bank balance 5% of Sales

Credit purchase 25%

The firm expects in increase of 50% in sales in the ensuing year

Estimate the working capital requirement of the firm for the ensuing year.

Ans. W.C. 6,65,000

Problem 30.

Using the following data, complete the Balance Sheet of X Ltd. as at 31.3.2000.

Gross profit 25% of Sales Gross profit Rs. 1,20,000

Shareholders equity Rs. 20,000 Credit Sales to total sales 80%.

Total turnover to total assets 4 times Cost of sales to inventory 10 times


Average collection period 5 days Long-term debt ?

Current ratio 1.5 Sundry creditors Rs. 60,000

assume 365 days in a year

Balance Sheet of X Ltd. as at 31.3.2000


Sundry Creditors Cash

Long-term Debt Sundry Debtors

Share Capital Inventory

––––––––– Fixed Assets –––––––––

Problem 31.

From the following prepare a balance sheet:

Current ratio is 1.75 Liquid ratio is 1.25

Stock turnover ratio (closing stock) is 9 times Gross profit ratio is 25%

Debtors collection period is 1.5 months Reserves to capital is 0.2

Turnover fixed Assets is 1.2 Capital gearing ratio is 0.6

Fixed Assets to net worth is 1.25 Sales for the year is Rs. 12,00,000

Solution Balance Sheet


Share capital 6,66,670 Fixed Assets 10,00,000

Reserves & Surplus 1,33,330 Investment 1,30,000

Current Assets :

Long-term Loans 4,80,000 Stock 1,00,000

Current Liabilities 2,00,000 Debtors 1,50,000

Cash 1,00,000 3,50,000

14,80,000 14,80,000

Working Notes:

1. Gross profit ratio = Sales

Profit Gross

Gross Profit

25% or ¼ = 12,00,000

Profit Gross

Gross profit = Rs. 3,00,000

Sales – Gross profit = Cost of goods sold

Rs. 12,00,000 –Rs. 3,00,000 = Rs. 9,00,000

2. Stock turnover ratio = stock Closing

sold goods ofCost

9 = stock Closing

9,00,000 Rs.

9 Closing stock = Rs. 9,00,000

Closing stock = Rs. 1,00,000


3. Liquid ratio sLiabilitieCurrent

Stock - AssetsCurrent

1.25 sLiabilitieCurrent

1,00,000 Rs. - AssetsCurrent

Current Assets- Rs. 1,00,000 = 1.25 Current Liabilities

4. Current ratio sLiabilitieCurrent

AssetsCurrent

1.75 = sLiabilitieCurrent

AssetsCurrent

Current Assets = 1.75 Current Liabilities

1.25 Current Liabilities = Current Liabilities – Rs. 1,00,000

0.50 Current Liabilities = 1.75 Current Liabilities – Rs. 1,00,000

0.50 Current Liabilities = Rs. 1,00,000

Current Liabilities = Rs. 2,00,000

1.75 Current Liabilities = Rs. 2,00,000 1.75 = Rs. 3,50,000

5. Debtors turnover ratio = 12Sales

Debtors

3 Debtors 12

–– months = ––––––––––––

2 Rs. 12,00,000

24 Debtors = Rs. 36,00,000

Debtors = Rs. 1,50,000

Current Assets = Rs. 3,50,000

Less: Stock 1,00,000

Debtors 1,50,000 2,50,000

Cash balance 1,00,000

Sales Rs. 12,00,000

6. Fixed Assets turnover ratio= ––––––––––––––– 1.2 = ––––––––––––

Fixed Assets Fixed Assets

1.2 Fixed Assets = Rs. 12,00,000

Fixed Assets = Rs. 10,00,000

Fixed Assets

Fixed Assets to net worth = –––––––––––

Net Worth

Rs. 10,00,000

1.25 = ––––––––––––

Net Worth

1.25 Net Worth = Rs. 10,00,000


Net Worth = Rs. 8,00,000

7. Net worth includes share capital and reserves and surplus

Net worth = Share capital + Reserve

Rs. 8,00,000 = y + 0.2 y (reserves to capital 0.2)

1.2 y = Rs. 8,00,000

y = Rs. 6,66,670

Share capital is Rs. 6,66,670 and reserves Rs. 1,33,330

Long-term loans

8. Capital gearing ratio = –––––––––––––––

Shareholders fund

Long-term loans

0.6 = –––––––––––––––––

Rs. 8,00,000

Long-term loans = Rs. 8,00,000 0.6 = Rs. 4,80,000.

Problem 32.

From the following information make out a statement of proprietor's funds with details:

Current ratio 2.5 Liquid ratio 1.5

Proprietary ratio (fixed assets/proprietary fund) 0.75 Working capital Rs. 60,000

Reserve and surplus Rs. 40,000 Bank overdraft Rs. 10, 000

There is no long term loan or fictitious assets.

[CS Dec.-91, Jun-94, Dec.-98]

Solution Balance Sheet as on......

Particulars Rs. Particulars Rs. Share capital 2,00,000 Fixed Assets 1,80,000

Reserves & Surplus 40,000 Stock 55,000

Bank overdraft 10,000 Other current assets 45,000

Other current liabilities 30,000

2,80,000 2,80,000

Working Notes:

(i) Proprietary ratio (fixed assets / proprietor's funds) = 0.75

Proprietary ratio (working capital/ proprietary funds) = 0.25

Let Proprietary fund = X

0.25X = Working capital = Rs.60,000

Rs. 60,000

X = ––––––––––– = Rs.2,40,000

25

Proprietary fund = Rs. 2,40,000

(ii) Fixed assets = 0.75 × Rs. 2,40,000

= Rs.1 ,80,000

(iii) Current Ratio = 2.5

Let Current Liabilities = X Current Assets Current Assets

––––––––––––––– = 2.5 –––––––––––– = 2.5

Current Liabilities X


Current Assets = 2.5 X

Current Assets -Current Liabilities = Working Capital

2.5X –X = Rs. 60,000 or 1.5 = Rs. 60,000

Rs.60,000

or X = ––––––––––– = Rs. 40,000

1.5

Current Liabilities = Rs. 40,000

Current Assets = 2.5 X = 2.5 × Rs. 40,000 = Rs. 1,00,000

(iv) Liquid Ratio = overdraft Bank - sLiabilitieCurrent

Stock - AssetsCurrent = 1.5

Rs.10,000- Rs.40,000

Stock - 0Rs.1,00,00= 1.5,

Rs.30,000

Stock - 0Rs.1,00,00= 1.5

Rs. 1,00,000 - Stock = Rs.30,000 1.5

Rs. 1,00,000 - Stock = Rs.45,000 Or Stock = Rs. 55,000

(v) Proprietors' fund = Share capital + Reserves & Surplus

Rs. 2,40,000 = Share Capital + Rs. 40,000

Share Capital = Rs. 2,00,000

Problem 33.

The following ratios and information relate to the business at Lakhotia Traders Ltd.

Credit period allowed to Debtors 2 months

Stock Turnover Ratio 8

Lag in payments to Suppliers 1 month

Gross Profit Ratio 25% on turnover

Opening stock Rs.l,05,000

Gross profit for the year ended 31.3.1999 amounted to Rs. 3,00,000.

Find out:

(a) Sales

(b) Sundry Debtors

(c) Closing Stock

(d) Sundry Creditors

Solution

Pr .3,00,000(a) .12,00,000

Pr 25%

Gross ofit RsSales Rs

Gross ofit Ratio onturnover

2(b) .12,00,000 .2,00,000

12 12

Averagecollection PeriodSundry Debtors Net credit Sales Rs Rs

Cost of goods sold= Sales- Gross profit = Rs.12,00,000 – Rs.3,00,000 =Rs.9,00,000

9,00,000(c) .1,12,500

8

Cost of Goods soldAverage Stock Rs

stock Turnover Ratio

Closing Stock = (2 × Average Stock) –Opening Stock = (2 × Rs.1,12,500) – Rs.1,05,000 =Rs.1,20,000


(d) Purchases = Cost of goods sold + Closing Stock-opening stock = Rs.9,00,000 + Rs.1,20,000 - Rs.1,05,000 =

Rs.9,15,000

Sundry Creditors :-

Net Credit Purchase × 250,76.12

1000,15,9.

12

supRsRs

plierstopaymentinLog

Problem 34.

SKS does not maintain proper books of accounts. However, he provides you with the following details :

(a) Sales and Purchase Policy. Total sales during 1987 Rs. 6,00,000. Volume of sales during 2nd

half of

1987 was 1/3 that of 1st half. Volume of credit sales was twice that of cash sales throughout the year.

(b) Credit Policy. Closing debtors represent last two months sales whereas closing creditors represent last 3

months purchases.

(c) Price Policy. Goods were sold at 10% profit on credit sales. Cash selling price was always at a profit of

5% of Sales.

(d) Inventory policy First 2 months requirement was held as opening stock whereas last months requirement

was held as closing stock.

From the above details ascertain the following:

1. Opening stock as on 1.1.1987, Closing stock as on 31.12.1987,

2. Total purchases during 1987 and Closing debtors and creditors as on 31.12.1987

Solution

Basic Calculations

(i) Cash & Credit Sales : (1: 2)

Cash Sales : 1/3th of Rs. 6,00,000 = Rs. 2,00,000

Credit Sales : 2/3rd

of Rs. 6,00,000 = Rs. 4,00,000

(ii) Sales in 1st

Half and 2nd Half

Total 1st Half 2

nd Half,

Rs. Rs. Rs.

Cash 2,00,000 3/4th 1,50,000 1/4

th 50,000

Credit 4,00,000 3/4th 3,00,000 1/4

th 1,00,000

6,00,000 4,50,000 1,50,000

(1) Opening Stock as on 1.1.1987:

Total Sales for first two months: 1/3rd

of Rs. 4,50,000 = Rs. 1,50,000

(i.e., January 1987 and February 1987):

(a) Cash Sales: 1/3 rd of Rs. 1,50,000 = Rs. 50,000

Less: Profit Margin @ 5% on Sales = Rs. 2,500

Cost of goods sold 47,500

(b) Credit Sales: 2/3 of Rs. 1,50,000 = Rs. 1,00,000

Less: Profit margin @ 10% = Rs. 10,000

Cost of goods sold 90,000

Total Opening stock at cost as on 1.1.87 1,37,500

(2) Closing Stock as on 31.12.1987:

Total Sales for last month = 1/6th of Rs. 1,50,000 = Rs. 25,000

(i.e., December, 1987)

(a) Cash Sales: 1/3rd of Rs. 25,000 = Rs. 8,333


Less: Profit Margin @ 5% on sales Rs. 417 Rs. 7,916

(b) Credit Sales: 2/3rd of Rs. 25,000 Rs. 16,667

Less: Profit Margin @ 10% on sales Rs. 1,667 Rs. 15,000

Total Closing Stock at cost 22,916

(3) Total Purchases during 1987: Rs.

Total Sales during 1987 6,00,000

Less: Profit on goods sold:

5% on. Rs. 2,00,000 = Rs. 10,000

10% on Rs. 4,00,000 = Rs. 40,000 50,000 5,50,000

Add: Closing Stock 22,916

5,72,916

Less: Opening Stock 1,37,500

Total Purchases during 1987 4,35,416

(4) Closing Debtors and Creditors as on 31.12.1987:

(a) Closing Debtors:

Total credit sales for the late two months (i.e. Nov. 1987 & Dec. 1987)

= 1/3rd of Rs. 1,00,000 Rs. 33,333

(b) Closing Creditors;

Total Purchases for the last three months (i.e. October, 1987, Nov. 1987

and Dec. 1987, 1/4 of Rs. 4,35,416 Rs. 1,08,854

Problem 35.

From the following particulars prepare the balance sheet.

Current ratio 2 Working capital Rs.4,00,000

Capital block to current assets 3:2 Fixed assets to turnover 1:3

Sales cash/credit 1:2 Debentures/share capital 1:2

Stock velocity 2 months Creditors velocity 2 months

Debtors velocity 3 months Gross profit ratio 25% (to sales)

Reserve 2½ % of turnover Net Profit 10% of turnover

[CS Dec. 92]

Solution

Working Notes :

(i) Since Current Ratio is 2,

Current Assets ÷ Current Liabilities = 2

Current Assets = 2 Current Liabilities

W.C. = Current Asset – Current Liabilities = 4,00,000

Current Asset – Current Liabilities =

2 Current Liabilities(CA= 2CL) – Current Liabilities = 4,00,000

Current Liabilities = 4,00,000

Current Assets = 2 Current Liabilities = 8,00,000

(ii) Capital Employed = 8,00,000 2

3 = 1,20,000

(iii) Since the total liabilities are Rs. 16,00,000 (i.e.Rs.12,00,000 + Rs.4,00,000), the total assets


will also be Rs.16,00,000.

Fixed Assets (Rs. 16,00,000 - Rs. 8,00,000) Rs. 8,00,000

(iv) Turnover (Rs. 8,00,000 3) Rs. 24,00,000

Credit Sales Rs. 16 00 000

Cash Sales Rs. 8,00,000

(v) Debtors velocity 3 months

Debtors are therefore (Rs.16,00,000 × 3/12) Rs. 4,00,000

(vi) Gross Profit (Rs.24,00,000 × 25/100) Rs. 6,00,000

Cost of Goods Sold Rs. 18,00,000

(vii) Stock turnover 2 months

Stock is therefore (Rs. 18,00,000 × 2/12) Rs. 3,00,000

(viii) Creditors velocity 2 months

Creditors are therefore (Rs.18,00,000 × 2/12) Rs. 3,00,000

(ix) Cash Balance (Rs.8,00,000 - Rs. 7,00,000) Rs. 1,00,000

(x) Reserves (Rs.24,00,000 2.5/100) Rs. 60,000

Profit (Rs.24,00,000 10/100) Rs. 2,40,000

(xi) Block or Fixed Capital Rs. 12,00,000

Reserve and Profit Rs. 3,00,000

Debentures and Share Capital Rs. 9,00,000

Share Capital Rs. 6,00,000

Debentures Rs. 3.00,000

Balance Sheet as on….


Share capital 6,00,000 Fixed Assets 8,00,000

Reserves 60,000 Current Assets :

Profit & Loss Account 2,40,000 Debtors 4,00,000

Debentures 3,00,000 Stock 3,00,000

Sundry Creditors 3,00,000 Cash 1,00,000

Other Current liabilities 1,00,000

16,00,000 16,00,000

Problem 36.

From the following information, prepare a summarised balance sheet as at March 31, 1999:

Stock Turnover ratio 6 Fixed assets turnover ratio 4

Capital turnover ratio 2 Gross profit 20%

Debt collection period 2 months Creditors payment period 73 days

The gross profit was Rs. 60,000

Closing stock was Rs. 5,000 in excess of the opening stock. [CS June-93, June-98]

Solution Balance Sheet as at March 31, 1999


Capital 1,50,000 Fixed Assets 75,000

Creditors 49,000 Closing Stock 42,500

Debtors 50,000

Cash (Bal. Fig.) 31,500

1,99,000 1,99,000


Working Notes:

1. Gross Profit Ratio = Sales

100Profit Gross 20 =

Sales

100000,60Rs. or Sales = Rs. 3,00,000

Cost of Goods Sold = Sales -Gross Profit

Rs. 3,00,000 - Rs. 60,000 = Rs. 2,40,000

2. Stock Velocity = Stock Average

sold goods ofost C =

Stock Average

2,40,000 Rs.= 6

Average Stock = (Opening Stock + Closing Stock) / 2 = Rs. 40,000

Opening Stock + Closing Stock = Rs. 40,000 × 2 = Rs. 80,000

Closing Stock = Opening Stock + 5,000

Opening Stock + Opening Stock + 5,000 = Rs. 80,000

Opening Stock = Rs. 37,500

Closing Stock = Opening Stock + 5,000 = Rs. 42,500

3. Capital Turnover Ratio = Capital

Turnover= 2 =

Capital

3,00,000 Rs. or Capital = Rs. 1,50,000

4. Fixed Assets Turnover ratio = Assets Fixed

Sales =

Assets Fixed

3,00,000 Rs = 4

Fixed Assets = Rs. 75,000

5. Debt collection period = 2 months

Debtors = Sales × 000,50.12

2000,00,3

12

2Rs

6. Creditors' payment period = 73 days

Assuming all purchases to be credit purchases, the amount of credit purchasing is determined as follows .

Cost of Goods Sold = 2,40,000

Opening Stock + Purchases - Closing Stock = 2,40,000

2,40,000 = Rs. 37,500 + Purchases - Rs. 42,500

Purchases = Rs. 2,45,000

Creditors = Credit Purchase × 73/365 = Rs. 2,45,000 × 73/365 = Rs. 49,000

Problem 37.

From the following particulars you are required to prepare the balance sheet of a Zinc Company :

Fixed Assets (after writing off 30%) Rs. 10,50,000

Fixed Assets Turnover Ratio (on Cost of Goods Sold) 2

Finished goods Turnover Ratio (on Cost of Goods Sold) 6

G.P. rate on sales 25%

Net profit (before interest) to sales 8%

Fixed charges cover (debenture interest 7%) 8

Debt collection period 1.5 months

Material consumed to sales 30%

Stock of raw materials (in terms of months consumption) 3

Current ratio 2.4

Quick ratio 1.0

Reserve to capital ratio 0.21


Solution Balance Sheet of Zinc Company as on ……

Liabilities Rs. Rs. Assets Rs. Rs.

Capital (J) 10,00,000 Fixed Assets 10,50,000

Reserves (J) 2,10,000 12,10,000 Current Assets : (I)

Debentures (E) 4,00,000 Debtors (F) 3,50,000

Current Liabilities (I) 4,00,000 Stocks –

Finished goods* 3,50,000

Raw material (H) 2,10,000

Cash (Bal. fig. of

current Assets ) 50,000 9,60,000

20,10,000 20,10,000

Working notes:

A. Cost of sales/Fixed Assets = 2

Fixed Assets = 10.5 lakhs

Cost of sales = Rs. 21,00,000

B. Cost of sales/Finished goods = 6

6goods Finished

000,00,21

6 Finished goods = Rs. 21,00,000

* Finished goods = Rs. 3,50,000

C. Gross Profit on sales = 25%

Cost of sales + Profit = Sales

Rs. 21,00,00 + .25X = X

Rs. 21,00,000

Sales = ––––––––––––– = Rs. 28,00,000

0.75

Gross profit = 7,00,000

D. Net Profit before interest = Rs. 28,00,000 8%

= Rs. 2,24,000

Net profit before interest

––––––––––––––––– = 8

Interest

Interest charges = Rs. 28,000

E. 7% interest charges = Rs. 28,000

Rs. 28,000

Debentures = ––––––––––– = Rs. 4,00,000

7%

F. Debt collection period = 1.5 times

000,50,3.12

5.1000,00,28 RsDebtors

G. Material consumed to sales is 30%..

Material consumed = Rs. 28,00,000 30%

= Rs. 8,40,000

H. Stock of raw material = Rs. 8,40,000 3 / 12

= Rs. 2,10,000

I. sLiabilitieCurrent

AssestCurrent = 2.4 times

sLiabilitieCurrent

Assets Liquid= 1 times

Value of Stock = 2.4 – 1.0 = 1.4

Finished goods + Raw material

= Rs. 3,50,000 + Rs. 2,10,000 = 1.4

Current assets = Rs. 9,60,000

Current Liabilities = Rs. 4,00,000

J. Reserves to capital = 0.21

If capital is 1.00 then Reserve = .21

If net worth is Rs. 12,10,000

then Capital = Rs. 10,00,000

Reserve = Rs. 2,10,000

Problem 38.

From the following information relating to Wise Limited you are required to prepare its summarised Balance Sheet .

Current ratio 2.5 Acid test ratio 1.5

Gross profit/sales ratio 0.2 Net working capital/Net worth ratio 0.3

Sales / Net Fixed Assets ratio 2.0 Sales/Net worth ratio 1.5

Sales/ Debtors ratio 6.0 Reserves/Capital ratio 1.0

Stock velocity 2 months. Paid up share capital Rs. 10 lakhs

Net worth /long term loan 20.0 [CA Final]

Solution Wise Ltd.

Balance Sheet as on……


Paid-up Share Capital 10 Fixed Assets 15

Reserves 10 Stock 4

Long-term Loans- 1 Debtors 5

Current Liabilities 4 Other Current – Assets 1

Total 25 Total 25


Problem 39.

From the following information and Ratios prepare the profit and Loss Account for the year ended 31st March. 1994;

and the Balance Sheet as on that date of M/s Stan & Co. an export company.

Current Assets to Stock 3 : 2 Current Ratio 3.00

Acid Test Ratio 1.00 Financial Leverage 2.20

Earnings per Share (each of Rs. 10 ) 10.00 Book Value per Share (Rs.) 40.00

Stock Turnover Ratio 5.00 Fixed Assets Turnover Ratio 1.20

External Liabilities to Net Worth 2.75 Net Working Capital Rs. 10.00 lakhs

Net Profit to Sales 10% Variable Cost 60%

Long—term Loan Interest 12% Taxation NIL

Ave. Collect. Period (assume 360 days in the year) 30 days [CA Inter Nov. 94]

Solution M/s. Stan & Co. Profit and Loss Account for the year ended 31

st March, 94

Rs. Sales 50,00,000 Less: Variable costs 30,00,000

20,00,000

Less: Fixed costs (excluding interest) 9,00,000

Earnings before interest and taxes 11,00,000

Less: Interest 6,00,000

Earnings before tax 5,00,000

Less: Tax Nil

Profit after tax 5,00,000

Balance Sheet as at 31st March, 1994

Rs. Rs.

Sources

Shareholder's Funds 20,00,000

Long term Liabilities 50,00,000

70,00,000

Applications

Fixed Assets 41,66,667

Current Assets:

Stock 10,00,000

Debtors 4,16,667

Others 83,333

15,00,000

Less: Current Liabilities 5,00,000

Net Current Assets 10,00,000

Investments (balancing figure) 18,33,333

70,00,000

Problem 40.

From the following information, prepare the projected trading and profit and Loss Account for the next financial

year ending December 31, 1985 and the projected Balance Sheet as on that date: — [CA Final]

Ratio of Gross Profit 25%

Stock Turnover Ratio 5 times

Creditors Velocity 3 months

Proprietary Ratio(Fixed Assets to Capital Employed) 80%

General Reserve and profit and Loss to Equity Capital 25%

Net Profit to Equity Capital 10%


Average Debt Collection Period 2 months

Current Ratio 2

Capital Gearing Ratio (Pref. Shares and debentures to Equity) 30%

Preference Share Capital to Debentures 2

Cost of Sales consists of 40% for materials and balance for Wages and Overheads.

Gross Profit Rs. 6,00,000

Problem 41.

The balance sheet of Major Ltd. as on 31st March, 1998 is as follows:


Share Capital: Fixed assets:

2,000 eq. sh. of Rs. 100 each fully paid 2,00,000 Cost 5,00,000

7½% preference shares 1,00,000 Less: Depreciation 1,60,000 3,40,000

General reserve 60,000 Current assets:

12% debenture 60,000 Stock 60,000

Current liabilities: Debtors 80,000

Sundry Creditors 80,000 Bank 20,000

5,00,000 5,00,000

The company wishes to forecast balance sheet as on 31st March, 1999. The following additional particulars are

available:

(i) Fixed assets costing Rs. 1,00,000 have been installed on 1st April, 1998 but the payment will be made on

31st March, 1999.

(ii) The fixed assets turnover ratio on the basis of gross value of fixed assets would be 1.5.

(iii) The stock turnover ratio would be 14.4 (calculated on the basis of average stock).

(iv) The break up of cost and profit would be as under:

Material 40%

Labour 25%

Manufacturing expenses 10%

Office and selling expenses 10%

Depreciation 5%

Profit 10%

100%

The profit is subject to interest and taxation at 50%

(v) Debtors would be 1/9 of sales

(vi) Creditors would be 1/5 of material consumed.

(vii) In March, 1999, a dividend @ 10% on equity capital would be paid.

(viii) 12% debentures for Rs. 25, 000 have been issued on 1st April, 1998.

Prepare the forecast balance sheet as on 31st March, 1999 and show the following resultant ratios:

(a) Current ratio; (b) Fixed assets/net worth ratio; and (b) Debt equity ratio. [CS June-90]

Solution

Working Notes:

(1) Fixed assets at cost = Rs. 5,00,000 + Rs. 1,00,000 = Rs. 6,00,000

(2) Fixed assets turnover ratio = assets Fixed

Sales= 1.5 (by Question)


Sales = Rs. 6,00,000 1.5 = Rs. 9,00,000

(3) Average stock =ratioover Stock turn

sold goods ofCost =

14.40

7,20,000 = Rs. 50,000

(4) Materials = 40% of sales = 3,60,000

Labour 25% = 2,25,000

Mfg exp. 10% = 90,000

Depreciation 5% = 45,000

Cost of goods sold = 7,20,000

office and selling exp. 10% = 90,000

Cost of sales or total cost = 8,10,000

Profit = 10% of sales = 90,000

Sales = 9,00,000

Profit & Loss Account

Rs. Rs.

To interests on Debentures

(Rs. 7,200 + Rs. 3,000) 10,200 By EBIT 90,000

To Provision for taxation (Earning before

(50% of Rs. 90,000 - Rs. 10,200) 39,900 Interest & tax)

To Net Profit 39,900 ______

90,000 90,000

To Preference Dividend

(7.5% of Rs. 1,00,000) 7,500 By Net profit 39,900

To Equity Dividend

(10% on Rs. 2,00,000) 20,000

To Balance c/d to B/s 12,400

39,900 39,900

(5) Debtors = 9

0Rs.9,00,00 Rs. 1,00,000

(6) Creditors = Rs. 3,60,000/5 = Rs. 72,000

Further data:-

Closing stock on 31-3-99 = (Rs. 50,000 × 2) – Rs. 60,000 = Rs. 40,000

Net profit after tax = Rs. 39,900 + Depreciation = Rs. 39,900 + Rs. 45,000

Fund from Operations = Rs. 84,900

Bank A/c

Rs. Rs.

To Balance b/d 20,000 By Debtors increase 20,000

To Stock Decrease 20,000 By Creditors decrease 8,000

To Debentures 25,000 By Purchase of fixed assets 1,00,000

To Funds from operations 84,900 By Preference dividend 7,500

To Provision to Income for taxation 39,900 By Equity dividend 20,000

(Increase in liability due to _______ By Balance c/d 34,300

nonpayment) 1,89,800 1,89,800


Forecast Balance sheet as on 31.3.1999


Share capital: Fixed Assets: 2,000 Equity shares of Actual cost 6,00,000

Rs. 100 each fully paid 2,00,000 Less: Depreciation

7 ½ % preference share 1,00,000 (1,60,000 + 45,000) 2,05,000 3,95,000

General reserve 60,000 Current Assets:

P & L A/C 12,400 Stock 40,000

Net Worth 3,72,400 Debtors 1,00,000

12% Debentures 85,000 Cash at Bank 34,300

Current liabilities:

Sundry creditors 72,000

Provision for taxation 39,900

5,69,300 5,69,300

Calculation of Ratios:

(a) Calculation of Current Assets and Current Liabilities

Current Assets = Stock + Debtors + Bank

= Rs. 40,000 + Rs. 1,00,000 + Rs. 34,300 = Rs.1,74,300

Current Liabilities = Sundry Creditors + provision for tax

= Rs. 72,000 + Rs. 39,900 = Rs.1,11,900

Current Ratio = 1:56.1900,11,1.

300,74,1.

sLiabilitieCurrent

AssetsCurrent

Rs

Rs

(b) Fixed Assets / Net Worth Ratio = 1:06.1400,72,3.

000,95,3.

Rs

Rs

(c) Debt Equity Ratio = 1:19.0400,57,4.

000,85.

000,85.400,72,3.

000,85.

Debt Equity

Debt

Rs

Rs

RsRs

Rs

Problem 42.

Following is the abridged balance sheet of the Everest Co. Ltd. As at 31st March, 1996:

Rs. Rs.

Paid up share Capital 5,00,000 Free hold Property 4,00,000

Profit & Loss Account 85,000 Plant & Machinery 2,50,000

Current Liabilities 2,00,000 Depreciation 75,000 1,75,000

Stocks 1,05,000

Debtors 1,00,000

Bank 5,000

7,85,000 7,85,000

From the following information you are required to prepare profit and loss account and balance sheet as at 31st

March, 1997:

(a) The composition of the total of the Liabilities side of the company‘s balance sheet as 31st March, 1997 (the paid

up share capital remaining the same as at 31st March, 1996) was :

Share capital 50 per cent Profit and loss A/c 15 per cent

7 per cent debentures 10 per cent Creditors 25 per cent

The Debentures were issued on 1st April, 1996, interest being paid on 30

th September 1996 and 31

st March, 1997.


(b) During the year ended on 31st March 1997. Addition plant and machinery had been bought and a further Rs.

25,000 depreciation written off. Freehold property remained unchanged. The total fixed assets then constituted

60 per cent of total fixed and current assets.

(c) The current ratio was 1.6 : 1. The quick assets ratio was 1: 1

(d) The debtors (four—fifths of the quick assets) to sales ratio revealed a credit period of two months.

(e) Gross profit was at the rate of 15 per cent of selling price and return on Net worth as at 31st March, 1997 was

10 per cent. Ignore taxation.

Solution Balance Sheet as at 31st March, 1996


Share Capital: 5,00,000 Fixed Assets :

Reserves & Surplus Freehold Property 4,00,000

Profit & Loss A/c 1,50,000 Plant and Machinery 3,00,000

Less: Depreciation 1,00,000 2,00,000

7% Debentures 1,00,000 6,00,000

Current Assets:

Stock 1,50,000

Creditors 2,50,000 Debtors 2,00,000

________ Bank 50,000 4,00,000

10,00,000 10,00,000

Dr. Profit and Loss Account for the year ended March 31, 1996 Cr.

Particulars Rs. Particulars Rs.

To Opening stock 1,05,000 By Sales 12,00,000

To Purchases (Balance figure) 10,65,000 By Closing Stock 1,50,000

To Gross Profit 1,80,000 ________

13,50,000 13,50,000

To Expenses (Balance figure) 83,000 by Gross Profit b/d 1,80,000

To Debenture Interest 7,000

To Depreciation 25,000

To Net Profit 65,000 ________

1,80,000 1,80,000

(i) Total of Liabilities Side = Rs. 5,00,000/ .50 = Rs. 10,00,000.

(ii) Profit & Loss A/c (Cr. Balance ) = 15% of Rs. 10,00,000 = Rs. 1,50,000.

(iii) 7% Debentures = 10% of Rs. 10,00,000 = Rs. 1,00,000.

(iv) Creditors = 25% of Rs. 10,00,000 = Rs. 2,50,000.

(v) Net fixed Assets = 60% of Rs. 10,00,000 = Rs. 6,00,000.

(vi) Net Plant & Machinery = Rs. 6,00,000 – Rs. 4,00,000 = Rs. 2,00,000.

(vii) Gross Plant & Machinery = Rs. 2,00,000 + (Rs. 75,000 + Rs. 25,000) = Rs. 3,00,000.

(viii) Current Assets = Rs. 2,50,000 1.6 = Rs. 4,00,000.

(ix) Liquid Assets = RS. 2,50,000 1 = Rs. 2,50,000

(x) Stock = Rs. 4,00,000- Rs. 2,50,000 = Rs. 1,50,00.

(xi) Debtors = Rs. 2,50,000 4 5 = Rs. 2,00,000.

(xii) Sales = Rs. 2,00,000 12/2 = Rs. 12,00,000.

(xiii) Gross Profit = 15 % of Rs. 12,00,000 = Rs. 1,80,000

(xiv) Net Worth = Rs. 5,0,000 + Rs. 1,50,000 = Rs. 6,50,000.

(xv) Net Profit = 10% of Rs. 6,50,000 = Rs. 65,000.


THEORETICAL QUESTIONS

Q.1 Discuss any three ratios computed for investment analysis.

[Nov-2004] 3 Marks

Answer

The three ratios computed for investment analysis are as follows:

(i) Equity to Total Funds Ratio = Shareholder's Funds

Total Funds

(ii) Debt Equity Ratio = Debt

Equity

(iii) Capital Gearing Ratio = Fixed Charge Bearing Capital

Equity Shareholder's Funds

(iv) Fixed Assets to Long Term Fund Ratio = Fixed Assets

Long Term Fund

(v) Proprietary Ratio = Proprietary Funds

Total Assets.

Note:

Proprietary Funds for B-5 can be computed through two ways from the Balance Sheet:

Liability Route : [Equity Share Capital + Preference Share Capital + Reserves & Surplus] Less: Accumulated

losses

Assets Route: (Net Fixed Assets + Net Working Capital] Less: Long Term Liabilities.

Q.2 Discuss the financial ratios for evaluating company performance on operating efficiency and liquidity position

aspects. [Nov-2006] 4 Marks

Answer

The financial ratios for evaluating company performance on operating efficiency and liquidity position aspects are

discussed as follows:

Evaluation of Operating Efficiency: Ratios throw light on the degree of efficiency in the management andutilisation of assets

and resources. These are indicated by activity or performance or turnover ratios e.g. Stock Turnover Ratio, Debtors

Turnover Ratio, Fixed Assets Turnover Ratio. These indicate the ability of the firm togenerate revenue (sales) per

rupee of investment in its assets.

Following are example the example of Operating Efficiency ratio/Activity based Ratios:

(i) Capital Turnover Ratio = Sales

Capital Employed

(ii) Fixed Assets Turnover Ratio = Turnover

Fixed Assets.

(iii) Working Capital Turnover Ratio = Turnover

Net Working Capital

(iv) Finished goods or Stock Turnover Ratio = Cost of Goods sold

Average stock

(v) Raw Material Turnover ratio = Cost of Material Consumed

Average stock of RM


(vi) Debtors Turnover ratio = Credit Sales

Average A/c Receivable

(vii) Creditor Turnover ratio = Credit Purchases

Average A/c Payable

Note:

The turnover ratios can also be computed in terms of days as 365 / Turnover Ratio. For example, Number of days

average stock is held = 365 / Stock Turnover Ratio.

Evaluation of Profitability: Profitability ratios i.e. Gross Profit Ratio, Operating Profit Ratio, Net Profit Ratio are basic

indicators of the profitability of the firm. In addition, various profitability indicators like Return on Capital Employed

(ROCE), Earnings per share (EPS), Return on Assets (ROA) etc. are used to assess the financial performance.

Following are example the example of Profitability based Ratios:

(i) Gross Profit Ratio = Gross Profit

Sales

(ii) Operating Profit ratio = Operating Profit

Sales

(iii) Net Profit Ratio = Net Profit

Sales

Q.3 Explain the need of debt service coverage ratio. [May-2007] 2 Marks

Or

Q. How is Debt service coverage ration calculated? What is its significance? [May-2009] 2 Marks

Answer

Debt service coverage ratio is the vital indicator to the lender to assess the extent of ability of the borrower to service

the loan in regard to timely payment of interest and repayment of principal amount. It shows whether the business is

earning sufficient profits to pay not only the interest charges, but also the installment due of the principal amount.

Debt service coverage ratio of 2:1 is considered ideal by the financial institutions. This ratio will enable the lender to

take correct view of the borrower‘s repayment capacity.

The ratio is calculated as follows:

Debt service coverage ratio = Earning available for debt service*

Interest on loan+Instalment of the principal

*Where earning available for Debt service = Profit after tax + Depreciation+ Interest on Loan

Q.4 Diagrammatically present the DU PONT CHART to calculate return on equity. [May-2007] 3 Marks

Answer

The financial ratios in themselves are not useful to assess the performance of a company in a given year. To interpret

the financial health of a company it is crucial to analyse and compare the ratios for a given year vis-a-vis the previous

financial years and the industry ratios. The DU-Pant company of USA pioneered a system of financial analysis which

has received widespread recognition and acceptance. The usefulness of DU-Pant chart lies in the fact that it presents

the overall picture of the performance of a firm and enables the management to identify the factors which have a

bearing on its profitability, Return on investment (ROI) represents the earning power of the company. ROI depends on

two ratios: (a) Net Profit Ratio and (b) Capital Turnover Ratio. A change in any of these ratios will change the firm's

earning power. These two ratios are affected by many factors. A change in any of these factors will change these ratios

also. The analysis has been presented by DU- Pont Company of U.S.A. through a chart popularly known as DU-Pont

Chart. The chart has been presented below:


DU PONT CONTROL CHART

+

X

+

The chart shows that return on capital employed is affected by a number of factors. Any change in these factors will

affect the return on capital employed. For example, if the cast of gods said increases, without any responding

increase in the selling price of the goods, the net profit would decrease and consequently ROI would also decrease.

Similarly, if there is, increase in working capital, the total capital employed would increase and, before, in the

absence of any increase in the net profit, ROI would decrease.

The chart helps the management in concentrating attention an different farces affecting profit. An increase in fit can

be achieved either by ",are effective use of capital which will result in a higher turnover ratio or better les efforts

which will result in a higher net profit ratio.

Q.5 How return on capital employed is calculated? What is its significance? [Nov-2008] 2 Marks

Answer

Return on capital employed = Total Earnings

Total Capital Employed

Total Earning:

Profits after taxes xxx

Add: Taxation xxx

Add: Interest xxx

Add: Non-trading expenses xxx

Less: Non-operating incomes like rents, interest and dividends (xxx)

Total Earning xxx

Total Capital Employed:

Assets Route:

Net Fixed Assets (including intangible assets like patents,

but not fictitious assets like miscellaneous expenditure not w/off) xxx

+ Net working Capital xxx

Total Capital Employed ___

Liability Route:

Equity Share Capital xxx

+ Preference Share Capital xxx

+ Reserves & Surplus xxx

Return

on

Equity

(ROE)

Net Profit

Ratio

Net Profit

Sales

Sale Cost of

Goods sold

Adm., Selling

and Distribution

Expenses

Expenses

Capital

Turnover

Sales

Capital

Employed

Working

Capital

Current

Assets

Current

Liabilities Fixed Assets


+ Debentures and Long Term Loans xxx

Less: Accumulated Losses (xxx)

Less: Non-Trade Investments (xxx)

Total Capital Employed

It’s significance in financial Analysis: Overall profitability of the business for the capital employed; indicates the return on the total capital Employed

Comparison of ROCE with rate of interest of debt leads to financial leverage. If ROCE > interest Rate, use of debt

funds is Justified.

Q.6 What is Quick ratio? What does it signify? [Nov-2008] 2 Marks

Answer

Quick Ratio or Acid = Quick Assets

Quick Liabilities

Quick Assets = Current Assets Less : Inventories Less: Prepaid Expenses

Quick Liabilities = Current Liabilities Less: Bank Overdraft Less: Cash Credit

Significance of Quick Ratio on Financial Analysis: Ability to meet immediate test ratio liabilities. Ideal Ratio is 1: 33:

1

Q.7 What do you mean by Stock turnover Ratio and Gearing ratio? [Nov-2008] 3 Marks

Answer

Stock turnover Ratio: It establishes the relationship between the cost of goods sold during the year and average inventory

held during the year.

It calculated as follows:

Stock turnover Ratio = Sales/Turnover

Average inventory

In above formula:

Average Inventory = Opening Stock+Closing Stock

2

This ratio indicates that how fat inventory is sold.

A high ratio is good from the view point of liquidity and a low ratio would indicate that inventory that inventory is

not sold and remains in godown for a long time.

Note: Turnover is generally taken as cost of goods sold.

Gearing ratio: It is also called as ―Capital Gearing Ratio‖. It shows the proportion of fixed interest (dividend) bearing

capital to funds belonging to equity shareholders funds.

It calculated as follows:

Capital Gearing Ratio = Preference capital+Debentures+Longterm loans

Eqity share Capital + Reserves and surplus - losses

This ratio helps to judge the long term solvency position of a firm.

Q.8 Discuss the composition of Return on Equity (ROI) using the DuPont model. [May-2009] 3 Marks

Answer

Composition of Return on Equity using the DuPont Model

There are three components in the computation of return on equity using the traditional DuPont the net profit margin,

asset turnover, and the equity multiplier. By examining each input individually, the sources of a company‘s return on

equity can be discovered and compared to its competitors.


(i) Net Profit Margin: The net profit margin is simply the after-tax profit a company generates for each rupee of

revenue.

Net profit margin = Net income + Revenue

Net profit margin is a safety cushion; the lower the margin, lesser the room for error.

(ii) Asset Turnover: The asset turnover ratio is a measures of how effectively a company converts its assets into

sales. It is calculated as follows:

Asset Turnover = Revenue + Assets

The asset turnover ratio tends to be inversely related to the net profit margin; i.e., the higher the net profit

margin, the lower the asset turnover.

(iii) Equity Multiplier: It is possible for a company with terrible sales and margins to take on excessive debt and

artificially increase its return on equity. The equity multiplier, a measure of financial leverage, allows the

investor to see what portion of the return on equity is the result of debt. The equity multiplier is calculated as

follows:

Equity Multiplier = Assets + Shareholder‘s Equity

Computation of Return on Equity To calculate the return on equity using the DuPont model, simply multiply the three components (net profit margin,

asset turnover, and equity multiplier.) Return on Equity = Net profit margin × Asset turnover × Equity multiplier.

Q.9 Explain briefly the limitations of Financial ratios.

[May 2009] 2 Marks

Answer

Limitations of Financial Ratios

The limitations of financial ratios are listed below:

(a) Diversified product lines: Many businesses operate a large number of divisions in quite different industries.

In such cases, ratios calculated on the basis of Aggregate data cannot be used for inter-firm comparisons.

(b) Financial data are badly distorted by inflection: Historical cost values may be Substantially different from

true values. Such distortions of financial data are also carried in the financial ratios.

(c) Seasonal factors may also influence financial data.

(d) To give a good shape to the popularly used financial ratios (like current ratio, debt-equity ratios, etc.): The

business may make some year-end adjustments. Such window dressing can change the character of financial

ratios which would be different had there been no such change.

(e) Differences in accounting policies and accounting period: It can make the accounting data of two firms non-

comparable as also the accounting ratios.

(f) There is no standard set of ratios against which a firm‘s ratios can be compared:

(g) Sometimes a firm‘s ratios are compared with the industry average. But if a firm desires to be above the

average, then industry average becomes a low standard. On the other hand, for a below average firm, industry

averages become too high a standard to achieve.

(h) It is very difficult to generalize whether a particular ratio is good or bad: For example, a low current ratio may

be said ‗bad‘ from the point of view of low. Liquidity, but a high current ratio may not be ‗good‘ as this may

result from inefficient working capital management.

(i) Financial ratios are inter-related, not independent: Viewed in isolation one ratio may highlight efficiency. But when considered as a set of ratios they may speak differently. Such interdependence among the ratios can be

taken of thoughts multivariate analysis.

(Note: Students to write any four limitations)


PRACTICAL PROBLEMS

Q.10 From the following information, prepare a summarised Balance Sheet as at 31st March, 2002:

Working Capital Rs. 2,40,000

Bank overdraft Rs. 40,000

Fixed Assets to Proprietory ratio 0.75

Reserves and Surplus Rs. 1,60,000

Current ratio 2.5

Liquid ratio 1.5

[Nov. 2002] 6 Marks

Solution Working Notes:

1. Current assets and Current liabilities computation:

(say)k 1

sliabilitieCurrent

5.2

assetsCurrent or

1

5.2

sliabilitieCurrent

assetsCurrent

Or, Current assets = 2.5 k and Current liabilities = k

Or, working capital = (Current assets- Current liabilities)

Or, Rs. 2,40,000 = k (2.5 - 1) = 1.5 k

Or, k = Rs. 1,60,000


Current assets = Rs. l,60,000 2.5 = Rs. 4,00,000

1. Computation of stock

Liquid ratio = sliabilitieCurrent

assets Liquied

Or, 1.5 =0Rs.1,60,00

Stock-assetsCurrent

Or, 1.5 Rs. 1,60,000 = Rs. 4,00,000 – Stock

Or, Stock = Rs. 1,60,000

2. Computation of Proprietary fund; Fixed assets; Capital and Sundry Creditor Fixed assets

Proprietary ratio = –––––––––––––– = 0.75

Proprietary fund

Fixed assets = 0.75 Proprietary fund

and Net working capital = 0.25 Proprietary fund

Or, Rs.2,40,000 / 0.25 = Proprietary fund

Or Proprietary fund = Rs.9,60,000

and Fixed assets = 0.75 proprietary fund

= 0.75 Rs.9,60,000

= Rs. 7,20,000

Capital = Proprietary fund - Reserves & surplus

= Rs. 9,60,000 - Rs. 1,60,000

= Rs.8,00,000

Sundry creditors = (Current liabilities - Bank overdraft)

= (Rs. 1,60,000 - Rs,40,000)

= Rs. 1,20,000


Construction of Balance sheet

Amount Rs. Amount Rs.

Capital 8,00,000 Fixed assets 7,20,000

Reserves & Surplus 1,60,000 Stock 1,00,000

Bank overdraft 40,000 Current assets 2,40,000

Sundry creditors 1,20,000

11,20,000 11,20,000

Q.11 The Financial statements of Excel AMP Graphics Limited are as under:

Balance Sheet

As at 31 December, 2001 (Rs. in crores)

2001 2000

Sources of Funds: Shareholders‘ Funds

Shares Capital 1,121 931

Reserves & Surplus 8,950 10,071 7,999

8,930

Loan Funds: Secured Loans – 259

Finance lease obligations 74 –

Unsecured loans 171 245 115

10,316 9,304

Applications of Funds: Fixed Assets

Gross Block 6,667 5,747

Less: Depreciation (3,150) 2,561

Net Block 3,517 3,186

Capital Work-in-progress 27 3,544 28

3,214

Investments 288 222

Current Assets, Loans & Advances :

Inventories 2,709 2,540

Sundry debtors 9,468 9,428

Cash & Bank Balances 3,206 662

Loans & Advances 2,043 1,712

17,426 14,342

Less: Current liabilities & Provisions

Current liabilities 10,109 7,902

Provisions 513 572

10,622 8,474

Net Current Assets 6,804 5,868

Net Deferred Tax Liability (320) –

10,316 9,304

Profit and Loss Account

For the year ended 31st December, 2001 (Rs. in crores)

2001 2000

Income:

Sales & Services 23,436 17,849

Other Income 320 306

A 23,756 18,155

Expenditure:

Cost of Materials 15,179 10,996

Personnel Expenses 2,543 2,293

Other Expenses 3,546 2,815

Depreciation 419 383

Less: Transfer from revaluation reserve 7 412 6 377

Interest 164 88


B 21,844 16,569

Profit before Tax (A-B) 1,912 1,586

Provision for Tax: Current Tax 450 371

Deferred Tax (6) –

Profit after Tax 1,468 1,215

Required:

(a) Compute and analyse the return on capital employed (ROCE) in a Du-Pont control chart framework

(b) Compute and analyse the average inventory holding period and average collection period.

(c) Compute and analyse the return on equity (ROE) by bringing out clearly the impact of financial

leverage. [Nov. 2003] (8+4+4=16 Marks)

Solution

(a) Working note: Computation of Cost of goods sold (COGS), Operating profit before depreciation, interest & tax (OPBDIT),

Operating profit before interest and tax (OPBIT), Profit before interest and tax (PBIT), Profit before tax (PBT) and

Profit after tax (PAT)

(Rs. in crores)

Year 2001 2000

Cost of goods sold (COGS) 21,268 16104

(Material consumed + Personnel expenses + Other expenses)

Operating profit before depreciation, interest and tax (OPBDIT) 2,168 1,745

(Income from sales & service - COGS)

Operating profit before interest and tax (OPBIT) 1,756 1,368

(OP§DIT - depreciation)

Profit before interest and tax (PBIT) 2,076 1,674

(OPBIT + Other incomes)

Profit before tax (PBT) 1,912 1,586

(PBIT - Interest)

Profit after tax (P AT) 1,465 1,215

(PBT - Tax)

Return on capital employed (ROCE): (Before interest & tax)

Operating profits before interest and tax Sales

= ×Sales Capital employed

OPBIT

=Capital employed

Capital employed = (Balance sheet total- Capital WIP - Investments - Loans & advances)

Year

2001 2000

ROCE 22.07% 18.63%

(Refer to working note)

100

436,23.

756,1.

Rs

Rs

Operating profit margin 7.49% 7.66%

(Refer to working note)

100

436,23.

756,1.

Rs

Rs

100

849,17.

368,1.

Rs

Rs

Material consumed/ Sales 64.77% 61.61%

Personnel expenses/ S ales 10.85% 12.85%

Other expenses/ Sales 15.13% 15.77%


Depreciation/ Sales 1.76% 2.11%

(b) Computation and analysis of average inventory holding period and average collection period:

(Rs.' in crores)

Year 2001 2000

1. Inventory turnover ratio:

(Material consumed/ Closing inventory)

5.6

(Rs.15,179/Rs.2,709)

4.33

(Rs.10,996/Rs.2,540)

2. Average inventory turnover period:

(360 days / Inventory turnover ratio) 64 days 83 days

3. Receivables turnover ratio:

(Net credit sales / Closing Sundry debtors)

2.48

(Rs.23,436/Rs.9,468)

1.89

(Rs.17,849/Rs.9,428)

4. Average collection period:

(360 days / Receivables turnover ratio) 145 days 190 days

(c) ROE = PAT

Equity Fund

2001 2000 1,468 Cr. 1,215Cr.

10,071 Cr. 8,930 Cr

= 14.58 % 13.61%

ROE = ROA + E

D{ (ROA - i * ( 1 - Tc )}

ROA (Post tax) 14.34% 12.11 %

{(ROCE * (1 - .35)}

Tax I PBT 23.22% 2.37%

Loan funds / Total funds 23.39% 4.02%

Shareholders Funds I Total funds 97.63% 95.98%

ROE is marginally better than ROA, as debt ratio employed by the company is minimal.

Q.12 With the help of the following information complete the Balance Sheet of MNOP Ltd.:

Equity share capital Rs. 1,00,000

The relevant ratios of the company are as follows:

Current debt to total debt .40

Total debt to owner's equity .60

Fixed assets to owner's equity .60

Total assets turnover 2 Times

Inventory turnover 8 Times

[May 2005] 7 Marks

Solution In the Books of MNOP LTD

Balance Sheet

Particulars Rs. Assets Rs.

Equity share capital 1,00,000 Fixed assets 60,000

Current debt 24,000 Inventory 40,000

Long term debt 36,000 Cash 60,000

1,60,000 1,60,000


Working Notes:

1. Total debt = 0.60 × Owners equity = 0.60 × Rs 1,00,000 = Rs 60,000

2. Current debt to total debt = 0.40, hence current debt = 0.40 × 60,000

= Rs. 24,000

3. Fixed assets = 0.60 × Owners equity = 0.60 × Rs. 1,00,000 – Rs.60,000

4. Total equity = Total debt + Owners equity = Rs.60,000 + 1,00,000

= Rs.1,60,000

5. Total assets consisting of fixed assets and current assets must be equal to

Rs.1,60,000 hence, current assets should be Rs 1,00,000.

6. Total assets turnover = 2 Times: Inventory turnover = 8 Times

Inventory 2 1

Total Assets 8 4

Inventory 1

.1,60,000 4Rs

Or, 4 × Inventory = 1 × Rs.1,60,000

= Rs.1,60,000

Or, Inventory =Rs.1,60,000

4

= Rs.40,000

Balance on Assets side

Cash = Rs.1,60,000 – Rs. 60,000 – Rs. 40,000

= Rs.60,000

Q.13 Using the following data, complete the Balance Sheet given below:

Gross Profits Rs. 54,000

Shareholders‘ Funds Rs. 6,00,000

Gross Profit margin 20%

Credit sales to Total sales 80%

Total Assets turnover 0.3 times

Inventory turnover 4 times

Average collection period (a 360 days year) 20 days

Current ratio 1.8

Long-term Debt of Equity 40%

Balance Sheet

Creditors …….. Cash ……..

Long-term debt …….. Debtors ……..

Shareholders' funds …….. Inventory ……..

Fixed assets

[Nov. 2005] 12 Marks

Solution Balance Sheet

Liabilities Amount (Rs.) Assets Amount (Rs.)

Creditors 60,000 Cash 42,000

Long term debts 2,40,000 Debtors 12,000

Share holders fund 6,00,000 Inventory 54,000

Fixed Assets 7,92,000

9,00,000 4,00,000

Working Notes:

1. Gross Profit :

GP margin = 20%

GP = Rs.54,000

Sales = Rs.2,70,000


2. Credit Sales :

Cr. Sales = 80% of total sales

= 2,70,000 × 80%

= Rs.2,16,000.

3. Total Assets :

Total Assets Turnover = Sales 0.3 times

Total Assets

Total Assets = 2,70,000

Rs.9,00,0000.3

4. Inventory Turnover :

Inventory Turnover = Cash

100 0.3 timesInventory

4 = 2,70,000-54,000

Inventory

Inventory = Rs.54,000

5. Debtors :

Debtors = Credit Sales

20 days360 days

= Rs.2,16,000

20 360

= Rs.12,000.

6. Creditors:

Long Term Debt

equity

= 40%

Long term debt = 40% of equity

= 6,00,000 × 40%

= Rs.2,40,000.

Creditors + Long term debt + Shareholders funds = Rs.9,00,000

Creditors + Rs.2,40,000 + Rs. 6,00,000 = Rs. 9,00,000

Creditors = Rs. 60,000.

7. Current Ratio – Cash :

Current Ratio = Current Assets

Current Liabilities

1.8 = Debtors+Inventory + cash

Creditors

1.8 = 12,000 + 54,000 + Cash

60,000

1,08,000 = 66,000 + Cash


Cash = Rs.42,000

8. Fixed Assets: It is the balancing figure on assets side.

Q.14 JKL Limited has the following Balance Sheets as on March 31, 2006 and March 31, 2005:

Balance Sheet (Rs. in Lakh)

March 31, 2006 March 31, 2005

Sources of Funds: Shareholders‘ Funds 2,377 1,472

Loan Funds 3,570 3,083

5,947 4,555

Applications of Funds: Fixed Assets 3,466 2,900

Cash and bank 489 470

Debtors 1,495 1,168

Stock 2,867 2,407

Other Current Assets 1,567 1,404

Less: Current Liabilities (3,937) (3,794)

5,947 4,555

The Income Statement of the JKL Ltd. for the year ended is as follows:

(Rs. in Lakh)

March 31, 2006 March 31, 2005

Sales 22,165 13,882

Less: Cost of Goods sold 20,860 12,544

Gross Profit 1,305 1,338

Less: Selling, General and Administrative exps. 1,135 752

Earnings before Interest and Tax (EBIT) 170 586

Interest Expense 113 105

Profits before Tax 57 481

Tax 23 192

Profits after Tax (PAT) 34 289

10 Marks

Required:

(i) Calculate for the year 2005-06

(a) Inventory turnover ratio

(b) Financial Leverage

(c) Return on Investment (ROI)

(d) Return on Equity (ROE)

(e) Average Collection period.

(ii) Give a brief comment on the Financial position of JKL Limited. [May 2006] 2 Marks

Solution (i) Computation of Ratios

Particulars March 31, 2006 March 31, 2005

(a) Inventory Turnover Ratio

Cost of goods sold

Closing stock

20,8607.28

2,867

12,5445.21

2,407

(b) Financial Leverage=EBIT

EBT

1702.98

57

5681.22

481

(c) Return on Investment (ROI) 170100 2.86%

5,947 586

100 12.86%4,555


EBIT100

Capital employed

(d) Return on Equity PAT

100Net worth

34100 1.43%

2,377 289

100 19.63%1,472

(e) Average Collection Period

Debtors365

Credit sales

1,495365 24.6

22,165

1,168365 30.7

13,882

(ii) Brief Comment on the Financial Position of JKL Ltd.:

The inventory turnover ratio is increased from 5.21 times to 7.28 times. This indicates the reduction in

investment of stock and increase in sale turnover with reduced stocks.

The financial leverage of the company is increased from 1.22 times to 2.98 times, which indicates the

lower the cushion for paying interest on borrowings. The increase in ratio warns the increase in risk as to

over gearing, which constitutes a strain on profits.

There is a steep fall in ROI from 12.86% to 2.86%, this may be due to increase in finances from fresh

issue of share and loan funds for expansion, modernization or new investment proposals, and increase in

sales has not resulted in increase of company‘s profitability.

The return on equity has also fallen from 19.63% to 1.43%. The current year PAT may not be sufficient

for declaration of dividends to shareholders.

The increase in sale and reduction in investment in debtor‘s balances has resulted in reduction of average

collection period from 30.7 days to 24.6 days.

Q.15 From the informations given below calculate the amount of Fixed assets and Proprietor's fund.

Ratio of fixed assets to proprietors fund = 0.75

Net working capital = Rs. 6,00,000. [Nov. 2009] 2 Marks

Solution Calculation of Fixed Assets and Proprietor’s Fund Since Ratio of Fixed Assets to proprietor‘s Fund = 0.7

Therefore, Fixed Assets = 0.75Proprietor‘s Fund

Net Working Capital = 0.25 Proprietor‘s Fund

6, 00,000 =0.25 Proprietor‘s Fund

Therefore, Proprietor‘s Fund = 000,00,2425.0

000,00,6.

Rs

Proprietor’s Fund = Rs. 24, 00,000 Since, Fixed Assets = 0.75 Proprietor‘s Fund

Therefore, Fixed Assets = 0.75 × 24, 00,000

= Rs.18, 00,000

Fixed Assets = Rs. 18, 00,000

Q.16 The following figures and ratios are related to a company:

(i) Sales for the year (all credit) Rs. 30,00,000

(ii) Gross Profit ratio 25 percent

(i) Fixed assets turnover (basis on cost of goods sold) 1.5

(ii) Stock turnover (basis on cost of goods sold) 6


(v) Liquid ratio 1 : 1

(vi) Current ratio 1.5 : 1

(vii) Debtors collection period 2 months

(viii) Reserve and surplus to Share capital 0.6 : 1

(ix) Capital gearing ratio 0.5

(x) Fixed assets to net worth 1.20 : 1

You are required to prepare:

(a) Balance Sheet of the company on the basis of above details.

(b) The statement showing Working capital requirement, if the company wants to make a provision for

contingencies @ 10 percent of net working capital including such provision.

[May- 2010] 4 Marks

Solution

(a) Projected Balance Sheet

(1) Sales

ofitGrossRatioofitGross

PrPr

000,00,3025.0

GP

000,50,7GP

Cost of Goods Sold = 30,00,000 75% = 22,50,000

(2) Fixed Assets Turnover Ratio = AssetsFixedAssetsFixed

SoldGoodsofCost 000,50,225.1

Fixed Assets = 15,00,000

(3)

WorthNetNetWorthNetWorth

AssetsFixedWorthNettoAssetsFixed

000,00,1520.1

(3) Let us assume that preference Share capital is zero.

DebtDebt

preferenceEquity

preferenceDebtRatioGearningCapital

0000,50,12

05.0

= 6,25,000

(5) Reserves & Surplus = 12,50,000 × 0.6/1.6 = 4,68,750

Share Capital = 12,50,000 × 1/1.6 = 7,81,250

(6) Stock Turnover =

TurnoverStock 000,75,3000,50,22

6 StockStockStock

SoldGoodsofCost

(7) Debtors 000,00,512

20000,00,30

12

PeriodCollectionSales

(8) Looking at the liquid ratio and Current ratio we can say that stock to current liability ratio is 0.5

000,50,7000,75,3

5.0 LiabilityCurrentLiabilityCurrent

AssetsCurrentAssetsCurrent

LiabitliesCurrent

etCurrentAssRatioCurrent

0000,50,750.1 = 11,25,0000

Cash in Hand = 11,25,000 – 3,75,000 -5,00,000 = 2,50,000


Balance Sheet


Share Capital 7,81,250 Fixed Assets 15,00,000

Reserve & Surplus 4,68,750 Stock 3,75,000

Debt 6,25,000 Debtors 5,00,000

Current Liabilities 7,50,000 Cash 2,50,000

26,25,000 26,25,000

(b) Calculation of working capital: Working Capital = Current Assets – Current Liabilities

= 11,25,000 – 7,50,000

= 3,75,000

If the above amount of Rs. 3,75,000 is 90% then full amount is = 3,75,000/0.9=Rs. Rs. 4,16,667.

Q.17 MNP Limited has made plans for the next year 2010-11. It is estimated that the company will employ total assets

of Rs.25,00,000; 30% of assets being financed by debt at an interest cost of 9% p.a. the direct costs for the

year are estimated at Rs.15,00,000 and all other operating expenses are estimated at Rs.2,40,000. The sales

revenue are Required to calculate:

(i) Net profit margin

(ii) Return on Assets

(iii) Assets turnover

(iv) Return on equity

[Nov. 2010] 4 Marks

Solution

(i) Net Profit Margin = × 100

= × 100 = 11.80%

(ii) Return on Assets = × 100

= × 100

= 13.32%

(iii) Assets turnover =

Income ` Sales Revenue

Less: Direct Cost

Contribution

Less: Other operating expenses

EBDIT

Less: Interest on 9% Debt

[ 2500000 × 30% × 9%]

EBDT

Less: Depreciation

EBT

Less: Taxes @ 40%

EAT

22,50,000

15,00,000

7,50,000

2,40,000

5,10,000

67,500

4,42,500

Nil

4,42,500

1,77,000

2,65,500


= = 0.90 times

(iv) Return on Equity = × 100

= × 100

= 15.17%

Q.18 Explain the following ratios: (i) Operating ratio

(ii) Price earnings ratio [May - 2011] 4 Marks

Solution (i) Operating Ratio: This ratio measures the relationship between operating cost & Net Sales.

Where:-

Operating Cost = Cost of goods sold & other operating exps

and

Net Sales = Gross Sales less Sales returns

Operating Ratio = 100SalesNet

CostOperating

The main objective of computing this ratio is to determine the operational efficiency with which production purchase

and selling operations are carried on.

(ii) Price Earnings Ratio:-

This ratio measures the relationship between the market price per share & earning per share.

The objective of computing this ratio is to find out expectations of the shareholders about the earning of the firm.

P.E. Ratio = ShareperEarning

sharepericeMarketPr

Note:- MPPS may be any share price or closing share price.

Q.19 The financial statements of a company contain the following information for the year ending 31st March, 2011.

Particulars Rs.

Cash

Sundry Debtors

Short-term Investment

Stock

Prepaid Expenses

Total Current Assets

Current Liabilities

10% Debentures


Retained Earnings

1,60,000

4,00,000

3,20,000

21,60,000

10,000

30,50,000

10,00,000

16,00,000

20,00,000

8,00,000

Statement of profit for the4 year ended 31st March, 2011

Sales (20% cash sales)

Less: Cost of goods sold

Profit before Interest & Tax

Less: Interest Profit Before Tax

Less: Tax @ 30%

Profit After Tax

40,00,000

28,00,000

12,00,000

1,60,000 10,40,000

3,12,000

7,28,000


You are required to calculate:

(i) Quick Ratio

(ii) Debt-equity Ratio

(iii) Return on Capital employed, and

(iv) Average collection period (Assuming 360 days in a year)

[Nov. - 2011] 8 Marks

Solution

1. sLiabilitieCurrent

Pr RatioQuick

ExpsepaidStockAssetsCurrent

times88.010,00,000

000,60,21000,50,30

2. Earning)RatinedEsc.Equity(i.e

%)10...( D

eiDebtRatioEquityebt

1:57.0)000,00,8000,00,20(

000,00,16

3. ]000,00,16)000,00,8000,00,20[(

000,00,12

DebtEquity

EBITROCE

= 27.27%

4. 000,00,4

000,00,40%80

Debtors Average /D

ofSalesCreditRatioOTebt

= 8 Times

day 458

360 = period Collection Average So

Q.20 Explain the important ratios that would be used in each of the following situations.

(i) A bank is approached by a company for a loan of ` 50 lakh for working capital purposes.

(ii) A long term creditors interested in determining whether his claim is adequately secured.

(iii) A shareholder who is examining his portfolio and who is to decide whether he should hold or sell

his holding in the company.

(iv) A finance manager interested to know effectiveness with which a firm uses its available resources.

[May - 2012] 4 Marks

Solution

(i) Current Ratio, Quick Ratio, Stock Turnover Ratio

(ii) Proprietary ratio, Debt – equity ratio

(iii) Earning per share, P/E ratio, Return on equity

(iv) Capital Turnover ratio, Return on capital employed.

Q.21 The following accounting information and financial rations of M Limited relate to the year ended 31st March, 2012:

Inventory Turnover Ratio 6 Times Creditors Turnover Ratio 10 Times Debtors Turnover Ratio 8 Times Current Ratio 2.4


Gross Profit Ratio 25% Total sales ` 3,00,000, each sales 25% of credit sales; cash purchase ` 2,30,000; working capital ` 2,80,000; closing inventory is Rs. 80,000 more than opening inventory.

You are required to calculate: (i) Average Inventory (ii) Purchases (iii) Average Debtors (iv) Average Creditors (v) Average Payment Period (vi) Average Collection Period (vii) Current Assets (viii) Current Liabilities

[Nov - 2012] 8 Marks

Ans.(i) Average Inventory:-

Inventory Turnover Ratio = InventorsAvg

cons.= 6 times

6 Avg. inventory = Cons = Sales – Gross profit

Avg. inventory = 6

%25000,00,30 = 3,75,000/-

(ii) Purchases:-

Purchase = Cons + Closing Stock – Opening stock = (30,00,000 – 25%) + 80,000 = 23,30,000/- (iii) Average Debtors:-

Debtors Turnover Ratio = DebtorsAverage

SalesCredit= 8 times

Average Debtors = times8

%25000,00,24 = 3,00,000/-

Credit Sales = Credit Sales + Cash Sales = 30,00,000

Credit Sale + 25% of Credit Sales = 30,00,000

Credit Sales = 000,00,24%125

000,00,30

(iv) Average Creditors:-

Creditors Turnover Ratio = timesCreditorsAverage

PurchaseCredit10

Average Creditors = 10

PurchaseCashPurchaseTotal

= 10

000,30,2000,30,23 = 2,10,000/-


(v) Average Payment period = RatioTurnoverCreditors

Days365

= .)(3710

365AppxDays

Days

(vi) Average Collection Period = RatioTurnoverDebtors

Days365

= .)(468

365AppxDays

Days

(vii) Current Assets:-

Current Assets - Current Liabilities = Working Capital

= 2,80,000……………………(i)

4.2sLiabilitieCurrent

AssetsCurrent

Current Assets = 2.4 Current Liabilities……………………(ii) Current Assets – Current Liabilities = 2,80,000 2.4 Current Liabilities – Current Liabilities = 2,80,000

Current Liabilities = 000,00,240.1

000,80,2

Current Assets = 2.4 × 2,00,000

= 4, 80,0000/-

(viii) Current Liabilities = 2,00,000/-

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Financial Analysis