Ratio Analysis

Problems and Solutions

Example 1

Following is the Profit and Loss Account and Balance Sheet of Jai Hind Ltd.
Redraft them for the purpose of analysis and calculate the following ratios:

1) Gross Profit Ratio

2) Overall Profitability Ratio

3) Current Ratio

4) Debt-Equity Ratio

5) Stock-Turnover Ratio

6) Finished goods Turnover Ratio

7) Liquidity ratio
Dr. Profit and Loss A/C Cr.
Amount Amount
Particulars (Rs) Particulars (Rs)
Opening stock of finished
goods 1,00,000 Sales 10,00,000
Opening stock of raw material 50,000 Closing stock of raw material 1,50,000
Purchase of raw material 3,00,000 Closing stock of finished goods 1,00,000
Direct wages 2,00,000 Profit on sale of shares 50,000
Manufacturing Exp 1,00,000
Administration Exp 50,000
Selling & distribution Exp 50,000
Loss on sale of Plant 55,000
Interest on debentures 10,000
Net Profit 3,85,000
13,00,000 13,00,000
 Balance Sheet
Amount Amount
Liabilities (Rs) Assets (Rs)
Equity share capital 1,00,000 Fixed assets 2,50,000
Preference share capital 1,00,000 Stock of raw material 1,50,000
Reserves 1,00,000 Stock of finished goods 1,00,000
Debentures 2,00,000 Bank balance 50,000
Sundry Creditors 1,00,000 Debtors 1,00,000
Bills Payable 50,000
6,50,000 6,50,000
 Jai Hind Ltd. Income Statement
Rs Rs
SALES 10,00,000
(-) Cost of goods sold:
Raw material consumed (300000 + 50000 – 150000) 2,00,000
Wages 2,00,000
Manufacturing expenses 1,00,000
Cost of production 5,00, 000
(+) Opening stock of FINISHED GOODS 1,00,000
(-) Closing stock of FINISHED GOODS (1,00,000) (5,00,000)
GROSS PROFIT 5,00,000
(-) Operating expenses:
Administrative expenses 50,000
Selling and distribution 50,000 (1,00,000)
OPERATING PROFIT 4,00,000
(+) Non operating income (Profit on Sale of Shares) 50,000
(-) Loss on sale of plant (55,000)
EBIT 3,95,000
(-) Interest (10,000)
EBT / Net Profit 3,85,000
 Statement of Financial Position Rs
Bank 50,000
Debtors 1,00,000
Liquid Assets 1,50,000
(+) Stock (R.M.+F.G.) 2,50,000
CURRENT ASSETS 4,00,000
(-) Current liabilities (S.C.B.P.) (1,50,000)
WORKING CAPITAL 2,50,000
(+) Fixed assets 2,50,000
CAPITAL EMPLOYED IN BUSINESS 5,00,000
(-) External liabilities (2,00,000)
SHAREHOLDERS FUNDS 3,00,000
(-) Preference share capital (1,00,000)
EQUITY SHARE Capital 2,00,000

Represented by
Equity share capital 1,00,000
(+) Reserves 1,00,000
2,00,000
1) GPR
Gross Profit Ratio = Gross Profit / Sales x 100
= 5,00,000/1,00,000 x 100
= 50%
2) Overall Profitability Ratio
Overall Profitability Ratio = Operating Profit /Capital employed x 100
= 4,00,000/5,00,000 x 100
= 80%

3) Current Ratio
Current Ratio = Current Assets /Current Liabilities x 100
= 4,00,000 /1,50,000 x 100
= 2.67 times
4) Debt equity Ratio
Debt equity Ratio = Long term debt /Long term fund x 100
= 2,00,000 /5,00,000
= 0.4

5) Stock turnover Ratio

Stock turnover Ratio = Raw material consumed /Average stock of raw material
= 2,00,000 / 1,00,000
=2
[Average stock of Raw Mat = (50,000 + 1,50,000)/2 = 1,00,000]

6) Finished goods turnover Ratio

Finished goods turnover Ratio = COGS / Average Stock of finished goods
= 5,00,000 /1,00,000
=5
[Average stock of Finished goods =(1,00,000 + 1,00,000) /2 = 1,00,000]
7) Liquidity Ratio
Liquidity Ratio = Liquid Assets /Current Liabilities
= 1,50,000 /1,50,000
=1
[Liquid Asset : Bank Balance + Debtors = 50,000 + 1,00,000 = 1,50,000]
Example 2
A company has a profit margin of 20% and asset turnover of
3 times. What is the company’s return on investment? How
will this return on investment vary if?
(i) Profit margin is increased by 5%?
(ii) Asset turnover is decreased to 2 times?
(iii) Profit margin is decreased by 5% and asset
turnover is increase to 4 times?
 Net profit ratio = 20% (given)
Assets turnover ratio = 3 times (given)
Return on Investment (ROI) = Net Profit ratio x Assets turnover ratio
= 20% x 3 times = 60%

(i) If net profit ratio is increased by 5%:

Then Revised Net Profit Ratio = 20 + 5 = 25%
Asset Turnover Ratio (as before) = 3 times
∴ ROI = 25 % x 3 times = 75%

(ii) If assets turnover ratio is decreased to 2 times:

NP Ratio (as before) = 20%
Revised Asset Turnover Ratio = 2 times
∴ ROI = 20% x 2 times = 40 %

(iii) If net profit ratio falls by 5% and assets turnover ratio raises to 4 times:
Then Revised NP Ratio = 20 – 5 = 15%
Revised Asset Turnover Ratio = 4 times
∴ ROI = 15% x 4 = 60%
 Example 3

The following is the Balance Sheet of M/S Yamuna Enterprise

Balance Sheet as on 31st December, 2012
Liabilities Amount(`) Assets Amount(`)
Equity share capital 1,00,000 Cash in hand 2,000
12% Preference share capital 1,00,000 Cash in bank 10,000
16% Debentures 40,000 Bills Receivable 30,000
18% Public debts 20,000 Investment 20,000
Bank overdraft 40,000 Debtors 70,000
Creditors 60,000 Stock 40,000
Outstanding Creditors 7,000 Furniture 30,000
Proposed dividends 10,000 Machinery 1,00,000
Reserves 1,50,000 Land & Building 2,20,000
Provision for taxation 20,000 Goodwill 35,000
Profit & Loss Account 20,000 Preliminary expenses 10,000
5,67,000 5,67,000
During the year provision for taxation was ` 20,000. Dividend was proposed at ` 10,000. Profit carried forward from
the last year was ` 15,000. You are required to calculate:
a) Short term solvency ratios, and
b) Long term solvency ratios.
 SHORT TERM SOLVENCY RATIOS:

Current Ratio = Current Assets /Current Liabilities x 100

= 1,52,000 /1,37,000
= 1.109 times
The ideal ratio is 2 but in the instant case it is only 1.109. Hence it is not
satisfactory.
Liquid Ratio = Liquid Assets /Current Liabilities x 100
= 1,12,000 /1,37,000
= 0.818 times
The ideal ratio is 1; hence it is not quite satisfactory.
Interest Coverage Ratio = EBIT /Interest x 100
= 45,000 /1,00,000 x100
= 4.5 times
This indicates that the company’s EBIT covers 4.5 times of its interest
expenses. Which is quit satisfactory.
 (`)
Profit retained 5,000
(+) Proposed dividend 10,000
PAT 15,000
(+) Tax 20,000
PBT 35,000
(+) Interest [6400 + 3600] 10,000
EBIT 45,000
LONG TERM SOLVENCY RATIOS:
Debt equity Ratio = Long term debt /Long term fund
= 60,000 /3,85,000
= 0.156
Long term debt: (`)
Debentures 40,000
Public debt 20,000
60,000
Long term fund (`)
Equity Share Capital 1,00,000
Preference Share Capital 1,00,000
Debentures 40,000
Public Debts 20,000
Reserves 1,50,000
Profit and Loss Account 20,000
4,30,000
Less: Goodwill 35,000
Preliminary Expenses 10,000
3,85,000
Share holder funds: (`)
Equity capital 1,00,000
Preference capital 1,00,000
Reserves 1,50,000
P & L A/c 20,000
(-) Good will 35,000
(-) Preliminary exp 10,000
3,25,000

Long term debt/ share holders funds = 60,000 / 3,25,000 = 0.18

Both are quite satisfactory. It seems the company has adopted a conservative policy
for raising finance. Under such policy the equity share holders may not avail the
benefit of trading on equity.
•Fixed Assets Ratio = Fixed Assets / Long Term Funds = 3,50,000 / 3,85,000 = 0.91
The ratio is satisfactory.
•Proprietary Ratio = Share holder Funds / Total Tangible Assets
= [3,25,000 / (5,67,000 – 45000)] = 0.6226
Ratio is ideal. And long term position is quite satisfactory, it is advised to improve
short term solvency.
 Example 4 Following is the Balance Sheet of Sun Ltd., as on December 31, 2012.

Following is the Balance Sheet of Sun Ltd., as on December 31, 2012.

Liabilities Amount(`) Assets Amount(`)
Equity share capital 20,000 Goodwill 12,000
Capital reserves 4,000 Fixed Assets 28,000
8% loan on mortgage 16,000 Stocks 6,000
Trade creditors 8,000 Debtors 6,000
Bank over draft 2,000 Investments 2,000
Taxation: Cash in hand 6,000
Current 2,000
Future 2,000
Profit & Loss A/c:
PAT for the year 12,000
Less: Transfer to:
Reserves 4,000
Dividend 2,000 6,000
60,000 60,000
Sales amounted to ` 1,20,000. Calculate ratio for (a) testing liquidity, and (b) testing
solvency.
RATIOS FOR TESTING LIQUIDITY
1. Current Ratio = Current Assets/ Current Liabilities
= 20,000/12,000
= 1.67
2. Liquidity Ratio = Liquid Assets/ Current Liabilities
= 14,000/12,000
= 1.17
The liquid position of the company is satisfactory. Both the current ratio and
liquidity ratio are satisfactory.

RATIOS FOR TESTING SOLVENCY

1. Debt- equity Ratio = Share holders Funds/ Total Long Term Funds
= 18,000/36,000
= 0.5
2. Fixed Assets Ratio = Net profit before interest and tax/ Interest
= 14,000/1,280
= 10.94
All solvency ratios are very much favorable to the company judged from the
above, the company has satisfactory position both from liquidity and solvency
viewpoints.
Working notes:
1. Current Assets (`)
Stock 6,000
Debtors 6,000
Investments* 2,000
Cash in hand 6,000
20,000
* presumed to be short- term.
2. Current Liabilities
Trade creditors 8,000
Bank overdraft 2,000
Taxation* 2,000
12,000
* excluding future taxation presumed to be payable after a year.
3. Liquid Assets
Current assets 20,000
Less: Stock 6,000
14,000
4. Share holders’ Funds
Equity share capital 20000
Capital reserves 4000
P & L accounts balance 6000 30000
Less: good will 12000
18000
5.Long Terms Funds
Share holders’ funds 18,000
Mortgage loan 16,000
Future taxation 2,000
36,000
Example 5 With the help of the following information
complete the Balance Sheet of MNOP Ltd.
Equity share capital Rs.1,00,000
The relevant ratios of the company are as follows:
Current debt to total debt 40 %
Total debt to owner’s equity 60 %
Fixed assets to owner’s equity 60 %
Total assets turnover 2 Times
Inventory turnover 8 Times
 In the Books of MNOP Ltd.
Balance Sheet
Liabilities Amount(`) Assets Amount(`)
Owners equity 1,00,000 Fixed Assets 60,000
Current debt 24,000Cash 60,000
Long term debt 36000Inventory 40000
1,60,000 1,60,000
Working Notes:
1. Fixed assets = 0.60 x Owners equity
= 0.60 x ` 1,00,000
= ` 60,000.
2. Total debt = 0.60 x Owners equity
= 0.60 x ` 1,00,000
= ` 60,000.
3. Total assets consisting of fixed assets and current assets
must be equal to ` 1,60,000 (Assets = Liabilities
+ Owners equity).
Since fixed assets are ` 60,000 hence, current assets should be `
1,00,000.
4. Total equity = Total debt + Owners equity
= ` 60,000 + ` 1,00,000
= ` 1,60,000.
5. Total assets turnover = 2 Times;
Inventory turnover = 8 Times.
Therefore, Inventory/Total assets = 2/8 = 1/4 ;
Total assets = ` 1,60,000.
Therefore, Inventory = 1,60,000 / 4 = 40,000.
Cash = ` 1,00,000 – ` 40,000 = ` 60,000.
Example 6 Using the following data,
prepare the Balance Sheet:
Gross profits Rs. 54,000
Shareholders Funds Rs. 6,00,000
Gross Profit Margin 20%
Credit Sales to Total Sales 80%
Total Assets turnover 0.3 times
Inventory turnover 4 times
Average collection period (a 360 days year) 20 days
Current ratio 1.8
Long-term Debt to Equity 40%
Balance Sheet
Liabilities Amount(`) Assets Amount(`)
Creditors (bal. fig) 60,000 Cash 42,000
Long Term Debts 2,40,000Debtors 12,000
Share Holders Fund 6,00,000 Inventory 54,000
Fixed Assets (bal. fig). 7,92,000
9,00,000 9,00,000
 Working Notes:
1. Gross Profit:
GP Margin = 20%
GP = ` 54,000
Sales = 54,000/20% = ` 2,70,000
2. Credit Sales:
Cr. Sales = 80% of Total Sales
= 2,70,000 x 80%
= ` 2,16,000
3. Total Assets:
Total Assets Turnover = Sales / Total Assets
= 0.3 Times
Total Assets = 2,70,000 / 0.3
= ` 9,00,000
4. Inventory Turnover:
Inventory Turnover = Cost of goods sold / Inventory x 100
= 2,70,000 – 54,000 / Inventory
Inventory = 2,16,000/4 = ` 54,000
5. Debtors
Debtors = Credit Sales x 20 days / 360 days
= 2,16,000 x 20/360 days
= ` 12,000
6. Creditors
Total Assets = 9,00,000
Total of Balance Sheet = 9,00,000
Now, Long Term Debt = Long Term Debt / Equity = 40%
Long Term Debt = 40% of equity
= 6,00,000 x 40%
= ` 2,40,000
Now Balancing figure of Liability side is creditors:
= 9,00,000 – 6,00,000 (Equity) – 2,40,000 (Long Term Debt)
= ` 60,000
Creditors = ` 60,000
7. Current Ratio – Cash:
Current ratio = Current Assets / Current Liabilities
1.8 = Debtors + Inventory + Cash / Creditors
1.8 = 12,000 + 54,000 + Cash / 60,000
1,08,000 = 66,000 + Cash
Cash = ` 42,000
8. Fixed Assets:
Balancing figure on Assets Side is Fixed Assets.
9. Sales
COGS = Sales - G.P.
COGS = ` 2,70,000 – 54,000
= 2,16,000