CA INTERMEDIATE

FINANCIAL MANAGEMENT
VOLUME I

By
CA. Namit Arora Sir

This book is dedicated to my Mother

‘MRS. RAMAN ARORA’

ABOUT THE AUTHOR

Mr. Namit Arora is a First class commerce graduate and member of The
Institute of Chartered Accountants of India (ICAI). He has cleared both groups of
PCC examination and final examination in his first attempt.
He has vast experience of teaching even at such young age. He has taught
large number of students of various professional courses such as CA, CS, CMA
and also of undergraduate and post graduate course for university
examinations. He is also author of Taxmann.
His specialized knowledge helps the students to understand the topic
easily and his expert advice makes the revision very easy and fast.
He gives practical examples that help students to visualize the concepts
and his teaching style is very famous among the students.
 PREFACE TO THIS EDITION
This is a comprehensive book having thoroughly explained concepts with lucid and systematic
presentation of the subject matter. All attempts are made in this book to keep concept easier
to understand and remember.
A special attention is given to presentation keeping in mind the examination needs to
the student. The book is primarily written for CA – INTERMEDIATE exams.

For any suggestion please mail me at [email protected]

A word to the students

My dear student, hard work is the key to success. Though smart work is publicized in today’s
world but to be smart, you have to work hard. So always be attentive in class and have
thorough revision after the class. It is also important to be motivated and inspired for working
hard. The key for success is:

“Work hard in class, be attentive and grab the concepts

&
Work smart during revision, select important questions for next
revision.”

ALL THE BEST

CA. NAMIT ARORA
 INDEX
S. NO. CHAPTERS NAME PAGE NO. WEIGHTAGE

0 INTRODUCTION 0.1 – 0.3 -

1 CAPITAL STRUCTURE - EBIT & EPS 1.1 – 1.30 5 – 10

ANALYSIS

2 LEVERAGES 2.1 – 2.50 5 – 10

3 MANAGEMENT OF RECEIVABLES & 3.1 – 3.33 5 – 10

PAYABLES

4 MANAGEMENT OF WORKING CAPITAL 4.1 – 4.46 10

5 TREASURY & CASH MANAGEMENT 5.1 – 5.23 5 – 10

6 RATIO ANALYSIS 6.1 – 6.64 5 – 10

7 CAPITAL BUDGETING OR 7.1 – 7.75 10

INVESTMENT DECISION

8 COST OF CAPITAL 8.1 – 8.50 5 – 10

9 CAPITAL STRUCTURE 9.1 – 9.22 5 – 10

10 DIVIDEND DECISIONS 10.1 – 10.21 5

11 TABLES - -
 INTRODUCTION
1. CA Intermediate Syllabus:

2. Study Pattern and Books:

 INTRODUCTION 0.2

3. Financial Management:

Financial management refers to that managerial activity which is concerned with the arrangement
of funds from various sources with consideration of cost, control and risk involved with such sources
and application of these funds in an effective manner to maximize shareholders earning and wealth
(EPS and MPS).

4. Financial Management Decisions:

 INTRODUCTION 0.3

5. Considerations in Case of Financing Decision:

6. Objectives of Financial Management:

7. Economic Value Added: ROI – Cost of Capital (KC)

 CHAPTER – 1

CAPITAL STRUCTURE
EBIT & EPS ANALYSIS
LEARNING OBJECTIVES

After studying this chapter you will be able to:

 Understand relationship between EBIT and EPS.
 Understand basis of selection of best capital structure out of
various options.
 Understand how to calculate and interpret indifference point
between two different capital structures?
 Calculate a firm’s financial break-even point.
 Understand EBIT and EPS graph and it’s application in decision
making or selection of proper alternative of financing.
 CAPITAL STRUCTURE - EBIT & EPS ANALYSIS 1.2
EARNING PER SHARE (EPS) AND MARKET PRICE OF SHARE (MPS)
BQ 1
Harper Ltd. has earned a profit before interest and tax of `6,00,000 for the year ended 31st March, 2023.
Calculate its profit after tax and EPS in the following situations:
(i) The company has entirely financed its project through issue of 3,00,000 equity shares of `10 each.
(ii) The company has financed its project through issue of 1,00,000 equity shares of `10 each and 20,000 14%
Debentures of `100 each.
The company's applicable corporate tax rate is 40%.

Answer
Statement of PAT and EPS
Particulars Situation I Situation II
Profit before interest and tax 6,00,000 6,00,000
Less: Interest charges - 2,80,000
Profit before tax 6,00,000 3,20,000
Less: Tax @ 40% 2,40,000 1,28,000
Profit after tax 3,60,000 1,92,000
÷ No. of Equity shares 3,00,000 1,00,000
EPS `1.20 `1.92

W.N.
Capital Structure Situation I Situation II
Equity Share Capital 30,00,000 10,00,000
14% Debenture - 20,00,000
30,00,000 30,00,000

BQ 2
Paramount Produces Ltd. wants to raise `100 lakhs for a diversification project. Current estimate of earnings
before interest and taxes (EBIT) from the new projects is `22 lakhs per annum.
Cost of debt will be 15% for amounts up to and including `40 lakhs, 16% for additional amounts up to
and including `50 lakhs and 18% for additional amounts above `50 lakhs.
The equity shares (face value `10) of the company have a current market value of `40. This is expected
to fall to `32 if debts exceeding `50 lakhs are raised. The following options are under consideration of the
company:
Options Equity Debt
I 50% 50%
II 60% 40%
III 40% 60%
Determine the earning per share (EPS) for each option and state which option the company should
exercise. Tax rate applicable to the company is 50%.
[(I) `5.76 (II) `5.33 (III) `5.04]

BQ 3
A company needs `12,00,000 for the installation of a new factory which would yield an annual EBIT of
`2,00,000. The company has the objective of maximising the earnings per share.
It is considering the possibility of issuing equity shares plus raising a debt of `2,00,000, `6,00,000 or
`10,00,000.
The current market price per share is `40 which is expected to drop to `25 per share if the market
borrowings were to exceed `7,50,000. Cost of borrowings is indicated as under:

Upto `2,50,000 10% p.a.

Between `2,50,001 and `6,25,000 14% p.a.
Between `6,25,001 and `10,00,000 16% p.a.
 CAPITAL STRUCTURE - EBIT & EPS ANALYSIS 1.3
Assuming the tax rate to be 50%, work out the EPS and the scheme which would meet the objective
of the management.
[(I) EPS `3.60 (II) EPS `4.20 (III) EPS `3.91; Alternative II should be selected]

BQ 4
A firm has an all equity capital structure consisting of 1,00,000 ordinary shares of `10 per share. The firm
wants to raise `250,000 to finance its investments and is considering three alternative methods of financing
(i) to issue 25,000 ordinary shares at `10 each, (ii) to borrow `2,50,000 at 8 per cent rate of interest, (iii) to
issue 2,500 preference shares of `100 each at an 8 per cent rate of dividend. The expected firm’s earnings
before interest and taxes after additional investment is `3,12,500 and the tax rate is 50 per cent.
Calculate EPS under all three alternatives.

Answer
Statement of Earnings Per Share (EPS)
Particulars Equity Debt Preference
EBIT 3,12,500 3,12,500 3,12,500
Less: Interest @ 8% of `2,50,000 - 20,000 -
PBT 3,12,500 2,92,500 3,12,500
Less: Tax @ 50% 1,56,250 1,46,250 1,56,250
PAT 1,56,250 1,46,250 1,56,250
Less: Preference Dividend @ 8% of `2,50,000 - - 20,000
Earnings Available for Equity Shareholders 1,56,250 1,46,250 1,36,250
÷ No. of Equity shares:
Existing 1,00,000 1,00,000 1,00,000
New 25,000 - -
EPS `1.25 `1.4625 `1.3625

BQ 5
A company's capital structure consists of the following:
Equity shares of `100 each 20,00,000
Retained earnings 10,00,000
9% Preference shares 12,00,000
7% Debentures 8,00,000
Total 50,00,000
Its return on capital employed which is likely to remain unchanged after expansion is 12%. The
expansion involves additional finances of `25 lakhs for which following alternatives are available to it:
(i) Issue of 20,000 equity shares at a premium of `25 per share.
(ii) Issue of 10% preference shares.
(iii) Issue of 8% debentures.

It is estimated that P/E ratio in the case of equity shares, preference shares and debentures financing
would be 21.4, 17 and 15.7 respectively.

Which of these alternatives of financing would you recommend and why? The income tax rate is
50%.

[(i) EPS `7.85, MV `167.99 (ii) EPS `3.20, MV`54.40 (iii) EPS `10.70, MV `167.99; Debenture alternative
should be selected]

BQ 6
A company desires to take up a capital project under its expansion programme involving an outlay or
investment of `10,00,000. If it is financed through issue of Debentures (Debt) carrying 14% interest rate, the
Price Earning Ratio will be 6 times. However, if it is financed through Equity Capital issued at premium of `15,
then the Price Earning Ratio is to be 7 times.
 CAPITAL STRUCTURE - EBIT & EPS ANALYSIS 1.4
This expansion programme is likely to enhance firm's sales by `6,00,000 a year with a net return of
15% on these additional sales before interest and tax. Firm's current financial position is given as below:
Total Debts @ 10% `4,00,000
Equity Share Capital (`10 each) `10,00,000
Retained Earnings `6,00,000
Total Capital employed `20,00,000

Present Sales `60,00,000

Less: Total Expenses/Costs (53,60,000)
EBIT `6,40,000
Interest on Debts (40,000)
EBT `6,00,000
Less: Tax @ 40% (2,40,000)
EAT `3,60,000
Calculate market value of shares in each case.

Answer
Statement of Market Value Per Share (MPS)
Particulars Debt Plan Equity Plan
EBIT: Existing 6,40,000 6,40,000
Additional (15% of `6,00,000) 90,000 90,000
7,30,000 7,30,000
Less: Interest: Existing 40,000 40,000
New (14% of `10,00,000) 1,40,000 -
EBT 5,50,000 6,90,000
Less: Tax @ 40% 2,20,000 2,76,000
PAT 3,30,000 4,14,000
÷ No. of Equity shares 1,00,000 1,40,000
EPS `3.30 `2.96
× PE Ratio 6 Times 7 Times
MPS `19.80 `20.70
Recommendation: Company should select Equity plan having higher MPS per share instead of Debt plan
having higher EPS.

BQ 7
Best of Luck Ltd., a profit making company, has a paid-up capital of `100 lakhs consisting of 10 lakhs ordinary
shares of `10 each. Currently, it is earning an annual pre-tax profit of `60 lakhs. The company's shares are
listed and are quoted in the range of `50 to `80. The management wants to diversify production and has
approved a project which will cost `50 lakhs and which is expected to yield a pre-tax income of `40 lakhs per
annum.

To raise this additional capital, the following options are under consideration of the management:
(a) To issue equity share capital for the entire additional amount. It is expected that the new shares (face
value of `10) can be sold at a premium of `15.

(b) To issue 16% non-convertible debentures of `100 each for the entire amount.

(c) To issue equity capital for `25 lakhs (face value of `10) and 16% non-convertible debentures for the
balance amount. In this case, the company can issue shares at a premium of `40 each.

You are required to advise the management as to how the additional capital can be raised, keeping in mind
that the management wants to maximise the earnings per share to maintain its goodwill. The company is
paying income tax at 50%.
 CAPITAL STRUCTURE - EBIT & EPS ANALYSIS 1.5
Answer
Statement of EPS
Alternatives
Particulars
Option I Option II Option III
Earnings before interest and tax 1,00,00,000 1,00,00,000 1,00,00,000
Less: Interest @ 16% on `50 Lakhs/`25 Lakhs - 8,00,000 4,00,000
EBT 1,00,00,000 92,00,000 96,00,000
Less: Tax @ 50% 50,00,000 46,00,000 48,00,000
EAT 50,00,000 46,00,000 48,00,000
÷ No. of Equity shares 12,00,000 10,00,000 10,50,000
EPS `4.17 `4.60 `4.57

Advise: Option II i.e. issue of 16% Debentures is most suitable to maximize the earnings per share.

BQ 8
Akash Limited provides you the following information:
Particulars `
Earnings before interest and tax 2,80,000
Less: Debenture interest @ 10% 40,000
Earnings before tax 2,40,000
Less: Income tax @ 50% 1,20,000
Earnings after tax 1,20,000
No. of Equity Shares (`10 each) 30,000
Earning per share (EPS) `4.00
Price Earning (PE) Ratio 10

The company has reserves and surplus of `7,00,000 lakhs and required `4,00,000 further for
modernisation. Return on Capital Employed (ROCE) is constant. Debt (Debt/Debt + Equity) Ratio higher than
40% will bring the P/E Ratio down to 8 and increase the interest rate on additional debts to 12%. You are
required to ascertain the probable price on the share.

(1) If the additional capital are raised as debt and

(2) If the amount is raised by issuing equity shares at ruling market price.

Answer
Statement of Market Value Per Share (MPS)
Particulars Debt Plan Equity Plan
EBIT @ 20% of 18,00,000 (14,00,000 + 4,00,000) 3,60,000 3,60,000
Less: Interest: Existing 40,000 40,000
New (12% of `4,00,000) 48,000 -
EBT 2,72,000 3,20,000
Less: Tax @ 50% 1,36,000 1,60,000
PAT 1,36,000 1,60,000
÷ No. of Equity shares 30,000 40,000
EPS `4.53 `4.00
× PE Ratio 8 Times 10 Times
MPS `36.24 `40.00

Working notes:
1. Calculation of capital employed before expansion plan:
Equity share capital (30,000 shares × `10) `3,00,000
Retained earnings `7,00,000
Debentures (40,000/10%) `4,00,000
Total capital employed `14,00,000
 CAPITAL STRUCTURE - EBIT & EPS ANALYSIS 1.6
2. Return on Capital Employed (ROCE):
EBIT 2,80 ,000
ROCE = × 100 = × 100 = 20%
Capital Employed 14 ,00 ,000

3. Debt Ratio if `4,00,000 is raised as debt:

8 ,00 ,000 ( 4 ,00 ,000 + 4 ,00 ,000 )
= × 100 = 44.44%
18 ,00 ,000 (14 ,00 ,000 + 4 ,00 ,000 )

As the debt ratio is more than 40% the P/E ratio will be brought down to 8 in Plan 1

4. Debt Equity Ratio if `4,00,000 is raised as Equity:

4 ,00 ,000
= × 100 = 22.22%
18 ,00 ,000

As the debt ratio is less than 40% the P/E ratio in this case will remain at 10 times in Plan 2.

4 ,00 ,000
5. Number of Equity Shares to be issued in Plan 2: = = 10,000 shares
40

BQ 9
The following data are presented in respect of Quality Automation Ltd.:
Particulars `
Profit before interest and tax 52,00,000
Less: Debenture interest @ 12% 12,00,000
Profit before tax 40,00,000
Less: Income tax @ 50% 20,00,000
Profit after tax 20,00,000
No. of Equity Shares (`10 each) 8,00,000
Earning per share (EPS) `2.50
Price Earning (PE) Ratio, 10
Market Price Per Share `25.00
The company is planning to start a new project requiring a total capital outlay of `40,00,000. You are
informed that a debt equity ratio (D/D+E) higher than 35% push the Ke up to 12.5% means reduce PE ratio to
8 and rises the interest rate on additional amount borrowed at 14%.

Find out the probable price of share if:

(1) The additional funds are raised as a loan.
(2) The amount is raised by issuing equity shares.
(Note: Retained earnings of the company is `1.2 crore)

Answer
Statement of Market Value Per Share (MPS)
Particulars Debt Plan Equity Plan
EBIT @ 17.⅓% of 3,40,00,000 (3,00,00,000 + 40,00,000) 58,93,333 58,93,333
Less: Interest: Existing 12,00,000 12,00,000
New (14% of `40,00,000) 5,60,000 -
EBT 41,33,333 46,93,333
Less: Tax @ 50% 20,66,667 23,46,667
PAT 20,66,666 23,46,666
÷ No. of Equity shares 8,00,000 9,60,000
EPS `2.583 `2.444
× PE Ratio 8 Times 10 Times
MPS `20.66 `24.44
 CAPITAL STRUCTURE - EBIT & EPS ANALYSIS 1.7
Note: In this question EBIT after proposed extension is not given. Therefore, we can assume that existing
return on capital employed will be maintained.

Working notes:
1. Calculation of capital employed before expansion plan:
Equity share capital (8,00,000 shares × `10) `80,00,000
Retained earnings `1,20,00,000
Debentures (12,00,000/12%) `1,00,00,000
Total capital employed `3,00,00,000

2. Return on Capital Employed (ROCE):

EBIT 52 ,00 ,000
ROCE = × 100 = × 100 = 17.⅓%
Capital Employed 3,00 ,00 ,000

3. Debt Equity Ratio if `40,00,000 is raised as Debt:

1 ,40 ,00 ,000 (1 ,00 ,00 ,000 + 40 ,00 ,000 )
= × 100 = 41.18%
3,40 ,00 ,000 (3,00 ,00 ,000 + 40 ,00 ,000 )

As the debt equity ratio is more than 35% the P/E ratio will be brought down to 8 in Plan 1

4. Debt Equity Ratio if `40,00,000 is raised as Equity:

1 ,00 ,00 ,000
= × 100 = 29.41%
3 ,40 ,00 ,000

As the debt equity ratio is less than 35% the P/E ratio in this case will remain at 10 times in Plan 2.

5. Number of Equity Shares to be issued in Plan 2:

40 ,00 ,000
= = 1,60,000 shares
25

Decision: Though loan option has higher EPS but equity option has higher MPS therefore company should
raise additional fund through equity option.

BQ 10
The following figures of Krish Ltd. are presented to you:
Particulars `
Earnings before interest and tax 23,00,000
Less: Debenture interest @ 8% 80,000
Less: Long term loan interest @ 11% 2,20,000
Earnings before tax 20,00,000
Less: Income tax 10,00,000
Earnings after tax 10,00,000
No. of Equity shares of `10 each 5,00,000
E.P.S. `2
Market price of Share `20
P/E ratio 10 times

The company has undistributed reserves and surplus of `20 lakhs. It is in need of `30 lakhs to payoff
debentures and modernise its plants. It seeks your advice on the following alternative modes of raising finance.
Alternative 1: Raising entire amount as term loan from banks @ 12%.
Alternative 2: Raising part of the funds by issue of 1,00,000 shares of `10 each issued at `20 and the rest by
term loan at 12%.
 CAPITAL STRUCTURE - EBIT & EPS ANALYSIS 1.8
The company expects to improve its rate of return by 2% as a result of modernization, but P/E ratio is
likely to go down to 8 if the entire amount is raised as term loan.

(i) Advise the company on the financial plan to be selected

(ii) If it is assumed that there will be no change in the P/E ratio if either of the two alternatives are
adopted, would your advice still hold good?

[(i) Alternative 1: EPS `2.42, MV `19.36 and Alternative 2: EPS `2.217, MV`22.17; Alternative 2 should
be selected (ii) Alternative 1: MV `24.42 and Alternative 2: MV`22.17; Alternative 1 should be selected]

INDIFFERENCE POINT
BQ 11
Ganesha Ltd. is setting up a project with a capital outlay of `60,00,000. It has the following two alternatives in
financing the project cost.
Alternative 1 : 100% Equity finance by issuing equity shares of `10 each
Alternative 2 : Debt-Equity ratio 2:1 (equity shares will be of `10 each)
The rate of interest payable on the debt is 18% p.a. The corporate rate of tax is 40%.
Calculate the indifference point between two alternative methods of financing.
[`10,80,000]

BQ 12
Aaina Ltd. is considering a new project which requires a capital investment of `9 crores. Interest on term loan
is 12% and Corporate Tax rate is 30%. Calculate the point of indifference for the project considering the Debt
Equity ratio insisted by the financing agencies being 2 : 1.

Answer
The capital investment can be financed in two ways i.e.
(i) By issuing equity shares only worth `9 crores or
(ii) By raising capital through taking a term loan of `6 crores and `3 crores through issuing equity shares
(as the company has to comply with the 2 : 1 Debt Equity ratio insisted by financing agencies).
Calculation of point of Indifference:
(EBIT−I) (1−T) (EBIT−I) (1−T)
=
N1 N2
(EBIT−Nil) (1−0.30) (EBIT−12% of 6,00,00,000) (1−0.30)
=
90,00,000 30,00,000
EBIT = 3 × (EBIT – 72,00,000)
EBIT = 2,16,00,0000 ÷ 2 = 1,08,00,000

Note: The face value of the equity shares is assumed as `10 per share.

BQ 13
M.C. Ltd. is planning an expansion programme which will require `30 crores and can be funded through one
of the three following options:
(a) Issue further equity shares of `100 each at par,
(b) Raise loans at 15% interest,
(c) Issue preference shares at 12%.
Present paid up capital is `60 crores and average annual EBIT is `12 crores. Assume Income-tax rate at
50%. After the expansion, EBIT is expected to be `15 crores p.a.
Calculate EPS under the three financing options indicating the alternative giving the highest return
to the equity shareholders also determine the point of indifference between Equity Share Capital and Debt
[i.e. option (a) and (b) above].
 CAPITAL STRUCTURE - EBIT & EPS ANALYSIS 1.9
Answer
(a) Statement of Earnings Per Share (EPS)
Particulars Equity Loan Preference
EBIT: Existing 15,00,00,000 15,00,00,000 15,00,00,000
Less: Interest @ 15% of `30 Cr. - 4,50,00,000 -
PBT 15,00,00,000 10,50,00,000 15,00,00,000
Less: Tax @ 50% 7,50,00,000 5,25,00,000 7,50,00,000
PAT 7,50,00,000 5,25,00,000 7,50,00,000
Less: Preference Dividend @ 12% of `30 Cr. - - 3,60,00,000
Earnings Available for Equity Shareholders 7,50,00,000 5,25,00,000 3,90,00,000
÷ No. of Equity shares:
Existing 60,00,000 60,00,000 60,00,000
New 30,00,000 - -
EPS `8.33 `8.75 `6.50

Analysis: Financing Option (b) i.e. raising of loans @ 15% interest give the highest EPS of `8.75.

(b) Calculation of Indifference point between Equity Share Capital and Debt:

EBIT  NIL 1  0.50  = EBIT  4 ,50 ,00 ,000 1  0.50 
90 ,00 ,000 60 ,00 ,000

EBIT = `13,50,00,000

BQ 14
A new project under consideration requires a capital outlay of `300 lakhs. The required funds can be raised
either fully by equity shares of `100 each or by equity shares of the value of `200 lakhs and by loan of `100
lakhs at 15% interest. Assuming a tax rate of 50%.

Calculate the figure of profit before interest and tax that would keep the equity investors
indifferent to the two options. Verify your answer by calculating the EPS.

Answer
Calculation of Indifference point:

EBIT  I 1  T  =
EBIT  I 1  T 
N1 N2

EBIT  NIL  1  0.50  = EBIT  15 ,00 ,000  1  0.50 

3,00 ,000 2,00 ,000

EBIT = `45,00,000

Verification: Statement of EPS

Particulars Situation I Situation II
Profit before interest and tax 45,00,000 45,00,000
Less: Interest charges - 15,00,000
Profit before tax 45,00,000 30,00,000
Less: Tax @ 50% 22,50,000 15,00,000
Profit after tax 22,50,000 15,00,000
÷ No. of Equity shares 3,00,000 2,00,000
EPS `7.50 `7.50

BQ 15
PCB Corporation has plans for expansion which calls for 50% increase in assets. The alternatives before the
Corporation are issued of equity shares or debt at 14%. Its balance sheet and profit and loss accounts are as
given below:
 CAPITAL STRUCTURE - EBIT & EPS ANALYSIS 1.10
Balance Sheet as at 31st March, 2023
Liabilities ` Assets `
Ordinary Shares (10,00,000 Shares 1,00,00,000 Total Assets 2,00,00,000
@ `10 each)
12% Debentures 25,00,000
General Reserve 75,00,000
Total 2,00,00,000 Total 2,00,00,000

Profit and Loss Account for the year ending 31st March, 2023
Particulars `
Sales 7,50,00,000
Less: total cost excluding interest 6,75,00,000
EBIT 75,00,000
Less: Interest @ 12% of `25,00,000 3,00,000
EBT 72,00,000
Less: Tax @ 50% 36,00,000
EAT 36,00,000
÷ No. of Equity shares: 10,00,000
EPS `3.60
Price Earning Ratio 5 Times
Market Price Per Share `18.00

If the PCB Corporation finances the expansion with debt, the incremental financing charges will be at
14% and P/E ratio is expected to be at 4 times. If the expansion is through equity, the P/E ratio will remain at
5 times. The company expects that its new issues will be subscribed to at a premium of 25%.

With the above information determine the following:

(i) If EBIT is 10% of sales, calculate EPS and MPS at sales levels of `4 crores, `8 crores and `10 crores.
(ii) After expansion determine at what level of EBIT, EPS would remain the same, whether new funds are
raised by equity or debt.

Answer
(i) Statement of EPS and MPS
Sales 4 Crores Sales 8 Crores Sales 10 Crores
Particulars
Equity Debt Equity Debt Equity Debt
EBIT @ 10% of Sales 40,00,000 40,00,000 80,00,000 80,00,000 1,00,00,000 1,00,00,000
Less: Interest:
Existing 3,00,000 3,00,000 3,00,000 3,00,000 3,00,000 3,00,000
New @ 14% of `1 cr. - 14,00,000 - 14,00,000 - 14,00,000
EBT 37,00,000 23,00,000 77,00,000 63,00,000 97,00,000 83,00,000
Less: Tax @ 50% 18,50,000 11,50,000 38,50,000 31,50,000 48,50,000 41,50,000
PAT 18,50,000 11,50,000 38,50,000 31,50,000 48,50,000 41,50,000
÷ No. of Equity shares
Existing 10,00,000 10,00,000 10,00,000 10,00,000 10,00,000 10,00,000
New 8,00,000 - 8,00,000 - 8,00,000 -
EPS `1.03 `1.15 `2.14 `3.15 `2.69 `4.15
× P/E Ratio 5 Times 4 Times 5 Times 4 Times 5 Times 4 Times
MPS `5.15 `4.60 `10.70 `12.60 `13.45 `16.60

(ii) Indifference point between two alternatives of financing:

EBIT  I1  T  =
EBIT  I1  T 
N1 N2
EBIT  3,00 ,000 1  0.50  = EBIT  17 ,00 ,000 1  0.50 
18 ,00 ,000 10 ,00 ,000
EBIT = `34,50,000
 CAPITAL STRUCTURE - EBIT & EPS ANALYSIS 1.11
BQ 16
DMC Corporation currently has 1,00,000 shares of common stock outstanding with a market price of `50 per
share. It also has `2 million (`20 lacs) in 7% bonds currently selling at par. The company is considering a `4
million (`40 lacs) expansion program that it can finance with either (I) all common stock at `50 per share, or
(II) all bonds at 9%. The company estimates that if the expansion program is undertaken, it can attain in the
near future `1 million (`10 lacs) in EBIT. The company's tax rate is 40%.

Required:
(a) Calculate the EPS for each plan.
(b) What is indifference point between the alternatives?
(c) Calculate financial break even point of both plans.
(d) Draw the EBIT - EPS graph.
(e) Suggest a course of action.
[(a) EPS: Plan 1: `2.87, Plan 2: `3.00 (b) `9,50,000 (c) Plan 1: `1,40,000; Plan 2: `5,00,000]

BQ 17
Yoyo Limited presently has `36,00,000 in debt outstanding bearing an interest rate of 10 per cent. It wishes
to finance a `40,00,000 expansion programme and is considering three alternatives: additional debt at 12 per
cent interest, preference shares with an 11 per cent dividend, and the issue of equity shares at `16 per share.
The company presently has 8,00,000 shares outstanding and is in a 40 per cent tax bracket.

(a) If earnings before interest and taxes are presently `15,00,000, what would be earnings per share for the
three alternatives, assuming no immediate increase in profitability?
(b) Analyse which alternative do you prefer? Compute how much would EBIT need to increase before the
next alternative would be best?

Answer
(a) Statement of EPS
Alternatives
Particulars
Debt Preference Equity
Earnings before interest and tax 15,00,000 15,00,000 15,00,000
Less: Interest:
Existing @ 10% on `36,00,000 3,60,000 3,60,000 3,60,000
New 12% on `40,00,000 4,80,000 - -
EBT 6,60,000 11,40,000 11,40,000
Less: Tax @ 40% 2,64,000 4,56,000 4,56,000
EAT 3,96,000 6,84,000 6,84,000
Less: Preference Dividend - 4,40,000 -
Earnings Available for Equity Shareholders 3,96,000 2,44,000 6,84,000
÷ No. of Equity shares 8,00,000 8,00,000 10,50,000
EPS `0.495 `0.305 `0.651

(b) For the present EBIT level, equity share is clearly preferable. EBIT would need to increase by `8,76,000
(`23,76,000 − `15,00,000) before next alternative i.e. debt would be best.

Working Note:
Indifference point between Equity (best option) and Debt (second best option) of financing:

EBIT  I1  T  =
EBIT  I1  T 
N1 N2

EBIT  3,60 ,000  1  0.40  = EBIT  8 ,40 ,000  1  0.40 

1 ,05 ,000 80 ,000

EBIT = `23,76,000
 CAPITAL STRUCTURE - EBIT & EPS ANALYSIS 1.12
BQ 18
Ganapati Limited is considering three financing plans. The key information is as follows:
(a) Total investment to be raised `2,00,000.
(b) Financing proportion of Plans:
Plans Equity Debt Preference Shares
A 100% - -
B 50% 50% -
C 50% - 50%

(c) Cost of debt is 8%

Cost of preference shares is 8%
(d) Tax rate 50%
(e) Equity shares of the face value of `10 each will be issued at a premium of `10 per share
(f) Expected EBIT is `80,000.

You are required to determine for each plan:

(1) Earnings per share
(2) Financial break-even-point
(3) Indicate if any of the plans dominate and compute the EBIT range among the plans for indifference.

Answer
(1) Statement of EPS
Alternatives
Particulars
A B C
Earnings before interest and tax 80,000 80,000 80,000
Less: Interest @ 8% on `1,00,000 - 8,000 -
EBT 80,000 72,000 80,000
Less: Tax @ 50% 40,000 36,000 40,000
EAT 40,000 36,000 40,000
Less: Preference Dividend @ 8% on `1,00,000 - - 8,000
Earning Available for Equity Shareholders 40,000 36,000 32,000
÷ No. of Equity shares (Issue price `20) 10,000 5,000 5,000
EPS `4.00 `7.20 `6.40

(2) Financial Break Even Point (EBIT equals to fixed financial cost):
Proposal A Financial B.E.P. = No Fixed Financial Cost = Zero
Proposal B Financial B.E.P. = Interest on Debt = 8,000
Pr eference Dividend
Proposal C Financial B.E.P. =
(1  t )
8,000
= = 16,000
1 − 0.50

(3) Indifference Point:

Between Proposal A & B:
(EBIT−I) (1−T) (EBIT−I) (1−T)
=
NA NB
(EBIT−0) (1−0.50) (EBIT−8,000) (1−0.50)
=
10,000 5,000
EBIT = `16,000

Between Proposal A & C:

 CAPITAL STRUCTURE - EBIT & EPS ANALYSIS 1.13
(EBIT−I) (1−T) {(EBIT−I) (1−T) − PD}
=
NA NC
(EBIT−0) (1−0.50) {(EBIT−0) (1−0.50) − 8,000}
=
10,000 5,000
EBIT = `32,000

Between Proposal B & C:

(EBIT−I) (1−T) {(EBIT−I) (1−T) − PD}
=
NB NC
(EBIT−8,000) (1−0.50) {(EBIT−0) (1−0.50) − 8,000}
=
5,000 5,000
0.5 EBIT – 4,000 ≠ 0.5 EBIT – 8,000

There is no indifference point between the financial plans B and C. It can be seen that Financial Plan B
dominates Plan C. Since, the financial break-even point of the former is only `8,000 but in case of latter it is
`16,000.

BQ 19
Xylo Ltd. is considering the following two alternative financing plans:

Particulars Plan A Plan B

Equity Shares of `10 each 8,00,000 8,00,000
12% Debentures 4,00,000 -
Preference Shares of `100 each - 4,00,000
12,00,000 12,00,000

The indifference point between the plans is `4,80,000. Corporate tax rate 30%.

Calculate the rate of dividend on preference shares.

Answer
Pr eference Dividend 33 ,600
Rate of dividend = × 100 = × 100 = 8.40%
Pr eference Share Capital 4 ,00 ,000

Working Notes:
Calculation of preference dividend:

EBIT  I 1  T  =
[EBIT  I 1  T ]  PD
N1 N2
4 ,80 ,000  48 ,000  1  0.30  =
[ 4 ,80 ,000  Nil  1  0.30 ]  PD
80 ,000 80 ,000
3,02,400 = 3,36,000 – PD

Preference dividend (PD) = `33,600

BQ 20
Stylo Ltd. is considering the following two alternative financing plans:
Particulars Plan A Plan B
Equity Shares of `10 each 8,00,000 8,00,000
Debentures 4,00,000 -
8.40% Preference Shares of `100 each - 4,00,000
12,00,000 12,00,000
 CAPITAL STRUCTURE - EBIT & EPS ANALYSIS 1.14
The indifference point between the plans is `4,80,000. Corporate tax rate 30%.

Calculate the rate of interest on debentures.

Answer
Interest 48 ,000
Rate of Interest = × 100 = × 100 = 12%
Amount of Debentures 4 ,00 ,000

Working Notes:
Calculation of Interest on debentures:

EBIT  I 1  T  = [EBIT  I 1  T ]  PD
N1 N2
4 ,80 ,000  I  1  0.30  = [ 4 ,80 ,000  Nil  1  0.30 ]  33 ,600
80 ,000 80 ,000
3,36,000 – 0.7I = 3,02,400
0.7I = 33,600

Interest on debentures (I) = 33,600 ÷ 0.7 = `48,000

BQ 21
Current Capital Structure of XYZ Ltd is as follows:
Equity Share Capital : 7 lakh shares of face value `20 each
Reserves : `10,00,000
9% bonds : `3,00,00,000
11% preference capital : 3,00,000 shares of face value `50 each
Additional Funds required : `5,00,00,000

XYZ Ltd is evaluating the following alternatives:

(1) Proposed alternative I: Raise the funds via 25% equity capital and 75% debt at 10%. PE ratio in such
scenario would be 12.
(2) Proposed alternative II: Raise the funds via 50% equity capital and rest from 12% Preference capital.
PE ratio in such scenario would be 11.

Any new equity capital would be issued at a face value of `20 each. Any new preferential capital would be
issued at a face value of `20 each. Tax rate is 34%

Determine the indifference point under both the alternatives.

Answer
Calculation of Indifference point between Proposal I & Proposal II:

Let the indifference point be X

[EBIT  I 1  T ]  PD [EBIT  I 1  T ]  PD
=
N1 N2

X  64 ,50 ,000  1  0.34   16 ,50 ,000 =

X  27 ,00 ,000  1  0.34   46 ,50 ,000
13 ,25 ,000 19 ,50 ,000

.66 X  42 ,57 ,000  16 ,50 ,000 .66 X  17 ,82 ,000  46 ,50 ,000
=
1 ,325 1 ,950
 CAPITAL STRUCTURE - EBIT & EPS ANALYSIS 1.15
.66 X  59 ,07 ,000 .66 X  64 ,32,0000
=
53 78

51.48X – 46,07,46,000 = 34.98X – 34,08,96,000

16.5 X = 11,98,50,000

X = `72,63,636.36

Working Notes:
(1) Calculation of number of Equity shares:

Under Proposal I = 7,00,000 Existing shares + 5,00 ,00 ,000  25% New shares
20
= 7,00,000 + 6,25,000 = 13,25,000 shares

Under Proposal II = 7,00,000 Existing shares + 5,00 ,00 ,000  50% New shares
20
= 7,00,000 + 13,50,000 = 19,50,000 shares

(2) Calculation of Interest:

Under Proposal I = 3,00,00,000 × 9% + (5,00,00,000 × 75%) × 10%
= 64,50,000

Under Proposal II = 3,00,00,000 × 9% = 27,00,000

(3) Calculation of Preference Dividend:

Under Proposal I = (3,00,000 × 50) × 11% = 16,50,000

Under Proposal II = 16,50,000 + (5,00,00,000 × 50%) × 12%

= 46,50,000
 CAPITAL STRUCTURE - EBIT & EPS ANALYSIS 1.16

PAST YEARS QUESTIONS

PYQ 1
The Modern Chemicals Ltd. requires `25,00,000 for a new plant. This plant is expected to yield earnings before
interest and taxes of `5,00,000. While deciding about the financial plan, the company considers the objective
of maximizing earnings per share.
It has three alternatives to finance the projects by raising debt of `2,50,000 or `10,00,000 or
`15,00,000 and the balance in each case, by issuing equity shares. The company’s share is currently selling at
`150, but is expected to decline to `125 in case the funds are borrowed in excess of `10,00,000. The funds can
be borrowed at the rate of 10% up to `2,50,000 at 15% over `2,50,000 and upto `10,00,000 and at 20% over
`10,00,000. The tax rate applicable to the company is 50%.
Which form of financing should the company choose?
[(7 Marks) Nov 1999]

Answer
Statement of EPS
Alternatives
Particulars
1 2 3
Earnings before interest and tax 5,00,000 5,00,000 5,00,000
Less: Interest:
@ 10% on first `2,50,000 25,000 25,000 25,000
@ 15% on `2,50,001 to `10,00,000 - 1,12,500 1,12,500
@ 20% on above `10,00,000 - - 1,00,000
EBT 4,75,000 3,62,500 2,62,500
Less: Tax @ 50% 2,37,500 1,81,250 1,31,250
EAT 2,37,500 1,81,250 1,31,250
÷ No. of Equity shares 15,000 10,000 8,000
(22,50,000/150) (15,00,000/150) (10,00,000/125)
EPS `15.833 `18.125 `16.406

Decision: The earning per share is higher in alternative II i.e. if the company finance the project by raising debt
of `10,00,000 & issue equity shares of `15,00,000. Therefore, the company should choose this alternative to
finance the project.

PYQ 2
A Company earns a profit of `3,00,000 per annum after meeting its interest liability of `1,20,000 on 12%
debentures. The Tax rate is 50%. The number of Equity Shares of `10 each are 80,000 and the retained
earnings amount to `12,00,000. The company proposes to take up an expansion scheme for which a sum of
`4,00,000 is required.
It is anticipated that after expansion, the company will be able to achieve the same return on
investment as at present. The funds required for expansion can be raised either through debt at the rate of
12% or by issuing Equity Shares at par.

Required:
(i) Compute the Earnings Per Share (EPS), if:
(a) The additional funds were raised as debt
(b) The additional funds were raised by issue of equity shares.

(ii) Advise the company as to which source of finance is preferable.

[(6 Marks) Nov 2002]

Answer
 CAPITAL STRUCTURE - EBIT & EPS ANALYSIS 1.17
(i) Statement of EPS
Alternatives
Particulars
Debt Plan Equity Plan
Earnings before interest and tax @ 14% of `34,00,000 4,76,000 4,76,000
Less: Interest:
Existing 1,20,000 1,20,000
New (12% on `4,00,000) 48,000 -
EBT 3,08,000 3,56,000
Less: Tax @ 50% 1,54,000 1,78,000
EAT 1,54,000 1,78,000
÷ No. of Equity shares
Existing 80,000 80,000
New - 40,000
EPS `1.925 `1.483

(ii) Advise to the company: Since EPS is greater in the case when company arranges additional funds as
debt. Therefore, the company should finance the expansion scheme by raising debt.
Working notes:
1. Calculation of capital employed before expansion plan:
Equity share capital `8,00,000
Retained earnings `12,00,000
Debentures (1,20,000/12%) `10,00,000
Total capital employed `30,00,000

2. Earnings before the payment of Interest and tax (EBIT):

Profit before tax `3,00,000
Interest `1,20,000
EBIT `4,20,000

3. Return on Capital Employed (ROCE):

EBIT 4 ,20 ,000
ROCE = × 100 = × 100 =
Capital Employed 30 ,00 ,000
14%

4. After expansion capital employed = `34,00,000 (`30,00,000 + `4,00,000)

PYQ 3
Calculate the level of earnings before interest and tax (EBIT) at which the EPS indifference point between
following financing alternatives will occur:
(i) Equity share capital of `6,00,000 and 12% debentures of `4,00,000 Or
(ii) Equity share capital of `4,00,000, 14% preference share capital of `2,00,000 and 12% debenture
`4,00,000.
Assume the corporate tax rate is 35% and par value of equity share is `10 in each case.
[(5 Marks) May 2003]

Answer
Calculation of Indifference point:

EBIT  I 1  T  =
EBIT  I 1  T   PD
N1 N2

EBIT  48 ,000  1  0.35  =

EBIT  48 ,000  1  0.35  28 ,000
60 ,000 40 ,000
 CAPITAL STRUCTURE - EBIT & EPS ANALYSIS 1.18
EBIT = `1,77,231 approximately
PYQ 4
A Company needs `31,25,000 for the construction of new plant. The following three plans are feasible:
(I) The Company may issue 3,12,500 equity shares at `10 per share.
(II) The Company may issue 1,56,250 ordinary equity shares at `10 per share and 15,625 debentures of
`100 denomination bearing 8% rate of interest.
(III) The Company may issue 1,56,250 equity shares at `10 per share and 15,625 preference shares at `100
per share bearing a 8% rate of dividend.

Required:
(i) If the Company's earnings before interest and taxes are `62,500, `1,25,000, `2,50,000, `3,75,000 and
`6,25,000, what are the earnings per share under each of three financial plans? Assume a Corporate
Income-tax rate of 40%.
(ii) Which alternative would you recommend and why?
(iii) Determine the EBIT-EPS indifference points by formula between Financing Plan I and Plan II and Plan I
and Plan III.
[(10 Marks) Nov 2005]

Answer
(i) Statement showing EPS with respect to various plans & different EBIT:
a. Equity Financing
Particulars ` ` ` ` `
EBIT 62,500 1,25,000 2,50,000 3,75,000 6,25,000
Less: Interest 0 0 0 0 0
EBT 62,500 1,25,000 2,50,000 3,75,000 6,25,000
Less: Tax @ 40% (25,000) (50,000) (1,00,000) (1,50,000) (2,50,000)
EAT 37,500 75,000 1,50,000 2,25,000 3,75,000
÷ No. of Equity Shares ÷ 3,12,500 ÷ 3,12,500 ÷ 3,12,500 ÷ 3,12,500 ÷ 3,12,500
EPS `0.12 `0.24 `0.48 `0.72 `1.20

b. Debt - Equity Mix

Particulars ` ` ` ` `
EBIT 62,500 1,25,000 2,50,000 3,75,000 6,25,000
Less: Interest (1,25,000) (1,25,000) (1,25,000) (1,25,000) (1,25,000)
EBT (62,500) 0 1,25,000 2,50,000 5,00,000
Less: Tax @ 40% *25,000 0 (50,000) (1,00,000) (2,00,000)
EAT (37,500) 0 75,000 1,50,000 3,00,000
÷ No. of Equity Shares ÷ 1,56,250 ÷ 1,56,250 ÷ 1,56,250 ÷ 1,56,250 ÷ 1,56,250
EPS (`0.24) `0.00 `0.48 `0.96 `1.92
*25,000 is the tax saving in case of loss.

c. Preference Share - Equity Mix

Particulars ` ` ` ` `
EBIT 62,500 1,25,000 2,50,000 3,75,000 6,25,000
Less: Interest 0 0 0 0 0
EBT 62,500 1,25,000 2,50,000 3,75,000 6,25,000
Less: Tax @ 40% (25,000) (50,000) (1,00,000) (1,50,000) (2,50,000)
EAT 37,500 75,000 1,50,000 2,25,000 3,75,000
Less: Preferential Dividend **(1,25,000) **(1,25,000) (1,25,000) (1,25,000) (1,25,000)
EAT after Pref. Dividend (87,500) (50,000) 25,000 1,00,000 2,50,000
÷ No. of Equity Shares ÷ 1,56,250 ÷ 1,56,250 ÷ 1,56,250 ÷ 1,56,250 ÷ 1,56,250
EPS (`0.56) (`0.32) `0.16 `0.64 `1.60
 CAPITAL STRUCTURE - EBIT & EPS ANALYSIS 1.19
**In case of cumulative preference shares, the company has to pay cumulative dividend to preference
shareholders, when company earns sufficient profits, so deducted here even in case of insufficient profit to
reach right decision.
(ii) Recommendation:
(a) If expected EBIT is less than `2,50,000 : Equity Finance (Alternative 1)
(b) If expected EBIT is equal to `2,50,000 : Equity or Debt - Equity Mix (Alternative 1 or 2)
(c) If expected EBIT is more than `2,50,000 : Debt – Equity Mix (Alternative 2)

(iii) Computation of EBIT – EPS indifference points:

Between financing Plan I & Plan II:
EBIT  I 1  T  =
EBIT  I 1  T 
N1 N2
EBIT  Nil  1  0.40  =
EBIT  1 ,25,000  1  0.40 
3,12 ,500 1 ,56 ,250
EBIT = 2,50,000

Between financing Plan I & Plan III:

EBIT  I 1  T  =
EBIT  I 1  T   PD
N1 N3
EBIT  Nil 1  0.40  =
EBIT  Nil 1  0.40   1 ,25,000
3 ,12 ,500 1 ,56 ,250
EBIT = 4,16,667 approx

PYQ 5
The management of Z Company Ltd. wants to raise its funds from market to meet out the financial demands of
its long-term projects. The company has various combinations of proposals to raise its funds. You are given
the following proposals of the company:
(i) Proposals Equity Shares (%) Debts (%) Preference shares (%)
P 100 - -
Q 50 50 -
R 50 - 50
(ii) Cost of debt and preference shares is 10% each.
(iii) Tax rate 50%.
(iv) Equity shares of the face value of `10 each will be issued at a premium of `10 per share.
(v) Total investment to be raised `40,00,000.
(vi) Expected earnings before interest and tax `18,00,000.

From the above proposals the management wants to take advice from you for appropriate plan after
computing the following:
(1) Earnings per share
(2) Financial break-even-point
(3) Compute the EBIT range among the plans for indifference. Also indicate if any of the plans dominate.
[(12 Marks) May 2011]

Answer
(i) Statement of EPS
Alternatives
Particulars
P Q R
Earnings before interest and tax 18,00,000 18,00,000 18,00,000
Less: Interest @ 10% on `20,00,000 - 2,00,000 -
EBT 18,00,000 16,00,000 18,00,000
Less: Tax @ 50% 9,00,000 8,00,000 9,00,000
 CAPITAL STRUCTURE - EBIT & EPS ANALYSIS 1.20
EAT 9,00,000 8,00,000 9,00,000
Less: Preference Dividend - - 2,00,000
Earning Available for Equity Shareholders 9,00,000 8,00,000 7,00,000
÷ No. of Equity shares (Issue price `20) 2,00,000 1,00,000 1,00,000
EPS `4.50 `8.00 `7.00

Recommendation: Company should select debt option having highest EPS among different plans.

(ii) Financial Break Even Point (EBIT equals to fixed financial cost):
Proposal P Financial B.E.P. = No Fixed Financial Cost = Zero
Proposal Q Financial B.E.P. = Interest on Debt = 2,00,000
Pr eference Dividend
Proposal R Financial B.E.P. =
(1  t )
2 ,00 ,000
= = 4,00,000
1  0.50 

(iii) Indifference Point:

Between Proposal P & Q:
EBIT  I 1  T  =
EBIT  I 1  T 
N1 N2
EBIT  Nil  1  0.50  =
EBIT  2,00 ,000  1  0.50 
2,00 ,000 1 ,00 ,000
EBIT = `4,00,000

Between Proposal P & R:

EBIT  I 1  T  =
EBIT  I 1  T  PD
N1 N3
EBIT  Nil  1  0.50  =
EBIT  Nil  1  0.50   2,00 ,000
2 ,00 ,000 1 ,00 ,000
EBIT = `8,00,000

Between Proposal Q & R:

EBIT  I 1  T  =
EBIT  I 1  T   PD
N2 N3
EBIT  2,00 ,000  1  0.50  =
EBIT  Nil  1  0.50   2,00 ,000
1 ,00 ,000 1 ,00 ,000
0.5 EBIT – 1,00,000 ≠ 0.5 EBIT – 2,00,000

There is no indifference point between proposal ‘Q’ and proposal ‘R’. It can be seen that financial proposal
‘Q’ dominates proposal ‘R’, since the financial break-even-point of the former is only `2,00,000 but in case of
latter, it is `4,00,000.

PYQ 6
X Ltd. is considering the following two alternative financing plans:

Particulars Plan I Plan II

Equity Shares of 10 each 4,00,000 4,00,000
12% Debentures 2,00,000 -
Preference Shares of 100 each - 2,00,000
6,00,000 6,00,000
 CAPITAL STRUCTURE - EBIT & EPS ANALYSIS 1.21
The indifference point between the plans is 2,40,000. Corporate tax rate 30%.

Calculate the rate of dividend on preference shares. [(Marks 5) Nov 2013]

Answer
Pr eference Dividend 16 ,800
Rate of dividend = × 100 = × 100 = 8.40%
Pr eference Share Capital 2 ,00 ,000

Working Notes:
Calculation of preference dividend:
EBIT  I 1  T  = [EBIT  I 1  T ]  PD
N1 N2
2,40 ,000  24 ,000  1  0.30  = [2,40 ,000  Nil  1  0.30 ]  PD
40 ,000 40 ,000
1,51,200 = 1,68,000 – PD

Preference dividend (PD) = 16,800

PYQ 7
Alpha Ltd. requires funds amounting to `80,00,000 for its new project. To raise the funds, the company has
following two alternatives:
(1) To issue Equity Shares of `100 each (at par) amounting to `60,00,000 and borrow the balance amount
at the interest of 12% p.a.; or
(2) To issue Equity Shares of `100 each (at par) and 12% Debentures in equal proportion.

Find out the point of indifference between two modes of financing and state which option will be
beneficial in different situations assuming tax rate 30%.
[(Marks 5) Nov 2014]

Answer
Calculation of Indifference two modes of financing:
EBIT  I 1  T  =
EBIT  I 1  T 
N1 N2
EBIT  12% of 20 lakhs  1  0.30 
=
EBIT  12% of 40 lakhs  1  0.30 
60 ,000 40 ,000
EBIT = `9,60,000

Course of action:
(a) If expected EBIT is less than `9,60,000 : Alternate 1
(b) If expected EBIT is equal to `9,60,000 : Alternate 1 or 2
(c) If expected EBIT is more than `9,60,000 : Alternate 2

PYQ 8
India Limited requires `50,00,000 for a New Plant. This Plant is expected to yield Earnings before Interest and
Taxes of `10,00,000. While deciding about the Financial Plan, the Company considers the objective of
maximizing Earnings per Share.

It has 3 alternatives to finance the Project: by raising Debt of `5,00,000 or `20,00,000 or `30,00,000
and the balance in each case, by issuing Equity Shares. The Company’s Share is currently selling at `150, but it
is expected to decline to `125 in case the funds are borrowed in excess of `20,00,000.

The Funds can be borrowed at the rate of 9% upto `5,00,000, at 14% over `5,00,000 and upto
`20,00,000 and at 19% over `20,00,000. The Tax rate applicable to the Company is 40%.

Which form of financing should the Company choose? Show EPS Amount upto two decimal points.
 CAPITAL STRUCTURE - EBIT & EPS ANALYSIS 1.22

[(Marks 8) Nov 2016]

Answer
Statement of EPS
Alternatives
Particulars
1 2 3
Earnings before interest and tax 10,00,000 10,00,000 10,00,000
Less: Interest:
@ 9% on first `5,00,000 45,000 45,000 45,000
@ 14% on `5,00,001 to `20,00,000 - 2,10,000 2,10,000
@ 19% on above `20,00,000 - - 1,90,000
EBT 9,55,000 7,45,000 5,55,000
Less: Tax @ 40% 3,82,000 2,98,000 2,22,000
EAT 5,73,000 4,47,000 3,33,000
÷ No. of Equity shares 30,000 20,000 16,000
(45,00,000/150) (30,00,000/150) (20,00,000/125)
EPS `19.10 `22.35 `20.8125

Decision: The earning per share is higher in alternative II i.e. if the company finance the project by raising debt
of `20,00,000 & issue equity shares of `30,00,000. Therefore, the company should choose this alternative to
finance the project.

PYQ 9
The X Ltd. Is willing to raise funds for its new project which requires an investment of `84,00,000. The
company has two options:
Option 1: To issue Equity Shares (`10 each) only.
Option 2: To avail term loan at an interest rate of 12%. But in this case, as insisted by the financing agencies,
the company will have to maintain a debt equity ratio of 2 : 1.
Find out the point of indifference for the project if corporate tax rate is 30%.
[(Marks 5) Nov 2017]

Answer
Calculation of point of Indifference:
EBIT  I 1  T  =
EBIT  I 1  T 
N1 N2
EBIT  Nil  1  0.30  =
EBIT  12% of 56 ,00 ,000  1  0.30 
8 ,40 ,000 2,80 ,000
EBIT = `10,08,000

Calculation of amount of Debt and Equity in option 2:

Debt amount = 84,00,000 × 2/3 = 56,00,000
Equity amount = 84,00,000 × 1/3 = 28,00,000

PYQ 10
Sun Ltd. is considering two financing plans. Details of which are as under:
(a) Funds requirement is `100 Lakhs.
(b) Financial plans:
Plan Equity Debts
I 100% -
II 25% 75%
(c) Cost of debt is 12% p.a.
(d) Tax rate is 30%
(e) Equity shares `10 each, issued at a premium of `15 per share
 CAPITAL STRUCTURE - EBIT & EPS ANALYSIS 1.23
(f) Expected earnings before interest and tax (EBIT) `40,00,000
You are required to compute:
(1) EPS in each of them plan
(2) The Financial break-even-point
(3) Indifference point between I and II [(5 Marks) May 2018]

Answer
(1) Statement of EPS
Alternatives
Particulars
Plan I Plan II
Earnings before interest and tax 40,00,000 40,00,000
Less: Interest @ 12% on `75,00,000 - 9,00,000
EBT 40,00,000 31,00,000
Less: Tax @ 30% 12,00,000 9,30,000
EAT 28,00,000 21,70,000
÷ No. of Equity shares (Issue price `25) ÷ 4,00,000 ÷1,00,000
EPS `7.00 `21.70

Calculation of amount of number of Equity shares:

Under Plan I = 1,00,00,000 ÷ 25 (10 + 15) = 4,00,000
Under Plan I = 25,00,000 ÷ 25 (10 + 15) = 1,00,000

(2) Financial Break Even Point (EBIT equals to fixed financial cost):
Plan I Financial B.E.P. = No Fixed Financial Cost = Zero
Plan II Financial B.E.P. = Interest on Debt = 9,00,000

(3) Indifference Point:

(EBIT − I) (1 − t) (EBIT − I) (1 − t)
=
N1 N1
(EBIT − Nil) (1 − 0.30) (EBIT −9,00,000) (1 − 0.30)
=
4,00,000 1,00,000
EBIT = `12,00,000

PYQ 11
Y Limited requires `50,00,000 for a new project. This project is expected to yield earnings before interest and
taxes of `10,00,000. While deciding about the financial plan, the company considers the objective of
maximizing earnings per share.
It has two alternatives to finance the project - by raising debt of `5,00,000 or `20,00,000 and the
balance, in each case, by issuing equity shares. The company’s share is currently selling at `300, but is expected
to decline to `250 in case the funds are borrowed in excess of `20,00,000. The funds can be borrowed at the
rate of 12% upto `5,00,000 and at 10% over `5,00,000. The tax rate applicable to the company is 25%.
Which form of financing should the company choose? [(5 Marks) Nov 2018]

Answer
Statement of EPS
Alternatives
Particulars
1 2
Earnings before interest and tax 10,00,000 10,00,000
Less: Interest:
@ 12% on first `5,00,000 60,000 60,000
@ 10% on `5,00,001 to `20,00,000 - 1,50,000
EBT 9,40,000 7,90,000
Less: Tax @ 25% 2,35,000 1,97,500
EAT 7,05,000 5,92,500
 CAPITAL STRUCTURE - EBIT & EPS ANALYSIS 1.24
÷ No. of Equity shares 15,000 10,000
(45,00,000/300) (30,00,000/300)
EPS `47.00 `59.25
Decision: The earning per share is higher in alternative II i.e. if the company finance the project by raising debt
of `20,00,000 & issue equity shares of `30,00,000. Therefore, the company should choose this alternative to
finance the project.

PYQ 12
RM Steels Limited requires `10,00,000 for the construction of new plant. It is considering three financial plans:
(1) The Company may issue 1,00,000 ordinary shares at `10 per share.
(2) The Company may issue 50,000 ordinary shares at `10 per share and 5,000 debentures of `100
denomination bearing 8% rate of interest.
(3) The Company may issue 50,000 ordinary shares at `10 per share and 5,000 preference shares at `100
per share bearing a 8% rate of dividend.
If RM Steels Limited’s earnings before interest and taxes are `20,000, `40,000, `80,000, `1,20,000 and
`2,00,000. Tax rate is 50%.
You are required to compute the earning per share under each of the three plans? Which
alternative would you recommend for RM Steels and why?
[(10 Marks) May 2019]

Answer
1. Statement showing EPS with respect to various plans & different EBIT:
a. Equity Financing
Particulars ` ` ` ` `
EBIT 20,000 40,000 80,000 1,20,000 2,00,000
Less: Interest 0 0 0 0 0
EBT 20,000 40,000 80,000 1,20,000 2,00,000
Less: Tax @ 50% (10,000) (20,000) (40,000) (60,000) (1,00,000)
EAT 10,000 20,000 40,000 60,000 1,00,000
÷ No. of Equity Shares ÷ 1,00,000 ÷ 1,00,000 ÷ 1,00,000 ÷ 1,00,000 ÷ 1,00,000
EPS `0.10 `0.20 `0.40 `0.60 `1.00

b. Debt - Equity Mix

Particulars ` ` ` ` `
EBIT 20,000 40,000 80,000 1,20,000 2,00,000
Less: Interest (40,000) (40,000) (40,000) (40,000) (40,000)
EBT (20,000) 0 40,000 80,000 1,60,000
Less: Tax @ 50% *10,000 0 (20,000) (40,000) (80,000)
EAT (10,000) 0 20,000 40,000 80,000
÷ No. of Equity Shares ÷ 50,000 ÷ 50,000 ÷ 50,000 ÷ 50,000 ÷ 50,000
EPS (`0.20) `0.00 `0.40 `0.80 `1.60
*10,000 is the tax saving in case of loss.

c. Preference Share - Equity Mix

Particulars ` ` ` ` `
EBIT 20,000 40,000 80,000 1,20,000 2,00,000
Less: Interest 0 0 0 0 0
EBT 20,000 40,000 80,000 1,20,000 2,00,000
Less: Tax @ 50% (10,000) (20,000) (40,000) (60,000) (1,00,000)
EAT 10,000 20,000 40,000 60,000 1,00,000
Less: Preferential Dividend **(40,000) **(40,000) (40,000) (40,000) (40,000)
EAT after Pref. Dividend (30,000) (20,000) 0 20,000 60,000
÷ No. of Equity Shares ÷ 50,000 ÷ 50,000 ÷ 50,000 ÷ 50,000 ÷ 50,000
 CAPITAL STRUCTURE - EBIT & EPS ANALYSIS 1.25
EPS (`0.60) (`0.40) `0.00 `0.40 `1.20
**In case of cumulative preference shares, the company has to pay cumulative dividend to preference
shareholders, when company earns sufficient profits, so deducted here even in case of insufficient profit to
reach right decision.

2. Recommendation:
(a) If expected EBIT is less than `80,000 : Equity Finance (Alternative 1)
(b) If expected EBIT is equal to `80,000 : Equity or Debt - Equity Mix (Alternative 1 or 2)
(c) If expected EBIT is more than `80,000 : Debt – Equity Mix (Alternative 2)

PYQ 13
J Limited is considering three financing plans. The key information is as follows:
(a) Total investment to be raised `4,00,000.
(b) Plans showing the Financing proportion:
Plans Equity Debt Preference Shares
X 100% - -
Y 50% 50% -
Z 50% - 50%
(c) Cost of debt is 10%
Cost of preference shares is 10%
(d) Tax rate 50%
(e) Equity shares of the face value of `10 each will be issued at a premium of `10 per share.
(f) Expected EBIT is `1,00,000.

You are required to compute the following for each plan:

(1) Earnings per share (EPS)
(2) Financial break-even-point
(3) Indifference point between the plans and indicate if any of the plans dominate.
[(10 Marks) Nov 2020]

Answer
(1) Statement of EPS
Alternatives
Particulars
X Y Z
Earnings before interest and tax 1,00,000 1,00,000 1,00,000
Less: Interest @ 10% on `2,00,000 - 20,000 -
EBT 1,00,000 80,000 1,00,000
Less: Tax @ 50% 50,000 40,000 50,000
EAT 50,000 40,000 50,000
Less: Preference Dividend @ 10% on `2,00,000 - - 20,000
Earning Available for Equity Shareholders 50,000 40,000 30,000
÷ No. of Equity shares (Issue price `20) 20,000 10,000 10,000
(4,00,000 ÷ 20) (2,00,000 ÷ 20) (2,00,000 ÷ 20)
EPS `2.50 `4.00 `3.00

(2) Financial Break Even Point (EBIT equals to fixed financial cost):
Proposal X Financial B.E.P. = No Fixed Financial Cost = Zero
Proposal Y Financial B.E.P. = Interest on Debt = 20,000
Pr eference Dividend
Proposal Z Financial B.E.P. =
(1  t )
20,000
= = 40,000
1 − 0.50
 CAPITAL STRUCTURE - EBIT & EPS ANALYSIS 1.26

(3) Indifference Point:

Between Proposal X & Y:
(EBIT−I) (1−T) (EBIT−I) (1−T)
=
NX NY
(EBIT−0) (1−0.50) (EBIT−20,000) (1−0.50)
=
20,000 10,000
EBIT = `40,000

Between Proposal X & Z:

(EBIT−I) (1−T) {(EBIT−I) (1−T) − PD}
=
NX NZ
(EBIT−0) (1−0.50) {(EBIT−0) (1−0.50) − 20,000}
=
20,000 10,000
EBIT = `80,000

Between Proposal Y & Z:

(EBIT−I) (1−T) {(EBIT−I) (1−T) − PD}
=
NY NZ
(EBIT−20,000) (1−0.50) {(EBIT−0) (1−0.50) − 20,000}
=
10,000 10,000
0.5 EBIT – 10,000 ≠ 0.5 EBIT – 20,000

There is no indifference point between the financial plans Y and Z. It can be seen that Financial Plan Y
dominates Plan Z. Since, the financial break-even point of the former is only `20,000 but in case of latter it is
`40,000.

PYQ 14
Earnings before interest and tax of a company are `4,50,000. Currently the company has 80,000 equity shares
of `10 each, retained earnings of `12,00,000. It pays annual interest of `1,20,000 on 12% Debentures. The
company proposes to take up an expansion scheme for which it needs additional fund of `6,00,000. It is
anticipated that after expansion, the company will be able to achieve the same rate of return on investment as
at present. It can raise fund either through debts at rate of 12% p.a. or by issuing Equity shares at par. Tax rate
is 40%.

Compute the earning per share if:

(a) The additional funds were raised through debt.
(b) The additional funds were raised by issue of Equity shares.

Advise whether the company should go for expansion plan and which sources of finance should be
preferred.
[(10 Marks) Dec 2021]

Answer
Statement of EPS
Alternatives
Particulars
Debt Plan (i) Equity Plan (ii)
Earnings before interest and tax @ 15% of `36,00,000 5,40,000 5,40,000
Less: Interest:
Existing 1,20,000 1,20,000
72,000 -
 CAPITAL STRUCTURE - EBIT & EPS ANALYSIS 1.27
New (12% on `6,00,000) 3,48,000 4,20,000
EBT 1,39,200 1,68,000
Less: Tax @ 40% 2,08,800 2,52,000
EAT
÷ No. of Equity shares 80,000 80,000
Existing - 60,000
New `2.61 `1.80
EPS

Advise to the company: Since EPS after expansion under debt plan is higher (`2.61) than Existing EPS
(`2.475), company should go for expansion plan and choose debt source of finance.

EPS before expansion =

EBIT  I 1  T  = 4 ,50 ,000  1 ,20 ,000  1  0.4  = `2.475
N 80 ,000
Working notes:
1. Calculation of capital employed before expansion plan:
Equity share capital (80,000 shares × `10) `8,00,000
Retained earnings `12,00,000
Debentures (`1,20,000/12%) `10,00,000
Total capital employed `30,00,000

2. Return on capital employed (ROCE) or Return on Investment:

EBIT 4 ,50 ,000
ROCE = × 100 = × 100 = 15%
Capital Employed 30 ,00 ,000

3. Capital employed after expansion = `36,00,000 (`30,00,000 + `6,00,000)

PYQ 15
The particulars related to Raj Ltd. for the year ended 31st March, 2022 are given as follows:
Output (units at normal capacity) 1,00,000
Selling price per unit `40
Variable cost per unit `20
Fixed cost `10,00,000

The capital structure of the company as on 31st March, 2022 is as follows:

Particulars `
Equity Share Capital (1,00,000 shares of `10 each) Reserves 10,00,000
and Surplus 5,00,000
Current Liabilities 5,00,000
Total 20,00,000

Raj Ltd. has decided to undertake an expansion project to use the market potential that will involve `20,00,000.
The company expects an increase in output by 50%. Fixed cost will be increased by `5,00,000 and variable
cost per unit will be decreased by 15%. The additional output can be sold at the existing selling price without
any adverse impact on the market.

The following alternative schemes for financing the proposed expansion program are planned:
Alternative Debt Equity Shares
1 `5,00,000 Balance
2 `10,00,000 Balance
3 `14,00,000 Balance

Slab wise interest rate for fund borrowed is as given follows:

 CAPITAL STRUCTURE - EBIT & EPS ANALYSIS 1.28
Fund Limit Applicable Interest Rate
Upto `5,00,000 10%
Over `5,00,000 and upto `10,00,000 15%
Over `10,00,000 20%
Current market price per share is 200.

Find out which of the above mentioned alternatives would you recommend for raj Ltd. with
reference to the EPS, assuming a corporate tax rate is 40%?
[(10 Marks) May 2022]

Answer
Statement of EPS
Alternatives
Particulars
1 2 3
Expected output in units (1,00,000 + 50%) 1,50,000 1,50,000 1,50,000
Sales @ `40 per unit 60,00,000 60,00,000 60,00,000
Less: Variable Cost @ `17 (`20 - 15%) per unit 25,50,000 25,50,000 25,50,000
Contribution 34,50,000 34,50,000 34,50,000
Less: Fixed Cost (`10,00,000 + `5,00,000) 15,00,000 15,00,000 15,00,000
Earnings before interest and tax 19,50,000 19,50,000 19,50,000
Less: Interest:
@ 10% on first `5,00,000 50,000 50,000 50,000
@ 15% on `5,00,001 to `10,00,000 - 75,000 75,000
@ 20% on above `10,00,000 - - 80,000
EBT 19,00,000 18,25,000 17,45,000
Less: Tax @ 40% 7,60,000 7,30,000 6,98,000
EAT 11,40,000 10,95,000 10,47,000
÷ No. of Equity shares
Existing 1,00,000 1,00,000 1,00,000
New 7,500 5,000 3,000
(15,00,000/200) (10,00,000/200) (6,00,000/200)
EPS `10.60 `10.43 `10.17

Decision: The earning per share is higher in alternative I i.e. if the company finance the project by raising debt
of `5,00,000 & issue equity shares of `15,00,000. Therefore, the company should choose this alternative to
finance the project.

PYQ 16
The following information pertains to CIZA Ltd.:
Capital Structure: `
Equity share capital (`10 each) 8,00,000
Retained earnings 20,00,000
9% Preference share capital (`100 each) 12,00,000
12% Long-term loan 10,00,000
Interest coverage ratio 8
Income tax rate 30%
Price- earnings ratio 25
The company is proposed to take up an expansion plan, which requires an additional investment of
`34,50,000. Due to this proposed expansion, earnings before interest and taxes of the company will increase
by `6,15,000 per annum. The additional fund can be raised in following manner:
(a) By issue of equity shares at present market price, or
(b) By borrowing 16% Long-term loans from bank.
 CAPITAL STRUCTURE - EBIT & EPS ANALYSIS 1.29
You are informed that Debt-equity ratio (Debt/Shareholders’ fund) in the range of 50% to 80% will bring
down the price-earnings ratio to 22 whereas; Debt-equity ratio over 80% will bring down the price-earnings
ratio to 18.

Advise which option is most suitable to raise additional capital so that the Market Price per Share
(MPS) is maximized.
[(10 Marks) May 23]

Answer
Statement of Market Value Per Share (MPS)
Particulars Equity Plan Debt Plan
EBIT (9,60,000 + 6,15,000) 15,75,000 15,75,000
Less: Interest: Existing 1,20,000 1,20,000
New (16% of `34,50,000) - 5,52,000
EBT 14,55,000 9,03,000
Less: Tax @ 30% 4,36,500 2,70,900
PAT 10,18,500 6,32,100
Less: Preference dividend (9% of `12,00,000) 1,08,000 1,08,000
Earning for Equity shareholders 9,10,500 5,24,100
÷ No. of Equity shares (Existing + New) 1,03,000 80,000
EPS `8.84 `6.55
× PE Ratio 25 Times 18 Times
MPS `221.00 `117.90

Advise: Company should raise additional capital through Equity plan to maximize MPS.

Working notes:
1. Debt Equity Ratio if `34,50,000 is raised as Equity:
10 ,00 ,000
= × 100 = 13.42%
74 ,50 ,000 ( 8 ,00 ,000  34 ,50 ,000  20 ,00 ,000  12 ,00 ,000 )

As the debt ratio is less than 50% the P/E ratio in this case will remain at 25 times in Plan 1.

2. Debt Ratio if `34,50,000 is raised as debt:

10 ,00 ,000  34 ,50 ,000
= × 100 = 111.25%
40 ,00 ,000 ( 8 ,00 ,000  20 ,00 ,000  12 ,00 ,000 )

As the debt ratio is more than 80% the P/E ratio will be brought down to 18 in Plan 2

3. Existing EBIT:
EBIT EBIT
Interest coverage ratio = = = 8
Interest 1 ,20 ,000
Existing EBIT = 9,60,000

(EBIT  I)( 1  t )  PD
4. Existing EPS =
N
( 9 ,60 ,000  1 ,20 ,000 ) (1  0.3)  1 ,08 ,000
= = `6
80 ,000

5. Present MPS = EPS × PE ratio = `6 × 25 = `150

34 ,50 ,000
6. Number of Equity Shares to be issued in Plan 1 = = 23,000 shares
150
 CAPITAL STRUCTURE - EBIT & EPS ANALYSIS 1.30

SUGGESTED REVISION
Page No. of 3rd, 4th & Revision
Ques. Observations or KEY Points 1st & 2nd
Practical 5th during
No. (Note down during revisions) Revision
Register Revision Exams
BQ (Book Questions covering Study Module of ICAI, PM, RTP’s, MTP’s and Important Questions)
1 Y - -
2 Y - -
3 Y - -
4 Y - -
5 Y Y -
6 Y Y -
7 Y Y -
8 Y Y Y
9 Y Y Y
10 Y Y Y
11 Y - -
12 Y Y -
13 Y - -
14 Y Y -
15 Y Y Y
16 Y Y Y
17 Y Y Y
18 Y Y Y
19 Y Y Y
20 Y Y Y
21 Y Y Y
PYQ (Past Year Questions)
1 Y Y -
2 Y Y Y
3 Y - -
4 Y Y Y
5 Y Y -
6 Y - -
7 Y Y Y
8 Y Y -
9 Y - -
10 Y Y -
11 Y Y Y
12 Y - -
13 Y - -
14 Y Y -
15 Y Y Y
16 Y Y Y
 CHAPTER - 2

LEVERAGES
LEARNING OBJECTIVES

After studying this chapter you will be able to:

 Understand the concept of business risk and financial risk.
 Discuss and interpret the types of leverages.
 Discuss the relationship between operating leverage, Break - even
analysis & Margin of Safety.
 Discuss positive and negative Leverage.
 Discuss Financial leverage as ‘Trading on equity’.
 Discuss Financial Leverage as ‘Double Edged Sword’.
 LEVERAGES 2.2
OPERATING, FINANCIAL AND COMBINED LEVERAGES
BQ 1
Firm X and Firm Y manufacture the same product and their cost sheets are given below:
Particulars Firm X Firm Y
Units manufactured and sold 20,000 20,000
Selling price per unit `30 `30
Direct material per unit `10 `10
Direct labour per unit `5 `5
Variable overheads per unit `5 `5
Fixed cost `1,00,000 `1,50,000
Calculate their net profit and operating leverage.
[Net Profit: X `1,00,000, Y `50,000; OL: X 2 times, Y 4 times]

BQ 2
Calculate the operating leverage for each of the four firms A, B, C and D from the following price and cost data:
Particulars A (`) B (`) C (`) D (`)
Sales price per unit 20 32 50 70
Variable cost per unit 6 16 20 50
Fixed operating cost 60,000 40,000 1,00,000 Nil
Units sold 5,000 5,000 5,000 5,000

Answer
Statement Showing Degree of Operating Leverage
Particulars A (`) B (`) C (`) D (`)
Sales (units) 5,000 5,000 5,000 5,000
Sales value 1,00,000 1,60,000 2,50,000 3,50,000
Less: Variable cost 30,000 80,000 1,00,000 2,50,000
Contribution 70,000 80,000 1,50,000 1,00,000
Less: Fixed operating cost 60,000 40,000 1,00,000 Nil
EBIT 10,000 40,000 50,000 1,00,000
OL (Contribution ÷ EBIT) 7 times 2 times 3 times 1 time

BQ 3
(a) Find the operating leverage from the following data:
Sales `50,000
Variable costs 60% of sales
Fixed costs `12,000

(b) Find the financial leverage from the following data:

Net Worth `25,00,000
Debt : Equity 3:1
Interest rate 12%
Operating profit `20,00,000
[(a) 2.5 times, (b) 1.82 times]

BQ 4
The following figures relate to two Companies:
Particulars P Ltd Q Ltd
Sales 500 1,000
Less: Variable cost 200 300
Contribution 300 700
Less: Fixed cost 150 400
Profit before interest and tax 150 300
 LEVERAGES 2.3
Less: Interest 50 100
Profit before tax 100 200

You are required to calculate:

(1) Operating, Financial and Combined Leverages of the two Companies, and
(2) Comment on the relative position of the Companies in respect of the risk.
[(1) P Ltd: 2 times, 1.5 times, 3 times; Q Ltd: 2.33 times, 1.5 times, 3.5 times; (2) Q Ltd has higher
business risk, financial risk is similar for both the companies and Q Ltd has higher overall risk]

BQ 5
A Company produces and sells 10,000 shirts. The selling price per shirt is `500. Variable cost is `200 per shirt
and fixed operating cost is `25,00,000.
(a) Calculate operating leverage, (b) If sales are up by 10%, then what is the impact on EBIT?

Answer
(a) Statement of Profitability
Particulars `
Sales (10,000 × 500) 50,00,000
Less: Variable cost (10,000 × 200) 20,00,000
Contribution 30,00,000
Less: Fixed cost 25,00,000
Profit before interest and tax 5,00,000

Contributi on 30 ,00 ,000

Operating Leverage = = = 6 times
EBIT 5 ,00 ,000

(b) Impact on EBIT, if sales are go up by 10%:

Δ EBIT (in %) = Δ Sales × DOL = 10% × 6 times = 60%
Δ EBIT (in amount) = Existing EBIT × 60%
= 5,00,000 × 60% = Increase by `3,00,000

BQ 6
Consider the following information for Omega Ltd:
Earning Before Interest and Tax (EBIT) `15,750
Fixed cost `1,575
Earning Before Tax (EBT) `7,000
Calculate percentage change in earnings per share, if sales increase by 5%

Answer
Contributi on EBIT  Fixed cos t
Combined Leverage = =
EBT EBT
15 ,750  1 ,575
= = 2.475 times
7 ,000

% change in EPS = % increase in sales × CL

= 5% × 2.475 times = 12.375%

BQ 7
From the following information extracted from the books of accounts of Imax Ltd., Calculate percentage
change in earnings per share, if sales increase by 10% and Fixed Operating cost is `1,57,500:
EBIT (Earnings before Interest and Tax) `31,50,000
Earnings before Tax (EBT) `14,00,000
 LEVERAGES 2.4
Answer
Calculation of percentage change in Earnings per share:

Δ EPS (in %) = Δ Sales × CL = 10% × 2.3625 times = 23.625%

Working note:
Contributi on 31 ,50 ,000 + 1 ,57 ,500
Combined Leverage = = = 2.3625
EBT 14 ,00 ,000

BQ 8
Betatronics Ltd. has the following balance sheet and income statement information:
Balance Sheet as on 31st March, 2023
Liabilities ` Assets `
Equity Capital (`10 per share) 8,00,000 Net Fixed Assets 10,00,000
Retained Earnings 3,50,000 Current Assets 9,00,000
10% Debentures 6,00,000
Current Liabilities 1,50,000
19,00,000 19,00,000

Income Statement for the year ending 31st March, 2023

Particulars `
Sales 3,40,000
Less: Operating Expenses (including `60,000 depreciation) 1,20,000
EBIT 2,20,000
Less: Interest @ 10% of 6,00,000 60,000
EBT 1,60,000
Less: Taxes 56,000
EAT 1,04,000

(a) Determine the degree of operating, financial and combined leverages at the current sales level, if all
operating expenses, other than depreciation, are variable costs.
(b) If total assets remain at the same level, but sales (i) increase by 20 percent and (ii) decrease by 20
percent, what will be the earnings per share at the new sales level?

Answer
(a) Calculation of Degree of Operating (DOL), Financial (DFL) and Combined leverages (DCL):

Contributi on 3,00 ,000  60 ,000

Degree of Operating Leverage = = = 1.27
EBIT 2,20 ,000

EBIT 2 ,20 ,000

Degree of Financial Leverage = = = 1.38
EBT 1 ,60 ,000

Degree Combined Leverage = DOL × DFL = 1.27 × 1.38 = 1.75

(b) Earnings per share at the new sales level:

EPS if sales level increases by 20% = Existing EPS + increase (% increase in sales × CL)
= `1.30 + 35% (20% × 1.75 times) = `1.755
EPS if sales level decreases by 20% = Existing EPS - decrease (% decrease in sales × CL)
= `1.30 - 35% (20% × 1.75 times) = `0.845

Working Notes:
(i) Variable Costs = `60,000 (total cost − depreciation)
(ii) Variable Costs at:
 LEVERAGES 2.5
(a) Sales level, `4,08,000 = `72,000 (increase by 20%)
(b) Sales level, `2,72,000 = `48,000 (decrease by 20%)

BQ 9
The Sale revenue of TM excellence Ltd. @ `20 per unit of output is `20 lakhs and Contribution is `10 lakhs. At
the present level of output the DOL of the company is 2.5. The company does not have any Preference Shares.
The number of Equity Shares are 1 lakh. Applicable corporate income tax rate is 50% and the rate of interest
on Debt Capital is 16% p.a.
What is the EPS (At sales revenue of `20 lakhs) and amount of Debt Capital of the company if a
25% decline in Sales will wipe out EPS.

Answer
( EBIT  I) (1  t ) (4,00,000 − 1,50,000) (1 −0.50)
(A) Earnings Per Share = =
Equity shares 1,00,000
= `1.25

(B) Amount of DEBT = Interest ÷ Rate of interest

= 1,50,000 ÷ 16% = `9,37,500

Working Note:
(1) Calculation of Fixed Cost:
Contributi on 10 ,00 ,000
DOL = = = 2.5 times
EBIT EBIT

EBIT = 10,00,000 ÷ 2.5 = `4,00,000

Fixed Cost = Contribution – EBIT = 10,00,000 – 4,00,000 = `6,00,000

(2) Calculation of Degree of Combined Leverage:

Question says that 25% change in sales will wipe out EPS, wipe out means it will reduce EPS by 100%.
% Change in EPS 100 %
DCL = = = 4 times
% Change in Sales 25 %

(3) Calculation of EBT and Interest:

Contributi on 10 ,00 ,000
DCL = = = 4 times
EBT EBT

EBT = 10,00,000 ÷ 4 = `2,50,000

Interest = EBIT – EBT = 4,00,000 – 2,50,000 = `1,50,000

BQ 10
If the combined leverage and operating leverage figures of a company are 2.5 and 1.25 respectively. Given that
the equity dividend per share is `2, interest payable per year is `1,00,000, total fixed cost `50,000 and sales
`10,00,000.
Find financial leverage and P/V ratio. [FL: 2 times and P/V Ratio: 25%]

BQ 11
Consider the following information for Mega Ltd.:
Production level 2,500 units
Contribution per unit 150
Operating leverage 6
Combined leverage 24
Tax rate 30%
 LEVERAGES 2.6
Compute its earnings after tax.

Answer
Earning after tax = EBT (1 - t)
= `15,625 (1 - 0.30) = `10,937.50

Working Notes:
Contributi on
Combined leverage =
EBT
Contributi on 2,500 × 150
24 times = =
EBT EBT
3,75,000
 EBT = = `15,625
24

BQ 12
The balance sheet of Alpha Numeric Company is given below:
Liabilities ` Assets `
Equity Share Capital 90,000 Net Fixed Assets 2,25,000
(`10 per share) Current Assets 75,000
Retained Earning 30,000
10% Long Term Debt 1,20,000
Current Liabilities 60,000
3,00,000 3,00,000

The company's total assets turnover ratio is 3 times, its fixed operating cost is `1,50,000 and its
variable operating cost ratio is 50%. The income tax rate is 50%.

You are required to:

(1) Calculate the different type of leverages for the company and EPS.
(2) Determine the likely level of EBIT if EPS is (a) `1.00, (b) `2.00 and (c) `Nil.
[(1) OL: 1.5 times, FL: 1.04 times, CL: 1.56 times; EPS : `16(2) EBIT: (a) `30,000 (b) `48,000 (c) `12,000]

BQ 13
Z Limited is considering the installation of a new project costing `80,00,000. Expected annual sales revenue
from the project is `90,00,000 and its variable costs are 60 percent of sales. Expected annual fixed cost other
than interest is `10,00,000. Corporate tax rate is 30 percent. The company wants to arrange the funds through
issuing 4,00,000 equity shares of `10 each and 12 percent debentures of `40,00,000.

You are required to:

(i) Calculate the operating, financial and combined leverages and Earnings per Share (EPS).
(ii) Determine the likely level of EBIT, if EPS is `4, or `2, or Zero.

Answer
Contributi on 90 Lacs  60 %
(i) Operating Leverage = = = 1.38
EBIT 36 Lacs  10 Lacs

EBIT 26 Lacs
Financial Leverage = = = 1.23
EBT 26 Lacs  12 % of 40 Lacs

Combined Leverage = OL × FL = 1.38 × 1.23 = 1.70

PAT 21 ,20 ,000 (1  .30 )

Earnings Per Share = = = `3.71
Equity shares 4 ,00 ,000
 LEVERAGES 2.7
(ii) Calculation of likely level of EBIT:

PAT ( EBIT  I) (1  t )
Earnings Per Share = =
Equity shares Equity shares

( EBIT  4 ,80 ,000 ) (1  0.30 )

Case I: `4.00 = or EBIT = `27,65,714
4 ,00 ,000

( EBIT  4 ,80 ,000 ) (1  0.30 )

Case II: `2.00 = or EBIT = `16,22,857
4 ,00 ,000

( EBIT  4 ,80 ,000 ) (1  0.30 )

Case III: `0.00 = or EBIT = `4,80,000
4 ,00 ,000

BQ 14
Calculate the operating leverage, financial leverage and combined leverage from the following data under
situations I and II and financial plans A and B:
Installed capacity 4,000 units
Actual production and sales 75% of the Capacity
Selling price `30 per unit
Variable cost `15 per unit
Fixed cost:

Under situation I `15,000

Under situation II `20,000

Capital structure:
Plan A Plan B
Equity `10,000 `15,000
Debt (rate of interest at 20%) `10,000 `5,000
Capital Employed `20,000 `20,000

Answer
Statement Showing OL, FL and CL
Situation I Situation II
Particulars
Plan A Plan B Plan A Plan B
Sales (3,000 × `30) 90,000 90,000 90,000 90,000
Less: Variable cost 45,000 45,000 45,000 45,000
Contribution 45,000 45,000 45,000 45,000
Less: Fixed Cost 15,000 15,000 20,000 20,000
EBIT 30,000 30,000 25,000 25,000
Less: Interest 2,000 1,000 2,000 1,000
EBT 28,000 29,000 23,000 24,000
OL (Contribution ÷ EBIT) 1.5 1.5 1.8 1.8
FL (EBIT ÷ EBT) 1.07 1.03 1.09 1.04
CL (Contribution ÷ EBT) 1.61 1.55 1.96 1.88

BQ 15
The capital structure of the Progressive Corporation consists of an ordinary share capital of `1,00,00,000
(share of `100 par value) and `10,00,000 of 10% debentures.
Sales increased by 20% from 1,00,000 units to 1,20,000 units, the selling price is `10 per unit; variable
cost amounts to `6 per unit and fixed expenses amount to `2,00,000. The income tax rate is assumed to be
50%.
 LEVERAGES 2.8
You are required to calculate the following:
(ii) The percentage increase in earnings per share;
(iii) The degree of operating leverage at 1,00,000 units and 1,20,000 units.
(iv) The degree of financial leverage at 1,00,000 units and 1,20,000 units.
(v) Comment on the behavior of operating and financial leverages in relation to increase in production
from 1,00,000 units to 1,20,000 units.

Answer
(i) Calculation of % increase in EPS
1,00,000 1,20,000
Particulars
units units
Sales @ `10 per unit 10,00,000 12,00,000
Less: Variable cost 6,00,000 7,20,000
Contribution 4,00,000 4,80,000
Less: Fixed cost 2,00,000 2,00,000
Profit before interest and tax 2,00,000 2,80,000
Less: Interest @ 10% of `10 lacs 1,00,000 1,00,000
Profit before tax 1,00,000 1,80,000
Less: Tax @ 50% 50,000 90,000
Profit after tax 50,000 90,000
÷ No. of shares 1,00,000 1,00,000
Earning per share `0.50 `0.90
% increase in EPS [(0.90 – 0.50) ÷ 0.50] × 100 - +80%

Contributi on
(ii) Degree of Operating Leverage =
EBIT

4 ,00 ,000
At 1,00,000 units = = 2 times
2 ,00 ,000
4 ,80 ,000
At 1,20,000 units = = 1.71 times
2 ,80 ,000

EBIT
(iii) Degree of Financial Leverage =
EBT
2 ,00 ,000
At 1,00,000 units = = 2 times
1 ,00 ,000
2 ,80 ,000
At 1,20,000 units = = 1.56 times
1 ,80 ,000

(iv) Increase in production and sales will result in decrease in risk.

INCOME STATEMENT
BQ 16
The following details of A Ltd for the year ended 31.03.2023 are furnished:
Operating Leverage 3:1
Financial Leverage 2:1
Interest charges per annum `20,00,000
Corporate tax rate 50%
Variable cost 60% of sales
Prepare the Income statement of the Company.
[Profit After Tax: `10,00,000]

BQ 17
The following financial data have been furnished by A Ltd and B Ltd for the year ended 31.03.2023:
 LEVERAGES 2.9
Particulars A Ltd B Ltd
Operating leverage 3:1 4:1
Financial leverage 2:1 3:1
Interest charges per annum `12,00,000 `10,00,000
Corporate tax rate 40% 40%
Variable cost as % of sales 60% 50%

Prepare Income statements of the two companies. Also comment on the financial position and
structure of the two companies.
[Profit After Tax: A Ltd `7,20,000 and B Ltd `3,00,000; Finance leverage for B Ltd is higher and indicates
higher financial risk and a higher percentage of debt in the capital structure of B Ltd.]

BREAK EVEN POINT, MARGIN OF SAFETY AND OPERATING LEVERAGE

BQ 18
X Corporation has estimated that for a new product, its break even point is 2,000 units, if the item is sold for
`14 per unit. The cost accounting department has currently identified variable cost of `9 per unit.
Calculate the operating leverage for sales volume of 2,500 units and 3,000 units. What do you
infer from the operating leverage of the sales volumes of 2,500 units and 3,000 units and their difference,
if any?

Answer
Statement Showing Operating Leverage
Particulars 2,500 units 3,000 units
Sales @ `14 per unit 35,000 42,000
Less: Variable cost @ `9 per unit 22,500 27,000
Contribution 12,500 15,000
Less: Fixed cost 10,000 10,000
Earning before interest and tax 2,500 5,000
Operating Leverage  Contributi on  12 ,500 15 ,000
 EBIT  2 ,500 5 ,000
= 5 times = 3 times

Difference between operating leverage at 2,500 units and 3,000 units = 2 times (5 - 3)
Working Notes:
Fixed cost = BEP in units × contribution per unit
= 2,000 units × `5 (14 - 9) = `10,000

Inference: Sales and risk have inverse relationship. Increase in sales would result in decrease in risk.

BQ 19
On the basis of following detail calculate Break-even point and Operating Leverage of Product X and Product
Y and comment on relationship of Break-even point and Operating Leverage:
Particulars Product X Product Y
Number of Unit Sold 1,000 1,000
Sale Price per unit `40 `20
Variable Cost per unit `20 `12
Fixed Cost `15,000 `5,000

Answer
Statement Showing Operating Leverage and Break-even Point
Particulars Product X Product Y
Sale 40,000 20,000
 LEVERAGES 2.10
Less: Variable Cost per unit 20,000 12,000
Contribution 20,000 8,000
Less: Fixed cost 15,000 5,000
Earning before interest and tax 5,000 3,000

Operating Leverage  Contributi on  20 ,000 8 ,000

 EBIT  5,000 3,000
= 4 times = 2.67 times
15,000 5,000
Fixed Cost
Break-even point 20 8
Contributi on Per Unit
= 750 units = 625 units
Relationship: Firm with high Operating Leverage has high Break-even point.

BQ 20
On the basis of following information calculate Operating leverage with the help of Margin of Safety:
Particulars Product X
Number of Unit Sold 1,000
Sale Price per unit `50
Variable Cost per unit `30
Fixed Cost `15,000

Answer
Statement Showing Operating Leverage
Particulars Product X
Sale 50,000
Less: Variable Cost per unit 30,000
Contribution 20,000
Less: Fixed cost 15,000
Earning before interest and tax 5,000
Break-even point (Fixed Cost ÷ Contribution per unit) or (15,000 ÷ 20) 750 units
Margin of Safety (1,000 units – 750 units) 250 units
Margin of Safety to Sales (250 units ÷ 1,000 units) 0.25
Operating Leverage (1 ÷ MOS to sales ratio) or (1 ÷ 0.25) 4 times

BQ 21
From the following information, prepare Income Statement of Company A & B:
Particulars Company A Company B
Margin of safety 0.20 0.25
Interest `3,000 `2,000
Profit volume ratio 25% 33.33%
Financial Leverage 4 3
Tax rate 45% 45%

Answer
Income Statement
Particulars Company A Company B
Sales 80,000 36,000
Less: Variable cost (b.f.) 60,000 24,000
Contribution 20,000 12,000
Less: Fixed cost (b.f.) 16,000 9,000
Profit before interest and tax 4,000 3,000
Less: Interest 3,000 2,000
Profit before tax 1,000 1,000
Less: Tax @ 45% 450 450
Profit after tax 550 550
 LEVERAGES 2.11
Working Notes (Company A):
(a) Company A:
Financial Leverage = EBIT/(EBIT - Interest)
= EBIT/(EBIT – `3,000) = 4 times
EBIT = 4 EBIT – `12,000
EBIT = `4,000

Company B:
Financial Leverage = EBIT/(EBIT - Interest)
= EBIT/(EBIT – `2,000) = 3 times
EBIT = 3 EBIT – `6,000
EBIT = `3,000

(b) Company A:
Operating Leverage = 1/Margin of Safety = 1/0.20 = 5 times
Operating Leverage = Contribution/EBIT
= Contribution/`4,000 = 5 times
Contribution = `20,000

Company B:
Operating Leverage = 1/Margin of Safety = 1/0.25 = 4 times
Operating Leverage = Contribution/EBIT
= Contribution/`3,000 = 4 times
Contribution = `12,000

(c) Company A:
Sales = Contribution/PV Ratio = `20,000/0.25 = `80,000
Company B:
Sales = Contribution/PV Ratio = `12,000/0.33 = `36,000

BQ 22
Company P and Q are having same earnings before tax. However, the margin of safety of Company P is 0.20
and, for Company Q, is 1.25 times than that of Company P. The interest expense of Company P is `1,50,000
and, for Company Q, is 1/3rd less than that of Company P. Further, the financial leverage of Company P is 4 and,
for Company Q, is 75% of Company P. Other information is given as below:
Particulars Company P Company Q
Profit volume ratio 25% 33.33%
Tax rate 45% 45%

You are required to prepare Income Statement for both the companies.

Answer
Income Statement
Particulars Company P Company Q
Sales 40,00,000 18,00,000
Less: Variable cost 30,00,000 12,00,000
Contribution 10,00,000 6,00,000
Less: Fixed cost 8,00,000 4,50,000
Profit before interest and tax 2,00,000 1,50,000
Less: Interest 1,50,000 1,00,000
Profit before tax 50,000 50,000
Less: Tax @ 45% 22,500 22,500
Profit after tax 27,500 27,500
 LEVERAGES 2.12
Working Notes:

(a) Margin of Safety:

For Company P = 0.20
For Company Q = 0.20 × 1.25 = 0.25

(b) Interest Expenses:

For Company P = `1,50,000
For Company Q = `1,50,000 - 1/3 of `1,50,000 = `1,00,000

(c) Financial Leverage:

For Company P = 4
For Company Q = 4 × 75% = 3

(d) EBIT:
For Company A
Financial Leverage = EBIT/(EBIT- Interest)
4 = EBIT/(EBIT- `1,50,000)
4 EBIT – `6,00,000 = EBIT
3 EBIT = `6,00,000
EBIT = `2,00,000

For Company B
Financial Leverage = EBIT/(EBIT - Interest)
3 = EBIT/(EBIT – `1,00,000)
3 EBIT – `3,00,000 = EBIT
2 EBIT = `3,00,000
EBIT = `1,50,000

(e) Contribution:
For Company A
Operating Leverage = 1/Margin of Safety = 1/0.20 = 5
Operating Leverage = Contribution/EBIT
5 = Contribution/`2,00,000
Contribution = `10,00,000

For Company B
Operating Leverage = 1/Margin of Safety = 1/0.25 = 4
Operating Leverage = Contribution/EBIT
4 = Contribution/`1,50,000
Contribution = `6,00,000

(f) Sales:
For Company A
Profit Volume Ratio = 25%
Profit Volume Ratio = (Contribution/Sales) × 100
25% = `10,00,000/Sales
Sales = `10,00,000/25%
Sales = `40,00,000

For Company B
Profit Volume Ratio = 33.33%
Therefore, Sales = `6,00,000/33.33%
Sales = `18,00,000
 LEVERAGES 2.13
PREFERENCE SHARE CAPITAL
BQ 23
The following is the income statement of XYZ Ltd for the year 2023:
Sales `50,00,000
Variable cost `10,00,000
Contribution `40,00,000
Fixed cost `20,00,000
EBIT `20,00,000
Interest `5,00,000
Profit before tax `15,00,000
Tax at 40% `6,00,000
Profit after tax `9,00,000
Preference dividend `1,00,000
Profit for equity share holders `8,00,000
The company has 4,00,000 equity shares issued to the shareholder.

Find out:
(1) Operating leverage,
(2) Financial leverage,
(3) Combined leverage,
(4) What would be the EPS if the sales level increases by 10% and the EPS if the sales level decreases by
20%.

Answer
Contributi on 40 ,00 ,000
(i) Operating Leverage = = = 2 times
EBIT 20 ,00 ,000

(ii) Financial Leverage = EBIT

Pr eference Dividend
EBT 
1  Tax
= 20 ,00 ,000 = 1.50 times
1 ,00 ,000
15,00 ,000 
1  0.40

(iii) Combined Leverage = OL × FL = 2 × 1.5 = 3 times

(iv) EPS if sales level increases by 10% = Existing EPS + increase (% increase in sales × CL)
= `2.00 + 30% (10% × 3 times) = `2.60

EPS if sales level decreases by 20% = Existing EPS - decrease (% decrease in sales × CL)
= `2.00 - 60% (20% × 3 times) = `0.80

BQ 24
The net sales of Apex Company are `15 crores. EBIT of the Company as a percentage of net sales is 12%. The
capital employed comprises `5 crores of Equity Shares, `1 crores of Cumulative Redeemable Preference
Shares bearing 13% rate of dividend and Debt Capital of `3 crores at an annual interest rate of 15%. Corporate
Income Tax rate is 40%.
Required:
(i) Calculate the Return on Equity (ROE) for the Company and indicate its segments due to the presence
of Preference Share Capital and Borrowing (Debentures).
(ii) Calculate the Operating Leverage of the Company given that its Combined Leverage is 3.
[(i) ROE: 13.60%; OL: 1.89 times]
 LEVERAGES 2.14
MISCELLANEOUS
BQ 25
Calculate EPS (earning per share) of Solid Ltd and Sound Ltd assuming (a) 20% before tax and interest rate of
return on assets (b) 10% before tax and interest rate of return on assets based on the following data:
Particulars Solid Ltd Sound Ltd
Total Assets 10,00,000 10,00,000
12% Debenture Nil 5,00,000
Equity Share Capital (Share of `10 each) 10,00,000 5,00,000
10,00,000 10,00,000
Assume a 50% Income tax in both cases. Give your comments on the financial leverage.

Answer
Statement Showing EPS
Solid Ltd Sound Ltd
Particulars
20% 10% 20% 10%
EBIT 2,00,000 1,00,000 2,00,000 1,00,000
Less: Interest 12% on `5 lacs Nil Nil 60,000 60,000
EBT 2,00,000 1,00,000 1,40,000 40,000
Less: Tax @ 50% 1,00,000 50,000 70,000 20,000
EAT 1,00,000 50,000 70,000 20,000
÷ No. of shares 1,00,000 1,00,000 50,000 50,000
EPS `1.00 `0.50 `1.40 `0.40

Analysis: When the rate of return on assets before tax is 20% (higher than the rate of interest 12%), Sound
Ltd could get a higher EPS of `1.40 than Solid Ltd, Hence financial leverage is favourable and vice-versa in case
of ROI is 10%.

BQ 26
Lovedove Ltd & Lovelee Ltd are both in the same business, having same capital employed. Their capital
structures & extracts of Income Statement are as follows:
Particulars Lovedove Lovelee
Equity share capital of `10 each 16,00,000 6,00,000
12% Debentures 1,00,000 11,00,000
Net Capital employed 17,00,000 17,00,000
Earning before interest and tax (EBIT) 5,10,000 5,10,000
Less: Debenture interest 12,000 1,32,000
Earning before tax (EBT) 4,98,000 3,78,000
Less: Tax @ 35% 1,74,300 1,32,300
Profit after tax (PAT) 3,23,700 2,45,700
No. of shares 1,60,000 60,000

Show the impact of Trading on Equity by comparing EPS & DFL of the two companies.

Answer
Earning Per Share (EPS) = PAT ÷ No. of Equity Shares

3 ,23 ,700
Lovedove Ltd = = `2.023
1 ,60 ,000
2 ,45 ,700
Lovelee Ltd = = `4.095
60 ,000

EBIT
Degree of Financial Leverage =
EBT
 LEVERAGES 2.15
5 ,10 ,000
Lovedove Ltd = = 1.024 times
4 ,98 ,000
5 ,10 ,000
Lovelee Ltd = = 1.349 times
3 ,78 ,000

Lovelee Ltd’s EPS is higher with high financial leverage, therefore ‘Trading on equity’ is now working in
favour of the Lovelee Ltd.

BQ 27
Delta Ltd. currently has an equity share capital of `10,00,000 consisting of 1,00,000 Equity share of `10 each.
The company is going through a major expansion plan requiring to raise funds to the tune of `6,00,000. To
finance the expansion the management has following plans:

Plan I Issue 60,000 Equity shares of `10 each.

Plan II Issue 40,000 Equity shares of `10 each and the balance through long-term borrowing at 12%
interest p.a.
Plan III Issue 30,000 Equity shares of `10 each and 3,000, 9% Debentures of `100 each.
Plan IV Issue 30,000 Equity shares of `10 each and the balance through 6% preference shares.

The EBIT of the company is expected to be `4,00,000 p.a. assume corporate tax rate of 40%.

Required:
(i) Calculate EPS in each of the above plans.
(ii) Ascertain financial leverage in each plan.

Answer
(i) Statement of EPS
Particulars I II III IV
Earnings before interest and tax 4,00,000 4,00,000 4,00,000 4,00,000
Less: Interest:
@ 12% on `2 Lacs - 24,000 - -
@ 9% on `3 Lacs - - 27000 -
EBT 4,00,000 3,76,000 3,73,000 4,00,000
Less: Tax @ 40% 1,60,000 1,50,400 1,49,200 1,60,000
EAT 2,40,000 2,25,600 2,23,800 2,40,000
Less: Pref. Dividend @ 6 % on `3 Lacs - - - 18,000
Earnings for Equity 2,40,000 2,25,600 2,23,800 2,22,000
÷ No. of Equity shares (`10 each) 1,60,000 1,40,000 1,30,000 1,30,000
EPS `1.50 `1.61 `1.72 `1.71

(ii) Statement of Financial Leverage

Particulars I II III IV
FL  
 
   4 ,00 ,000   4 ,00 ,000   4 ,00 ,000   4 ,00 ,000 
       
 EBIT   4 ,00 ,000   3,76 ,000   3,73 ,000   18 ,000 
 Pr eference Dividend   4 ,00 ,000  
 1  0.40 
 EBT  
 1  Tax 
1 1.06 1.07 1.08

Comments: Since the EPS is highest in plan III, the management could accept it.

BQ 28
The following particulars relating to Navya Ltd. for the year ended 31st March 2023 is given:

Output 1,00,000 units at normal capacity

Selling price per unit `40
 LEVERAGES 2.16
Variable cost per unit `20
Fixed cost `10,00,000

The capital structure of the company as on 31st March, 2023 is as follows:

Particulars `
Equity share capital (1,00,000 shares of `10 each) 10,00,000
Reserves and surplus 5,00,000
7% Debentures 10,00,000
Current liabilities 5,00,000
Total 30,00,000

Navya Ltd. has decided to undertake an expansion project to use the market potential, that will involve `10
lakhs. The company expects an increase in output by 50%. Fixed cost will be increased by `5,00,000 and
variable cost per unit will be decreased by 10%. The additional output can be sold at the existing selling price
without any adverse impact on the market.

The following alternative schemes for financing the proposed expansion programme are planned:
(1) Entirely by equity shares of `10 each at par.
(2) `5 lakh by issue of equity shares of `10 each and the balance by issue of 6% debentures of `100 each
at par.
(3) Entirely by 6% debentures of `100 each at par.

Find out which of the above-mentioned alternatives would you recommend for Navya Ltd. with
reference to the risk and return involved, assuming a corporate tax of 40%.

Answer
Statement Showing Profitability of Alternative Schemes for Financing
Particulars Existing Alt 1 Alt 2 Alt 3
Production (in units) 1,00,000 1,50,000 1,50,000 1,50,000
Sales value @ `40 per unit 40,00,000 60,00,000 60,00,000 60,00,000
Less: Variable cost @ `20/ `18 per unit 20,00,000 27,00,000 27,00,000 27,00,000
Contribution 20,00,000 33,00,000 33,00,000 33,00,000
Less: Fixed cost 10,00,000 15,00,000 15,00,000 15,00,000
EBIT 10,00,000 18,00,000 18,00,000 18,00,000
Less: Interest on loan: 70,000 70,000 70,000
Existing @ 7% of `10,00,000 70,000 - 30,000 60,000
New @ 6% of `5/`10 Lakh -
EBT 9,30,000 17,30,000 17,00,000 16,70,000
Less: Tax @ 40% (3,72,000) (6,92,000) (6,80,000) (6,68,000)
EAT 5,58,000 10,38,000 10,20,000 10,02,000
÷ Number of Equity Shares (Existing + New) ÷ 1,00,000 ÷ 2,00,000 ÷ 1,50,000 ÷ 1,00,000
EPS `5.58 `5.19 `6.80 `10.02
Operating leverage (Contribution ÷ EBIT) 2.00 1.83 1.83 1.83
Financial Leverage (EBIT ÷ EBT) 1.08 1.04 1.06 1.08
Combined Leverage (Contribution ÷ EBT) 2.15 1.91 1.94 1.98
Lower than
Risk - Lowest Highest
Alt 3
Lower than
Return - Lowest Highest
Alt 3

From the above figures, we can see that the Operating Leverage is same in all alternatives though Financial
Leverage differs. Alternative (3) uses the maximum amount of debt and result into the highest degree of
financial leverage, followed by alternative (2). Accordingly, risk of the company will be maximum in these
options. Corresponding to this scheme, however, maximum EPS (i.e., `10.02 per share) will be also in option
(3).
 LEVERAGES 2.17
So, if Navya Ltd. is ready to take a high degree of risk, then alternative (3) is strongly
recommended. In case of opting for less risk, alternative (2) is the next best option with a reduced EPS of
`6.80 per share. In case of alternative (1), EPS is even lower than the existing option, hence not
recommended.

BQ 29
A firm’s details are as under:
Sales (@100 per unit) `24,00,000
Variable Cost 50%
Fixed Cost `10,00,000
It has borrowed `10,00,000 @ 10% p.a. and its equity share capital is `10,00,000 (`100 each).
Assuming tax rate 50%.

Calculate:
(1) Operating Leverage
(2) Financial Leverage
(3) Combined Leverage
(4) Return on Investment as ROE
(5) If the sales increases by `6,00,000; what will the new EBIT?

Answer
Contributi on 12 ,00 ,000
(1) Operating Leverage = = = 6 times
EBIT 2 ,00 ,000

EBIT 2 ,00 ,000

(2) Financial Leverage = = = 2 times
EBT 1 ,00 ,000

(3) Combined Leverage = OL × FL = 6×2 = 12 times

Earnings for Equity

(4) ROI as ROE = × 100
Equity shareholde r' s fund
50 ,000
= × 100 = 5%
10 ,00 ,000

(5) New EBIT:

Δ EBIT (in %) = Δ Sales × DOL = 25% × 6 times
= 150% or 1.5 times

New EBIT = Existing EBIT + 150% = 2,00,000 + 150%

= `5,00,000

Calculation of EPS
Particulars `
Sales 24,00,000
Less: Variable cost @ of 50% of sales 12,00,000
Contribution 12,00,000
Less: Fixed cost 10,00,000
EBIT 2,00,000
Less: Interest @ 10% of 10,00,000 1,00,000
EBT 1,00,000
Less: Tax @ 50% 50,000
EAT 50,000

BQ 30
 LEVERAGES 2.18
A firm has sales of `75,00,000 variable cost is 56% and fixed cost is `6,00,000. It has a debt of `45,00,000 at
9% and equity of `55,00,000.

(i) What is the firm’s ROI?

(ii) Does it have favourable financial leverage?
(iii) If the firm belongs to an industry whose capital turnover is 3, does it have a high or low capital
turnover?
(iv) What are the operating, financial and combined leverages of the firm?
(v) If the sales is increased by 10% by what percentage EBIT will increase?
(vi) At what level of sales the EBT of the firm will be equal to zero?
(vii) If EBIT increases by 20%, by what percentage EBT will increase?

Answer
Income Statement
Particulars `
Sales 75,00,000
Less: Variable cost @ of 56% of sales 42,00,000
Contribution 33,00,000
Less: Fixed costs 6,00,000
EBIT 27,00,000
Less: Interest @ 9% of 45,00,000 4,05,000
EBT 22,95,000

EBIT 27 ,00 ,000

(i) ROI = ×100 = ×100 = 27%
Capital Employed 45 ,00 ,000  55 ,00 ,000

(ii) ROI is 27% and Interest on debt is 9%, hence, it has a favourable financial leverage.

Net Sales 75 ,00 ,000

(iii) Capital Turnover = = = 0.75
Capital 1 ,00 ,00 ,000

Firm has very low capital turnover as compared to industry average of 3.

(iv) Calculation of Operating, Financial and Combined leverages:

Contributi on 33 ,00 ,000

Operating Leverage = = = 1.222
EBIT 27 ,00 ,000

EBIT 27 ,00 ,000

Financial Leverage = = = 1.176
EBT 22 ,95 ,000

Combined Leverage = OL × FL = 1.222 × 1.176 = 1.437

(v) Operating leverage is 1.22. So if sales is increased by 10% then EBIT will be increased by 1.222 × 10
i.e. 12.22% (approx)

(vi) EBT = Sales – Variable cost – Fixed cost – Interest

Nil = Sales – 56% sales – 6,00,000 – 4,05,000
44% of sales = 10,05,000
Sales = 22,84,091

Hence at `22,84,091 sales level EBT of the firm will be equal to Zero.

(vii) Financial leverage is 1.176. So, if EBIT increases by 20% then EBT will increase by 1.18 × 20% =
23.52% (approx)
 LEVERAGES 2.19

PAST YEARS QUESTIONS

PYQ 1
The net Sales of A Ltd is `30 crores. Earning before interest and tax of the company as a percentage of net sales
is 12%. The capital employed comprises `10 crores of Equity, `2 crores of 13% Cumulative Preference Share
Capital and 15% Debentures of `6 crores. Income tax rate is 40%.
Required:
(i) Calculate the Return on Equity (ROE) for the Company and indicate its segments due to the presence
of Preference Share Capital and Borrowing (Debentures).
(ii) Calculate the Operating Leverage of the Company given that its Combined Leverage is 3.
[5 Marks (May 2002)]

Answer
(i) Calculation of ROE:
Earnings for Equity Shareholde rs 1 .36 Crores
ROE = × 100 = × 100
Equity Shareholde r' s Fund 10 Crores
= 13.60%

Segment:
EBIT 3.60 crores
ROCE / ROI = × 100 = × 100
Capital Employed 18 crores
= 20%

Segment due to Preference Share Capital = [20% (1-.40) – 13%] × 2 = - .20%

10

Segment due to Debentures = [(20% - 15%) (1-.40)] × 6 = 1.80%

10

Return on Equity with segment effect = ROI (1-t) - .20% + 1.80%

= [20% (1-.40)] - .20% + 1.80% = 13.60%

(ii) Operating Leverage = Combined Leverage ÷ Financial Leverage

= 3 times ÷ 1.59 times = 1.89 times

Working Notes:
1. Calculation of Earnings Available for Equity Shareholders
Particulars `
EBIT (12% of `30 Crores) 3,60,00,000
Less: Interest @ 15% of `6 Crores 90,00,000
Profit Before Tax 2,70,00,000
Less: Tax @ 40% 1,08,00,000
Profit After Tax 1,62,00,000
Less: Preference Dividend @ 13% of `2 Crores 26,00,000
Earnings Available for Equity Shareholders 1,36,00,000

2. Calculation of Financial Leverage:

EBIT 3,60 ,00 ,000
Financial Leverage = =
Pr eference Dividend 26 ,00 ,000
EBT  2,70 ,00 ,000 
1  Tax 1  0.40
= 1.59 times

PYQ 2
The data relating to two Companies are as given below:
 LEVERAGES 2.20
Company A Company B
Equity Share Capital `6,00,000 `3,50,000
12% Debentures `4,00,000 `6,50,000
Output (units) per annum 60,000 15,000
Selling price per unit `30 `250
Fixed cost per annum `7,00,000 `14,00,000
Variable cost per unit `10 `75

You are required to calculate the Operating leverage, Financial leverage and Combined leverage
of two Companies.
[(4 Marks) Nov 2002]

Answer
Statement of OL, FL and CL
Particulars A B
Number of units 60,000 15,000
Sales @ `30 and `250 per unit 18,00,000 37,50,000
Less: Variable cost @ `10 and `75 per unit 6,00,000 11,25,000
Contribution 12,00,000 26,25,000
Less: Fixed cost 7,00,000 14,00,000
EBIT 5,00,000 12,25,000
Less: Interest @ 12% of 4 lacs and 6.50 lacs 48,000 78,000
EBT 4,52,000 11,47,000
12,00,000 26,25,000
Operating leverage 
Contributi on  5,00,000 12,25,000

 EBIT  2.40 times 2.143 times
5,00,000 12,25,000

Financial Leverage 
EBIT  4,52,000 11,47,000

 EBT  1.106 times 1.068 times
2.40 × 1.106 2.143 × 1.068
Combined Leverage (OL × FL) 2.654 times 2.289 times

PYQ 3
The following summarizes the percentage changes in operating income, percentage changes in revenue, and
Beta factors for four pharmaceutical firms.
Name of Firm Change in Revenue Change in Operating Income Beta Factor
PQR Ltd 27% 25% 1.00
RST Ltd 25% 32% 1.15
TUV Ltd 23% 36% 1.30
WXY Ltd 21% 40% 1.40
Required:
(i) Calculate the degree of operating leverage for each of these firms. Comment also.
(ii) Use the operating leverage to explain why these firms have different beta. [(8 Marks) Nov 2004]

Answer
(i) Calculation of operating leverage
Particulars PQR Ltd RST Ltd TUV Ltd WXY Ltd
Degree of Operating Leverage 25 % 32 % 36 % 40 %
 % Change in operating income  27 % 25 % 23 % 21 %
 
 % change in Revenue  0.93 1.28 1.57 1.91

WXY Ltd is operating its business with higher business risk.

(ii) High operating leverage leads to high beta. So when operating leverage is lowest i.e. 0.9259, Beta is
minimum 1.00 and when operating leverage is maximum i.e. 1.9048, beta is highest i.e. 1.40
 LEVERAGES 2.21
PYQ 4
A Company had the following Balance Sheet as on March 31, 2006
Liabilities ` (in Crores) Assets ` (in Crores)
Equity Share Capital 10 Fixed Assets (net) 25
(1 Crores Shares of `10 each) Current Assets 15
Reserve and Surplus 2
15% Debentures 20
Current Liabilities 8
40 40
The additional information given is as under:
Fixed costs per annum (excluding interest) : `8 Crores
Variable operating costs ratio : 65% of sales
Total Assets turnover ratio : 2.5 times
Income tax rate : 40%
Calculate (i) Earnings per share, (ii) Operating Leverage, (iii) Financial Leverage, (iv) Combined Leverage.
[(8 Marks) Nov 2006]

Answer
(i) Statement of EPS
Particulars ` (in Crores)
Sales @ (2.50 times of `40 Crores) 100.00
Less: Variable cost @ 65% 65.00
Contribution 35.00
Less: Fixed cost 8.00
EBIT 27.00
Less: Interest @ 15% of 20 Crores 3.00
EBT 24.00
Less: Tax @ 40% 9.60
EAT 14.40
÷ No. of Equity Shares ÷1
EPS `14.40
Contributi on 35 Crores
(ii) Operating Leverage = = = 1.296 times
EBIT 27 Crores

It indicates fixed cost in cost structure. It indicates sensitivity of earnings before interest and tax (EBIT)
to change in sales at a particular level.

EBIT 27 Crores
(iii) Financial Leverage = = = 1.125 times
EBT 24 Crores

The financial leverage is very comfortable since the debt service obligation is small vis-a-vis EBIT.

(iv) Combined Leverage = OL × FL = 1.296 × 1.125 = 1.458 times

The combined leverage studies the choice of fixed cost in cost structure and choice of debt in capital
structure. It studies how sensitive the change in EPS is vis-a-vis change in sales.
The leverages - operating, financial and combined are measures of risk.

PYQ 5
The following details of RST Limited for the year ended 31 March, 2006 are given below:
Operating leverage 1.4 times
Combined leverage 2.8 times
Fixed Cost (Excluding interest) `2.04 lakhs
 LEVERAGES 2.22
Sales `30.00 lakhs
12% Debentures of `100 each `21.25 lakhs
Equity Share Capital of `10 each `17.00 lakhs
Income tax rate 30 per cent
Required:
(i) Calculate Financial Leverage.
(ii) Calculate P/V ratio and Earning Per Share (EPS).
(iii) If the company belongs to an industry, whose assets turnover is 1.5, does it have a high or low assets
turnover?
(iv) At what level of sales the Earning before Tax (EBT) of the company will be equal to zero?
[(8 Marks) May 2007]

Answer
(i) Calculation of Financial Leverage:
Financial Leverage = CL ÷ OL = 2.80 ÷ 1.40 = 2 times

(ii) P/V Ratio and EPS:

Contributi on 7 ,14 ,000
P/V ratio = × 100 = × 100 = 23.80%
Sales 30 ,00 ,000

PAT 1 ,78 ,500

EPS = = = `1.05
No . of Shares 1 ,70 ,000

Calculation of contribution:
Contributi on Contributi on
Operating leverage = =
Contributi on  FC Contributi on  2,04 ,000
= 1.4 times
1.4 Contribution – 2,85,600 = Contribution = 7,14,000

Calculation of PAT:
Profit after tax = (Contribution – fixed cost – interest) (1 - t)
= (23.80% of 30 lacs – 2.04 lacs – 12% of 21.25lacs)(1 - 0.30)
= 1,78,500

(iii) Assets turnover:

Sales 30 ,00 ,000
Assets turnover = = = .784
Total Assets 38 ,25 ,000

0.784 < 1.5 means lower than industry assets turnover.

(iv) Level of sales to earn zero EBT:

EBT = Sales – Variable cost – Fixed cost – Interest
Nil = Sales – 76.20% sales – 2,04,000 – 2,55,000
23.80% of sales = 4,59,000
Sales = 19,28,571

PYQ 6
A firm has sales of `40 lakhs, variable cost of `25 lakhs, fixed cost of `6 lakhs, 10% debts of `30 lakhs and
Equity Capital of `45 lakhs. Calculate operating and financial leverage.
[(2 Marks) Nov 2007]

Answer
Contributi on 40 Lacs  25 Lacs
Operating Leverage = = = 1.67 times
EBIT 40 Lacs  25 Lacs  6 Lacs
 LEVERAGES 2.23
EBIT 40 Lacs  25 Lacs  6 Lacs
Financial Leverage = = = 1.5 times
EBT 40 Lacs  25 Lacs  6 Lacs  3 Lacs

PYQ 7
The following data relate to RST Ltd:
Earning before interest and tax (EBIT) `10,00,000
Fixed cost `20,00,000
Earning Before Tax (EBT) `8,00,000
Calculate combined leverage
[(2 Marks) May 2008]

Answer
Contributi on 30 ,00 ,000
Combined Leverage = = = 3.75 times
EBT 8 ,00 ,000

Where, contribution = EBIT + Fixed Cost

= `10,00,000 + `20,00,000 = 30,00,000

PYQ 8
A Company operates at a production level of 1,000 units. The contribution is `60 per unit, operating leverage
is 6, and combined leverage is 24. If tax rate is 30%, what would be its earnings after tax?
[(3 Marks) Nov 2008]

Answer
Earning after tax = EBT (1 - t) = `2,500 (1 - 0.30) = `1,750

Working Notes:
Contributi on
Combined leverage =
EBT
Contributi on 1,000  60
24 times = =
EBT EBT
60,000
 EBT = = `2,500
24

PYQ 9
From the following financial data of Company A and Company B, prepare their Income statements.
Company A Company B
Variable cost `56,000 60% of sales
Fixed cost `20,000 ?
Interest expenses `12,000 `9,000
Financial Leverage 5:1 ?
Operating Leverage ? 4:1
Income tax rate 30% 30%
Sales ? 1,05,000
[(8 Marks) Nov 2009]

Answer
Income Statement
Particulars Company A Company B
Sales 91,000 1,05,000
Less: Variable cost 56,000 63,000
Contribution 35,000 42,000
Less: Fixed cost 20,000 31,500
Profit before interest and tax 15,000 10,500
 LEVERAGES 2.24
Less: Interest 12,000 9,000
Profit before tax 3,000 1,500
Less: Tax @ 30% 900 450
Profit after tax 2,100 1,050

Working Notes (Company A):

EBIT EBIT
(a) Financial Leverage = = = 5 times
EBIT  Interest EBIT  12 ,000
EBIT = `15,000

(b) Contribution = EBIT + Fixed Cost = 15,000 + 20,000 = `35,000

(c) Sales = Contribution + VC = 35,000 + 56,000 = `91,000

Working Notes (Company B):

(a) Contribution = 40 % of sales (as variable costs is 60% of sales)

= 40 % of 1,05,000 = `42,000

Contributi on 42,000
(b) Operating Leverage = = = 4 times
EBIT EBIT
EBIT = `10,500

(c) Fixed Cost = Contribution – EBIT = 42,000 – 10,500 = `31,500

PYQ 10
Calculate the degree of operating leverage, degree of financial leverage and the degree of combined leverage
for following firms and interpret the results:
Particulars P Q R
Output (Units) 2,50,000 1,25,000 7,50,000
Fixed Cost `5,00,000 `2,50,000 `10,00,000
Unit Variable cost `5.00 `2.00 `7.50
Unit Selling price `7.50 `7.00 `10.00
Interest Expense `75,000 `25,000 Nil
[(4 Marks) Nov 2010]
Answer
Statement Showing OL, FL and CL
Particulars P Q R
Output (in units) 2,50,000 1,25,000 7,50,000
Sales @ `7.50, `7.00 and `10.00 per unit 18,75,000 8,75,000 75,00,000
Less: Variable cost @ `5.00, `2.00 and `7.50 p.u. 12,50,000 2,50,000 56,25,000
Contribution 6,25,000 6,25,000 18,75,000
Less: Fixed cost 5,00,000 2,50,000 10,00,000
EBIT 1,25,000 3,75,000 8,75,000
Less: Interest 75,000 25,000 Nil
EBT 50,000 3,50,000 8,75,000
Operating leverage  Contributi on 
6 ,25 ,000 6 ,25 ,000 18 ,75 ,000
 EBIT  1 ,25 ,000 3 ,75 ,000 8 ,75 ,000
5 times 1.67 times 2.14 times
Financial leverage  EBIT 
1 ,25 ,000 3 ,75 ,000 8 ,75 ,000
 EBT  50 ,000 3 ,50 ,000 8 ,75 ,000
Combined leverage (OL × FL) 2.50 times 1.07 times 1 time
5 × 2.50 1.67 × 1.07 2.14 × 1
12.50 times 1.79 times 2.14 times
 LEVERAGES 2.25
High Business, Medium
Comment on Risk Financial and Medium risk operating risk
Combined risk only
Moderate
Aggressive Moderate
Comment on Policy policy without
policy policy
Financial risk

PYQ 11
You are the given two financial plans of a company which has two financial situations. The detailed
information are as under:
Installed capacity : 10,000 units
Actual production and sales : 60% of installed capacity
Selling price per unit : `30
Variable cost per unit : `20

Fixed Cost:
Situation A : `20,000
Situation B : `25,000

Capital structure of the company is as follows:

Financial Plans
XY XM
Equity 12,000 35,000
12% Debt 40,000 10,000
52,000 45,000

You are required to calculate operating leverage and financial leverage of both the plans.
[(4 Marks) May 2011]

Answer
Statement Showing Operating & Financial leverage
Situation A Situation B
Particulars
Plan XY Plan XM Plan XY Plan XM
Sales (6,000 × `30) 1,80,000 1,80,000 1,80,000 1,80,000
Less: Variable cost (6,000 × `20) 1,20,000 1,20,000 1,20,000 1,20,000
Contribution 60,000 60,000 60,000 60,000
Less: Fixed Cost 20,000 20,000 25,000 25,000
EBIT 40,000 40,000 35,000 35,000
Less: Interest @ 12% 4,800 1,200 4,800 1,200
EBT 35,200 38,800 30,200 33,800
OL (Contribution ÷ EBIT) 1.50 times 1.50 times 1.71 times 1.71 times
FL (EBIT ÷ EBT) 1.14 times 1.03 times 1.16 times 1.04 times

PYQ 12
Alpha Ltd has furnished the following Balance Sheet as on March 31, 2011:
Liabilities ` Assets `
Equity Share Capital 10,00,000 Fixed Assets 30,00,000
(1,00,000 shares of `10 each) Current Assets 18,00,000
General Reserve 2,00,000
15% Debentures 28,00,000
Current Liabilities 8,00,000
48,00,000 48,00,000

Additional information:
 LEVERAGES 2.26
(1) Annual Fixed Cost other than Interest `28,00,000
(2) Variable Cost Ratio 60% of sales
(3) Total Assets Turnover Ratio 2.5 times
(4) Tax Rate 30%

You are required to calculate:

(i) Earning per Share (EPS), and
(ii) Combined Leverage.
[(8 Marks) Nov 2011]

Answer
(i) Combined leverage = Contribution ÷ EBT = 48 lacs ÷ 15.80 lacs = 3.04

(ii) Calculation of EPS:

Particulars `
Sales (2.5 × 48,00,000) 1,20,00,000
Less: Variable cost @ of 60% of sales 72,00,000
Contribution 48,00,000
Less: Fixed cost 28,00,000
EBIT 20,00,000
Less: Interest @ 15% of 28,00,000 4,20,000
EBT 15,80,000
Less: Tax @ 30% 4,74,000
EAT 11,06,000
÷ No. of Shares ÷ 1,00,000
EPS `11.06

PYQ 13
The capital structure of JCPL Ltd. is as follows:
Equity share capital of `10 each : `8,00,000
8% Preference share capital of `10 each : `6,25,000
10% Debenture of `100 each : `4,00,000
Additional Information:
Profit after tax (tax rate 30%) : `1,82,000
Operating expenses (including depreciation `90,000) : 1.50 times of EBIT
Equity share dividend paid : 15%
Market price per equity share : `20.00

Required to calculate:
(i) Operating and financial leverage.
(ii) Cover the preference and equity share dividends.
(iii) The earning yield and price earning ratio.
(iv) The net fund flow.
[(8 Marks) May 2012]

Answer
(i) Operating & Financial leverage:
Contributi on 3 ,90 ,000
Operating Leverage = = = 1.3 times
EBIT 3 ,00 ,000

EBIT 3,00 ,000

Financial Leverage = =
Pr eference Dividend 8% of 6 ,25,000
EBT  2,60 ,000 
1  Tax 1  0.30
 LEVERAGES 2.27
3,00 ,000
= = 1.59 times
50 ,000
2,60 ,000 
0.70

(ii) Calculation of cover the preference & equity share dividends:

Pr ofit after tax
Cover the Preference Share Dividend =
Pr eference dividend
1 ,82 ,000
= = 3.64 times
50 ,000

Pr ofit after tax  Pr eference dividend

Cover the Equity Share Dividend =
Equity dividend
1 ,82 ,000  50 ,000
= = 1.10 times
15 % of 8 ,00 ,000

(iii) Earning yield & price earning ratio:

EPS 1.65
Earning Yield Ratio = × 100 = × 100 = 8.25%
MPS 20 .00

MPS 20
Price Earning Ratio = = = 12.12 times
EPS 1.65

PAT  Pr eference dividends 1 ,82 ,000  50 ,000

Calculation of EPS = =
No . of Equity shares 80 ,000
= `1.65

(iv) Net fund flow:

Net fund flow = PAT - Preference dividends - Equity dividends + Depreciation
= 1,82,000 – 50,000 – 1,20,000 + 90,000 = `1,02,000

Calculation of contribution:
Particulars `
Profit after tax 1,82,000
Add: Tax  1,82,000  30  78,000
 70 
Profit before tax 2,60,000
Add: Interest on debenture (4,00,000 × 10%) 40,000
Earning before interest and tax 3,00,000
Add: Fixed cost (assumed only depreciation is fixed) 90,000
Contribution 3,90,000

PYQ 14
X Limited has estimated that for a new product its break-even point is 20,000 units if the item is sold for `14
per unit and variable cost `9 per unit. Calculate the degree of operating leverage for sales volume 25,000 units
and 30,000 units.
[(5 Marks) Nov 2012]

Answer
Statement of Operating Leverage
Particulars 25,000 Units 30,000 Units
Contribution @ `5 (`14 - `9) per unit 1,25,000 1,50,000
Less: Operating fixed cost (W.N.) 1,00,000 1,00,000
EBIT 25,000 50,000
Operating Leverage (Contribution ÷ EBIT) 5 times 3 times

Calculation of operating fixed cost:

 LEVERAGES 2.28
Contribution at BEP = Fixed Cost
`5 × 20,000 Units = `1,00,000

Note: BEP to be assumed as operating BEP or Financial fixed cost to be assumed as Nil.

PYQ 15
The following information related to XL company Ltd. for the year ended 31st March, 2013 are available
to you:
Equity share capital of `10 each : `25,00,000
11% Bonds of `1,000 each : `18,50,000
Sales : `42,00,000
Fixed cost (Excluding Interest) : `3,48,000
Financial leverage : 1.39
Profit Volume Ratio : 25.55%
Income Tax Rate : 35%

You are required to calculate:

(i) Operating Leverage;
(ii) Combined Leverage; and
(iii) Earning Per Share.
[(6 Marks) May 2013]

Answer
Contributi on 10 ,73 ,100
(i) Operating Leverage = = = 1.48 times
EBIT 7 ,25 ,100

(ii) Combined Leverage = OL × FL = 1.48 × 1.39 = 2.06 times

PAT 3 ,39 ,040

(iii) Earnings Per Share = = = `1.356
No of Equity shares 2 ,50 ,000

Working Notes:
(1) Contribution = Sales × PV Ratio
= 42 Lacs × 25.55% = 10,73,100
(2) EBIT = Contribution - Operating Fixed Cost
= 10,73,100 – 3,48,000 = 7,25,100
(3) Profit after tax = (EBIT – Interest) (1 - t)
= (7,25,100 – 11% of 18,50,000) (1 – 0.35) = 3,39,040

PYQ 16
Calculate the degree of operating leverage, degree of financial leverage and the degree of combined leverage
for the following firms:
Particulars N S D
Production (in units) 17,500 6,700 31,800
Fixed cost `4,00,000 `3,50,000 `2,50,000
Interest on loan `1,25,000 `75,000 Nil
Selling price per unit `85 `130 `37
Variable cost per unit `38.00 `42.50 `12.00
[(5 Marks) Nov 13]

Answer
Statement of the Degree of OL, Degree of FL and the Degree of CL
Particulars N S D
Production (in units) 17,500 6,700 31,800
 LEVERAGES 2.29
Sales value @ `85/ `130/ `37 per unit 14,87,500 8,71,000 11,76,600
Less: Variable cost @ `38/ `42.50/ `12 per unit 6,65,000 2,84,750 3,81,600
Contribution 8,22,500 5,86,250 7,95,000
Less: Fixed cost 4,00,000 3,50,000 2,50,000
EBIT 4,22,500 2,36,250 5,45,000
Less: Interest on loan 1,25,000 75,000 -
EBT 2,97,500 1,61,250 5,45,000
8,22,500 5,86,250 7,95,000
Operating leverage 
Contributi on  4,22,500 2,36,250 5,45,000

 EBIT  1.95 2.48 1.46
4,22,500 2,36,250 5,45,000

Financial Leverage 
EBIT  2,97,500 1,61,250 5,45,000

 EBT  1.42 1.47 1.00
8,22,500 5,86,250 7,95,000

Combined Leverage 
Contributi on  2,97,500 1,61,250 5,45,000

 EBT  2.76 3.64 1.46

PYQ 17
A company had the following Balance Sheet as on 31st March, 2014: [in crores]
Liabilities ` Assets `
Equity Share Capital 5.00 Fixed Assets (Net) 12.50
(50 lakh shares of `10 each) Current Assets 7.50
Reserve and Surplus 1.00
15% Debentures 10.00
Current Liabilities 4.00
20.00 20.00

The additional information given is as under:

Fixed cost per annum (excluding interest) 4 crores
Variable operating cost ratio 65%
Total assets turnover ratio 2.5
Income Tax rate 30%

Required:
(i) Earnings Per Share
(ii) Operating Leverage
(iii) Financial Leverage
(iv) Combined Leverage
[(8 Marks) May 2014]

Answer
(i) Calculation of EPS:
EAT 840 Lakhs
EPS = = = `16.80
No. of Shares 50 Lakhs
(ii) Calculation of OL:
Contributi on 17 .50 Crores
OL = = = 1.296 times
EBIT 13 .50 Crores
(iii) Calculation of FL:
EBIT 13 .50 Crores
FL = = = 1.125 times
EBT 12 .00 Crores
(iv) Calculation of CL:
CL = OL × FL = 1.296 × 1.125 = 1.458 times
 LEVERAGES 2.30
Working Notes:
Income Statement
Particulars ` (in crores)
Sales (2.5 times of 20 crores) 50.00
Less: Variable Cost @ 65% of 50 crores 32.50
Contribution 17.50
Less: Fixed Cost 4.00
EBIT 13.50
Less: Interest @ 15% of 10 crores 1.50
EBT 12.00
Less: Tax @ 30% 3.60
EAT 8.40

PYQ 18
The capital structure of RST Ltd. is as follows:
Equity share capital of `10 each : `8,00,000
10% Preference share capital of `100 each : `5,00,000
12% Debenture of `100 each : `7,00,000

Additional Information:
Profit after tax (tax rate 30%) : `2,80,000
Operating expenses (including depreciation `96,800) : 1.50 times of EBIT
Equity share dividend paid : 15%
Market price per equity share : `23.00

Required to calculate:
(i) Operating and financial leverage.
(ii) Cover the preference and equity share dividends.
(iii) The earning yield and price earning ratio.
(iv) The net fund flow.

Note: All operating expenses (excluding depreciation) are variable.

[(8 Marks) Nov 2014]

Answer
(i) Operating & Financial leverage:
Contributi on 5,80 ,800
Operating Leverage = = = 1.2 times
EBIT 4 ,84 ,000

EBIT 4 ,84 ,000

Financial Leverage = =
Pr eference Dividend 50 ,000
EBT  4 ,00 ,000 
1  Tax 1  0.30
= 1.473 times

(ii) Calculation of cover the preference & equity share dividends:

Pr ofit after tax 2 ,80 ,000
Cover the Preference Share Dividend = =
Pr eference dividend 50 ,000
= 5.6 times

Pr ofit after tax  Pr eference dividend

Cover the Equity Share Dividend =
Equity dividend
2,80 ,000  50 ,000
= = 1.92 times
15 % of 8 ,00 ,000
 LEVERAGES 2.31
(iii) Earning yield & price earning ratio:
EPS 2.875
Earning Yield Ratio = × 100 = × 100 = 12.50%
MPS 23 .00

MPS 23 .00
Price Earning Ratio = = = 8 times
EPS 2.875

PAT  Pr eference dividends 2,80 ,000  50 ,000

Calculation of EPS = =
No . of Equity shares 80 ,000
= `2.875

(iv) Net fund flow:

Net fund flow = PAT - Preference dividends - Equity dividends + Depreciation
= 2,80,000 – 50,000 – 1,20,000 + 96,800 = `2,06,800

Calculation of contribution
Particulars `
Profit after tax 2,80,000
Add: Tax (2,80,000 × 30/70) 1,20,000
Profit before tax 4,00,000
Add: Interest on debenture (7,00,000 × 12%) 84,000
Earning before interest and tax 4,84,000
Add: Fixed cost (only depreciation) 96,800
Contribution 5,80,800

PYQ 19
Following information are related to four firms of the same industry:
Firm Change in Revenue Change in Operating Income Change in EPS
P 27% 25% 30%
Q 25% 32% 24%
R 23% 36% 21%
S 21% 40% 23%

Find out:
(i) Degree of operating leverage , and
(ii) Degree of combined leverage of all the firms.
[(5 Marks) May 2015]

Answer
% Change in opereating income
(i) Degree of Operating Leverage =
% Chacge in revenue

P = 25% ÷ 27% = 0.93

Q = 32% ÷ 25% = 1.28
R = 36% ÷ 23% = 1.57
S = 40% ÷ 21% = 1.91

% Change in EPS
(ii) Degree of Combined Leverage =
% Chacge in revenue

P = 30% ÷ 27% = 1.11

Q = 24% ÷ 25% = 0.96
R = 21% ÷ 23% = 0.91
S = 23% ÷ 21% = 1.10
 LEVERAGES 2.32
PYQ 20
The capital structure of the ABC Ltd as at 31.03.15 consists of ordinary share capital of `5,00,000 (face value
`100 each) and 10% debentures of `5,00,000 (`100 each). In the year ended March 15, sales decreased from
60,000 units to 50,000 units. During the year and in the previous year, the selling price is `12 per unit; variable
cost stood at `8 per unit and fixed expenses were at `1,00,000 p.a. The income tax rate was 30%.

You are required to calculate the following:

(i) The percentage decrease in earnings per share.
(ii) The degree of operating leverage at 60,000 units and 50,000 units.
(iii) The degree of financial leverage at 60,000 units and 50,000 units.
[(5 Marks) June 2015]

Answer
(i) Calculation of % decrease in EPS
Particulars 60,000 units 50,000 units
Sales @ `12 per unit 7,20,000 6,00,000
Less: Variable cost @ `8 per unit 4,80,000 4,00,000
Contribution 2,40,000 2,00,000
Less: Fixed cost 1,00,000 1,00,000
Profit before interest and tax 1,40,000 1,00,000
Less: Interest @ 10% of `5,00,000 50,000 50,000
Profit before tax 90,000 50,000
Less: Tax @ 30% 27,000 15,000
Profit after tax 63,000 35,000
÷ No. of shares 5,000 5,000
Earning per share `12.60 `7.00
12 .60  7.00
% Decrease in EPS = × 100 = 44.44%
12 .60

Contributi on
(ii) Degree of Operating Leverage =
EBIT

2 ,40 ,000
At 60,000 units = = 1.71 times
1 ,40 ,000

2 ,00 ,000
At 50,000 units = = 2 times
1 ,00 ,000

EBIT
(iii) Degree of Financial Leverage =
EBT

1 ,40 ,000
At 60,000 units = = 1.56 times
90 ,000

1 ,00 ,000
At 50,000 units = = 2 times
50 ,000

PYQ 21
From the following details of X Ltd., prepare the Income Statement for the year ended 31st December 2014:

Financial Leverage : 2
Interest : `2,000
Operating Leverage : 3
Variable cost as a % of sales : 75%
Income tax rate : 30%
[(5 Marks) Nov 2015]
 LEVERAGES 2.33
Answer
Income Statement for the year ended 31st December, 2014
Particulars `
Sales 48,000
Less: Variable cost 36,000
Contribution 12,000
Less: Fixed cost 8,000
EBIT 4,000
Less: Interest 2,000
EBT 2,000
Less: Tax @ 30% 600
EAT 1,400

Working Notes:
(a) Calculation of EBIT:
EBIT EBIT
Financial Leverage = 2 = =
EBT EBIT  Interest
EBIT
= or EBIT = `4,000
EBIT  2 ,000

(b) Calculation of Contribution:

Contributi on Contributi on
Operating Leverage = 3 = =
EBIT 4 ,000

Contribution = `12,000

(c) Calculation of Sales:

Contributi on 12 ,000
Sales Value = = = `48,000
PV Ratio 100 %  75 %

PYQ 22
A company had the following Balance Sheet as on 31st March, 2015.
Liabilities ` Assets `
Equity Share Capital of `10 each 40,00,000 Fixed Assets (Net) 1,28,00,000
Reserve and Surplus 8,00,000 Current Assets 32,00,000
15% Debentures 80,00,000
Current Liabilities 32,00,000
1,60,00,000 1,60,00,000

The additional information given is as under:

Fixed cost per annum (excluding interest) `32,00,000
Variable operating cost ratio 70%
Total assets turnover ratio 2.5
Income Tax rate 30%
Required:
(i) Operating Leverage, (ii) Financial Leverage, (iii) Combined Leverage and (iv) Earnings Per Share
[(5 Marks) May 2016]

Answer
(i) Calculation of OL:
Contributi on 1 ,20 ,00 ,000
OL = = = 1.364 times
EBIT 88 ,00 ,000
 LEVERAGES 2.34
(ii) Calculation of FL:
EBIT 88 ,00 ,000
FL = = = 1.158 times
EBT 76 ,00 ,000

(iii) Calculation of CL:

CL = OL × FL = 1.364 × 1.158 = 1.579 times

(iv) Calculation of EPS:

EAT 53 ,20 ,000
EPS = = = `13.30
No . of Shares 4 ,00 ,000

Working Notes:
Income Statement
Particulars `
Sales (2.5 times of 1,60,00,000) 4,00,00,000
Less: Variable Cost @ 70% of 400 Lacs 2,80,00,000
Contribution 1,20,00,000
Less: Fixed Cost 32,00,000
EBIT 88,00,000
Less: Interest @ 15% of 80,00,000 12,00,000
EBT 76,00,000
Less: Tax @ 30% 22,80,000
EAT 53,20,000

PYQ 23
The following information related to YZ company Ltd. for the year ended 31st March, 2016 are available
to you:
Equity share capital of `10 each : `50,00,000
12% Bonds of `1,000 each : `37,00,000
Sales : `84,00,000
Fixed cost (Excluding Interest) : `6,96,000
Financial leverage : 1.49
Profit Volume Ratio : 27.55%
Income Tax Rate : 40%

You are required to calculate:

(a) Operating Leverage;
(b) Combined Leverage; and
(c) Earning Per Share. [upto two decimal points]
[(5 Marks) Nov 2016]

Answer
Contributi on 23 ,14 ,200
(a) Operating Leverage = = = 1.43 times
EBIT 16 ,18 ,200

(b) Combined Leverage = OL × FL = 1.43 × 1.49 = 2.13 times

PAT 6 ,51 ,624

(c) Earnings Per Share = = = `1.303
No of Equity shares 5 ,00 ,000

Working Notes:
1. Contribution = Sales × PV Ratio = 84 Lacs × 27.55%= 23,14,200
 LEVERAGES 2.35
2. EBIT = Contribution - Operating Fixed Cost
= 23,14,200 – 6,96,000 = 16,18,200
3. Profit after tax = (EBIT – Interest) (1 - t)
= (16,18,200 – 5,32,160) (1 – 0.40) = 6,51,624
4. Interest:
Financial Leverage = EBIT ÷ EBT = 16,18,200 ÷ EBT = 1.49
EBT = 16,18,200 ÷ 1.49 = 10,86,040
Interest = EBIT – EBT = 16,18,200 – 10,86,040 = 5,32,160
Other interest = Total interest – Interest on bonds
= 12% of 37,00,000 – 5,32,160 = 88,160

PYQ 24
You are given the following information of 5 firms of the same industry:
Firm Change in Revenue Change in Operating Income Change in EPS
M 28% 26% 32%
N 27% 34% 26%
P 25% 38% 23%
Q 23% 43% 27%
R 25% 40% 28%

Find out:
(a) Degree of operating leverage , and
(b) Degree of combined leverage of all the firms.
[(5 Marks) May 2017]

Answer
% Change in opereating income
(a) Degree of Operating Leverage =
% Chacge in revenue

M = 26% ÷ 28% = 0.93

N = 34% ÷ 27% = 1.26
P = 38% ÷ 25% = 1.52
Q = 43% ÷ 23% = 1.87
R = 40% ÷ 25% = 1.60

% Change in EPS
(b) Degree of Combined Leverage =
% Chacge in revenue

M = 32% ÷ 28% = 1.14

N = 26% ÷ 27% = 0.96
P = 23% ÷ 25% = 0.92
Q = 27% ÷ 23% = 1.17
R = 28% ÷ 25% = 1.12

PYQ 25
The following details of a company for the year ended 31 March, 2017 are given below:

Operating leverage 2 times

Combined leverage 2.5 times
Fixed Cost (Excluding interest) `3.40 lakhs
Sales `50.00 lakhs
8% Debentures of `100 each `30.25 lakhs
Equity Share Capital of `10 each `34.00 lakhs
Income tax rate 30 per cent
 LEVERAGES 2.36
Required:
(i) Calculate Financial Leverage.
(ii) Calculate P/V ratio and Earning Per Share (EPS).
(iii) If the company belongs to an industry, whose assets turnover is 1.5, does it have a high or low assets
turnover?
(iv) At what level of sales the Earning before Tax (EBT) of the company will be equal to zero?
[(8 Marks) Nov 2017]

Answer
(i) Calculation of Financial Leverage:
Financial Leverage = CL ÷ OL = 2.50 ÷ 2 = 1.25

(ii) P/V Ratio and EPS:

Contributi on 6 ,80 ,000
P/V ratio = × 100 = × 100 = 13.60%
Sales 50 ,00 ,000

PAT 68 ,600
EPS = = = `0.2018
No . of Shares 3 ,40 ,000

Calculation of contribution:
Contributi on Contributi on
Operating leverage = =
Contributi on  FC Contributi on  3,40 ,000
= 2 times
2 Contribution – 6,80,000 = Contribution = 6,80,000

Calculation of PAT:
Profit after tax = (Contribution – fixed cost – interest) (1 - t)
= (6,80,000 – 3,40,000 – 8% of 30,25,000)(1 - 0.30)
= 68,600

(iii) Assets turnover:

Sales 50 ,00 ,000
Assets turnover = = = 0.778
Total Assets 34 ,00 ,000  30 ,25 ,000

0.778 < 1.5 means lower than industry assets turnover.

(iv) Level of sales to earn zero EBT:

EBT = Sales – Variable cost – Fixed cost – Interest
Nil = Sales – 86.40% sales – 3,40,000 – 2,42,000
13.60% of sales = 5,82,000
Sales = 42,79,412

Note: The question can also be solved by first calculating EBIT with the help of Financial Leverage. Accordingly
answer to the requirement (ii) and (iv) will also vary. Calculation of interest in such case as follows:

Financial Leverage = EBIT ÷ EBT = 6,80,000 – 3,40,000 ÷ EBT

= 1.25 = 3,40,000 ÷ EBT
EBT = 3,40,000 ÷ 1.25 = 2,72,000
Interest = EBIT – EBT = 3,40,000 – 2,72,000
= 68,000

PYQ 26
Following are the selected financial information of A Ltd and B Ltd for the year ended March 31, 2018:
A Ltd B Ltd
 LEVERAGES 2.37
Variable cost ratio 60% 50%
Interest `20,000 `1,00,000
Operating Leverage 5 2
Financial Leverage 3 2
Tax rate 30% 30%

You are required to find out:

(1) EBIT
(2) Sales
(3) Fixed cost
(4) Identify the company which is better placed with reasons besed on leverages.
[(8 Marks) May 2018]

Answer
EBIT
(1) Financial Leverage =
EBIT - Interest

EBIT
Financial Leverage (A Ltd) = = 3 times
EBIT - 20,000

EBIT = `30,000

EBIT
Financial Leverage (B Ltd) = = 2 times
EBIT - 1,00,000

EBIT = `2,00,000

Contribution
(2) Operating Leverage =
EBIT
Contribution
Operating Leverage (A Ltd) = = 5 times
30,000

Contribution = `1,50,000

Sales = `1,50,000 ÷ 40% (PV) = `3,75,000

Contribution
Operating Leverage (B Ltd) = = 2 times
2,00,000

Contribution = `4,00,000

Sales = `4,00,000 ÷ 50% (PV) = `8,00,000

(3) Contribution = EBIT + Fixed Cost

Contribution (A Ltd) = 30,000 + Fixed Cost = `1,50,000

Fixed cost = `1,20,000

Contribution (B Ltd) = 2,00,000 + Fixed Cost = `4,00,000

Fixed cost = `2,00,000

(4) Comment based on leverage: B Ltd is better than A Ltd having lower degree of Business risk, Financial
risk and overall risk.

PYQ 27
The following data have been extracted from the books of LM Ltd:
 LEVERAGES 2.38
Sales `100 Lakhs
Interest payable per annum `10 Lakhs
Operating leverage 1.2
Combined leverage 2.16

You are required to find out:

(1) The Financial leverage
(2) Fixed cost and
(3) P/V ratio
[(5 Marks) May 2018]

Answer
(1) Financial Leverage = Combined leverage ÷ Operating leverage
= 2.16 ÷ 1.2 = 1.8 times

(2) Calculation of fixed cost:

EBIT
Financial Leverage = = 1.8 times
EBIT - Interest

EBIT
= = 1.8 times
EBIT - 10,00,000

EBIT = `22,50,000

Contribution
Operating Leverage = = 1.2 times
EBIT

Contribution = `22,50,000 × 1.2 = `27,00,000

Fixed cost = Contribution – EBIT

= `27,00,000 – 22,50,000 = `4,50,000

(3) P/V ratio = Contribution ÷ Sales

= 27,00,000 ÷ 1,00,00,000 = 27%

PYQ 28
Following is Balance Sheet of Soni Ltd. as on 31st March, 2018.
Liabilities ` Assets `
Equity Share Capital of `10 each 25,00,000 Non Current Assets 60,00,000
Reserve and Surplus 5,00,000 Current Assets 40,00,000
Non Current liabilities (12% Debt) 50,00,000
Current Liabilities 20,00,000
1,00,00,000 1,00,00,000

Additional information:
Fixed cost per annum (excluding interest) `20,00,000
Variable operating cost ratio 60%
Total assets turnover ratio 5 times
Income Tax rate 25%

You are required to:

(1) Prepare Income Statement
(2) Calculate the following and comment:
 LEVERAGES 2.39
(a) Operating Leverage
(b) Financial Leverage
(c) Combined Leverage
[(10 Marks) Nov 2018]

Answer
(1) Income Statement
Particulars `
Sales (5 times of 1,00,00,000) 5,00,00,000
Less: Variable Cost @ 60% of 500 Lacs 3,00,00,000
Contribution 2,00,00,000
Less: Fixed Cost 20,00,000
EBIT 1,80,00,000
Less: Interest @ 12% of 50,00,000 6,00,000
EBT 1,74,00,000
Less: Tax @ 25% 43,50,000
EAT 1,30,50,000

(2) Calculation of OL:

Contributi on 2,00,00,000
OL = = = 1.11 times
EBIT 1,80,00,000

It indicates fixed cost in cost structure. It indicates sensitivity of earnings before interest and tax (EBIT) to
change in sales at a particular level.

Calculation of FL:
EBIT 1,80,00,000
FL = = = 1.03 times
EBT 1,74,00,000

The financial leverage is very comfortable since the debt service obligation is small vis-à-vis EBIT.

Calculation of CL:
CL = OL × FL = 1.11 × 1.03 = 1.15 times

The combined leverage studied the choice of fixed cost in cost structure and choice of debt in capital structure.
It studies how sensitive the change in EPS is vis-à-vis change in sales.

PYQ 29
A company has sales of `1,00,00,000; variable cost is 55% of sales and fixed cost is `6,00,000. The capital
structure of the company is: Equity `1,20,00,000 and 8% Debt `80,00,000.

Calculate:
(1) Operating, Financial and Combined Leverages.
(2) If the sales amount is increased by 12%, by what percentage EBIT will increase?
[(5 Marks) Nov 2018]

Answer
Contributi on 1,00,00,000 × 45%
(1) Operating Leverage = = = 1.154 times
EBIT 45,00,000 − 6,00,000

EBIT 39,00,000
Financial Leverage = = = 1.196 times
EBT 39,00,000 − 8% of 80,00,000

Combined Leverage = OL × FL
 LEVERAGES 2.40
= 1.154 × 1.196 = 1.38 times

(2) % increase on EBIT:

Δ EBIT (in %) = Δ Sales × DOL
= 12% × 1.154 times = 13.848%

PYQ 30
The capital structure of the Shiva Ltd. consists of an ordinary share capital of `20,00,000 (share of `100 par
value) and `20,00,000 of 10% debentures.
Sales increased by 20% from 2,00,000 units to 2,40,000 units, the selling price is `10 per unit; variable
cost amounts to `6 per unit and fixed expenses amount to `4,00,000. The income tax rate is assumed to be
50%.

You are required to calculate the following:

(1) The percentage increase in earnings per share;
(2) Financial leverage at 2,00,000 units and 2,40,000 units.
(3) Operating leverage at 2,00,000 units and 2,40,000 units.
(4) Comment on the behavior of operating and financial leverages in relation to increase in production
from 2,00,000 units to 2,40,000 units.
[(10 Marks) May 2019]

Answer
(1) Calculation of % increase in EPS
2,00,000 2,40,000
Particulars
units units
Sales @ `10 per unit 20,00,000 24,00,000
Less: Variable cost 12,00,000 14,40,000
Contribution 8,00,000 9,60,000
Less: Fixed cost 4,00,000 4,00,000
Profit before interest and tax 4,00,000 5,60,000
Less: Interest @ 10% of `20,00,000 2,00,000 2,00,000
Profit before tax 2,00,000 3,60,000
Less: Tax @ 50% 1,00,000 1,80,000
Profit after tax 1,00,000 1,80,000
÷ No. of shares 20,000 20,000
Earning per share `5.00 `9.00
9.00 − 5.00
% increase in EPS = × 100 = 80%
5.00

EBIT
(2) Financial Leverage =
EBT

4 ,00 ,000
At 2,00,000 units = = 2 times
2,00 ,000
5 ,60 ,000
At 2,40,000 units = = 1.56 times
3 ,60 ,000

Contributi on
(3) Operating Leverage =
EBIT
8 ,00 ,000
At 2,00,000 units = = 2 times
4 ,00 ,000
9 ,60 ,000
At 2,40,000 units = = 1.71 times
5,60 ,000

(4) Increase in production and sales will result in decrease in risk.

 LEVERAGES 2.41
PYQ 31
The balance sheet of Gitashree Ltd. is given below:
Liabilities ` Assets `
Equity Share Capital 1,80,000 Net Fixed Assets 4,50,000
(`10 per share) Current Assets 1,50,000
Retained Earning 60,000
10% Long Term Debt 2,40,000
Current Liabilities 1,20,000
6,00,000 6,00,000

The company's total assets turnover ratio is 4 times, its fixed operating cost is `2,00,000 and its
variable operating cost ratio is 60%. The income tax rate is 30%.

You are required to:

1. (a) Degree of Operating Leverage.
(b) Degree of Financial Leverage.
(c) Degree of Combined Leverage.

2. Determine the likely level of EBIT if EPS is (A) `1.00, (B) `2.00 and (C) `Nil.
[(10 Marks) Nov 2019]

Answer
Contributi on 9 ,60 ,000
1. (a) Operating Leverage = = = 1.26
EBIT 7 ,60 ,000

EBIT 7 ,60 ,000

(b) Financial Leverage = = = 1.03
EBT 7 ,36 ,000

(c) Combined Leverage = OL × FL = 1.26 × 1.03 = 1.30

2. Calculation of likely level of EBIT:

(EBIT − I) (1 − t)
Earnings Per Share =
N
(EBIT − 24,000) (1 − 0.30)
Case A: `1.00 = or EBIT = `49,714
18,000
(EBIT − 24,000) (1 − 0.30)
Case B: `2.00 = or EBIT = `75,429
18,000
(EBIT − 24,000) (1 − 0.30)
Case C: `0.00 = or EBIT = `24,000
18,000

Working Note:
Income Statement
Particulars `
Sales (4 times of 6,00,000) 24,00,000
Less: Variable Cost @ 60% of 24,00,000 14,40,000
Contribution 9,60,000
Less: Fixed Cost 2,00,000
EBIT 7,60,000
Less: Interest @ 10% of 2,40,000 24,000
EBT 7,36,000

PYQ 32
The following data is available for Stone Ltd.:
 LEVERAGES 2.42
Particulars `
Sales 5,00,000
Less: Variable cost @ of 40% of sales 2,00,000
Contribution 3,00,000
Less: Fixed costs 2,00,000
EBIT 1,00,000
Less: Interest 25,000
Profit before tax 75,000

Using the concept of leverage, find out:

(i) The percentage change in taxable income if EBIT increases by 10%.
(ii) The percentage change in EBIT if sales increases by 10%.
(iii) The percentage change in taxable income if sales increases by 10%.

Also verify the results in each of the above case.

[(10 Marks) Nov 2020]

Answer
(i) % change in taxable income (EBT) = % increase in EBIT × FL
= 10% × 1.333 times = 13.33%

(ii) % change in EBIT = % increase in Sales × OL

= 10% × 3 times = 30%

(iii) % change in taxable income (EBT) = % increase in Sales × CL

= 10% × 4 times = 40%

Verification in each case:

(i) % change in taxable income if EBIT increases by 10%:

Revised taxable income (EBT) = EBIT + 10% - Interest

= 1,00,000 + 10% - 25,000 = 85,000

85,000−75,000
% change in taxable income = ×100 = 13.33%
75,000

(ii) % change in EBIT if Sales increases by 10%:

Revised EBIT = (Sales + 10%) - Variable cost @ 40% - Fixed cost

= (5,00,000 + 10%) – 40% of 5,50,000 – 2,00,000
= 1,30,000

1,30,000−1,00,000
% change in EBIT = ×100 = 30%
1,00,000

(iii) % change in taxable income if Sales increases by 10%:

Revised taxable income (EBT) = (Sales+10%) - Variable cost@40% - Fixed cost - Interest
= (5,00,000 + 10%) – 40% of 5,50,000 – 2,00,000 – 25,000
= 1,05,000

1,05,000−75,000
% change in taxable income = ×100 = 40%
75,000

Working Note:
 LEVERAGES 2.43
Contributi on 3 ,00 ,000
(a) Operating Leverage = = = 3 times
EBIT 1 ,00 ,000
EBIT 1 ,00 ,000
(b) Financial Leverage = = = 1.333 times
EBT 75 ,000

(c) Combined Leverage = OL × FL = 3 × 1.333 = 4 times

PYQ 33
The following information related to XYZ Company Ltd. for the year ended 31 st March, 2020 are as
follows:
Equity share capital of `100 each : `50 Lakhs
12% Bonds of `1,000 each : `30 Lakhs
Sales : `84 Lakhs
Fixed cost (Excluding Interest) : `7.5 Lakhs
Financial leverage : 1.39
Profit Volume Ratio : 25%
Market Price per Equity Share : `200
Income Tax Rate Applicable : 30%

You are required to calculate:

(i) Operating Leverage
(ii) Combined Leverage
(iii) Earning Per Share
(iv) Earning Yield
[(10 Marks) Jan 2021]

Answer
Contributi on 21 ,00 ,000
(i) Operating Leverage = = = 1.56 times
EBIT 13 ,50 ,000

(ii) Combined Leverage = OL × FL = 1.56 × 1.39 = 2.16 times

PAT 6 ,93 ,000

(iii) Earnings Per Share = = = `13.86
No of Equity shares 50 ,000

EPS 13.86
(iv) Earnings Yield = × 100 = × 100 = 6.93%
MPS 200

Working Notes:

(1) Contribution = Sales × PV Ratio = 84 Lakhs × 25% = 21,00,000

(2) EBIT = Contribution - Fixed Cost = 21,00,000 – 7,50,000 = 13,50,000

(3) Profit after tax = (EBIT – Interest) (1 - t)

= (13,50,000 – 12% of 30,00,000) (1 – 0.30) = 6,93,000

PYQ 34
A Company had the following Balance Sheet as on 31st March 31, 2021:
Liabilities ` (in Crores) Assets ` (in Crores)
Equity Share Capital 7.50 Building 12.50
(75 lakhs Shares of `10 each) Machinery 6.25
Reserve and Surplus 1.50 Current Assets:
15% Debentures 15.00 Stock 3.00
 LEVERAGES 2.44
Current Liabilities 6.00 Debtors 3.25
Bank Balance 5.00
30.00 30.00

The additional information given is as under:

Fixed costs per annum (excluding interest) : `6 Crores
Variable operating costs ratio : 60% of sales
Total assets turnover ratio : 2.5 times
Income tax rate : 40%

Calculate the following and comment:

(a) Earnings per share
(b) Operating Leverage
(c) Financial Leverage
(d) Combined Leverage
[(10 Marks) July 2021]

Answer
(a) Statement of EPS
Particulars ` (in Crores)
Sales @ (2.50 times of `30 Crores) 75.00
Less: Variable cost @ 60% 45.00
Contribution 30.00
Less: Fixed cost 6.00
EBIT 24.00
Less: Interest @ 15% of 15 Crores 2.25
EBT 21.75
Less: Tax @ 40% 8.70
EAT 13.05
÷ No. of Equity Shares ÷ 0.75
EPS `17.40

EPS indicates the amount the company earns per share. Investors use this as a guide while valuing the share
and making investment decisions. It is also an indicator used in comparing firms within an industry or industry
segment.

Contributi on 30 Crores
(b) Operating Leverage = = = 1.25 times
EBIT 24 Crores

It indicates the choice of technology and fixed cost in cost structure. It is level specific. When firm operates
beyond operating break-even level, then operating leverage is low. It indicates sensitivity of earnings before
interest and tax (EBIT) to change in sales at a particular level.

EBIT 24 Crores
(c) Financial Leverage = = = 1.10 times
EBT 21 .75 Crores

The financial leverage is very comfortable since the debt service obligation is small vis-a-vis EBIT.

(d) Combined Leverage = OL × FL = 1.25 × 1.10 = 1.38 times

The combined leverage studies the choice of fixed cost in cost structure and choice of debt in capital structure.
It studies how sensitive the change in EPS is vis-a-vis change in sales.

PYQ 35
Information of A Ltd. is given below:
 Earnings after tax : 5% of sales
 LEVERAGES 2.45
 Income tax rate : 50%
 Degree of Operating leverage : 4 times
 10% Debenture in capital structure : `3 lakhs
 Variable costs : `6 lakhs

Required:
(i) From the given data complete following statement:
Sales XXXX
Less: Variable Costs `6,00,000
Contribution XXXX
Less: Fixed costs XXXX
EBIT XXXX
Less: Interest expenses XXXX
EBT XXXX
Less: Income tax XXXX
EAT XXXX

(ii) Calculate Financial Leverage and Combined Leverage.

(iii) Calculate percentage change in earning per share, if sales increased by 5%.
[(10 Marks) Dec 2021]

Answer
(i) Statement of EAT
Particulars `
Sales 12,00,000
Less: Variable Costs 6,00,000
Contribution 6,00,000
Less: Fixed costs 4,50,000
EBIT 1,50,000
Less: Interest expenses @ 10% of `3 lakhs 30,000
EBT 1,20,000
Less: Income tax 60,000
EAT @5% of `12,00,000 `60,000

EBIT 1 ,50 ,000

(ii) Financial Leverage = = = 1.25 times
EBT 1 ,20 ,000

Combined Leverage = OL × FL = 4 × 1.25 = 5 times

(iii) % change in EPS = % change in Sales × CL = 5% × 5 = 25% Increased

Working Notes:
Contributi on Contributi on
(a) Operating Leverage = = = 4
EBIT Contributi on  Fixed cos t
Contribution = 4 Contribution – 4 Fixed cost
- 3 Contribution = - 4 Fixed cost
¾ Contribution = Fixed cost
Contribution = Sales – Variable cost = Sales – `6,00,000
∴ Fixed cost = ¾ or 75% of contribution = 75% (Sales - `6,00,000)
= 75% Sales - `4,50,000

(b) EAT = 5% of Sales

EBT = EAT ÷ (1 - t) = 5% Sales ÷ (1 – 0.5)
= 10% Sales
 LEVERAGES 2.46

(c) EBT = Sales – Variable cost – Fixed cost – Interest

10% Sales = Sales - `6,00,000 – (75% Sales - `4,50,000) - `30,000
10% Sales = Sales - `6,00,000 – 75% Sales + `4,50,000 - `30,000
10% Sales = 25% Sales - `1,80,000
15% Sales = `1,80,000
Sales = `1,80,000 ÷ 15% = `12,00,000

(d) EBT = 10% of Sales = 10% of `12,00,000

= `1,20,000

(e) EBIT = EBT + Interest = `1,20,000 + `30,000

= `1,50,000

(f) Fixed cost = 75% of Contribution = 75% of `6,00,000

= `4,50,000

PYQ 36
Details of a company for the year ended 31st March, 2022 are given below:

Sales : `86,00,000
Profit Volume (P/V) Ratio : 35%
Fixed Cost excluding interest expense : `10,00,000
10% Debt : `55,00,000
Equity Share Capital of `10 each : `75,00,000
Income Tax Rate : 40%

Required:
(1) Determine company’s Return on Capital Employed (Pre-tax) and EPS.
(2) Does the company have a favourable financial leverage?
(3) Calculate operating and combined leverage of the company.
(4) Calculate percentage change in EBIT, if sales increases by 10%
(5) At what level of sales, the Earning before tax (EBT) of the company will be equal to zero?
[(10 Marks) May 2022]

Answer
EBIT 20 ,10 ,000
(1) ROCE = ×100 = ×100 = 15.46%
Capital Employed 55,00 ,000  75,00 ,000

Statement of EPS
Particulars `
Sales 86,00,000
Less: Variable cost @ of 65% (100 – P/V ratio) of sales 55,90,000
Contribution 30,10,000
Less: Fixed costs 10,00,000
EBIT 20,10,000
Less: Interest @ 10% of 55,00,000 5,50,000
EBT 14,60,000
Less: Income Tax @ 40% 5,84,000
EAT 8,76,000
÷ Number of Equity Shares ÷ 7,50,000
EPS 1.168

(2) ROCE is 15.46% and Interest on debt is 10%, hence, it has a favourable financial leverage.
(3) Calculation of Operating and Combined leverages:
 LEVERAGES 2.47
Contributi on 30 ,10 ,000
Operating Leverage = = = 1.497
EBIT 20 ,10 ,000

Contributi on 30 ,10 ,000

Combined Leverage = = = 2.062
EBT 14 ,60 ,000

(4) Operating leverage is 1.497. So if sales is increased by 10% then EBIT will be increased by 1.497 × 10
i.e. 14.97% (approx.)

(5) EBT = Sales – Variable cost – Fixed cost – Interest

Nil = Sales – 65% sales – 10,00,000 – 5,50,000
35% of sales = 15,50,000
Sales = `44,28,571

PYQ 37
The following information is available for SS Ltd.

Profit volume (PV) ratio - 30%

Operating leverage - 2.00
Financial leverage - 1.50
Loan - `1,25,000
Post-tax interest rate - 5.6%
Tax rate - 30%
Market Price per share (MPS) - `140
Price Earnings Ratio (PER) - 10

You are required to

(1) Prepare the Profit-Loss statement of SS Ltd. and
(2) Find out the number of equity shares.
[(10 Marks) Nov 2022]

Answer
(1) Profit-Loss Statement
Particulars Company A
Sales 2,00,000
Less: Variable cost (b.f.) 1,40,000
Contribution 60,000
Less: Fixed cost (b.f.) 30,000
Earnings before interest and tax (EBIT) 30,000
Less: Interest 10,000
Profit before tax 20,000
Less: Tax @ 30% 6,000
Profit after tax 14,000

(2) Number of Equity Shares = PAT/EPS = `14,000/`14 = 1,000 Shares

Working Notes:
(a) Financial Leverage = EBIT/(EBIT - Interest)
= EBIT/(EBIT – `10,000*) = 1.5
EBIT = 1.5 EBIT – `15,000
EBIT = `30,000

*Interest = Loan × Pre-tax interest rate

= `1,25,000 × 8% [5.6% ÷ (1 – 0.3)] = `10,000

(b) Operating Leverage = Contribution/EBIT

 LEVERAGES 2.48
= Contribution/30,000 = 2.00
Contribution = `60,000

(c) Sales = Contribution/PV Ratio

= `60,000/0.30 = `2,00,000

(d) EPS = MPS/PE Ratio

= `140/10 times = `14

PYQ 38
Following information is given for X Ltd:
Total contribution (`) 4,25,000
Operating leverage 3.125
15% Preference shares (`100 each) 1,000
Number of equity shares 2,500
Tax rate 50%

Calculate EPS of X Ltd., if 40% decrease in sales will result EPS to zero.
[(5 Marks) May 23]

Answer
EPS of X Ltd. = {EBT (1 – t) – PD} ÷ No of Equity Shares
= {2,00,000 (1 – 0.5) – 15,000} ÷ 2,500 = `34

Working Note:

Calculation of CL and EBT:

Question says that 40% decrease in sales will result in 100% decrease in EPS:

% Change in EPS 100 %

Combined Leverage = = = 2.5 times
% Change in Sales 40 %

= Contributi on = 4 ,25,000
Pr eference Dividend 15,000
EBT  EBT 
1  Tax 1  0.50

4 ,25 ,000
2.5 =
EBT  30 ,000
2.5 EBT – 75,000 = 4,25,000

EBT = 2,00,000
 LEVERAGES 2.49

SUGGESTED REVISION
Page No. of 3rd, 4th & Revision
Ques. Observations or KEY Points 1st & 2nd
Practical 5th during
No. (Note down during revisions) Revision
Register Revision Exams
BQ (Book Questions covering Study Module of ICAI, PM, RTP’s, MTP’s and Important Questions)
1 Y - -
2 Y - -
3 Y - -
4 Y - -
5 Y Y -
6 Y Y -
7 Y - -
8 Y Y Y
9 Y Y Y
10 Y Y Y
11 Y Y Y
12 Y Y Y
13 Y Y -
14 Y Y Y
15 Y Y Y
16 Y Y -
17 Y Y -
18 Y Y Y
19 Y Y Y
20 Y Y Y
21 Y Y Y
22 Y Y Y
23 Y Y Y
24 Y - -
25 Y Y -
26 Y Y Y
27 Y Y -
28 Y Y Y
29 Y Y Y
30 Y Y Y
PYQ (Past Year Questions)
1 Y Y Y
2 Y - -
3 Y Y Y
4 Y Y Y
5 Y Y Y
6 Y - -
7 Y - -
8 Y Y -
9 Y Y Y
10 Y - -
11 Y Y -
12 Y - -
13 Y Y Y
14 Y Y Y
15 Y Y -
16 Y - -
17 Y - -
 LEVERAGES 2.50
18 Y - -
19 Y - -
20 Y Y -
21 Y - -
22 Y - -
23 Y Y Y
24 Y Y Y
25 Y - -
26 Y - -
27 Y - -
28 Y - -
29 Y Y -
30 Y - -
31 Y - -
32 Y Y Y
33 Y Y Y
34 Y Y Y
35 Y Y Y
36 Y Y Y
37 Y Y Y
38 Y Y Y
 CHAPTER - 3

MANAGEMENT OF
RECEIVABLES & PAYABLES

LEARNING OBJECTIVES

After studying this chapter you will be able to:

 Discuss in details about management of receivables, its meanings
and its significance to any business.
 Understand the concept of credit policies and the estimation of
optimum credit period and credit amount.
 Understand the need for a business to invest in receivables.
 Know why it is important to manage efficiently the receivables?
 Discuss the cost of receivables.
 Understand the concept of factoring and its types.
 Understand the concept of management of payables.
 MANAGEMENT OF RECEIVABLES & PAYABLES 3.2
EVALUATION OF CREDIT POLICIES
BQ 1
Gemini Products Ltd. is considering the revision of its credit policy with a view to increasing its sales and
profits. Currently all its sales are on credit and the customers are given one month time to settle the dues. It
has a contribution of 40% on sales and it can raise additional funds at a cost of 20% per annum. The marketing
director of the company has given the following options with draft estimates for consideration:
Particulars Existing Option 1 Option 2 Option 3
Sales (` in lacs) 200 210 220 250
Credit period (in months) 1 1.5 2 3
Bad debts (` in lacs) 2 2.5 3 5
Cost of administration (` in lacs) 1.20 1.30 1.5 3.00
Advise the company to take the right decision. (Workings should form part of the answer)

Answer
Statement of Evaluation of Credit Policies (Total Approach)
Classifications (in Lakhs)
Particulars
Existing Option 1 Option 2 Option 3
Credit sales 200 210 220 250
Less: Variable cost @ 60% 120 126 132 150
Profit before bad debts and admin cost 80 84 88 100
Less: Bad debts 2 2.5 3 5
Less : Cost of administration 1.2 1.3 1.5 3
Expected Profit 76.80 80.20 83.5 92
Less: Cost of funds 2 3.15 4.40 7.50
Net Benefit 74.80 77.05 79.10 84.50
Working Notes:
Calculation of cost of funds
Existing Option 1 Option 2 Option 3
120 × 1/12 × 20% 126 × 1.5/12 × 20% 132 × 2/12 × 20% 150 × 3/12 × 20%
= 2.00 = 3.15 = 4.40 = 7.50
Select Option 3 with credit of 3 months having higher net benefit.
Note:
In the above solution, investment in accounts receivable is based on total cost of goods sold on credit. Since
fixed costs are not given in the problem, therefore, it is assumed that there are no fixed costs and investment
in receivables is determined with reference to variable costs only. The above solution may alternatively be
worked out on the basis of incremental approach. However, the recommendation would remain the same.

BQ 2
ABC Ltd. is considering the following credit policy alternatives:
Particulars Existing Option 1 Option 2
Sales (` in lacs) 10.00 9.60 12.00
Credit period (in days) 30 41 60
Bad debts (% of sales) 5 3.33 6
Cost of administration (` in lacs) .20 .12 .25
Average effective collection period (in days) 45 51 72
The average effective collection period differs from the credit period as all debtors do not strictly
adhere to the condition stipulated. The company achieves a contribution of 40% on sales and the firm requires
a 20% p.a. return on investment.

You are required to suggest which credit period is more suitable to the company. Do you have any
further suggestions to make to the management in the context of your finding?
 MANAGEMENT OF RECEIVABLES & PAYABLES 3.3
Answer
Statement of Evaluation of Credit Policies (Total Approach)
Particulars Existing Option 1 Option 2
Credit sales 10,00,000 9,60,000 12,00,000
Less: Variable cost @ 60% 6,00,000 5,76,000 7,20,000
Profit before bad debts and admin cost 4,00,000 3,84,000 4,80,000
Less: Bad debts 50,000 31,968 72,000
Less : Cost of administration 20,000 12,000 25,000
Expected Profit 3,30,000 3,40,032 3,83,000
Less: Cost of funds 14,795 16,096 28,405
Net Benefit 3,15,205 3,23,936 3,54,595

Working notes
Calculation of required return on investment:
Existing = 6,00,000 × 45/365 × 20% = 14,795
Option 1 = 5,76,000 × 51/365 × 20% = 16,096
Option 2 = 7,20,000 × 72/365 × 20% = 28,405

Select Option 2 with credit period of 60 Days. It is further suggested that company should collect amount
from debtors within credit period allowed.

BQ 3
The following are the details regarding the operation of a firm during a period of 12 months:
Sales `12,00,000
Selling price `10 per unit
Variable cost `7 per unit
Total cost `9 per unit
Credit period allowed to customers One month
The firm is considering a proposal for a more liberal extension of credit by increasing the average
collection period from one month to two months. This relaxation is expected to increase the sales by 25%.

You are required to advise the firm regarding adopting of the new credit policy, presuming that
the firm's required return on investment is 25%.

Answer
Statement of Evaluation of Proposed Policy
Policies
Particulars
Present Proposed
Sales units 1,20,000 1,50,000
Sales value 12,00,000 15,00,000
Less: Variable cost @ `7 per unit/ 70% 8,40,000 10,50,000
Less: Fixed Cost (1,20,000 × `2) 2,40,000 2,40,000
Expected Profit 1,20,000 2,10,000
Less: Required return @ 25% on investment in debtors 22,500 53,750
Net Benefit 97,500 1,56,250
Incremental Benefit - 58,750
Calculation of required return on investment in cost of debtors:
Existing = (8,40,000 + 2,40,000) × 1/12 × 25% = 22,500
Proposed = (10,50,000 + 2,40,000) × 2/12 × 25% = 53,750

Analysis: The proposal for a more liberal extension of credit by increasing the average collection period from
one month to two months is suggested to adopt.
 MANAGEMENT OF RECEIVABLES & PAYABLES 3.4
BQ 4
A company sells 40,000 units of its product per year @ `35 per unit. The average cost per unit is `31 out of
which variable cost per unit is `28. The average collection period is 60 days. Bad debts losses are 3% on sales
and the collection charges amount to `15,000.
The company is considering the proposal to follow stricter collection policy which would bring down
the losses on account of bad debts to 1% of sales and average collection period to 45 days. It would, however,
reduce the sales volume by 1,000 units and increase collection expenses to `25,000. The company requires a
rate of return of 20%.
Would you recommend the adoption of the new credit policy? (Assume 360 days in a year for the
purpose of your calculation.)

Answer
Statement of Evaluation of Proposed policy
Policies
Particulars
Present Proposed
Sales units 40,000 39,000
Sales value @ `35 per unit 14,00,000 13,65,000
Less: Variable cost @ `28 per unit 11,20,000 10,92,000
Less: Fixed Cost (40,000 × `3) 1,20,000 1,20,000
Profit before cost of credit 1,60,000 1,53,000
Less: Bad debts @ 3% / 1% 42,000 13,650
Less: Collection charges 15,000 25,000
Expected Profit 1,03,000 1,14,350
Less: Required return @ 20% on investment in debtors 41,333 30,300
Net Benefit 61,667 84,050
Incremental Benefit - 22,383
Analysis: Company should adopt stricter policy of credit i.e. 45 days of credit having higher net benefit.

Working notes:
Calculation of required return on investment in cost of debtors:
Existing = (11,20,000 + 1,20,000) × 60/360 × 20% = 41,333
Proposed = (10,92,000 + 1,20,000) × 45/360 × 20% = 30,300

BQ 5
XYZ Corporation is considering relaxing its present credit policy and is in the process of evaluating two
proposed policies. Currently, the firm has annual credit sales of `50 lakhs and accounts receivable turnover
ratio of 4 times a year. The current level of loss due to bad debts is `1,50,000. The firm is required to give a
return of 25% on the investment in new accounts receivables. The company’s variable costs are 70% of the
selling price. Given the following information, identify which is the better option?
Policies
Particulars
Present Option 1 Option 2
Annual credit sales `50,00,000 `60,00,000 `67,50,000
Account receivable turnover ratio 4 times 3 times 2.4 times
Bad debt losses `1,50,000 `3,00,000 `4,50,000

Answer
Statement of Evaluation of Credit Policies
Particulars Existing Option 1 Option 2
Credit sales 50,00,000 60,00,000 67,50,000
Less: Variable cost @ 70% 35,00,000 42,00,000 47,25,000
Profit before bad debt losses 15,00,000 18,00,000 20,25,000
Less: Bad debt losses 1,50,000 3,00,000 4,50,000
 MANAGEMENT OF RECEIVABLES & PAYABLES 3.5
Expected Profit 13,50,000 15,00,000 15,75,000
Less: Required return on investment ‘WN’ 2,18,750 3,50,000 4,92,188
Net Benefit 11,31,250 11,50,000 10,82,812
Working notes:
Calculation of required return on investment:
Existing = 35,00,000 × 1/4 × 25% = 2,18,750
Option 1 = 42,00,000 × 1/3 × 25% = 3,50,000
Option 2 = 47,25,000 × 1/2.4 × 25% = 4,92,188

Recommendation: The Proposed Policy I (option 1) should be adopted since the net benefits under this policy
are higher as compared to other policies.

BQ 6
Mosaic Limited has current sales of `15 lakhs per year. Cost of sales is 75 per cent of sales and bad debts are
one per cent of sales. Cost of sales comprises 80 per cent variable costs and 20 per cent fixed costs, while the
company’s required rate of return is 12 per cent. Mosaic Limited currently allows customers 30 days’ credit,
but is considering increasing this to 60 days’ credit in order to increase sales.

It has been estimated that this change in policy will increase sales by 15 per cent, while bad debts will
increase from one per cent to four per cent. It is not expected that the policy change will result in an increase
in fixed costs and creditors and stock will be unchanged.

Should Mosaic Limited introduce the proposed policy? Analyse (Assume a 360 days year)

Answer
Statement of Evaluation
Policies
Particulars
Present Proposed
Sales value 15,00,000 17,25,000
Less: Variable cost @ 80% 9,00,000 10,35,000
Less: Fixed cost 2,25,000 2,25,000
Profit before bad debt losses 3,75,000 4,65,000
Less: Bad debt losses @1%/4% 15,000 69,000
Expected Profit 3,60,000 3,96,000
Less: Required return on investment ‘WN’ 11,250 25,200
Net Benefit 3,48,750 3,70,800

Advise: Mosaic Limited should introduce the proposed policy.

Working notes:
Calculation of Variable cost:
Existing = 15,00,000 × 75% × 80% = 9,00,000
Proposed = 9,00,000 + 15% = 10,35,000

Calculation of Fixed cost:

Existing = 15,00,000 × 75% × 20% = 2,25,000
Proposed = Same as at existing level = 2,25,000

Calculation of required return:

Existing = 11,25,000 × 30/360 × 12% = 11,250
Proposed = 12,60,000 × 60/360 × 12% = 25,200
 MANAGEMENT OF RECEIVABLES & PAYABLES 3.6
BQ 7
A trader whose current sales are in the region of `6 lakhs per annum and an average collection period of 30
days wants to pursue a more liberal policy to improve sales. A study made by a management consultant reveals
the following information:
Increase in Collection Present default
Credit Policy Increase in Sales
Period anticipated
A 10 days `30,000 1.5%
B 20 days `48,000 2%
C 30 days `75,000 3%
D 45 days `90,000 4%

The selling price per unit is `3. Average cost per unit is `2.25 and variable costs per unit are `2. The current
bad debt loss is 1%. Required return on additional investment is 20%. Assume a 360 days year.
Analyse which of the above policies would you recommend for adoption?

Answer
Statement of Evaluation of Credit Policies
Particulars Existing A B C D
No of units 2,00,000 2,10,000 2,16,000 2,25,000 2,30,000
Credit sales @ `3 per unit 6,00,000 6,30,000 6,48,000 6,75,000 6,90,000
Less: Variable cost @ `2 per unit 4,00,000 4,20,000 4,32,000 4,50,000 4,60,000
Less: Fixed cost (2.25 - 2) × 2,00,000 50,000 50,000 50,000 50,000 50,000
Profit before bad debt losses 1,50,000 1,60,000 1,66,000 1,75,000 1,80,000
Less: Bad debt losses 6,000 9,450 12,960 20,250 27,600
Expected Profit 1,44,000 1,50,550 1,53,040 1,54,750 1,52,400
Less: Required return on investment 7,500 10,444 13,389 16,667 21,250
Net Benefit 1,36,500 1,40,106 1,39,651 1,38,083 1,31,150
Recommendation: The Proposed Policy A (i.e. increase in collection period by 10 days or total 40 days) should
be adopted since the net benefits under this policy are higher as compared to other policies.

Working notes:
Calculation of cost required rate of return:
Collection Period
Required rate of return = Total cost × × Rate of return
360 Days
30
Existing Policy = 4,50,000 × × 20% = 7,500
360 Days
40
Credit Policy A = 4,70,000 × × 20% = 10,444
360 Days
50
Credit Policy B = 4,82,000 × × 20% = 13,389
360 Days
60
Credit Policy C = 5,00,000 × × 20% = 16,667
360 Days
75
Credit Policy D = 5,10,000 × × 20% = 21,250
360 Days

BQ 8
As a part of the strategy to increase sales and profits, the sales manager of a company proposes to sell goods
to a group of new customers with 10% risk of non-payment. This group would require one and a half months
credit and is likely to increase sales by `1,00,000 p.a. Production and Selling expenses amount to 80% of sales
and the income-tax rate is 50%. The company’s minimum required rate of return (after tax) is 25%.
(1) Should the sales manager’s proposal be accepted?
(2) Also find the degree of risk of non-payment that the company should be willing to assume if the
required rate of return (after tax) were (i) 30%, (ii) 40% and (iii) 60%.
 MANAGEMENT OF RECEIVABLES & PAYABLES 3.7
Answer
(1) Statement of Evaluation
Particulars `
Increase in sales 1,00,000
Less: Cost of sales @ 80% 80,000
Profit before bad debts 20,000
Less: Bad debts @ 10% 10,000
Expected PBT 10,000
Less: Tax @ 50% 5,000
Expected PAT 5,000
Less: Required return after tax (80,000 × 1.5/12 × 25%) 2,500
Net Benefit (After Tax) 2,500

Advise: The sales manager’s proposal should be accepted.

(2) Computation the Degree of risk of non-payment:

Required return after tax = (Sales – Cost of sales – Risk of non payment) (1 - t)

Case I
Required return after tax = (Sales – Cost of sales – Risk of non payment) (1 - t)
80,000 × 1.5/12 × 30% = (1,00,000 – 80,000 - Risk of non payment) (1 - .50)
Risk of non payment = 14,000
Degree of risk of non-payment = 14,000/
1,00,000 × 100 = 14%

Case II
Required return after tax = (Sales – Cost of sales – Risk of non payment) (1 - t)
80,000 × 1.5/12 × 40% = (1,00,000 – 80,000 - Risk of non payment) (1 - .50)
Risk of non payment = 12,000
Degree of risk of non-payment = 12,000/
1,00,000 × 100 = 12%

Case III
Required return after tax = (Sales – Cost of sales – Risk of non payment) (1 - t)
80,000 × 1.5/12 × 60% = (1,00,000 – 80,000 - Risk of non payment) (1 - .50)
Risk of non payment = 8,000
Degree of risk of non-payment = 8,000/
1,00,000 × 100 = 8%

BQ 9
Slow Payers are regular customer of Goods Dealers Ltd., Calcutta and have approached the sellers of extension
of a credit facility for enabling them to purchase goods from Goods Dealer Ltd. On an analysis of past
performance and on the basis of information supplied, the following pattern of payment schedule is regard to
Slow Payers:
Pattern of Payment Schedule
At the end of 30 Days 15% of the bills
At the end of 60 Days 34% of the bills
At the end of 90 Days 30% of the bills
At the end of 100 Days 20% of the bills
Non-recovery 1% of the bills

Slow Payers want to enter into a firm commitment for purchase of goods of `15 Lacs in 2023, deliveries
to be made in equal quantities on the first day of each quarter in the calendar year. The price per unit of
commodity is `150 on which a profit of `5 per unit is expected to be made. It is anticipated by Goods Dealers
Ltd. that taking up of this contract would mean an extra recurring expenditure of `5,000 per annum.

If the opportunity cost of funds in the hands of Goods dealers is 24% per annum, would you as the
finance manager of the seller recommend the grant of credit to Slow Payers? Workings should form part
of your answer. Assume year of 365 days.
 MANAGEMENT OF RECEIVABLES & PAYABLES 3.8
Answer
Statement of Evaluation of Credit Policy
Particulars Proposed
Sales in units 10,000
Sales value @ `150 per unit 15,00,000
Less: Variable cost @ `145 per unit 14,50,000
Less: Extra recurring expenditure 5,000
Profit before bad debt 45,000
Less: Bad debts @ 1% 15,000
Expected Profit 30,000
Less: Opportunity cost of investment in receivables (WN) 68,788
Net Benefit (38,788)

Recommendation: The proposed policy should not be adopted since the net benefit under this policy is
negative.

Working notes:
Calculation of Opportunity cost of average investment:
Average Collection Period
Opportunity cost = Total cost × × Rate
365
= 14,55,000 × 71.90/365 × 24% = 68,788

Calculation of Average collection period:

Average collection period = 30 days × 15% + 60 days × 34% + 90 days × 30% + 100 days × 20%
= 71.90 Days

BQ 10
A regular customer of your company has approached to you for extension of a credit facility for enabling them
to purchase goods. On an analysis of past performance and on the basis of information supplied, the following
pattern of payment schedule emerges:
Pattern of Payment Schedule
At the end of 30 Days 20% of the bills
At the end of 60 Days 30% of the bills
At the end of 90 Days 30% of the bills
At the end of 100 Days 18% of the bills
Non-recovery 2% of the bills

The customer wants to enter into a firm commitment for purchase of goods of `30 Lacs in 2023,
deliveries to be made in equal quantities on the first day of each quarter in the calendar year. The price per
unit of commodity is `300 on which a profit of `10 per unit is expected to be made. It is anticipated that taking
up of this contract would mean an extra recurring expenditure of `10,000 per annum.

If the opportunity cost is 18% per annum, would you as the finance manager of the company
recommend the grant of credit to the customer? Assume year of 360 days.

Answer
Statement of Evaluation of Credit Policy
Particulars Proposed
Sales in units 10,000
Sales value @ `300 per unit 30,00,000
Less: Variable cost @ `290 per unit 29,00,000
Less: Extra recurring expenditure 10,000
Profit before bad debt 90,000
Less: Bad debts @ 2% 60,000
 MANAGEMENT OF RECEIVABLES & PAYABLES 3.9
Expected Profit 30,000
Less: Opportunity cost of investment in receivables (WN) 1,00,395
Net Benefit (70,395)

Recommendation: The proposed policy should not be adopted since the net benefit under this policy is
negative.

Working notes:
Calculation of Opportunity cost of average investment:
Average Collection Period
Opportunity cost = Total cost × × Rate
360
= 29,10,000 × 69/360 × 18% = 1,00,395

Calculation of Average collection period:

Average collection period = 30 days × 20% + 60 days × 30% + 90 days × 30% + 100 days × 18%
= 69 Days

BQ 11
Star Limited manufacturer of color TV sets, are considering the liberalization of existing credit terms to three
of their large customers A, B and C. The credit period and likely quantity of TV sets that will be lifted by the
customers are as follows:
Quantity Lifted (No. of TV Sets)
Credit Period (Days) A B C
0 1,000 1,000 -
30 1,000 1,500 -
60 1,000 2,000 1,000
90 1,000 2,500 1,500

The selling price per TV set is `9,000. The expected contribution is 20% of the selling price. The cost of carrying
debtors averages 20% per annum.

You are required:

(a) Determine the credit period to be allowed to each customer. (Assume 360 days in a year for calculation
purposes).
(b) What other problems the company might face in allowing the credit period as determined in (a) above?

Answer
(a) In case of customer A, there is no increase in sales even if the credit is given. Hence, it is suggested not
to extend any credit period to customer A. Statement of evaluation for B and C is given below:
(` Lakhs)
Particulars Customer B Customer C
Credit period (days) 0 30 60 90 60 90
Sales (units) 1,000 1,500 2,000 2,500 1,000 1,500
Sales 90 135 180 225 90 135
Less: Variable cost @ 80% 72 108 144 180 72 108
Contribution 18 27 36 45 18 27
Less: Cost of debtors @ 20% - 1.8 4.8 9 2.4 5.4
Net Benefit 18 25.2 31.2 36 15.6 21.6

The excess of contribution over cost of carrying Debtors is highest in case of credit period of 90 days in respect
of both the customers B and C. Hence, credit period of 90 days should be allowed to B and C.

(b) Problems:
1. Customer A is taking 1,000 TV sets whether credit is given or not. Customer C is taking 1,000 TV sets
at credit for 60 days. Hence, A also may demand credit for 60 days compulsorily.
 MANAGEMENT OF RECEIVABLES & PAYABLES 3.10
2. B will take 2,500 TV sets at credit for 90 days whereas C would lift 1,500 sets only. In such case B
will demand further relaxation in credit period i.e. B may ask for 120 days credit.

BQ 12
A company offers standard credit terms of 60 days net. Its cost of short term borrowings is 16% per annum.
Determine whether a 2.5% discount should be offered for payment within7 days to customers who would
normally pay after (i) 60 days (ii) 80 days, and (iii) 105 days.

Answer
This cost of using a discount to obtain funds and improve liquidity should be compared with alternative
sources of finance. If the cost of short term borrowings is 16%, then cost of discount offer must be less than
this, otherwise discount need not be offered. A customer who is paying after 60, 80 or 105 days involves a cost
@ 16% per annum for the respective period.

If the firm offers a discount @ 2.5% for payment within 7 days, then it means that 97.5% of the fund
will be available for 53 days, 73 days and 98 days respectively. The percentage cost of getting funds for
respective period is `2.50/`97.50.

However, the annual percentage cost of the discount in each case is the discount should be offered to
customers who would have paid after 80 or 105 days, and not to those who would have paid after 60 days. The
reason is being that the cost of funds is 16% and the customers who would have paid after 60 days, would
inflict a cost of 17.66% if the discount terms are offered to them.

2.50 365
(a) × = 17.66% p.a.
97.50 53

2.50 365
(b) × = 12.82% p.a.
97.50 73

2.50 365
(c) × = 9.55% p.a.
97.50 98

BQ 13
The Dolce Company purchases raw materials on terms of 2/10, net 30. A review of the company’s records by
the owner, Mr. Gautam, revealed that payments are usually made 15 days after purchases are made. When
asked why the firm did not take advantage of its discounts, the accountant, Mr. Rohit, replied that it cost only
2% for these funds, whereas a bank loan would cost the company 12%.

(a) Analyse, what mistake is Rohit making?

(b) If the firm could not borrow from the bank and was forced to resort to the use of trade credit funds,
what suggestion might be made to Rohit that would reduce the annual interest cost? Identify.

Answer
(a) Rohit’s argument of comparing 2% discount with 12% bank loan rate is not rational as 2% discount
can be earned by making payment 5 days in advance i.e. within 10 days rather 15 days as payments
are made presently. Whereas 12% bank loan rate is for a year.

Assume that the purchase value is `100, the discount can be earned by making payment within 10 days
is `2, therefore, net payment would be `98 only. Annualized benefit:
2 365
× × 100 = 148.98% p.a.
98 5
This means cost of not taking cash discount is 148.98%.

(b) If the bank loan facility could not be available, then in this case the company should resort to utilise
maximum credit period as possible. Therefore, payment should be made in 30 days to reduce the
interest cost. The annual interest cost in such case:
 MANAGEMENT OF RECEIVABLES & PAYABLES 3.11
2 365
× × 100 = 37.24% p.a.
98 20

BQ 14
The Alliance Ltd., a petrochemical sector company had just invested huge amount in its new expension project.
Due to huge capital investment, the company is in need of an additional `1,50,000 in working capital
immediately. The finance manager has determined the following three feasible sources of funds:

(a) Bank loan: The Company’s bank will lend `2,00,000 at 15%. A 10% compensating balance will be
required, which otherwise would not be maintained by the company.

(b) Trade credit: The Company has been offered credit term from its major supplier of 3/30, net 90 for
purchasing raw materials worth `1,00,000 per month

(c) Factoring: A factoring firm will buy the company’s receivables of `2,00,000 per month, which have a
collection period of 60 days. The factor will advance up to 75% of the face value of the receivables at
12% on an annual basis. The factor will also charge commission of 2% on all receivables purchased. It
has been estimated that the factor’s services will save the company a credit department expense and
bad debt expenses of `1,250 and `1,750 per month respectively.

On the basis of annual percentage cost, Advise which alternative should the company select?
Assume 360 days year.

Answer
(a) Bank Loan:
Loan amount will be `2,00,000, company has to pay 15% interest on `2,00,000 but company can use
only `1,80,000. The real cost of bank loan would be
15 % of 2 ,00 ,000
× 100 = 16.67% p.a.
1 ,80 ,000

(b) Trade Credit:

If discounts are not taken, the real cost of not taking advantage of the discount would be:
3 360
× × 100 = 18.56% p.a.
97 60

(c) Factoring:
The factor commission for the year would be (2% of `24,00,000) `48,000. Borrowing `1,50,000 (75%
of `2,00,000) attract interest of `18,000 p.a. (12% interest will be paid on `1,50,000) on the receivables
The savings effected, however, would be `36,000 p.a. [(`1,250 + `1,750) × 12], giving a net factoring cost
of `30,000 (`48,000 + `18,000 – `36,000). Thus cost would be:
30 ,000
× 100 = 20% p.a.
1 ,50 ,000

Advise: The company should select alternative of Bank Loan as it has the lowest annual cost i.e. 16.67% p.a.

FACTORING SERVICES
BQ 15
A company is considering using a factor, the following information is relevant:
(a) The current average collection period for the company's debts is 80 days and ½% of debt default. The
factor has agreed to pay over money due, after 60 days, and it will suffer loss of any bad debts.
(b) The annual charge for the factoring is 2% of turnover payable annually in arrears. Administration cost
saving will total `1,00,000 per annum.
 MANAGEMENT OF RECEIVABLES & PAYABLES 3.12
(c) Annual sales, all on credit are `1,00,00,000. Variable costs total 80% of sales price. The company's cost of
borrowings is 15% per annum. Assume year consisting of 365 days. Should the company enter into a
factoring agreement?

Answer
Statement of Evaluation
Particulars `
(A) Savings:
Saving in administration cost 1,00,000
Saving in bad debts (0.5% of 1,00,00,000) 50,000
*Saving in cost of debtors (1,00,00,000 × 80% × 80 – 60/365 × 15%) 65,753
Total (A) 2,15,753
(B) Cost:
Annual charges (2% of 1,00,00,000) 2,00,000
Total (B) 2,00,000
Net Benefit (A -B) 15,753

*Presently, the debtors of the company pay after 80 days. However, the factor has agreed to pay after 60 days
only. So, the investment in Debtors will be reduced by 20 days.

Conclusion: Yes, company should enter into factoring agreement.

BQ 16
A Factoring firm has credit sales of `360 lakhs and its average collection period is 30 days. The financial
controller estimates, bad debt losses are around 2% of credit sales. The firm spends `1,40,000 annually on
debtors administration. This cost comprises of telephonic and fax bills along with salaries of staff members.
These are the avoidable costs. A Factoring firm has offered to buy the firm’s receivables. The factor will charge
1% commission and will pay an advance against receivables on an interest @15% p.a. after withholding 10%
as reserve.

What should the firm do? Assume 360 days in a year.

Answer
Statement of Effective Cost of Factoring to the Firm
Particulars `
(1) Cost of factoring:
Factoring commission (1% of 3,60,00,000) 3,60,000
Interest charges (33,375 × 360 Days/30 Days) 4,00,500
Total (A) 7,60,500
(2) Savings:
Saving in credit administration cost 1,40,000
Saving in bad debts (2% of 3,60,00,000) 7,20,000
Total (B) 8,60,000
Net Benefits to Firm (B - A) 99,500

Working Notes:
Calculation of advance:
Particulars `
Average receivables (360 Lakhs × 30/360) 30,00,000
Less: Factor reserve @ 10% of 30,00,000 3,00,000
27,00,000
Less: Commission @ 1% of 30,00,000 30,000
Amount available for advance 26,70,000
Less: Interest (26,70,000 × 15% × 30/360) 33,375
Amount of advance 26,36,625
 MANAGEMENT OF RECEIVABLES & PAYABLES 3.13
Advice: Since the savings to the firm exceeds the cost to the firm on account of factoring, therefore, the
proposal is acceptable.

BQ 17
A Ltd. has a total sale of `6.4 crores and its average collection period is 90 days. The past experience indicates
that bad debt losses are 1.5% on sales.
The expenditure incurred by the firm in administering its receivable collection efforts is `10,00,000. A
factor is prepared to buy the firm’s receivables by charging 2% commissions.
The factor will pay advance on receivables to the firm at an interest rate of 18% p.a. after withholding
10% as reserve.

(1) Calculate the effective cost of factoring to the firm (360 Days in a year),
(2) If bank finance for working capital is available at 14% interest, should the firm avail of factoring
service?

Answer
(1) Statement of Effective Cost of Factoring to the Firm
Particulars `
(1) Cost of factoring:
Factoring commission (3,20,000 × 360 Days/90 Days) 12,80,000
Interest charges (6,33,600 × 360 Days/90 Days) 25,34,400

Total (1) 38,14,400

(2) Savings:
Saving in credit administration cost 10,00,000
Saving in bad debts (1.5% of 6,40,00,000) 9,60,000

Total (2) 19,60,000

Effective cost of factoring (1 - 2) 18,54,400

Rate of effective cost  

18 ,54 ,400 13.79%
100 
 1 ,34 ,46 ,400 

Working Notes:
Calculation of advance:
Particulars `
Average receivables (6,40,00,000 × 90/360) 1,60,00,000
Less: Factor reserve @ 10% of 1,60,00,000 16,00,000
Maximum possible advance 1,44,00,000
Less: Commission @ 2% of 1,60,00,000 3,20,000
Amount available for advance 1,40,80,000
Less: Interest (1,40,80,000 × 18% × 90/360) 6,33,600
Amount of advance 1,34,46,400

(2) If bank finance for working capital is available at 14%, firm should avail factoring service at 13.79%
which is lower than bank interest.

Note: Alternatively rate of effective cost also can be calculated by some authors on amount avail for advance
(1,40,80,000).

MANAGEMENT OF PAYABLES (CREDITORS)

BQ 18
ABC Ltd has been offered credit terms from its major supplier 2/10 net 45. If ABC Ltd. can invest the additional
 MANAGEMENT OF RECEIVABLES & PAYABLES 3.14
cash and can obtain an annual return of 25% per annum and the amount of invoice is `10,000.

Should ABC Ltd accept the discount offer?

Answer
Statement of Evaluation of Discount Offer
Particulars Refuse Accept
Payment to supplier 10,000 9,800
Less: Return from investing `9,800 between day 10 and day 45 (235) -
(`9,800 × 35/365 × 25%)
Net Cost 9,765 9,800

Advise: Thus it is better for the company to refuse the discount, as return on cash retained is more than the
saving on account of discount.

BQ 19
A Ltd. is in manufacturing business and it acquires raw material from X Ltd. on a regular basis. As per the terms
of agreement the payment must be made within 40 days of purchase. However, A Ltd. has a choice of paying
`98.50 per `100 it owes to X Ltd. on or before 10th day of purchase.

Examine whether A Ltd. should accept the offer of discount assuming average billing of A Ltd. is
`10,00,000 and an alternative investment yield a return of 15% and company pays the invoice.

Answer
Statement of Evaluation of Discount Offer
Particulars Refuse Accept
Payment to supplier 10,00,000 9,85,000
Less: Return from investing `9,85,000 between day 10 and day 40 (12,144) -
(`9,85,000 × 30/365 × 15%)
Net Cost 9,87,856 9,85,000

Advise: Thus it is cheaper for the company to accept the discount.

MANAGEMENT OF INVENTORY

BQ 20
A company’s requirements for ten days are 6,300 units. The ordering cost per order is `10 and the carrying
cost per unit is `0.26.

You are required to Calculate the economic order quantity.

Answer
2AO 2×6,300×36.5×10
EOQ = √ = √ = 696 Units
C 0.26×36.5

BQ 21
Marvel Limited uses a large quantity of salt in its production process. Annual consumption is 60,000 tonnes
over a 50-week working year. It costs `100 to initiate and process an order and delivery follow two weeks
later. Storage costs for the salt are estimated at `0.10 per tonne per annum. The current practice is to order
twice a year when the stock falls to 10,000 tonnes.

Identify an appropriate ordering policy for Marvel Limited, and contrast it with the cost of the
current policy.

Answer
 MANAGEMENT OF RECEIVABLES & PAYABLES 3.15
The recommended policy should be based on the EOQ model:

2AO 2×60,000×100
EOQ = √ = √ = 10,954 tonnes
C 0.10

Annual Ordering Cost at EOQ = Number of orders × Cost per order

= *6 × 100 = `600

Annual Carrying Cost at EOQ = ½ of EOQ × C

= ½ of 10,954 × 0.10 = `548

Total Ordering & Carrying Cost = `600 + `548 = `1,148

*Number of orders per year = 60,000/10,954 = 5.47 or 6 orders

Now in Existing Policy,

Minimum Stock = ROL – Average Consumption × Average Lead Time

= 10,000 – [(60,000 ÷ 50 weeks) × 2 weeks]
= 7,600 tonnes

Maximum Stock = ROL + *ROQ – Minimum Consumption × Minimum Lead Time

= 10,000 + 30,000 – [(60,000 ÷ 50 weeks) × 2 weeks]
= 37,600 tonnes

*ROQ = 60,000 ÷ 2 Orders = 30,000 tonnes

Annual Carrying Cost = Average Stock × C

= [(7,600 + 37,600) ÷ 2] × 0.10 = `2,260

Annual Ordering Cost = 2 Orders × 100 = `200

Total Ordering & Carrying Cost = `2,260 + `200 = `2,460

Advise: The recommended policy (i.e. EOQ) should be adopted as the costs are less than the current policy by
`1,312 (`2,460 – `1,148).

BQ 22
Pureair Company is a distributor of air filters to retail stores. It buys its filters from several manufacturers.
Filters are ordered in lot sizes of 1,000 and each order costs `40 to place. Demand from retail stores is 20,000
filters per month, and carrying cost is `0.10 a filter per month.
(a) Compute the optimal order quantity with respect to so many lot sizes?
(b) Calculate the optimal order quantity if the carrying cost were `0.05 a filter per month?
(c) Compute the optimal order quantity if ordering costs were `10?

Answer
2AO 2×20×12×40
(a) EOQ = √ = √ = 4 Lots
C 100×12

Carrying costs = `0.10 × 1,000 = `100 per month for one lot of 1,000 units.

2AO 2×20×12×40
(b) EOQ = √ = √ = 5.66 or 6 Lots
C 50×12

2AO 2×20×12×10
(c) EOQ = √ = √ = 2 Lots
C 100×12
 MANAGEMENT OF RECEIVABLES & PAYABLES 3.16

PAST YEARS QUESTIONS

PYQ 1
The present credit terms of P Company are 1/10 net 30. Its annual sales is `80 lakhs, its average collection
period is 20 days. Its variable costs and average total costs to sales are 0.85 and 0.95 respectively and its cost
of capital is 10 per cent. The proportion of sales on which customers currently take discount is 0.5.
P Company is considering relaxing its discount terms to 2/10 net 30. Such relaxation is expected to
increase sales by `5 lakhs, reduce the average collection period to 14 days and increase the proportion of
discount sales to 0.8.
What will be the effect of relaxing the discount policy on company's profit? Take year as 360 days.
[(10 Marks) May 1998]

Answer
Statement of Evaluation
Policies
Particulars
Present Proposed
Sales value 80,00,000 85,00,000
Less: Variable cost @ 85% 68,00,000 72,25,000
Less: Fixed Cost (10% of 80,00,000) 8,00,000 8,00,000
Profit before cost of credit 4,00,000 4,75,000
Less: Cash discount 40,000 1,36,000
Expected Profit 3,60,000 3,39,000
Less: Cost of investment in debtors 42,222 31,208
Net benefit 3,17,778 3,07,792
Effect: Income will be decreased by `9,986.
Working Notes:
(1) Calculation of cost of investment in debtors:
Existing = (68,00,000 + 8,00,000) × 10% × 20/360 = 42,222
Proposed = (72,25,000 + 8,00,000) × 10% × 14/360 = 31,208
(2) Calculation of cash discount:
Existing = 80,00,000 × 0.50 × 1% = 40,000
Proposed = 85,00,000 × 0.80 × 2% = 1,36,000

PYQ 2
Radiance Garments Ltd. manufactures readymade garments and sells them on credit basis through a network
of dealers. Its present sale is `60,00,000 per annum with 20 days credit period. The company is contemplating
an increase in the credit period with a view to increasing sales. Present variable costs are 70% of sales and the
total fixed costs `8,00,000 per annum.

The company expects pre-tax return on investment @ 25%. Some other details are given as under:

Proposed Credit Average Collection Expected Annual

Policy Period (days) Sales (` lakh)
I 30 65
II 40 70
III 50 74
IV 60 75

Required: Which credit policy should the company adopt? Present your solution in a tabular form. Assume
360 days a year. Calculations should be made upto two digits after decimal.
[(10 Marks) Nov 1999]
 MANAGEMENT OF RECEIVABLES & PAYABLES 3.17
Answer
Statement of Evaluation
Policies
Particulars
Present I II III IV
Sales value 60,00,000 65,00,000 70,00,000 74,00,000 75,00,000
Less: Variable cost @ 70% 42,00,000 45,50,000 49,00,000 51,80,000 52,50,000
Less: Fixed Cost 8,00,000 8,00,000 8,00,000 8,00,000 8,00,000
Expected Profit 10,00,000 11,50,000 13,00,000 14,20,000 14,50,000
Less: Required return (WN) 69,444 1,11,459 1,58,333 2,07,640 2,52,083
Net benefit 9,30,556 10,38,541 11,41,666 12,12,360 11,97,916
Working Notes:
Calculation of required return on investment in cost of average debtors:
Present = (42,00,000 + 8,00,000) × 25% × 20/360 = 69,444
Option I = (45,50,000 + 8,00,000) × 25% × 30/360 = 1,11,459
Option II = (49,00,000 + 8,00,000) × 25% × 40/360 = 1,58,333
Option III = (51,80,000 + 8,00,000) × 25% × 50/360 = 2,07,640
Option IV = (52,50,000 + 8,00,000) × 25% × 60/360 = 2,52,083
Analysis:
The company should adopt the credit policy III (with collection period of 50 days) as it yields a maximum
profit to the company.

PYQ 3
A Bank is analyzing the receivables of Jackson Company in order to identify acceptable collateral for a short
term loan. The company’s credit policy is 2/10 net 30.
The bank lends 80 per cent on accounts where customers are not currently overdue and where the
average payment period does not exceed 10 days past the net period.
A schedule of Jackson’s receivables has been prepared. How much will the bank lend on a pledge of
receivables, if the bank uses a 10 per cent allowance for cash discount and returns?
Account Amount Days Outstanding Average Pay Period
74 `25,000 15 20
91 `9,000 45 60
107 `11,500 22 24
108 `2,300 9 10
114 `18,000 50 45
116 `29,000 16 10
123 `14,000 27 48
[(6 Marks) Nov 2000]

Answer
Statement of the amount lend by the banks on a pledge of receivables
(If bank allows 10% allowance or cash discount and returns)
Account No. Amount 90% of amount (10% allowance) 80% of amount (Loan)
74 `25,000 25,000 – 10% = 22,500 22,500 × 80% = 18,000
107 `11,500 11,500 – 10% = 10,350 10,350 × 80% = 8,280
108 `2,300 2,300 – 10% = 2,070 2,070 × 80% = 1,656
116 `29,000 29,000 – 10% = 26,100 26,100 × 80% = 20,880
Total loan amount `48,816

For identification of acceptable collateral for a short term to loan, Bank analyses the receivables of Jackson
Company:
 MANAGEMENT OF RECEIVABLES & PAYABLES 3.18
Bank lends 80% on A/c where customers are not currently overdue and average payment period
does not exceed 10 day past the period of 30 days.
On the basis of this, schedule of Jackson’s: Account No. 91 & Account No. 114 are currently overdue
and Account No. 123 payment period exceeds 40 days. So, these accounts are eliminated and Account No. 74,
107, 108 and 116 are selected or lending decision.

PYQ 4
The credit manager of XYZ Ltd. is reappraising the company’s credit policy. The company sells its products on
terms of net 30. Cost of goods sold is 85% of sales and fixed costs are further 5% of sales. XYZ classifies its
customers on a scale of 1 to 4. During the past five years, the experience was as under:
Classification Default as % of sales Average collection period
1 0 45 Days
2 2 42 Days
3 10 40 Days
4 20 80 Days
The average rate of interest is 15%. What conclusion do you draw about the Company’s credit policy? What
other factors should be taken into account before changing the present policy? Discuss.
[(6 Marks) May 2001]

Answer
Let the amount of revenue generated for each type of customers be `100.
Statement of Evaluation
Classifications
Particulars
1 2 3 4
Sales 100 100 100 100
Less: COGS @ 85% 85 85 85 85
Less: Further expenses 5% 5 5 5 5
Profit 10 10 10 10
Less: Bad debts - 2 10 20
Expected Profit 10 8 Nil (10)
Less: Interest cost 1.66 1.55 1.48 2.96
Net Benefit 8.34 6.45 (1.48) (12.96)
Evaluation Accept Accept Reject Reject
Calculation of interest cost
Category 1 Category 2 Category 3 Category 4
90  15%  45 days 90  15%  42 days 90  15%  40 days 90  15%  80 days
365 days 365 days 365 days 365 days
= `1.66 = `1.55 = `1.48 = `2.96
Recommendation: The reappraisal of company’s credit policy indicates that the company either follows a
lenient credit policy or it is inefficient in collection of debts. Even though the company sells its products on
term of net 30 days, it allows average collection period for more than 30 days to all categories of its customers.
The company can continue with customers covered in categories 1 and 2 since net benefits are
favourable. The company either should not continue with customer covered in categories 3 and 4 or should
reduce the bad debt % by at least 1.48% and 12.96% respectively since net benefits are unfavourable to the
extent of 1.48% and 12.96% of sales respectively.
The other factors to be taken into consideration before changing the present policy includes (1) past
performance of the customers and (2) their credit worthiness.

PYQ 5
A Ltd. has a total sale of `3.2 crores and its average collection period is 90 days. The past experience indicates
that bad debt losses are 1.5% on sales.
The expenditure incurred by the firm in administering its receivable collection efforts is `5,00,000. A
factor is prepared to buy the firm’s receivables by charging 2% commissions.
 MANAGEMENT OF RECEIVABLES & PAYABLES 3.19
The factor will pay advance on receivables to the firm at an interest rate of 18% p.a. after withholding
10% as reserve.
Calculate the effective cost of factoring to the firm (360 Days in a year).
[(6 Marks) May 2002]

Answer
Statement of Effective Cost of Factoring to the Firm
Particulars `
(A) Cost of factoring:
Factoring commission (1,60,000 × 360 Days/90 Days) 6,40,000
Interest charges (3,16,800 × 360 Days/90 Days) 12,67,200
Total (A) 19,07,200
(B) Savings:
Saving in credit administration cost 5,00,000
Saving in bad debts (1.5% of 3,20,00,000) 4,80,000
Total (B) 9,80,000
Effective cost of factoring (A - B) 9,27,200
Rate of effective cost  
9 ,27 ,200
100  13.79%
 67 ,23,200 

Working Notes:
Calculation of advance
Particulars `
Average receivables (3,20,00,000 × 90/360) 80,00,000
Less: Factor reserve @ 10% of 80,00,000 8,00,000
Maximum possible advance 72,00,000
Less: Commission @ 2% of 80,00,000 1,60,000
Advance net of commission 70,40,000
Less: Interest (70,40,000 × 18% × 90/360) 3,16,800
Amount of advance 67,23,200
Note: Alternatively rate of effective cost can be calculated on amount available for advance (70,40,000)

PYQ 6
A company has prepared the following projections for a year:
Sales 21,000 units
Selling price per unit `40
Variable cost per unit `25
Total costs per unit `35
Credit period allowed One month
The Company proposes to increase the credit period allowed to its customers from one month to two
months. It is envisaged that the change in the policy as above will increase the sales by 8%. The company
desires a return of 25% on its investment.
You are required to examine and advise whether the proposed credit policy should be
implemented or not.
[(4 Marks) Nov 2002]

Answer
Statement of Evaluation
Policies
Particulars
Present Proposed
Sales units 21,000 22,680
Sales value @ `40 per unit 8,40,000 9,07,200
Less: Variable cost @ `25 per unit/ 62.50% 5,25,000 5,67,000
Less: Fixed Cost (21,000 × `10) 2,10,000 2,10,000
 MANAGEMENT OF RECEIVABLES & PAYABLES 3.20
Expected Profit 1,05,000 1,30,200
Less: Required return (WN) 15,313 32,375
Net Benefit 89,687 97,825

Analysis: The proposal for a more liberal extension of credit by increasing the average collection period from
one month to two months is suggested to adopt.

Working notes:
Calculation of required return on investment in cost of debtors:
Existing = (5,25,000 + 2,10,000) × 1/12 × 25% = 15,313
Proposed = (5,67,000 + 2,10,000) × 2/12 × 25% = 32,375

PYQ 7
A firm has a current sales of `2,56,48,750. The firm has unutilized capacity. In order to boost its sales, it is
considering the relaxation in its credit policy. The proposed terms of credit will be 60 days credit against the
present policy of 45 days. As a result, the bad debts will increase from 1.5% to 2% of sales. The firm's sales are
expected to increase by 10%. The variable operating costs are 72% of the sales. The firm's corporate tax rate
is 35%, and it requires an after tax return of 15% on its investment.
Should the firm change its credit period? Assume 360 days in a year.
[(4 Marks) Nov 2003]

Answer
Statement of Evaluation
Policies
Particulars
Present Proposed
Sales value 2,56,48,750 2,82,13,625
Less: Variable cost @ 72% of sales 1,84,67,100 2,03,13,810
Profit before cost of credit 71,81,650 78,99,815
Less: Bad debts @ 1.5% / 2% 3,84,731 5,64,273
Expected PBT 67,96,919 73,35,542
Less: Tax @ 35% 23,78,922 25,67,440
Expected PAT 44,17,997 47,68,102
Less: Cost of investment in debtors 3,46,258 5,07,845
Net benefit after tax 40,71,739 42,60,257

Yes, the firm should change its credit period.

Working Notes:
Calculation of cost of investment in debtors:
Existing = 1,84,67,100 × 45/360 × 15% = 3,46,258
Proposed = 2,03,13,810 × 60/360 × 15% = 5,07,845

PYQ 8
A firm is considering offering 30 days credit to its customers. The firm like to charge them an annualized rate
of 24%. The firm wants to structure the credit in terms of a cash discount for immediate payment.
How much would the discount rate have to be?
[(4 Marks) Nov 2004]

Answer
Interest @ 24% p.a. for a period of 30 days (year 365 days) = 0.24 × 30/365
= 0.019726 i.e. 1.9726%

Hence, the principal of `1 including the interest after 30 days will become 1.019726.
 MANAGEMENT OF RECEIVABLES & PAYABLES 3.21
Hence, discount which can be offered to receivables as on zero date = 1 - 0.980656
= 0.019344 i.e. 1.93%.

PYQ 9
A company has sales of `25,00,000. Average collection period is 50 days, bad debt losses are 5% of sales and
collection expenses are `25,000. The cost of funds is 15%. The company has two alternative collection
programs:
Programme I Programme II
Average collection period reduced to 40 days 30 days
Bad debt losses reduced to 4% of sales 3% of sales
Collection expenses `50,000 `80,000
Evaluate which programme is viable.
[(6 Marks) May 2006]

Answer
Statement of Evaluation
Current Program 1 Program 2
Particulars
50 days 40 days 30 days
Sales 25,00,000 25,00,000 25,00,000
Cost of investment in Debtors 51,370 41,096 30,822
Bad debt losses 1,25,000 1,00,000 75,000
Collection expenses 25,000 50,000 80,000
Cost of credit 2,01,370 1,91,096 1,85,822
Analysis: The Proposed Policy II should be adopted since the total costs under this policy is least as compared
to other policies.

Note: In absence of Cost of Sales, sales has been taken for purpose of calculating cost of investment in
debtors.

Working Notes:
Calculation of cost of investment in debtors:
Existing = 25,00,000 × 50/365 × 15% = 51,370
Program 1 = 25,00,000 × 40/365 × 15% = 41,096
Program 2 = 25,00,000 × 30/365 × 15% = 30,822

PYQ 10
The sales manager of AB Limited suggests that if credit period is given for 1.5 months then sales may likely to
increases by `1,20,000 per annum. Cost of sales amounted to 90% of sales. The risk of non payment is 5%.
Income tax rate is 30%. The expected return on investment is `3,375 (after tax).
Should the company accept the suggestion of sales manager? [(3 marks) May 2008]

Answer
Statement of Evaluation
Particulars `
Increase in sales 1,20,000
Less: Cost of sales @ 90% 1,08,000
Profit before cost of credit 12,000
Less: Risk of non payments @ 5% 6,000
Expected PBT 6,000
Less: Tax @ 30% 1,800
Expected PAT 4,200
Less: Required return after tax 3,375
Net Benefit 825
Conclusion:
 MANAGEMENT OF RECEIVABLES & PAYABLES 3.22
Since company has positive benefit after fulfill of required return from investment in debtors, Suggestion of
the sales manager should be accepted.

PYQ 11
A firm has a total sales of `12,00,000 and its average collection period is 90 days. The past experience indicates
that bad debt losses are 1.5% on sale. The expenditure incurred by the firm in administering receivable
collection effort are `50,000.
A factor is prepared to buy the firm’s receivables by charging 2% commission. The factor will pay
advance on receivables to this firm at an interest rate of 16% p.a. after withholding 10% as reserve.

Calculate effective cost of factoring to the firm. Assume 360 days in a year.
[(8 Marks) May 2009]

Answer
Statement of Effective Cost of Factoring to the Firm
Particulars `
(A) Cost of factoring:
Factoring commission (12,00,000 × 2%) 24,000
Interest charges (10,560 × 360 Days/90 Days) 42,240
Total (A) 66,240
(B) Savings:
Saving in credit administration cost 50,000
Saving in bad debts (1.5% of 12,00,000) 18,000
Total (B) 68,000
Net Benefit to firm (B - A) 1,760

Calculation of advance
Particulars `
Average receivables (12,00,000 × 90/360) 3,00,000
Less: Factor reserve @ 10% of 3,00,000 30,000
Maximum possible advance 2,70,000
Less: Commission @ 2% of 3,00,000 6,000
Amount available for advance 2,64,000
Less: Interest (2,64,000 × 16% × 90/360) 10,560
Amount of advance 2,53,440

Conclusion: Since company has positive benefit, it is suggested to enter into factoring agreement.

PYQ 12
RST Limited is considering relaxing its present credit policy and is in the process of evaluating two proposed
policies. Currently, the firm has annual credit sales of `225 lakhs and accounts receivable turnover ratio of 5
times a year. The current level of loss due to bad debts is `7,50,000. The firm is required to give a return of
20% on the investment in new accounts receivables. The Company’s variable costs are 60% of the selling price.

On the basis of the following information, which is better option?

Particulars Present Option I Option II

Annual credit sales (`) 2,25,00,000 2,75,00,000 3,50,00,000
Accounts receivables turnover ratio 5 times 4 times 3 times
Bad debt losses (`) 7,50,000 22,50,000 47,50,000
[(8 Marks) Nov 2010]

Answer
Statement of Evaluation of Credit Policies (in Lakhs)
Particulars Present Option 1 Option 2
 MANAGEMENT OF RECEIVABLES & PAYABLES 3.23
Credit sales 225.00 275.00 350.00
Less: Variable cost @ 60% 135.00 165.00 210.00
Profit before bad debt losses 90.00 110.00 140.00
Less: Bad debt losses 7.50 22.50 47.50
Expected Profit 82.50 87.50 92.50
Less: Required return on investment 5.40 8.25 14.00
(Variable cost × 1/DTR × 20%)
Net Benefit 77.10 79.25 78.50

Recommendation: The Proposed Policy I should be adopted since the net benefits under this policy are higher
than those under other policies.

Note: In the above solution, investment in accounts receivable is based on total cost of goods sold on credit.
Since fixed costs are not given in the problem, therefore, it is assumed that there are no fixed costs and
investment in receivables is determined with reference to variable costs only. The above solution may
alternatively be worked out on the basis of incremental approach. However, the recommendation would
remain the same.

PYQ 13
The marketing manager of XY Ltd. is giving a proposal to the board of directors of the company that an increase
in credit period allowed to customers from the present one month to two months will bring a 25% increase in
sales volume in the next year.
The following operational data of the company for the current year are taken from the records of
the company:
Selling price `21 per unit
Variable cost `14 per unit
Total cost `18 per unit
Sales value `18,90,000
The board, by forwarding the above proposal and data requests you to give your expert opinion on the
adoption of the new credit policy in next year subject to a condition that the company’s required rate of return
on investments is 40%.
[(8 Marks) May 2011]

Answer
Statement of Evaluation
Policies
Particulars
Present Proposed
Sales units 90,000 1,12,500
Sales value @ `21 per unit 18,90,000 23,62,500
Less: Variable cost @ `14 per unit 12,60,000 15,75,000
Less: Fixed Cost (90,000 × `4) 3,60,000 3,60,000
Expected profit 2,70,000 4,27,500
Less: Required return (WN) 54,000 1,29,000
Net Benefit 2,16,000 2,98,500
Analysis:
The proposal for a more liberal extension of credit by increasing the average collection period from one month
to two months is suggested to adopt.
Working notes:
Calculation of required return on investment in cost of debtors:
Existing = (12,60,000 + 3,60,000) × 1/12 × 40% = 54,000
Proposed = (15,75,000 + 3,60,000) × 2/12 × 40% = 1,29,000
PYQ 14
 MANAGEMENT OF RECEIVABLES & PAYABLES 3.24
A new customer with 10% risk of non-payment desires to establish business connection with you. He would
require 1.5 month of credit and is likely to increase you sales by `1,20,000 p.a. Cost of sales amounted to 85%
of sales. The tax rate is 30%. Required rate of return is 40% (after tax).
Should you accept the offer?
[(4 Marks) Nov 2011]

Answer
Statement of Evaluation
Particulars `
Increase in sales 1,20,000
Less: Cost of sales @ 85% 1,02,000
18,000
Less: Expected bad debts loss (10% on sales) 12,000
Expected PBT 6,000
Less: Tax @ 30% 1,800
Expected PAT 4,200
Less: Required return after tax (1,02,000 × 1.5/12 × 40%) 5,100
Net benefit (after tax) (900)

Conclusion: Since company has negative benefit after tax ,offer should be rejected.

PYQ 15
A company is presently having credit sales of `12,00,000. The existing credit terms are 1/10 net 45 days and
average collection period is 30 days. The current bad debts loss is 1.5%.
In order to accelerate the collection process further as also to increase sales, the company is
contemplating liberalization of its existing credit terms to 2/10 net 45 days.
It is expected that sales are likely to increase 1/3 of existing sales, bad debts increase to 2% of sales and
average collection period to decline to 20 days.
The contribution to sales ratio of the company is 22% and opportunity cost of investment in
receivables is 15 percent (pre tax). 50 percent and 80 percent of customers in term of sales revenue are
expected to avail cash discount under existing and liberalisation scheme respectively. The tax rate is 30%.

Should the company change its credit terms? (Assume 360 days in a year).
[(5 Marks) May 2012]

Answer
Statement of Evaluation
Policies
Particulars
Present Proposed
Sales value 12,00,000 16,00,000
Less: Variable cost @ 78% 9,36,000 12,48,000
Contribution @ 22% 2,64,000 3,52,000
Less: Bad debts 18,000 32,000
Less: Cash discount (WN) 6,000 25,600
Expected Profit 2,40,000 2,94,400
Less: Opportunity cost of investment in receivables (WN) 11,700 10,400
Net Benefit Before Tax 2,28,300 2,84,000
Less: Tax @ 30% 68,490 85,200
Net Benefit After Tax 1,59,810 1,98,800

Advise: Company should change its credit terms having higher net benefit.

Working notes:
(1) Calculation of opportunity cost of investment in receivables:
 MANAGEMENT OF RECEIVABLES & PAYABLES 3.25
Existing = 9,36,000 × 15% × 30/360 = 11,700
Proposed = 12,48,000 × 15% × 20/360 = 10,400

(2) Calculation of cash discount:

Existing = 12,00,000 × 50% × 1% = 6,000
Proposed = 16,00,000 × 80% × 2% = 25,600

PYQ 16
PTX Limited is considering a change in its present credit policy. Currently it is evaluating two policies. The
company is required to give a return of 20% on the investment in new receivables. The company’s variable
costs are 70% of selling price.
Information regarding present and proposed policies are as follows:
Policies
Particulars
Present Option 1 Option 2
Annual credit sales `30,00,000 `42,00,000 `45,00,000
Debtors turnover ratio 4 times 3 times 2.4 times
Loss due to bad debts 3% of sales 5% of sales 6% of sales
Note: Return on investment in new account receivable is based on cost of investment in debtors.

Which option would you recommend?

[(Marks 8) Nov 13]

Answer
Statement of Evaluation
Particulars Existing Option 1 Option 2
Credit sales 30,00,000 42,00,000 45,00,000
Less: Variable cost @ 70% 21,00,000 29,40,000 31,50,000
Profit before bad debt losses 9,00,000 12,60,000 13,50,000
Less: Bad debt losses 90,000 2,10,000 2,70,000
Expected Profit 8,10,000 10,50,000 10,80,000
Less: Required return on investment ‘WN’ 1,05,000 1,96,000 2,62,500
(Variable cost × 1/DTR × 20%)
Net Benefit 7,05,000 8,54,000 8,17,500
Recommendation: PTX Limited is advised to adopt Policy Option 1.

Note: In the above solution, investment in accounts receivable is based on total cost of goods sold on credit.
Since fixed costs are not given in the problem, therefore, it is assumed that there are no fixed costs and
investment in receivables is determined with reference to variable costs only. The above solution may
alternatively be worked out on the basis of incremental approach. However, the recommendation would
remain the same.

PYQ 17
PQR Ltd. having annual sales of `30,00,000, is re considering its present collection policy. At present the
average collection period is 50 days, bad debt losses are 5% of sales. The company is incurring an expenditure
of `30,000 on account of collection of receivables. Cost of funds is 10 percent.
The alternative policies are:
Alternative I Alternative II
Average collection period reduced to 40 days 30 days
Bad debt losses 4% of sales 3% of sales
Collection expenses `60,000 `95,000
Evaluate the alternatives on the basis of incremental approach and state which alternative is
more beneficial. [(8 Marks) Nov 2014]
Answer
 MANAGEMENT OF RECEIVABLES & PAYABLES 3.26
Statement of Evaluation
Particulars Current Alternate 1 Alternate 2
Sales 30,00,000 30,00,000 30,00,000
Cost of investment in Debtors 41,096 32,877 24,658
1. Saving in cost in Debtors - 8,219 16,438
Bad debt losses 1,50,000 1,20,000 90,000
2. Saving in Bad debt losses - 30,000 60,000
Collection expenses 30,000 60,000 95,000
3. Increase in collection expenses - 30,000 65,000
Incremental Benefit (1 + 2 - 3) - 8,219 11,438
Analysis: Since incremental benefit over present policy is higher in case of alternative II, select Alternative II.
It is suggested to reduce the collection period from existing 50 days to 30 days.

Working Notes:
Calculation of cost of investment in debtors:
Existing = 30,00,000 × 50/365 × 10% = 41,096
Alternative I = 30,00,000 × 40/365 × 10% = 32,877
Alternative II = 30,00,000 × 30/365 × 10% = 24,658

Note: In absence of Cost of Sales, sales has been taken for purpose of calculating investment in receivables.

PYQ 18
A new customer has approached a firm to establish new business connection. The customer require 1.5 month
of credit. If the proposal is accepted, the sales of the firm will go up by `2,40,000 per annum. The new customer
is being considered as a member of 10% risk of non-payment group.
The cost of sales amounted to 80% of sales. The tax rate is 30% and required rate of return is 40%
(after tax).
Should the firm accept the offer? Give your opinion on the basis of calculations.
[(5 Marks) May 2015]
Answer
Statement of Evaluation
Particulars `
Increase in sales 2,40,000
Less: Cost of sales @ 80% 1,92,000
Profit before cost of credit 48,000
Less: Risk of non payments @ 10% 24,000
Expected PBT 24,000
Less: Tax @ 30% 7,200
Expected PAT 16,800
Less: Required return after tax (WN) 9,600
Net Benefit (After Tax) 7,200
Conclusion: Since company has positive benefit after fulfill of required return from investment in debtors,
offer should be accepted.

Working notes:
Calculation of cost of investment in debtors:
Existing = 1,92,000 × 1.5/12 × 40% = 9,600

PYQ 19
A firm has total sales as `200 lakhs of which 80% is on credit. It is offering credit term of 2/40, net 120. Of the
total, 50% of customers avail of discount and the balance pay in 120 days. Past experience indicates that bad
debt losses are around 1% of credit sales. The firm spends about `2,40,000 per annum to administer its credit
 MANAGEMENT OF RECEIVABLES & PAYABLES 3.27
sales. These are avoidable as a factor is prepared to buy the firm’s receivables. He will charge 2% commission.
He will pay advance against receivables to the firm at an interest rate of 18% after withholding 10% as reserve.
(i) What is the effective cost of factoring? Consider year as 360 days.
(ii) If bank finance for working capital is available at 14% interest, should the firm avail of factoring
service?
[(8 Marks) Nov 2015]

Answer
(i) Statement of Effective Cost of Factoring to the Firm
Particulars `
(1) Cost of factoring:
Factoring commission (`71,111 × 360 Days/80 Days) 3,20,000
Interest charges (`31,28,889 × 18%) 5,63,200
Total (A) 8,83,200
(2) Savings:
Saving in credit administration cost 2,40,000
Saving in bad debts (1% × 80% × `2,00 Lakhs) 1,60,000
Total (B) 4,00,000
Effective cost of factoring (A - B) 4,83,200
Rate of effective cost  
4 ,83,200
 100  16.09%
 30 ,03,733 

Alternatively:
If cost of factoring is calculated on the basis of total amount available for advance, then, it will be
 4 ,83,200 
Rate of effective cost =   100  = 15.44%
 31 ,28 ,889 
Working Notes:
1. Calculation of advance:
Particulars `
Average receivables (`200 Lakhs × 80% × 80/360) 35,55,556
Less: Factor reserve @ 10% of `35,55,556 3,55,556
Maximum possible advance 32,00,000
Less: Commission @ 2% of `35,55,556 71,111
Amount available for advance 31,28,889
Less: Interest (`31,28,889 × 18% × 80/360) 1,25,156
Amount of advance 30,03,733

2. Average collection period = 40 Days × ½ + 120 Days × ½ = 80 Days

(ii) If bank finance for working capital is available at 14%, firm will not avail factoring services as 14% is
less than 16.08% (or 15.44%).

PYQ 20
A trader whose current sales are `4,20,000 per annum and an average collection period of 30 days, wants to
pursue a more liberal policy to improve sales. A study made by a management consultant reveals the following
information:
Increase in Collection Present default
Credit Policy Increase in Sales
Period anticipated
I 10 days `21,000 1.5%
II 30 days `52,500 3%
III 45 days `63,000 4%
The selling price per unit is `3. Average cost per unit is `2.25 and variable cost per unit is `2. The current bad-
debts loss is 1%. Required return on additional investment is 20%. Assume a 360 days year.
 MANAGEMENT OF RECEIVABLES & PAYABLES 3.28
Which of the above policies would you recommend for adoption?
[(8 Marks) May 2016]

Answer
Statement of Evaluation of Credit Policies
Particulars Present I II III
No of units 1,40,000 1,47,000 1,57,500 1,61,000
Credit sales @ `3 per unit 4,20,000 4,41,000 4,72,500 4,83,000
Less: Variable cost @ `2 per unit 2,80,000 2,94,000 3,15,000 3,22,000
Less: Fixed cost (2.25 - 2) × 1,40,000 35000 35,000 35,000 35,000
Profit before bad debt losses 1,05,000 1,12,000 1,22,500 1,26,000
Less: Bad debt losses 4,200 6,615 14,175 19,320
Expected Profit 1,00,800 1,05,385 1,08,325 1,06,680
Less: Required return on investment 5,250 7,311 11,667 14,875
Net Benefit 95,550 98,074 96,658 91,805

Recommendation: Proposed Policy I (i.e. increase in collection period by 10 days or total 40 days) should be
adopted since the net benefits under this policy are higher as compared to other policies.

Working notes:
Calculation of cost required rate of return:
Collection Period
Required rate of return = Total cost × × Rate of return
360 Days
30
Existing = 3,15,000 × × 20% = 5,250
360 Days
40
Credit Policy I = 3,29,000 × × 20% = 7,311
360 Days
60
Credit Policy II = 3,50,000 × × 20% = 11,667
360 Days
75
Credit Policy III = 3,57,000 × × 20% = 14,875
360 Days

PYQ 21
A current credit sales of a firm is `15,00,000 and the firm still has an unutilized capacity. In order to boost its
sales, the firm is willing to relax its credit policy.
The firm proposes a new credit policy of 2/10 net 60 days as against the present policy of 1/10 net 45
days. The firm expects an increase in the sales by 12%. However, it is also expected that bad debts will go upto
2% of sales from 1.5%.
The contribution to sales ratio of the firm is 28%. The firm's tax rate is 30% and firm requires an after
tax return of 15% on its investment. 50 percent and 80 percent of customers in term of sales revenue are
expected to avail cash discount under existing and liberalization scheme respectively.
Should the firm change its credit period?
[(8 Marks) Nov 2017]

Answer
Statement of Evaluation
Policies
Particulars
Present Proposed
Sales value 15,00,000 16,80,000
Less: Variable cost @ 72% of sales 10,80,000 12,09,600
Profit before cost of credit 4,20,000 4,70,400
Less: Bad debts @ 1.5% / 2% 22,500 33,600
Less: Cash Discount ‘WN’ 7,500 26,880
 MANAGEMENT OF RECEIVABLES & PAYABLES 3.29
Expected PBT 3,90,000 4,09,920
Less: Tax @ 30% 1,17,000 1,22,976
Expected PAT 2,73,000 2,86,944
Less: Cost of investment in debtors ‘WN’ 12,205 9,942
Net benefit after tax 2,60,795 2,77,002
Yes, the firm should change its credit period.
Working notes:
1. Calculation of opportunity cost of investment in receivables:
Existing = 10,80,000 × 15% × 27.5 (.5×10+.5×45)/365 = 12,205
Proposed = 12,09,600 × 15% × 20 (.8×10+.2×60)/365 = 9,942

2. Calculation of cash discount:

Existing = 15,00,000 × 50% × 1% = 7,500
Proposed = 16,80,000 × 80% × 2% = 26,880

PYQ 22
A company is considering to engage a factor. The following information is available:
 The current average collection period for the company's debtors is 90 days and ½% of debtors default.
The factor has agreed to pay money due after 60 days, and will take the responsibility of any loss on
account of bad debts.
 The annual charge for the factoring is 2% of turnover. Administration cost saving is likely to be `1,00,000
per annum.
 Annual credit sales are `1,20,00,000. Variable costs is 80% of sales price. The company's cost of
borrowings is 15% per annum. Assume 360 days in a year.
Should the company enter into a factoring agreement?
[(8 Marks) May 2018]

Answer
Statement of Evaluation
Particulars `
(A) Savings:
Saving in administration cost 1,00,000
Saving in bad debts (0.5% of 1,20,00,000) 60,000
*Saving in cost of debtors (1,20,00,000 × 80% × 90 – 60/360 × 15%) 1,20,000
Total (A) 2,80,000
(B) Cost:
Annual charges (2% of 1,20,00,000) 2,40,000
Total (B) 2,40,000
Net Benefit (A -B) 40,000
*Presently, the debtors of the company pay after 90 days. However, the factor has agreed to pay after 60 days
only. So, the investment in Debtors will be reduced by 30 days.
Conclusion: Yes, company should enter into factoring agreement.

PYQ 23
MN Ltd has a current turnover of `30,00,000 p.a. Cost of sale is 80% of turnover and bad debts are 2% of
turnover. Cost of sales includes 70% Variable cost and 30% Fixed cost, while company’s required rate of return
is 15%. MN Ltd. currently allows 15 days credit to its customer, but it is considering increase this to 45 days
credit in order to increase turnover.
It has been estimated that this change in policy will increase turnover by 20%, while bad debts will
increase by 1%. It is not expected that the policy change will result in an increase in fixed cost and creditors
 MANAGEMENT OF RECEIVABLES & PAYABLES 3.30
and stock will be unchanged.

Should MN Ltd introduce the proposed policy? (Assume 360 days year)
[(10 Marks) Nov 2018]

Answer
Statement of Evaluation
Policies
Particulars
Present Proposed
Sales value 30,00,000 36,00,000
Less: Variable cost 70% of 80% of sales 16,80,000 20,16,000
Less: Fixed cost (30% of 80% of current sales 30,00,000) 7,20,000 7,20,000
Profit before cost of credit 6,00,000 8,64,000
Less: Bad debts @ 2%/3% 60,000 1,08,000
Expected Profit 5,40,000 7,56,000
Less: Required return 15,000 51,300
Net Benefit 5,25,000 7,04,700

Yes, the firm should change its credit period.

Working Notes:
Calculation of required return in debtors:
Existing = (16,80,000 + 7,20,000) × 15/360 × 15% = 15,000
Proposed = (20,16,000 + 7,20,000) × 45/360 × 15% = 51,300

PYQ 24
Current annual sales of SKD Ltd. `360 Lakhs. It’s directors are of the opinion that company’s current
expenditure on receivables management is too high and with a view to reduce the expenditure they are
considering following two new alternate credit policies:
Policy X Policy Y
Average collection period 1.5 months 1 month
% of default 2% 1%
Annual collection expenditure `12 Lakhs `20 lakhs

Selling price per unit of product is `150. Total cost per unit is `120. Current credit terms are 2 months and
percentage of default is 3%. Current annual collection expenditure is `8 Lakhs. Required rate of return on
investment of SKD Ltd. is 20%.

Determine which credit policy SKD Ltd. should follow.

[(5 Marks) July 2021]

Answer
Statement of Evaluation of Credit Policies
Particulars Current Policy Policy X Policy Y
Sales Units (3,60,00,000 ÷ `150) 2,40,000 2,40,000 2,40,000
Sales value 3,60,00,000 3,60,00,000 3,60,00,000
Less: Cost @ `120 per units 2,88,00,000 2,88,00,000 2,88,00,000
Profit before cost of credit 72,00,000 72,00,000 72,00,000
Less: Bad debts @ 3%/2%/1% 10,80,000 7,20,000 3,60,000
Less: Annual Collection Expenses 8,00,000 12,00,000 20,00,000
Expected Profit 53,20,000 52,80,000 48,40,000
Less: Cost of investment in debtors 9,60,000 7,20,000 4,80,000
Net Benefit 43,60,000 45,60,000 43,60,000

Recommendation: The proposed policy X should be adopted having higher net benefit.
 MANAGEMENT OF RECEIVABLES & PAYABLES 3.31
Working Notes:
Calculation of cost of investment in debtors:
Current policy = 3,60,00,000 × 80% × 2/12 × 20% = 9,60,000
Policy X = 3,60,00,000 × 80% × 1.5/12 × 20% = 7,20,000
Policy Y = 3,60,00,000 × 80% × 1/12 × 20% = 4,80,000

PYQ 25
A factoring firm has offered a to buy it’s accounts receivables. The relevant information is given below.
(a) The current average collection period for the company's debts is 80 days and ½% of debtors default.
The factor has agreed to pay over money due, to the company after 60 days, and it will suffer losses of
any bad debts also.
(b) Factor will charge commission @2%.
(c) The company spends `1,00,000 p.a. on administration of debtor. These are avoidable cost.
(d) Annual credit sales are `90,00,000. Total variable costs is 80% of sales. The company's cost of
borrowings is 15% per annum. Assume 365 days in a year.
Should the company enter into a factoring agreement?
[(5 Marks) Dec 2021]

Answer
Statement of Evaluation
Particulars `
(A) Savings:
Saving in administration cost 1,00,000
Saving in bad debts (0.5% of 90,00,000) 45,000
*Saving in cost of debtors (90,00,000 × 80% × 80 – 60/365 × 15%) 59178
Total (A) 2,04,178
(B) Cost:
Annual charges (2% of 90,00,000) 1,80,000
Total (B) 1,80,000
Net Benefit (A - B) 24,178

*Presently, the debtors of the company pay after 80 days. However, the factor has agreed to pay after 60 days
only. So, the investment in Debtors will be reduced by 20 days.
Conclusion: Yes, company should enter into factoring agreement.

PYQ 26
A company has current sale of `12 lakhs per year. The profit-volume ratio is 20% and post-tax cost of
investment in receivables is 15%. The current credit terms are 1/10, net 50 days and average collection period
is 40 days. 50% of customers in terms of sales revenue are availing cash discount and bad debt is 2% of sales.

In order to increase sales, the company want to liberalize its existing credit terms to 2/10, net 35 days. Due to
which, expected sales will increase to `15 lakhs. Percentage of default in sales will remain same. Average
collection period will decrease by 10 days. 80% of customers in terms of sales revenue are expected to avail
cash discount under this proposed policy. Tax rate is 30%.

Advise, should the company change its credit terms. (Assume 360 days in a year.)
[(5 Marks) May 23]

Answer
Statement of Evaluation
Policies
Particulars
Present Proposed
Sales value 12,00,000 15,00,000
Less: Variable cost @ 80% 9,60,000 12,00,000
 MANAGEMENT OF RECEIVABLES & PAYABLES 3.32
Contribution @ 20% 2,40,000 3,00,000
Less: Bad debts @ 2% of sales 24,000 30,000
Less: Cash discount (WN) 6,000 24,000
Expected Profit Before Tax 2,10,000 2,46,000
Less: Tax @ 30% 63,000 73,800
Expected Profit After Tax 1,47,000 1,72,200
Less: Cost of investment (WN) 16,000 15,000
Net Benefit After Tax 1,31,000 1,57,200

Advise: Company should change its credit terms having higher net benefit after tax.

Working notes:
(3) Calculation of Cost of investment:
Existing = 9,60,000 × 15% × 40/360 = 16,000
Proposed = 12,00,000 × 15% × 30/360 = 15,000

(4) Calculation of cash discount:

Existing = 12,00,000 × 50% × 1% = 6,000
Proposed = 15,00,000 × 80% × 2% = 24,000
 MANAGEMENT OF RECEIVABLES & PAYABLES 3.33

SUGGESTED REVISION
Page No. of 3rd, 4th & Revision
Ques. Observations or KEY Points 1st & 2nd
Practical 5th during
No. (Note down during revisions) Revision
Register Revision Exams
BQ (Book Questions covering Study Module of ICAI, PM, RTP’s, MTP’s and Important Questions)
1 Y - -
2 Y Y -
3 Y Y -
4 Y Y -
5 Y Y Y
6 Y Y Y
7 Y Y Y
8 Y Y Y
9 Y Y Y
10 Y - -
11 Y Y Y
12 Y Y -
13 Y Y Y
14 Y Y Y
15 Y Y Y
16 Y - -
17 Y Y Y
18 Y Y -
19 Y Y Y
20 Y Y -
21 Y Y -
22 Y Y -
PYQ (Past Year Questions)
1 Y Y Y
2 Y - -
3 Y Y -
4 Y Y -
5 Y - -
6 Y Y -
7 Y Y -
8 Y Y Y
9 Y Y Y
10 Y Y -
11 Y Y Y
12 Y - -
13 Y - -
14 Y - -
15 Y Y Y
16 Y Y -
17 Y Y Y
18 Y Y -
19 Y Y Y
20 Y Y -
21 Y - -
22 Y Y Y
23 Y Y -
24 Y Y -
25 Y Y -
26 Y Y -
 CHAPTER - 4

MANAGEMENT OF WORKING
CAPITAL
LEARNING OBJECTIVES

After studying this chapter you will be able to:

 Discuss in details about working capital management, its
meanings and its significance to any business/firm.
 Understand the concept of operating cycle and the estimation of
working capital needs.
 Understand the need for a business to invest in current assets.
 Know why it is important to manage efficiently the current assets
and current liabilities?
 Discuss the financing of working capital.
 MANAGEMENT OF WORKING CAPITAL 4.2
OPERATING OR WORKING CAPITAL CYCLE METHOD
BQ 1
ABC Ltd. expects its cost of goods for 2022 - 23 to be `600 lakhs. The expected operating cycle is 90 days. It
wants to keep minimum cash balance of `1,00,000.
What is the expected working capital requirement (assume 360 days in a year)?
[`1,51,00,000]

BQ 2
From the following information of XYZ Ltd., you are required to calculate:
(a) Net operating cycle period.
(b) Number of operating cycles in a year.
Raw material inventory consumed during the year `6,00,000
Average stock of raw material `50,000
Annual cost of production `5,00,000
Average work-in-progress inventory `30,000
Annual cost of goods sold `8,00,000
Average finished goods stock held `40,000
Average collection period from debtors 45 days
Average credit period availed 30 days
No. of days in a year 360 days

Answer
(a) Operating cycle = R+W+F+D–C
= 30 + 22 + 18 + 45 – 30 = 85 Days
Calculations:
Average stock of raw materials
Raw materials storage period (R) =
Average cos t of raw materials consumptio n per day

50 ,000
= = 30 days
6 ,00 ,000  360

Average stock of WIP

WIP holding period =
Average cos t of production per day

30 ,000
= = 22 days
5 ,00 ,000  360

Average stock of FG
Finished Goods storage period =
Average cos t of goods sold per day

40 ,000
= = 18 days
8 ,00 ,000  360

(b) Number of operating cycles in the year:

360 360
= = 4.24 times
Operating cycle period 85

BQ 3
Following information is forecasted by the CS Limited for the year ending 31st March 2023:
Bal as at 01.04.22 Bal as at 31.03.23
Raw Material 45,000 65,356
Work-in-process 35,000 51,300
 MANAGEMENT OF WORKING CAPITAL 4.3
Finished goods 60,161 70,175
Receivables 1,12,123 1,35,000
Payables 50,079 70,469
Annual purchases of raw materials (all credit) 4,00,000
Annual cost of production 7,50,000
Annual cost of goods sold 9,15,000
Annual operating cost 9,50,000
Sales (all credit) 11,00,000
You may take one year as equal to 365 days
You are required to calculate:
(i) Net operating cycle period.
(ii) Number of operating cycles in the year.
(iii) Amount of working capital requirement.

Answer
(i) Operating cycle = R+W+F+D–C
= 53 + 21 + 26 + 41 – 55 = 86 Days

Calculations:
Average stock of raw materials
Raw materials storage period (R) =
Average cos t of raw materials consumptio n per day
55 ,178
= = 53 days
3 ,79 ,644  365

Raw materials consumption = Opening RM + Purchases – Closing RM

= 45,000 + 4,00,000 – 65,356 = 3,79,644
Average stock of WIP
WIP holding period =
Average cos t of production per day
43 ,150
= = 21 days
7 ,50 ,000  365

Average stock of FG
Finished Goods storage period =
Average cos t of goods sold per day
65 ,178
= = 26 days
9 ,15 ,000  365

Average book debts

Debtors collection period =
Average credit sales per day
1 ,23 ,562
= = 41 days
11 ,00 ,000  365

Average trade creditors

Credit period availed =
Average credit purchases per day
60 ,274
= = 55 days
4 ,00 ,000  365

Calculation of averages:

1. Average stock of raw materials = (45,000 + 65,356) ÷ 2 = 55,178

2. Average stock of WIP = (35,000 + 51,300) ÷ 2 = 43,150
3. Average stock of FG = (60,181 + 70,175) ÷ 2 = 65,178
4. Average receivables = (1,12,123 + 1,35,000) ÷ 2 = 1,23,562
5. Average payables = (50,079 + 70,469) ÷ 2 = 60,274

(ii) Number of operating cycles in the year:

 MANAGEMENT OF WORKING CAPITAL 4.4
365 365
= = 4.244 times
Operating cycle period 86

(iii) Amount of working capital required:

Annual operating cos t 9 ,50 ,000
= = `2,23,845 Or
Number of operating cycles 4.244

Annual operating cos t 9 ,50 ,000

× Operating cycle period = × 86 = `2,23,836
365 365

BQ 4
Following information is forecasted by R Limited for the year ending 31st March, 2023:
Balance as at 31.03.23 Balance as at 31.03.22
(` in Lakh) (` in Lakh)
Raw Material 65 45
Work-in-process 51 35
Finished goods 70 60
Receivables 135 112
Payables 71 68
Annual purchases of raw materials (all credit) 400
Annual cost of production 450
Annual cost of goods sold 525
Annual operating cost 325
Sales (all credit) 585
You may take one year as equal to 365 days

You are required to calculate:

(i) Net operating cycle period.
(ii) Number of operating cycles in the year.
(iii) Amount of working capital requirement.

Answer
(i) Operating cycle = R+W+F+D–C
= 53 + 35 + 45 + 77 – 63 = 147 Days

(ii) Number of operating cycles in the year:

365 365
= = 2.48 times
Operating cycle period 147

(iii) Amount of working capital required:

Annual operating cos t 325 Lakhs
= = `131 Lakhs
Number of operating cycles 2.48

Calculations:
Average stock of raw materials
Raw materials storage period (R) =
Average cos t of raw materials consumptio n per day
55
= = 53 days
380 ÷ 365

Raw materials consumption = Opening RM + Purchases – Closing RM

= 45 + 400 – 65 = 380

Average stock of WIP

WIP holding period =
Average cos t of production per day
 MANAGEMENT OF WORKING CAPITAL 4.5
43
= = 35 days
450 ÷ 365

Average stock of FG
Finished Goods storage period =
Average cos t of goods sold per day
65
= = 45 days
525 ÷ 365

Average book debts

Debtors collection period =
Average credit sales per day
123.5
= = 77 days
585 ÷ 365

Average trade creditors

Credit period availed =
Average credit purchases per day
69.5
= = 63 days
400 ÷ 365

Calculation of averages:
1. Average stock of raw materials = (45 + 65) ÷ 2 = 55
2. Average stock of WIP = (35 + 51) ÷ 2 = 43
3. Average stock of FG = (60 + 70) ÷ 2 = 65
4. Average receivables = (112+ 135) ÷ 2 = 123.5
5. Average payables = (68 + 71) ÷ 2 = 69.5

COMPONENTWISE ESTIMATION METHOD

BQ 5
A Company provided the following data:
Cost per unit (`)
Raw materials `52.00
Direct labour `19.50
Overheads `39.00
Total cost `110.50
Profit `19.50
Selling price `130.00
The following additional information is available:
Average raw materials in stock : one month;
Average materials in process : half-a-month;
Average finished goods in stock : one month;
Credit allowed by suppliers : one month;
Credit allowed to debtors : two months;
Time lag in payment of wages : one and a half weeks;
Time lag in payment of Overheads : one month;
Sales : 25% on cash basis;
Expected cash balance : `1,20,000.

You are required to prepare a statement showing the working capital needed to finance a level
of activity of 70,000 units of annual output. The production is carried throughout the year on even basis
and wages and overheads accrue similarly. (Calculation can be made on the basis of 30 days a month
and 52 weeks a year).
[`17,01,562]
Assumption: WIP: Material 100%, Wages & Overhead 50%.

BQ 6
 MANAGEMENT OF WORKING CAPITAL 4.6
On 1st January, the Managing Director of Naureen Ltd. wishes to know the amount of working capital that will
be required during the year. From the following information prepare the working capital requirements
forecast.
Production during the previous year was 60,000 units. It is planned that this level of activity would
be maintained during the present year.
The expected ratios of the cost to selling prices are Raw materials 60%, Direct wages 10% and
Overheads 20%.
Raw materials are expected to remain in store for an average of 2 months before issue to production.
Each unit is expected to be in process for one month, the raw materials being fed into the pipeline
immediately and the labour and overhead costs accruing evenly during the month. Finished goods will stay
in the warehouse awaiting dispatch to customers for approximately 3 months. Credit allowed by creditors is
2 months from the date of delivery of raw material. Credit allowed to debtors is 3 months from the date of
dispatch.
Selling price is ` 5 per unit. There is a regular production and sales cycle. Wages and overheads are
paid on the 1st of each month for the previous month. The company normally keeps cash in hand to the
extent of ` 20,000.

You are required to prepare the forecast statement. The finance manager is particularly
interested in applying the quantitative techniques for forecasting the working capital needs of the
company.

Answer
Statement of Working Capital Requirement
Particulars `
(A) Current Assets:
Raw materials (1,80,000 × 2/12) 30,000
Work in progress:
Material (1,80,000 × 100% × 1/12) 15,000
Labour and Overheads (30,000 + 60,000 × 50% × 1/12) 3,750
Finished goods (2,70,000 × 3/12) 67,500
Debtors (2,70,000 × 3/12) 67,500
Cash 20,000
Total (A) 2,03,750
(B) Current Liabilities:
Creditors (1,80,000 × 2/12) 30,000
Outstanding labour (30,000 × 1/12) 2,500
Outstanding overhead (60,000 × 1/12) 5,000
Total (B) 37,500
Working Capital (A - B) 1,66,250

Working Notes:
Projected Income Statement
Particulars `
Raw materials (60,000 × 5 × 60%) 1,80,000
Direct Labour (60,000 × 5 × 10%) 30,000
Overheads including depreciation (60,000 × 5 × 20%) 60,000
Total cost 2,70,000
Profit (60,000 × 5 × 10%) 30,000
Sales (60,000 × 5) 3,00,000

BQ 7
The following annual figures relate to XYZ Co.
Sales (at 2 months' credit) `36,00,000
Materials consumed (suppliers extend two months’ credit) `9,00,000
Wages paid (1 month lag in payment) `7,20,000
 MANAGEMENT OF WORKING CAPITAL 4.7
Cash Manufacturing expenses (1 month lag in payment) `9,60,000
Administrative expenses (cash 1 month lag in payment) `2,40,000
Sales promotion expenses (paid quarterly in advance) `1,20,000

The company sells its products on gross profit 25%. Depreciation is considered as a part of the cost
of production. It keeps one month’s stock each of raw materials and finished goods and a cash balance of
`1,00,000. Assuming a 20% safety margin, ignore work-in-process.

Find out the requirements of working capital of the company on cash cost basis.

Answer
Statement of Working Capital Requirement (Cash Cost Basis)
Particulars `
(A) Current Assets:
Raw Materials (9,00,000 × 1/12) 75,000
Finished Goods (25,80,000 × 1/12) 2,15,000
Debtors (29,40,000 × 2/12) 4,90,000
Cash 1,00,000
Prepaid Sales Promotion Expenses (1,20,000 × 1/4) 30,000
Total (A) 9,10,000
(B) Current Liabilities:
Creditors (9,00,000 × 2/12) 1,50,000
Outstanding labour (7,20,000 × 1/12) 60,000
Outstanding Manufacturing Expenses (9,60,000 × 1/12) 80,000
Outstanding Administrative Expenses (2,40,000 × 1/12) 20,000
Total (B) 3,10,000
Working Capital Before Provision (A - B) 6,00,000
Add : Safety Margin @ 20% of 6,00,000 1,20,000
Working Capital 7,20,000

Working Notes:
Projected Income Statement (Cash Cost Basis)
Particulars `
Raw Materials 9,00,000
Wages 7,20,000
Manufacturing Expenses (in cash) 9,60,000
Cash Cost of Goods Sold 25,80,000
Administration Expenses (in cash) 2,40,000
Sales Promotion Expenses (in cash) 1,20,000
Cash Cost of Sales 29,40,000

MPBF AS PER (MR. P. L. TANDON’S) TANDON COMMITTEE (1974)

BQ 8
Calculate MPBF under the all three methods suggested by Tandon Committee on the basis of information
given below:
Current assets (Inclusive 20% core current assets) `20,00,000
Current liabilities (Excluding bank finance) `5,00,000

Answer
Calculation of MPBF:
Method 1 = 75% (CA - CL) = 75% (20,00,000 – 5,00,000) = `11,25,000
Method 2 = (75% CA) – CL = (75% 20,00,000) – 5,00,000 = `10,00,000
Method 3 = (75% CA other than core CA) – CL
= 75% (20,00,000 – 20%) – 5,00,000 = `7,00,000
 MANAGEMENT OF WORKING CAPITAL 4.8
BQ 9
Calculate MPBF under the all three methods suggested by Tandon Committee on the basis of information
given below:
Current assets `20,00,000
Core current assets 20% of CA
Current liabilities (Including `1,00,000 bank finance) `5,00,000

Answer
Calculation of MPBF:
Method 1 = 75% (CA - CL) = 75% (20,00,000 – 4,00,000) = `12,00,000
Method 2 = (75% CA) – CL = (75% 20,00,000) – 4,00,000 = `11,00,000
Method 3 = (75% CA other than core CA) – CL
= 75% (20,00,000 – 20%) – 4,00,000 = `8,00,000

Note: CL is taken excluding bank finance `1,00,000.

BQ 10
From the following data, calculate maximum permissible bank finance under the all three methods suggested
by Tandon Committee:
Current Liabilities ` In Lakhs
Creditors 120
Other current liabilities 40
Bank borrowings 250
Total 410
Current Assets ` In Lakhs
Raw materials 180
Work-in-progress 60
Finished goods 100
Receivables 150
Other current assests 20
Total 510
The core current assets (CCA) are `200 Lakhs

Answer
Calculation of MPBF:

Method 1 = 75% (CA - CL) = 75% (510 – 160) = `262.50 Lakhs

Method 2 = (75% CA) – CL = (75% 510) – 160 = `222.50 Lakhs
Method 3 = (75% CA other than core CA) – CL
= 75% (510 – 200) – 160 = `72.50 Lakhs

Note: CL is taken excluding bank finance `250 Lakhs.

Note: As the firm, has already availed the bank loan of 250 lakhs, it can still avail a loan of `12.50 lakhs as per
the first method. However, as per the second and third method, it is not eligible for additional financing as
maximum financing allowed is for `222.50 lakhs and `72.50 lakhs only whereas its present bank borrowings
are already `250 lakhs.

BQ 11
The management of Royal industries has called for a statement showing the working capital needs to finance
a level of 1,80,000 units of output for the year. The cost structure for the company's product for the above
mentioned activity level is detailed below:
Cost per Unit (`)
Raw materials 20
Direct labour 5
 MANAGEMENT OF WORKING CAPITAL 4.9
Overheads (including depreciation of `5 per unit) 15
Total cost 40
Profit 10
Selling price 50

Additional Information:
(a) Minimum desired cash balance is `20,000.
(b) Raw materials are held in stock on an average for 2 months.
(c) Work-in-progress (assume 50% completion stage) will approximate to half month's production.
(d) Finished goods remain in warehouse on an average for a month.
(e) Suppliers of materials extend a month's credit and debtors are provided two month's credit.
(f) Cash sales are 25% of total sales.
(g) There is a time lag in payment of wages of a month and half a month in case of overheads.

From the above data, you are required to:

(1) Prepare a statement showing working capital needs; and
(2) Determine the maximum working capital finance available under the first two methods suggested by
Tandon Committee.

Answer
(1) Statement of Working Capital Requirement
Particulars `
(A) Current Assets:
Raw materials (36,00,000 × 2/12) 6,00,000
Work in progress (72,00,000 × 50% × .5/12) 1,50,000
Finished goods (72,00,000 × 1/12) 6,00,000
Debtors (72,00,000 × 75% × 2/12) 9,00,000
Cash 20,000
Total (A) 22,70,000
(B) Current Liabilities:
Creditors (36,00,000 × 1/12) 3,00,000
Outstanding labour (9,00,000 × 1/12) 75,000
Outstanding overhead (18,00,000 × .5/12) 75,000
Total (B) 4,50,000
Working Capital (A - B) 18,20,000

(2) Calculation of Maximum Permissible Bank Finance under the suggestion of Tandon Committee:
Method 1 = 75% (CA - CL) = 75% of 18,20,000 = `13,65,000
Method 2 = (75% CA) – CL = (75% 22,70,000) – 4,50,000 = `12,52,500

Working Notes:
Projected Income Statement
Particulars `
Raw materials (1,80,000 × 20) 36,00,000
Direct Labour (1,80,000 × 5) 9,00,000
Overheads including depreciation (1,80,000 × 15) 27,00,000
Total cost 72,00,000
Profit 18,00,000
Sales (1,80,000 × 50) 90,00,000

NEW PROJECT
BQ 12
A newly formed company has applied to the commercial bank for the first time for financing its working
capital requirements.
 MANAGEMENT OF WORKING CAPITAL 4.10
The following information is available about the projections for the current year:
Estimated level of activity is 2,08,000 completed units of production plus 8,000 units of work-in-
progress.
Based on the above activity, estimated cost per unit is:
Raw material `16
Direct wages `6
Overheads (exclusive of depreciation) `12
Total cost `34
Selling price `40
Raw materials in stock: average 4 weeks consumption, work-in-progress (assume 50% completion
stage in respect of conversion cost and materials issued at the start of the processing).
Finished goods in stock 16,000 units
Credit allowed by suppliers Average 4 weeks
Credit allowed to debtors Average 8 weeks
Lag in payment of wages Average 1.5 weeks
Lag in payment of overheads Average 4 weeks
Cash at banks (for smooth operation) `50,000
Assume that production is carried on evenly throughout the year (52 weeks) and wages and
overheads accrue similarly. All sales are on credit basis only.

You are required to estimate net working capital.

Answer
Statement of Working Capital Requirement
Particulars `
(1) Current Assets:
Raw materials (34,56,000 × 4/52) 2,65,846
Work in progress 2,00,000
Finished goods 5,44,000
Debtors (65,28,000 × 8/52) 10,04,308
Cash 50,000
Total (1) 20,64,154
(2) Current Liabilities:
Creditors (34,56,000 + 2,65,846) × 4/52 2,86,296
Outstanding labour (12,72,000 × 1.5/52) 36,692
Outstanding overheads (25,44,000 × 4/52) 1,95,692
Total (2) 5,18,680
Working Capital (1 - 2) 15,45,474

Working Notes:
Projected Income Statement
Particulars `
Raw materials (2,16,000 × 16) 34,56,000
Direct labour (2,08,000 + ½ × 8,000) × 6 12,72,000
Overheads (2,08,000 + ½ × 8,000) × 12 25,44,000
Cost Upto Factory 72,72,000
Less: Closing WIP 8,000 units × (16 + 3 + 6) (2,00,000)
Cost of Production (2,08,000 units) 70,72,000
Less: Closing FG 16,000 units × 34 (5,44,000)
Cost of Goods Sold (1,92,000 units) 65,28,000
Profit 11,52,000
Sales (1,92,000 × 40) 76,80,000
 MANAGEMENT OF WORKING CAPITAL 4.11
BQ 13
PQ Ltd. a company newly commencing business in 2023 has the under-mentioned projected P & L Account:
Particulars ` `
Sales 2,10,000
Cost of goods sold 1,53,000
Gross Profit 57,000
Administrative Expenses 14,000
Selling Expenses 13,000 27,000
Profit Before Tax 30,000
Provision for taxation 10,000
Profit After Tax 20,000

The cost of goods sold has been arrived at as under:

Materials used 84,000

Wages and manufacturing Expenses 62,500
Depreciation 23,500
Cost of Finished Goods Produced 1,70,000
Less: Stock of Finished Goods 17,000
(10% of goods produced not yet sold) 1,53,000

The figure given above relate only to finished goods and not to work-in-progress. Goods equal to
15% of the year’s production (in terms of physical units) will be in process on the average requiring full
materials but only 40% of the other expenses. The company believes in keeping materials equal to two
months consumption in stock.

All expenses will be paid one month in advance. Suppliers of materials will extend 1-½months credit.
Sales will be 20% for cash and rest at two months credit. 70% of the income tax will be paid in advance in
quarterly installments. The company wishes to keep `8,000 in cash. 10% has to be added to the estimated
figure for unforeseen contingencies.

Prepare an estimate of working capital on cash cost basis.

Answer
Statement of Working Capital Requirement
Particulars `
(1) Current Assets:
Raw materials (96,600 × 2/12) 16,100
Work in progress 16,350
Finished goods 14,650
Debtors (1,58,850 × 80% × 2/12) 21,180
Prepaid expenses:
Wages and Manufacturing Expenses (66,250 × 1/12) 5,521
Administrative Expenses (14,000 × 1/12) 1,167
Selling Expenses (13,000 × 1/12) 1,083
Advance tax paid [(70% of 10,000) × 3/12] 1,750
Cash 8,000
Total (1) 85,801
(2) Current Liabilities:
Creditors (96,600 + 16,100) × 1.5/12 14,088
Provision for Tax (Net of Advance Tax) (10,000 × 30%) 3,000
Total (2) 17,088
Working Capital Before Provision(1 - 2) 68,713
Add : Provision for Contingencies @ 10% of 68,713 6,871
Working Capital Including Provision 75,584

Working Notes:
 MANAGEMENT OF WORKING CAPITAL 4.12
Projected Income Statement
Particulars `
Raw Materials (84,000 + 15%) 96,600
Wages and Manufacturing Expenses (62,500 + 15% of 62,500 × 40%) 66,250
Cost Upto Factory 1,62,850
Less: Closing WIP (84,000 × 15%) + (15% of 62,500 × 40%) (16,350)
Cost of Production 1,46,500
Less: Closing FG (10% of 1,46,500) (14,650)
Cost of Goods Sold 1,31,850
Administrative Expenses 14,000
Selling Expenses 13,000
Cash Cost of Sales 1,58,850

BQ 14
PQR Ltd. a company newly commencing business in 2023 has the under-mentioned projected P & L Account:
Particulars ` `
Sales 5,04,000
Cost of goods sold 3,67,200
Gross Profit 1,36,800
Administrative Expenses 33,600
Selling Expenses 31,200 64,800
Profit Before Tax 72,000
Provision for taxation 24,000
Profit After Tax 48,000

The cost of goods sold has been arrived at as under:

Materials used 2,01,600

Wages and manufacturing Expenses 1,50,000
Depreciation 56,400
Cost of Finished Goods Produced 4,08,000
Less: Stock of Finished Goods 40,800
(10% of goods produced not yet sold) 3,67,200

The figure given above relate only to finished goods and not to work-in-progress. Goods equal to
15% of the year’s production (in terms of physical units) will be in process on the average requiring full
materials but only 40% of the other expenses. The company believes in keeping materials equal to two
months consumption in stock.

All expenses will be paid one month in advance. Suppliers of materials will extend 1-½months credit.
Sales will be 20% for cash and rest at two months credit. 70% of the income tax will be paid in advance in
quarterly installments. The company wishes to keep `19,200 in cash. 10% has to be added to the estimated
figure for unforeseen contingencies.

Prepare an estimate of working capital on cash cost basis.

Answer
Statement of Working Capital Requirement
Particulars `
(1) Current Assets:
Raw materials (2,31,840 × 2/12) 38,640
Work in progress 39,240
Finished goods 35,160
Debtors (3,81,240 × 80% × 2/12) 50,832
Prepaid expenses:
Wages and Manufacturing Expenses (1,59,000 × 1/12) 13,250
 MANAGEMENT OF WORKING CAPITAL 4.13
Administrative Expenses (33,600 × 1/12) 2,800
Selling Expenses (31,200 × 1/12) 2,600
Advance tax paid [(70% of 24,000) × 3/12] 4,200
Cash 19,200
Total (1) 2,05,922
(2) Current Liabilities:
Creditors (2,31,840 + 38,640) × 1.5/12 33,810
Provision for Tax (Net of Advance Tax) (24,000 × 30%) 7,200
Total (2) 41,010
Working Capital Before Provision(1 - 2) 1,64,912
Add : Provision for Contingencies @ 10% of 1,64,912 16,491
Working Capital Including Provision 1,81,403

Working Notes:
Projected Income Statement
Particulars `
Raw Materials (2,01,600 + 15%) 2,31,840
Wages and Manufacturing Expenses (1,50,000 + 15% of 1,50,000 × 40%) 1,59,000
Cost Upto Factory 3,90,840
Less: Closing WIP (2,01,600 × 15%) + (15% of 1,50,000 × 40%) (39,240)
Cost of Production 3,51,600
Less: Closing FG (10% of 3,51,600) (35,160)
Cost of Goods Sold 3,16,440
Administrative Expenses 33,600
Selling Expenses 31,200
Cash Cost of Sales 3,81,240

OTHERS
BQ 15
The management of Trux Company Ltd. is planning to expand its business and consults you to prepare an
estimated working capital statement. The records of the company reveals the following annual information:

The records of the company revealed the following annual information:

Sales:
Domestic at one month’s credit `18,00,000
Export at three month’s credit `8,10,000
(Sales price 10% below Domestic price)
Material used (suppliers extend two months credit) `6,75,000
Lag in payment of wages - ½ month `5,40,000
Lag in payment of manufacturing expenses (cash) - 1 month `7,65,000
Lag in payment of administrative expenses - 1 month `1,80,000
Sales promotion expenses payable quarterly in advance `1,12,500
Income tax payable in four installments (of which one falls in the next financial year) `1,68,000

Rate of gross profit is 20%. Ignore work-in-progress and depreciation. The company keeps one
month’s stock of raw materials and finished goods (each) and believes in keeping `2,50,000 available to it
including the overdraft limit of `75,000 not yet utilized by the company. The management is also of the
opinion to make 10% margin for contingencies on computed figure.

You are required to prepare the estimated working capital statement for next year.

Answer
Statement of Working Capital Requirement (Cash Cost Basis)
Particulars `
 MANAGEMENT OF WORKING CAPITAL 4.14
(A) Current Assets:
Raw Materials (6,75,000 × 1/12) 56,250
Finished Goods (21,60,000 × 1/12) 1,80,000
Debtors:
Domestic (14,40,000 + 77,586) × 1/12 1,26,466
Export (7,20,000 + 34,914) × 3/12 1,88,729
Cash (2,50,000 – 75,000) 1,75,000
Prepaid Sales Promotion Expenses (1,12,500 × 1/4) 28,125
Total (A) 7,54,570
(B) Current Liabilities:
Creditors (6,75,000 × 2/12) 1,12,500
Outstanding labour (5,40,000 × 0.5/12) 22,500
Outstanding Manufacturing Expenses (7,65,000 × 1/12) 63,750
Outstanding Administrative Expenses (1,80,000 × 1/12) 15,000
Income Tax Payable(1,68,000 × 1/4) 42,000
Total (B) 2,55,750
Working Capital Before Provision (A - B) 4,98,820
Add : Safety Margin @ 10% of 4,98,820 49,882
Working Capital 5,48,702

Working Notes:
1. Calculation of Cash cost of Debtors:
Export sales (10% below domestic sales price) = 8,10,000

Export sales equivalent to domestic sales = 8,10,000 × 100 = 9,00,000

90
Total equivalent domestic sales = 18,00,000 + 9,00,000 = 27,00,000

Apportionment of cash cost of sales except sales promotion expenses in proportion of equivalent
domestic sales between Domestic and Foreign Sales:

Domestic sales = 21,60,000 × 18 ,00 ,000 = 14,40,000

27 ,00 ,000

Foreign sales = 21,60,000 × 9 ,00 ,000 = 7,20,000

27 ,00 ,000

Apportionment of sales promotion expenses between Domestic and Foreign Sales in sales ratio:

Domestic sales = 1,12,500 × 18 ,00 ,000 = 77,586

26 ,10 ,000

Foreign sales = 1,12,500 × 8 ,10 ,000 = 34,914

26 ,10 ,000

2. Projected Income Statement

Particulars `
Raw Materials 6,75,000
Wages 5,40,000
Manufacturing Expenses (in cash) 7,65,000
Administration Expenses (in cash) 1,80,000
Cash Cost of Goods Sold 21,60,000
Sales Promotion Expenses (in cash) 1,12,500
Cash Cost of Sales 22,72,500

Assumption: Administrative expenses is related to production.

BQ 16
M.A. Limited is commencing a new project of a plastic component. The following cost information has been
ascertained for annual production of 12,000 units which is the full capacity.
 MANAGEMENT OF WORKING CAPITAL 4.15
(Cost per unit)
Materials `40
Direct labour and variable expenses `20
Fixed manufacturing expenses `6
Depreciation `10
Fixed administrative expenses `4

The selling price per unit is expected to be `96 and the selling expenses `5 per unit 80% of which is
variable. In the first two years of operation, productivity and sales are expected to be as follows:
Year Productivity Sales
No. of units No. of units
1 6,000 5,000
2 9,000 8,500

To assess the working capital requirement, the following additional information is available:
(a) Stock of Materials 2.25 months average
(b) Work-in-Progress Nil
(c) Debtors 1 month's average sales
(d) Cash balance `10,000
(e) Creditors for supply of materials 1 month's average purchase
(f) Creditors for expenses 1 month average of all expenses

Prepare for two years:

(1) Projected Statement of Profit and Loss (ignoring taxation) and
(2) Projected Statement of working capital requirements.

Answer
(1) M.A. Limited
Projected Statement of Profit and Loss
Particulars Year 1 Year 2
Production (in units) 6,000 9,000
Sales (in units) 5,000 8,500
Materials 2,40,000 3,60,000
Direct labour and variable expenses 1,20,000 1,80,000
Fixed manufacturing expenses 72,000 72,000
Depreciation 1,20,000 1,20,000
Fixed administrative expenses 48,000 48,000
Cost of production 6,00,000 7,80,000
Add: Opening FG (Year 1: Nil; Year 2: 1,000 units) Nil 1,00,000
Total cost of goods available for sale 6,00,000 8,80,000
Less: Closing FG (Year 1: 1,000; Year 2: 1,500 units) (1,00,000) (1,32,000)
Cost of goods sold 5,00,000 7,48,000
Selling expenses: Variable @ `4 per unit sold 20,000 34,000
Fixed 12,000 12,000
Cost of sales 5,32,000 7,94,000
Profit or loss (52,000) 22,000
Sales 4,80,000 8,16,000

(2) Projected Statement of Working Capital Requirement

Particulars Year 1 Year 2
(A) Current Assets:
Raw materials 45,000 67,500
Finished goods 1,00,000 1,32,000
Debtors (on sales value) 40,000 68,000
 MANAGEMENT OF WORKING CAPITAL 4.16
Cash 10,000 10,000
Total (A)
1,95,000 2,77,500
(B) Current Liabilities:
Creditors (Purchase = RMC + CS - OS)
23,750 31,875
Outstanding expenses
22,667 28,833
Total (B)
46,417 60,708
Working Capital (A - B)
1,48,583 2,16,792

Assumptions:
1. Administrative expenses is related to production.
2. Stock of finished goods is valued as per weighted average method.

BQ 17
Following are cost information of KG Ltd. which has commenced a new project for an annual production of
24,000 units which is the full capacity.
(Cost per unit)
Materials `80
Direct labour and variable expenses `40
Fixed manufacturing expenses `12
Depreciation `20
Fixed administrative expenses `8
The selling price per unit is expected to be `192 and the selling expenses `10 per unit 80% of which
is variable. In the first two years of operation, productivity and sales are expected to be as follows:

Year Productivity Sales

No. of units No. of units
1 12,000 10,000
2 18,000 17,000

To assess the working capital requirement, the following additional information is available:

(a) Stock of Materials 2 months average consumption

(b) Work-in-Progress Nil
(c) Debtors 2 month's average sales
(d) Cash balance `1,00,000
(e) Creditors for supply of materials 1 month's average purchase
(f) Creditors for expenses 1 month average of all expenses

Prepare for two years:

(1) Projected Statement of Profit and Loss (ignoring taxation) and
(2) Projected Statement of working capital requirements.

Answer
(1) KG Ltd.
Projected Statement of Profit and Loss
Particulars Year 1 Year 2
Production (in units) 12,000 18,000
Sales (in units) 10,000 17,000
Materials 9,60,000 14,40,000
Direct labour and variable expenses 4,80,000 7,20,000
Fixed manufacturing expenses 2,88,000 2,88,000
Depreciation 4,80,000 4,80,000
Fixed administrative expenses 1,92,000 1,92,000
Cost of production 24,00,000 31,20,000
Add: Opening FG (Year 1: Nil; Year 2: 2,000 units) Nil 4,00,000
 MANAGEMENT OF WORKING CAPITAL 4.17
Total cost of goods available for sale 24,00,000 35,20,000
Less: Closing FG (Year 1: 2,000; Year 2: 3,000 units) (4,00,000) (5,28,000)
Cost of goods sold 20,00,000 29,92,000
Selling expenses: Variable @ `4 per unit sold 80,000 1,36,000
Fixed 48,000 48,000
Cost of sales 21,28,000 31,76,000
Profit or loss (2,08,000) 88,000
Sales 19,20,000 32,64,000

(2) Projected Statement of Working Capital Requirement

Particulars Year 1 Year 2
(A) Current Assets:
Raw materials 1,60,000 2,40,000
Finished goods 4,00,000 5,28,000
Debtors (on sales value) 3,20,000 5,44,000
Cash 1,00,000 1,00,000
Total (A) 9,80,000 14,12,000
(B) Current Liabilities:
Creditors (Purchase = RMC + CS - OS) 93,333 1,26,667
Outstanding expenses 90,667 1,15,333
Total (B) 1,84,000 2,42,000
Working Capital (A - B) 7,96,000 11,70,000

Assumptions:
1. Administrative expenses is related to production.
2. Stock of finished goods is valued as per weighted average method.

BQ 18
The following annual figures relate to manufacturing entity:
Sales at one month credit `84,00,000
Material consumption 60% of sales value
Wages (paid in a lag of 15 days) `12,00,000
Cash Manufacturing Expenses `3,00,000
Administrative Expenses `2,40,000
Creditors extend 3 months credit for payment
Cash manufacturing and administrative expenses 1 months in arrear

The company maintains stock of raw material equal to economic order quantity. The company incurs `100
as per ordering cost per order and opportunity cost of capital is 15% p.a. The optimum cash balance is
determined using Baumol’s model. The bank charges `10 for each cash withdrawal. Finished goods are held
in stock for 1 month. The company maintains a bank balance of `12,00,000 on an average. Creditors are paid
through net banking and all other expenses are incurred in cash which is withdrawn from bank.

Assuming a 20% safety margin, you are required to estimate the amount of working capital that
needs to be invested by the Company (1 Year of 360 Days).

Answer
Statement of Working Capital Requirement (Cash Cost Basis)
Particulars `
(A) Current Assets:
Raw Materials 81,976
Finished Goods (65,40,000 × 1/12) 5,45,000
Debtors (67,80,000 × 1/12) 5,65,000
Cash 15,232
Bank 12,00,000
Total (A) 24,07,208
 MANAGEMENT OF WORKING CAPITAL 4.18
(B) Current Liabilities:
Creditors (50,40,000 × 3/12) 12,60,000
Outstanding labour (12,00,000 × 15/360) 50,000
Outstanding Manufacturing Expenses (3,00,000 × 1/12) 25,000
Outstanding Administrative Expenses (2,40,000 × 1/12) 20,000
Total (B) 13,55,000
Working Capital Before Safety Margin (A - B) 10,52,208
Add : Safety Margin @ 20% of 10,52,208 2,10,442
Working Capital 12,62,650

Working Notes:
1. Projected Income Statement (Cash cost)
Particulars `
Raw Materials Consumed (`84,00,000 × 60%) 50,40,000
Wages 12,00,000
Manufacturing Expenses 3,00,000
Cash Cost of Production 65,40,000
Administration Expenses 2,40,000
Cash Cost of Sales 67,80,000

2. Computation of Stock of Materials:

A = `50,40,000
O = `100
C = `0.15

2𝐴𝑂 2×50,40,000×100
EOQ = √ = √ = `81,976
𝐶 .15

3. Computation of Cash Balance:

U = `12,00,000 + 3,00,000 + 2,40,000 (Payment to creditors through net banking)
= `17,40,000
P = `10
S = `0.15

2𝑈𝑃 2×17,40,000×10
Optimum Cash Balance = √ = √ = `15,232
𝑆 .15

BQ 19
A firm has the following data for the year ending 31st March, 2023:
Sales (1,00,000 @ `20) `20,00,000
Earnings before Interest and Taxes `2,00,000
Fixed Assets `5,00,000
The three possible current assets holdings of the firm are `5,00,000, `4,00,000 and `3,00,000. It is
assumed that fixed assets level is constant and profits do not vary with current assets levels.
Explain the effect of the three alternative current assets policies.

Answer
Effect of Alternative Working Capital Policy
Particulars Conservative Moderate Aggressive
Sales 20,00,000 20,00,000 20,00,000
Earnings before interest and tax (EBIT) 2,00,000 2,00,000 2,00,000
Current Assets 5,00,000 4,00,000 3,00,000
Fixed Assets 5,00,000 5,00,000 5,00,000
Total Assets 10,00,000 9,00,000 8,00,000
 MANAGEMENT OF WORKING CAPITAL 4.19
Return on Total Assets (EBIT ÷ Total Assets) 20% 22.22% 25%
Current Assets/Fixed Assets 1.00 0.80 0.60

The aforesaid calculation shows that the conservative policy provides greater liquidity (solvency) to the
firm, but lower return on total assets. On the other hand, the aggressive policy gives higher return, but low
liquidity and thus is very risky. The moderate policy generates return higher than Conservative policy but
lower than aggressive policy. This is less risky than aggressive policy but riskier than conservative policy.

DOUBLE SHIFT
BQ 20
Samreen Enterprises has been operating its manufacturing facilities till 31.03.2022 on a single shift
working with the following cost structure:
Per unit
Cost of Materials `6.00
Wages (out of which 40% fixed) `5.00
Overheads (out of which 80% fixed) `5.00
Profit `2.00
Selling price `18.00
Sales during 2021-2022 `4,32,000

As at 31.03.22 the company held:

Stock of raw materials (at cost) `36,000

Work-in-progress (valued at prime cost) `22,000
Finished goods (valued at total cost) `72,000
Sundry debtors `1,08,000

In view of increased market demand, it is proposed to double production by working an extra shift. It
is expected that a 10% discount will be available from suppliers of raw materials in view of increased volume
of business. Selling price will remain the same. The credit period allowed to customers will remain unaltered.
Credit availed of from suppliers will continue to remain at the present level i.e. 2 months. Lag in payment of
wages and expenses will continue to remain half a month.

You are required to assess the additional working capital requirement, if the policy to increase
output is implemented.

Answer
Statement of Working Capital for Single Shift and Double Shift Working
Single Shift (24,000) Double Shift (48,000)
Particulars
P. U. Units Total P. U. Units Total
(A) Current Assets:
Raw Materials Stock 6.00 6,000 36,000 5.40 12,000 64,800
WIP Stock 11.00 2,000 22,000 9.40 2,000 18,800
FG Stock 16.00 4,500 72,000 12.40 9,000 1,11,600
Debtors 16.00 6,000 96,000 12.40 12,000 1,48,800
Total (A) - - 2,26,000 - - 344,000
(B) Current Liabilities:
Creditors 6.00 4,000 24,000 5.40 8,000 43,200
Outstanding Wages 5.00 1,000 5,000 4.00 2,000 8,000
Outstanding Overheads 5.00 1,000 5,000 3.00 2,000 6,000
Total (B) - - 34,000 - - 57,200
Working Capital (A - B) - - 1,92,000 - - 2,86,800

Increase in working capital requirement is `94,800 (`2,86,800 - `1,92,000).

Working Notes:
 MANAGEMENT OF WORKING CAPITAL 4.20
1. Statement of Cost at Single Shift and Double Shift Working
Single Shift (24,000) Double Shift (48,000)
Particulars
P. U. Total P. U. Total
Raw Materials 6.00 1,44,000 5.40 2,59,200
Wages Variable 3.00 72,000 3.00 1,44,000
Wages Fixed 2.00 48,000 1.00 48,000
Prime Cost 11.00 2,64,000 9.40 4,51,200
Overhead Variable 1.00 24,000 1.00 48,000
Overhead Fixed 4.00 96,000 2.00 96,000
Total Cost 16.00 3,84,000 12.40 5,95,200
Profit 2.00 48,000 5.60 2,68,800
Sales Value 18.00 4,32,000 18.00 8,64,000

2. Sales units in 2021-2022 = Sales ÷ Sale Price per unit

= `4,32,000 ÷ `18
= 24,000 units

3. Raw Material units on 31.03.2022 = Raw Material Stock ÷ Raw Material cost per unit
= `36,000 ÷ `6
= 6,000 units

4. WIP units on 31.03.2022 = WIP Stock ÷ Prime cost per unit

= `22,000 ÷ `11
= 2,000 units

5. Finished Goods units on 31.03.2022 = Finished Goods Stock ÷ Total cost per unit
= `72,000 ÷ `16
= 4,500 units

6. Debtors units on 31.03.2022 = Sundry debtors ÷ Sale Price per unit

= `1,08,000 ÷ `18
= 6,000 units

7. Credit allowed to Customers = 6,000 ÷ (24,000 units ÷ 12 months)

= 3 months

BQ 21
MT Ltd has been operating its manufacturing facilities till 31.03.2022 on a single shift working with the
following cost structure:
Per unit
Cost of Materials `24.00
Wages (out of which 60% variable) `20.00
Overheads (out of which 20% variable) `20.00
Profit `8.00
Selling price `72.00
Sales during 2021-2022 `17,28,000

As at 31.03.22 the company held:

Stock of raw materials (at cost) `1,44,000

Work-in-progress (valued at prime cost) `88,000
Finished goods (valued at total cost) `2,88,000
Sundry debtors `4,32,000

In view of increased market demand, it is proposed to double production by working an extra shift. It
is expected that a 10% discount will be available from suppliers of raw materials in view of increased volume
of business. Selling price will remain the same. The credit period allowed to customers will remain unaltered.
 MANAGEMENT OF WORKING CAPITAL 4.21
Credit availed of from suppliers will continue to remain at the present level i.e. 2 months. Lag in payment of
wages and expenses will continue to remain at one month.

You are required to calculate the additional working capital requirement, if the policy to
increase output is implemented.

Answer
Statement of Working Capital for Single Shift and Double Shift Working
Single Shift (24,000) Double Shift (48,000)
Particulars
P. U. Units Total P. U. Units Total
(A) Current Assets:
Raw Materials Stock 24.00 6,000 1,44,000 21.60 12,000 2,59,200
WIP Stock 44.00 2,000 88,000 37.60 2,000 75,200
FG Stock 64.00 4,500 2,88,000 49.60 9,000 4,46,400
Debtors 64.00 6,000 3,84,000 49.60 12,000 5,95,200
Total (A) - - 9,04,000 - - 13,76,000
(B) Current Liabilities:
Creditors 24.00 4,000 96,000 21.60 8,000 1,72,800
Outstanding Wages 20.00 2,000 40,000 16.00 4,000 64,000
Outstanding Overheads 20.00 2,000 40,000 12.00 4,000 48,000
Total (B) - - 1,76,000 - - 2,84,800
Working Capital (A - B) - - 7,28,000 - - 10,91,200

Increase in working capital requirement is `3,63,200 (`10,91,200 - `7,28,000).

Working Notes:
1. Statement of Cost at Single Shift and Double Shift Working
Single Shift (24,000) Double Shift (48,000)
Particulars
P. U. Total P. U. Total
Raw Materials 24.00 5,76,000 21.60 10,36,800
Wages Variable 12.00 2,88,000 12.00 5,76,000
Wages Fixed 8.00 1,92,000 4.00 1,92,000
Prime Cost 44.00 10,56,000 37.60 18,04,800
Overhead Variable 4.00 96,000 4.00 1,92,000
Overhead Fixed 16.00 3,84,000 8.00 3,84,000
Total Cost 64.00 15,36,000 49.60 23,80,800
Profit 8.00 1,92,000 22.40 10,75,200
Sales Value 72.00 17,28,000 72.00 34,56,000

2. Sales units in 2021-2022 = Sales ÷ Sale Price per unit

= `17,28,000 ÷ `72
= 24,000 units

3. Raw Material units on 31.03.2022 = Raw Material Stock ÷ Raw Material cost per unit
= `1,44,000 ÷ `24
= 6,000 units

4. WIP units on 31.03.2022 = WIP Stock ÷ Prime cost per unit

= `88,000 ÷ `44
= 2,000 units

5. Finished Goods units on 31.03.2022 = Finished Goods Stock ÷ Total cost per unit
= `2,88,000 ÷ `64
= 4,500 units

6. Debtors units on 31.03.2022 = Sundry debtors ÷ Sale Price per unit

 MANAGEMENT OF WORKING CAPITAL 4.22
= `4,32,000 ÷ `72
= 6,000 units

7. Credit allowed to Customers = 6,000 ÷ (24,000 units ÷ 12 months)

= 3 months
 MANAGEMENT OF WORKING CAPITAL 4.23

PAST YEARS QUESTIONS

PYQ 1
Aneja Limited, a newly formed company, has applied to the commercial bank for the first time for financing
its working capital requirements.
The following information is available about the projections for the current year:
Estimated level of activity is 1,04,000 completed units of production plus 4,000 units of work-in-
progress.
Based on the above activity, estimated cost per unit is:
Raw material `80
Direct wages `30
Overheads (exclusive of depreciation) `60
Total cost `170
Selling price `200

Raw materials in stock: average 4 weeks consumption, work-in-progress (assume 50% completion
stage in respect of conversion cost but materials issued at the start of the processing).
Finished goods in stock 8,000 units
Credit allowed by suppliers Average 4 weeks
Credit allowed to debtors Average 8 weeks
Lag in payment of wages Average 1.5 weeks
Cash at banks (for smooth operation) `25,000

Assume that production is carried on evenly throughout the year (52 weeks) and wages and
overheads accrue similarly. All sales are on credit basis only.
Find out:
(a) The net working capital required;
(b) The maximum permissible bank finance under first and second methods of financing as per Tandon
Committee Norms.
[(12 Marks) Nov 1998]

Answer
(a) Statement of Working Capital Requirement
Particulars `
(1) Current Assets:
Raw materials (86,40,000 × 4/52) 6,64,615
Work in progress [4,000 units × (80 + 15 + 30)] 5,00,000
Finished goods (8,000 units × 170) 13,60,000
Debtors (1,63,20,000 × 8/52) 25,10,769
Cash 25,000
Total (1) 50,60,384
(2) Current Liabilities:
Creditors (86,40,000 + 6,64,615) × 4/52 7,15,740
Outstanding labour (31,80,000 × 1.5/52) 91,731
Total (2) 8,07,471
Working Capital (1 - 2) 42,52,913

(b) Calculation of MPBF under the suggestion of Tandon Committee Norms:

Method 1 = 75% (50,60,384 – 8,07,471) = 75% of 46,95,990 = `31,89,685

Method 2 = (75% CA) – CL = (75% 50,60,384) – 8,07,471 = `29,87,817

 MANAGEMENT OF WORKING CAPITAL 4.24
Working Notes:
Projected Income Statement
Particulars `
Raw materials (1,08,000 × 80) 86,40,000
Direct labour (1,04,000 + ½ × 4,000) × 30 31,80,000
Overheads (1,04,000 + ½ × 4,000) × 60 63,60,000
Cost Upto Factory 1,81,80,000
Less: Closing WIP 4,000 units × (80 + 15 + 30) (5,00,000)
Cost of Production (1,08,000 units) 1,76,80,000
Less: Closing FG 8,000 units × 170 (13,60,000)
Cost of Goods Sold (96,000 units) 1,63,20,000
Profit 28,80,000
Sales (96,000 × 200) 1,92,00,000

PYQ 2
Q Ltd. sells goods at a uniform rate of gross profit of 20% on sales including depreciation as part of cost of
production.
Its annual figures are as under:
Sales (at 2 months' credit) `24,00,000
Materials consumed (suppliers credit 2 months) `6,00,000
Wages paid (monthly at the beginning of the subsequent month) `4,80,000
Manufacturing expenses (cash expenses are paid one month in arrear) `6,00,000
Administration expenses (cash expenses are paid one month in arrear) `1,50,000
Sales promotion expenses (paid quarterly in advance) `75,000
The company keeps one month stock each of raw materials and finished goods. A minimum cash
balance of `80,000 is always kept. The company wants to adopt a 10% safety margin in the maintenance of
working capital. The company has no work-in-progress.
Find out the requirements of working capital of the company on cash cost basis.
[(8 Marks) May 1994, 1999]

Answer
Statement of Working Capital Requirement (Cash Cost Basis)
Particulars `
(1) Current Assets:
Raw Materials (6,00,000 × 1/12) 50,000
Finished Goods (16,80,000 × 1/12) 1,40,000
Debtors (19,05,000 × 2/12) 3,17,500
Cash 80,000
Prepaid Sales Promotion Expenses (75,000 × 1/4) 18,750
Total (1) 6,06,250
(2) Current Liabilities:
Creditors (6,00,000 × 2/12) 1,00,000
Outstanding labour (4,80,000 × 1/12) 40,000
Outstanding Manufacturing Expenses (6,00,000 × 1/12) 50,000
Outstanding Administrative Expenses (1,50,000 × 1/12) 12,500
Total (2) 2,02,500
Working Capital Before Provision (1 - 2) 4,03,750
Add : Safety Margin @ 10% of 4,03,750 40,375
Working Capital 4,44,125

Working Notes:
Projected Income Statement
Particulars `
Raw Materials 6,00,000
 MANAGEMENT OF WORKING CAPITAL 4.25
Wages 4,80,000
Manufacturing Expenses (in cash) 6,00,000
Cash Cost of Goods Sold 16,80,000
Administration Expenses (in cash) 1,50,000
Sales Promotion Expenses (in cash) 75,000
Cash Cost of Sales 19,05,000

PYQ 3
A company is considering its working capital investment and financial policies for the next year. Estimated
fixed assets and current liabilities for the next year are `2.60 crores and `2.34 crores respectively. Estimated
sales and EBIT depends on current assets investment, particularly inventories and book-debts.
The Financial Controller of the company is examining the following alternative Working Capital
Policies:
(` Crore)
Working capital policy Investment in CA Estimated sales EBIT
Conservative 4.50 12.30 1.23
Moderate 3.90 11.50 1.15
Aggressive 2.60 10.00 1.00
After evaluating the working capital policy, the Financial Controller has advised the adoption of the
moderate working capital policy. The company is now examining the use of long term and short term
borrowings for financing its assets. The company will use `2.50 crores of the equity funds. The corporate tax
rate is 35%.
The company is considering the following debt alternatives: (` Crore)
Financing policy Short term debt Long term debt
Conservative 0.54 1.12
Moderate 1.00 0.66
Aggressive 1.50 0.16
Interest rate 12% 16%

You are required to calculate the following:

(1) Working Capital Investment for each policy:
a. Net working capital position, b. Rate of return on total assets, c. Current ratio.

(2) Financing for each policy:

a. Net working capital position, b. Rate of return on shareholder’s equity, c. Current ratio.
[(8 Marks) Nov 2001]

Answer
(1) Statement Showing Working Capital Investment for Each Policy (` Crore)
Particulars Conservative Moderate Aggressive
(a) Net working capital position (CA – CL) 4.50 – 2.34 3.90 – 2.34 2.60 – 2.34
2.16 1.56 0.26

(b) Rate of return on total assets 1.23

×100 1.15
×100 1.00
×100
 EBIT  2.60  4.50 2.60  3.90 2.60  2.60
 100 
 Total assets  17.32% 17.69% 19.23%

(c) Current ratio (CA ÷ CL) 4.50 ÷ 2.34 3.90 ÷ 2.34 2.60 ÷ 2.34
1.92 : 1 1.67 : 1 1.11 : 1

(2) Statement Showing Effect of Financing Policies (` Crore)

Particulars Conservative Moderate Aggressive
(a) Net working capital position (CA – CL) 3.90 – *2.88 3.90 – 3.34 3.90 – 3.84
CL includes short term borrowings 1.02 0.56 0.06
 MANAGEMENT OF WORKING CAPITAL 4.26
(b) Rate of return on shareholder’s equity 0.589
×100 0.601
×100 0.614
×100
 PAT  2.50 2.50 2.50
  100 
 Equity  23.56% 24.04% 24.56%

(c) Current ratio (CA ÷ CL) 3.90 ÷ 2.88 3.90 ÷ 3.34 3.90 ÷ 3.84
1.35 : 1 1.167 : 1 1.016 : 1
Calculation of PAT:
EBIT 1.15 1.15 1.15
Less: interest @ 12% on short term 0.065 0.12 0.18
Less: interest @ 16% on long term 0.179 0.106 0.026
EBT 0.906 0.924 0.944
Less: Tax @ 35% 0.317 0.323 0.330
PAT 0.589 0.601 0.614
* CL = CL + Short term borrowings = 2.34 + 0.54 = 2.88

PYQ 4
The following information has been extracted from the records of a Company, estimated cost per unit is:
Raw material `45
Direct wages `20
Overheads `40
Total cost `105
Profit `15
Selling price `120
(a) Raw materials are in stock on an average of two months.
(b) The materials are in process on an average for 4 weeks. The degree of completion is 50%.
(c) Finished goods stock on an average is for one month.
(d) Time lag in payment of wages and overheads is 1-½ weeks.
(e) Time lag in receipt of proceeds from debtors is 2 months.
(f) Credit allowed by suppliers is 1 month.
(g) 20% of the output is sold against cash.
(h) The company expects to keep a cash balance of `1,00,000.
(i) Take 52 weeks per annum.
(j) The company is poised for a manufacture of 1,44,000 units in the year.
You are required to prepare a statement showing the working capital requirements of the
company.
[(8 Marks) Nov 2002]

Answer
Statement of Working Capital Requirement
Particulars `
(1) Current Assets:
Raw Materials (1,44,000 units × `45 × 2/12) 10,80,000
WIP (1,44,000 units × `105 × 50% × 4/52) 5,81,538
Finished Goods (1,44,000 units × `105 × 1/12) 12,60,000
Debtors (1,44,000 units × `105 × 80% × 2/12) 20,16,000
Cash 1,00,000
Total (1) 50,37,538
(2) Current Liabilities:
Creditors (1,44,000 units × `45 × 1/12) 5,40,000
Outstanding labour (1,44,000 units × `20 × 1.5/52) 83,077
Outstanding Overhead (1,44,000 units × `40 × 1.5/52) 1,66,154
Total (2) 7,89,231
Working Capital (1 - 2) 42,48,307

PYQ 5
 MANAGEMENT OF WORKING CAPITAL 4.27
An engineering company is considering its working capital investment for the year 2003-04. The estimated
fixed assets and current liabilities for the next year are `6.63 crores and `5.967 crores respectively. The sales
and earnings before interest and taxes (EBIT) depend on investment in its current assets particularly
inventory and receivables.
The company is examining the following alternative working capital policies: (` Crore)
Working capital policy Investment in CA Estimated sales EBIT
Conservative 11.475 31.365 3.1365
Moderate 9.945 29.325 2.9325
Aggressive 6.63 25.50 2.55

You are required to calculate the following for each policy:

(a) Rate of return on total assets.
(b) Net working capital position.
(c) Current assets to fixed assets ratio.
(d) Discuss the risk-return trade off of each working capital policy.
[(8 Marks) May 2003]

Answer
Statement Showing Working Capital Investment for Each Policy (` Crore)
Particulars Conservative Moderate Aggressive
(a) Rate of return on total assets 3.1365
×100 2.9325
×100 2.55
×100
 EBIT  11.475  6.63 9.945  6.63 6.63  6.63
  100 
 Total assets (CA  FA )  17.32% 17.69% 19.23%

(b) Net working capital position 11.475 – 5.967 9.945 – 5.967 6.63 – 5.967
(CA – CL) 5.508 3.978 0.663
(c) Current assets to fixed assets ratio 11.475 ÷ 6.63 9.945 ÷ 6.63 6.63 ÷ 6.63
(CA ÷ Fixed assets) 1.73 : 1 1.50 : 1 1:1

(d) Risk-return trade off: The net working capital or current ratio is a measure of risk. Rate of return on
total assets is a measure of return. The expected risk and return are minimum in the case of conservative
investment policy and maximum in case of aggressive investment policy. The firm can improve profitability
by reducing investment in working capital.

PYQ 6
The following annual figures relate to MNP Limited:
Sales (at 3 months credit) `90,00,000
Materials consumed (suppliers credit one and half months) `22,50,000
Wages paid (one month in arrear) `18,00,000
Manufacturing expenses outstanding (cash expenses are paid one month in arrear) `2,00,000
Administration expenses (cash expenses are paid one month in arrear) `6,00,000
Sales promotion expenses (paid quarterly in advance) `12,00,000

The company sells its products on gross profit of 25% of assuming depreciation as a part of cost of
production. It keeps two month’s stock of finished goods and one month's stock of raw materials as
inventory. It keeps cash balance of `2,50,000.

Assume a 5% safety margin, work out the working capital requirements of the company on cash
cost basis. Ignore work-in-process
[(8 Marks) May 2004]

Answer
Statement of Working Capital Requirement (Cash Cost Basis)
Particulars `
 MANAGEMENT OF WORKING CAPITAL 4.28
(A) Current Assets:
Raw Materials (22,50,000 × 1/12) 1,87,500
Finished Goods (64,50,000 × 2/12) 10,75,000
Debtors (82,50,000 × 3/12) 20,62,500
Cash 2,50,000
Prepaid Sales Promotion Expenses (12,00,000 × 1/4) 3,00,000
Total (A) 38,75,000
(B) Current Liabilities:
Creditors (22,50,000 × 1.5/12) 2,81,250
Outstanding labour (18,00,000 × 1/12) 1,50,000
Outstanding Manufacturing Expenses 2,00,000
Outstanding Administrative Expenses (6,00,000 × 1/12) 50,000
Total (B) 6,81,250
Working Capital Before Provision (A - B) 31,93,750
Add : Safety Margin @ 5% of 31,93,750 1,59,688
Working Capital 33,53,438
Working Notes:
Projected Income Statement
Particulars `
Raw Materials 22,50,000
Wages 18,00,000
Manufacturing Expenses in cash (2,00,000 × 12 months) 24,00,000
Cash Cost of Goods Sold 64,50,000
Administration Expenses (in cash) 6,00,000
Sales Promotion Expenses (in cash) 12,00,000
Cash Cost of Sales 82,50,000

PYQ 7
XYZ Company Ltd. is a pipe manufacturing company. Its production cycle indicates that materials are
introduced in the beginning of the production cycle; wages and overhead accrue evenly throughout the
period of the cycle. Wages are paid in the next month following the month of accrual. Work in process
includes full units of raw materials used in the beginning of the production process and 50% of wages and
overheads are supposed to be conversion costs.
Details of production process and the components of working capital are as follows:
Production of pipes 12,00,000 units
Duration of the production cycle 1 month
Raw materials inventory held 1 month consumption
Finished goods inventory held for 2 months
Credit allowed by creditors 1 months
Credit given to debtors 2 months
Cost price of raw materials `60 per units
Direct wages `10 per unit
Overheads `20 per unit
Selling price of finished pipes `100 per unit

Required to calculate:
(1) The amount of working capital required for the company.
(2) Its maximum permissible bank finance under all the three methods of lending norms as suggested by
the Tandon Committee, assuming the value of core current assets `1,00,00,000.
[(8 Marks) May 2005]

Answer
(1) Statement of Working Capital Requirement
Particulars `
 MANAGEMENT OF WORKING CAPITAL 4.29
(A) Current Assets:
Raw Materials (12,00,000 units × `60 × 1/12) 60,00,000
WIP:
Materials (12,00,000 units × `60 × 100% × 1/12) 60,00,000
Wages and Overheads (12,00,000 units × `30 × 50% × 1/12) 15,00,000
Finished Goods (12,00,000 units × `90 × 2/12) 1,80,00,000
Debtors (12,00,000 units × `90 × 2/12) 1,80,00,000
Total (A) 4,95,00,000
(B) Current Liabilities:
Creditors (12,00,000 units × `60 × 1/12) 60,00,000
Outstanding labour (12,00,000 units × `10 × 1/12) 10,00,000
Total (B) 70,00,000
Working Capital (A - B) 4,25,00,000
(2) Calculation of MPBF:
Method 1 = 75% (CA - CL) = 75% of 4,25,00,000 = `3,18,75,000
Method 2 = (75% CA) – CL = (75% of 495 Lacs) – 70 Lacs = `3,01,25,000
Method 3 = (75% CA other than core current assets) - CL
= 75% (4,95,,00,000 – 1,00,00,000) – 70,00,000 = `2,26,25,000

PYQ 8
A Proforma cost sheet of a company provides the following particulars, estimated cost per unit is:
Raw material `100.00
Direct wages `37.50
Overheads `75.00
Total cost `212.50
Profit `37.50
Selling price `250.00
The Company keeps raw material in stock, on an average for one month; work in progress, on an
average for one week; and finished goods in stock, on an average for two weeks. The credit allowed by
supplier is three weeks and company allows four weeks credit to its debtors. The lag in payment of wages in
one week and lag in payment of overhead expenses is two weeks. The company sells one fifth of the output
against cash and maintains cash in hand and at bank put together at `37,500.

Prepare a statement showing estimate of Working Capital needed of finance an activity level of
1,30,000 units of production. Assume that production is carried on evenly throughout the year and
wages and overheads accrue similarly work in progress stock is 80% complete in all respects.
[(8 Marks) Nov 06]

Answer
Statement of Working Capital Requirement
Particulars `
(A) Current Assets:
Raw Materials (1,30,000 units × `100 × 1/12) 10,83,333
WIP (1,30,000 units × `212.50 × 80% × 1/52) 4,25,000
Finished Goods (1,30,000 units × `212.50 × 2/52) 10,62,500
Debtors (1,30,000 units × `212.50 × 4/5 × 4/52) 17,00,000
Cash and Bank Balance 37,500
Total (A) 43,08,333
(B) Current Liabilities:
Creditors (1,30,000 units × `100 × 3/52) 7,50,000
Outstanding labour (1,30,000 units × `37.50 × 1/52) 93,750
Outstanding Overheads (1,30,000 units × `75 × 2/52) 3,75,000
Total (B) 12,18,750
Working Capital (A - B) 30,89,583
 MANAGEMENT OF WORKING CAPITAL 4.30
PYQ 9
A newly formed company has applied to the commercial bank for the first time for financing its working
capital requirements.
The following information is available about the projected cost per unit for the current year:
Raw material `40
Direct labour `15
Overhead `30
Total cost `85
Profit `15
Sales `100
Raw material in stock: average 4 weeks consumption, Work in progress (completion stage 50
percent), on an average half a month. Finished goods in stock: on an average one month. Credit allowed by
suppliers is one month. Credit allowed to debtors is two months. Average time lag in payment of wages is 1.5
weeks and 4 weeks in overhead expenses. Cash in hand and at bank is desired to be maintained at `50,000.
All Sales are on credit basis only.
Required:
(1) Prepare statement showing estimate of working capital needed to finance an activity level of 96,000
units of production. Assume that production is carried on evenly throughout the year and wages and
overhead accrue similarly. For the calculation purpose 4 weeks may be taken as equivalent to a
month and 52 weeks in a year.
(2) From the above information calculate the maximum permissible bank finance by all the three
methods for working capital as per Tandon Committee norms; assume the core current assets
constitute 25% of the current assets.
[(8 Marks) Nov 2007]

Answer
(1) Statement of Working Capital Requirement
Particulars `
(A) Current Assets:
Raw materials (39,20,000 × 4/52) 3,01,538
Work in progress 1,70,000
Finished goods 6,80,000
Debtors (74,80,000 × 2/12) 12,46,667
Cash 50,000
Total (A) 24,48,205
(B) Current Liabilities:
Creditors (39,20,000 + 3,01,538) × 1/12 3,51,795
Outstanding wages (14,70,000 × 1.5/52) 42,404
Outstanding overheads (29,40,000 × 4/52) 2,26,154
Total (B) 6,20,353
Working Capital (A - B) 18,27,852
Note: one may use 4 weeks instead of 1 month for the purpose of calculations.

(2) Calculation of MPBF under the suggestion of Tandon Committee Norms:

Method 1 = 75% of (CA – CL) = 75% of 18,27,852 = `13,70,889
Method 2 = (75% of CA) – CL = (75% of 24,48,205) – 6,20,353 = `12,15,801
Method 3 = (75% of CA other than core CA) - CL
= [75% of (24,48,205 – 25%)] – 6,20,353 = `7,56,762

Working Notes:
Activity level = 96,000 units of production (Excluding WIP)
FG Stock = on an average one month
= 96,000 × 1/12 = 8,000 units
 MANAGEMENT OF WORKING CAPITAL 4.31
Units sold = 96,000 – 8,000 = 88,000 units
WIP = on an average half a month
= 96,000 × .5 = 4,000 units
12

Projected Income Statement

Particulars `
Raw materials (96,000 + ½ × 4,000) × 40 39,20,000
Direct labour (96,000 + ½ × 4,000) × 15 14,70,000
Overheads (96,000 + ½ × 4,000) × 30 29,40,000
Cost Upto Factory 83,30,000
Less: Closing WIP 4,000 units × (20 + 7.50 + 15) (1,70,000)
Cost of Production (96,000 units) 81,60,000
Less: Closing FG 8,000 units × 85 (6,80,000)
Cost of Goods Sold (88,000 units) 74,80,000
Profit 13,20,000
Sales (88,000 × 100) 88,00,000

PYQ 10
MN Ltd. is commencing a new project for manufacturing of electric toys. The following cost information has
been ascertained for annual production of 60,000 units at full capacity:
Cost per unit
Raw materials `20
Direct labour `15
Manufacturing overheads:
Variable `15
Fixed `10
Selling and Distribution overheads:
Variable `3
Fixed `1
Total cost `64
Profit `16
Selling price `80

In the first year of operations expected production and sales are 40,000 units and 35,000 units
respectively. To assess the need of working capital the following additional information is available:

(i) Stock of raw material 3 months consumption

(ii) Credit allowable for debtors 1-½ months
(iii) Credit allowable by creditors 4 months
(iv) Lag in payment of wages 1 month
(v) Lag in payment of overheads ½ month
(vi) Cash in hand and bank is expected to `60,000

Provision for contingencies is required @10% of Working capital requirement including that
provision. You are required to prepare a projected statement of working capital requirement for the
first year of operation. Debtors are taken at cost.
[(8 Marks) Nov 2008]

Answer
Statement of Working Capital Requirement
Particulars `
(A) Current Assets:
Raw materials (8,00,000 × 3/12) 2,00,000
Finished goods 3,25,000
Debtors (24,40,000 × 1.5/12) 3,05,000
Cash 60,000
 MANAGEMENT OF WORKING CAPITAL 4.32
Total (A) 8,90,000
(B) Current Liabilities:
Creditors (8,00,000 + 2,00,000) × 4/12 3,33,333
Outstanding labour (6,00,000 × 1/12) 50,000
Outstanding overheads (13,65,000 × 0.5/12) 56,875
Total (B) 4,40,208
Gross Working Capital (A - B) 4,49,792
Add: Provision for contingencies @ 10% of Working Capital 49,977
Working Capital 4,99,769

WN:
Projected Income Statement
Particulars `
Raw Materials (40,000 × 20) 8,00,000
Direct Labour (40,000 × 15) 6,00,000
Manufacturing Overheads: Variable (40,000 × 15) 6,00,000
Fixed (60,000 × 10) 6,00,000
Cost of Production (40,000 units) 26,00,000
Less: Closing FG (26,00,000 × 5,000/40,000) (3,25,000)
Cost of Goods Sold (35,000 units) 22,75,000
Selling and Distribution Overheads: Variable (35,000 × 3) 1,05,000
Fixed (60,000 × 1) 60,000
Cost of Sales 24,40,000
Profit 3,60,000
Sales (35,000 × 80) 28,00,000

PYQ 11
The management of MNP Company Ltd. is planning to expand its business and consult you to prepare an
estimated working capital statement.
The records of the company revealed the following annual information:
Sales:
Domestic at one month’s credit `24,00,000
Export at three month’s credit `10,80,000
(Sales price 10% below Domestic price)
Material used (suppliers extend two months credit) `9,00,000
Lag in payment of wages - ½ month `7,20,000
Lag in payment of manufacturing expenses (cash) - 1 month `10,80,000
Lag in payment of administrative expenses - 1 month `2,40,000
Sales promotion expenses payable quarterly in advance `1,50,000
Income tax payable in four installments (of which one falls in the next financial year) `2,25,000
Rate of gross profit is 20%. Ignore work-in-progress and depreciation. The company keeps one
month’s stock of raw materials and finished goods (each) and believes in keeping `2,50,000 available to it
including the overdraft limit of `75,000 not yet utilized by the company. The management is also of the
opinion to make 12% margin for contingencies on computed figure.
You are required to prepare the estimated working capital statement for next year.
[(16 Marks) May 2011]

Answer
Statement of Working Capital Requirement (Cash Cost Basis)
Particulars `
(A) Current Assets:
Raw Materials (9,00,000 × 1/12) 75,000
Finished Goods (29,40,000 × 1/12) 2,45,000
Debtors:
Domestic (19,60,000 + 1,03,448) × 1/12 1,71,954
 MANAGEMENT OF WORKING CAPITAL 4.33
Export (9,80,000 + 46,552) × 3/12 2,56,638
Cash (2,50,000 – 75,000) 1,75,000
Prepaid Sales Promotion Expenses (1,50,000 × 1/4) 37,500
Total (A) 9,61,092
(B) Current Liabilities:
Creditors (9,00,000 × 2/12) 1,50,000
Outstanding labour (7,20,000 × 0.5/12) 30,000
Outstanding Manufacturing Expenses (10,80,000 × 1/12) 90,000
Outstanding Administrative Expenses (2,40,000 × 1/12) 20,000
Income Tax Payable (2,25,000 × 1/4) 56,250
Total (B) 3,46,250
Working Capital Before Provision (A - B) 6,14,842
Add : Safety Margin @ 12% of 6,14,842 73,781
Working Capital 6,88,623

Working Notes:
1. Calculation of Cash cost of Debtors:
Export sales (10% below domestic sales price) = 10,80,000

Export sales equivalent to domestic sales = 10,80,000 × 100 = 12,00,000

90
Total equivalent domestic sales = 24,00,000 + 12,00,000 = 36,00,000

Apportionment of cash cost of sales except sales promotion expenses in proportion of equivalent
domestic sales between Domestic and Foreign Sales:

Domestic sales = 29,40,000 × 24 ,00 ,000 = 19,60,000

36 ,00 ,000
Foreign sales = 29,40,000 × 12 ,00 ,000 = 9,80,000
36 ,00 ,000

Apportionment of sales promotion expenses between Domestic and Foreign Sales in sales ratio:

Domestic sales = 1,50,000 × 24 ,00 ,000 = 1,03,448

34 ,80 ,000

Foreign sales = 1,50,000 × 10 ,80 ,000 = 46,552

34 ,80 ,000

2. Projected Income Statement

Particulars `
Raw Materials 9,00,000
Wages 7,20,000
Manufacturing Expenses (in cash) 10,80,000
Administration Expenses (in cash) 2,40,000
Cash Cost of Goods Sold 29,40,000
Sales Promotion Expenses (in cash) 1,50,000
Cash Cost of Sales 30,90,000

Assumption: Administrative expenses is related to production.

PYQ 12
The Trading and Profit and Loss Account of Beta Ltd. for the year ended 31st March, 2011 is given below:
Particulars ` Particulars `
To Opening Stock: By Seles (credit) 20,00,000
Raw materials 1,80,000 By Closing Stock:
Work-in-progress 60,000 Raw materials 2,00,000
Finished goods 2,60,000 Work-in-progress 1,00,000
To Purchases (credit) 11,00,000 Finished Goods 3,00,000
 MANAGEMENT OF WORKING CAPITAL 4.34
To Wages 3,00,000
To Production Expenses 2,00,000
To Gross Profit 5,00,000
26,00,000 26,00,000
To Administration Expenses 1,75,000 By Gross Profit 5,00,000
To Selling Expenses 75,000
To Net Profit 2,50,000
5,00,000 5,00,000
The opening and closing balances of debtors were `1,50,000 and `2,00,000 respectively whereas
opening and closing creditors were `2,00,000 and `2,40,000 respectively.

You are required to ascertain the working capital requirement by operating cycle method.
[(8 Marks) Nov 2011]

Answer
Operating cycle
Working Capital = Annual cost of sales ×
365 Days
110 .24
= (`20,00,000 – `2,50,000) × = `5,28,548
365

Operating cycle = R+W+F+D–C

= 64.21 + 18.96 + 68.13 + 31.94 – 73 = 110.24 Days

Calculations:
Average stock of raw materials
Raw materials storage period =
Average cos t of raw materials consumptio n per day
1 ,90 ,000
= = 64.21 days
10 ,80 ,000  365

Raw materials consumed = Opening RM + Purchases - Closing RM

= 1,80,000 + 11,00,000 – 2,00,000 = 10,80,000

Average stock of WIP 80 ,000

WIP holding period = =
Average cos t of production per day 15 ,40 ,000  365
= 18.96 days

Cost of production = RMC + Wages + Production expenses + Op. WIP - Closing WIP
= 10,80,000 + 3,00,000 + 2,00,000 + 60,000 – 1,00,000
= 15,40,000

Average stock of FG 2 ,80 ,000

Finished Goods storage period = =
Average cos t of goods sold per day 15 ,00 ,000  365
= 68.13 days

Cost of goods sold = COP + Opening FG - Closing FG

= 15,40,000 + 2,60,000 – 3,00,000 = 15,00,000

Average debtors 1 ,75 ,000

Debtors collection period = =
Average credit sales per day 20 ,00 ,000  365
= 31.94 days

Average trade creditors 2,20 ,000

Credit period availed = =
Average credit purchases per day 11 ,00 ,000  365
= 73 days
Calculation of averages:
 MANAGEMENT OF WORKING CAPITAL 4.35
Average stock of raw materials = (1,80,000 + 2,00,000) ÷ 2 = 1,90,000
Average stock of WIP = (60,000 + 1,00,000) ÷ 2 = 80,000
Average stock of FG = (2,60,000 + 3,00,000) ÷ 2 = 2,80,000
Average debtors = (150,000 + 2,00,000) ÷ 2 = 1,75,000
Average trade creditors = (2,00,000 + 2,40,000) ÷ 2 = 2,20,000

PYQ 13
STN Ltd. is a readymade garment manufacturing company. Its production cycle indicates that materials are
introduced in the beginning of the production phase; wages and overhead accrue evenly throughout the
period of cycle.

The following figures for the 12 months ending 31st December 2011 are given:
Production of shirts 54,000 units
Selling price per unit `200
Duration of the production cycle 1 month
Raw material inventory held 2 month’s consumption
Finished goods stock held for 1 month
Credit allowed to debtors 1.5 months
Credit allowed by creditors 1 month

Wages are paid in the next month following the month of accrual. In the work in progress 50% of
wages and overheads are supposed to be conversion costs. The ratios of cost to sales price are raw materials
60%, direct wages 10% and overheads 20%. Cash is to be held to the extent of 40% of current liabilities and
safety margin of 15% will be maintained.
Calculate amount of working capital required for the company on a cash cost basis.
[(8 Mark) May 12]

Answer
Statement of Working Capital Requirement (Cash Cost Basis)
Particulars `
(A) Current Assets:
Raw Materials (64,80,000 × 2/12) 10,80,000
WIP:
Materials (64,80,000 units × 1/12 × 100%) 5,40,000
Wages and Overheads (32,40,000 units × 1/12 × 50%) 1,35,000
Finished Goods (97,20,000 × 1/12) 8,10,000
Debtors (97,20,000 × 1.5/12) 12,15,000
Cash (40% of 6,30,000) 2,52,000
Total (A) 40,32,000
(B) Current Liabilities:
Creditors (64,80,000 × 1/12) 5,40,000
Outstanding Wages (10,80,000 × 1/12) 90,000
Total (B) 6,30,000
Working Capital Before Provision (A - B) 34,02,000
Add : Safety Margin @ 15% of 34,02,000 5,10,300
Working Capital 39,12,300

Working Notes:
Projected Income Statement
Particulars `
Raw Materials (54,000 units × `200 × 60%) 64,80,000
Wages (54,000 units × `200 × 10%) 10,80,000
Overheads treated as cash (54,000 units × `200 × 20%) 21,60,000
Cash Cost of Goods Sold/ Cash Cost of Sales 97,20,000

PYQ 14
 MANAGEMENT OF WORKING CAPITAL 4.36
The following information is provided by the DPS Limited for the year ending 31st March, 2013
Raw material storage period 55 days
Work-in progress conversion period 18 days
Finished Goods storage period 22 days
Debt collection period 45 days
Creditor’s payment period 60 days
Annual Operating cost (including depreciation of `2,10,000) `21,00,000
1 year 360 days
You are required to calculate:
I. Operating Cycle period.
II. Number of Operating Cycle in a year.
III. Amount of working capital required of the company on a cash cost basis.
IV. The company is a market leader in its product, there is virtually no competitor in the market. Based
on a market research it is planning to discontinue sales on credit and deliver products based on pre-
payment. Thereby, it can reduce its working capital requirement substantially. What would be the
reduction in working capital requirement due to such decision?
[(Marks 8) May 2013, May 2015]

Answer
I. Operating cycle = R+W+F+D–C = 55 + 18 + 22 + 45 – 60
= 80 Days
360
II. No. of operating cycle = = 4.5 times
80

Operating cycle
III. Working Capital = Annual cash operating cost ×
360 Days
80 Days
= (`21,00,000 – `2,10,000) × = `4,20,000
360 Days

IV. In case of cash sales operating cycle period will reduce by 45 Days (Debt collection period).
80 Days  35 Days
Reduction in working capital = (`21,00,000 – `2,10,000) ×
360 Days
= `2,36,250

PYQ 15
Black Limited has furnished the following cost sheet:
Per Unit
Raw Material `98
Direct Labour `53
Factory Overhead `88
Total Cost `239
Profit `43
Selling Price `282

Factory overheads includes depreciation of `15 per unit at budgeted level of activity
Additional Information:
(i) Average raw material in stock 3 weeks
(ii) Average work-in-progress 2 weeks
(% of completion with respect to Materials 75% and Labour and Overhead 70%)
(iii) Finished goods in stock 4 weeks
(iv) Credit allowed to debtors 2.5 weeks
(v) Credit allowed by creditors 3.5 weeks
(vi) Time lag in payment of labour 2 weeks
(vii) Time lag in payment of factory overheads 1.5 weeks
 MANAGEMENT OF WORKING CAPITAL 4.37
(viii) Company sells, 25% of the output against cash
(ix) Cash in hand and bank is desired to be maintained `2,25,000
(x) Provision for contingencies is required @ 4% of working capital requirement including that
provision.

You are required to prepare a statement showing estimate of working capital needed to finance
a budgeted activity level of 1,04,000 units of production. Finished stock, debtors and overheads are
taken at cash cost.
[(8 Marks) May 2014]

Answer
Statement of Working Capital Requirement (Cash Cost Basis)
Particulars `
(A) Current Assets:
Raw Materials (1,01,92,000 × 3/52) 5,88,000
Work-in-progress:
Materials (1,01,92,000 × 75%) × 2/52 2,94,000
Labour and Overhead [(55,12,000 + 75,92,000) × 70%] × 2/52 3,52,800
Finished Goods (2,32,96,000 × 4/52) 17,92,000
Debtors (2,32,96,000 × 75% × 2.5/52) 8,40,000
Cash 2,25,000
Total (A) 40,91,800
(B) Current Liabilities:
Creditors (1,01,92,000 × 3.5/52) 6,86,000
Outstanding labour (55,12,000 × 2/52) 2,12,000
Outstanding Factory Overhead (75,92,000 × 1.5/52) 2,19,000
Total (B) 11,17,000
Working Capital Before Provision (A - B) 29,74,800
Add : Provision for contingencies @ 4% of wc including provision 1,23,950
Working Capital (29,74,800 ÷ 96%) 30,98,750

Working Notes:
Projected Income Statement (Production of 1,04,000 units)
Particulars `
Raw Materials (1,04,000 × 98) 1,01,92,000
Wages (1,04,000 × 53) 55,12,000
Factory Overhead in cash [1,04,000 × 73 (88 - 15)] 75,92,000
Cash Cost 2,32,96,000

PYQ 16
The following data relating to an auto component manufacturing company is available for the year
2014:
Raw material held in storage 20 days
Debtors collection period 30 days
Conversion process period (raw materials 100%, other cost 50%) 10 days
Finished Goods storage period 45 days
Credit period from supplier 60 days
Advance payment to supplier 5 days
Total cash operating expenses per annum `800 Lakhs
1 year 360 days
75% of total cash operating expenses for raw materials. 360 days assumed in a year.
You are required to calculate:
(a) Each item of current assets and current liabilities,
(b) The working capital requirement, if the company wants to maintain a cash balance of `10 Lakhs at all
the times. [(Marks 8) June 2015]
 MANAGEMENT OF WORKING CAPITAL 4.38
Answer
(a) Calculation of each item of current assets and current liabilities:
Stock of Raw Materials = `600 Lacs × 20/360 = `33.33 Lacs

Debtors = `800 Lacs × 30/360 = `66.67 Lacs

Stock of WIP = [(`600 Lacs ×100%) + (`200 Lacs ×50%)] × 10/360

= `19.44 Lacs

Stock of Finished Goods = `800 Lakhs × 45/360 = `100 Lacs

Advance to Supplier = `600 Lakhs × 5/360 = `8.33 Lacs

Creditors = `600 Lakhs × 60/360 = `100 Lacs

(b) Calculation of working capital requirement:

Working Capital = Current Assets – Current Liabilities
= (Raw Materials Stock + Debtors + WIP Stock + Finished Goods
Stock + Advance to Supplier + Cash Balance) - Creditors
= (`33.33 + `66.67 + `19.44 + `100 + `8.33 + `10) – `100
= `137.77 Lakhs

Projected Income Statement

Particulars ` (in Lakhs)
Raw Materials (75% of 800) 600
Other Operating Expenses (25% of 800) 200
Cash Cost 800

PYQ 17
PQ Limited wants to expand its business and has applied for a loan from a commercial bank for its growing
financial requirements.
The records of the company reveals that the company sells goods in the domestic market at a gross
profit of 25% not counting depreciation as part of the cost of goods sold.

The following additional information is also available for you:

Sales:
Home at one month’s credit `1,20,00,000
Export at three month’s credit `54,00,000
(Sales price 10% below Home price)
Material used (suppliers extend two months’ credit) `45,00,000
Wages paid ½ month in arrear `36,00,000
Manufacturing expenses (cash) paid (1 month in arrear) `54,00,000
Administrative expenses paid 1 month in arrear `12,00,000
Income tax payable in four installments (of which one falls in the next financial year) `15,00,000
The company keeps one month’s stock of raw materials and finished goods (each) and believes in
keeping `10,00,000 available to it including the overdraft limit of `5,00,000 not yet utilized by the company.
Assume a 15% margin for contingencies.
You are required to ascertain the requirement of the working capital of the company.
[(8 Marks) May 2017]

Answer
Statement of Working Capital Requirement (Cash Cost Basis)
Particulars `
(A) Current Assets:
 MANAGEMENT OF WORKING CAPITAL 4.39
Raw Materials (45,00,000 × 1/12) 3,75,000
Finished Goods (1,47,00,000 × 1/12) 12,25,000
Debtors:
Home (98,00,000 × 1/12) 8,16,667
Export (49,00,000 × 3/12) 12,25,000
Cash (10,00,000 – 5,00,000) 5,00,000
Total (A) 41,41,667
(B) Current Liabilities:
Creditors (45,00,000 × 2/12) 7,50,000
Outstanding labour (36,00,000 × 0.5/12) 1,50,000
Outstanding Manufacturing Expenses (54,00,000 × 1/12) 4,50,000
Outstanding Administrative Expenses (12,00,000 × 1/12) 1,00,000
Income Tax Payable (15,00,000 × 1/4) 3,75,000
Total (B) 18,25,000
Working Capital Before Provision (A - B) 23,16,667
Add: Contingency Margin @ 15% of 23,16,667 3,47,500
Working Capital 26,64,167
Working Notes:
1. Calculation of Cash cost of Debtors:
Export sales (10% below home sales price) = 54,00,000

Export sales equivalent to home sales = 54,00,000 × 100 = 60,00,000

90
Total equivalent home sales = 1,20,00,000 + 60,00,000= 1,80,00,000
Apportionment of cash cost of COGS in proportion of equivalent home sales between Home and Foreign
Sales:

Home sales = 1,47,00,000 × 1 ,20 ,00 ,000 = 98,00,000

1 ,80 ,00 ,000

Foreign sales = 1,47,00,000 × 60 ,00 ,000 = 49,00,000

1 ,80 ,00 ,000

2. Projected Income Statement

Particulars `
Raw Materials 45,00,000
Wages 36,00,000
Manufacturing Expenses (in cash) 54,00,000
Administration Expenses 12,00,000
Cash Cost of Goods Sold 1,47,00,000

Assumption: Administrative expenses is related to production.

PYQ 18
Day Ltd., a newly formed company has applied to the Private bank for the first time for financing its working
capital requirements.
The following information is available about the projection for the current year:
Estimated level of activity Completed units of production 31,200 units
Plus units of WIP 12,000
Raw material cost `40 per unit
Direct wages cost `15 per unit
Overhead (Inclusive Depreciation `10 per unit) `40 per unit
Selling price `130
Raw material in stock Average 30 days consumption
Work in progress stock Material 100% and conversion cost 50%
 MANAGEMENT OF WORKING CAPITAL 4.40
Finished goods stock 24,000 units
Credit allowed by suppliers 30 days
Credit allowed to purchasers 60 days
Direct wages (lag in payment) 15 days
Expected cash balance `2,00,000

Assume that production is carried on evenly throughout the year (360 days) and wages and overhead
accrue similarly. All sales are on credit basis.
You are required to calculate the Net Working Capital requirement on Cash Cost Basis.
[(10 Marks) May 2018]

Answer
Statement of Working Capital Requirement
Particulars `
(A) Current Assets:
Raw Materials Stock (17,28,000 × 30/360) 1,44,000
Work in progress 7,50,000
Finished goods 20,40,000
Debtors (6,12,000 × 60/360) 1,02,000
Cash 2,00,000
Total (A) 32,36,000
(B) Current Liabilities:
Creditors (17,28,000 + 1,44,000) × 30/360 1,56,000
Outstanding wages (5,58,000 × 15/360) 23,250
Total (B) 1,79,250
Working Capital (A - B) 30,56,750

Projected Cost of Goods Sold

Particulars `
Raw Materials (31,200 × 40 + 12,000 × 40) 17,28,000
Direct Wages (31,200 × 15 + 12,000 × 7.5) 5,58,000
Overheads excluding Depreciation (31,200 × 30 + 12,000 × 15) 11,16,000
Cost Upto Factory 34,02,000
Less: Closing WIP 12,000 units × (40 + 7.50 + 15) (7,50,000)
Cost of Production (31,200 units) 26,52,000
Less: Closing FG 24,000 units × (40 + 15 + 30) (20,40,000)
Cost of Goods Sold (7,200 units) 6,12,000

PYQ 19
Following information has been extracted from the books of ABS Limited:
01.04.17 31.03.18
Raw Material 1,00,000 70,000
Work-in-process 1,40,000 2,00,000
Finished goods 2,30,000 2,70,000
Average Receivables 2,10,000
Average Payables 3,14,000
Purchases 15,70,000
Wages and overheads 17,50,000
Selling expenses 3,20,000
Sales 42,00,000
All purchases and sales are on credit basis. Company is willing to know:
(1) Net operating cycle period.
(2) Amount of working capital requirement (Assume 360 days in a year).
[(8 Marks) Nov 2018]
 MANAGEMENT OF WORKING CAPITAL 4.41
Answer
(1) Operating cycle = R+W+F+D–C
= 19 + 19 + 28 + 18 – 72 = 12 Days

Calculations:
Average stock of raw materials
Raw materials storage period (R) =
Average cos t of raw materials consumptio n per day
(1 ,00 ,000 + 70 ,000 ) ÷ 2
= = 19 days
16 ,00 ,000 ÷ 360

Raw materials consumption = Opening RM + Purchases – Closing RM

= 1,00,000 + 15,70,000 – 70,000 = 16,00,000
Average stock of WIP
WIP holding period =
Average cos t of production per day
(1 ,40 ,000 + 2,00 ,000 ) ÷ 2
= = 19 days
32 ,90 ,000 ÷ 360

Cost of Production = RM consumed + Wages and OH + Opening WIP

– Closing WIP
= 16,00,000 + 17,50,000 + 1,40,000 – 2,00,000
= 32,90,000
Average stock of FG
Finished Goods storage period =
Average cos t of goods sold per day
(2,30 ,000 + 2,70 ,000 )÷ 2
= = 28 days
32,50 ,000 ÷ 360

Cost of Goods Sold = Cost of Production + Opening FG – Closing FG

= 32,90,000 + 2,30,000 – 2,70,000
= 32,50,000
Average book debts
Debtors collection period =
Average credit sales per day
2,10 ,000
= = 18 days
42 ,00 ,000 ÷ 360

Average trade creditors

Credit period availed =
Average credit purchases per day
3,14 ,000
= = 72 days
15 ,70 ,000 ÷ 360

(2) Amount of working capital required:

Annual Cost of Sales
Working Capital = × Operating Cycle Period
360
35,70 ,000
= × 12 = `1,19,000
360

Cost of Sales = Cost of Goods Sold + Selling expenses

= 32,50,000 + 3,20,000 = 35,70,000

PYQ 20
Bita Limited manufactures a product used in the steel industry. The following information regarding the
company is given for your consideration:
(1) The cost structure for Bita Limited’s product is as follows:
Per Unit
Raw Material `80
Direct Labour `20
 MANAGEMENT OF WORKING CAPITAL 4.42
Overhead (including depreciation `20) `80
Total Cost `180
Profit `20
Selling Price `200
(2) Expected level of production 9,000 units per annum.
(3) Raw materials are expected to remain in stores for an average of two months before issue to
production.
(4) Work-in-progress (50% complete as to conversion cost) will approximately to ½ month’s
production.
(5) Finished goods remain in warehouse on an average for one month.
(6) Credit allowed by supplier is one month.
(7) Two month’s credit is normally allowed to debtors.
(8) A minimum cash balance of `67,500 is expected to be maintained.
(9) Cash sales are 75% less than the credit sales.
(10) Safety margin of 20% to cover unforeseen contingencies.
(11) The production pattern is assumed to be even during the year.
You are required to estimate the working capital requirement of Bita Limited.
[(10 Marks) May 2019]

Answer
Statement of Working Capital Requirement
Particulars `
(A) Current Assets:
Raw Materials (7,20,000 × 2/12) 1,20,000
Work-in-progress:
Materials (7,20,000 × 0.5/12 × 100%) 30,000
Labour and Overhead [(1,80,000 + 7,20,000) × 50%] × 0.5/12 18,750
Finished Goods (16,20,000 × 1/12) 1,35,000
Debtors (16,20,000 × 4/5 × 2/12) 2,16,000
Cash 67,500
Total (A) 5,87,250
(B) Current Liabilities:
Creditors (7,20,000 × 1/12) 60,000
Total (B) 60,000
Working Capital Before Provision (A - B) 5,27,250
Add : Safety margin @ 20% 1,05,450
Working Capital 6,32,700

Working Notes:
1. Projected Income Statement (Production of 9,000 units)
Particulars `
Raw Materials (9,000 × 80) 7,20,000
Direct Labour (9,000 × 20) 1,80,000
Overhead : in cash (9,000 × 60) 5,40,000
: Depreciation (9,000 × 20) 1,80,000 7,20,000
Cost of Goods Sold 16,20,000
Profit (9,000 × 20) 1,80,000
Sales 18,00,000

2. Proportion between cash and credit sales:

Let Credit sales be x then cash sales will be 0.25 x (x – 75%)
Cash Sales : Credit Sales = x : .25x = 1 : .25 = 4:1

PYQ 21
 MANAGEMENT OF WORKING CAPITAL 4.43
PK Ltd. a manufacturing company, provides the following information:
Particulars `
Sales 1,08,00,000
Raw material consumed 27,00,000
Labour paid 21,60,000
Manufacturing overhead 32,40,000
(including depreciation for the year `3,60,000)
Administrative and Selling overheads 10,80,000

Additional information:
(a) Receivables are allowed 3 months’ credit.
(b) Raw material supplier extends 3 months’ credit.
(c) Lag in payment of labour is 1 month.
(d) Manufacturing overheads are paid one month in arrear.
(e) Administrative and Selling overhead is paid 1 month advance.
(f) Inventory holding period of raw material and finished goods are of 3 months.
(g) Work-in-progress is Nil.
(h) PK Ltd. sells goods at cost plus 33⅓%.
(i) Cash balance `3,00,000.
(j) Safety margin 10%.

You are required to compute the working capital requirements of PK Ltd. on cash cost basis.
[(10 Marks) Nov 2020]

Answer
Statement of Working Capital Requirement (Cash Cost Basis)
Particulars `
(A) Current Assets:
Raw Materials (27,00,000 × 3/12) 6,75,000
Finished Goods (77,40,000 × 3/12) 19,35,000
Debtors (88,20,000 × 3/12) 22,05,000
Cash balance 3,00,000
Prepaid Administrative and Selling overhead (10,80,000 × 1/12) 90,000
Total (A) 52,05,000
(B) Current Liabilities:
Creditors (27,00,000 × 3/12) 6,75,000
Outstanding labour (21,60,000 × 1/12) 1,80,000
Outstanding Manufacturing Expenses (28,80,000 × 1/12) 2,40,000
Total (B) 10,95,000
Working Capital Before Provision (A - B) 41,10,000
Add : Safety Margin @ 10% of 41,10,000 4,11,000
Working Capital 45,21,000

Working Notes:
Projected Income Statement (Cash Cost Basis)
Particulars `
Raw Materials 27,00,000
Labour 21,60,000
Manufacturing overhead (32,40,000 – 3,60,000) 28,80,000
Cash Cost of Goods Sold 77,40,000
Administrative and Selling overhead 10,80,000
Cash Cost of Sales 88,20,000

PYQ 22
The following information is provided by MNP Ltd. for the year ending 31st March, 2020:
 MANAGEMENT OF WORKING CAPITAL 4.44
Raw material storage period 45 days
Work-in progress conversion period 20 days
Finished Goods storage period 25 days
Debt collection period 30 days
Creditor’s payment period 60 days
Annual Operating cost (including depreciation of `2,50,000) `25,00,000
Assume 360 days in a year.

You are required to calculate:

I. Operating Cycle period.
II. Number of Operating Cycle in a year.
III. Amount of working capital required of the company on a cash cost basis.
IV. The company is a market leader in its product, there is virtually no competitor in the market. Based
on a market survey it is planning to discontinue sales on credit and deliver products based on pre-
payment in order to reduce its working capital requirement substantially. You are required to
compute the reduction in working capital requirement in such a scenario.
[(5 Marks) Jan 2021]

Answer
I. Operating cycle = R+W+F+D–C
= 45 + 20 + 25 + 30 – 60 = 60 Days
360
II. No. of operating cycle = = 6 times
60

Operating cycle
III. Working Capital = Annual cash operating cost ×
360 Days
60 Days
= (`25,00,000 – `2,50,000) ×
360 Days
= `3,75,000

IV. Reduction in working capital = (`25,00,000 – `2,50,000) × 30 days/360 days

= `1,87,500

PYQ 23
Balance sheet of X Ltd for the year ended 31st March, 2022 is given below:
(` in lakhs)
Liabilities Amount Assets Amount
Equity Shares `10 each 200 Fixed Assets 500
Retained Earnings 200 Raw Materials 150
11% Debentures 300 WIP 100
Public Deposits (Short-term) 100 Finished Goods 50
Trade Creditors 80 Debtors 125
Bills Payable 100 Cash and Bank 55
980 980

Calculate the amount of maximum permissible bank finance under three methods as per Tandon
Committee lending norms.

Total core current assets are assumed to be `30 Lakhs.

[(5 Marks) May 2022]

Answer
Calculation of MPBF:
Method 1 = 75% (CA - CL) = 75% (480 – 280) = `150 Lakhs
 MANAGEMENT OF WORKING CAPITAL 4.45
Method 2 = (75% CA) – CL = (75% 480) – 280 = `80 lakhs

Method 3 = (75% CA other than core CA) – CL

= 75% (480 – 30) – 280 = `57.50 Lakhs

Current Assets = Raw Materials + WIP + Finished Goods + Debtors + Cash and Bank
= 150 + 100 + 50 + 125 + 55 = `480 Lakhs

Current Liabilities = Public deposit (Short term) + Trade Creditors + Bills Payable
= 100 + 80 + 100 = `280 Lakhs
 MANAGEMENT OF WORKING CAPITAL 4.46

SUGGESTED REVISION
Page No. of 3rd, 4th & Revision
Ques. Observations or KEY Points 1st & 2nd
Practical 5th during
No. (Note down during revisions) Revision
Register Revision Exams
BQ (Book Questions covering Study Module of ICAI, PM, RTP’s, MTP’s and Important Questions)
1 Y - -
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18 Y Y Y
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21 Y - -
PYQ (Past Year Questions)
1 Y Y -
2 Y Y -
3 Y Y Y
4 Y - -
5 Y - -
6 Y Y Y
7 Y Y -
8 Y Y -
9 Y Y Y
10 Y Y Y
11 Y Y Y
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23 Y Y -
 CHAPTER - 5

TREASURY AND CASH

MANAGEMENT
LEARNING OBJECTIVES

After studying this chapter you will be able to:

 Discuss in details about cash management, its meanings and its
significance to any business.
 Understand the concept of cash budget and the estimation of cash
needs.
 Understand the decision making in case of excess cash balance or
in case of deficiency of cash.
 Know why it is important to manage efficiently the cash?
 Discuss the cash models as suggested by Baumol, Miller & Orr.
 TREASURY AND CASH MANAGEMENT 5.2
CASH BUDGET FOR SHORT PERIOD
BQ 1
Prepare a cash budget for the three months ended 30th September, 2023 based on the following
information:
Cash at bank on 1st July, 2023 `25,000
Monthly salaries and wages (estimated) `10,000
Interest payable in August, 2023 `5,000
Particulars June July August September
Cash sales 1,20,000 1,40,000 1,52,000 1,21,000
Credit sales 1,00,000 80,000 1,40,000 1,20,000
Purchases 1,60,000 1,70,000 2,40,000 1,80,000
Other expenses 18,000 20,000 22,000 21,000
Credit sale are collected 50% in the month of sale and 50% in the month following. Collection from
credit sales are subject to 10% discount if received in the month of sale and to 5% if received in the month
following. 10% of the purchases are in cash and balance is paid in next month.
[July: `57,500; August: `96,500; September: `73,000]

BQ 2
Prepare monthly cash budget for six months beginning from April 2023 on the basis of the following
information:
(a) Estimated monthly sales are as follows:
January `1,00,000 June `80,000
February `1,20,000 July `1,00,000
March `1,40,000 August `80,000
April `80,000 September `60,000
May `60,000 October `1,00,000
(b) Wages and salaries are estimated to be payable as follows:
April `9,000 July `10,000
May `8,000 August `9,000
June `10,000 September `9,000
(c) Of the sales, 80% is on credit and 20% for cash. 75% of the credit sales are collected within one month
and the balance in two months. There are no bad debts losses.
(d) Purchase amount to 80% of sales and are made and paid for in the month preceding the sales.
(e) The firm has 10% debenture of `1,20,000. Interest on these has to be paid quarterly in January, April
and so on.
(f) The firm is to make an advance payment of tax of `5,000 in July 2023.
(g) The firm had a cash balance of `20,000 on April 1, 2023, which is the minimum desired level of cash
balance. Any cash surplus or deficit above or below this level is made up by temporary investment or
liquidation of temporary investment or temporary borrowing at the end of each month (interest on
these to be ignored).

Answer
Monthly Cash Budget for Six Months, April to September 2023
Particulars April May June July August Sept
Opening balance 20,000 20,000 20,000 20,000 20,000 20,000
Cash sales 16,000 12,000 16,000 20,000 16,000 12,000
Collection from debtors 1,08,000 76,000 52,000 60,000 76,000 68,000
Cash available (A) 1,44,000 1,08,000 88,000 1,00,000 1,12,000 1,00,000
Payment for purchases 48,000 64,000 80,000 64,000 48,000 80,000
Wages and salaries 9,000 8,000 10,000 10,000 9,000 9,000
Interest on debentures 3,000 - - 3,000 - -
Tax payment - - - 5,000 - -
Total payments (B) 60,000 72,000 90,000 82,000 57,000 89,000
 TREASURY AND CASH MANAGEMENT 5.3
Balance (A - B) 84,000 36,000 (2,000) 18,000 55,000 11,000
Less: Temporary Invest (64,000) (16,000) - - (35,000) -
Add: Liquidation of - - 22,000 2,000 - 9,000
Invest or borrowings
Closing balance 20,000 20,000 20,000 20,000 20,000 20,000

WN: Collection from debtors: (` in Thousands)

Particulars Feb March April May June July August Sept
Sales 120 140 80 60 80 100 80 60
Credit sales 96 112 64 48 64 80 64 48
(80% of total sales)
Collections:
75% in one month 72 84 48 36 48 60 48
25% in two months 24 28 16 12 16 20
Total collection 108 76 52 60 76 68

BQ 3
Gold Stone Ltd. has given the following particulars. You are required to prepare a cash budget for three
months ended 31st December, 2023 and in Total.

Months Sales Materials Wages Overheads

August 40,000 20,400 7,600 3,800
September 42,000 20,000 7,600 4,200
October 46,000 19,600 8,000 4,600
November 50,000 20,000 8,400 4,800
December 60,000 21,600 9,000 5,000

(a) Credit terms are:

Sales: 10% Sales are on cash basis. 50% of the credit sales are collected next month and the
balance following months.
Creditors: Materials 2 months, Wages 1/5 month and Overheads 1/2 month
(b) Cash balance on 1st October, 2023 is expected to be `8,000
(c) A machinery will be installed in August, 2023 at a cost of `1,00,000 and the monthly instalment of
`5,000 is payable from October onwards.
(d) Dividend at 10% on preference share capital of `3,00,000 will be paid on 1st December, 2023.
(e) Advance to be received for sale of vehicle `20,000 in December.
(f) Income-tax (advance) to be paid in December `5,000.

Answer
Cash Budget
(From October to December)
Particulars October November December Total
Opening balance 8,000 11,780 18,360 8,000
Cash sales & Debtors collection 41,500 44,600 49,200 1,35,300
Advance against sale of vehicle - - 20,000 20,000
Total A 49,500 56,380 87,560 1,63,300
Payments to creditors (2 months credit) 20,400 20,000 19,600 60,000
Wages 7,920 8,320 8,880 25,120
Overheads 4,400 4,700 4,900 14,000
Preference dividend - - 30,000 30,000
Machine installments 5,000 5,000 5,000 15,000
Income tax - - 5,000 5,000
Total B 37,720 38,020 73,380 1,49,120
Closing balance (A - B) 11,780 18,360 14,180 14,180

Working Note 1: Cash Sales and Collection from Debtors:

 TREASURY AND CASH MANAGEMENT 5.4
Cash From Debtors Total
Month Sales
Sales 10% 50% 50% Collection
August 40,000 4,000 - - -
September 42,000 4,200 18,000 - -
October 46,000 4,600 18,900 18,000 41,500
November 50,000 5,000 20,700 18,900 44,600
December 60,000 6,000 22,500 20,700 49,200

Working Note 2: Payment of wages:

Payment Total Payment Total
Month Wages Overheads
4/5 1/5 Payment 50% 50% Payment
September 7,600 6,080 - - 4,200 2,100 - -
October 8,000 6,400 1,520 7,920 4,600 2,300 2,100 4,400
November 8,400 6,720 1,600 8,320 4,800 2,400 2,300 4,700
December 9,000 7,200 1,680 8,880 5,000 2,500 2,400 4,900

BQ 4
From the information and the assumption that the cash balance in hand on 1st January 2023 is `72,500
prepare a cash budget.

Assume that 50% of total sales are cash sales. Assets are to be acquired in the months of February
and April. Therefore, provisions should be made for the payment of `8,000 and `25,000 for the same. An
application has been made to the bank for the grant of a loan of `30,000 and it is hoped that the loan amount
will be received in the month of May.

It is anticipated that a dividend of `35,000 will be paid in June. Debtors are allowed one month’s
credit. Creditors for materials purchased and overheads grant one month’s credit. Sales commission at 3%
on sales is paid to the salesman each month.
Materials Salaries & Production Office &
Months Sales
Purchases Wages Overheads Selling OH
January 72,000 25,000 10,000 6,000 5,500
February 97,000 31,000 12,100 6,300 6,700
March 86,000 25,500 10,600 6,000 7,500
April 88,600 30,600 25,000 6,500 8,900
May 1,02,500 37,000 22,000 8,000 11,000
June 1,08,700 38,800 23,000 8,200 11,500

Answer
Monthly Cash Budget for Six Months, January to June 2023
Particulars Jan Feb March April May June Total
Opening balance 72,500 96,340 1,21,330 1,55,650 1,51,292 2,05,767 72,500
Receipts:
Cash sales 36,000 48,500 43,000 44,300 51,250 54,350 2,77,400
Collection from debtors - 36,000 48,500 43,000 44,300 51,250 2,23,050
Bank Loan - - - - 30,000 - 30,000
Cash available (A) 1,08,500 1,80,840 2,12,830 2,42,950 2,76,842 3,11,367 6,02,950
Payments:
Payment for purchases - 25,000 31,000 25,500 30,600 37,000 1,49,100
Salaries and wages 10,000 12,100 10,600 25,000 22,000 23,000 1,02,700
Production OH - 6,000 6,300 6,000 6,500 8,000 32,800
Selling and Office OH - 5,500 6,700 7,500 8,900 11,000 39,600
Sales commission 2,160 2,910 2,580 2,658 3,075 3,261 16,644
Purchase of Assets - 8,000 - 25,000 - - 33,000
Dividend paid - - - - - 35,000 35,000
Total payments (B) 12,160 59,510 57,180 91,658 71,075 1,17,261 4,08,844
Closing balance (A - B) 96,340 1,21,330 1,55,650 1,51,292 2,05,767 1,94,106 1,94,106
 TREASURY AND CASH MANAGEMENT 5.5
BQ 5
The following information relates to Zeta Limited, a publishing company:
The selling price of a book is `15, and sales are made on credit through a book club and invoiced on
the last day of the month. Variable costs of production per book are materials (`5), labour (`4), and
overhead (`2). The sales manager has forecasted the following volumes:
Month No. of Books
November 1,000
December 1,000
January 1,000
February 1,250
March 1,500
April 2,000
May 1,900
June 2,200
July 2,200
August 2,300

Customers are expected to pay as follows:

One month after sale 40%

Two months after the sale 60%.

The company produces the books two months before they are sold and the creditors for materials
are paid two months after production. Variable overheads are paid in the month following production and
are expected to increase by 25% in April; 75% of wages are paid in the month of production and 25% in the
following month. A wage increase of 12.5% will take place on 1st March.
The company is going through a restructuring and will sell one of its freehold properties in May for
`25,000, but it is also planning to buy a new printing press in May for `10,000. Depreciation is currently
`1,000 per month, and will rise to `1,500 after the purchase of the new machine.
The company’s corporation tax (of `10,000) is due for payment in March. The company presently has
a cash balance at bank on 31st December 2023, of `1,500.

You are required to prepare a cash budget for the six months from January to June, 2023.

Answer
Monthly Cash Budget for Six Months, January to June 2023
Particulars Jan Feb March April May June
Opening balance 1,500 3,250 1,500 (11,912) (15,024) 576
Receipts:
Sales receipts 15,000 15,000 16,500 20,250 25,500 29,400
Sell of property - - - - 25,000 -
Cash available (A) 16,500 18,250 18,000 8,338 35,476 29,976
Payments:
Payment for purchases 5,000 6,250 7,500 10,000 9,500 11,000
Variable overheads 2,500 3,000 4,000 3,800 5,500 5,500
Wages 5,750 7,500 8,412 9,562 9,900 10,237
Printing press - - - - 10,000 -
Corporation tax - - 10,000 - - -
Total payments (B) 13,250 16,750 29,912 23,362 34,900 26,737
Closing balance (A - B) 3,250 1,500 (11,912) (15,024) 576 3,239

Working note:
Calculation of Sales receipts, payment for Purchases, Variable overheads and Wages:
Particulars Nov Dec Jan Feb March April May June
 TREASURY AND CASH MANAGEMENT 5.6
Forecast sales in units 1,000 1,000 1,000 1,250 1,500 2,000 1,900 2,200
(no. of books)

1. Sales receipts:
Sales @ `15/unit 15,000 15,000 15,000 18,750 22,500 30,000 28,500 33,000
1 month 40% - 6,000 6,000 6,000 7,500 9,000 12,000 11,400
2 months 60% - - 9,000 9,000 9,000 11,250 13,500 18,000
- - 15,000 15,000 16,500 20,250 25,500 29,400
2. Pay for purchase:
Quantity produced 1,000 1,250 1,500 2,000 1,900 2,200 2,200 2,300
(2 months before sales)
Materials cost @ `5 p.u. 5,000 6,250 7,500 10,000 9,500 11,000 11,000 11,500
Payment after 2 month - - 5,000 6,250 7,500 10,000 9,500 11,000

3. Pay for variable oh:

Quantity produced 1,000 1,250 1,500 2,000 1,900 2,200 2,200 2,300
Variable oh @ `2 and 2,000 2,500 3,000 4,000 3,800 5,500 5,500 5,750
`2.50 p.u. from April
Payment next month - 2,000 2,500 3,000 4,000 3,800 5,500 5,500

4. Pay for wages:

Quantity produced 1,000 1,250 1,500 2,000 1,900 2,200 2,200 2,300
Wages @ `4 and `4.50 4,000 5,000 6,000 8,000 8,550 9,900 9,900 10,350
p.u. from March
Same month 75% 3,000 3,750 4,500 6,000 6,412 7,425 7,425 7,762
Next month 25% - 1,000 1,250 1,500 2,000 2,137 2,475 2,475
- 4,750 5,750 7,500 8,412 9,562 9,900 10,237

BQ 6
Consider the balance sheet of Maya Limited as on 31st December, 2023:
[` in Thousand]
Equity & Liabilities ` Assets `
Equity shares capital 100 Net fixed assets 1,836
Retained earnings 1,439 Inventories 545
Long-term borrowings 450 Accounts receivables 530
Accounts payables 360 Cash and bank 50
Loan from banks 400
Other liabilities 212
2,961 2,961

The company has received a large order and anticipates the need to go to its bank to increase its
borrowings. As a result, it has to forecast its cash requirements for January, February and March, 2023.
Typically, the company collects 20 per cent of its sales in the month of sale, 70 per cent in the subsequent
month, and 10 per cent in the second month after the sale. All sales are credit sales.
Actual sales in November and December and projected sales for January through April are as follows
(in thousands):
Month ` Month ` Month `
November 500 January 600 March 650
December 600 February 1,000 April 750

Purchases of raw materials are made in the month prior to the sale and amounts to 60 per cent of
sales. It is paid in the subsequent month. Payments for these purchases occur in the month after the
purchase. Labour costs, including overtime, are expected to be `1,50,000 in January, `2,00,000 in February,
and `1,60,000 in March. Selling, administrative, taxes, and other cash expenses are expected to be `1,00,000
per month for January through March.
 TREASURY AND CASH MANAGEMENT 5.7
On the basis of this information:
(a) Prepare a cash budget for the months of January, February, and March and determine the amount of
additional bank borrowings necessary to maintain a cash balance of `50,000 at all times.
(b) Prepare a proforma balance sheet for 31st March, 2024.

Answer
(a) Cash Budget
(From January to March) (` in Thousand)
Particulars January February March
Opening balance 50 50 50
Debtors Collection:
20% in month of sales 120 200 130
70% of sales in 1 Month 420 420 700
10% of sales in 2 Month 50 60 60
Total (A) 640 730 940
Payments to creditors 360 600 390
Labour cost 150 200 160
Selling, administrative, taxes and other cash expenses 100 100 100
Total (B) 610 900 650
Balance (A - B) 30 (170) 290
Add: Additional Borrowing/(Repayment) 20 220 (240)
Closing balance 50 50 50

(b) Proforma Balance Sheet, 31st March, 2024

[` in Thousand]
Equity & Liabilities ` Assets `
Equity shares capital 100 Net fixed assets 1,836
Retained earnings 1,529 Inventories 635
Long-term borrowings 450 Accounts receivables 620
Accounts payables 450 Cash and bank 50
Loan from banks 400
Other liabilities 212
3,141 3,141

Working notes:
Accounts receivable = Sales in March × 80% + Sales in February × 10%
= 6,50,000 × 80% + 10,00,000 × 10% = `6,20,000

Inventories = `5,45,000 + Total purchases from January to March − Total sales from
January to March × 60%
= `5,45,000 + (10,00,000 + 6,50,000 + 7,50,000) × 60% - (6,00,000 +
10,00,000 + 6,50,000) × 60% = `6,35,000

Accounts payable = Purchases in March

= `7,50,000 × 60% = `4,50,000

Retained earnings = `14,39,000 + Sales – Material Cost – Labour costs and Other expenses,
all for January to March

= `14,39,000 + (6,00,000 + 10,00,000 + 6,50,000) - (6,00,000 +

10,00,000 + 6,50,000) × 60% - (1,50,000 + 2,00,000 + 1,60,000)
(1,00,000 × 3 months)

= `14,39,000 + (`22,50,000 - `13,50,000 - `5,10,000 – `3,00,000)

= `15,29,000
 TREASURY AND CASH MANAGEMENT 5.8
BQ 7
On 30th September, 2023, the balance sheet of Maharaja Ltd. (retailer) was as under:
Liabilities ` Assets `
Equity share of `10 each 20,000 Equipment (at cost) 20,000
Reserves 10,000 Less: Depreciation (5,000) 15,000
Trade creditors 40,000 Stock 20,000
Proposed dividend 15,000 Trade debtors 15,000
Balance at bank 35,000
85,000 85,000

The company is developing a system of forward planning and on 1st October 2023 it supplies the following
information:
Sales
Months Purchases
Credit Cash
September 15,000 14,000 40,000
October 18,000 5,000 23,000
November 20,000 6,000 27,000
December 25,000 8,000 26,000

All trade debtors are allowed one month's credit and are expected to settle promptly. All trade creditors are
paid in the months following delivery.
On 1st October’23 all equipments were replaced at a cost of `30,000 and `14,000 was allowed in
exchange for the old equipment and a net payment of `16,000 was made. The proposed dividend will be paid
in December, 2023.

The following expenses will be paid:

Wages `3,000 per month
Administration `1,500 per month
Rent (to be paid in October’23) `3,600 for the year upto 30th September’24

You are required to prepare a cash budget for the months of October, November and December, 2023.

Answer
Cash Budget of Maharaja Ltd. for the quarter ending 31st December, 2023
Particulars October November December Total
Opening Balance 35,000 (9,100) (12,600) 35,000
Cash Sales 5,000 6,000 8,000 19,000
Collection of credit sales 15,000 18,000 20,000 53,000
Total A 55,000 14,900 15,400 1,07000
Payments of creditors 40,000 23,000 27,000 90,000
Wages 3,000 3,000 3,000 9,000
Payment of new equipment 16,000 - - 16,000
Administration expenses 1,500 1,500 1,500 4,500
Rent 3,600 - - 3,600
Dividend - - 15,000 15,000
Total B 64,100 27,500 46,500 1,38,100
Closing balance (A - B) (9,100) (12,600) (31,100) (31,100)

BQ 8
Vivek and Company are manufactures of check valves which are sold at `50 each.
The cost data are:
(a) Variable manufacturing cost : `25 per unit.
(b) Variable selling expenses : `5 per unit.
(c) Fixed manufacturing cost paid in cash : `1,50,000 per month
Fixed selling expenses : `1,00,000 p.m. payable in cash
(d) Depreciation : `30,000 per month.
 TREASURY AND CASH MANAGEMENT 5.9
Other data:
(1) The company's policy is to hold at the end of each month an inventory of finished goods representing
targeted sales for next two months. Opening inventory on 1st January was 30,000 units.
(2) The raw material required each month is purchased in cash which is the included in variable
manufacturing cost of `25. No inventory of raw material is held.
(3) All sales are on credit. Collection is 50% in the same month and the balance in the following month.
The Debtors balance was `4,00,000 on 1st January.
(4) All manufacturing costs are paid in cash in the month of production.
(5) The company pays 80% of its variable selling expenses in the month of sale and the balance in the
following month. On 1st January the company owed `25,000 for December expenses.
(6) The minimum desired cash balance is `50,000 which is held on 1st January.
(7) The company borrows at the beginning of the month and repays at the end amount available in
excess of `50,000. Ignore interest.
(8) The sales budget is:
Month Units Month Units
January 15,000 February 20,000
March 25,000 April 27,000
May 30,000 June 30,000

Prepare cash budget of the company (i) for January, February and March; and (ii) in total.

Answer
Cash Budget of Vivek & Company for the period January to March
Particulars January February March Total
Opening Balance 50,000 50,000 50,000 50,000
Collection from debtors:
50% of current month 3,75,000 5,00,000 6,25,000 15,00,000
Previous period 4,00,000 3,75,000 5,00,000 12,75,000
Total A 8,25,000 9,25,000 11,75,000 28,25,000
Variable manufacturing cost @ `25 each 7,50,000 6,75,000 7,50,000 21,75,000
Fixed manufacturing cost
Fixed selling expenses 1,50,000 1,50,000 1,50,000 4,50,000
Variable selling expenses: 1,00,000 1,00,000 1,00,000 3,00,000
Current month 80% 60,000 80,000 1,00,000 2,40,000
Next month 20% 25,000 15,000 20,000 60,000
Total B 10,85,000 10,20,000 11,20,000 32,25,000
Balance (A - B) (2,60,000) (95,000) 55,000 (4,00,000)
Add: Borrowing 3,10,000 1,45,000 - 4,50,000
Less: Repayment - - (5,000) -
Closing balance 50,000 50,000 50,000 50,000

Working Notes: Calculation of units to be produced

Particulars January February March
Sales 15,000 20,000 25,000
Add: Closing stock 45,000 52,000 57,000
(next two months requirements)
60,000 72,000 82,000
Less: Opening stock (30,000) (45,000) (52,000)
Production 30,000 27,000 30,000

BQ 9
From the following information relating to a departmental store, you are required to prepare for the
three months ending 31st March, 2023:

(a) Month-wise cash budget on receipts and payments basis; and

(b) Statement of Sources and uses of funds for the three months period.
 TREASURY AND CASH MANAGEMENT 5.10
It is anticipated that the working capital at 1st January, 2023 will be as follows:
Particulars ` in ‘000’s
Cash in hand and at bank 545
Short term investments 300
Debtors 2,570
Stock 1,300
Trade creditors 2,110
Other creditors 200
Dividends payable 485
Tax due 320
Plant 800
` in ‘000’s
Budgeted Profit Statement
January February March
Sales 2,100 1,800 1,700
Cost of sales 1,635 1,405 1,330
Gross Profit 465 395 370
Administrative, Selling and Distribution Expenses 315 270 255
Net Profit before tax 150 125 115

` in ‘000’s
Budgeted balances at the end of each months
31stJan. 28th Feb. 31st March
Short term investments 700 - 200
Debtors 2,600 2,500 2,350
Stock 1,200 1,100 1,000
Trade creditors 2,000 1,950 1,900
Other creditors 200 200 200
Dividends payable 485 - -
Tax due 320 320 320
Plant (depreciation ignored) 800 1,600 1,550
Depreciation amount to `60,000 is included in the budgeted expenditure for each month.

Answer
(a) Cash Budget
(3 months ending 31st March, 2023)
` in ‘000’s
Particulars
Jan. Feb. March
Opening Cash Balances 545 315 65
Add: Receipts:
From Debtors 2,070 1,900 1,850
Sale of Investments - 700 -
Sale of Plant - - 50
Total (A) 2,615 2,915 1,965
Payments:
Creditors 1,645 1,355 1,280
Cash Expenses (Exp – 60,000 for depreciation) 255 210 195
Purchase of Plant - 800 -
Payment of dividend - 485 -
Purchase of Investments 400 - 200
Total (B) 2,300 2,850 1,675
Closing Cash Balance (A - B) 315 65 290

(b) Statement of Sources and uses of Funds

(3 months ending 31st March, 2023)
Sources of Funds ` in ‘000’s
Funds from Operations:
Net profit (150 + 125 + 115) 390
 TREASURY AND CASH MANAGEMENT 5.11
Add: Depreciation (60 × 3) 180 570
Sale of Plant 50
Decrease in Working Capital (W.N.) 665
Total (A) 1,285
Uses of Funds ` in ‘000’s
Purchase of Plant 800
Dividend Payment 485
Total (B) 1,285

Working Note:
1. Calculation of receipts from debtors and payment to creditors:
` in ‘000’s
Workings
Jan’ 23 Feb’ 23 March’ 23
Opening balance of debtors 2,570 2,600 2,500
Add: Sales 2,100 1,800 1,700
Less: Closing balance of debtors (2,600) (2,500) (2,350)
Receipts from debtors 2,070 1,900 1,850
Cost of sales 1,635 1,405 1,330
Add: Closing stock 1,200 1,100 1,000
Less: Opening stock (1,300) (1,200) (1,100)
Purchases 1,535 1,305 1,230
Add: Opening balance of creditors 2,110 2,000 1,950
Less: Closing balance of creditors (2,000) (1,950) (1,900)
Payment to creditors 1,645 1,355 1,280

2. Statement of Changes in Working Capital

` in ‘000’s
Particulars
January’ 23 March’ 23
(A) Current Assets:
Cash in hand and at Bank 545 290
Short term Investments 300 200
Debtors 2,570 2,350
Stock 1,300 1,000
Total (A) 4,715 3,840
(B) Current Liabilities:
Trade Creditors 2,110 1,900
Other Creditors 200 200
Tax Due 320 320
Total (B) 2,630 2,420
Working Capital (A - B) 2,085 1,420
Decrease in Working Capital - (665)

CASH BUDGET FOR LONG PERIOD

BQ 10
You are given below the Profit & Loss Accounts for two years for a company:
Particulars Year 1 Year 2 Particulars Year 1 Year 2
To Opening stock 80,00,000 1,00,00,000 By Sales 8,00,00,000 10,00,00,000
To Raw materials 3,00,00,000 4,00,00,000 By Closing stock 1,00,00,000 1,50,00,000
To Stores 1,00,00,000 1,20,00,000 By Misc. Income 10,00,000 10,00,000
To Manufacturing exps 1,00,00,000 1,60,00,000
To Other expenses 1,00,00,000 1,00,00,000
To Depreciation 1,00,00,000 1,00,00,000
To Net Profit 1,30,00,000 1,80,00,000
9,10,00,000 11,60,00,000 9,10,00,000 11,60,00,000
 TREASURY AND CASH MANAGEMENT 5.12
Sales are expected to be `12,00,00,000 in year 3.
As a result, other expenses will increase by `50,00,000 besides other charges. Only raw materials are
in stock. Assume sales and purchases are in cash terms and the closing stock is expected to go up by the
same amount as between year 1 and 2. You may assume that no dividend is being paid. The Company can
use 75% of the cash generated to service a loan.
Compute how much cash from operations will be available in year 3 for the purpose? Ignore
income tax.

Answer
Projected Profit and Loss Account for the year 3
(` in Lakhs)
Year 2 Year 3 Year 2 Year 3
Particulars Particulars
(Actual) (Projected) (Actual) (Projected)
To Raw Materials Consumed 350 420 By Sales 1,000 1,200
To Stores 120 144 By Misc. Income 10 10
To Manufacturing Expenses 160 192
To Other Expenses 100 150
To Depreciation 100 100
To Net Profit 180 204
1,010 1,210 1,010 1,210

Cash Flow:
Particulars (` in Lakhs)
Net Profit 204
Add: Depreciation 100
304
Less: Cash required for increase in stock (50 Lakhs same as between year 1 and 2) (50)
Net Cash Inflow 254

Available for servicing the loan: 75% of `2,54,00,000 = `1,90,50,000

Note: The above also shows how a projected profit and loss account is prepared

Working Notes:
(a) Material consumed in year 2 = `350 Lakhs ÷ `1,000 lakhs = 35% of sales

Likely consumption in year 3 = `1,200 Lakhs × 35% = `420 Lakhs

(b) Stores are 12% of sales, as in year 2

(c) Manufacturing expenses are 16% of sales

BQ 11
You are given below the Profit & Loss Accounts for two years for a company:
Particulars Year 1 Year 2 Particulars Year 1 Year 2
To Opening stock 32,00,000 40,00,000 By Sales 3,20,00,000 4,00,00,000
To Raw materials 1,20,00,000 1,60,00,000 By Closing stock 40,00,000 60,00,000
To Stores 38,40,000 48,00,000 By Misc. Income 4,00,000 4,00,000
To Manufacturing exps 51,20,000 64,00,000
To Other expenses 40,00,000 40,00,000
To Depreciation 40,00,000 40,00,000
To Net Profit 42,40,000 72,00,000
3,64,00,000 4,64,00,000 3,64,00,000 4,64,00,000

Sales are expected to be `4,80,00,000 in year 3.

As a result, other expenses will increase by `20,00,000 besides other charges. Only raw materials are
 TREASURY AND CASH MANAGEMENT 5.13
in stock. Assume sales and purchases are in cash terms and the closing stock is expected to go up by the
same amount as between year 1 and 2. You may assume that no dividend is being paid. The Company can
use 75% of the cash generated to service a loan.
Compute how much cash from operations will be available in year 3 for the purpose? Ignore
income tax.

Answer
Projected Profit and Loss Account for the year 3
(` in Lakhs)
Year 2 Year 3 Year 2 Year 3
Particulars Particulars
(Actual) (Projected) (Actual) (Projected)
To Raw Materials Consumed 140 168 By Sales 400 480
To Stores 48 57.60 By Misc. Income 4 4
To Manufacturing Expenses 64 76.80
To Other Expenses 40 60
To Depreciation 40 40
To Net Profit 72 81.60
404 484 404 484

Cash Flow:
Particulars (` in Lakhs)
Net Profit 81.60
Add: Depreciation 40
121.60
Less: Cash required for increase in stock (20 Lakhs same as between year 1 and 2) (20)
Net Cash Inflow 101.60

Available for servicing the loan: 75% of `1,01,60,000 = `76,20,000

Working Notes:
(a) Material consumed in year 2 = `140 Lakhs ÷ `400 lakhs = 35% of sales

Likely consumption in year 3 = `480 Lakhs × 35% = `168 Lakhs

(b) Stores are 12% of sales, as in year 2

(c) Manufacturing expenses are 16% of sales

CASH CYCLE AND CASH TURNOVER

BQ 12
The following information is available in respect of Sai trading company:
1. On an average, debtors are collected after 45 days; inventories have an average holding period of 75
days and creditor’s payment period on an average is 30 days.
2. The firm spends a total of ` 120 lakhs annually at a constant rate.
3. It can earn 10 per cent on investments.

From the above information, you are required to Calculate:

(a) The cash cycle and cash turnover,
(b) Minimum amounts of cash to be maintained to meet payments as they become due,
(c) Savings by reducing the average inventory holding period by 30 days.

Answer
(a) Cash cycle = F+D–C = 75 days + 45 days – 30 days
= 90 days (3 months)

Cash turnover = 12 months (365 days) ÷ 3 months (90 days) = 4 times

 TREASURY AND CASH MANAGEMENT 5.14
(b) Minimum operating cash = Total operating annual outlay ÷ Cash turnover
= `120 lakhs ÷ 4 times = `30 lakhs

(c) Revised Cash cycle = F+D–C = 45 days + 45 days – 30 days

= 60 days (2 months)

Revised Cash turnover = 12 months (365 days) ÷ 2 months (60 days) = 6 times

Revised Minimum operating cash = Total operating annual outlay ÷ Cash turnover
= `120 lakhs ÷ 6 times = `20 lakhs

Reduction in investments = `30 lakhs – `20 lakhs = `10 lakhs

Savings = 0.10 × `10 lakhs = `1 lakh

CLEAR AND UNCLEARED FUNDS

BQ 13
Prachi Ltd is a manufacturing company producing and selling a range of cleaning products to wholesale
customers. It has three suppliers and two customers. Prachi Ltd relies on its cleared funds forecast to
manage its cash.
You are an accounting technician for the company and have been asked to prepare a cleared funds
forecast for the period Monday 7 August to Friday 11 August 2023 inclusive. You have been provided with
the following information:

(1) Receipts from customers:

Customers Credit terms Payment method 7 Aug 2023 sales 7 July 2023 sales
W Ltd 1 Calendar month BACS `1,50,000 `1,30,000
X Ltd None Cheque `1,80,000 `1,60,000

(a) Receipt of money by BACS (Bankers' Automated Clearing Services) is instantaneous.

(b) X Ltd’s cheque will be paid into Prachi Ltd’s bank account on the same day as the sale is made and will
clear on the third day following this (excluding day of payment).

(2) Payments to suppliers:

Supplier Credit terms Payment 7 Aug 2023 7 July 2023 7 June 2023
method Purchase purchases purchases
A Ltd 1 Calendar month BACS `65,000 `55,000 `45,000
B Ltd 2 Calendar months Cheque `85,000 `80,000 `75,000
C Ltd None Cheque `95,000 `90,000 `85,000

(a) Prachi Ltd has set up a standing order for `45,000 a month to pay for supplies from A Ltd. This will
leave Prachi’s bank account on 7 August.
Every few months, an adjustment is made to reflect the actual cost of supplies purchased (you
do not need to make this adjustment).

(b) Prachi Ltd will send out, by post, cheques to B Ltd and C Ltd on 7 August. The amounts will leave its
bank account on the second day following this (excluding the day of posting).

(3) Wages and salaries:

July 2023 August 2023

Weekly wages `12,000 `13,000

Monthly salaries `56,000 `59,000
 TREASURY AND CASH MANAGEMENT 5.15
(a) Factory workers are paid cash wages (weekly). They will be paid one week’s wages, on 11 August, for
the last week’s work done in July (i.e. they work a week in hand).

(b) All the office workers are paid salaries (monthly) by BACS. Salaries for July will be paid on 7 August.

(4) Other miscellaneous payments:

(a) Every Monday morning, the petty cashier withdraws `200 from the company bank account for the
petty cash. The money leaves Prachi’s bank account straight away.

(b) The room cleaner is paid `30 from petty cash every Wednesday morning.

(c) Office stationery will be ordered by telephone on Tuesday 8 August to the value of `300. This is paid
for by company debit card. Such payments are generally seen to leave the company account on the next
working day.

(d) Five new softwares will be ordered over the Internet on 10 August at a total cost of `6,500. A cheque
will be sent out on the same day. The amount will leave Prachi Ltd’s bank account on the second day
following this (excluding the day of posting).

(5) Other information: The balance on Prachi’s bank account will be `200,000 on 7 August 2023. This
represents both the book balance and the cleared funds.

Prepare a cleared funds forecast for the period Monday 7 August to Friday 11 August 2023
inclusive using the information provided. Show clearly the uncleared funds float each day.

Answer
Clear Fund Forecast
Particulars 7 Aug 23 8 Aug 23 9 Aug 23 10 Aug 23 11 Aug 23
(Monday) (Tuesday) (Wednesday) (Thursday) (Friday)
Receipts:
W Ltd 1,30,000 - - - -
X Ltd - - - 1,80,000 -
Total A 1,30,000 - - 1,80,000 -
Payments:
A Ltd 45,000 - - - -
B Ltd - - 75,000 - -
C Ltd - - 95,000 - -
Wages - - - - 12,000
Salaries 56,000 - - - -
Petty Cash 200 - - - -
Stationery - - 300 - -
Total B 1,01,200 - 1,70,300 - 12,000
Cleared Excess Receipts (A - B) 28,800 - (1,70,300) 1,80,000 (12,000)
Add: Opening Cleared Balance 2,00,000 2,28,800 2,28,800 58,500 2,38,500
Closing Cleared Balance (C) 2,28,800 2,28,800 58,500 2,38,500 2,26,500
Uncleared Float:
Uncleared receipts 1,80,000 1,80,000 1,80,000 - -
Less: Uncleared Payments (1,70,000) (1,70,300) - (6,500) (6,500)
Uncleared Balance (D) 10,000 9,700 1,80,000 (6,500) (6,500)
Total Book Balance (C + D) 2,38,800 2,38,500 2,38,500 2,32,000 2,20,000

*1,70,000 = Cheque to B Ltd for `75,000 and Cheque to C Ltd for `95,000

WILLIAM J. BAUMOL’S EOQ MODEL (1952)

BQ 14
 TREASURY AND CASH MANAGEMENT 5.16
Tarus Ltd. has an estimated cash payments of `8,00,000 for a one month period and the payments are
expected to steady over the period. The fixed cost per transaction is `250 and the interest rate on
marketable securities is 12% p.a.
Calculate the optimal transaction size, average cash and number of transactions during one
month.

Answer
2 × 8 ,00 ,000 × 12 × 250
Optimal transaction size = = `2,00,000
0.12

Number of transactions p.m. = Monthly cash requirement ÷ Transaction size

= `8,00,000 ÷ `2,00,000 = 4 transactions

BQ 15
A firm maintains a separate account for cash disbursement. Total disbursement are `1,05,000 per month or
`12,60,000 per year. Administrative and transaction cost of transferring cash to disbursement account is
`20 per transfer. Marketable securities yield is 8% per annum.

Determine the optimum cash balance according to William J. Baumol model.

Answer
2UP
Optimal Cash Balance (C) =
S
2 × 12,60 ,000 × 20
= = `25,100
0.08
 TREASURY AND CASH MANAGEMENT 5.17

PAST YEARS QUESTIONS

PYQ 1
JPL has two dates when it receives its cash inflows i.e. February 15 and August 15. On each of these dates, it
expects to receive `15 crores. Cash expenditures are expected to be steady throughout the subsequent 6
months period.
Presently the ROI in marketable securities is 8% per annum, and the cost of transfer from securities
to cash is `125 each time a transfer occurs.
(a) What is the optimal transfer size using the EOQ model? What is the average cash balance?
(b) What would be your Solution to part (a), if the ROI were 12% per annum and the transfer costs were
`75? Why do they differ from those in part (a)?
[(10 Marks) May 2001]

Answer
(a) Optimal transfer size and average cash:
2UP
Optimal transfer size =
S
Where,
U = Total annual cash required.
P = Transaction cost per transfer.
S = Interest rate per annum.

2 30,00,00,0 00  125
Optimal transfer size = = 9,68,246
0.08

Average cash balance = 1/2 × 9,68,246 = 4,84,123

(b) Revised optimum transfer and average cash:

2 30,00,00,0 00  75
Optimal transfer size = = 6,12,372
0.12
Average cash balance = 1/
2 × 6,12,372 = 3,61,186

Causes of difference in figure (b) from the figure of part (a):

(i) Transaction cost is lower as comparison to part (a),
(ii) Higher opportunity cost of holding as comparison to part (a).

PYQ 2
A firm maintains a separate account for cash disbursement. Total disbursements are `2,62,500 per month.
Administrative and transaction cost of transferring cash to disbursement account is `25 per transfer.
Marketable securities yield is 7.5% per annum.
Determine the optimum cash balance according to William J Baumol model.
[(3 Marks) May 2009]

Answer
2UP 2 2,62,500  12  25
Optimal transfer size = = = 45,826
S 0.075

PYQ 3
The following details are forecasted by a company for the purpose of effective utilization and management of
cash:
(i) Estimated sales and manufacturing costs:
 TREASURY AND CASH MANAGEMENT 5.18
Month Sales ` Materials ` Wages ` Overheads `
April 4,20,000 2,00,000 1,60,000 45,000
May 4,50,000 2,10,000 1,60,000 40,000
June 5,00,000 2,60,000 1,65,000 38,000
July 4,90,000 2,82,000 1,65,000 37,500
August 5,40,000 2,80,000 1,65,000 60,800
September 6,10,000 3,10,000 1,70,000 52,000
(ii) Credit terms:
20% sales are on cash, 50% of the credit sales are collected next month and the balance in the
following month.
Credit allowed by suppliers is 2 months and delay in payment of wages is 1/2 month and of overheads
is 1 month.
(iii) Interest on 12 percent debentures of `5,00,000 is to be paid half yearly in June and December.
(iv) Dividends on investments amounting to `25,000 are expected to be received in June, 2010.
(v) A new machinery will be installed in June, 2010 at a cost of `4,00,000 which is payable in 20 monthly
installments from July, 2010 onwards.
(vi) Advance income-tax to be paid in August, 2010 is `15,000.
(vii) Cash balance on 1st June, 2010 is expected to be `45,000 and the company wants to keep it at the end
of every month around this figure, the excess cash (in multiple of thousand rupees) being put in fixed
deposit.
You are required to prepare monthly cash budget on the basis of above information for four
months beginning from June, 2010.
[(7 Marks) May 2010]

Answer
Cash Budget
(From July to September)
Particulars June July August September
Opening Balance 45,000 45,500 45,500 45,000
Cash Sales & Debtors Collection 4,48,000 4,78,000 5,04,000 5,34,000
Dividend 25,000 - - -
Total A 5,18,000 5,23,500 5,49,500 5,79,000
Payments to creditors 2,00,000 2,10,000 2,60,000 2,82,000
Wages 1,62,500 1,65,000 1,65,000 1,67,500
Overheads 40,000 38,000 37,500 60,800
Interest 30,000 - - -
Machine installments - 20,000 20,000 20,000
Advance tax - - 15,000 -
Total B 4,32,500 4,33,000 4,97,500 5,30,300
Balance (A – B) 85,500 90,500 52,000 48,700
Less: Fixed deposit 40,000 45,000 7,000 3,000
Closing balance 45,500 45,500 45,000 45,700

Working Note 1:
Cash Sales and Collection from Debtors:
Cash From Debtors Total
Month Sales
Sales 20% 50% 50% Collection
April 4,20,000 - - - -
May 4,50,000 - - - -
June 5,00,000 1,00,000 1,80,000 1,68,000 4,48,000
July 4,90,000 98,000 2,00,000 1,80,000 4,78,000
August 5,40,000 1,08,000 1,96,000 2,00,000 5,04,000
September 6,10,000 1,22,000 2,16,000 1,96,000 5,34,000
 TREASURY AND CASH MANAGEMENT 5.19
Working Note 2: Payment of wages:
Payment
Month Wages Total Payment
50% 50%
May 1,60,000 - - -
June 1,65,000 80,000 82,500 1,62,500
July 1,65,000 82,500 82,500 1,65,000
August 1,65,000 82,500 82,500 1,65,000
September 1,70,000 82,500 85,000 1,67,500

PYQ 4
Following information relates to ABC company for the year 2016:
(a) Projected sales (` in lakhs)
August September October November December
35 40 40 45 46
(b) Gross profit margin will be 20% on sale.
(c) 10% of projected sale will be cash sale. Out of credit sale of each month, 50% will be collected in the
next month and the balance will be collected during the second month following the month of sale.
(d) Creditors will be paid in the first month following credit purchase. There will be credit purchase only.
(e) Wages and salaries will be paid on the first day of the next month. The amount will be `3 lakhs each
month.
(f) Interim dividend of `2 lakhs will be paid in December 2016.
(g) Machinery costing `10 lakhs will be purchased in September 2016. Repayment by instalment of
`50,000 p.m. will start from October 2016.
(h) Administrative expenses of `1,00,000 per month will be paid in the month of their incurrence.
(i) Assume no minimum cash balance is required. Opening cash balance as on 01.10.2016 is estimated at
`10 lakhs.
You are required to prepare the monthly cash budget for the 3 month period (October 2016 to
December 2016).
[(8 Marks) Nov 2016]

Answer
Cash Budget
(From Oct 2016 to December 2016)
Particulars October November December
Opening Balance 10,00,000 14,25,000 21,25,000
Cash Sales @ 10% of Sales 4,00,000 4,50,000 4,60,000
Debtors Collection:
50% of Credit Sales 1 Month 18,00,000 18,00,000 20,25,000
50% of Credit Sales 2 Month 15,75,000 18,00,000 18,00,000
Total A 47,75,000 54,75,000 64,10,000
Payments to creditors (1 Month Credit) 29,00,000 29,00,000 33,00,000
Purchase = Sales – GP - Wages (40L – 20% - 3L) (40L – 20% - 3L) (45L – 20% - 3L)
Wages & Salaries 3,00,000 3,00,000 3,00,000
Admin Expenses 1,00,000 1,00,000 1,00,000
Interim dividend - - 2,00,000
Machine installments 50,000 50,000 50,000
Total B 33,50,000 33,50,000 39,50,000
Closing Balance (A - B) 14,25,000 21,25,000 24,60,000

PYQ 5
VK Co. Ltd. has total cash disbursement amounting `22,50,000 in the year 2017 and maintains a separate
account for cash disbursements. Company has an administrative and transaction cost on transferring cash to
disbursement account `15 per transfer. The yield rate on marketable securities is 12% per annum.
Determine the optimum cash balance according to William J Baumol model. [(5 Marks) May 2017]
 TREASURY AND CASH MANAGEMENT 5.20
Answer
2UP 2 ×22,50,000 ×15
Optimal transfer size = √ = √ = 23,717
S 0.12

PYQ 6
Slide Ltd is preparing a cash flow forecast for the three months period from January to the end of March. The
following sales volumes have been forecasted:
December January February March April
Sales (units) 1,800 1,875 1,950 2,100 2,250

Selling price per unit is `600. Sales are all on one month credit. Production of goods for sales takes place one
month before sales. Each unit produced requires two units of raw material costing `150 per unit. No raw
material inventory is held. Raw materials purchases are on one month credit. Variable overheads and wages
equal to `100 per unit are incurred during production and paid in the month of production. The opening
cash balance on 1st January is expected to be `35,000. A long term loan of `2,00,000 is excepted to be
received in the month of March. A machine costing `3,00,000 will be purchased in March.

(a) Prepare a cash budget for the months of January, February and March and calculate the cash balance
at the end of each month in the three month period.
(b) Calculate the forecast current ratio at the end of the three months period.
[(10 Marks) Nov 2019]

Answer
(a) Cash Budget
(for three months period January to March)
Particulars January February March
Opening Balance 35,000 3,57,500 6,87,500
Collection from debtors 10,80,000 11,25,000 11,70,000
Loan receivable - - 2,00,000
Total A 11,15,000 14,82,500 20,57,500
Payments to creditors 5,62,500 5,85,000 6,30,000
Variable overheads and wages 1,95,000 2,10,000 2,25,000
Purchase of machine - - 3,00,000
Total B 7,57,500 7,95,000 11,55,000
Closing Balance (A - B) 3,57,500 6,87,500 9,02,500

Working note:
Calculation of Collection from debtors, payment for Purchases, Variable overheads and Wages:
Particulars December January February March
Forecast sales in units 1,800 1,875 1,950 2,100

1. Sales receipts:
Sales @ `600 per unit 10,80,000 11,25,000 11,70,000 12,60,000
Collection from debtors - 10,80,000 11,25,000 11,70,000

2. Payment for purchase:

Quantity produced 1,875 1,950 2,100 2,250
(1 months before sales)
Materials cost 5,62,500 5,85,000 6,30,000 6,75,000
@ `300 p.u. (150 × 2)
Payment after 1 month - 5,62,500 5,85,000 6,30,000

3. Payment for variable OH and wages:

Quantity produced - 1,950 2,100 2,250
Variable OH and wages @ `100 per unit - 1,95,000 2,10,000 2,25,000
 TREASURY AND CASH MANAGEMENT 5.21
(b) Forecast Current Ratio:
Expected Current Assets
Forecast Current Ratio =
Expected Current Liabilities
Current Assets = Cash and bank balance + Sundry debtors + Stock of Finished
Goods
= `9,02,500 + `12,60,000 + `9,00,000 = `30,62,500
Value of stock of Finished Goods = 2,250 units × [(2 units of raw material × `150) + `100]
= `9,00,000
Current Liabilities = Sundry creditors = `6,75,000
30,62,500
Forecast Current Ratio = = 4.537 times
6,75,000

PYQ 7
A garment trader is preparing cash forecast for first three months of calendar year 2021. His estimated sales
for the forecasted periods are as below:
January (` ‘000) February (` ‘000) March (` ‘000)
Total sales 600 600 800

(i) The trader sells directly to public against cash payments and to other entities on credit. Credit sales
are expected to be four times the value of direct sales to public. He expects 15% customers to pay in
the month in which credit sales are made, 25% to pay in the next month and 58% to pay in the next to
next month. The outstanding balance is expected to be written off.
(ii) Purchase of goods are made in the month prior to sales and it amounts to 90% of sales and are made
on credit. Payments of these occur in the month after the purchase. No inventories of goods held.
(iii) Cash balance as on 1st January, 2021 is `50,000.
(iv) Actual sales for the last two months of calendar year 2020 are as below:
November (` ‘000) December (` ‘000)
Total sales 640 880

You are required to prepare a monthly cash budget for the three months from January to March, 2021.
[(5 Marks) Dec 2021]

Answer
Cash Budget
(From January to March, 2021)
Particulars January February March
Opening Balance 50,000 1,74,960 3,55,280
Cash Sales & Debtors Collection 6,64,960 7,20,320 6,54,400
Total A 7,14,960 8,95,280 10,09,680
Payments to creditors (90% of sales) 5,40,000 5,40,000 7,20,000
Total B 5,40,000 5,40,000 7,20,000
Closing balance (A - B) 1,74,960 3,55,280 2,89,680

Working Note: Cash Sales and Collection from Debtors:

(` ‘000)
Cash Sales Credit Sales From Debtors Total
Month Sales
20% 80% 15% 25% 58% Collection
November 640 128 512 76.8 - - -
December 880 176 704 105.6 128 - -
January 600 120 480 72 176 296.96 664.96
February 600 120 480 72 120 408.32 720.32
March 800 160 640 96 120 278.4 654.4
 TREASURY AND CASH MANAGEMENT 5.22
PYQ 8
K Ltd. has a Quarterly cash outflow of `9,00,000 arising uniformly during the Quarter. The company has an
Investment portfolio of Marketable Securities. It plans to meet the demands for cash by periodically selling
marketable securities. The marketable securities are generating a return of 12% p.a. Transaction cost of
converting investments to cash is `60. The company uses Baumol model to find out the optimal transaction
size for converting marketable securities into cash.
Consider 360 days in a year.

You are required to calculate:

(a) Company’s average cash balance,
(b) Number of conversions each year and
(c) Time interval between two conversions.
[(5 Marks) Nov 2022]

Answer
(a) Average cash balance = ½ of `60,000
= `30,000
Annual Cash Requirement 9,00,000 × 4
(b) Number of conversions p.a. = Optimal Transaction Size
= 60,000

= 60 conversions per annum

360 360
(c) Time interval between two conversions = =
No.of Coversions 60

= 6 Days

Working Note:
2UP 2  9 ,00 ,000  4  60
Optimal Cash Balance (C) = = = `60,000
S 0.12
 TREASURY AND CASH MANAGEMENT 5.23

SUGGESTED REVISION
Page No. of 3rd, 4th & Revision
Ques. Observations or KEY Points 1st & 2nd
Practical 5th during
No. (Note down during revisions) Revision
Register Revision Exams
BQ (Book Questions covering Study Module of ICAI, PM, RTP’s, MTP’s and Important Questions)
1 Y Y -
2 Y Y Y
3 Y Y Y
4 Y Y -
5 Y Y Y
6 Y Y -
7 Y Y -
8 Y Y Y
9 Y Y Y
10 Y Y Y
11 Y - -
12 Y Y -
13 Y Y Y
14 Y Y -
15 Y - -
PYQ (Past Year Questions)
1 Y Y -
2 Y - -
3 Y Y Y
4 Y Y Y
5 Y - -
6 Y Y Y
7 Y Y Y
8 Y Y Y
 CHAPTER – 6

RATIO ANALYSIS
LEARNING OBJECTIVES

Learning Outcomes:
 Discuss Sources of financial data for Analysis.
 Discuss financial ratios and its Types.
 Discuss use of financial ratios to analyse the financial statement.
 Analyse the ratios from the perspective of investors, lenders,
suppliers, managers etc. to evaluate the profitability and financial
position of an entity.
 Describe the users and objective of Financial Analysis (A Birds Eye
View).
 Discuss Du Pont analysis
 State the limitations of Ratio Analysis.
 RATIO ANALYSIS 6.2
PROFITABILITY RATIOS
BQ 1
Income Statement
Particulars ` Particulars `
To Opening Stock 4,00,000 By Sales 40,00,000
To Purchases 15,00,000 By Closing Stock 3,00,000
To Wages 6,00,000
To Other Direct Expenses 8,00,000
To Gross profit 10,00,000
43,00,000 43,00,000
To Administrative Expenses 2,00,000 By Gross Profit b/d 10,00,000
To Selling Expenses 1,00,000 By Non Operating Income 3,00,000
To Non Operating Expenses 50,000
To Interest on Debt 1,50,000
To Provision for Tax 3,20,000
To Net Profit 4,80,000
13,00,000 13,00,000

Calculate (a) Gross Profit Ratio, (b) COGS Ratio, (c) Operating Expenses Ratio, (d) Operating Ratio, (e)
Operating Profit Ratio, (f) Net Profit Ratio.
[(a) 25% (b) 75% (c) 7.50% (d) 82.50% (e) 17.50% (f) 12%]

BQ 2
Balance Sheet as at 31st March
Liabilities ` Assets `
Equity Share Capital 10,00,000 Fixed Assets 14,00,000
(1,00,000 Shares @ `10 each) Investment (trade) 4,00,000
General Reserve 2,00,000 Capital Work-in-progress 2,00,000
Profit and Loss 1,00,000 Current Assets 2,50,000
15% Preference Share Capital 6,00,000 Miscellaneous Expenditure 1,00,000
10% Debenture 4,00,000
Current Liabilities 50,000
23,50,000 23,50,000

Note: Market Price of Equity Share (MPS) is `18.

Income Statement
Particulars `
Earning Before Interest and tax (EBIT) 6,00,000
Less: Interest @ 10% of `4,00,000 40,000
Earnings Before Tax (EBT) 5,60,000
Less: Tax @ 40% 2,24,000
Earnings After Tax (EAT) 3,36,000
Less: Preference Dividend @ 15% of `6,00,000 90,000
Earnings Available for Equity Shareholders 2,46,000
Less: Equity Dividend 1,47,600
Retained Earnings 98,400
Calculate: (a) Return on Capital Employed, (b) Return on Equity (ROE), (c) Return on Shareholders Fund,
(d) Return on Total Assets, (e) Earning Per Share (EPS), (f) Dividend Per Share (DPS), (g) Dividend Payout
Ratio, (h) Earning Retention Ratio, (i) Price Earning Ratio (PE), (j) Earning Yield Ratio, (k) Dividend Yield
Ratio, (l) MVBV Ratio.
[(a) 30% (b) 20.50% (c) 18.67% (d) 16% (e) `2.46 (f) `1.476 (g) 60% (h) 40% (i) 7.317 times (j)
13.67% (k) 8.20% (l) 1.5 times]
 RATIO ANALYSIS 6.3
ACTIVITY RATIOS
BQ 3
Sales:
Cash `4,00,000
Credit `6,00,000
Cost of goods sold `8,00,000
Opening stock `80,000
Closing stock `1,20,000
Year end debtors (before provision) `60,000
Provision for doubtful debt `5,000
Calculate (a) Stock Turnover Ratio, (b) Debtors Turnover Ratio, (c) Stock Holding Period, and (d) Debtors
Collection Period (360 days a year).
[(a) 8 times (b) 10 times (c) 45 Days (d) 36 Days]

BQ 4
Purchase for the year `30,00,000
Purchase return `5,00,000
Sundry creditors as on 31.03.22 `4,00,000
Sundry creditors as on 31.03.23 `5,00,000
Bills payable as on 31.03.22 `70,000
Bills payable as on 31.03.23 `30,000
Taking year for 360 days, calculate (i) Creditors Turnover Ratio, (ii) Average Payment Period.

Answer
Credit Purchase ( Net )
(i) Creditors Turnover Ratio =
Average Payables
30 ,00 ,000  5,00 ,000
= = 5 times
5 ,00 ,000

360 360
(ii) Average Payment Period = =
Creditors Turnover Ratio 5
= 72 days

Working Notes:
Opening Payables  Clo sin g Payables
Average Payables =
2
(4,00,000 + 70,000) + (5,00,000 + 30,000)
= = 5,00,000
2

Note: Total purchases have been treated as credit purchases.

BQ 5
Sales `40,00,000
Capital Employed `8,00,000
Fixed Assets `6,00,000
Current Assets `4,00,000
Current Liabilities `2,00,000
Total Assets (Inclusive Miscellaneous Expenditure) `11,00,000
Miscellaneous Expenditure (Fictitious Assets) `1,00,000

Calculate: (a) Capital Employed Turnover Ratio, (b) Fixed Assets Turnover Ratio, (c) Current Assets Turnover
Ratio, (d) Working Capital Turnover Ratio and (e) Total Assets Turnover Ratio.

[(a) 5 times (b) 6.67 times (c) 10 times (d) 20 times (e) 4 times]
 RATIO ANALYSIS 6.4
DU PONT (ROI)
BQ 6
Sales `20,00,000
Capital Employed `10,00,000
Operating Profit `3,00,000
Calculate Return on Capital Employed by applying Du Pont model.

Answer
Return on Capital Employed = Operating Profit Ratio × Capital Employed Turnover
Ratio
= 15% × 2 times = 30%

Working Notes:
Operating Pr ofit 3 ,00 ,000
Operating Profit Ratio = × 100 = × 100
Sales 20 ,00 ,000
= 15%
Sales 20 ,00 ,000
Capital Employed Turnover Ratio = =
Capital Employed 10 ,00 ,000
= 2 times

BQ 7
Net Profit Ratio 20%
Asset Turnover 1.2 times
Equity Multiplier 1.5 times
Calculate Return on Equity by applying Du Pont model.

Answer
Return on Equity (ROE) = Net Profit Ratio × Asset Turnover × Equity Multiplier
= 20% × 1.2 times × 1.5 times = 36%

LIQUIDITY RATIOS
BQ 8
Calculate Absolute Cash Ratio from following information.
Particulars 2022 2023
Bank balance 50,000 70,000
Cash 15,000 5,000
Investments (total) 1,50,000 1,20,000
Trade investments 20,000 30,000
Non trade investments 1,30,000 90,000
Market value of total investments 1,35,000 96,000
Current liabilities 4,00,000 5,00,000

Answer
Cash  Bank  Marketable Securities
Absolute Cash Ratio =
Current Liabilitie s

15 ,000  50 ,000  1 ,17 ,000

2022 = = 0.455
4 ,00 ,000

5 ,000  70 ,000  72 ,000

2023 = = 0.294
5,00 ,000
 RATIO ANALYSIS 6.5
Working Notes:
Calculation of Marketable securities (Market value of non trade investment):
1 ,35 ,000
2022 = × 1,30,000 = 1,17,000
1 ,50 ,000

96 ,000
2023 = × 90,000 = 72,000
1 ,20 ,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.

BQ 9
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:
(a) Payment of a current liability,
(b) Purchase of fixed assets,
(c) Cash collected from customers,
(d) Bills receivable dishonoured and
(e) Issue of new shares.
[(a) Improve (b) Decline (c) No change (d) No change (e) Improve]

BQ 10
Income Statement (ABC Ltd.)
(For the Year ended at 31st March, 2023)
Particulars ` Particulars `
To Purchases 18,00,000 By Sales 50,00,000
To Wages 5,00,000
To Other Direct Expenses 6,00,000
To Gross profit 21,00,000
50,00,000 50,00,000
To Salaries, Bonus etc. 1,70,000 By Gross Profit b/d 21,00,000
To Telephone 80,000
To Internet Charges 50,000
To Advertisement 1,50,000
To Commission 1,20,000
To Depreciation 1,00,000
To Bad Debts 20,000
To Goodwill Written off 45,000
To Loss on Sale of Asset 25,000
To Provision for Tax 4,96,000
To Net Profit 8,44,000
21,00,000 21,00,000

Cash and cash equivalents is `2,75,000.

Find out Daily Operating Expenses (cash) and calculate Basic Defense Interval.

Answer
COGS + Operating Cash Expenses 34 ,70 ,000
Daily Operating Expenses = =
365 365
= 9,507

Cash and Cash Equivalent s 2,75 ,000

Basic Defense Interval = =
Daily Operating Expenses 9 ,507
= 29 Days
 RATIO ANALYSIS 6.6
SOLVENCY RATIOS
BQ 11
Balance Sheet as at 31st March, 2023
Liabilities ` Assets `
Equity Share Capital 6,00,000 Non Current Assets 15,00,000
(60,000 Shares @ `10 each) Current Assets 4,50,000
Reserve and Surplus 4,00,000
13% Preference Share Capital 2,00,000
10% Debenture 6,00,000
Current Liabilities 1,50,000
19,50,000 19,50,000

Income Statement
(For the period ended at 31st March, 2023)
Particulars `
Earnings Before Interest and Tax (EBIT) 4,50,000
Less: Interest @ 10% of `6,00,000 60,000
Earnings Before Tax (EBT) 3,90,000
Less: Tax @ 50% 1,95,000
Earnings After Tax (EAT) 1,95,000
Less: Preference Dividend @ 13% of `2,00,000 26,000
Earnings Available for Equity Shareholders 1,69,000
Less: Equity Dividend 1,20,000
Retained Earnings 49,000

Calculate: (a) Debt to Equity Ratio, (b) Total Assets to Debt Ratio, (c) Proprietary Ratio, (d) Capital
Gearing Ratio, (e) Equity Ratio, (f) Debt Ratio, (g) Interest Coverage Ratio, (h) Preference Dividend
Coverage Ratio, (i) Equity Dividend Coverage Ratio.

[(a) 6 : 10 (b) 3.25 : 1 (c) 61.54% (d) 0.80 (e) 0.55 (f) .33 (g) 7.5 times (h) 7.5 times (i) 1.41 times]

MISCELLANEOUS
BQ 12
Equity share capital `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

Complete the following balance sheet from the above information:

Balance Sheet
Liabilities ` Assets `
Current Debt - Inventory -
Long Term Debt - Cash -
Total Debt - Total Current Assets -
Equity Share Capital - Fixed Assets -
- -
 RATIO ANALYSIS 6.7
Answer
Balance Sheet
Liabilities ` Assets `
Current Debt 24,000 Inventory 40,000
Long Term Debt 36,000 Cash 60,000
Total Debt 60,000 Total Current Assets 1,00,000
Equity Share Capital 1,00,000 Fixed Assets 60,000
1,60,000 1,60,000

Working Notes:
1. Total debt:
0.60 × Owners equity = 0.60 × `1,00,000 = `60,000
2. Current Debt:
Current debt to total debt = 0.40
Current debt = 0.40 × `60,000 = `24,000
3. Fixed assets:
0.60 × Owners equity = 0.60 × `1,00,000 = `60,000
4. Total of liability side:
Total debt + Owners equity = `60,000 + `1,00,000 = `1,60,000
5. Total assets consisting of fixed assets and current assets must be equal to `1,60,000 hence, current
assets should be `1,00,000.
6. Total assets turnover is 2 times:
Sales
= 2 times
Total Assets
Sales = `1,60,000 × 2 = `3,20,000

Inventory turnover is 8 times:

Sales
= 8 times
Inventory
Sales 3,20 ,000
Inventory = = = `40,000
8 8
7. Cash: = `1,00,000 – `40,000 = `60,000

BQ 13
Using the following information, Prepare this Balance sheet:

Long term debt to net worth 0.5

Total assets turnover 2.5
*Average collection period 18 days
Inventory turnover 9
Gross profit margin 10%
Acid test ratio 1 to 1

*Assume a 360 day year and all sales on credit

` `
Cash - Notes and payables 1,00,000
Account receivables - Long term debt -
Inventory - Common stock 1,00,000
Plant and equipment - Retained earnings 1,00,000
Total Assets - Total liabilities and equity -

Answer
 RATIO ANALYSIS 6.8
Balance Sheet
` `
Cash 50,000 Notes and payables 1,00,000
Account receivables 50,000 Long term debt 1,00,000
Inventory 1,00,000 Common stock 1,00,000
Plant and equipment 2,00,000 Retained earnings 1,00,000
Total Assets 4,00,000 Total liabilities and equity 4,00,000

Working Notes:

1. Long term debt to net worth = Long term debt ÷ Net worth = 0.5
Long term debt = Net worth × 0.5
= `2,00,000 × 0.5 = `1,00,000

2. Total Assets Turnover = Sales ÷ Total Assets = 2.5

Sales = Total Assets × 0.5
= `4,00,000 × 2.5 = `10,00,000

3. Debtors = Credit Sales × Average collection period/360

= `10,00,000 × 18/360 = `50,000

4. Inventory turnover ratio = COGS ÷ Inventory = 9

Inventory = (`10,00,000 × 90%) ÷ 9 = `1,00,000

5. Acid test ratio = (CA – Inventory) ÷ CL = 1

= (CA – `1,00,000) ÷ `1,00,000 = 1
Current Assets = `2,00,000

Current Assets = Cash + Account receivables + Inventory

= Cash + `50,000 + `1,00,000 = `2,00,000
Cash = `50,000

BQ 14
Complete the following annual financial statements on the basis of ratios given below:

Profit and loss account for the year ended 31st March, 2023
Particulars ` Particulars `
To Cost of goods sold 6,00,000 By Sales 20,00,000
To Operating expenses -
To EBIT -
20,00,000 20,00,000
To Debenture interest 10,000 By EBIT -
To Income tax -
To Net profit -
- -

Balance Sheet as at 31st March, 2023

Liabilities ` Assets `
Net worth: Fixed assets -
Share capital - Current assets:
Reserve and surplus - Cash -
10% Debenture - Stock -
Sundry creditors 60,000 Debtors 35,000
- -

Net Profit to sales 5% Current Ratio 1.5 times

 RATIO ANALYSIS 6.9
Return on net worth 20% Share capital to reserves 4:1
Rate of Income - tax 50% Inventory turnover 15 times
(based on cost of goods sold)

Answer
Profit and loss account for the year ended 31st March, 2023
Particulars ` Particulars `
To Cost of goods sold 6,00,000 By Sales 20,00,000
To Operating expenses 11,90,000
To EBIT 2,10,000
20,00,000 20,00,000
To Debenture interest 10,000 By EBIT 2,10,000
To Income tax 1,00,000
To Net profit 1,00,000
2,10,000 2,10,000

Balance Sheet as at 31st March, 2023

Liabilities ` Assets `
Net worth: Fixed assets 5,70,000
Share capital 4,00,000 Current assets:
Reserve and surplus 1,00,000 Cash 15,000
10% Debenture 1,00,000 Stock 40,000
Sundry creditors 60,000 Debtors 35,000
6,60,000 6,60,000

BQ 15
Using the following data, complete the Balance Sheet of X Ltd. as at 31.03.2023:

Gross profit 25% of Sales Gross profit `1,20,000

Shareholder’s equity `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 `60,000
Assume 365 days in a year

Balance Sheet of as at 31.03.2023

Liabilities ` Assets `
Share capital - Cash -
Long term debt - Inventory -
Sundry creditors - Debtors -
Fixed assets -
- -

BQ 16
From the following information, prepare a summarised balance sheet as at March 31, 2023:
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
Gross profit `60,000

Closing stock was `5,000 in excess of the opening stock.

Answer
Working Notes:
 RATIO ANALYSIS 6.10
Gross Profit 60,000
1. Sales = =
GP Ratio 20%
= `3,00,000
COGS
2. Stock Velocity = = 6
Average Stock

COGS 2,40,000
Average Stock = =
6 6
= `40,000
Opening Stock  Clo sin g Stock
3. Average Stock =
2
40,000 × 2 = Opening Stock + Closing Stock
80,000 = (Closing – 5,000) + Closing Stock
Closing Stock = `42,500 [Opening Stock = Closing – 5,000]
Turnover
4. Capital Turnover Ratio = = 2
Capital
3,00,000
Capital = = `1,50,000
2
Sales
5. Fixed Assets Turnover = = 4
Fixed Assets
3,00,000
Fixed Assets = = `75,000
4
Collection period
6. Debtors = Credit sales ×
12
2
= 3,00,000 × = `50,000
12

Payment period
7. Creditors = Credit purchase ×
12
73
= 2,45,000 × = `49,000
365

Assuming all purchases to be credit purchases, the amount of credit purchase is determined as follows:
Cost of Goods Sold = Opening Stock + Purchases - Closing Stock
= 2,40,000
Purchase = COGS + Closing Stock – Opening Stock
= 2,40,000 + 42,500 - 37,500 = `2,45,000

Balance Sheet as at 31st March, 2023

Liabilities ` Assets `
Capital 1,50,000 Fixed assets 75,000
Sundry creditors 49,000 Current assets:
Stock 42,500
Debtors 50,000
Cash (b.f.) 31,500
1,99,000 1,99,000

BQ 17
From the following particulars prepare the balance sheet:
Current ratio 2 Working capital `4,00,000
Capital block to current assets 3 : 2 Fixed assets to turnover 1:3
 RATIO ANALYSIS 6.11
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%
Reserve 2 1/2% of sales Profit & Loss (Cr. balance) 10% of sales

Answer
Balance Sheet
Liabilities ` Assets `
Share Capital 6,00,000 Fixed assets 8,00,000
Reserves 60,000 Current assets:
Profit & Loss A/C 2,40,000 Stock 3,00,000
Debentures 3,00,000 Debtors 4,00,000
Sundry creditors 3,00,000 Cash 1,00,000
Other Current Liabilities 1,00,000
16,00,000 16,00,000
Working Notes:
(a) Working Capital = Current Assets – Current Liabilities
= 4,00,000 (i)
Current Assets
= 2
Current Liabilitie s
Current Assets = 2 Current Liabilities (ii)
CA – CL = 4,00,000
2 CL – CL = 4,00,000
Current Liabilities = `4,00,000
Current Assets = 2 × `4,00,000 = `8,00,000
(b) Capital Employed/Block = 8,00,000 × 3/2
Capital Employed = `12,00,000
(c) Total liabilities = 12,00,000 + 4,00,000 = Total Assets
Fixed Assets = 16,00,000 - 8,00,000 = `8,00,000
(d) Turnover/ Sales = 8,00,000 (FA) × 3
Sales = `24,00,000

Credit sales and cash sales `16,00,000 and `8,00,000 respectively.

(e) Debtors = 16,00,000 × 3/12 = `4,00,000
(f) Stock = COGS × 2/12
= 18,00,000 × 2/12 = `3,00,000
(g) Creditors = Credit purchase 2/12
= 18,00,000 × 2/12 = `3,00,000
[Credit purchase = COGS]
(h) Cash Balance = 8,00,000 - 7,00,000 = `1,00,000
(i) Reserves = 24,00,000 × 2.5% = `60,000
(j) Profit = 24,00,000 × 10% = `2,40,000
(k) Block or Fixed Capital = 12,00,000
Reserve and Profit = 3,00,000
Debentures and Share Capital = 9,00,000

Share Capital is `6,00,000 and Debentures are `3,00,000 respectively.

 RATIO ANALYSIS 6.12
BQ 18
From the following prepare a balance sheet:

Current ratio 1.75 Liquid ratio 1.25

Stock turnover ratio (closing stock) 9 times Gross profit ratio 25%
Debtors collection period 1.5 months Reserves to capital 0.2
Turnover fixed Assets 1.2 Capital gearing ratio 0.6
Fixed Assets to net worth 1.25 Sales for the year `12,00,000

[Share capital: 6,66,667 Reserve: 1,33,333 Debt: 4,80,000 CL: 2,00,000 CA 3,50,000 Fixed Assets
10,00,000]

BQ 19
From the following particulars you are required to prepare the balance sheet of ABC Ltd:

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

Fixed Assets Turnover Ratio (on Cost of Goods Sold) 2 times
Finished goods Turnover Ratio (on Cost of Goods Sold) 6 times
G.P. rate on sales 25%
Net profit (before interest) to sales 8%
Interest coverage (debenture interest 7%) 8 times
Debt collection period 1.5 months
Material consumed to sales 30%
Stock of raw materials (in terms of months consumption) 3 months
Current ratio 2.4 : 1
Quick ratio 1:1
Reserve to capital ratio 0.21

Answer
Balance Sheet of ABC Ltd
Liabilities ` Assets `
Share Capital 10,00,000 Fixed assets 10,50,000
Reserves 2,10,000 Current assets:
Debentures 4,00,000 Stock of Raw materials 2,10,000
Current Liabilities 4,00,000 Stock of Finished goods 3,50,000
Debtors 3,50,000
Cash 50,000
20,10,000 20,10,000

Working notes:
A. COGS/Fixed Assets =2 F. Debt collection period = 1.5 times
Fixed Assets = 10.5 lakhs Sales × 1.5/12 = `3,50,000
Cost of goods sold = `21,00,000
G. Material consumed to sales is 30%
B. COGS/Finished goods =6 Material consumed = `28,00,000 × 30%
21 ,00 ,000
=6 = `8,40,000
Finished goods
6 Finished goods = `21,00,000 H. Stock of raw material = `8,40,000 × 3/12
* Finished goods = `3,50,000 = `2,10,000

C. Gross Profit on sales = 25% Current Assest

I. = 2.4 times
COGS + Profit = Sales Current Liabilitie s
`21,00,000 + .25X = X Liquid Assets
= 1 times
Sales = 21,00,000 ÷ 0.75 = `28,00,000 Current Liabilitie s
Gross profit = `7,00,000  Value of Stock = (2.4 - 1) CL = 1.4 CL
Finished goods + Raw material
D. Net Profit before interest = `28,00,000 × 8%
 RATIO ANALYSIS 6.13
= `2,24,000 = `3,50,000 + `2,10,000 = 1.4 CL
Net profit before int erest
=8 Current assets = `9,60,000
Interest Current Liabilities = `4,00,000
Interest charges = `28,000
J. Reserves to capital = 0.21
E. 7% interest charges = `28,000 If capital is 1.00 then Reserve = .21
Debentures = 28,000 ÷ 7% = `4,00,000 If net worth is `12,10,000
then Capital = `10,00,000
Reserve = `2,10,000

BQ 20
From the following information relating to Wise Limited you are required to prepare its summarized
Balance Sheet.

Current ratio 2.5 Acid test ratio 1.5

Gross profit to sales ratio 0.2 Sales to net fixed assets ratio 2.0
Sales to net worth ratio 1.5 Sales to debtors ratio 6.0
Reserves to capital ratio 1.0 Stock velocity (in months) 2
Net worth to long term loan 20 Paid up share capital `10 lakhs
Net working capital to net worth ratio 0.3

Answer
Balance Sheet of ABC Ltd
Liabilities ` Assets `
Share Capital 10,00,000 Fixed assets 15,00,000
Reserves 10,00,000 Stock 4,00,000
Long term Loans 1,00,000 Debtors 5,00,000
Current Liabilities 4,00,000 Other Current Assets 1,00,000
25,00,000 25,00,000

BQ 21
Following is the abridged Balance Sheet of Alpha Ltd:
Liabilities ` Assets ` `
Share Capital 1,00,000 Land and Buildings 80,000
Profit and Loss Account 17,000 Plant and Machineries 50,000
Current Liabilities 40,000 Less: Depreciation 15,000 35,000
1,15,000
Stock 21,000
Receivables 20,000
Bank 1,000 42,000
1,57,000 1,57,000

With the help of the additional information furnished below, you are required to prepare trading and profit &
loss account and a balance sheet as at 31st march, 2023:

(1) The company went in for reorganisation of capital structure, with share capital remaining the same as
follows:
Particulars %
Share capital 50%
Other shareholders funds 15%
5% Debentures 10%
Payables 25%
100%

Debentures were issued on 1st April, interest being paid annually on 31st March.

(2) Land and Buildings remained unchanged. Additional plant and machinery has been bought and a further
 RATIO ANALYSIS 6.14
`5,000 depreciation written off.
(The total fixed assets then constituted 60% of total fixed and current assets.)
(3) Working capital ratio was 8 : 5.
(4) Quick assets ratio was 1 : 1.
(5) The receivables (four-fifth of the quick assets) to sales ratio revealed a credit period of 2 months. There
were no cash sales.
(6) Return on net worth was 10%.
(7) Gross profit was at the rate of 15% of selling price.
(8) Stock turnover was eight times for the year.
(9) Ignore Taxation.

Answer
Projected Profit and Loss account for the year ended 31-03-2023
Particulars ` Particulars `
To Cost of Goods Sold 2,04,000 By Sales 2,40,000
To Gross profit (15% of `2,40,000) 36,000
2,40,000 2,40,000
To Administration and other 22,000 By Gross Profit 36,000
expenses (b.f.)
To Interest on Debenture 1,000
(5% on `20,000)
To Net Profit 13,000
36,000 36,000

Projected Balance Sheet as at 31st March, 2023

Liabilities ` Assets ` `
Share Capital 1,00,000 Land and Buildings 80,000
Other shareholders funds 30,000 Plant and Machineries 60,000
5% Debentures 20,000 Less: Depreciation 20,000 40,000
Payables 50,000 1,20,000
Stock 30,000
Receivables 40,000
Bank (b.f.) 10,000 80,000
2,00,000 2,00,000

Working Notes:
(1) Total Liabilities:
Share capital = 50% of total liabilities = `1,00,000
Total Liabilities = `1,00,000 ÷ 50% = `2,00,000

(2) Classification of total liabilities:

Particulars % (`)
Share capital 50% 1,00,000
Other shareholders funds 15% 30,000
5% Debentures 10% 20,000
Payables 25% 50,000
100% 2,00,000

(3) Fixed Assets:

Total liabilities = Total Assets = `2,00,000
Fixed Assets = 60% of total fixed assets and current assets
= `2,00,000 × 60% = `1,20,000

(4) Calculation of Historical cost of Plant & Machinery:

 RATIO ANALYSIS 6.15
Particulars `
Total fixed assets 1,20,000
Less: Land and Buildings 80,000
Plant and Machinery (after providing depreciation) 40,000
Depreciation on Machinery up to 31.03.2018 15,000
Add: Further depreciation 5,000
20,000
Historical Cost of Plant and Machinery (40,000 + 20,000) 60,000

(5) Current Assets:

Current assets = Total assets – Fixed assets
= `2,00,000 – `1,20,000 = `80,000

(6) Calculation of Stock:

Current assets−Stock
Quick ratio = = 1
Current liabilities
80,000−Stock
= = 1
50,000
Stock = `80,000 – `50,000 = `30,000

(7) Receivables:
Receivables = 4/5th of quick assets
= (`80,000 – `30,000) × 4/5 = `40,000

(8) Receivables turnover ratio:

Receivables
= × 12 Months = 12 months
Credit Sales
40,000
= × 12 Months = 2 months
Credit Sales
Credit sales = 40,000 × 12/2 = `2,40,000

(9) Return on net worth (net profit):

Net worth = `1,00,000 + `30,000 = `1,30,000
Net profit = `1,30,000 × 10% = `13,000

BQ 22
The following accounting information and financial ratios of PQR Ltd. relate to the year ended 31st December,
2022:
Accounting Information:
Gross profit 15% of sales
Net profit 8% of sales
Raw material consumed 20% of works cost
Direct wages 10% of works cost
Stock of raw materials 3 months’ usage
Stock of finished goods 6% of works cost
Debt collection period 60 days
All sales are on credit
Financial Ratios:
Fixed assets to Sales 1:3
Fixed assets to Current assets 13 : 11
Current ratio 2:1
Long term loan to Current liabilities 2:1
Capital to Reserve and Surplus 1:4

If value of fixed assets as on 31st December, 2022 amounted to `26 lakhs, prepare a summarised profit and
loss account of the company for the year ended 31st december, 2022 and also the balance sheet as on 31st
 RATIO ANALYSIS 6.16
december, 2022.

Answer
Profit and Loss account for the year ended 31.12.2022
Particulars ` Particulars `
To Direct Materials 13,26,000 By Sales 78,00,000
To Direct Wages 6,63,000
To Works Overheads (b.f.) 46,41,000
To Gross profit (15% of `78,00,000) 11,70,000
78,00,000 78,00,000
To Administration and Selling 5,46,000 By Gross Profit 11,70,000
expenses (b.f.)
To Net Profit (8% of `78,00,000) 6,24,000
11,70,000 11,70,000

Balance Sheet as at 31st December, 2022

Liabilities ` Assets `
Share Capital 3,00,000 Fixed Assets 26,00,000
Reserves and Surplus 12,00,000 Current Assets:
Long term loans 22,00,000 Raw Material Stock 3,31,500
Current Liabilities 11,00,000 Finished Goods Stock 3,97,800
Receivables 12,82,192
Cash 1,88,508
48,00,000 48,00,000

Working Notes:
(a) Calculation of Sales:
Fixed Assets
= 1/3 or Sales = 3 × `26,00,000
Sales
Sales = `78,00,000

(b) Calculation of Current Assets:

Fixed Assets
= 13/11 or Current Assets = `26,00,000 × 11/13
Current Assets
Current Assets = `22,00,000

(c) Calculation of Raw Material Consumption and Direct Wages:

Works Cost = Sales – Gross Profit

= 78,00,000 – 15% of Sales = `66,30,000

Raw Material Consumption = 20% of `66,30,000 = `13,26,000

Direct Wages = 10% of `66,30,000 = `6,63,000

(d) Calculation of Finished Goods Stock:

Finished Goods Stock = 6% of `66,30,000 = `3,97,800

(e) Calculation of Raw Material Stock:

Raw Material Stock = Raw Material Consumption × 3/12

= `13,26,000 × 3/12 = `3,31,500

(f) Calculation of Current Liabilities:

Current Assets
Current Ratio = = 2
Current Liabilities
Current Liabilities = `22,00,000 ÷ 2 = `11,00,000
 RATIO ANALYSIS 6.17
(g) Calculation of Receivables:
ACP 60
Receivables = Credit Sales × = `78,00,000 ×
365 365
= `12,82,192

(h) Calculation of Long Term Loan:

Long Term Loan
= 2
Current Liabilities

Long Term Loan = 2 × `11,00,000 = `22,00,000

(i) Calculation of Cash Balance:

Current Assets = Cash + Stock + Receivables

Cash Balance = `22,00,000 – (`3,97,800 + `3,31,500 + `12,82,192)

= `1,88,508

(j) Calculation of Net Worth:

Total Liabilities = Total Assets (Fixed Assets + Current Assets)
= `22,00,000 + `26,00,000 = `48,00,000

Net Worth = Total Liabilities – Long Term Loan – Current Liabilities

= `48,00,000 - `22,00,000 - `11,00,000 = `15,00,000

(k) Calculation of Capital, Reserve and Surplus:

Net Worth = Share Capital + Reserve and surplus

Capital to Reserve and Surplus = 1:4

Share Capital = `15,00,000 × 1/5 = `3,00,000
Reserve and Surplus = `15,00,000 × 4/5 = `12,00,000

BQ 23
The following figures and ratios are related to a company:
(a) Sales for the year (all credit) `90,00,000
(b) Gross profit ratio 35 percent
(c) Fixed assets turnover (basis on cost of goods sold) 1.5
(d) Stock turnover (basis on cost of goods sold) 6
(e) Liquid ratio 1.5 : 1
(f) Current ratio 2.5 : 1
(g) Debtors collection period 1 month
(h) Reserve and surplus to Share capital 1 : 1.5
(i) Capital gearing ratio 0.7875
(j) Fixed assets to net worth 1.3 : 1
You are required to prepare:
1. Balance Sheet of the company on the basis of above details.
2. The statement showing working capital requirement, if the company wants to make a provision for
contingencies @ 15% of net working capital.

Answer
(1) Balance Sheet
Liabilities ` Assets `
Share Capital 18,00,000 Fixed Assets 39,00,000
Reserve & Surplus 12,00,000 Stock 9,75,000
Debt 23,62,500 Debtors 7,50,000
 RATIO ANALYSIS 6.18
Current Liabilities 9,75,000 Cash 7,12,500
63,37,500 63,37,500

(2) Statement of Working Capital Requirement

Particulars `
Current Assets: Stock 9,75,000
Debtors 7,50,000
Cash 7,12,500
24,37,500
Less: Current Liabilities (9,75,000)
Working Capital Before Provision 14,62,500
Add: Provision for Contingencies @ 15% of WC 2,19,375
Working Capital Including Provision 16,81,875

Working Notes:

a. Cost of Goods Sold = 90,00,000 - 35% = 58,50,000

COGS
b. Fixed Assets Turnover Ratio = = 1.5 times
Fixed Assets
58 ,50 ,000
Fixed Assets = = `39,00,000
1 .5

Fixed Assets
c. Fixed Assets to Net Worth = = 1.3 times
Net Worth
39 ,00 ,000
Net Worth = = `30,00,000
1 .3

Debt + Pr eference Debt + Nil

d. Capital Gearing = =
Equity 30 ,00 ,000
Debt = 0.7875 × `30,00,000 = `23,62,500
Assumption: Preference Share capital is zero.

e. Reserves & Surplus = 30,00,000 × 1/2.5 = `12,00,000

f. Share Capital = 30,00,000 × 1.5/2.5 = `18,00,000

COGS
g. Stock Turnover = = 6 times
Clo sin g Stock
58 ,50 ,000
Closing Stock = = `9,75,000
6

Collection Period 1
h. Debtors = Sales × = 90,00,000 ×
12 12
= `7,50,000

i. Stock = CL (Current ratio – Liquid ratio)

Current Liabilities = Stock ÷ (CR - LR)
= 9,75,000 ÷ (2.5 – 1.5) = `9,75,000

j. Current Ratio = CA ÷ CL = 2.5 times

Current Assets = 2.5 × 9,75,000 = `24,37,500

k. Cash in Hand = 24,37,500 – 9,75,000 - 7,50,000

= `7,12,500
 RATIO ANALYSIS 6.19
BQ 24
Following information has been provided from the books of Laxmi Pvt. Ltd. for the year ending on 31st March,
2023:
Working capital `4,80,000
Bank overdraft `80,000
Fixed assets to proprietary ratio 0.75
Reserves and Surplus `3,20,000
Current ratio 2.5
Liquid ratio 1.5

You are required to prepare a summarised Balance Sheet as at 31st March, 2023 assuming that
there is no long term debt.

Answer
Balance Sheet
As at 31.03.2023
Liabilities ` Assets `
Share Capital 16,00,000 Fixed Assets 14,40,000
Reserves and Surplus 3,20,000 Stock 3,20,000
Bank Overdraft 80,000 Other Current Assets 4,80,000
Sundry creditors 2,40,000
22,40,000 22,40,000

Working Notes:
1. Current assets and Current liabilities computation:
CA
= 2.5
CL
CA = 2.5 CL
Working capital = CA – CL
4,80,000 = 2.5 CL – CL
CL = 3,20,000
CA = 3,20,000 × 2.5 = 8,00,000

2. Computation of stock:
Liquid Assets
Liquid ratio =
Current Liabilitie s
Current Assets - Stock
1.5 =
3,20,000
1.5 × 3,20,000 = 8,00,000 – Stock
Stock = 3,20,000

3. Computation of Proprietary fund, Fixed assets, Capital and Sundry Creditor

Fixed Assets
= 0.75
Proprietar y Fund
Fixed assets = 0.75 Proprietary fund
Net working capital = 0.25 Proprietary fund
4,80,000 = 0.25 Proprietary fund
4,80,000
Proprietary fund = = 19,20,000
0.25

Fixed assets = 0.75 Proprietary fund

= 0.75 × 19,20,000 = 14,40,000
Share Capital = Proprietary fund – R & S
= 19,20,000 – 3,20,000 = 16,00,000
 RATIO ANALYSIS 6.20
Sundry creditors = CL - Bank overdraft
= 3,20,000 - 80,000 = 2,40,000

BQ 25
Manan Pvt. Ltd. gives you the following information relating to the year ending 31st March, 2023:
Current Ratio : 2.5 : 1
Debt-Equity Ratio : 1 : 1.5
Return on Total Assets (After Tax) : 15%
Total Assets Turnover Ratio : 2
Gross Profit Ratio : 20%
Stock Turnover Ratio : 7
Net Working Capital : `13,50,000
Fixed Assets : `30,00,000
1,80,000 Equity Shares of : `10 each
60,000, 9% Preference Shares of : `10 each
Opening Stock : `11,40,000
You are required to calculate:
(a) Quick Ratio
(b) Fixed Assets Turnover Ratio
(c) Proprietary Ratio
(d) Earnings per Share

Answer
(a) Calculation of Quick Ratio
Quick Assets 9,90,000
Quick Ratio = = = 1.1 : 1
Current Liabities 9,00,000

(b) Calculation of Fixed Assets Turnover Ratio

Sales 1,05,00,000
Fixed Assets Turnover Ratio = = = 3.5
Fixed Assets 30,00,000

(c) Calculation of Proprietary Ratio

Proprietary Fund 28,50,000
Proprietary Ratio = = = 0.54
Total Assets 52,50,000

(d) Calculation of Earnings per Equity Share (EPS)

PAT − Preference Share Dividend
Earnings per Equity Share (EPS) =
Number of Equity Shares
7,87,500 −9% of 6,00,000
= = `4.075
1,80,000
Workings Notes:
Current Assets
(i) Current Ratio = = 2.5
Current Liabilities
Current Assets = 2.5 Current Liabilities

Working Capital = Current Assets – Current Liabilities

13,50,000 = 2.5 Current Liabilities – Current Liabilities
Current Liabilities = 13,50,000 ÷ 1.5 = 9,00,000

Current Assets = 2.5 Current Liabilities

= 2.5 × 9,00,000 = 22,50,000

(ii) Sales = Total Assets Turnover × Total Assets

= 2 × (Fixed Assets + Current Assets)
2 × (30,00,000 + 22,50,000) = 1,05,00,000
 RATIO ANALYSIS 6.21
(iii) Cost of Goods Sold = 80% of Sales
= 80% of 1,05,00,000 = 84,00,000

Cost of Goods Sold 84,00,000

(iv) Average Stock = = = 12,00,000
Stock Turnover Ratio 7

Closing Stock = (Average Stock × 2) – Opening Stock

= (12,00,000 × 2) – 11,40,000 = 12,60,000

Quick Assets = Current Assets – Closing Stock

= 22,50,000 – 12,60,000 = 9,90,000

Debt
Debt – Equity Ratio = = 1 : 1.5
Equity
1.5 Debt = Equity

Total Assets = Equity + Preference Share Capital + Debt + CL

52,50,000 = 1.5 Debt + 6,00,000 + Debt + 9,00,000 = 2.5 Debt
Debt = 37,50,000 ÷ 2.5 = 15,00,000

Equity = 15,00,000 × 1.5 = 22,50,000

Proprietary Fund = Equity + Preference Share Capital
= 22,50,000 + 6,00,000 = 28,50,000

(v) Profit After Tax (PAT) = Total Assets × Return on Total Assets
= 52,50,000 × 15% = 7,87,500

BQ 26
The Balance Sheets of A Ltd. and B Ltd. as on 31st March 2023 are as follows:
Particulars A Ltd B Ltd
Liabilities:
Share Capital 40,00,000 40,00,000
Reserve and surplus 32,30,000 25,00,000
Secured Loans 25,25,000 32,50,000
Current Liabilities and provisions:
Sundry Creditors 15,00,000 14,00,000
Outstanding Expenses 2,00,000 3,00,000
Provision for Tax 3,00,000 3,00,000
Proposed Dividend 6,00,000 -
Unclaimed Dividend 15,000 -
Assets: 1,23,70,000 1,17,50,000
Fixed Assets (Net) 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 & 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 `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.
 RATIO ANALYSIS 6.22
Answer
Particulars A B
Current Assets and Liquid Assets:
Stock (23,00,000 × 75%) + 20% 20,70,000 -
Debtor (17,00,000 × 50%) - 8,50,000
Cash & Bank 5,70,000 5,50,000
Liquid Assets 26,40,000 14,00,000
Add: Stock (23,00,000 × 25%) 5,75,000 45,00,000
Total Current Assets 32,15,000 59,00,000
Current Liabilities:
Proposed Dividend 6,00,000 6,00,000
Creditor 15,00,000 15,20,000
Out Expenses 2,00,000 3,00,000
Provision for tax 3,00,000 3,00,000
Unclaimed Dividend 15,000 -
26,15,000 27,20,000
Evaluation of Liquidity
RATIO A B
CA 32 ,15 ,000 59 ,00 ,000
1. Current Ratio  = 1.23 = 2.17
CL 26 ,15 ,000 27 ,20 ,000
LA 26 ,40 ,000 14 ,00 ,000
2. Liquid Ratio  = 1.009 = .51
CL 26 ,15 ,000 27 ,20 ,000

BQ 27
The following ratios and information relate to the business:
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 `1,05,000

Gross profit for the year ended 31.03.2023 amounted to `3,00,000.

Find out: (a) Sales; (b) Sundry Debtors; (c) Closing Stock; (d) Sundry Creditors.

Answer
Gross Pr ofit 3 ,00 ,000
(a) Sales = = = `12,00,000
GP Ratio 25 %

Average collection period

(b) Sundry Debtors = Credit sales × = 12,00,000 × 2
12 12
= `2,00,000

(c) Closing Stock:

COGS 12 ,00 ,000  25%
Average stock = = = `1,12,500
STR 8
Opening Stock  Clo sin g Stock
Average stock =
2
1,05,000  Clo sin g Stock
1,12,500 =
2
Closing Stock = `1,20,000

Average payment period

(d) Creditors = Credit purchase × = 9,15,000 × 1
12 12
= `76,250
 RATIO ANALYSIS 6.23
Purchase = COGS + Closing Stock – Opening Stock
= 9,00,000 + 1,20,000 – 1,05,000 = `9,15,000

BQ 28
The total sales (all credit) of a firm are `6,40,000. It has a gross profit margin of 15 per cent and a current ratio
of 2.5. The firm’s current liabilities are `96,000; inventories `48,000 and cash `16,000.

(a) Determine the average inventory to be carried by the firm, if an inventory turnover of 5 times is
expected? (assume a 360 day year).
(b) Determine the average collection period if the opening balance of debtors is intended to be of `80,000?
(assume a 360 day year).

Answer
Cost of goods sold 6,40,000 × 85%
(a) Inventory turnover = = = 5
Average inventory Average inventory

Average inventory = `5,44,000 ÷ 5 = `1,08,800

(b) Average collection period:

Current Ratio = Current Assets ÷ Current Liabilities = 2.5

2.5 = (Closing Debtors + Closing Inventories + Cash) ÷ Current Liabilities
2.5 = Closing Debtors + `48,000 + `16,000) ÷ `96,000
Closing Debtors = `1,76,000

Average debtors = (80,000 + 1,76,000) ÷ 2 = `1,28,000

Average Receivables 1,28,000

Average coll. period = × 360 = × 360 = 72 Days
Annual Credit Sales 6,40,000

BQ 29
The capital structure of Beta Limited is as follows:
Equity Share Capital of `10 each 8,00,000
9% Preference Share Capital of `10 each 3,00,000
11,00,000

Additional information: Profit (after tax at 35 per cent), `2,70,000; Depreciation, `60,000; Equity dividend
paid, 20 per cent; Market price of equity shares, `40.

You are required to compute the following, showing the necessary workings:
(a) Dividend yield on the equity shares.
(b) Cover for the preference and equity dividends.
(c) Earnings per shares.
(d) Price-earnings ratio.

Answer
(a) Dividend yield on the equity shares:
DPS 20% of 10
Dividend Yield = × 100 = × 100 = 5%
MPS 40

(b) Dividend Coverage Ratio:

PAT 2,70,000
Preference = = = 10 times
Preference Dividend 9% of 3,00,000

PAT−PD 2,70,000−27,000
Equity = = = 1.52 times
Equity Dividend 20% of 8,00,000
 RATIO ANALYSIS 6.24
(c) Earning Per Share:
PAT−PD
EPS =
Number of Equity Shares
2,70,000−27,000
= = `3.0375
80,000

(d) Price Earning Ratio:

MPS 40
PE Ratio = = = 13.17 times
EPS 3.0375

BQ 30
X Co. has made plans for the next year. It is estimated that the company will employ total assets of `8,00,000;
50 per cent of the assets being financed by borrowed capital at an interest cost of 8 per cent per year. The
direct costs for the year are estimated at `4,80,000 and all other operating expenses are estimated at `80,000.
The goods will be sold to customers at 150 per cent of the direct costs. Tax rate is assumed to be 50 per cent.

You are required to calculate: (a) Operating profit margin (before tax), (b) Net profit margin
(after tax); (c) Return on assets (on operating profit after tax); (d) Asset turnover and (e) Return on
owners’ equity.

Answer
EBIT 1 ,60 ,000
(a) Operating Profit Margin= × 100 = × 100 = 22.22%
Sales 7 ,20 ,000

EAT 64 ,000
(b) Net Profit Margin = × 100 = × 100 = 8.89%
Sales 7 ,20 ,000

EBIT (1−t) 1,60,000 (1−.50)

(c) Return on Assets = = = 10%
Assets 8,00,000

Sales 7 ,20 ,000

(d) Assets turnover = = = 0.9 times
Total Assets 8 ,00 ,000

EAT 64 ,000
(e) Return on Equity = × 100 = × 100 = 16%
Equity Fund 4 ,00 ,000

The Net Profit is calculated as follows:

Particulars `
Sales Revenue (150% of `4,80,000) 7,20,000
Less: Direct Cost 4,80,000
Gross Profit 2,40,000
Less: Other operating expenses 80,000
Operating Profit/EBIT 1,60,000
Less: Interest on 8% Debt (8,00,000 × 50% × 8%) 32,000
EBT 1,28,000
Less: Taxes @ 50% 64,000
EAT 64,000

BQ 31
In a meeting held at Solan towards the end of 2022, the Directors of M/s HPCL Ltd. have taken a decision to
diversify. At present HPCL Ltd. sells all finished goods from its own warehouse.

The company issued debentures on 01.01.2023 and purchased fixed assets on the same day. The
purchase prices have remained stable during the concerned period. Following information is provided to you:
 RATIO ANALYSIS 6.25
Income Statement
Particulars 2022 2023
Cash Sales 30,000 32,000
Credit Sales 2,70,000 3,00,000 3,42,000 3,74,000
Less: Cost of Goods Sold 2,36,000 2,98,000
Gross profit 64,000 76,000
Less: Operating Expenses:
Warehousing 13,000 14,000
Transport 6,000 10,000
Administrative 19,000 19,000
Selling 11,000 49,000 14,000 57,000
Net Profit 15,000 19,000

Balance Sheet
Particulars 2022 2023
Fixed Assets (Net Block) - 30,000 - 40,000
Receivables 50,000 82,000
Cash at Bank 10,000 7,000
Stock 60,000 94,000
Total Current Assets (CA) 1,20,000 1,83,000
Payables 50,000 76,000
Total Current Liabilities (CL) 50,000 76,000
Working Capital (CA -CL) 70,000 1,07,000
Total Assets 1,00,000 1,47,000
Represented by:
Share Capital 75,000 75,000
Reserve and Surplus 25,000 42,000
Debentures - 30,000
1,00,000 1,47,000

You are required to calculate the following ratios for the years 2022 and 2023.
(1) Gross Profit Ratio
(2) Operating Expenses to Sales Ratio
(3) Operating Profit Ratio
(4) Capital Turnover ratio
(5) Stock Turnover ratio
(6) Net Profit to Net worth Ratio, and
(7) Receivables Collection Period.
Ratio relating to capital employed should be based on the capital at the end of the year. Give the reasons for
change in the ratios for 2 years. Assume opening stock of `40,000 for the year 2022. Ignore Taxation.

Answer
Computation of Ratios
Particulars 2022 2023
(1) Gross Profit ratio
64 ,000 76 ,000
× 100 = 21.3% × 100 = 20.3%
Gross Profit ÷ Sales 3 ,00 ,000 3,74 ,000

(2) Operating Expenses to Sales

49 ,000 57 ,000
× 100 = 16.3% × 100 = 15.2%
Operating Expenses ÷ Sales 3,00 ,000 3 ,74 ,000

(3) Operating Profit Ratio

15 ,000 19 ,000
Operating Profit ÷ Sales × 100 = 5% × 100 = 5.08%
3,00 ,000 3 ,74 ,000
 RATIO ANALYSIS 6.26
(4) Capital Turnover Ratio 3,00 ,000
=3
3,74 ,000
= 2.54
1 ,00 ,000 1 ,47 ,000
Sales ÷ Capital employed

(5) Stock Turnover Ratio 2,36 ,000 2,98 ,000

= 4.72 = 3.87
50 ,000 77 ,000
COGS ÷ Average Stock

(6) Net profit to Net Worth 15 ,000 19 ,000

× 100 = 15% × 100 = 16.24%
1 ,00 ,000 1 ,17 ,000
Net Profit ÷ Net Worth
(7) Receivable Collection Period 50 ,000
× 365 = 67.6 days 82 ,000
× 365 = 87.5 days
2,70 ,000 3 ,42 ,000
Average Receivables ÷ Average Daily
Credit Sales

Analysis: The decline in the Gross profit ratio could be either due to a reduction in the selling price or increase
in the direct expenses (since the purchase price has remained the same). In this case, cost of goods sold have
increased more than proportion of increment in sales & hence impacting gross profit ratio.
Similarly, there is a decline in the ratio of operating expenses to sales. Further analysis reveals that in
comparison to increase in sales, there has a lesser proportionate increase in operating expenses. As a result,
even the operating profit ratio has remained the same approximately in spite of a decline in the Gross profit
ratio.
The company has not been able to deploy its capital efficiently. This is indicated by a decline in the Capital
turnover ratio from 3 to 2.54 times.
The decline in stock turnover ratio implies that the company has increased its investment in stock. Net Profit
to Net worth ratio has increased indicating that the company’s Net worth or Shareholders’ capital is efficient
in generating profits.
The increase in the Receivables collection period indicates that the company has become liberal in extending
credit on sales. There is a corresponding increase in the receivables also due to such credit policy.

BQ 32
ABC Company sells plumbing fixtures on terms of 2/10, net 30. Its financial statements over the last 3 years
are as follows:
Particulars 2020-21 2021-22 2022-23
Cash 30,000 20,000 5,000
Accounts receivable 2,00,000 2,60,000 2,90,000
Inventory 4,00,000 4,80,000 6,00,000
6,30,000 7,60,000 8,95,000
Net fixed assets 8,00,000 8,00,000 8,00,000
14,30,000 15,60,000 16,95,000
Account payable 2,30,000 3,00,000 3,80,000
Accruals 2,00,000 2,10,000 2,25,000
Bank loan, short term 1,00,000 1,00,000 1,40,000
5,30,000 6,10,000 7,45,000
Long term debt 3,00,000 3,00,000 3,00,000
Common stock 1,00,000 1,00,000 1,00,000
Retained earnings 5,00,000 5,50,000 5,50,000
14,30,000 15,60,000 16,95,000
Sales 40,00,000 43,00,000 38,00,000
Cost of goods sold 32,00,000 36,00,000 33,00,000
Net profit 3,00,000 2,00,000 1,00,000

Considering opening balance of Accounts Receivable and Inventory as 2,00,000 and 4,00,000
respectively as on 01.04.2020, Analyse the company’s financial condition and performance over the last
3 years. Are there any problems?
 RATIO ANALYSIS 6.27
Answer
Ratios 2020-21 2021-22 2022-23
Current Ratio 1.19 1.25 1.20
(Current Assets ÷ Current 6,30,000 7,60,000 8,95,000
( ) ( ) ( )
Liabilities) 5,30,000 6,10,000 7,45,000
Acid Test Ratio 0.43 0.46 0.40
(Quick Assets ÷ Current 2,30,000 2,80,000 2,95,000
( ) ( ) ( )
Liabilities) 5,30,000 6,10,000 7,45,000
Receivable Turnover Ratio 20 18.70 13.82
(Annual Credit Sales ÷ Average 40,00,000 43,00,000 38,00,000
( ) ( ) ( )
Receivables) 2,00,000 2,30,000 2,75,000
Average Collection Period 18.25 days 19.52 days 26.41 days
[(Average Receivables × 365) ÷ 2,00,000 2,30,000 2,75,000
( × 365) ( × 365) ( × 365)
Annual Credit Sales] 40,00,000 43,00,000 38,00,000
Inventory Turnover 8 8.18 6.11
(COGS ÷ Average Inventory) 32,00,000 36,00,000 33,00,000
( ) ( ) ( )
4,00,000 4,40,000 5,40,000
Total Debt To Net Worth 1.38 1.40 1.61
(*Total Debt ÷ Equity Fund) 8,30,000 9,10,000 10,45,000
( ) ( ) ( )
*Total Debt including CL 6,00,000 6,50,000 6,50,000
Long Term Debt To Total 0.33 0.32 0.32
Capitalization 3,00,000 3,00,000 3,00,000
( ) ( ) ( )
(Long Term Debt ÷ Long Term 9,00,000 9,50,000 9,50,000
Fund)
Gross Profit Margin 20% 16.28% 13.16%
[(Gross Profit ÷ Sales) × 100] 8,00,000 7,00,000 5,00,000
( × 100) ( × 100) ( × 100)
40,00,000 43,00,000 38,00,000
Net Profit Margin 7.50% 4.65% 2.63%
[(Net Profit ÷ Sales) × 100] 3,00,000 2,00,000 1,00,000
( × 100) ( × 100) ( × 100)
40,00,000 43,00,000 38,00,000
Asset Turnover 2.80 2.76 2.24
(Sales ÷ Total Assets) 40,00,000 43,00,000 38,00,000
( ) ( ) ( )
14,30,000 15,60,000 16,95,000
Return on Assets 20.98% 12.82% 5.90%
[(Net Profit ÷ Total Assets) × 100] 3,00,000 2,00,000 1,00,000
( × 100) ( × 100) ( × 100)
14,30,000 15,60,000 16,95,000

Analysis: The current ratio and quick ratio are less than the ideal ratio (2:1 and 1:1 respectively) indicating
that the company is not having enough resources to meet its current obligations.
Receivables are growing slower, although the average collection period is still very reasonable relative to the
terms given. Inventory turnover is slowing as well, indicating a relative build-up in inventories. The increase
in receivables and inventories, coupled with the fact that net worth has increased very little, has resulted in
the total debt-to-net worth ratio increasing to what would have to be regarded on an absolute basis as a high
level.
Long-term debt to total capitalization has not changed relatively coupled with the fact that retained earnings
of only `50,000 is made in year 2021-22, and there is no issuance of new long-term debt in year 2021-22 and
2022-23.
Both the gross profit and net profit margins have declined substantially. The relationship between the two
suggests that the company has incurred more relative expenses. The build-up in inventories and receivables
has resulted in a decline in the asset turnover ratio, and this, coupled with the decline in profitability, has
resulted in a sharp decrease in the return on assets ratio.

BQ 33
Following information are available for Navya Ltd. along with various ratio relevant to the particulars industry
it belongs to. Appraise your comments on strength and weakness of Navya Ltd. comparing its ratios with the
given industry norms.
 RATIO ANALYSIS 6.28
Balance Sheet as at 31.03.2023
Liabilities ` Assets `
Equity Share Capital 48,00,000 Fixed Assets 24,20,000
10% Debentures 9,20,000 Cash 8,80,000
Sundry Creditors 6,60,000 Sundry Debtors 11,00,000
Bills Payable 8,80,000 Stock 33,00,000
Other Current Liabilities 4,40,000
77,00,000 77,00,000

Statement of Profitability for the year ended 31.03.2023

Particulars (`) (`)
Sales 1,10,00,000
Less: Cost of Goods Sold:
Materials 41,80,000
Wages 26,40,000
Factory Overheads 12,98,000 81,18,000
Gross Profit 28,82,000
Less: Selling and Distribution Cost 11,00,000
Less: Administrative Cost 12,28,000 23,28,000
Earnings before Interest and Taxes (EBIT) 5,54,000
Less: Interest Charges 92,000
Earning before Tax (EBT) 4,62,000
Less: Taxes @ 50% 2,31,000
Net Profit (PAT) 2,31,000

Industry Norms
Ratio Norm
Current Ratio 2.5
Receivables Turnover Ratio 8.0
Inventory Turnover Ratio (based on Sales) 9.0
Total Assets Turnover Ratio 2.0
Net Profit Ratio 3.5%
Return on Total Assets (on EBIT) 7.0%
Return on Net worth (Based on Net profit) 10.5%
Total Debt/Total Assets 60.0%

Answer
Computation of Ratios
Ratios Navya Ltd. Industry Norms
1. Current Ratio 52,80,000/19,80,000 = 2.67 2.50

2. Receivables Turnover Ratio 1,10,00,000/11,00,000 = 10.00 8.00

3. Inventory Turnover Ratio (based on Sales) 1,10,00,000/33,00,000 = 3.33 9.00

4. Total Assets Turnover Ratio 1,10,00,000/77,00,000 = 1.43 2.00

5. Net Profit Ratio 2,31,000/1,10,00,000 = 2.10% 3.50%

6. Return on Total Assets (on EBIT) 5,54,000/77,00,000 = 7.19% 7.00%

7. Return on Net worth (Based on Net profit) 2,31,000/48,00,000 = 4.81% 10.50%

8. *Total Debt /Total Assets 29,00,000/77,00,000 = 37.66% 60.00%

*Total debt = Liabilities other than shareholder’s fund

 RATIO ANALYSIS 6.29
Comments:
(1) The position of Navya Ltd. is better than the industry norm with respect to Current Ratio and Receivables
Turnover Ratio.
(2) However, the Inventory turnover ratio and Total Asset Turnover ratio is poor comparing to industry
norm indicating that company is inefficient to utilize its inventory and assets.
(3) The firm also has its net profit ratio and return on net worth ratio much lower than the industry norm.
(4) Total debt to total assets ratio is lower that the industry standard which suggests that the firm is less
levered by debt and more by equity resulting in less risky company.

BQ 34
Balance Sheet as at 31st March, 2023
Liabilities ` Assets `
Equity Share Capital 10,00,000 Goodwill 5,00,000
General Reserve 1,00,000 Plant and Machinery 6,00,000
Profit and Loss 4,00,000 Land and Building 7,00,000
16% Preference Share Capital 5,00,000 Furniture and Fixtures 1,00,000
12% Debenture 5,00,000 Stock in trade 6,00,000
Provision for Tax 1,76,000 Bills Receivable 30,000
Bills Payable 1,24,000 Debtors 1,50,000
Bank Overdraft 20,000 Bank 2,00,000
Creditors 80,000 Marketable Securities 20,000
29,00,000 29,00,000

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.

Answer
Current Assets 10 ,00 ,000
(i) Current Ratio = = = 2.5
Current Liabilitie s 4 ,00 ,000

Liquid Assets 4 ,00 ,000

(ii) Quick Ratio = = = 1
Current Liabilitie s 4 ,00 ,000

Cash and Cash Equivalent 2,20 ,000

(iii) Absolute Liquidity ratio = = = 0.55
Current Liabilitie s 4 ,00 ,000

Inventory 6 ,00 ,000

(iv) Inventory to Working Capital = = = 1
Working Capital 6 ,00 ,000

Current Assets 10 ,00 ,000

(v) Current Assets to Fixed Assets = = = .526
Fixed Assets 19 ,00 ,000

Long Term Debt 5 ,00 ,000

(vi) Debt to Equity Ratio = = = 0.33
Equity 15 ,00 ,000

Shareholde r' s Fund 20 ,00 ,000

(vii) Proprietary Ratio = = = 0.69
Total Assets 29 ,00 ,000

Debentures  Pr eference Share Capital

(viii) Capital Gearing Ratio =
Equity Shareholde r' s Fund
10 ,00 ,000
= = 0.67
15 ,00 ,000
 RATIO ANALYSIS 6.30
BQ 35
Given below are estimate for the next year by NITI Ltd.:

Particulars (` in crores)
Fixed Assets 5.20
Current Liabilities 4.68
Current Assets 7.80
Sales 23.00
EBIT 2.30

The company will issue equity funds of `5 crores in the next year. It is also considering the debt alternatives
of `3.32 crores for financing the assets. The company wants to adopt one of the policies given below:
(` Crore)
Financing policy Short term debt @12% Long term debt @ 16% Total
Conservative 1.08 2.24 3.32
Moderate 2.00 1.32 3.32
Aggressive 3.00 0.32 3.32

Assuming corporate tax rate is 30%. Calculate the following for each of the financing policy:
(1) Return on total assets, (2) Return on owner’s equity, (3) Net working capital and (4) Current ratio.

Answer
Statement Showing Ratios for Each of the Financing Policy (` Crore)
Particulars Conservative Moderate Aggressive
(1) Return on total assets 12.38% 12.38% 12.38%
 EBIT (1  t )   2.30 (1  0.3)   2.30 (1  0.3)   2.30 (1  0.3) 
  100    100    100    100 
 Total Assets   5 . 20  7 . 80   5 . 20  7 . 80   5 . 20  7 . 80 

(2) Return on shareholder’s equity 25.37% 25.88% 26.44%

 PAT   1.2684   1.2942   1.3222 
  100   100   100   100 
 5   5   5 
 Equity 

2.04 1.12 0.12

(3) Net working capital (CA – *CL)
(7.80 – 4.68 – 1.08) (7.80 – 4.68 – 2.00) (7.80 – 4.68 – 3.00)
*CL includes short term debt
1.35 : 1 1.17 : 1 1.02 : 1
(4) Current ratio
[7.80÷(4.68+1.08)] [7.80÷(4.68+2.00)] [7.80÷(4.68+3.00)]
(Current Assets ÷ Current Liabilities)

Calculation of PAT :
EBIT 2.3000 2.3000 2.3000
Less: interest @ 12% on short term 0.1296 0.2400 0.3600
Less: interest @ 16% on long term 0.3584 0.2112 0.0512
EBT 1.8120 1.8488 1.8888
Less: Tax @ 30% 0.5436 0.5546 0.5666
PAT 1.2684 1.2942 1.3222
 RATIO ANALYSIS 6.31

PAST YEARS QUESTIONS

PYQ 1
From the following information, prepare a summarised Balance Sheet as at 31st March, 2002:
Working capital `2,40,000
Bank overdraft `40,000
Fixed assets to proprietary ratio 0.75
Reserves and Surplus `1,60,000
Current ratio 2.5
Liquid ratio 1.5
[(6 Marks) Nov 2002]

Answer
Balance Sheet
As at 31.03.2002
Liabilities ` Assets `
Share Capital 8,00,000 Fixed Assets 7,20,000
Reserves and Surplus 1,60,000 Stock 1,60,000
Bank Overdraft 40,000 Other Current Assets 2,40,000
Other Current Liabilities 1,20,000
11,20,000 11,20,000
Working Notes:
1. Current assets and Current liabilities computation:
CA
= 2.5
CL
CA = 2.5 CL
Working capital = CA – CL
2,40,000 = 2.5 CL – CL
CL = 1,60,000
CA = 1,60,000 × 2.5 = 4,00,000
2. Computation of stock:
Liquid Assets
Liquid ratio =
Current Liabilitie s
Current Assets - Stock
1.5 =
1,60,000
1.5 × 1,60,000 = 4,00,000 – Stock
Stock = 1,60,000
3. Computation of Proprietary fund, Fixed assets, Capital and Sundry Creditor
Fixed Assets
= 0.75
Proprietar y Fund
Fixed assets = 0.75 Proprietary fund
Net working capital = 0.25 Proprietary fund
2,40,000 = Proprietary fund
2,40,000
Proprietary fund = = 9,60,000
0.25

Fixed assets = 0.75 Proprietary fund

= 0.75 × 9,60,000 = 7,20,000
Share Capital = Proprietary fund – R & S
 RATIO ANALYSIS 6.32
= 9,60,000 - 1,60,000 = 8,00,000
Sundry creditors = CL - Bank overdraft
= 1,60,000 - 40,000 = 1,20,000

PYQ 2
Equity share capital `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
Complete the following balance sheet from the above information:
Balance Sheet
Liabilities ` Assets `
Current Debt - Inventory -
Long Term Debt - Cash -
Total Debt - Total Current Assets -
Equity Share Capital - Fixed Assets -
- -
[(7 Marks) May 2005]

Answer
Balance Sheet
Liabilities ` Assets `
Current Debt 24,000 Inventory 40,000
Long Term Debt 36,000 Cash 60,000
Total Debt 60,000 Total Current Assets 1,00,000
Equity Share Capital 1,00,000 Fixed Assets 60,000
1,60,000 1,60,000
Working Notes:
1. Total debt:
Owners equity × 0.60 = 0.60 × `1,00,000 = `60,000
2. Current Debt:
Current debt to total debt = 0.40
Current debt = 0.40 × `60,000 = `24,000
3. Fixed assets:
0.60 × Owners equity = 0.60 × `1,00,000 = `60,000
4. Total of liability side:
Total debt + Owners equity = `60,000 + `1,00,000 = `1,60,000
5. Total assets consisting of fixed assets and current assets must be equal to `1,60,000 hence, current assets
should be `1,00,000.
6. Total assets turnover is 2 times:
Sales
= 2 times
Total Assets
Sales = `1,60,000 × 2 = `3,20,000

Inventory turnover is 8 times:

Sales
= 8 times
Inventory
 RATIO ANALYSIS 6.33
Sales 3,20 ,000
Inventory = = = `40,000
8 8
7. Cash: = `1,00,000 – `40,000 = `60,000

PYQ 3
Gross profits `54,000
Shareholders’ funds `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 20 days (360 days a year)
Current ratio 1.8
Long term Debt to Equity 40%
Balance Sheet
Liabilities ` Assets `
Creditors - Cash -
Long Term Debt - Debtors -
Shareholder’s Fund - Inventory -
Fixed Assets -
- -
[(12 Marks) Nov 2005]

Answer
Balance Sheet
Liabilities ` Assets `
Creditors (b.f.) 60,000 Cash 42,000
Long Term Debt 2,40,000 Debtors 12,000
Shareholder’s Fund 6,00,000 Inventory 54,000
Fixed Assets (b.f.) 7,92,000
9,00,000 9,00,000

Working Notes:

1. Sales:
Gross profit margin = 20% of sales = `54,000
54 ,000
Sales = = `2,70,000
20 %

2. Credit Sales:
Credit sales = 80% of total sales
= `2,70,000 × 80% = `2,16,000

3. Total Assets:
Sales
Total assets turnover = = 0.3 times
Total assets
2,70 ,000
Total assets = = `9,00,000
0 .3

4. Inventory:
COGS
Inventory Turnover = = 4 times
Inventory
2,70 ,000  54 ,000
Inventory = = `54,000
4
 RATIO ANALYSIS 6.34
5. Debtors:
Credit sales
Debtors = × 20 Days
360 Days
2 ,16 ,000
= × 20 Days = `12,000
360 Days

6. Long term debt:

Long term debt
= 40%
Equity

Long term debt = 40% of equity

= `6,00,000 × 40% = `2,40,000
7. Current Ratio:
CA
Current ratio =
CL

CA
= 1.8
Creditors

CA = 60,000 × 1.8 = `1,08,000

Cash + Debtors + Inventory = `1,08,000

Cash = 1,08,000 – 12,000 + 54,000 = `42,000

PYQ 4
JKL Limited has the following Balance Sheets as on March 31, 2006 and March 31, 2005:
Balance Sheet (` in Lakh)
Particulars 31.03.2006 31.03.2005

Sources of Funds:
Shareholder’s Fund 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 (` in Lakh):
Particulars 31.03.2006 31.03.2005
Sales 22,165 13,882
Less: Cost of Goods Sold 20,860 12,544
Gross profit 1,305 1,338
Less: Selling, General and Administration Expenses 1,135 752
EBIT 170 586
Less: Interest Expenses 113 105
PBT 57 481
Less: Tax 23 192
PAT 34 289
 RATIO ANALYSIS 6.35
Required:
(1) Calculate for the years 2005 and 2006:
a. Inventory turnover ratio
b. Financial Leverage
c. Return on Investment (ROI)
d. Return on Equity (ROE)
e. Average Collection period.
(2) Give a brief comment on the financial position of JKL Limited.
[(10+2 Marks) May 2006]

Answer
(1) Computation of Ratios
Particulars 31.03.2006 31.03.2005
(a) Inventory turnover ratio
COGS 20 ,860 12 ,544
= 7.28 = 5.21
Clo sin g Stock 2 ,867 2 ,407
(b) Financial leverage
EBIT 170 568
= 2.98 = 1.22
EBT 57 481
(c) Return on investment
EBIT 170 586
× 100 × 100 = 2.86% × 100 = 12.86%
Capital Employed 5 ,947 4 ,555
(d) Return on equity
PAT 34 289
× 100 × 100 = 1.43% × 100 = 19.63%
Net worth 2 ,377 1 ,472
(e) Average collection period
Debtors 1 ,495 1 ,168
× 365 × 365 = 24.6 days × 365 = 30.7 days
Credit sales 22 ,165 13 ,882

(2) 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.

PYQ 5
From the information given below calculate the amount of fixed assets and proprietor's fund.

Ratio of fixed assets to proprietor’s fund 0.75

Net working capital `6,00,000

[(2 Marks) Nov 2009]

Answer
Calculation of Fixed Assets and Proprietor’s Fund:
 RATIO ANALYSIS 6.36
Fixed assets
= 0.75
Pr oprietor ' s fund
Fixed assets = 0.75 Proprietor’s fund
Net Working Capital = 0.25 Proprietor’s fund
6,00,000 = 0.25 Proprietor’s Fund
6 ,00 ,000
Proprietor’s fund = = `24,00,000
0.25

Fixed assets = 0.75 Proprietor’s fund

= 0.75 × 24, 00,000 = `18,00,000

Assumption: There is no long term debt in the business.

PYQ 6
The following figures and ratios are related to a company:
(a) Sales for the year (all credit) `30,00,000
(b) Gross profit ratio 25 percent
(c) Fixed assets turnover (basis on cost of goods sold) 1.5
(d) Stock turnover (basis on cost of goods sold) 6
(e) Liquid ratio 1:1
(f) Current ratio 1.5 : 1
(g) Debtors collection period 2 months
(h) Reserve and surplus to Share capital 0.6 : 1
(i) Capital gearing ratio 0.5
(j) Fixed assets to net worth 1.20 : 1

You are required to prepare:

1. Balance Sheet of the company on the basis of above details.
2. The statement showing working capital requirement, if the company wants to make a provision for
contingencies @ 10% of net working capital including such provision.
[(6+4 Marks) May 2010]

Answer
(1) Projected Balance Sheet Balance Sheet
Liabilities ` Assets `
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

Working Notes:
a. Cost of Goods Sold = 30,00,000 - 25% = 22,50,000
COGS
b. Fixed Assets Turnover Ratio = = 1.5 times
Fixed Assets
22,50 ,000
Fixed Assets = = `15,00,000
1 .5
Fixed Assets
c. Fixed Assets to Net Worth = = 1.2 times
Net Worth
15,00 ,000
Net Worth = = `12,50,000
1 .2
Debt + Pr eference Debt + Nil
d. Capital Gearing = =
Equity 12,50 ,000
 RATIO ANALYSIS 6.37
Debt = 0.5 × `12,50,000 = `6,25,000
Assumption: Preference Share capital is zero.
e. Reserves & Surplus = 12,50,000 × 0.6/1.6 = `4,68,750
f. Share Capital = 12,50,000 × 1/1.6 = `7,81,250
COGS
g. Stock Turnover = = 6 times
Stock
22,50 ,000
Stock = = `3,75,000
6

Collection Period 2
h. Debtors = Sales × = 30,00,000 ×
12 12
= `5,00,000
i. Stock = CL (Current ratio – Liquid ratio)
Stock 3,75,000
Current Liabilities = =
CR  LR 1 .5  1
= `7,50,000
CA
j. Current Ratio = = 1.5 times
CL
Current Assets = 1.5 × 7,50,000 = `11,25,000
k. Cash in Hand = 11,25,000 - 3,75,000 - 5,00,000
= `2,50,000

(2) Statement of Working Capital Requirement

Particulars `
Current Assets: Stock 3,75,000
Debtors 5,00,000
Cash 2,50,000
11,25,000
Less: Current Liabilities (7,50,000)
Working Capital Before Provision 3,75,000
Add: Provision for Contingencies @ 10% of WC (Including provision) 41,667
Working Capital Including Provision  3,75,000  100  4,16,667
 90 

PYQ 7
MNP Limited has made plans for the next year 2010-11. It is estimated that the company will employ total
assets of `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 `15,00,000 and all other operating expenses are estimated at `2,40,000. The sales
revenue are estimated at `22,50,000. Tax rate is assumed to be 40%.
You are required to calculate: (i) Net profit margin, (ii) Return on Assets, (iii) Assets turnover, (iv) Return
on equity
[(4 Marks) Nov 2010]

Answer
EAT 2 ,65 ,500
(i) Net Profit Margin = × 100 = × 100 = 11.80%
Sales 22 ,50 ,000

EBIT (1−t) 5,10,000 (1−.40)

(ii) Return on Assets = = = 12.24%
Assets 25,00,000
Sales 22 ,50 ,000
(iii) Assets turnover = = = 0.90
Total Assets 25 ,00 ,000
 RATIO ANALYSIS 6.38
EAT 2 ,65 ,500
(iv) Return on Equity = × 100= × 100 = 15.171%
Shareholde r' s Fund 17 ,50 ,000

Working Notes:
Particulars `
Sales Revenue 22,50,000
Less: Direct Cost 15,00,000
Gross Profit 7,50,000
Less: Other operating expenses 2,40,000
EBIT 5,10,000
Less: Interest on 9% Debt (2500000 × 30% × 9%) 67,500
EBT 4,42,500
Less: Taxes @ 40% 1,77,000
EAT 2,65,500

PYQ 8
The financial statements of a company contain the following information for the year ending 31st March,
2011:
Statement of profit for the year ended 31st March, 2011
Sales (20% cash sales) 40,00,000
Less: Cost of goods sold 28,00,000
Profit Before Interest & Tax 12,00,000
Less: Interest 1,60,000
Profit Before Tax 10,40,000
Less: Tax @ 30% 3,12,000
Profit After Tax 7,28,000

Particulars `
Cash 1,60,000
Sundry Debtors 4,00,000
Short-term Investment 3,20,000
Stock 21,60,000
Prepaid Expenses 10,000
Total Current Assets 30,50,000
Current Liabilities 10,00,000
10% Debentures 16,00,000
Equity Share Capital 20,00,000
Retained Earnings 8,00,000
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)
[(8 Marks) Nov 2011]

Answer
CA  Stock  Pr epaid Expenses
(i) Quick Ratio =
Current Liabilitie s
30 ,50 ,000  21 ,60 ,000  10 ,000
= = .88 times
10 ,00 ,000

Debt
(ii) Debt-Equity Ratio =
Equity
16 ,00 ,000
= = 0.57 : 1
20 ,00 ,000  8 ,00 ,000
 RATIO ANALYSIS 6.39
EBIT
(iii) ROCE = × 100
Capital Employed
12 ,00 ,000
= × 100 = 27.27%
20 ,00 ,000  8 ,00 ,000  16 ,00 ,000

Average Debtors
(iv) Average Collection Period = × 360
Credit Sales
4 ,00 ,000
= × 360 = 45 Days
80 %  40 ,00 ,000

PYQ 9
The following accounting information and financial rations of M Limited relate to the year ended 31 st
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 `30,00,000; cash sales is 25% of credit sales; cash purchase `2,30,000; working capital `2,80,000;
closing inventory is `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
[(8 Marks) Nov 2012]

Answer
(i) Average Inventory:
COGS
Inventory Turnover Ratio = = 6 times
Average Inventory
COGS 30 ,00 ,000  25%
Average Inventory = =
6 6
= `3,75,000
(ii) Purchases:
Purchase = COGS + Closing Stock – Opening stock
= (30,00,000 – 25%) + 80,000 = `23,30,000
(iii) Average Debtors:
Credit Sales
Debtors Turnover Ratio = = 8 times
Average Debtors

Credit Sales 24 ,00 ,000

Average Debtors = =
8 Times 8 Times
= `3,00,000
Credit Sales:
Total Sales = Credit Sales + Cash Sales
30,00,000 = Credit Sales + 25% of Credit Sales
125% of Credit Sales = `30,00,000
30 ,00 ,000
Credit Sale = = `24,00,000
125 %
 RATIO ANALYSIS 6.40
(iv) Average Creditors:
Credit Purchase
Creditors Turnover Ratio = = 10 Times
Average Creditors

Credit Purchase
Average Creditors =
10 Times
23,30 ,000  2,30 ,000
= = `2,10,000
10
365 Days 365 Days
(v) Average Payment period = =
Creditors Turnover Ratio 10
= 36.5 Days
365 Days 365 Days
(vi) Average Collection Period = =
Debtors Turnover Ratio 8
= 45.625 Days
(vii) Current Assets
Working Capital = Current Assets – Current Liabilities
= 2,80,000 (i)
Current Assets
= 2.4
Current Liabilitie s
Current Assets = 2.4 Current Liabilities (ii)
CA – CL = 2,80,000
2.4 CL – CL = 2,80,000
2,80 ,000
Current Liabilities = = `2,00,000
1.40
Current Assets = 2.4 × `2,00,000 = `4,80,000
(viii) Current Liabilities = `2,00,000

PYQ 10
The following information relates to Beta Ltd for the year ended 31st March 2013.
Net Working Capital `12,00,000
Fixed Assets to Proprietor’s Fund Ratio 0.75
Working Capital Turnover Ratio 5 times
Return on Equity (ROE) 15%
There is no debt capital.
You are required to calculate:
(i) Proprietor’s Fund
(ii) Fixed Assets
(iii) Net Profit Ratio.
[(5 Marks) May 2013]

Answer
(i) Proprietor’s Fund = Net Working Capital + Fixed Assets
= 12,00,000 + 0.75 Proprietor’s Fund
0.25 Proprietor’s Fund = 12,00,000
12,00 ,000
Proprietor’s Fund = = 48,00,000
0.25

(ii) Fixed Assets:

Fixed Assets = 0.75 Proprietor’s Fund
= 0.75 of 48,00,000 = 36,00,000
 RATIO ANALYSIS 6.41
PAT 7 ,20 ,000
(iii) Net profit Ratio = × 100 = × 100
Sales 60 ,00 ,000
= 12%
Working Notes:
PAT = 15% of Equity Fund/Proprietor’s Fund
= 15% of 48,00,000 = 7,20,000
Sales = 5 times of working capital
= 5 × 12,00,000 = 60,00,000

PYQ 11
The assets of SONA Ltd. consist of fixed assets and current assets, while its current liabilities comprise bank
credit in the ratio of 2 : 1.
You are required to prepare the Balance Sheet of the company as on 31st March 2013 with the help of
following information:
Share Capital : `5,75,000
Working Capital (CA - CL) : `1,50,000
Gross Margin : 25%
Inventory Turnover : 5 times
Average Collection Period : 1.5 months
Current Ratio : 1.5 : 1
Quick Ratio : 0.8 : 1
Reserves & Surplus to Bank & Cash : 4 times
[(8 Marks) Nov 2013]

Answer
SONA Ltd
Balance Sheet
(As at 31.03.2013)
Liabilities ` Assets `
Share Capital 5,75,000 Fixed Assets (b.f.) 6,85,000
Reserves & Surplus 2,60,000 Current Assets:
Current Liabilities: Bank & Cash 65,000
Bank Credit 1,50,000 Inventory 2,10,000
Other 1,50,000 Debtors 1,75,000
11,35,000 11,35,000
Working Notes:
1. Calculation of Current Assets and Current Liabilities:
CA
Current Ratio = = 1.5
CL
CA = 1.5 CL
CA – CL = 1,50,000
1.5 CL – CL = .5 CL = 1,50,000
CL = 3,00,000
CA = 1.5 CL = 1.5 × 3,00,000
= 4,50,000
2. Calculation of Bank Credit and other CL:
CL
= 2:1
Bank Credit

Bank credit = CL ÷ 2 = 3,00,000 ÷ 2

= 1,50,000
Other CL = 1,50,000
 RATIO ANALYSIS 6.42
3. Calculation of Inventory:
CA  Inventory
Quick Ratio = = 0.8
CL
CA – Inventory = 0.8 CL
4,50,000 – Inventory = 0.8 × 3,00,000
Inventory = 2,10,000
4. Calculation of Debtors and Bank and Cash:
COGS
Inventory Turnover = = 4
Inventory

COGS = 5 × 2,10,000 = 10,50,000

COGS 10 ,50 ,000
Sales = × 100 = × 100
100  m arg in 100  25
= 14,00,000

Debtors = Sales × Average Collection Period

12
= 14,00,000 × 1.5/12 = 1,75,000
Bank and Cash = CA – Inventory – Debtors
= 4,50,000 – 2,10,000 – 1,75,000= 65,000
5. Calculation of Reserves & Surplus:
Re serves & Surplus
= 4 times
Bank & Cash

Reserves & Surplus = 4 × 65,000 = 2,60,000

PYQ 12
NOOR Limited provides the following information for the year ending 31st March, 2014:
Equity Share Capital `25,00,000
Closing Stock `6,00,000
Stock Turnover Ratio 5 Times
Gross Profit Ratio 25%
Net Profit/Sale 20%
Net profit/Capital 1/4

You are required to prepare Trading and Profit and Loss Account for the year ending 31st March, 2014.
[(5 Marks) May 2014]

Answer
Trading and Profit & Loss Account
(For the year ending 31st March, 2014)
Particulars ` Particulars `
To Opening Stock [WN (iv)] 3,37,500 By Sales [WN (ii)] 31,25,000
To Purchase and Conversion Cost 26,06,250 By Closing Stock 6,00,000
To Gross Profit [WN (iii)] 7,81,250
37,25,000 37,25,000
To Operating Expenses 1,56,250 By Gross Profit b/d 7,81,250
To Net Profit [WN (i)] 6,25,000
7,81,250 7,81,250
Working Notes:
(i) Calculation of Net Profit:
Net Pr ofit 1 Capital
= or Net Profit =
Capital 4 4
 RATIO ANALYSIS 6.43
25,00 ,000
Net Profit = = `6,25,000
4
(ii) Calculation of Sales:
Net Pr ofit Net Pr ofit
= 20% or Sales =
Sales 20 %
6 ,25 ,000
Sales = = `31,25,000
20 %

(iii) Calculation of Gross Profit:

Gross Profit = 25% of Sales
= 25% of `31,25,000 = `7,81,250
(iv) Calculation of Opening Stock:
COGS
Stock Turnover Ratio = = 5 Times
Average Stock
COGS (Sales  25%)
Average Stock =
5
31 ,25,000  25%
= = `4,68,750
5
Opening Stock  Clo sin g Stock
Average Stock =
2
Average Stock × 2 = Opening Stock + Closing Stock
4,68,750 × 2 = Opening Stock + 6,00,000
Opening Stock = 9,37,500 – 6,00,000 = `3,37,500
Note: All figures in Trading and Profit and Loss A/c are balancing figures except calculated in working
notes.

PYQ 13
SRS Ltd has furnished the following ratios and information relating to the year ended 31st March,2015.
Sales `60,00,000
Return on Net Worth 25%
Rate of Income Tax 50%
Share Capital to Reserve 7: 3
Current Ratio 2
Net Profit to Sales (after tax) 6.25%
Inventory Turnover 12
(Based on cost of goods sold and closing stock)
Cost of Goods Sold `18,00,000
Interest on Debenture @ 15% `60,000
Sundry Debtors `2,00,000
Sundry Creditors `2,00,000
You are required to:
(a) Calculate the operating expenses for the year ended 31st March,2015.
(b) Prepare Balance Sheet as on 31st March,2015.
[(8 Marks) May 2015]

Answer
(i) Operating Expenses = Gross Profit - EBIT
= `42,00,000 – `8,10,000 = `33,90,000

Working:
 RATIO ANALYSIS 6.44
Calculation of EBIT
Particulars `
Net Profit After Tax (EAT) 6.25% of `60,00,000 3,75,000
Add: Tax @ 50% (3,75,000 × 0.50/1-0.50) 3,75,000
Net Profit Before Tax (EBT) 7,50,000
Add: Interest 60,000
Earning Before Interest and Tax (EBIT) 8,10,000

(ii) Balance Sheet

(As on 31.03.2015)
Liabilities ` Assets `
Share Capital 10,50,000 Fixed Assets (b.f.) 17,00,000
Reserves 4,50,000 Current Assets:
Debentures 4,00,000 Bank & Cash 50,000
Sundry Creditors 2,00,000 Inventory 1,50,000
Debtors 2,00,000
21,00,000 21,00,000

Working Notes:
PAT
(a) Return on Net Worth = × 100 = 25%
Net Worth
3 ,75 ,000
Net Worth = = 15,00,000
25 %
Net Worth = Share Capital + Reserve = 15,00,000

Share Capital to Reserve = 7:3

Share Capital = 15,00,000 × 7/10 = 10,50,000

Reserve = 15,00,000 × 3/10 = 4,50,000

Interest 60 ,000
(b) Debentures = =
Rate of Interest 15 %
= 4,00,000

COGS
(c) Inventory Turnover =
Clo sin g Stock
COGS 18 ,00 ,000
Closing Stock = =
Inventory Turnover 12
= 1,50,000

CA
(d) Current Ratio = = 2 times
CL
Debtors  Clo sin g Stock  Cash
2 times =
Creditors
2 ,00 ,000  1 ,50 ,000  Cash
2 =
2 ,00 ,000

Cash and Bank = 4,00,000 – 3,50,000 = 50,000

PYQ 14
VRA Limited has provided the following information for the year ending 31st March, 2015:

Debt Equity Ratio 2:1

 RATIO ANALYSIS 6.45
14% long term debt `50,00,000
Gross Profit Ratio 30%
Return on equity 50%
Income Tax Rate 35%
Capital Turnover Ratio 1.2 Times
Opening Stock `4,50,000
Closing Stock 8% of sales

You are required to prepare Trading and Profit and Loss Account for the year ending 31st March,
2015.

[(8 Marks) Nov 2015]

Answer
Trading and Profit & Loss Account
(For the year ending 31st March, 2015)
Particulars ` Particulars `
To Opening Stock 4,50,000 By Sales 90,00,000
To Purchase & Conversion Cost (b.f.) 65,70,000 By Closing Stock (8% of 90 Lacs) 7,20,000
To Gross Profit c/d (30% of 90 Lacs) 27,00,000
97,20,000 97,20,000
To Operating Expenses (b.f.) 76,923 By Gross Profit b/d 27,00,000
To Interest on debt (14% of 50 Lacs) 7,00,000
To Income tax 6,73,077
To Net Profit 12,50,000
27,00,000 27,00,000

Working Notes:
(i) Calculation of Equity:
Debt
= 2:1
Equity
Equity = Debt ÷ 2
50,00,000 ÷ 2 = `25,00,000

(ii) Calculation of Net Profit After Tax(PAT):

PAT
Return on Equity = × 100 = 50%
Equity
Profit After Tax = 50% of 25,00,000 = `12,50,000

(iii) Calculation of Income Tax:

PAT
Income Tax = 35% of PBT = 35% of
1t
12,50 ,000
= 35% of = `6,73,077
1  .35

(iv) Calculation of Sales:

Sales Sales
Capital Turnover Ratio = =
Capital Equity  Debt
Sales
= 1.2 times
25 ,00 ,000  50 ,00 ,000
Sales = 75,00,000 × 1.2 = `90,00,000

PYQ 15
With the following ratios and further information given below prepare a Trading Account, Profit and
 RATIO ANALYSIS 6.46
Loss Account and Balance Sheet of ABC Company.

Fixed Assets `40,00,000

Closing Stock `4,00,000
Stock turnover ratio 10 times
Gross Profit Ratio 25%
Net Profit Ratio 20%
Net profit to capital 1/5
Capital to total liabilities 1/2
Fixed assets to capital 5/4
Fixed assets / Total current assets 5/7
[(8 Marks) May 2016]

Answer
Trading and Profit & Loss Account
Particulars ` Particulars `
To Opening Stock 80,000 By Sales 32,00,000
To Purchase & Conversion Cost (b.f.) 27,20,000 By Closing Stock 4,00,000
To Gross Profit c/d (25% of 32 Lacs) 8,00,000
36,00,000 36,00,000
To Operating Expenses (b.f.) 1,60,000 By Gross Profit b/d 8,00,000
To Net Profit 6,40,000
8,00,000 8,00,000

Balance Sheet
Liabilities ` Assets `
Capital 32,00,000 Fixed Assets 40,00,000
Other Liabilities 64,00,000 Current Assets:
Stock 4,00,000
Other CA (b.f.) 52,00,000 56,00,000
96,00,000 96,00,000

Working Notes:
(i) Calculation of Capital:
Fixed Assets
= 5/4 or Capital = 40,00,000 × 4/5
Capital
= `32,00,000
(ii) Calculation of Other Liabilities:
Capital
= 1/2 or Other Liabilities = 32,00,000 × 2
Other Liabilitie s
= `64,00,000
(iii) Calculation of Current Assets:
Fixed Assets
= 5/7 or Current Assets = 40,00,000 × 7/5
Current Assets
= `56,00,000
(iv) Calculation of Net Profit:
Net Pr ofit
= 1/5 or Net Profit = 32,00,000 × 1/5
Capital
= `6,40,000
(v) Calculation of Sales:
Net Pr ofit
= 20% or Sales = 6,40,000 ÷ 20%
Sales
 RATIO ANALYSIS 6.47
= `32,00,000
(vi) Calculation of Opening Stock:
COGS = 75% of Sales = 75% of 32,00,000 = 24,00,000
COGS
= 10 or Average Stock = 24,00,000 ÷ 10
Average Stock
= 2,40,000
Average stock = (Opening Stock + Closing Stock) ÷ 2 = 2,40,000
Opening Stock = (2,40,000 × 2) – 4,00,000 = `80,000

PYQ 16
The following figures and ratios pertains to ABG Company Limited for the year ending 31st March, 2016:
Annual sales (credit) `50,00,000
Gross Profit ratio 28%
Fixed assets turnover ratio (based on COGS) 1.5
Stock turnover ratio (based on COGS) 6
Quick ratio 1:1
Current ratio 1.5
Debtors collection period 45 days
Reserve and surplus to Share capital 0.60 : 1
Capital gearing ratio 0.5
Fixed assets to net worth 1.2 : 1
You are required to prepare the Balance Sheet as at 31st March, 2016 based on the above information.
Assume 360 days in a year.
[(8 Marks) Nov 2016]

Answer
Balance Sheet
Liabilities ` Assets `
Equity Share Capital 12,50,000 Fixed Assets 24,00,000
Reserve and Surplus 7,50,000 Current Assets:
Long Term Debts 10,00,000 Stock 6,00,000
Current Liabilities 12,00,000 Debtors 6,25,000
Cash & Cash Eq. (b.f.) 5,75,000 18,00,000
42,00,000 42,00,000
Working Notes:
(i) Cost of Goods Sold = Sales – Gross Profit (28% of Sales)
= `50,00,000 – `14,00,000 = `36,00,000
(ii) Closing Stock = Cost of Goods Sold/Stock Turnover
= `36,00,000/6 = `6,00,000
(iii) Fixed Assets = Cost of Goods Sold/Fixed Assets Turnover
= `36,00,000/1.5 = `24,00,000
(iv) Current Assets and Current Liabilities
Stock = (CR - LR) × CL
6,00,000 = (1.5 – 1) CL OR CL = `12,00,000
Current Assets = 12,00,000 × 1.5 = `18,00,000
(v) Debtors = Sales × Debtors Collection Period(days) /360 days
= `50,00,000 × 45/360 = `6,25,000
(vi) Net worth = Fixed Assets / 1.2
= `24,00,000/1.2 = `20,00,000
 RATIO ANALYSIS 6.48
(vii) Reserves and Surplus and Share Capital
Reserves & Surplus and Share Capital = 0.6 + 1 = 1.6
Reserves and Surplus = `20,00,000 × 0.6/1.6 = `7,50,000
Share Capital = Net worth – Reserves and Surplus
= `20,00,000 – `7,50,000 = `12,50,000
(viii) Long- term Debts
Capital Gearing Ratio = Long-term Debts / Equity Shareholders’ Fund (Net worth)
Long-term Debts = `20,00,000 × 0.5 = `10,00,000

PYQ 17
The following information relate to a concern:
Debtors velocity 3 months
Creditors velocity 2 months
Stock turnover ratio 1.5
Gross profit ratio 25%
Bills receivables `25,000
Bills payables `10,000
Gross profit `4,00,000
Fixed assets turnover ratio 4
Closing stock of the period is `10,000 above the opening stock.
Find out:
1. Sales and cost of goods sold
2. Sundry Debtors
3. Sundry Creditors
4. Closing Stock
5. Fixed Assets
[(8 Marks) May 2017]

Answer
1. Sales = Gross Profit ÷ Gross Profit Ratio
= `4,00,000 ÷ 25% = `16,00,000
Cost of goods sold = Sales - Gross Profit
= `16,00,000 - `4,00,000 = `12,00,000

2. Sundry debtors = Credit sales × 3/12 – Bills receivables

= `16,00,000 × 3/12 – `25,000 = `3,75,000

3. Sundry creditors = Credit Purchase × 2/12 – Bills payables

= `12,10,000 × 2/12 – `10,000 = `1,91,667

Credit purchase = COGS + Closing Stock – Opening Stock

= `12,00,000 + `10,000 = `12,10,000

4. Closing Stock:
Average Stock = COGS ÷ 1.5 = `12,00,000 ÷ 1.5 = `8,00,000
Opening Stock  Clo sin g Stock
Average Stock =
2
8,00,000 × 2 = Opening Stock + Closing Stock
16,00,000 = (Closing – 10,000) + Closing Stock
Closing Stock = `8,05,000
[Opening Stock = Closing – 10,000]

5. Fixed Asset Turnover = COGS ÷ Fixed asset

 RATIO ANALYSIS 6.49
Fixed Asset = 12,00,000 ÷ 4 = `3,00,000

Note: Alternatively Fixed Asset Turnover ratio can be calculated on the basis of sales.

PYQ 18
XY Ltd. provides the following information for the year ending 31st March, 2017:
Equity share capital `8,00,000
Closing Stock `1,50,000
Stock turnover ratio 5 times
Gross Profit Ratio 20%
Net Profit/Sales 16%
Net profit/Capital 25%
You are required to prepare Trading and Profit & Loss account for the year ending 31st March, 2017.
[(8 Marks) Nov 2017]

Answer
Trading and Profit & Loss Account
Particulars ` Particulars `
To Opening Stock 2,50,000 By Sales 12,50,000
To Purchase & Conversion Cost (b.f.) 9,00,000 By Closing Stock 1,50,000
To Gross Profit (20% of 12,50,000) 2,50,000
14,00,000 14,00,000
To Operating Expenses (b.f.) 50,000 By Gross Profit b/d 2,50,000
To Net Profit 2,00,000
2,50,000 2,50,000

Working Notes:
(i) Calculation of Net Profit:
Net Pr ofit
= 25% or Net Profit = 8,00,000 × 25%
Capital
= `2,00,000
(ii) Calculation of Sales:
Net Pr ofit
= 16% or Sales = 2,00,000 ÷ 16%
Sales
= `12,50,000
(iii) Calculation of Opening Stock:
COGS = 80% of Sales = 80% of 12,50,000 = 10,00,000
COGS
= 5 or Average Stock = 10,00,000 ÷ 5
Average Stock
= 2,00,000
Average stock = (Opening Stock + Closing Stock) ÷ 2 = 2,00,000
Opening Stock = (2,00,000 × 2) – 1,50,000 = `2,50,000

PYQ 19
Equity share capital G Ltd. has furnished the following information relating to the year ended 31st March,
2017 and 31st March, 2018:

Particulars 31st March, 2017 31st March, 2018

Share Capital 40,00,000 40,00,000
Reserve and Surplus 20,00,000 25,00,000
Long term loan 30,00,000 30,00,000
 RATIO ANALYSIS 6.50
 Net profit ratio: 8%
 Gross profit ratio: 20%
 Long-term loan has been used to finance 40% of the fixed assets.
 Stock turnover with respect to cost of goods sold is 4.
 Debtors represent 90 days sales.
 The company holds cash equivalent to 1½ months cost of goods sold.
 Ignore taxation and assume 360 days in a year.

You are required to prepare Balance Sheet as on 31st March, 2018 in following format:
Liabilities ` Assets `
Share Capital - Fixed Assets -
Reserve and Surplus - Sundry Debtors -
Long-Term Loan - Closing Stock -
Sundry Creditors - Cash in hand -
[(8 Marks) May 2018]

Answer
Balance Sheet
Liabilities ` Assets `
Share Capital 40,00,000 Fixed Assets 75,00,000
Reserve and Surplus 25,00,000 Sundry Debtors 15,62,500
Long-Term Loan 30,00,000 Closing Stock 12,50,000
Sundry Creditors (b.f.) 14,37,500 Cash in hand 6,25,000
1,09,37,500 1,09,37,500
Working Notes:
(1) Net Profit = Change in Reserve and Surplus
= 25,00,000 – 20,00,000 = `5,00,000

(2) Sales:
Net Profit ratio = 8% of sales
∴ Sales = Net Profit ÷ Net profit ratio
= 5,00,000 ÷ 8% = `62,50,000

(3) Cost of Goods Sold = Sales – Gross Profit (20% of Sales)

= `62,50,000 – 20% of `62,50,000 = `50,00,000

(4) Fixed Assets = Long term loan ÷ 40%

= `30,00,000 ÷ 40% = `75,00,000

(5) Closing Stock = Cost of Goods Sold ÷ Stock Turnover

= `50,00,000 ÷ 4 = `12,50,000

(6) Debtors = Sales × Debtors Collection Period(days)/360 days

= `62,50,000 × 90/360 = `15,62,500

(7) Cash Equivalent = COGS × 1.5/12

= `50,00,000 × 1.5/12 = `6,25,000

PYQ 20
The accountant of Moon Ltd. has reported the following data:

Gross profit : `60,000

Gross profit margin : 20%
Total Assets Turnover : 0.30 : 1
Net Worth to Total Assets : 0.90 : 1
Current Ratio : 1.5 : 1
 RATIO ANALYSIS 6.51
Liquid Assets to current liability : 1:1
Credit Sales to Total Sales : 0.80 : 1
Average Collection Period : 60 days
Days in a Year : 360 days

You are required to complete the following:

Balance Sheet of Moon Ltd.
Liabilities ` Assets `
Net Worth - Fixed Assets -
Current Liabilities - Debtors -
Stock -
Cash -
Total Liabilities - Total Assets -
[(5 Marks) May 2018]

Answer
Balance Sheet of Moon Ltd.
Liabilities ` Assets `
Net Worth 9,00,000 Fixed Assets 8,50,000
Current Liabilities (b.f.) 1,00,000 Debtors 50,000
Stock 40,000
Cash 60,000
Total Liabilities 10,00,000 Total Assets 10,00,000
Working Notes:
(1) Sales = Gross Profit ÷ Gross Profit ratio
= 60,000 ÷ 20% = `3,00,000

(2) Total Assets = Sales / Total Assets Turnover

= 3,00,000 ÷ .030 = `10,00,000

(3) Net worth = Total Assets × 0.90

= `10,00,000 × 0.90 = `9,00,000

(4) Current Assets = Current Liabilities × 1.50

= `1,00,000 × 1.50 = `1,50,000

(5) Fixed Assets = Total Assets - Current Assets

= `10,00,000 - `1,50,000 = `8,50,000

(6) Liquid Assets = Current Liabilities × 1

= `1,00,000 × 1 = `1,00,000

(7) Closing Stock = Current Assets – Liquid Assets

= `1,50,000 - `1,00,000 = `50,000

(8) Debtors = Credit Sales × Debtors Collection Period(days)/360 days

= `3,00,000 × .080 × 60/360 = `40,000

(9) Cash = Current Assets – Stock - Debtors

= `1,50,000 - 50,000 - `40,000 = `60,000

PYQ 21
A limited Company’s books reveals following information:
Net Income : `3,60,000
Shareholder’s Equity : `4,00,000
 RATIO ANALYSIS 6.52
Assets Turnover : 2.5 times
Net Profit Margin : 12%

You are required to calculate ROE of the company based on the ‘DuPont model’.
[(5 Marks) Nov 2018]

Answer
Return on Equity = Net Profit Margin × Asset Turnover × Equity Multiplier
= 12% × 2.5 times × 3 times = 90%
Working Notes:
1. Sales:
Net profit Margin = Net Income ÷ Sales = 12%
Sales = `3,60,000 ÷ 12% = `30,00,000
2. Total Assest:
Asset Turnover = Sales ÷ Total Assets = 2.5 times
Total Assets = Sales ÷ 2.5 = 30,00,000 ÷ 2.5 = `12,00,000
3. Equity Multiplier = Total Assets ÷ Equity
= `12,00,000 ÷ `4,00,000 = 3 times

PYQ 22
The following is the information of XML Ltd. relate to the year ended 31-03-2018:
Gross profit 20% of sales
Net profit 10% of sales
Inventory holding period 3 months
Receivable holding period 3 months
Non-current assets to sales 1:4
Non-current assets to current assets 1:2
Current ratio 2:1
Non-current liabilities to current liabilities 1:1
Share capital to reserve and surplus 4:1
Non-current assets as on 31.03.2017 `50,00,000

Assume that:
(a) No change in Non-current assets during the year 2017-18.
(b) No depreciation charged on Non-current assets during the year 2017-18
(c) Ignoring tax

You are required to calculate cost of goods sold, Net profit, Inventory, receivables and cash for the year
ended on 31.03.2018.
[(5 Marks) Nov 2018]

Answer
(a) Net Profit = 10% of sales = 10% of `2,00,00,000 = `20,00,000

(b) Cost of Goods Sold = Sales – Gross Profit

= `2,00,00,000 – 20% = `1,60,00,000

(c) Inventory = COGS × 3/12 = `1,60,00,000 × 3/12 = `40,00,000

(d) Receivables = Sales × 3/12 = `2,00,00,000 × 3/12 = `50,00,000

(e) Cash = Current assets – Stock – receivables

= `1,00,00,000 - `40,00,000 - `50,00,000 = `10,00,000
Working:
 RATIO ANALYSIS 6.53
Non current assets 50 ,00 ,000
1. = ½ or = ½
Current assets Current assets
So, Current assets = `50,00,000 × 2 = `1,00,00,000

Non current assets 50 ,00 ,000

2. = ¼ or = 1/4
Sales Sales
So, Sales = `50,00,000 × 4 = `2,00,00,000

PYQ 23
Following figures and ratios are related to a company Q Ltd.:
Sales for the year (all credit) : `30,00,000
Gross Profit Ratio : 25%
Fixed Assets Turnover (based on COGS) : 1.5
Stock turnover (based on COGS) : 6
Liquid Ratio : 1:1
Current Ratio : 1.5 : 1
Receivables (Debtors) Collection Period : 2 months
Reserve and Surplus to Share Capital : 0.6 : 1
Capital Gearing Ratio : 0.5
Fixed Assets to Net Worth : 1.20 : 1
You are required to calculate Closing Stock, Fixed Assets, Current Assets, Debtors and Net Worth.
[(5 Marks) May 2019]

Answer
(1) Closing Stock:
Stock Turnover = COGS ÷ Closing Stock
6 = (`30,00,000 – 25%) ÷ Closing Stock
Closing Stock = `3,75,000

(2) Fixed Assets:

Fixed Assets Turnover = COGS ÷ Fixed Assets
1.5 = (`30,00,000 – 25%) ÷ Fixed Assets
Fixed Assets = `15,00,000

(3) Current Assets:

Liquid Ratio = [CA – Stock (Non Liquid Assets)] ÷ Current liabilities
1 = (CA - `3,75,000) ÷ Current liabilities
Current Liabilities = Current Assets - `3,75,000 …..Equation (i)

Current Ratio = Current Assets ÷ Current liabilities

1.5 Current Liabilities = Current Assets
1.5 (Current Assets - `3,75,000) = Current Assets
Current Assets = `11,25,000

(4) Debtors:
Debtors = Credit Sales × Average collection Period/12
= `30,00,000 × 2/12 = `5,00,000

(5) Net Worth:

Fixed Assets to Net Worth = Fixed Assets ÷ Net Worth
1.20 = `15,00,000 ÷ Net Worth
Net Worth = `12,50,000

PYQ 24
Following information has been gathered from the books of Tram Ltd. The equity share of which is trading in
the stock market at `14.
 RATIO ANALYSIS 6.54
Particulars Amount (`)
Equity Share Capital (Face Value `10 each) 10,00,000
10% Preference Shares 2,00,000
Reserves 8,00,000
10% Debentures 6,00,000
Profit Before Interest and Tax for the year 4,00,000
Interest 60,000
Profit After Tax for the year 2,40,000

Calculate the following:

(a) Return on Capital Employed
(b) Earnings Per Share
(c) PE Ratio
[(5 Marks) Nov 2019]

Answer
EBIT 4,00,000
(a) Return on Capital Employed = × 100 = × 100
Capital Employed 26,00,000
= 15.38%

PAT−PD 2,40,000−20,000
(b) Earnings Per Share (EPS) = =
Number of Shares 1,00,000
= `2.20

MPS 14
(c) Price Earning Ratio (PE) = =
EPS 2.20
= 6.36 times

Working Note:
Capital Employed = Equity Share Capital + Reserves + Preference Share Capital +
Debentures
= `10,00,000 + `8,00,000 + `2,00,000 + `6,00,000
= `26,00,000

PYQ 25
Following information relates to RM Co. Ltd.
Total Assets employed `10,00,000
Direct Cost `5,50,000
Other Operating Cost `90,000
The goods will be sold to customers at 150 per cent of the direct costs. 50 per cent of the assets being
financed by borrowed capital at an interest cost of 8 per cent per year. Tax rate is assumed to be 30 per cent.

You are required to calculate: (a) Net profit margin; (b) Return on Assets; (c) Asset turnover and
(d) Return on owners’ equity.
[(5 Marks) Nov 2020]

Answer
EAT 1 ,01 ,500
(a) Net Profit Margin = × 100 = × 100 = 12.30%
Sales 8 ,25 ,000

EBIT (1−t) 1,85,000 (1−.30)

(b) Return on Assets = = × 100 = 12.95%
Assets 10,00,000

Sales 8 ,25 ,000

(c) Assets turnover = = = 0.825 times
Total Assets 10 ,00 ,000
 RATIO ANALYSIS 6.55
EAT 1 ,01 ,500
(d) Return on Equity = × 100 = × 100 = 20.30%
Equity Fund 5,00 ,000

The Net Profit is calculated as follows:

Particulars `
Sales Revenue (150% of `5,50,000) 8,25,000
Less: Direct Cost 5,50,000
Gross Profit 2,75,000
Less: Other operating expenses 90,000
EBIT 1,85,000
Less: Interest on 8% Debt (10,00,000 × 50% × 8%) 40,000
EBT 1,45,000
Less: Taxes @ 30% 43,500
EAT 1,01,500

PYQ 26
From the following information, complete the Balance Sheet given below:
(a) Equity share capital `2,00,000
(b) Total debt to owner's equity 0.75
(c) Total assets turnover 2 Times
(d) Inventory turnover 8 Times
(e) Fixed assets to owner's equity .60
(f) Current debt to total debt .40

Balance Sheet
Liabilities ` Assets `
Equity Share Capital 2,00,000 Fixed Assets ?
Long Term Debt ? Current Assets:
Current Debt ? Inventory ?
Cash ?
[(5 Marks) Jan 2021]

Answer
Balance Sheet
Liabilities ` Assets `
Equity Share Capital 2,00,000 Fixed Assets 1,20,000
Long Term Debt 90,000 Current Assets:
Current Debt 60,000 Inventory 87,500
Cash 1,42,500
3,50,000 3,50,000

Working Notes:
1. Total debt:
0.75 × Owners equity = 0.75 × `2,00,000 = `1,50,000

2. Current debt:
Current debt to total debt = 0.40
Current debt = 0.40 × `1,50,000 = `60,000

3. Long term debt:

Long term debt = Total debt – Current debt
= `1,50,000 - `60,000 = `90,000

4. Fixed assets:
0.60 × Owners equity = 0.60 × `2,00,000 = `1,20,000
 RATIO ANALYSIS 6.56
5. Total of liability side:
Total debt + Owners equity = `1,50,000 + `2,00,000 = `3,50,000

6. Total assets consisting of fixed assets and current assets must be equal to `3,50,000 hence, current
assets should be `2,30,000.

7. Total assets turnover is 2 times:

Sales
= 2 times
Total Assets
Sales = `3,50,000 × 2 = `7,00,000

Inventory turnover is 8 times:

Sales
= 8 times
Inventory
Sales 7 ,00 ,000
Inventory = = = `87,500
8 8

8. Cash: = `2,30,000 – `87,500 = `1,42,500

PYQ 27
Masco Limited has furnished the following ratios and information relating to the year ended 31st March,
2021.
Sales `75,00,000
Return on Net Worth 25%
Rate of Income Tax 50%
Share Capital to Reserve 6:4
Current Ratio 2.5
Net Profit to Sales (after tax) 6.50%
Inventory Turnover (Based on cost of goods sold) 12
Cost of Goods Sold `22,50,000
Interest on Debenture `75,000
Receivables (includes Debtors `1,25,000) `2,00,000
Payables `2,50,000
Bank Overdraft `1,50,000

You are required to:

(a) Calculate the operating expenses for the year ended 31st March, 2021.
(b) Prepare Balance Sheet as on 31st March in the following format:
Liabilities ` Assets `
Share Capital Fixed Assets
Reserves and Surplus Current Assets:
15% Debentures Stock
Payables Receivables
Bank Overdraft Cash
[(10 Marks) July 2021]

Answer
Working notes:
1. Calculation of EBIT
Particulars `
Net Profit After Tax (EAT) 6.50% of `75,00,000 4,87,500
Add: Tax (4,87,500 × 0.50/1-0.50) 4,87,500
Net Profit Before Tax (EBT) 9,75,000
Add: Interest 75,000
Earnings Before Interest and Tax (EBIT) 10,50,000
 RATIO ANALYSIS 6.57
PAT
2. Return on Net Worth = × 100 = 25%
Net Worth
Net Worth = 4,87,500 ÷ 25% = 19,50,000

Net Worth = Share Capital + Reserve = 19,50,000

Share Capital to Reserve = 6:4

Share Capital = 19,50,000 × 6/10 = 11,70,000

Reserve = 19,50,000 × 4/10 = 7,80,000

Interest
3. Debentures =
Rate of Interest
= 75,000 ÷ 15% = 5,00,000

COGS
4. Inventory Turnover =
Clo sin g Stock
COGS 22 ,50 ,000
Closing Stock = =
Inventory Turnover 12
= 1,87,500

CA
5. Current Ratio =
CL
Re ceivables  Clo sin g Stock  Cash
2.5 times =
Payables  Bank Overdraft
2 ,00 ,000  1 ,87 ,500  Cash
2.5 =
2 ,50 ,000  1 ,50 ,000
Cash = 4,00,000 × 2.5 – 2,00,000 – 1,87,500 = 6,12,500

(a) Operating Expenses = Gross Profit (Sales - COGS) - EBIT

= `52,50,000 (75,00,000 – 22,50,000) – `10,50,000
= `42,00,000

(b) Balance Sheet

Liabilities ` Assets `
Share Capital 11,70,000 Fixed Assets (b.f.) 18,50,000
Reserves and Surplus 7,80,000 Current Assets:
15% Debentures 5,00,000 Stock 1,87,500
Payables 2,50,000 Receivables 2,00,000
Bank Overdraft 1,50,000 Cash 6,12,500
28,50,000 28,50,000

PYQ 28
Following are the data in respect of ABC Industries for the year ended 31st March, 2021:

Debt to Total assets ratio : 0.40

Long-term debts to equity ratio : 30%
Gross profit margin on sales : 20%
Accounts receivables period : 36 days
Quick ratio : 0.9
Inventory holding period : 55 days
Cost of goods sold : `64,00,000

Balance Sheet
Liabilities ` Assets `
Equity Share Capital 20,00,000 Fixed Assets
 RATIO ANALYSIS 6.58
Reserves & surplus Inventory
Long-term debts Accounts receivables
Accounts payable Cash
Total 50,00,000 Total

Complete the Balance Sheet of ABC Industries as on 31st March, 2021. All calculations should be in
nearest rupee. Assume 360 days in a year.
[(10 Marks) Dec 2021]

Answer
Balance Sheet
Liabilities ` Assets `
Equity Share Capital 20,00,000 Fixed Assets 30,32,222
Reserves & surplus 10,00,000 Inventory 9,77,778
Long-term debts 9,00,000 Accounts receivables 8,00,000
Accounts payable 11,00,000 Cash 1,90,000
Total 50,00,000 Total 50,00,000

Working Notes:

Inventory holding period

1. Inventory = COGS ×
360
= `64,00,000 × 55/360 = `9,77,778

2. Sales = COGS ÷ COGS ratio

= `64,00,000 ÷ 80% (100 – G.P. ratio) = `80,00,000

Account receivable s period

3. Debtors = Sales ×
360
= `80,00,000 × 36/360 = `8,00,000

4. Debt:
Debt ( Long  term debt  Accounts payables )
Debt to Total asset = = 40%
Total Asset
Debt = 40% of Total Assets
= `50,00,000 × 40% = `20,00,000

Note: In debt we are considering total debt i.e. Long-term debt and Accounts payables.

5. Equity Fund = Equity Share Capital + Reserve and surplus

= Total Liabilities – Debt (Long term debt + Account payable)
= `50,00,000 – `20,00,000 = `30,00,000

Reserve and surplus = Equity fund – Equity share capital

= `30,00,000 – `20,00,000 = `10,00,000

6. Long-term debt:

Long  term debt

Long-term debt to equity= = 30%
Equity

Long-term debt = 30% of Equity

= 30% of `30,00,000 = `9,00,000

Accounts payables = Debt – Long-term debt

= `20,00,000 – `9,00,000 = `11,00,000
 RATIO ANALYSIS 6.59
Current assets  Inventorie s
7. Quick Ratio = = 0.9
Current liabilitie s
Current assets – `9,77,778 = 0.9 × `11,00,000
Current Assets = `9,90,000 + `9,77,778 = `19,67,778

Cash = Current assets – Inventories – Accounts receivables

= `19,67,778 - `9,77,778 - `8,00,000 = `1,90,000

8. Fixed assets = Total assets – Current assets

= `50,00,000 – `19,67,778 = `30,32,222

PYQ 29
Following are the information and ratios are given for W limited for the year ended 31st March, 2022:

Equity Share Capital of `10 each : `10 Lakhs

Reserves & Surplus to Shareholder’s Fund : 0.50
Sales/ Shareholders’ Fund : 1.50
Current Ratio : 2.50
Debtors Turnover Ratio : 6.00
Stock Velocity : 2 Months
Gross profit Ratio : 20%
Net Working Capital Turnover Ratio : 2.50

You are required to calculate:

(1) Shareholders’ Fund
(2) Stock
(3) Debtors
(4) Current Liabilities
(5) Cash Balance
[(5 Marks) May 2022]

Answer
(1) Shareholders’ Fund = Equity Share Capital + Reserve and Surplus
= `10 Lakhs + 0.50 Shareholders’ Fund
0.50 Shareholders’ Fund = `10 Lakhs

Shareholders’ Fund = `10 Lakhs ÷ 0.50 = `20,00,000

Reserve and Surplus
= 0.50 or Reserve & Surplus = 0.50 Shareholders’ Fund
Shareholders′ Fund

(2) Stock = COGS × Stock velocity/12

= `24,00,000 × 2/12 = `4,00,000
Sales
Shareholders′ Fund
= 1.50 or Sales = 1.50 Shareholders’ Fund

Sales = 1.50 × `20,00,000 = `30,00,000

COGS = Sales – Gross Profit

= `30,00,000 – 20% = `24,00,000

(3) Debtors = Annual Credit Sales ÷ Debtors Turnover Ratio

= `30,00,000 ÷ 6 = `5,00,000

(4) Current Liabilities:

Current Ratio = CA ÷ CL = 2.50
Current Asset = 2.50 CL
 RATIO ANALYSIS 6.60
Sales
Net Working Capital
= 2.50
Net Working Capital = Sales ÷ 2.50 = `30,00,000 ÷ 2.50
= `12,00,000

CA – CL = `12,00,000
2.5 CL – CL = `12,00,000
Current Liabilities = `12,00,000 ÷ 1.5 = `8,00,000

(5) Cash Balance = Current Asset – Debtors – Stock

= `20,00,000 - `5,00,000 - `4,00,000
= `11,00,000

Current Asset = 2.5 CL

= 2.5 × 8,00,000 = `20,00,000

PYQ 30
The following figure are related to the trading activities of M Ltd.

Total assets - `10,00,000

Debt to total assets - 50%
Interest cost - 10% per year
Direct Cost - 10 times of the interest cost
Operating Exp. - `1,00,000

The goods are sold to customers at a margin of 50% on the direct cost Tax Rate is 30%.

You are required to calculate:

(a) Net profit margin
(b) Net operating profit margin
(c) Return on assets
(d) Return on owner’s equity
[(5 Marks) Nov 2022]

Answer
EAT 70 ,000
(a) Net Profit Margin = × 100 = × 100 = 9.33%
Sales 7 ,50 ,000

EBIT 1 ,50 ,000

(b) Net Operating Profit Margin = × 100 = × 100 = 20%
Sales 7 ,50 ,000

EBIT (1−t) 1,50,000 (1−.30)

(c) Return on Assets = Assets
= 10,00,000
= 10.50%

EAT 70 ,000
(d) Return on Equity = Equity Fund
×100= × 100 = 14%
5 ,00 ,000

Working Notes:

(1) Debt = 50% of `10,00,000 = `5,00,000

(2) Interest = 10% of `5,00,000 = `50,000

(3) Direct cost = 10 times of `50,000 = `5,00,000

(4) Sales = Direct cost + 50% = `5,00,000 + 50% = `7,50,000

 RATIO ANALYSIS 6.61
(5) Equity Fund = Total Assets – Debt = `10,00,000 - `5,00,000= `5,00,000

(6) The Net Profit is calculated as follows:

Particulars `
Sales Revenue 7,50,000
Less: Direct Cost 5,00,000
Gross Profit 2,50,000
Less: Operating expenses 1,00,000
Operating Profit/EBIT 1,50,000
Less: Interest 50,000
EBT 1,00,000
Less: Taxes @ 30% 30,000
EAT 70,000

PYQ 31
Following information and ratios are given in respect of AQUA Ltd. for the 10 year ended 31st March, 2023:
Current ratio 4.0
Acid test ratio 2.5
Inventory turnover ratio (based on sales) 6
Average collection period (days) 70
Earnings per share `3.5
Current liabilities `3,10,000
Total assets turnover ratio (based on sales) 0.96
Cash ratio 0.43
Proprietary ratio 0.48
Total equity dividend `1,75,000
Equity dividend coverage ratio 1.60

Assume 360 days in a year. You are required to complete Balance Sheet as on 31st March, 2023.

Balance Sheet as on 31st March, 2023

Liabilities ` Assets `
Equity share capital XXX Fixed assets XXX
(`10 per share) Inventory XXX
Reserve & surplus XXX Debtors XXX
Long-term debt (b.f.) XXX Loans & advances XXX
Current liabilities 3,10,000 Cash & bank XXX
XXX XXX
[(10 Marks) May 23]

Answer
Balance Sheet as on 31st March, 2023
Liabilities ` Assets `
Equity share capital 8,00,000 Fixed assets 16,66,250
(`10 per share) Inventory 4,65,000
Reserve & surplus 5,95,000 Debtors 5,42,500
Long-term debt (b.f.) 12,01,250 Loans & advances 99,200
Current liabilities 3,10,000 Cash & bank 1,33,300
29,06,250 29,06,250

Working Notes:
CA
a. Current Ratio = = 4 times
CL
Current Assets = 4 × 3,10,000 = `12,40,000
 RATIO ANALYSIS 6.62

CA  Stock 12 ,40 ,000  Stock

b. Acid test ratio = = = 2.5 times
CL 3 ,10 ,000
Inventory = `4,65,000

Cash & bank Cash & bank

c. Cash ratio = = = 0.43
CL 3,10 ,000
Cash & bank = `1,33,300

Sales Sales
d. Inventory turnover = = = 6
Inventory 4 ,65 ,000
Sales = `27,90,000

e. Debtors = Credit Sales × 70/360

= 27,90,000 × 70/360 = `5,42,500

f. Loans & advances = CA – Debtors – Inventory – Cash and Bank

= 12,40,000 – 5,42,500 – 4,65,000 – 1,33,300 = `99,200

Sales 27 ,90 ,000

g. Total assets turnover = = = 0.96
Total assets Total assets
Total assets = `29,06,250

h. Fixed assets = Total assets – Current assets

= 29,06,250 – 12,40,000 = `16,66,250

Pr op . fund Pr op . fund
i. Proprietary ratio = = = 0.48
Total assets 29 ,06 ,250
Proprietor’s fund = 0.48 × 29,06,250 = `13,95,000

EAT
j. Equity dividend coverage =
Equity Dividend
EAT
1.6 =
1 ,75 ,000
EAT = 1.6 × 1,75,000 = `2,80,000

EAT 2,80 ,000

k. Number of Equity shares = = = 80,000
EPS 3 .5

l. Equity share capital = 80,000 shares × `10 = `8,00,000

Reserves & surplus = 13,95,000 – 8,00,000 = `5,95,000
 RATIO ANALYSIS 6.63

SUGGESTED REVISION
Page No. of 3rd, 4th & Revision
Ques. Observations or KEY Points 1st & 2nd
Practical 5th during
No. (Note down during revisions) Revision
Register Revision Exams
BQ (Book Questions covering Study Module of ICAI, PM, RTP’s, MTP’s and Important Questions)
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 RATIO ANALYSIS 6.64
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