Unit – 2

Chapter 3
Ratio Analysis
 Introduction
 Our study of accounting so far has been restricted to recording of
business transaction in books of accounts, preparing a trial balance to
check the arithmetical accuracy of accounts and preparing profit and loss
account and a balance sheet with a view to ascertaining trading results of
a specified period and financial position of the business on a specified
date respectively.
 The functions of the accountant do not end at this stage. He should be
able to analyze and interpret the figures disclosed by these statements to
gauge accurately the financial health of the enterprise.
 The student of accountancy are frequently called upon to advise the
prospective investors and should be able to analyze the accounts and say
whether it is advisable for him to risk his savings in a particular
enterprise.
 Accounting Ratios
 The financial statements as prepared and presented annually are of little use for guidance of
prospective investors, creditors and even management. If relationship between various
related items in these financial statements are established, they can provide useful clues to
gauge accurately the financial health and ability of business to make profit.
 This relation between two related items of financial statements is known as ratio. A ratio, is
thus, one number expressed in terms of another, e.g., in order to obtain the rate of return on
paid up capital, the net profit of the business is divided by the paid up share capital. The
figure so obtained is the ratio. If the same is multiplied by 100, a percentage rate of return on
paid up capital is obtained.
 A ratio is customarily expressed in three different ways:
◦ Simple figure: It may be expressed as a proportion between two figures. For example, if the
current assets are twice the current liabilities it can be said that the current ratio is 2 : 1.
◦ Percentage: Second method is to express it in the form of percentage. E.g., the rate of return on
capital employed is 30%.
◦ Rate or Times: Third method is to express it as rates. For example, stock turnover is 6 or stock
turns over 6 times a year.
 Interpretation through Ratios
 Comparison with Ideal Ratio

 Comparison with Past Ratios

 Help of some Related Ratios

 Comparison with Ratios of Other Firms

 Classification of Accounting Ratios
 Accounting ratios are generally classified as follows: (1) Traditional classification or
classification according to the type of financial statements, (2) Functional classification

(1) Traditional Classification: The ratios are grouped into three categories on the basis of
the statements from which the figures are taken for computing the ratios. It is well-known
traditional classification and has been so grouped since the advent of ratio analysis. The
ratios according to this classification are:
◦ Revenue Statement Ratios: These are the ratios computed on the basis of items taken from
revenue statement. i.e., profit and loss account. E.g., Net profit ratio is computing by dividing
Net Profit by Sales. Here, both net profit and sales are appearing in P & L Account.
◦ Balance Sheet Ratios: When two items or groups of items appearing in the balance sheet are
compared the ratio so obtained is a balance sheet ratio. E.g., a ratio establishing relationship
between current assets and current liabilities is a balance sheet ratio.
◦ Composite Ratios: A ratio showing the relationship between one item taken from Balance Sheet
and another taken from Profit and Loss Account is a composite ratio or a combined ratio known
as balance sheet and revenue statement ratio. E.g., A return on capital employed shows the
proportion of net profit to capital employed and it is a composite ratio.
(2) Functional Classification: Ratios are also grouped in accordance with certain tests. On the
basis there are four categories of ratios:
◦ Liquidity Ratios: These ratios indicate the position of liquidity. They are computed to ascertain
whether the company is capable of meeting its short-term obligations from its short-term resources.
For example, Current ratio shows the capacity of a firm to meet its current liabilities as and when
they mature. E.g., (1) Current Ratio, (2) Liquidity Ratio, (3) Acid-Test Ratio.
◦ Profitability Ratios: A number of ratios are designed to indicate the profitability of the business
and are grouped into the category of profitability ratio. For example, Return on capital employed is
an example of profitability ratio. E.g., (1) Gross Profit Ratio, (2) Net Profit Ratio, (3) Expenses
Ratio, (4) Operating Ratio, (5) Return on Capital Employed, (6) Return on shareholders’ Funds, and
(7) Debt service Coverage Ratio.
◦ Leverage Ratios: The composition of capital of business and the proportion of owners’ capital and
capital provided by outsiders are reflected by leverage ratios. For example, gearing ratio showing
the relationship between the preference capital and ordinary capital is a leverage ratio. E.g., (1)
Proprietary Ratio, (2) Debt-Equity Ratio, (3) Gearing Ratio, (4) Fixed Capital-Fixed Assets Ratio.
◦ Activity or Efficiency Ratios: These are the ratios showing the effectiveness with which the
resources of the business are employed. It signifies the efficiency of the management. For example,
stock turnover is an activity ratio, showing the number of times the average stock is turned over
during the year. E.g., (1) Debtors Ratio or Turnover, (2) Creditors Ratio or Turnover, (3) Total
Assets Turnover, (4) Fixed Assets Turnover, etc.
 Example – 1: The following are the summarized balance sheets of Ashok Mills Co. Ltd.:
Balance Sheets
31-3-2018 31-3-2019 31-3-2018 31-3-2019
Liabilities Assets
₹ ₹ ₹ ₹
Share Capital 1,00,000 1,00,000 Fixed Assets:
Reserves 90,000 1,00,000 Land & Building 50,000 50,000
9% Debentures 1,00,000 1,00,000 Plant & Machinery 2,00,000 1,80,000
Current Liabilities: Current Assets:
Sundry Creditors 40,000 60,000 Stock 55,000 65,000
Provision for Taxation 20,000 10,000 Sundry Debtors 30,000 40,000
Cash 15,000 35,000
3,50,000 3,70,000 3,50,000 3,70,000

Additional Information:
2017-’18 (₹) 2018-’19 (₹)
Sales 3,65,000 2,92,000
Gross Profit 90,000 52,000
Net Profit (before interest and tax) 58,000 30,000
The stock on 1-4-2017 was valued at ₹ 45,000.
 Calculate the following accounting ratios and comment in
brief on each of them:
(1) Current Ratio
(2) Stock Turnover
(3) Debtor’s Ratio and Debtors Turnover
(4) Return on Capital Employed
 𝑪𝒖𝒓𝒓𝒆𝒏𝒕 𝑨𝒔𝒔𝒆𝒕𝒔
 Solution: (1) Current Ratio =
𝑪𝒖𝒓𝒓𝒆𝒏𝒕 𝑳𝒊𝒂𝒃𝒊𝒍𝒊𝒕𝒊𝒆𝒔

Working Notes: 31-3-2018 31-3-2019

Current Assets:
Stock 55,000 65,000
Sundry Debtors 30,000 40,000
Cash 15,000 35,000
Total Current Assets 1,00,000 1,40,000

Current Liabilities:
Sundry Creditors 40,000 60,000
Provision for Taxation 20,000 10,000
Total Current Liabilities 60,000 70,000

Current Ratio 1,00,000 1,40,000

60,000 70,000

1.67 : 1 2:1
Comment: Current ratio has increased in current year shows the good liquid position.
 𝑪𝑶𝑮𝑺
(2) Stock Turnover Ratio =
𝑨𝒗𝒆𝒓𝒂𝒈𝒆 𝑺𝒕𝒐𝒄𝒌

Working Notes: 31-3-2018 31-3-2019

COGS = Sales – Gross Profit
Sales 3,65,000 2,92,000
Less: Gross Profit 90,000 52,000
COGS 2,75,000 2,40,000

Average Stock:
𝑂𝑝𝑒𝑛𝑖𝑛𝑔 𝑠𝑡𝑜𝑐𝑘+𝐶𝑙𝑜𝑠𝑖𝑛𝑔 𝑠𝑡𝑜𝑐𝑘 45,000+55,000 55,000+65,000
2 2 2
= 50,000 = 60,000

Stock Turnover Ratio 2,75,000 2,40,000

50,000 60,000

5.5 times 4 times

Comment: Stock Turnover Ratio decrease during current year shows the weak distribution policy.
 𝑫𝒆𝒃𝒕𝒐𝒓𝒔+𝑩𝒊𝒍𝒍𝒔 𝑹𝒆𝒄𝒆𝒊𝒗𝒂𝒃𝒍𝒆
(3) Debtors Ratio = × 𝑫𝒂𝒚𝒔 𝒐𝒇 𝒕𝒉𝒆 𝒚𝒆𝒂𝒓
𝑪𝒓𝒆𝒅𝒊𝒕 𝑺𝒂𝒍𝒆𝒔

31-3-2018 31-3-2019

Debtors Ratio 30,000 40,000

× 365 × 365
3,65,000 2,92,000

30 Days 50 Days

Comment: In current year debtors turnover ratio has also decreased, shows that the
collection policy is not effective.
 𝑬𝑩𝑰𝑻
(4) Return on Capital Employed = × 𝟏𝟎𝟎
𝑪𝒂𝒑𝒊𝒕𝒂𝒍 𝑬𝒎𝒑𝒍𝒐𝒚𝒆𝒅

Working Notes: 31-3-2018 31-3-2019

Capital Employed:
Share Capital 1,00,000 1,00,000
Reserves 90,000 1,00,000
9% Debentures 1,00,000 1,00,000
Less: Fictitious Assets ---- ----
Capital Employed 2,90,000 3,00,000

Return on Capital Employed 58,000 30,000

× 100 × 100
2,90,000 3,00,000

20 % 10 %

Comment: Return on Capital Employed decrease half in current year, shows company does
not earn sufficient to fulfill its requirement.
 Example – 2: The following is the Balance Sheet of The Desai Ltd. as on 31-3-2019:
Balance Sheet
31-3-2019 31-3-2019
Liabilities Assets
₹ ₹
Equity Share Capital 30,000 Plant and Machinery 60,000
Reserves 20,700 Stock of Goods 15,000
Debentures 30,000 Debtors 3,500
Creditors 5,000 Bills Receivable 1,500
Bills Payable 2,000 Cash 7,700

87,700 87,700

Total Sales ₹ 60,000; and Net Profit ₹ 12,000.

From the above information calculate the following ratios and explain what they shows:
(1) Current Ratio
(2) Liquidity Ratio
(3) Debtors Ratio
(4) Net Profit to Sales Ratio
 𝑪𝒖𝒓𝒓𝒆𝒏𝒕 𝑨𝒔𝒔𝒆𝒕𝒔
 Solution: (1) Current Ratio =
𝑪𝒖𝒓𝒓𝒆𝒏𝒕 𝑳𝒊𝒂𝒃𝒊𝒍𝒊𝒕𝒊𝒆𝒔

Working Notes: ₹
Current Assets:
Stock of Goods 15,000
Debtors 3,500
Bills Receivable 1,500
Cash 7,700
Total Current Assets 27,700
Current Liabilities:
Creditors 5,000
Bills Payable 2,000
Total Current Liabilities 7,000

Current Ratio 27,700

7,000

3.96 : 1
Comment: Current ratio of the company is 3.96:1, shows very comfortable liquid position of
the company.
 𝑳𝒊𝒒𝒖𝒊𝒅 𝑨𝒔𝒔𝒆𝒕𝒔
(2) Liquid Ratio =
𝑪𝒖𝒓𝒓𝒆𝒏𝒕 𝑳𝒊𝒂𝒃𝒊𝒍𝒊𝒕𝒊𝒆𝒔

Working Notes: ₹
Liquid Assets:
Current Assets 27,700
Less: Stock 15,000
Total Liquid Assets 12,700

Current Liabilities:
Current Liabilities 7,000

Liquid Ratio 12,700

7,000

1.81 : 1
Comment: Liquid ratio of the company is 1.81:1, shows very comfortable liquid position.
 𝑫𝒆𝒃𝒕𝒐𝒓𝒔+𝑩𝒊𝒍𝒍𝒔 𝑹𝒆𝒄𝒆𝒊𝒗𝒂𝒃𝒍𝒆
(3) Debtors Ratio = × 𝑫𝒂𝒚𝒔 𝒐𝒇 𝒕𝒉𝒆 𝒚𝒆𝒂𝒓
𝑪𝒓𝒆𝒅𝒊𝒕 𝑺𝒂𝒍𝒆𝒔

𝟑,𝟓𝟎𝟎+𝟏,𝟓𝟎𝟎
= × 𝟑𝟔𝟓
𝟔𝟎,𝟎𝟎𝟎
= 30 Days

Comment: Debtors ratio is 30 days which shows the collection policy of the company is very
efficient.

(4) Net Profit to Sales Ratio = 𝑵𝒆𝒕 𝑷𝒓𝒐𝒇𝒊𝒕 × 𝟏𝟎𝟎

𝑺𝒂𝒍𝒆𝒔

= 𝟏𝟐,𝟎𝟎𝟎 × 𝟏𝟎𝟎
𝟔𝟎,𝟎𝟎𝟎

= 20 %

Comment: Net Profit of the company is 20% to sales, which is reasonable for any business.
 Example – 3: The details of Shreenath company are as under:
Revenue from Operations:
Cash Sales 6,00,000
+ Credit Sales 9,00,000 15,00,000
Less: Cost of goods sold 7,50,000
Gross Profit 7,50,000
Less: Other Expenses:
Office Expenses 1,25,000
Selling Expenses 1,25,000 2,50,000
Profit before taxes 5,00,000
Less: Taxes 2,50,000
Net Profit after taxes 2,50,000
 Particulars ₹
I. EQUITY AND LIABILITIES:
(1) Shareholder’s Funds:
(a) Share Capital: Equity Share Capital 20,00,000
10% Preference Share Capital 20,00,000
(b) Reserves and Surplus 11,00,000
(2) Non-Current Liabilities:
(a) Long Term Borrowings: Bank Loan 10,00,000
(3) Current Liabilities:
(a) Trade Payables: Creditors 1,00,000
Bills Payables 45,000
(b) Other Current Liabilities: Bank Overdraft 1,50,000
Outstanding Expenses 5,000
TOTAL 64,00,000
II. ASSETS:
(1) Non-Current Assets:
(a) Fixed Assets: Tangible Assets 55,00,000
(b) Other Non-Current Assets: Preliminary Expenses 1,00,000
(2) Current Assets:
(a) Inventories: Stock 1,75,000
(b) Trade Receivables: Debtors 3,50,000
Bills Receivable 50,000
(c) Cash and Cash Equivalents: Cash Balance 2,25,000
TOTAL 64,00,000
 Besides the details mentioned above the opening stock was of ₹ 3,25,000.
360 days of the year, calculate the following ratios; also discuss taking the position
of the company:
(1) Gross profit ratio
(2) Stock turnover ratio
(3) Operating ratio
(4) Current ratio
(5) Liquid ratio
(6) Debtors ratio
(7) Creditors ratio
(8) Proprietary ratio
(9) Rate of return on net capital employed
(10) Rate of return on equity shares
 𝑮𝒓𝒐𝒔𝒔 𝑷𝒓𝒐𝒇𝒊𝒕
 Solution: (1) Gross Profit Ratio = × 𝟏𝟎𝟎
𝑵𝒆𝒕 𝑺𝒂𝒍𝒆𝒔

𝟕,𝟓𝟎,𝟎𝟎𝟎
= × 𝟏𝟎𝟎
𝟏𝟓,𝟎𝟎,𝟎𝟎𝟎

= 50 %

𝑪𝑶𝑮𝑺
(2) Stock Turnover Ratio =
𝑨𝒗𝒆𝒓𝒂𝒈𝒆 𝑺𝒕𝒐𝒄𝒌

Working Notes: ₹
Average Stock:
𝑂𝑝𝑒𝑛𝑖𝑛𝑔 𝑠𝑡𝑜𝑐𝑘+𝐶𝑙𝑜𝑠𝑖𝑛𝑔 𝑠𝑡𝑜𝑐𝑘 3,25,000+1,75,000 = 2,50,000
2 2

Stock Turnover Ratio 7,50,000

2,50,000

3 times
 𝑪𝑶𝑮𝑺+𝑶𝒑𝒆𝒓𝒂𝒕𝒊𝒏𝒈 𝒆𝒙𝒑𝒆𝒏𝒔𝒆𝒔
(3) Operating Ratio = × 𝟏𝟎𝟎
𝑵𝒆𝒕 𝑺𝒂𝒍𝒆𝒔

𝟕,𝟓𝟎,𝟎𝟎𝟎+𝟐,𝟓𝟎,𝟎𝟎𝟎
= × 𝟏𝟎𝟎 = 66.67 %
𝟏𝟓,𝟎𝟎,𝟎𝟎𝟎
Where, Operating expenses = Office Exp. + Selling Exp.
= 1,25,000 + 1,25,000 = 2,50,000

𝑪𝒖𝒓𝒓𝒆𝒏𝒕 𝑨𝒔𝒔𝒆𝒕𝒔
(4) Current Ratio =
𝑪𝒖𝒓𝒓𝒆𝒏𝒕 𝑳𝒊𝒂𝒃𝒊𝒍𝒊𝒕𝒊𝒆𝒔

𝟖,𝟎𝟎,𝟎𝟎𝟎
= = 2.67 : 1
𝟑,𝟎𝟎,𝟎𝟎𝟎
Where, Current Assets = Stock + Debtors + B.R. + Cash
= 1,75,000 + 3,50,000 + 50,000 + 2,25,000
= ₹ 8,00,000
Current Liabilities = Creditors + Bills Payable + Bank O/d + O/s Exp.
= 1,00,000 + 45,000 + 1,50,000 + 5,000 = ₹ 3,00,000
 𝑳𝒊𝒒𝒖𝒊𝒅 𝑨𝒔𝒔𝒆𝒕𝒔
(5) Liquid Ratio =
𝑪𝒖𝒓𝒓𝒆𝒏𝒕 𝑳𝒊𝒂𝒃𝒊𝒍𝒊𝒕𝒊𝒆𝒔

𝟔,𝟐𝟓,𝟎𝟎𝟎
= = 2.08 : 1
𝟑,𝟎𝟎,𝟎𝟎𝟎
Where, Liquid Assets = Current Assets – Stock
= 8,00,000 – 1,75,000 = ₹ 6,25,000
Current Liabilities = 3,00,000

𝑫𝒆𝒃𝒕𝒐𝒓𝒔+𝑩𝒊𝒍𝒍𝒔 𝑹𝒆𝒄𝒆𝒊𝒗𝒂𝒃𝒍𝒆
(6) Debtors Ratio = × 𝑫𝒂𝒚𝒔 𝒐𝒇 𝒕𝒉𝒆 𝒚𝒆𝒂𝒓
𝑪𝒓𝒆𝒅𝒊𝒕 𝑺𝒂𝒍𝒆𝒔

𝟑,𝟓𝟎,𝟎𝟎𝟎+𝟓𝟎,𝟎𝟎𝟎
= × 𝟑𝟔𝟎 = 160 Days
𝟗,𝟎𝟎,𝟎𝟎𝟎
 𝑪𝒓𝒆𝒅𝒊𝒕𝒐𝒓𝒔+𝑩𝒊𝒍𝒍𝒔 𝑷𝒂𝒚𝒂𝒃𝒍𝒆
(7) Creditors Ratio = × 𝑫𝒂𝒚𝒔 𝒐𝒇 𝒕𝒉𝒆 𝒚𝒆𝒂𝒓
𝑪𝒓𝒆𝒅𝒊𝒕 𝑷𝒖𝒓𝒄𝒉𝒂𝒔𝒆

𝟏,𝟎𝟎,𝟎𝟎𝟎+𝟒𝟓,𝟎𝟎𝟎
= × 𝟑𝟔𝟎 = 87 Days
𝟔,𝟎𝟎,𝟎𝟎𝟎

Where, Purchase = COGS – Opening Stock + Closing Stock

= 7,50,000 – 3,25,000 + 1,75,000 = ₹ 6,00,000

𝑷𝒓𝒐𝒑𝒓𝒊𝒆𝒕𝒂𝒓′ 𝒔 𝒇𝒖𝒏𝒅𝒔
(8) Proprietary Ratio = × 𝟏𝟎𝟎
𝑻𝒐𝒕𝒂𝒍 𝒇𝒖𝒏𝒅𝒔

𝟓𝟎,𝟎𝟎,𝟎𝟎𝟎
= × 𝟏𝟎𝟎 = 79.37%
𝟔𝟑,𝟎𝟎,𝟎𝟎𝟎

Where, Proprietor’s funds = Eq. Share capital + Pref. share capital + Reserves – Fictitious assets
= 20,00,000 + 20,00,000 + 11,00,000 – 1,00,000 = ₹ 50,00,000
Total funds = Total of Balance sheet – Fictitious assets
= 64,00,000 – 1,00,000 = ₹ 63,00,000
 𝑬𝑩𝑰𝑻
(9) Return on Capital Employed = × 𝟏𝟎𝟎
𝑪𝒂𝒑𝒊𝒕𝒂𝒍 𝑬𝒎𝒑𝒍𝒐𝒚𝒆𝒅

𝟓,𝟎𝟎,𝟎𝟎𝟎
= × 𝟏𝟎𝟎 = 8.33 %
𝟔𝟎,𝟎𝟎,𝟎𝟎𝟎

Where, EBIT = Profit Before Tax + Interest

= ₹ 5,00,000
Capital Employed = Proprietor’s Fund + Long term Liabilities
= 50,00,000 + 10,00,000 = ₹ 60,00,000

𝑷𝑨𝑻 −𝑷𝒓𝒆𝒇.𝑫𝒊𝒗𝒊𝒅𝒆𝒏𝒅
(10) Rate of return on equity shares = × 𝟏𝟎𝟎
𝑬𝒒𝒖𝒊𝒕𝒚 𝒔𝒉𝒂𝒓𝒆 𝒄𝒂𝒑𝒊𝒕𝒂𝒍

𝟐,𝟓𝟎,𝟎𝟎𝟎−𝟐,𝟎𝟎,𝟎𝟎𝟎
= × 𝟏𝟎𝟎 = 2.5%
𝟐𝟎,𝟎𝟎,𝟎𝟎𝟎

Where, Preference Dividend = 20,00,000 × 10% = ₹ 2,00,000

Example – 8: The following is the summarized Balance Sheet of Raj Ltd. as on 31-3-2019:
Particulars ₹
I. EQUITY AND LIABILITIES:
(1) Shareholder’s Funds:
(a) Share Capital: Equity Share Capital 2,50,000
10% Pref. Share Capital 1,00,000
(b) Reserves & Surplus: General Reserve 1,12,500
(2) Non-Current Liabilities:
(a) Long Term Borrowings: 12% Debentures 1,50,000
(3) Current Liabilities:
(a) Trade Payables: Creditors 95,000
Bills Payable 30,000
(b) Other Current Liabilities: Bank Overdraft 25,000
7,62,500
II. ASSETS:
(1) Non-Current Assets:
(a) Fixed Assets 4,80,000
(b) Other Non-Current Assets: Preliminary Expenses 12,500
(2) Current Assets:
(a) Inventories: Stock 1,12,500
(b) Trade Receivables: Debtors 87,500
Bills Receivable 25,000
(c) Cash and Cash Equivalents: Cash balance 45,000
7,62,500
 Additional Information: ₹
(1) Total sales (Cash sales are 1/5th of credit sales) 9,00,000
(2) Gross Profit 3,60,000
(3) Net Profit (Before Interest and Tax) 2,43,000
Rate of tax is 50%
(4) Stock on 1-4-2018 1,03,500

From the above information, calculate the following accounting ratios for the year
and make brief comment on each of them. In bracket, standard ratios are shown (300 days
to be taken for the year).
(1) Current Ratio
(2) Debtors Ratio (300 days)
(3) Net Profit Ratio
(4) Capital Gearing Ratio
(5) Return on Shareholder’s Funds
(6) Stock Ratio
 𝑪𝒖𝒓𝒓𝒆𝒏𝒕 𝑨𝒔𝒔𝒆𝒕𝒔
Solution: (1) Current Ratio =
𝑪𝒖𝒓𝒓𝒆𝒏𝒕 𝑳𝒊𝒂𝒃𝒊𝒍𝒊𝒕𝒊𝒆𝒔

𝟐,𝟕𝟎,𝟎𝟎𝟎
= = 1.8 : 1
𝟏,𝟓𝟎,𝟎𝟎𝟎

Where, Current Assets = Stock + Debtors + Bills Receivable + Cash Balance

= 1,12,500 + 87,500 + 25,000 + 45,000 = ₹ 2,70,000
Current Liabilities = Creditors + Bills Payable + Bank Overdraft
= 95,000 + 30,000 + 25,000 = ₹ 1,50,000
𝑫𝒆𝒃𝒕𝒐𝒓𝒔+𝑩𝒊𝒍𝒍𝒔 𝑹𝒆𝒄𝒆𝒊𝒗𝒂𝒃𝒍𝒆
(2) Debtors Ratio = × 𝑫𝒂𝒚𝒔 𝒐𝒇 𝒕𝒉𝒆 𝒚𝒆𝒂𝒓
𝑪𝒓𝒆𝒅𝒊𝒕 𝑺𝒂𝒍𝒆𝒔

𝟖𝟕,𝟓𝟎𝟎+𝟐𝟓,𝟎𝟎𝟎
= × 𝟑𝟎𝟎 = 45 Days
𝟕,𝟓𝟎,𝟎𝟎𝟎

Here, Cash sales are 20% of Credit sales. So, we assume credit sales as 100 X.
It means cash sales are 20% of 100 X.
Now, Total sales = Cash Sales + Credit Sales
9,00,000 = 20 X + 100 X
120 X = 9,00,000 So, X = 7,500.
So, Credit sales = 100 (7,500) = ₹ 7,50,000
 𝑷𝑨𝑻 (𝑷𝒓𝒐𝒇𝒊𝒕 𝑨𝒇𝒕𝒆𝒓 𝑻𝒂𝒙)
(3) Net Profit Ratio = × 𝟏𝟎𝟎
𝑵𝒆𝒕 𝑺𝒂𝒍𝒆𝒔

1,12,500
= × 100 = 12.5 %
9,00,000
EBIT (Profit Before Interest and Tax) 2,43,000
Less: Interest on Debentures (1,50,000 × 12%) 18,000
Profit Before Tax 2,25,000
Less: Taxes (50%) 1,12,500
Profit After Tax 1,12,500

𝑭𝒊𝒙𝒆𝒅 𝒊𝒏𝒕𝒆𝒓𝒆𝒔𝒕 𝒂𝒏𝒅 𝒅𝒊𝒗𝒊𝒅𝒆𝒏𝒅 𝒃𝒆𝒂𝒓𝒊𝒏𝒈 𝒄𝒂𝒑𝒊𝒕𝒂𝒍

(4) Capital Gearing Ratio =
𝑶𝒓𝒅𝒊𝒏𝒂𝒓𝒚 𝒄𝒂𝒑𝒊𝒕𝒂𝒍

𝟐,𝟓𝟎,𝟎𝟎𝟎
= =1:1
𝟐,𝟓𝟎,𝟎𝟎𝟎

Where, Fixed int. and dividend bearing capital = Pref. capital + Debentures
= 1,00,000 + 1,50,000 = ₹ 2,50,000
 𝑷𝑨𝑻
(5) Return on Shareholders’ Funds = × 𝟏𝟎𝟎
𝑺𝒉𝒂𝒓𝒆𝒉𝒐𝒍𝒅𝒆𝒓𝒔′ 𝑭𝒖𝒏𝒅𝒔

𝟏,𝟏𝟐,𝟓𝟎𝟎
= × 𝟏𝟎𝟎 = 25 %
𝟒,𝟓𝟎,𝟎𝟎𝟎

Where, PAT = Profit After Tax = ₹ 1,12,500

Shareholders’ Funds = Share Capital + Reserves – Fictitious Assets
= 2,50,000 + 1,00,000 + 1,12,500 – 12,500 = ₹ 4,50,000

𝑪𝑶𝑮𝑺
(5) Stock Turnover Ratio =
𝑨𝒗𝒆𝒓𝒂𝒈𝒆 𝑺𝒕𝒐𝒄𝒌
5,40,000
= = 5 times
1,08,000
Where, Average Stock:
𝑂𝑝𝑒𝑛𝑖𝑛𝑔 𝑠𝑡𝑜𝑐𝑘+𝐶𝑙𝑜𝑠𝑖𝑛𝑔 𝑠𝑡𝑜𝑐𝑘 = 1,03,500+1,12,500 = ₹ 1,08,000
2 2
 Example – 7: Balance sheet on 31-3-2019 of Buddh Dev Company Ltd.:
Liabilities ₹ Assets ₹
Equity Share Capital 20,00,000 Fixed Assets 15,20,000
Reserve and Surplus 10,80,000 Underwriting Commission 20,000
10% Debentures 10,00,000 Current Investments 10,00,000
Provident Fund 1,80,000 Stock 7,50,000
Creditors 4,50,000 Debtors 8,25,000
Bills Payable 1,50,000 Bills Receivable 3,75,000
Outstanding expenses 1,00,000 Bank Balance 4,00,000
Provision for taxation 40,000 Prepaid expenses 1,00,000
Prepaid Income-tax 10,000
50,00,000 50,00,000

Additional Information:
(1) Gross profit is 40% of the sales.
(2) Net profit is ₹ 10,00,000 (Before Interest and Tax), Taxation rate is 50%.
(3) Cash sales are 25% of the credit sales.
(4) On 1-4-2018, the stock is worth ₹ 4,50,000.
(5) The collections are received in 108 days from the debtors (360 days of the year to be considered).
 From the above information, calculate the following accounting ratios for the
year.

(1) Rate of return on capital employed

(2) Stock turnover ratio
(3) Proprietary ratio
(4) Current ratio
(5) Net profit ratio
(6) Operating ratio
Solution:
𝑬𝑩𝑰𝑻
(1) Rate of Return on Capital Employed = × 𝟏𝟎𝟎
𝑪𝒂𝒑𝒊𝒕𝒂𝒍 𝑬𝒎𝒑𝒍𝒐𝒚𝒆𝒅

𝟏𝟎,𝟎𝟎,𝟎𝟎𝟎
= × 𝟏𝟎𝟎
𝟒𝟎,𝟔𝟎,𝟎𝟎𝟎

= 24.63 %

Where, EBIT = Profit Before Interest & Tax = ₹ 10,00,000

Capital Employed = Share Capital + Reserves + Long term liabilities – Fictitious Assets
= 20,00,000 + 10,80,000 + 10,00,000 – 20,000
= ₹ 40,60,000
 𝑪𝑶𝑮𝑺
(2) Stock Turnover Ratio =
𝑨𝒗𝒆𝒓𝒂𝒈𝒆 𝑺𝒕𝒐𝒄𝒌

30,00,000
=
6,00,000
= 5 times
Where, COGS = Sales – Gross Profit
= 50,00,000 – 20,00,000 (40% of sales) = ₹ 30,00,000
Average Stock: 𝑂𝑝𝑒𝑛𝑖𝑛𝑔 𝑠𝑡𝑜𝑐𝑘+𝐶𝑙𝑜𝑠𝑖𝑛𝑔 𝑠𝑡𝑜𝑐𝑘
2
= 4,50,000+7,50,000 = ₹ 6,00,000
2

Here, Sales is not given, we can find out sales from debtors ratio.
Debtors ratio = 𝐷𝑒𝑏𝑡𝑜𝑟𝑠+𝐵𝑖𝑙𝑙𝑠 𝑅𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒 × 𝐷𝑎𝑦𝑠 𝑜𝑓 𝑡ℎ𝑒 𝑦𝑒𝑎𝑟
𝐶𝑟𝑒𝑑𝑖𝑡 𝑠𝑎𝑙𝑒𝑠
108 days = 8,25,000+3,75,000 × 360
𝐶𝑟𝑒𝑑𝑖𝑡 𝑠𝑎𝑙𝑒𝑠
So, Credit sales = 12,00,000
× 360 = ₹ 40,00,000
108
Total sales = Cash sales + Credit Sales
= 10,00,000 (25% of credit sales) + 40,00,000 = ₹ 50,00,000
 𝑷𝒓𝒐𝒑𝒓𝒊𝒆𝒕𝒂𝒓′ 𝒔 𝒇𝒖𝒏𝒅𝒔
(3) Proprietary Ratio = × 𝟏𝟎𝟎
𝑻𝒐𝒕𝒂𝒍 𝒇𝒖𝒏𝒅𝒔

𝟑𝟎,𝟔𝟎,𝟎𝟎𝟎
= × 𝟏𝟎𝟎 = 61.45 %
𝟒𝟗,𝟖𝟎,𝟎𝟎𝟎

Where, Proprietor’s funds = Eq. Capital + Reserve & Surplus – Fictitious Assets
= 20,00,000 + 10,80,000 – 20,000 = ₹ 30,60,000
Total funds = Total of Balance sheet – Fictitious assets
= 50,00,000 – 20,000 = ₹ 49,80,000
𝑪𝒖𝒓𝒓𝒆𝒏𝒕 𝑨𝒔𝒔𝒆𝒕𝒔
(4) Current Ratio =
𝑪𝒖𝒓𝒓𝒆𝒏𝒕 𝑳𝒊𝒂𝒃𝒊𝒍𝒊𝒕𝒊𝒆𝒔
𝟑𝟒,𝟔𝟎,𝟎𝟎𝟎
= = 4.68 : 1
𝟕,𝟒𝟎,𝟎𝟎𝟎
Where, Current Assets = Invest. + Stock + Debtors + Prepaid Exp. + Prepaid I.T. + B/R + Bank
= 10,00,000 + 7,50,000 + 8,25,000 + 1,00,000 + 10,000 + 3,75,000 + 4,00,000
= ₹ 34,60,000
Current Liabilities = Creditors + Bills Payable + O/s Exp. + Provision for taxation
= 4,50,000 + 1,50,000 + 1,00,000 + 40,000
= ₹ 7,40,000
(5) Net Profit Ratio = 𝑵𝒆𝒕 𝑷𝒓𝒐𝒇𝒊𝒕(𝑷𝑨𝑻) × 𝟏𝟎𝟎
𝑺𝒂𝒍𝒆𝒔

= 𝟒,𝟓𝟎,𝟎𝟎𝟎
× 𝟏𝟎𝟎
𝟓𝟎,𝟎𝟎,𝟎𝟎𝟎

=9%

Where, Net Profit (PAT) = EBIT 10,00,000

– Interest on debentures 1,00,000 (10% of 10,00,000)
Profit Before Tax 9,00,000
– Tax (50%) 4,50,000
Profit After Tax (PAT) 4,50,000
 𝑪𝑶𝑮𝑺+𝑶𝒑𝒆𝒓𝒂𝒕𝒊𝒏𝒈 𝒆𝒙𝒑𝒆𝒏𝒔𝒆𝒔
(6) Operating Ratio = × 𝟏𝟎𝟎
𝑵𝒆𝒕 𝑺𝒂𝒍𝒆𝒔

𝟑𝟎,𝟎𝟎,𝟎𝟎𝟎+𝟏𝟎,𝟎𝟎,𝟎𝟎𝟎
= × 𝟏𝟎𝟎
𝟓𝟎,𝟎𝟎,𝟎𝟎𝟎

= 80 %

Where, Operating expenses = Gross Profit – Profit Before Interest and Tax
= 20,00,000 – 10,00,000
= ₹ 10,00,000
 Solution:
𝑮𝒓𝒐𝒔𝒔 𝑷𝒓𝒐𝒇𝒊𝒕
(1) Gross Profit Ratio = × 𝟏𝟎𝟎
𝑵𝒆𝒕 𝑺𝒂𝒍𝒆𝒔

2018-’19 2019-’20

Gross Profit Ratio 4,00,000 8,00,000

× 100 × 100
16,00,000 24,00,000

25 % 33.33 %

Comment: Gross Profit ratio of current year is better than previous year, it shows good profitability.
 𝑵𝒆𝒕 𝑷𝒓𝒐𝒇𝒊𝒕 (𝑷𝑨𝑻)
(2) Net Profit Ratio = × 𝟏𝟎𝟎
𝑵𝒆𝒕 𝑺𝒂𝒍𝒆𝒔

Working Notes: 2018-’19 2019-’20

Profit Before Interest and Tax 3,40,000 5,96,000
Less: Interest on debentures 20,000 20,000
Profit Before Tax 3,20,000 5,76,000
Less: Tax (50%) 1,60,000 2,88,000
Profit after Tax (PAT) 1,60,000 2,88,000

Net Profit Ratio 1,60,000 2,88,000

× 100 × 100
16,00,000 24,00,000

10 % 12 %

Comment: Net profit ratio of the company also shows good profitability because it is high in the
current year.
 𝑪𝑶𝑮𝑺
(3) Stock Turnover Ratio =
𝑨𝒗𝒆𝒓𝒂𝒈𝒆 𝑺𝒕𝒐𝒄𝒌

Working Notes: 2018-’19 2019-’20

COGS = Sales – Gross Profit
Sales 16,00,000 24,00,000
Less: Gross Profit 4,00,000 8,00,000
COGS 12,00,000 16,00,000

Average Stock:
𝑂𝑝𝑒𝑛𝑖𝑛𝑔 𝑠𝑡𝑜𝑐𝑘+𝐶𝑙𝑜𝑠𝑖𝑛𝑔 𝑠𝑡𝑜𝑐𝑘 2,40,000+3,60,000 3,60,000+4,40,000
2 2 2
= 3,00,000 = 4,00,000

Stock Turnover Ratio 12,00,000 16,00,000

3,00,000 4,00,000

4 times 4 times
Comment: Stock Turnover Ratio is same in both the year, it shows efficiency of company is stable.
 𝑪𝒖𝒓𝒓𝒆𝒏𝒕 𝑨𝒔𝒔𝒆𝒕𝒔
(4) Current Ratio =
𝑪𝒖𝒓𝒓𝒆𝒏𝒕 𝑳𝒊𝒂𝒃𝒊𝒍𝒊𝒕𝒊𝒆𝒔

Working Notes: 2018-’19 2019-’20

Current Assets:
Stock 3,60,000 4,40,000
Debtors 2,50,000 3,00,000
Bank Balance 1,40,000 2,60,000
Total Current Assets 7,50,000 10,00,000

Current Liabilities:
Creditors 2,00,000 4,00,000
Bills Payable 50,000 1,00,000
Total Current Liabilities 2,50,000 5,00,000

Current Ratio 7,50,000 10,00,000

2,50,000 5,00,000

3:1 2:1
Comment: Current ratio has decreased in current year shows the weak liquid position.
 𝑫𝒆𝒃𝒕𝒐𝒓𝒔+𝑩𝒊𝒍𝒍𝒔 𝑹𝒆𝒄𝒆𝒊𝒗𝒂𝒃𝒍𝒆
(5) Debtors Ratio = × 𝑫𝒂𝒚𝒔 𝒐𝒇 𝒕𝒉𝒆 𝒚𝒆𝒂𝒓
𝑪𝒓𝒆𝒅𝒊𝒕 𝑺𝒂𝒍𝒆𝒔

2018-’19 2019-’20

Debtors Ratio 2,50,000 3,00,000

× 360 × 360
10,00,000 15,00,000

90 Days 72 Days
Here, Cash sales are 3/5th of Credit sales. So, we assume credit sales as 100 X.
It means cash sales are 3/5th of 100 X.
Now, Total sales = Cash Sales + Credit Sales
In 2018-’19 16,00,000 = 60 X + 100 X
160 X = 16,00,000 So, X = 10,000.
So, Credit sales = 100 (10,000) = ₹ 10,00,000
In 2019-’20 24,00,000 = 60 X + 100 X
160 X = 24,00,000 So, X = 15,000.
So, Credit sales = 100 (15,000) = ₹ 15,00,000

Comment: In current year debtors ratio has decreased, shows that the collection policy is effective
and speedy.
 𝑪𝒖𝒓𝒓𝒆𝒏𝒕 𝑨𝒔𝒔𝒆𝒕𝒔
 Solution: (1) Current Ratio =
𝑪𝒖𝒓𝒓𝒆𝒏𝒕 𝑳𝒊𝒂𝒃𝒊𝒍𝒊𝒕𝒊𝒆𝒔

Working Notes: 2017-’18 2018-’19

Current Assets:
Stock 3,80,000 60,000
Debtors 2,40,000 4,00,000
Bills Receivable 1,00,000 1,00,000
Cash & Bank Balance 80,000 2,00,000
Total Current Assets 8,00,000 7,60,000
Current Liabilities:
Creditors 2,40,000 3,00,000
Bills Payable 1,60,000 2,00,000
Bank Overdraft 2,00,000 2,60,000
Total Current Liabilities 6,00,000 7,60,000

Current Ratio 8,00,000 7,60,000

6,00,000 7,60,000

1.33 : 1 1:1
Comment: Current ratio has decreased in current year shows the weak liquid position.
 𝑬𝑩𝑰𝑻
(2) Return on Capital Employed = × 𝟏𝟎𝟎
𝑪𝒂𝒑𝒊𝒕𝒂𝒍 𝑬𝒎𝒑𝒍𝒐𝒚𝒆𝒅
Working Notes: 2017-’18 2018-’19
Profit After Tax 2,00,000 3,00,000
Add: Tax (100% of PAT) 2,00,000 3,00,000
Profit Before Tax 4,00,000 6,00,000
Add: Interest on Debentures 24,000 24,000
Profit Before Interest and Tax 4,24,000 6,24,000
Capital Employed = Share Capital + Reserves + Long term liabilities – Fictitious Assets
In 2017-’18 = 10,00,000 + 6,00,000 + 1,40,000 + 2,60,000 + 2,00,000 – 0
= ₹ 22,00,000
In 2018-’19 = 12,00,000 + 6,00,000 + 2,40,000 + 1,60,000 + 2,00,000 – 0
= ₹ 24,00,000

Return on Capital Employed 4,24,000 6,24,000

× 100 × 100
22,00,000 24,00,000

19.27 % 26 %
Comment: Return on Capital Employed of the company shows good profitability because it is high in
the current year.
 𝑪𝒓𝒆𝒅𝒊𝒕𝒐𝒓𝒔+𝑩𝒊𝒍𝒍𝒔 𝑷𝒂𝒚𝒂𝒃𝒍𝒆
(3) Creditors Ratio = × 𝑫𝒂𝒚𝒔 𝒐𝒇 𝒕𝒉𝒆 𝒚𝒆𝒂𝒓
𝑪𝒓𝒆𝒅𝒊𝒕 𝑷𝒖𝒓𝒄𝒉𝒂𝒔𝒆

2017-’18 2018-’19

Creditors Ratio 2,40,000+1,60,000 3,00,000+2,00,000

× 360 × 360
9,00,000 14,00,000

160 Days 129 Days

Here, Cash Purchase are 2/5th of Credit purchase. So, we assume credit purchase as 100 X.
It means cash purchase are 2/5th of 100 X.
Now, Total purchase = Cash Purchase + Credit Purchase
In 2017-’18 12,60,000 = 40 X + 100 X
140 X = 12,60,000 So, X = 9,000.
So, Credit purchase = 100 (9,000) = ₹ 9,00,000
In 2018-’19 19,60,000 = 40 X + 100 X
140 X = 19,60,000 So, X = 14,000.
So, Credit purchase = 100 (14,000) = ₹ 14,00,000

Comment: In current year creditors ratio has decreased, shows that the payment policy is
effective and speedy.
 𝑷𝑨𝑻 −𝑷𝒓𝒆𝒇.𝒅𝒊𝒗𝒊𝒅𝒆𝒏𝒅
(4) Return on Equity Shareholder’s fund = × 𝟏𝟎𝟎
𝑬𝒒.𝑺𝒉𝒂𝒓𝒆𝒉𝒐𝒍𝒅𝒆𝒓′ 𝒔 𝒇𝒖𝒏𝒅

Eq. Shareholder’s fund = Equity Share Capital + Reserves – Fictitious Assets

In 2017-’18 = 10,00,000 + 1,40,000 + 2,60,000 – 0
= ₹ 14,00,000
In 2018-’19 = 12,00,000 + 2,40,000 + 1,60,000 – 0
= ₹ 16,00,000

Return on Capital Employed 2,00,000 −60,000 3,00,000 −60,000

× 100 × 100
14,00,000 16,00,000

10 % 15 %

Comment: Return on Equity Shareholder’s fund of the company has increased, shows good
profitability.
 𝑷𝒓𝒆𝒇.𝑪𝒂𝒑𝒊𝒕𝒂𝒍+𝑫𝒆𝒃𝒆𝒏𝒕𝒖𝒓𝒆𝒔
(5) Capital Gearing Ratio =
𝑬𝒒𝒖𝒊𝒕𝒚 𝑺𝒉𝒂𝒓𝒆 𝑪𝒂𝒑𝒊𝒕𝒂𝒍

2017-’18 2018-’19

Capital Gearing Ratio 6,00,000+2,00,000 6,00,000+2,00,000

10,00,000 12,00,000

0.8 : 1 0.67 : 1

Comment: In current year, gearing ratio of company goes down shows that the proportion of ordinary
shares is high.
 𝑳𝒐𝒏𝒈 𝑻𝒆𝒓𝒎 𝑭𝒖𝒏𝒅𝒔
(6) Long term funds to Fixed assets =
𝑭𝒊𝒙𝒆𝒅 𝑨𝒔𝒔𝒆𝒕𝒔

Working Notes: 2017-’18 2018-’19

Long Term Funds:
Equity Share Capital 10,00,000 12,00,000
10% Pref. Share Capital 6,00,000 6,00,000
Reserve & Surplus (Gen. Res. and P & L A/c) 4,00,000 4,00,000
12% Debentures 2,00,000 2,00,000
Total Long term Funds 22,00,000 24,00,000
Fixed Assets:
Land & Building 10,00,000 12,00,000
Machinery 7,00,000 8,00,000
Furniture & Fixtures 3,00,000 4,00,000
Total Fixed Assets 20,00,000 24,00,000

Long term Fund to Fixed assets 22,00,000 24,00,000

20,00,000 24,00,000

1.1 : 1 1:1
Comment: In second year company is able to pay all its long term funds by selling their fixed assets.
 𝑵𝒆𝒕 𝑷𝒓𝒐𝒇𝒊𝒕 (𝑷𝑨𝑻)
(7) Net Profit Ratio = × 𝟏𝟎𝟎
𝑵𝒆𝒕 𝑺𝒂𝒍𝒆𝒔

Here, Credit sales are 75% of Total sales.

In 2017-’18: Credit sales Total Sales
75 100
6,00,000 (?) ₹ 8,00,000
In 2018-’19: Credit sales Total Sales
75 100
7,20,000 (?) ₹ 9,60,000

Net Profit Ratio 2,00,000 3,00,000

× 100 × 100
8,00,000 9,60,000

25 % 31.25 %

Comment: Net profit ratio of the company shows good profitability because it is high in the current
year.