1

OST SHEET FORMAT

Particulars

Opening Stock of Raw Material

Add: Purchase of Raw materials
Add: Purchase Expenses
Less: Closing stock of Raw Materials
Raw Materials Consumed
Direct Wages (Labour)
Direct Charges
Prime cost (1)
Add :- Factory Over Heads:
Factory Rent
Factory Power
Indirect Material
Indirect Wages
Salary
Drawing Office Salary
Factory Insurance
Factory Asset Depreciation
Works cost Incurred
Add: Opening Stock of WIP
Less: Closing Stock of WIP
Works cost (2)
Add:- Administration Over Heads:Office Rent
Asset Depreciation
General Charges
Audit Fees
Bank Charges
Counting house Salary
Other Office Expenses
Cost of Production (3)
Add: Opening stock of Finished Goods
Less: Closing stock of Finished Goods
Cost of Goods Sold
Add:- Selling and Distribution OH:Sales man Commission
Sales man salary
Traveling Expenses
Advertisement
Delivery man expenses
Sales Tax
Bad Debts
Cost of Sales (5)
Profit (balancing figure)
Sales

Amount
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Supervisor

Notes:1) Factory Over Heads are recovered as a percentage of direct wages

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Amount

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2) Administration Over Heads, Selling and Distribution Overheads are recovered as

a percentage of works cost.

RECONCILATION OF COST AND FINANCIAL A/C

Causes of differences:1) Purely financial items :
i) Appropriation of profits Transferred to reserves, goodwill, preliminary
expenses, dividend paid etc.
ii) Loss on sale of investment, penalties and fines
iii) Income Interest received on Bank deposits, profit on sale of investments,
fixed assets, transfer fees.

3
2) Purely cost account items: - Notional Rent / Interest / Salary
3) Valuation of stock:i) Raw-material = In financial a/cs stock is valued at cost or market value
Whichever is less, while in cost a/cs it is valued at LIFO, FIFO etc.
ii) Work in progress = In financial a/cs administrative expenses are also
considered while valuing stock, but in cost a/cs it may be
valued at prime (or) factory cost (or) cost of production
iii) Finished Goods = In financial a/cs it is valued at cost or market price
whichever is less, in cost a/cs it is valued at total cost of production.
4) Overheads: In financial = Actual expenses are taken
In cost
= Expenses are taken at predetermined rate.
5) Depreciation: In financial = Charged in diminishing or fixed balance method
In cost
= Charged in machine hour rate
6) Abnormal Gains: In financial = Taken to profit & Loss a/c
In cost =
Excluded to cost a/cs or charged in costing
profit & Loss a/c

JOINT PRODUCT AND BY PRODUCT COSTING

Methods of apportioning joint cost over joint products :
1) Physical unit method = Physical base to measure (i.e.) output quantity is used to
separate joint cost. Joint cost can be separated on the basis of ratio of output
quantity. While doing this wastage is also to be added back to find total quantity.
2) Average unit cost method = In this method joint cost is divided by total units
Produced of all products and average cost per unit is arrived and is multiplied
With number of units produced in each product.

4
3) Survey method or point value method = Product units are multiplied by points or
weights and the point is divide on that basis.
4) Standard cost method = Joint costs are separated on the basis of standard cost set
for respective joint products.
5) Contribution margin method = Cost are divided into two categories (i.e.) variable
and fixed. Variable costs are separated on unit produced. Fixed on the basis of
contribution ratios made by different products.
6) Market value method:a) Market value at the point of separation: Joint cost to sales revenue
is found which is called as multiplying factor = Joint cost
* 100
Sales Revenue
Joint cost for each product is apportioned by applying this % on sales revenue
of each product.
Sales revenue = Sales Revenue at the point of separation.
This method cannot be done till the sales revenue at the separation point is
given.
b) Market value after processing: Joint cost is apportioned on the basis of total
sales Value of each product after further processing.
c) Net Realizable value method = Form sales value following items are deducted
i) Estimated profit margin
ii) Selling and distribution expenses if any included.
iii) Post split off cost
The resultant amount is net realizable value. Joint cost is apportioned on this basis.
Bi-product Method of accounting

Treat as other income in profit and loss a/c

Net Realizable value of Bi-product is reduced from cost of main product.

Instead of standard process, Standard cost or comparative price or re-use

price is credited to joint process a/c.

MARGINAL COSTING
Statement of profit:Particulars
Sales
Less:-Variable cost
Contribution
Less:- Fixed cost
Profit

Amount
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1) Sales = Total cost + Profit = Variable cost + Fixed cost + Profit

2) Total Cost = Variable cost + Fixed cost

3) Variable cost = It changes directly in proportion with volume

4) Variable cost Ratio = {Variable cost / Sales} * 100
5) Sales Variable cost = Fixed cost + Profit
6) Contribution = Sales * P/V Ratio
7) Profit Volume Ratio [P/V Ratio]: {Contribution / Sales} * 100
{Contribution per unit / Sales per unit} * 100
{Change in profit / Change in sales} * 100
{Change in contribution / Change in sales} * 100
8) Break Even Point [BEP]: Fixed cost / Contribution per unit [in units]
Fixed cost / P/V Ratio [in value] (or) Fixed Cost * Sales value per unit
(Sales Variable cost per unit)
9) Margin of safety [MOP]
Actual sales Break even sales
Net profit / P/V Ratio
Profit / Contribution per unit [In units]
10) Sales unit at Desired profit = {Fixed cost + Desired profit} / Cont. per unit
11) Sales value for Desired Profit = {Fixed cost + Desired profit} / P/V Ratio
12) At BEP Contribution = Fixed cost
13) Variable cost Ratio = Change in total cost
Change in total sales

* 100

14) Indifference Point = Point at which two Product sales result in same amount of
profit
= Change in fixed cost
(in units)
Change in variable cost per unit
= Change in fixed cost
Change in contribution per unit

(in units)

= Change in Fixed cost

Change in P/Ratio

(in Rs.)

= Change in Fixed cost

Change in Variable cost ratio

(in Rs.)

15) Shut down point = Point at which each of division or product can be closed
= Maximum (or) Specific (or) Available fixed cost
P/V Ratio (or) Contribution per unit
If sales are less than shut down point then that product is to shut down.
Note :1) When comparison of profitability of two products if P/V Ratio of one product is
greater than P/V Ratio of other Product then it is more profitable.
2) In case of Indifference point if
Sales > Indifference point --- Select option with higher fixed cost (or) select
option with lower fixed cost.

STANDARD COSTING
Method one of reading:Material:SP * SQ
SP * AQ
SP * RSQ
AP * AQ
(1)
(2)
(3)
(4)
a) Material cost variance = (1) (4)
b) Material price variance = (2) (4)
c) Material usage variance = (1) (2)
d) Material mix variance = (3) (2)
e) Material yield variance = (1) (3)
Labour :SR*ST SR*AT (paid) SR*RST AR*AT SR*AT(worked)
(1) (2)
(3)
(4) (5)
a) Labour Cost variance
=
b) Labour Rate variance
=
c) Labour Efficiency variance =

(1) (4)
(2) (4)
(1) (2)

d) Labour mix variance

=
e) Labour Idle time variance =

(3) (5)
(5) (2)

Variable Overheads cost variance :SR * ST

SR * AT
AR * AT
(1)
(2)
(3)
a) Variable Overheads Cost Variance
= (1) (3)
b) Variable Overheads Expenditure Variance = (2) (3)
c) Variable Overheads Efficiency Variance = (1) (2)
[Where: SR =Standard rate/hour = Budgeted variable OH
Budgeted Hours ]
Fixed Overheads Cost Variance:SR*ST
SR*AT(worked)
SR*RBT
(1)
(2)
(3)
(4)

SR*BT
(5)

a) Fixed Overheads Cost Variance

=
(1) (5)
b) Fixed Overheads Budgeted Variance = (4) (5)
c) Fixed Overheads Efficiency Variance = (1) (2)
d) Fixed Overheads Volume Variance
= (1) (4)
e) Fixed Overheads Capacity Variance
= (2) (3)
f) Fixed Overheads Calendar Variance
= (3) (4)
Sales value variance:Budgeted Price*BQ
BP*AQ
BP*Budgeted mix
(1)
(2)
(3)
(4)
a) Sales value variance
=
b) Sales price variance
=
c) Sales volume variance =
d) Sales mix variance
=
e) Sales quantity variance =

AR*AT(paid)

AP*AQ

(4) (1)
(4) (2)
(2) (1)
(2) (3)
(3) (1)

Note :i) Actual margin per unit (AMPU) = Actual sale price selling cost per unit
ii) Budgeted margin per unit (BMPU) = Budgeted sale price selling price per unit
Sales margin variance :BMPU*BQ
(1)

BMPU*AQ
(2)

BMPU*Budgeted mix
(3)
(4)

AMPU*AQ

9
a) Sales margin variance
= (4) (1)
b) Sales margin price variance
=
(4) (2)
c) Sales margin volume variance = (2) (1)
d) Sales margin mix variance
= (2) (3)
e) Sales margin quantity variance = (3) (1)
Control Ratio :1) Efficiency Ratio = Standard hours for actual output * 100
Actual hours worked
2) Capacity Ratio = Actual Hours Worked * 100
Budgeted Hours
3) Activity Ratio = Actual hours worked * 100
Budgeted Hours
Verification: Activity Ratio = Efficiency * Capacity Ratio

STANDARD COSTING
Method two of reading:Material:a) Material cost variance = SC AC = (SQ*AQ) (AQ*AP)
b) Material price variance = AQ (SP AP)
c) Material usage variance = SP (SQ AQ)
d) Material mix variance = SP (RSQ AQ)
e) Material yield variance = (AY SY for actual input) Standard material cost per
unit of output
f) Material revised usage variance (calculated instead of material yield variance)
= [standard quantity Revised standard
for actual output
quantity
]
* Standard price
Labour :-

10
a) Labour Cost variance = SC AC = (SH*SR) (AH*AR)
b) Labour Rate variance = AH (SR - AR)
c) Labour Efficiency or time variance = SR (SH AH)
d) Labour Mix or gang composition Variance = SR(RSH-AH)
e) Labour Idle Time Variance = Idle hours * SR
f) Labour Yield Variance = [Actual Output Standard output for actual input]
* Standard labour cost/unit of output
g) Labour Revised Efficiency Variance (instead of LYV) =
[Standard hours for actual output Revised standard hours] * Standard rate
Notes :- i) LCV = LRV + LMV + ITV + LYV
ii) LCV = LRV + LEV + ITV
iii) LEV = LMV, LYV (or) LREV
Overhead variance :- (general for both variable and fixed)
a) Standard overhead rate (per hour) = Budgeted Overheads
Budgeted Hours
b) Standard hours for actual output = Budgeted hours * Actual Output
Budgeted output
c) Standard OH

= Standard hrs for actual output * Standard OH rate per hour

d) Absorbed OH

= Actual hrs * Standard OH rate per hour

e) Budgeted OH

= Budgeted hrs * Standard OH rate per hour

f) Actual OH

= Actual hrs * Actual OH rate per hour

g) OH cost variance = Absorbed OH Actual OH

Variable Overheads variance :a) Variable OH Cost Variance = Standard OH Actual OH
b) Variable OH Exp. Variance = Absorbed OH Actual Variable OH

11
c) Variable OH Efficiency Variance = Standard OH Absorbed OH
= [Standard hours for Actual
* Standard rate
actual output
hours]
for variable OH
Fixed Overheads variance :a) Fixed OH Cost Variance = Standard OH Actual OH
b) Fixed OH expenditure variance = Budgeted OH Actual OH
c) Fixed OH Efficiency Variance = Standard OH (units based) Absorbed OH
(Hours based)
d) Fixed OH Volume Variance = Standard OH Budgeted OH
= [Standard hrs for Budgeted
actual output
hours ]

* standard rate

e) Fixed OH capacity variance = Absorbed OHBudgeted OH

f) Fixed OH Calendar Variance = [Revised budgeted hrs Budgeted hrs]
* Standard rate/hrs
Note:- When there is calendar variance capacity variance is calculated as follows :Capacity variance = [Actual hours Revised
* Standard
(Revised)
Budgeted hrs]
rate/hour
Verification :i) variable OH cost variance = Variable OH Expenditure variance
+ Variable OH Efficiency variance
ii) Fixed OH cost variance = Fixed OH Expenditure variance + Fixed OH volume
variance
iii) Fixed OH volume variance = Fixed OH Efficiency variance + Capacity variance
+ Calander variance
Sales variances :Turnover method (or) sales value method :a) Sales value variance = Actual Sales Budgeted Sales
b) Sales price variance = [Actual Price Standard price] * Actual quantity

= Actual sales standard sales

c) Sales volume variance = [Actual-Budgeted quantity] *Standard price
= Standard sales Budgeted sales
d) Sales mix variance = [Actual quantity Revised standard quantity] * Standard
price
= Standard sales Revised sales
e) Sales quantity variance = [Revised standard variance Budgeted quantity]
* Standard price
= Revised Standard sales Budgeted sales
Profit method:a) Total sales margin variance = (Actual ProfitBudgeted price)
= {Actual quantity * Actual profit per unit}{Budgeted quantity * Standard profit per unit}
b) Sales margin price variance=Actual profitStandard profit
= {Actual Profit per unit Standard profit per unit} * Actual quantity of sales
c) Sales margin volume variance = Standard profit Budgeted Profit
= {Actual quantity Budgeted quantity} * Standard profit per unit
d) Sales margin mix variance = Standard profit Revised Standard profit
= {Actual quantity Revised standard quantity} * Standard profit per unit
e) Sales margin quantity variance = Revised standard profit - Budgeted profit
= {Revised standard quantity Budgeted quantity} * Standard profit per unit

12

13

STANDARD COSTING
Diagrammatic Representation: Material Variance: -

Material cost variance = SC AC = (SQ*AQ) (AQ*AP)

Labour Variances:-

Labour Cost variance = SC AC = (SH*SR) (AH*AR)

Fixed Overhead Variance : a) Standard OH

= Standard hrs for actual output * Standard OH rate per hour
b) Absorbed OH

= Actual hrs * Standard OH rate per hour

c) Budgeted OH

= Budgeted hrs * Standard OH rate per hour

d) Actual OH

= Actual hrs * Actual OH rate per hour

14

e) Revised Budgeted Hour = Actual Days * Budgeted Hours per day

(Expected hours for actual days worked)
When Calendar variance is asked then for capacity variance Budgeted
Overhead is (Budgeted days * Standard OH rate per day)

Revised Budgeted Hour (Budgeted hours for actual days) = Actual days * Budgeted
hours per day
Variable Overhead Variance : -

15

Sales Value Variances : -

Sales value variance = Actual Sales Budgeted Sales

Sales Margin Variances : -

16

Total sales margin variance = (Actual ProfitBudgeted price)

= {Actual quantity * Actual profit per unit}{Budgeted quantity * Standard profit per unit}
[Where :SC = Standard Cost,
SP = Standard Price,
AP = Actual Price,
AY = Actual Yield,
RSQ = Revised Standard Quantity,
ST = Standard Time
AT = Actual Time
BP = Budgeted Price,
RBT = Revised Budgeted Time
BMPU = Budgeted Margin per Unit
AMPU = Actual Margin per Unit

AC = Actual Cost
SQ = Standard Quantity
AQ = Actual Quantity
SY = Standard Yield
SR = Standard Rate,
AR = Actual Rate,
RST = Revised Standard Time,
BQ = Budgeted Quantity

Reconciliation:Reconciliation statement is prepared to reconcile the actual profit with the

budgeted profit
Particulars
Favorable Unfavorable (Rs)
Budgeted Profit :
Add Favorable variances
Less Unfavorable variances
Sales Variances :
Sales price variance
Sales mix variance
Sales quantity variance
Cost variance :Material :
Cost variance
Usage variance

17

Mix variance
Labour :
Rate variance
Mix variance
Efficiency variance
Idle time variance
Fixed overhead variance :
Expenditure variance
Efficiency variance
Fixed overhead variance :
Expenditure variance
Efficiency variance
Capacity variance
Calendar variance

Activity Based costing

In Traditional Method we split the Over Head incurred in production, based
on machine hours which are not acceptable for many reasons.
In ABC method Over Head are splited according to the related activity, for
each type of Over Head. Overhead are apportioned among various Production cost
centers on the basis of Activity cost drivers.
Relevant Costing - some theory
Introduction: A management decision involves predictions of costs & revenues. Only the
costs and revenues that will differ among alternative actions are relevant to the
decision. The role of historical data is to aid the prediction of future data. But
historical data may not be relevant to the management decision itself. Qualitative

18

factors may be decisive in many cases, but to reduce the number of such factors to
be judged, accountants usually try to express many decision factors as possible in
quantitative terms.
Meaning of Relevant Costs: Relevant costs represent those future costs that will be changed by a
particular decision. While irrelevant costs are those costs that will not be affected by
a decision. In the short run, if the relevant revenues exceed the relevant costs then it
will be worthwhile accepting the decision. Therefore relevant costs playa major role
in the decision-making process of an organization. A particular cost can be relevant
in one situation but irrelevant in another, the important point to note is that relevant
costs represent those future costs that will be changed by a particular decision, while
irrelevant costs are those costs that will not be affected by that decision. We shall
now see what are relevant costs and revenues for decision-making process. In
summary relevant information concerns:
Other Important Terminologies : Relevant costs are costs appropriate to aiding the making of specific
management decisions. Actually, to affect a decision a cost must be:
Future: Past costs are irrelevant as they are not affected them by future decisions &
decisions should be made as to what is best now.
Incremental: This refers to additional revenue or expenditure, which may appear as a
result of our decision-making.
(A cash flow - Such charges as depreciation may be future but do not represent cash
flows and, as such, are not relevant.)
Sunk costs: Past costs, not relevant for decision making
Committed costs: This is future in nature but which arise from past decisions,
perhaps as the result of a contract.
Relevant Costs: Problem areas:
1 Problems in determining the relevant costs of materials:
When considering various decisions, if the any materials required is not taken
from existing stocks but would be purchased on a later date, then the estimated
purchase price would be the relevant material cost. A more difficult problem arises
when materials are taken from existing stock. In this situation the relevant cost of
materials for a particular job (say job X) depends on

19
Material is in regular use of the company
Material is not in regular use of the company
Material is in short supply.
If the material is in regular use of the company then the material taken from
existing stock requires replacement for the purpose of regular use therefore the
relevant cost of material will be the Replacement cost.
If the material is not in regular use of the company the relevant cost of the
materials depends on their alternative use. The alternative use of the materials will be
either to sell them or to use them on other jobs. Hence the cost of using the materials
results in an opportunity cost consisting of either
The net sales revenue if the materials were sold (or) The expense that would be
avoided if the materials were used on some other job Whichever is greater.
If the material is in short supply the only way material for the job under
consideration can be obtained is by reducing production of some other product / job.
This would release material for the order. but the reduced production will result in
loss of contribution which should be taken in to account when ascertaining the
relevant costs for the specific order. Therefore the relevant cost will be Contribution
lost (before the material cost since the material cost will be incurred in any case) will
be the relevant cost.
labour:
2 Determining the direct labour that are relevant to short - term decision depends on
the circumstances.
Where a company has temporary sparse capacity and the labour force is to be
maintained in the short - term, the direct labour cost incurred will remain same for all
alternative decisions. The direct labour cost will therefore be irrelevant for short term decision - making purposes.
However where casual labour is used and where workers can be hired on a
daily basis; a company may then adjust the employment of labour to exactly the
amount required to meet the production requirements. The labour cost will increase
if the company accepts additional work, and will decrease if production is reduced.
In this situation the labour cost be a relevant cost for decision - making purposes.
In a situation where full capacity exists and additional labour supplies are
unavailable in the short - term, and where no further overtime working is possible,
the only way that labour resources could then be obtained for a specific order would
be to reduce existing production. This would release labour for the order. but the
reduced production will result in loss of contribution, which should be taken in to
account when ascertaining the relevant costs for the specific' order. Therefore the
relevant cost will be Contribution lost (before the labour cost) will be the relevant

20

cost.
PROBLEMS

1. In a firm, material A has no alternative uses and 200 units of which lie in stock.
The information below has been collected. You are required to find the relevant price
of 120 units and 250 units respectively.
Book value
Current price
Sale price obtainable
Rs.2 per kg Rs.3 per kg Rs.2.80 per kg
2. Assume in the above problem the material is in regular use of the company
3. Assume in the above problem the material is in short supply and it is not possible
to obtain the stock of material for some more time. At present the material is used in
another product on which a contribution at the rate of Rs.1 O/unit is earned (after
meeting the material cost). Each unit of the product requires 1 KG of Raw material A.

Cash and fund flow statement

Rules for preparing schedule of changes in working capital :Increase in a current asset, results in increase in working capital so Add
Decrease in current asset, results in decrease in working capital so Decrease
Increase in current liability, results in decrease in working capital so Decrease
Decrease in current liability results in increase in working capital so Add
Funds from operations Format
Particulars
Net profit
Add : Depreciation
Goodwill written off
Preliminary Exp. Written off
Discount on share written off
Transfer to General Reserve
Provision for Taxation
Provision for Dividend
Loss on sale of asset
Loss on revaluation of asset

Rs.

Rs.
***

***
***
***
***
***
***
***
***
*** ***
***

Less : Profit on sale of asset

***
Profit on Revaluation of
*** ***
asset
Fund flow statement
***

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Fund flow statement

Particulars
Sources of funds : Issue of shares
Issue of Debentures
Long term borrowings
Sale of fixed assets
Operating profit

Rs.
***
***
***
***
***
***
Total Sources ***
Application of funds : ***
Redumption of Redeemable preference shares ***
Redumption of Debentures
***
Payment of other long term loans
***
Purchase of Fixed assets
***
Operating Loss
***
Payment of dividends, tax etc
***
Total Uses ***
Net Increase / Decrease in working capital
(Total sources Total
***
uses)
Cash flow statement
Cash From Operation : = Net profit

+ Decrease in Current Asset

+ Increase in Current Liability
- Increase in Current Asset
- Decrease in Current Liability
Cash flow statement

Sources
Opening cash and bank
balance
Issue of shares
Raising of long term loans
Sales of fixed assets
Short term Borrowings
Cash Inflow

Rs.
**
**
**
**
**
**
**

Application
Opening Bank O/D
Redumption of Preference Shares
Redumption of Long term loans
Purchase of fixed assets
Decrease in Deferred payment
Liability
Cash Outflow

Rs.
**
**
**
**
**
**
**

Closing Bank O/D

**

Tax paid
Dividend paid
Decrease in Unsecured loans, Deposits
Closing cash and bank balance

22
**
**
**
**

Ratio Analysis
A) Cash Position Ratio : 1) Absolute Cash Ratio = Cash Reservoir
Current Liabilities
2) Cash Position to Total asset Ratio = Cash Reservoir
(Measure liquid layer of assets)
Total Assets

* 100

3) Interval measure
= Cash Reservoir
(ability of cash reservoir to meet cash expenses) Average daily cash expenses
( Answer in days)
Notes : Cash Reservoir = Cash in hand + Bank + Marketable Non trade investment at
market value.
Current liabilities = Creditors + Bills Payable + Outstanding Expenses +
Provision for tax (Net of advance tax) + Proposed dividend + Other
provisions.
Total assets = Total in asset side Miscellaneous expenses Preliminary
expenses + Any increase in value of marketable non trading Investments.
Average cash expenses =Total expenses in debit side of P & L a/c Non cash
item such as depreciation, goodwill, preliminary expenses written off, loss on

sale of investments, fixed assets written off + advance tax (Ignore

provision for tax) . The net amount is divided by 365 to arrive average
expenses.

23

Remarks : - In Comparison
When absolute cash ratio is lower then current liability is higher
When cash position to Total Asset ratio is lower then the total asset is
relatively higher.
When cash interval is lower the company maintain low cash position. It is not
good to maintain too low cash position or too high cash position.
B) Liquidity Ratio : 1) Current ratio = Current asset
Current Liability
2) Quick ratio or Acid Test ratio = Quick Asset
Quick liability
Notes : Quick Asset = Current Asset Stock
Quick Liability = Current liability Cash credit, Bank borrowings, OD and
other Short term Borrowings.
Secured loan is a current liability and also come under cash credit
Sundry debtors considered doubtful should not be taken as quick asset.
Creditors for capital WIP is to be excluded from current liability.
Current asset can include only marketable securities.
Loans to employees in asset side are long term in nature and are not part of
current assets.
Provision for gratuity is not a current liability.
Gratuity fund investment is not a part of marketable securities.
Trade investments are not part of marketable securities.
Remarks : Higher the current ratios better the liquidity position.
C) Capital structure ratios : 1) Debt equity ratio
(or) Leverage ratio

= Debt
Equity
= Long term debt
Long term fund

= External Equity
Internal Equity
= Share holders fund
Long term fund

24

2) Proprietary ratio = Proprietary fund

Total Assets
3) Total Liability to Net worth ratio = Total Liabilities
Net worth
4) Capital gearing ratio = Preference share capital + Debt
Equity Preference share capital

Notes : Share holders fund (or) Equity (or) Proprietary fund (or) Owners fund (or)
Net worth = Equity share + Preference share + Reserves and surplus P & L
a/c Preliminary Expenses.
Debt (or) Long term liability (or) Long term loan fund = Secured loan
(excluding cash credit) + unsecured loan + Debentures.
Total asset = Total assets as per Balance sheet Preliminary expenses.
Total liability = Long term liability + Current liability (or) short term liability
Long term fund = Total asset Current liability = Share holders fund + long
term loan fund.
Remarks : In debt equity ratio higher the debt fund used in capital structure, greater is
the risk.
In debt equity ratio, operates favorable when if rate of interest is lower than
the return on capital employed.
In total liability to Net worth Ratio = Lower the ratio, better is solvency
position of business, Higher the ratio lower is its solvency position.
If debt equity ratio is comparatively higher then the financial strength is
better.
D) Profitability Ratio : 1) Gross Profit Ratio = Gross Profit
Sales
2) Net Profit Ratio = Net Profit
Sales

* 100
* 100

3) Operating Profit ratio = Operating profit

Sales

* 100

4) Return to shareholders = Net profit after interest and tax

Share holders fund
5) Return on Net Worth = Return on Net worth

* 100

Net worth

25

6) Return on capital employed (or) Return on investment = Return (EBIT)

Capital Employed
7) Expenses Ratios :a) Direct expenses Ratios : i) Raw material consumed
* 100
Sales
ii) Wages
* 100
Sales
iii) Production Expenses * 100
Sales
b) Indirect expenses Ratios : i) Administrative Expenses
* 100
Sales
ii) Selling Expenses * 100
Sales
iii) Distribution Expenses
* 100
Sales
iv) Finance Charge
* 100
Sales
Notes : In the above the term term is used for business engaged in sale of goods,
for other enterprises the word revenue can be used.
Gross profit = Sales Cost of goods sold
Operating profit = Sales Cost of sales
= Profit after operating expenses but before Interest and tax.
Operating Expenses = Administration Expenses + Selling and distribution
expenses, Interest on short term loans etc.
Return = Earning before Interest and Tax
= Operating profit
= Net profit + Non operating expenses Non operating Income
Capital employed = Share holders fund + Long term borrowings
= Fixed assets + Working capital
If opening and closing balance is given then average capital employed can be
substituted in case of capital employed which is
Opening capital employed + Closing capital employed
2
E) Debt service coverage ratios = Profit available for debt servicing
Loan Installments + Interest

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Notes : Profit available for debt servicing = Net profit after tax provision +
Depreciation + Other non cash charges + Interest on debt.
Remarks : Higher the debt servicing ratio is an indicator of better credit rating of the
company.
It is an indicator of the ability of a business enterprise to pay off current
installments and interest out of profits.

F) Turnover Ratios: i) Assets turnover =

Sales
Total assets

2) Fixed assets turnover =

Sales
Fixed assets

3) Working capital turnover =

[Number of times fixed assets has

turned into sales]

Sales
Working capital

4) Inventory turnover = Cost of goods sold

(for finished goods) Average inventory
5) Debtors turnover (or) Average collection period = Credit sales
(in ratio)
Average accounts receivable
(or) = Average accounts receivable * 365
(in days)
Credit sales
6) Creditors turnover (or) Average payment period Credit purchases
(in ratio)
Average accounts payable
(or) = Average accounts Payable * 365
(in days)
Credit Purchases
7) Inventory Turnover (for WIP) = Cost of production
Average Inventory (for WIP)
8) Inventory Turnover (for Raw material) = Raw material consumed
Average inventory (for raw material)
10) Inventory Holding Period =

365

Inventory turnover ratio

27

11) Capital Turnover ratio = Cost of sales

Capital employed
Note : Working capital = Current asset Current liability
= 0.25 * Proprietary ratio
Accounts Receivable = Debtors + Bills receivable
Accounts payable = Creditors + Bills Payable
Remarks : If assets turnover ratio is more than 1, then profitability based on capital
employed is profitability based on sales.
Higher inventory turnover is an indicator of efficient inventory movement. It
is an indicator of inventory management policies.
Low inventory holding period lower working capital locking, but too low is
not safe.
Higher the debtors turnover, lower the credit period offered to customers. It is
an indicator of credit management policies.
Higher the creditors turnover, lower the credit period offered by suppliers.
G) Other Ratios: 1) Operating profit ratio = Net profit ratio + Non operating loss / Sales ratio
2) Gross profit ratio = Operating profit ratio + Indirect expenses ratio
3) Cost of goods sold / Sales ratio = 100% - Gross profit ratio
4) Earnings per share = Net profit after interest and tax
Number of equity shares
5) Price earning ratio = Market price per equity share
Earning per share
6) Pay out ratio = Dividend per equity share
Earning per equity shares

* 100

7) Dividend yield ratio = Dividend per share

* 100
Market price per share
8) Fixed charges coverage ratio = Net profit before interest and tax
Interest charges

9) Interest coverage ratio = Earning before interest and tax

Interest charges
10) Fixed dividend coverage ratio =

28

Net profit
.
Annual Preference dividend

11) Over all profitability ratio = Operating profit

Capital employed
12) Productivity of assets employed =

* 100

Net profit
.
Total tangible asset

13) Retained earning ratio = Retained earnings * 100

Total earnings
H) General Remarks: Fall in quick ratio when compared with last year or other company is due to
huge stock pilling up.
If current ratio and liquidity ratio increases then the liquidity position of the
company has been increased.
If debt equity ratio increases over a period of time or is greater when
comparing two ratios, then the dependence of the company in borrowed
funds has increased.
Direct expenses ratio increases in comparison then the profitability decreases.
If there is wages / Sales ratio increases, then this is to verified
a) Wage rate
b) Output / Labour rate
Increment in wage rate may be due to increased rate or fall in labour
efficiency.
Again there are many reasons for fall in labour productivity namely abnormal
idle time due to machine failure, power cut etc.
Reduction in Raw material consumed / sales ratio may be due to reduction in
wastage or fall in material price.
Increase in production expenses ratio may also be due to price raise.
Stock turnover ratio denotes how many days we are holding stock.
In stock turnover ratio greater the number of days, the movement of goods
will be on the lower side.
Financial ratios are Current ratio, Quick ratio, Debt equity ratio, Proprietary
ratio, Fixed asset ratio.
Short term solvency ratios are current ratio, Liquidity ratio
Long term solvency or testing solvency of the company ratios are Debt equity
ratio, fixed asset ratio, fixed charges coverage ratio (or) Interest coverage
ratio.

To compute financial position of the business ratios to be calculated are

current ratio, Debt equity ratio, Proprietary ratio, fixed asset ratio.
Fictitious asset are Preliminary expenses, Discount on issue of shares and
debentures, Profit and loss account debit balance.

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