8 - Ratio Analysis Answer

CA CAPII – FM (Ratio Analysis) CA Suraj Kumar Dhakal
Chapter 8 Ratio Analysis

Ratio Analysis: Introduction
 Financial ratios are relationship between financial statement's two figures.

 Ratio analysis help to express the relationship between two accounting figures in such a
way that users can draw conclusions about the firm's current and future levels of risk
and return, its financial health and monitor its performance from period to period.
 Ratios of current year is compared with previous year, or at the same time ratios of one
firm is compared with another firm for making subjective judgment of health of the
firm.
Ratio Analysis: Types
Types of Ratios
Liquidity Ratio Leverage Ratio Activity Ratio Profitability Ratio
Liquidity Ratios (Short term solvency ratio):

 It shows the relationship of a firm's cash and other current assets to its current liabilities.
 It measures a firm's ability to satisfy its short term obligations as they come due.
 There are 5 types of ratios under liquidity ratios.
1 Current ratio: Formula:

 It indicates the extent to which current liabilities are
covered by those assets expected to be covered to cash. Current Ratio =
 A generally acceptable current ratio is 2:1 however it
depends upon nature of business.
 Current ratio is also called working capital ratio.
2 Quick ratio (Acid Test Ratio): Formula:

 It is similar to the current ratio. It measures the ability
of a firm to meet its short term obligations with its Quick Ratio = or,
most liquid assets.
 It only consists of cash and near cash assets (e.g.
inventory is not near cash assets hence is excluded)
 Source of finance which is used only when required is Quick Ratio =
also excluded e.g. bank overdraft.
 The standard quick ratio is 1.
 Quick Assets = CA – Inventory – prepaid expenses
 Quick Liabilities = CL – bank overdraft – cash credit
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3 Cash Ratio (Super Quick Ratio / Absolute Liquidity Formula:

Ratio): Cash Ratio =
 It measures the absolute liquidity of the business.
 It is the most conservative test of firm's liquidity
position.
4 Basic Defense Interval: Formula:

 Basic defense interval shows that if all the firm's Basic Defense Interval
revenues are ceased suddenly how many days the firm
can fulfill its requirement without the aid of additional =
( )
finance.
 Higher ratio shows the firm's ability to exist for longer
period on such situation.
5 Net Working Capital Ratio: Formula:

 It is more a measure of cash flow than a ratio.
 The greater the amount of WC Ratio, greater is the Net Working Capital = Current
liquidity of the firm. Assets (CA) – Current Liabilities
 Where, CL excludes short term bank borrowings. (CL)
Leverage Ratios (Long term solvency ratio):

 Leverage ratio is used to calculate the financial leverage of a company to get an idea of the
company's methods of financing or to measure its ability to meet its financial liability.
 Leverage Ratio consist 'Capital Structure ratio' and 'coverage ratio'.
Capital Structure Ratio: It shows the percent of long term financing represented by long term debt.
1 Equity ratio (Propriety Ratio): Formula:

 It measures the proportion of owner's fund to total
fund invested in the business. Equity Ratio =
 Shareholder's equity means Share capital (both
equity share and preference shares capital) + Reserve
and surplus – accumulated loss
 Total capital employed = Shareholder's equity + long
term debt
2 Debt Ratio: Formula:

 It measures the proportion of debt to total fund
invested in the business. It is used to analyze the long Debt Ratio =
term solvency of firm.
 This measure gives an idea to the leverage of the
company along with the potential risk the company
faces in terms of debt-load.
 Debt includes both short and long-term bank
borrowings, debentures, deposits and other interest
bearing loan.
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3 Debt Equity Ratio Formula:

 It is an alternative measure of the firm's leverage, Debt Equity Ratio:
which focuses solely on the firm's long term debt.
 A high ratio shows lesser protection to the long term = , or
creditors.
= ,
Coverage Ratio: It is the ratio of cash available for debt servicing of interest, principle and lease
payments.
1 Debt Service Coverage Ratio (Debt coverage ratio): Formula:

 It is a measure of the firm's ability to pay off current Debt Service Coverage Ratio
interest and installments.
 Earnings available for debt service = Net Profit + = ,or
Interest on debt service + Non cash operating
expenses (e.g. depreciation) + Non-operating ( )( )
adjustment (e.g. loss on sale of fixed assets) =
2 Interest Coverage Ratio(Times Interest earned): Formula:

 It is the measure of firm's ability to meet its annual
interest payment. Interest Coverage Ratio =
 A higher ratio means firm's position to easily meet its
interest obligations whereas lower ratio means
excessive use of debt.
3 Preference Dividend Coverage Ratio: Formula:

 It is the measure of firm's ability to pay dividend on
preference shares which carry stated rate of return. Preference Dividend Coverage Ratio
 It shows the margin of safety available to preference
shareholders. =
4 Capital Gearing Ratio: Formula:

 It measures the proportion of fixed finance cost
(Interest + preference dividend) bearing capital to Capital Gearing Ratio
funds belonging to equity share capital.
 It is mainly used to analyze the capital structure of =
the company. Higher the gearing (borrowings), higher
is the risk.
Activity Ratios (Turnover / Performance Ratios):

 Activity ratios measure the speed at which the firm converts various accounts into sales or cash.
 Activity ratios are used as guidelines to assess how efficiently firm manages its assets and
account payable.
 It is measured in terms of rate or times.
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1 Capital Turnover ratio: Formula:

 It shows the efficiency with which a firm uses its
capital employed. Capital Turnover Ratio
 This ratio indicates the firm's ability of generating = or,
sales per rupee of long term investment.
 Higher the ratio, the more efficient utilization of
owner's and long term debts. =
 Sales should be taken net of sales returns.
2 Fixed Assets Turnover Ratio: Formula:

 It shows the efficiency with which a firm uses its fixed
assets. Fixed Assets Turnover Ratio
 This ratio indicates the firm's ability of generating = or,
sales per rupee of fixed assets.
fixed assets =
 Sales should be taken net of sales returns.
3 Working Capital Turnover Ratio: Formula:

 It shows the efficiency with which a firm uses its
working capital. Working Capital Turnover Ratio
 This ratio indicates the firm's ability of generating
sales per rupee of working capital. = or,
working capital.
4 Inventory Turnover Ratio: Formula:

 This ratio indicates how fast inventory is used / sold.
 A high ratio indicates that inventory is quickly Inventory Turnover Ratio
converted into finished goods and sold. = or,
 If 'Cost of Sales' figure is not available, then we may
use 'Sales' instead of 'Cost of Sales'.
 Cost of Sales = Sales – Gross Profit =
Formula:
Inventory Holding Period: Inventory Holding period:
 This ratio indicates
= /
5 Debtor Turnover Ratio: Formula:

 It measures how quickly a firm realizes its credit
sales. Debtor Turnover Ratio
 Higher ratio indicates greater efficiency in debtor
management. = or,
 Account receivable = Trade debtor + Bills Receivable
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6 Debtor Velocity: Formula:

 It givens average collection period.
 High debtor velocity in compared to industry means Average Collection period:
that debtor's management is no effective and debtors = or,
are not paying time. Hence firm is investing more in
forms of working capital.
=
Where, Average daily credit sales

=
7 Creditor Turnover Ratio: Formula:

 It measures velocity of debt payment by firm for Creditor Turnover Ratio
credit purchases.
 Low ratio indicates liberal credit terms granted by =
suppliers.
 Account Payable = Trade Creditors + Bills Payable
8 Creditor Velocity: Formula:

 It givens average payment period.
Average payment period:
= or,
Where, Average daily credit

Purchase
=
Profitability Ratios:
 Profitability ratios are a group of ratios that show the combined effect of liquidity, asset
management, and debt on operating results.
Profitability Ratio from Owner's Point of View:
1 Return on Equity (ROE): Formula:

 This ratio measures the return on owner's investment
in the firm. Return on Equity:
 A high ROE shows the better productivity or
efficiency in utilization of owner's fund. = or,
2 Earnings per Share (EPS): Formula:

 Earnings per share (EPS) is the portion of a EPS:
company's profit allocated to each outstanding equity
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share. =
.
 The EPS is an important fundamental used in
valuing a company because it breaks down a firm's
profits on a per share basis.
3 Dividend per share (DPS): Formula:

 DPS is the portion of a company's profit distributed to DPS:
each outstanding equity share.
=
.
4 Price Earnings Ratio (PE Ratio): Formula:

 PE ratio measures the amount investors are willing to PE Ratio:
pay for each rupee of the firm's earnings.
 Investor's often use the PE ratio, the most widely ( )
= ( )
used market ratio, as a barometer of a firm's long
term growth prospects and investors’ confidence in
the firm's future performance.
Profitability Ratio based on Assets and Investments:
1 Return on Capital Employed (ROCE) / Formula:

Return on investment (ROI) :
 It is the percentage return on invested in the business Return on Capital Employed (ROCE)
by its owners.
 It indicates the investors whether investment should = or,
be made in the firm is worthwhile or not.
 Capital Employed = Equity + long term debt – ( )
Accumulated losses =
2 Return on Assets (ROA): Formula:

 It measures the profitability of firm in terms of assets
employed in the firm. ROA (pre-tax) =
 Higher ratio indicates management's effective
utilization of assets to generate the returns. ( )
ROA (post-tax) =
Profitability Ratio based on Sales of firm:
1 Gross Profit Ratio (GP Ratio): Formula:

 High gross profit ratio means that the cost of Gross Profit Ratio =
production of the firm is relatively low.
2 Operating Profit Ratio: Formula:

 Operating Profit = Sales – Cost of sales Operating Profit Ratio
=
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3 Net Profit Ratio: Formula:

 It measures overall profitability of the firm. Net Profit Ratio =
 Higher is the better.
Profitability Ratio based on Capital market information:
1 Dividend Yield: Formula:

 It measures ratio of divided per share to marker price Dividend Yield =
per share.
2 Earning Yield: Formula:

 It measures ratio of earning per share to market price Earning Yield =
per share.
3 Dividend Payout ratio: Formula:

 It measures the ratio of dividend per share to Dividend Payout =
earnings per share.
4 Retention ratio: Formula:

 It measures the ratio of retention per share to Retention Ratio = 1 – dividend
earnings per share. payout ratio
Du Pont Model: This approach used both income statement and balance sheet information to
break the ratio into component pieces.
1 Du Pont Analysis of Return on Equity: Formula,

 As per Du Pont analysis, Return on equity can be
decomposed into 3 components viz. net profit margin, = x x
total assets turnover, asset to equity ratio (equity
multiplier).
= Net profit margin x Assets
turnover x Equity Multiplier
2 ROE due to use of Debt and Preference Share: Formula,

 Under, segment decomposition effect of both debt and = Post tax ROCE +( (Post tax
preference capital is analyzed.
ROCE – Post tax Kd) + ( (Post
 D = Debt amount, E = Equity Capital.
P = Preference Capital, tax ROCE – Post tax Kp)
Kd = Cost of debt, Kp = Cost of Preference Capital = EAT / equity
3 Du Pont Analysis of ROCE: Formula,

 As per Du Pont analysis, ROCE can be decomposed Return on ROCE
into 2 components viz. operating profit ratio and
Capital turnover ratio. = x
= Operating profit margin x

Capital turnover ratio
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BASIC QUESTIONS
Question No. – 1A
A factory engaged in an industry which is capital intensive has been in operation for five
years. Total fund of Rs. 170 lakhs out of which Rs. 100 lakhs represents equity capital and
reserves, Rs. 50 lakhs long term borrowings on debenture and Rs. 20 lakhs cash credit from
banks. The working capital of the company Rs. 85 lakhs is made up of stocks: Rs. 30 lakhs,
stores: Rs. 14 lakhs, debtors: 35 lakhs, advance and deposits: Rs. 6 lakhs.
Calculation the following ratios from the use of the management:
i) Current Ratio
ii) Quick Ratio
iii) Net working capital ratio
iv) Equity ratio
v) Debt ratio
vi) Debt equity ratio
Solution:
i) Current Ratio:
Current Ratio = = = = 4.25
ii) Quick ratio:

Quick Ratio = = = = 2.05
iii) Net working capital ratio:

Net Working Capital = Current Assets (CA) – Current Liabilities (CL) = 85 – 20 = 65
iv) Equity ratio:

Equity Ratio = = = 66.67%
v) Debt ratio:
Debt Ratio = = = 33.33%
vi) Debt equity ratio:

Debt Equity Ratio = = = 50%
Question No. – 1B
Natraj Paper Ltd’s Balance Sheet shows the following structure of finance for the year
ended 31 March 2011.
Particulars Amount (Rs. In lakhs)
Equity Share Capital (500,000 equity shares of Rs. 10 each 50.00
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Preference Share Capital (12%) (10,000 preference shares of 10.00

Rs. 100 each)
Share Premium 20.00
General Reserve 15.00
Non-convertible Debenture (14%) fully secured 40.00
Current Liabilities 5.00
Total 140.00
The profit earned during the year before interest premiums and tax (@40%) amounted to
Rs. 34 lakhs Board of Directors recommend a dividend @18% on Equity Shares.
Calculate:
1. Gearing Ratio 2. Earnings per share
3. Dividend Cover (for both equity and preference shares 4. Interest Cover
Solution:
i) Gearing Ratio:
Capital Gearing Ratio = = = 58.8%
ii) Earning per share:

.
EPS = = = Rs. 3.17
.
iii) Preference Dividend Cover:

.
Preference Dividend Coverage Ratio = = = 14.2 times
.
iv) Equity Dividend Cover:

.
Equity Dividend Coverage Ratio = = = 1.76 times
v) Interest Cover:
Interest Coverage Ratio = = = 6.07 times
.
Workings:
Income Statement: in lakhs
EBIT 34
Less: Interest (40 * 14%) 5.6
EBT 28.4
Less: Tax @ 40% 4.11.36
EAT 17.04
Less: Preference dividend 1.20
(10 * 12%)
Earning for equity-holders 15.84
Equity Dividend (50 * 18%) 9
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Retained Earnings 6.84
Question No. – 1C (June. 2017 – 5 Marks)

Nepal Ltd. provides you the following information:
Gross profit ratio 40%, Net profit (after tax) ratio 12%, Operating profit ratio 30%, 15%
Debt-Equity ratio 2:1, Tax rate 50%, Shareholder’s fund Rs. 400,000.
Required:
Calculate (i) Gross profit (ii) Operating expenses (iii) Interest coverage ratio, (iv) Return on
capital employed, (v) Return on shareholders’ funds.
Solution:
i) Calculation of Gross Profit:
Gross Profit ratio = 40%
Gross Profit = Rs. 2,000,000 * 40% = Rs. 800,000
ii) Calculation of Operating Expenses:

Operating Expenses = Sales * (Gross Profit ratio – operating profit ratio) = 2,000,000 * 10%
= Rs. 200,000
iii) Calculation of Interest Coverage:

Interest Coverage = EBIT / Interest = (2,000,000 * 30%) / 120,000 = 5 times
iv) Calculation of Return on Capital Employed:

, , ∗ %
Capital Employed = = = 50%
, ,
v) Calculation of Return on Shareholder's fund:
Return on Shareholder's fund = Profit after tax / shareholder's fund = 2,000,000 * 12% /
400,000 = 60%
Workings:
Given, Shareholder's fund = Rs. 400,000
a) Debt Equity ratio = 2
Debt = 400,000 x 2 = Rs. 800,000
Interest on debt = 800,000 x 15% = Rs. 120,000
Capital Employed = 800,000 + 400,000 = 1,200,000
b) Let Sales be x
Operating Profit @ 30% 0.3x
Less: Interest 120,000
Profit before tax 0.3x – 120,000
Less; Tax (0.3x – 120,000) 50%
Profit after tax (0.15x – 60,000)
Now, Net profit ratio = 12%
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Or, (0.15x – 60,000) / x = 12%

Or, 0.15x – 0.12x = 60,000
Or, Sales (x) = Rs. 2,000,000
Question No. – 1D
From the following information, prepare a summarized balance sheet as at 31st March
2014. Rs.
i. Working Capital 120,000
ii. Reserve and Surplus 80,000
iii. Bank Overdraft 20,000
iv. Fixed Assets – Propriety ratio 0.75
v. Current Ratio 2.5
vi. Liquid Ratio 1.5
Solution:
Summarized Balance-sheet as on 31st March 201
Equity and Liabilities Amount Rs. Assets Amount Rs.
Share Capital 400,000 Fixed Asset 360,000
Reserve and Surplus 80,000
Current Assets:
Current Liabilities: Stocks 110,000
Bank Overdraft 20,000 Other current assets 90,000
Other liabilities 60,000
560,000 560,000
Workings:
a) Let, Current Liabilities be x
Current ratio = 2.5
Current Assets = 2.5x ------- (1)
Working Capital = Rs. 120,000
Current assets = 120,000 + x ------ (2)
From (1) and (2)
2.5x – x = 120,000
Or, Current Liabilities (x) = Rs. 80,000
Current Assets = 80,000 * 2.5 = Rs. 200,000
b) Liquid ratio = 1.5
Or, = 1.5
, ,
Or, Quick Assets = Rs. 90,000
Stocks = Current assets – quick assets = 200,000 – 90,000 = Rs. 110,000
c) Fixed Asset to Propriety Fund = 0.75

Or, Fixed Assets = 0.75 Propriety Fund
Or, Net current assets = 0.25 Propriety Fund
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Or, Propriety fund = (200,000 – 80,000) / 0.25 = Rs. 480,000
Now, Fixed Asset = 480,000 * 0.75 = Rs. 360,000

Share Capital = 480,000 – 80,000 = Rs. 400,000
Question No. – 1E
Certain items of the annual account of ABC Ltd. are missing as shown below:
Trading and Profit and Loss A/c
Particulars Rs. Particulars Rs.
To Opening stock 350,000 By Sales ------------
To Purchase ------------ By Closing Stock ------------
To Direct Expenses ------------
By Gross Profit c/d ------------
To Office and other expenses 213,431 By Gross Profit b/d ------------

To Interest on Debentures 30,000 By Commission 50,000
To Provision for taxation ------------
To Net profit for the year ------------
To Proposed Dividends ------------ By Balance c/d 70,000

To Transfer to ------------ By Net profit for the year ------------
General Reserve
To Balance c/d (T/f to BS) ------------
Balance Sheet as on 31st March 2014

Equity and Liabilities Rs. Particulars Rs.
Paid up capital 500,000 Fixed assets:
Plant and Machinery 700,000
General Reserve: other fixed assets ------------
Opening Balance ------------
Proposed Addition ------------ Current Assets:
Stock in trade ------------
Profit and Loss A/c ------------ Sundry Debtors ------------
Bank Balance 62,500
10% Debenture ------------
Current Liabilities ------------
You are required to supply the missing figures with the help of following information:
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i) Current ratio 2:1

ii) Closing stock is 25% of sales
iii) Proposed dividend are 40% of paid up capital
iv) Gross profit ratio is 60%
v) Ratio of current liabilities to debentures 2:1
vi) Transfer to General Reserve is equal to proposed dividends
vii) Profit carried forward is 10% of the proposed dividends.
viii) Provision for taxation is 50% of profit after tax
ix) Opening balance for general reserve at the beginning of the year is twice the amount
transferred to that account from the current profits.
Solution:
Trading and Profit and Loss A/c
Particulars Rs. Particulars Rs.
To Opening stock 350,000 By Sales 1,197,385
To Purchase (bal. fig) 428,300 By closing stock 299,346

To Direct Expenses
By Gross Profit c/d 718,431
1,496,731 1,496,731
To Office and other

expenses 213,431 By Gross Profit b/d (bal. fig) 718,431
To Interest on Debentures 30,000 By Commission 50,000
To Provision for taxation 175,000
To Net profit for the year 350,000
768,431 768,431
To Proposed Dividends 200,000 By Balance c/d 70,000

By Net profit for the year (bal.
To Transfer to 200,000 fig) 350,000
General Reserve
To Balance c/d (T/f to BS) 20,000
420,000 420,000
Balance Sheet as on 31st March 2014

Equity and Liabilities Rs. Particulars Rs.
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Paid up capital 500,000 Fixed assets:

Plant and Machinery 700,000
General Reserve: other fixed assets (bal. fig) 120,000
Opening Balance 400,000
Proposed Addition 200,000 Current Assets:
Stock in trade 299,346
Profit and Loss A/c 20,000 Sundry Debtors 838,154
Bank Balance 62,500
10% Debenture 300,000
Current Liabilities 600,000

2,020,000 2,020,000
Workings:
i) Proposed Dividend = 40% of paid up capital = 500,000 * 40% = 200,000
ii) Transfer to General Reserve = Proposed dividend = 200,000
iii) Profit carried forward (t/f to BS) = 200,000 * 10% = 20,000
iv) Provision for taxation = 350,000 * 50% =175,000
v) GP ratio = 60%
Sales = 718,431 / 60% = Rs. 1,197,385
vi) Closing stock = 1,197,385 * 25% = 299,346
vii) Opening general reserve = 200,000 * 2 = 400,000
viii) 10% Debenture = 30,000 / 10% = 300,000
ix) Ratio of current liabilities to debenture = 2
Current liabilities = 300,000 * 2 = 600,000
x) Current ratio = 2
Current assets = 1,200,000
Debtors = 1200,000 – 299,346 – 62500 = 838,154
Question No. – 1F
A company is presently working with an earnings before interest and taxes (EBIT) of Rs. 15
lacs. Its present borrowings are: Rs. In lacs
15% term loan 50
Borrowings from bank @20% 33
Public deposit @14% 15
The sales of the company are growing and to support this the company proposes to obtain
additional borrowings of Rs. 25 lacs. The increase in EBIT is expected to be 20%.
Calculate the change in interest coverage ratio after the additional borrowings and
commitment.
Solution:
Particulars Existing Proposed
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EBIT 15 18
Interest:
Interest on 15% long term loan 7.5 7.5
Interest on 20% borrowing 6.6 11.6
Interest on 14% public deposit 2.1 2.1
Total Interest 16.2 21.2
Interest Coverage 0.93 0.85
(EBIT / Interest)
Interest coverage has fallen by 0.8 due to additional borrowing.
Question No. – 1G
A company is capitalized as follows:
7% Preference shares, Rs. 1 each Rs. 600,000
Ordinary shares, Rs. 1 each Rs. 1,600,000
Rs. 2,200,000
The following information is relevant as to its financial year just ended:
Profit after tax at 50% is Rs. 542,000; Ordinary dividend paid 20%; Depreciation Rs.
120,000; Market price of ordinary shares Rs. 4; Capital commitment Rs. 240,000.
You are required to state the following showing the necessary workings:
i. The dividend yield on the ordinary shares;
ii. The cover for the preference and ordinary dividends;
iii. The earnings yield;
iv. The price earnings ratio and
v. The net cash flows.
Solution:
1) Dividend yield on the ordinary shares:
Dividend per share (DPS) = 1 * 20% = Rs. 0.2
.
Dividend yield = = = 5%
2) Preference Dividend and Ordinary Dividend coverage:
, , , ,
Preference Dividend Coverage = = , ∗ %
= ,
= 12.9 times
– , , , , , ,
Ordinary Dividend Coverage = = , , ∗ %
= , ,
= 1.56
times
3) Earnings Yield:
,
, ,
Earnings yield = = = 7.8%
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4) Price Earnings Ratio:
Price Earnings Ratio = = , = 12.9

, ,
5) Calculation of net cash flow:
Profit after tax 542,000

Add: Depreciation 120,000
Less: Dividend on
Preference shares 42,000
Equity Shares 320,000
Net Cash flow 300,000
Question No. – 1H
JKL Limited has the following Balance Sheets as on March 31, 2006 and March 31, 2005:
March 31, 2006 March 31, 2005
Source of Funds 2,377 1,472
Loan Funds 3,570 3,083
5,947 4,555
Application of Funds:
Fixed Assets 3,466 2,900
Cash and Bank 489 470
Debtors 1,495 1,168
Stock 2,867 2,407
Other current assets 1,567 1,404
Less: Current Liabilities (3,937) (3,794)
5,947 4,555
The Income Statement of the JKL Ltd. for the year ended is as follows:
Rs. In lakhs
March 31, 2006 March 31, 2005
Sales 22,165 13,882
Less: Cost of goods sold 20,860 12,544
Gross Profit 1,305 1,338
Less: Selling, General and Administrative expenses 1,135 752
EBIT 170 586
Interest expenses 113 105
Profit before tax 57 481
Tax 23 192
Profit after tax (PAT) 34 289
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Required:
a. Calculate for the year 2005-06
i. Inventory turnover ratio
ii. Financial leverage
iii. Return on investment (ROI)
iv. Return on equity (ROE)
v. Average collection period
b. Give a brief comment on the financial position of JKL Limited.
Solution:
i) Calculation of ratios for the year 2005-06:
a) Inventory Turnover Ratio:
,
Inventory Turnover Ratio = = = 7.91 times
( , , )/
b) Financial Leverage:
Financial Leverage = EBIT / EBT = 170 / 57 = 2.98
c) Return on investment (ROI):

ROI = = 170 / 5,947 = 2.86%
d) Return on Equity (ROE):

Return on Equity = = 34 / 2,377= 1.43%
e) Average Collection Period:

Average Collection period =
= 1,495 / (22,165 / 365) = 1,495 / 60.726 = 24.6 days
ii) Comment on financial position:

Current ratio is low, capital is blocked in inventory as compared to last year, affects
liquidity
Regarding utilization of debt capital, debt to assets ratio not high, it is levered company,
considerable risk to equity shareholders.
Question No. – 1I
MNP Limited has mande plans for the next year 2010-11. It is estimated that the company
will employ total assets of Rs. 2,500,000; 30% of assets being financed by debt at an interest
rate of 9% p.a. the direct cost for the year are estimated at Rs. 1,500,000 and all other
operating expenses are estimated at Rs. 240,000. The sales revenue are estimated at Rs.
2,250,000. Tax rate is assumed to be 40%. Required to calculate:
i. Net profit margin
ii. Return on assets
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iii. Assets turnover

iv. Return on equity
Solution:
Income Statement:
Sales 2,250,000
Less: Direct cost 1,500,000
Less: Other operating expenses 240,000
EBIT 510,000
Less: Interest (2,500,000 * 30% * 9%) 67,500
EBT 442,500
Less: Tax @ 40% 177,000
EAT 265,500
i) Net profit margin:

Net Profit Ratio = = 265,500 / 2,250,000 = 11.8%
ii) Return on assets:

( – ) , , ( – . )
Return on assets = = = 306,000 / 2,500,000 = 12.24%
iii) Assets turnover:

, ,
Assets Turnover = = , ,
= 0.9 times
iv) Return on equity:

, ,
Return on Equity= = = 15.17%
, , ∗ %
Question No. – 1J
CNP Distributors has the following Balance Sheet and Income Statement:
Balance Sheet
Liabilities Amount (Rs.) Assets Amount (Rs.)
Account Payable 80,000 Cash 25,00
Other current 20,000 Account Receivables 60,000
liabilities
Long term debt 100,000 Inventory 65,000
Share-holders equity 300,000 Long term Assets 350,000
(50,000 shares)
500,000 500,000
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Income Statement
Particulars Amount (Rs.)
Sales 900,000
Cost of goods sold 400,000
General, Administrative and Selling expenses 100,000
All other expenses 250,000
Net Income (EAT) 150,000
You are required to:
a. Determine CNP Distributors’ Liquidity position by calculating the current ratio,
working capital, the ratio of current assets to total assets, the ratio of current liabilities
to total assets and cash conversion cycle.
b. Calculate the current market price per share of CNP’s stock if its P/E ratio is eight
times earnings.
Solution:
i) Calculation of ratio for liquidity position:
, , ,
a) Current Ratio = = = 1,50,000 / 100,000 = 1.5
, ,
b) Working Capital = 150,000 – 100,000 = Rs. 50,000
,
c) Current Assets to Total Assets = = 0.3
, , ,
,
d) Current liabilities to total assets = ,
= 0.2
e) Cash conversion cycle:
Cash conversion cycle = Average collection period + Inventory collection Period - Average
payment
Period
= + -
, , ,
= , /
+ , /
-( , , )/
, , ,
= , .
+ , .
- , .
= 24.33 + 59.31 - 58.4 = 25.24 days
ii) Calculation of market share price:

Earnings per share = 150,000 / 50,000 = 3
19 | P a g e
Market price per share = EPS * PE ratio = 3 * 8 = Rs. 24 per share
Question No. – 1K
Using the following data, complete the balance sheet given below:
1) Gross profit Rs. 54,000
2) Shareholder's fund Rs. 600,000
3) Gross profit ratio 20%
4) Credit sales to total sales Rs. 80%
5) Total asset turnover 0.3 times
6) Inventory turnover 4 times.
7) Average collection period 20 days
8) Total 360 days in a year
9) Current ratio 1.8
10) Long term debt to equity 40%
Balance Sheet
Creditors ------------- Cash -------------
Debtors -------------
Inventory -------------
Long Term Debt -------------
Share-holder's fund ------------- Fixed Assets -------------
560,000 560,000
Solution:
Balance Sheet
Creditors 60,000 Cash 42,000
Debtors 12,000
Inventory 54,000
Long Term Debt 240,000
Share-holder's fund 600,000 Fixed Assets 792,000
9000,000 9000,000
Workings:
i) Gross profit = Rs. 54,000
Gross profit ratio = 20%
Sales = 54,000 / 20% = Rs. 270,000
ii) Credit sales = Rs. 270,000 * 80% = Rs. 216,000
iii) Total assets = 270,000 / 0.3 = Rs. 900,000
iv) Cost of sales = 270,000 * 80% = Rs. 216,000
Inventory = 216,000 / 4 = 54,000
v) Average collection period = Debtor / (216,000 / 360)
20 | P a g e
Or, Debtor = 20 * 600 = Rs. 12,000

vi) Long term debt to equity = 40%
Long term debt = 600,000 * 40% = 240,000
Creditors = 900,000 – 600,000 – 240,000 = 60,000
vii) Current ratio = Current assets / current liabilities
Or, 1.8 * 60,000 = Current Assets
Or, Current Assets = Rs. 108,000
Cash = 108,000 – 54,000 – 12,000 = Rs. 42,000
viii) Fixed Assets = 900,000 – 108,000 = Rs. 792,000
Question No. – 1L
From the following information, draw the Balance Sheet of M/s Ravi and Co. as on 31st
March, 2011:
Current ratio 2:1
Liquid ratio 1:1
Return on capital employed 10%
Fixed assets turnover ratio 5:8
Closing stock was 12.5% of sales
Owners’ equity to fixed assets 8:15
Debtor turnover 1 month
Debt equity ratio 5:4
For the year ended 31 March, 2011, M/s Ravi and Co. made a profit of Rs. 100,000 after
st
paying interest of Rs. 120,000 on term loan but before tax. Tax paid for the year was Rs.
40,000. Bank stood at Rs. 100,000 besides stock and debtors of the concern.
Solution:
Balance Sheet of M/S Ravi and Co. as on 31st March 2011
Equity 800,000 Fixed Assets 15,00,000
Term Loan 10,00,000
Bank 100,000
Current Liabilities 300,000 Debtors 200,000
Share-holder's fund Inventory 300,000
21,00,000 21,00,000
Workings:
i) Profit after interest but before tax Rs. 100,000
Add: Interest Rs. 120,000
EBIT Rs. 220,000
( ) , ,
Return on Capital Employed (ROCE) = =
21 | P a g e
Or, Capital employed = 180,000 / 10% = Rs. 1,800,000
ii) Debt equity ratio = 5:4

Assuming debt consist of term loan only,
Term loan = 1,800,000 * 5 / 9 = Rs. 1,000,000
Equity = Rs. 800,000
iii) Equity to fixed assets = 8:15

Fixed assets = 800,000 * 15 / 8 = Rs. 1,500,000
iv) Fixed assets turnover ratio = 5:8

Turnover = 1500,000 * 5 / 8 = Rs. 2,400,000
v) Closing stock = 2,400,000 * 12.5% = Rs. 300,000
vi) Debtor turnover = 1 month

Or, Debtors / (2,400,000 / 12) = 1
Or, Debtors = Rs. 200,000
vii) Current Assets = 100,000 + 200,000 + 300,000 = Rs. 600,000

viii) Current ratio = 2
Current liabilities = Rs. 600,000 / 2 = Rs. 300,000
Question No. – 1M
From the following information pertaining to M/s Sukanya and Co. Ltd prepares its
Trading, Profit and Loss A/c for the year ended on 31st March 2014 and as summarized
Balance Sheet as at that time:
Current ratio 2.5
Quick ratio 1.3
Propriety ratio (fixed assets / propriety fund) 0.6
Gross profit to sales ratio 10%
Debtor’s velocity 40 days
Sales Rs. 730,000
Working capital Rs. 120,000
Bank overdraft Rs. 15,000
Share capital Rs. 250,000
Closing stock is 10% more than opening stock
Net profit 10% of propriety funds.
Solution:
Trading and Profit and loss account
of M/S Sukanya and Co. Ltd for the period ended 31st March 2014
Particulars Amount Particulars Amount
To opening stock 105,000 By Sales 730,000
To Purchase (bal. fig.) 667,500 By Closing Stock 115,500
22 | P a g e
To Gross Profit 73,000

845,500 845,500
To other expenses 43,000 By Gross Profit 73,000
To Net Profit 30,000
73,000 73,000
Balance Sheet of M/S Sukanya and Co. Ltd as on 31st March 2014
Share Capital 250,000 Fixed Assets 180,000
Profit and loss a/c
opening (bal. fig) 20,000 Current assets:
current 30,000 Inventory 115,500
300,000 Debtors 80,000
Other Current liabilities 15,000 Other current assets 4,500
Bank overdraft 65,000
380,000 380,000
Workings:
i) Sales = Rs. 730,000
Gross profit = 730,000 * 10% = 73,000
ii) Current Ratio = 2.5

Current assets = 2.5 current liabilities
Working capital = 120,000
Current assets = 120,000 + current liabilities
Hence, 120,000 + current liabilities = 2.5 Current liabilities

Or, Current liabilities = 120,000 / 1.5 = 80,000
Or, Current assets = 2.5 * 80,000 = Rs. 200,000
iii) Quick ratio = 1.3

= 1.3
,
Or, , ,
= 1.3, Or, Closing Inventory = Rs. 115,500
Hence, Opening inventory = 115,500 * 100 / 110 = 105,000
iv) = 0.6
Or, = 0.4
23 | P a g e
,
Or, = 0.4. Or, Proprietary fund = Rs. 300,000
Net Profit = 300,000 * 10% = Rs. 30,000
v) Debtor's velocity = 40 days

Or, Debtors / (730,000 / 365) = 40
Or, Debtors = 80,000
vi) Other current assets = 200,000 – 115,500 – 80,000 = 4,500

vii) Other current liabilities = 80,000 – 65,000 = 15,000
Note: It is assumed that there is no other reserve except opening profit of Rs. 20,000.
Question No. – 1N
From the following ratios and further information prepare a Trading and Profit and Loss
Account and Balance Sheet of Mr. Green:
i. Fixed Assets/ Capital = 5/4
ii. Fixed Assets Rs. 500,000
iii. Capital / Liabilities =½
iv. Net / Capital = 1/5
v. Gross profit ratio 25%
vi. Stock turnover ratio = 10
vii. Fixed assets / total current assets = 5/7
viii. Net profit to sales = 20%
ix. Closing stock Rs. 50,000
Out of current assets, Sundry debtors are Rs. 600,000. The balance represents the cash and
closing stock.
Solution:
Trading and Profit and loss account of Mr. Green
To opening stock 10,000 By Sales 400,000
To Purchase (bal.fig) 340,000 By Closing Stock 50,000
450,000 450,000
To other expenses 20,000 By Gross Profit 100,000
100,000 100,000
Balance Sheet of Mr. Green

Share Capital 400,000 Fixed Assets 500,000
24 | P a g e
Current assets:
Inventory 50,000
Liabilities 800,000 Debtors 600,000
Cash 50,000
12,00,000 12,00,000
Workings:
i) Fixed assets = 500,000
Fixed assets / capital = 5/4
Or, Capital = 500,000 *4 / 5 = 400,000
ii) Capital / liabilities = ½
Or, Liabilities = 400,000 *2 = 800,000
iii) Net profit / capital = 1/5
Or, Net profit = 400,000 / 5 = 80,000
iv) Net profit ratio = 20%
Sales = 80,000 / 20% = 400,000
v) Gross profit ratio = 25%
Gross profit = 400,000 * 25% = 100,000
vi) Cost of sales = 400,000 * 75% = 300,000
vii) Stock turnover ratio = 10
or, 300,000 / average stock = 10
Or, Average stock = 30,000
Opening stock = 30,000 * 2 – 50,000 = 10,000
viii) Fixed assets / total current assets = 5/7
Or, total current assets = 500,000 * 7 / 5 = 700,000
ix) Cash = 700,000 – 600,000 – 50,000 = 50,000
Question No. – 1O
From the following information, prepare a summarized balance sheet as at 31st March
2014.
Current Ratio 1.75 Liquid Ratio 1.25
Stock turnover ratio (closing stock) 9 times Gross profit ratio 25%
Debt collection period 1.5 months Reserve or Capital 0.2
Turnover fixed assets 1.2 Capital Gearing ratio 0.6
Fixed assets to net worth 1.25 Sales for the year 1,200,000
Solution:
Balance Sheet
Share Capital 666,666 Fixed Assets 10,00,000
25 | P a g e
Reserve and surplus 133,334 Investment (bal.fig) 110,000

Current assets:
Long term loans 460,000 Inventory 100,000
Current Liabilities 200,000 Debtors 150,000
Other current assets 100,000
14,60,000 14,60,000
Workings:
i) Sales = 1,200,000
Gross profit ratio = 25%
Cost of sales = 1,200,000 * 75% = 900,000
ii) Stock turnover ratio = 9 times
Or, 900,000 / stock = 9
Or, Closing stock = 100,000
iii) Debt collection period = 1.5 months
Or, Debtors / (1,200,000 / 12) = 1.5
iv) Current ratio – quick ratio = Stock = 1.75 – 1.25 = 0.5 times
Or, current assets = 100,000 * 1.75 / 0.5 = 350,000
Or, Other current assets = 350,000 – 100,000 – 150,000 = 100,000
v) Turnover fixed asset = 1.2
Or, fixed assets = 1200,000 / 1.2 = 1,000,000
vi) Fixed assets to net worth = 1.25
Or, net worth = 1,000,000 / 1.25 = 800,000
vii) Reserve to capital = 0.2
Capital = 800,000 * 1 / 1.2 = 666,666
Reserve = 800,000 * 0.2 / 1.2 = 133,334
viii) Capital gearing ratio = Long term debt / equity = 0.6
Or, Long term debt = 0.6 * 800,000
Or, Long term debt = 460,000
Not: Balance figure of 110,000 is assumed to be investment.
Question No. – 1P
From the following information and ratios, prepare the Profit and Loss A/c for the year
ended 31st March, 2010, and the Balance Sheet as on that date of M/s Stan and Co. an
export company.
Current assets to stock 3:2 Current Ratio 3
Acid Test Ratio 1 Financial Leverage 2.2
Earnings per share (each of Rs. 10) 10 Book value per share (Rs.) 40
26 | P a g e
Stock turnover ratio 5 Fixed assets turnover ratio 1.2

Total liabilities to net worth 2.75 Net working capital Rs. 10 lakhs
Net profit to sales 10% Variable cost 60%
Long term loan interest 12% Taxation Nil
Average collection period (assume 30 days
360 days in a year)
Solution:
Profit and loss a/c for the year ended 31st march 2010
Particulars Amount
Sales 5,000,000
Less: variable cost 3,000,000
2,000,000
operating fixed cost (bal.fig) 900,000
EBIT 1,100,000
Interest (bal.fig) 600,000
EBT 500,000
Less: tax -
EAT 500,000
Balance sheet as on 31st march 2010

Particulars Amount
Shareholder's fund 2,000,000
-
Long term loans 5,000,000
-
Current liabilities 500,000
Total 7,500,000
-
Fixed Assets 4,166,700
-
Investment (bal.fig) 1,833,300
-
Current assets: -
Inventory 1,000,000
Debtors 416,700
Total 7,500,000
Workings amount in lakhs
27 | P a g e
i) Net working capital = 10

Current assets = 10 + current liabilities
Current ratio = 3
Current assets = 3 current liabilities
Hence,
3 current liabilities = 10 + current liabilities
Or, Current liabilities = 10/2 = 5
Or, Current assets = 5 * 3 = 15
ii) Current assets to stock = 3:2

Or, Stock = 15 *2/3 = 10
iii) Stock turnover ratio = 5

Or, Sales = 10 * 5 = 50
Variable cost = 50 * 60% = 30
iv) Net profit = 50 * 10% = 5

Since, tax is nil , EBT = EAT = 5
v) Financial leverage = 2.2

Or, EBIT / 5 = 2.2
Or, EBIT = 11
vi) Interest on 12% long term loan = EBIT – EBT = 11 – 5 = 6

Long term loan = 6 / 12% = 50
vii) Total liabilities to net woth = 2.75

Or, Net worth = (50 + 5) / 2.75 = 20
viii) Average collection period = 30 days

Or, debtors / (50 / 360) = 30
Or, Debtors = 4.167
ix) Other current assets = 15 – 10 – 4.167 = 0.833
x) Fixed assets to turnover = 1.2

Or, Fixed assets = 50 / 1.2 = 41.667
Note: Remaining balancing figure in assets is assumed to be investment.
28 | P a g e
Question No. – 1Q
Following is the abridged balance sheet of the Everest Co. Ltd as at 31st March 2006
Paid up share capital 500,000 Free hold property 400,000
Profit and loss account 85,000 Plant and Machinery 250,000
Less: Depreciation (75,000)
Current Liabilities 200,000 Stocks 105,000
Debtors 100,000
785,000 7,85,000
From the following information you are required to prepare profit and loss account and
balance sheet as at 31st March 2007:
a. The composition of the total of the liabilities side of the company’s balance sheet as
31st march 2007 (paid up share capital remaining same as at 31st March 2006) was:
Share capital 50% Profit and loss account 15%
7% Debentures 10% Creditors 25%
The debenture was issued on 1 April 2006, interest being paid on 30 September
st th
2006 ad 31st March 2007.

b. During the year ended on 31st March 2007, additional plant and machinery has been
bought and a further Rs. 25,000 depreciation written off. Freehold property
remained unchanged. The total fixed assets then constituted 60% of total fixed and
current assets.
c. The current ratio was 1.6:1.The quick assets ratio was 1:1.
d. The debtors (four fifth of quick assets) to sales ratio revealed a credit period of two
months.
e. Gross profit was at the rate of 15% of selling price and return on net worth as at 31st
March 2007 was 10%. Ignore taxation.
Solution:
Profit and loss for the year ended 31st March 2007
To opening stock 105,000 By Sales 1,200,000
To Purchase (bal. fig.) 1,065,000 By Closing Stock 150,000
1,350,000 1,350,000
To other expenses (bal. fig.) 83,000 By Gross Profit 180,000
Interest 7,000
Depreciation 25,000
180,000 180,000
29 | P a g e
Balance Sheet as at 31st March 2007

Share Capital 500,000 Fixed Assets
Profit and loss a/c 150,000 Free hold property 400,000
Plant and machinery 300,000
7% debentures 100,000 Less: Depreciation 100,000 200,000
Current assets:
Inventory 150,000
Debtors 200,000
Current liabilities 250,000 Other current assets 50,000
1,000,000 1,000,000
Workings:
i) Total equity and liability = 500,000 / 0.5 = 1,000,000
ii) Profit and loss a/c = 1,000,000 * 15% = 150,000
iii) 7% debentures= = 1,000,000 * 10% = 100,000
Interest on debenture = 100,000 * 7% = 7000
iv) Creditor = 1,000,000 * 25% - 250,000
v) Total fixed assets = 60% of total assets = 1,000,000 * 60% = 600,000
Net plant and machinery = 600,000 – 400,000 = 200,000
Gross plant and machinery = 200,000 + (75,000 + 25,000) = 300,000
vi) Current assets = 1,000,000 – 600,000 = 400,000
vii) Current ratio = 1.6
viii) Liquid ratio = 1
Or, Liquid assets = 250,000
Or, Closing stock = 400,000 – 250,000 = 150,000
ix) Debtors = 4 / 5 * 250,000
Other current assets = 400,000 – 150,000 – 200,000 = 50,000
x) Average collection period = 2 months
Or, Debtors / (sales / 12) = 2
Or, Sales = 200,000 / 2 * 12 = 1,200,000
xi) Gross profit = 1,200,000 * 15% = 180,000
xii) Net worth = 500,000 + 150,000 = 650,000
Return on net worth = 10%
Net profit = 650,000 * 10% = 65,000
30 | P a g e
Question No. – 2A
A company given you the following information:
Year 1 Year 2
Sales Rs. 500,000 Rs. 800,000
Operating profit Rs. 200,000 Rs. 360,000
Capital employed Rs. 1,000,000 Rs. 1,250,000
Required:
Give your comments on the basis of Du-Pont Analysis.
Solution:
Calculation of ROCE on the basis of Du-pont analysis:
Return on ROCE = Operating profit margin x Capital turnover ratio
= x
, ,
Year 1 = x = 0.2
, , ,
, ,
Year 2 = x = 0.288
, , ,
Comment: A company return on capital employed has increased in year 2 as compared to

year 1 which shows that it is worthwhile to invest in the company.
Question No. – 2B
The financial statements of Excel AMP Graphics Limited are as under:
Balance Sheet as at 31st December 2013
Source of Funds: 2013 2012
Shareholder's Fund
Share Capital 1,121 931
Reserve and Surplus 8,950 10,071 7,999 8,930
Loan Funds
Secured Loans - 259
Finance Lease Obligation 74 -
Unsecured Loans 171 245 115 374
Total 10,316 9,304
Application of Funds:
Fixed Assets
Gross Block 6,667 5,747
Less: Depreciation (3,150) (2,561)
Net Block 3,517 3,186
31 | P a g e
Capital Work in Progress 27 3,544 28 3,214

Investments 288 222
Current Assets, Loans

and Advances
Inventories 2,709 2,540
Sundry Debtors 9,468 9,428
Cash and Bank Balances 3,206 662
Loans and Advances 2,043 17,426 1,712 14,342
Less: Current Liabilities

and Provisions
Current Liabilities 10,109 7,902
Provisions 513 10,622 572 8,474
Net Current Assets 6,804 5,868

Net Deferred Tax Liability (320) -
Total 10,316 9,304
Profit and Loss Account for the year ended 31st December 2013
Source of Funds: 2013 2012
Income
Sales and Services 23,436 17,849
Other Income 320 23,756 306 18,155
Expenditure
Cost of Materials 15,179 10,996
Personnel Expenses 2,543 2,293
Other expenses 3,543 2,815
Depreciation 419 383
Less: Transfer from revaluation reserve (7) 412 (6) 377
Interest 164 88
21,841 16,569
Profit before tax 1,915 1,586
Provision for tax:
Current Tax 450 371
Deferred Tax - -
Profit after tax 1,465 1,215
a. Compute and analyze the return on capital employed (ROCE) in a Du Pont Control
Chart Framework.
b. Compute and analyze the average inventory holding period and average collection
period.
32 | P a g e
c. Compute and analyze the return on equity by bringing out clearly the impact of
financial leverage.
Solution: 2013 2012

Profit before tax Rs. 1,912 Rs. 1,586
Add: Interest Rs. 164 Rs. 88
EBIT Rs. 2,076 Rs. 1,674
Less: other income Rs. 320 Rs. 306
Operating EBIT Rs. 1,756 Rs. 1,368
Capital Employed Rs. 10,316 Rs. 9,304

Operating capital employed Rs.7,958 Rs. 7,342
(10,316 – 27 – 288 – 2,043) (9,304 – 28 – 222 – 1,712)
a) Calculation of ROCE in a of Du-pont chart:
Return on ROCE = Operating profit margin x Capital turnover ratio
= x
, ,
2013 = ,
x ,
= 22.06%
, ,
2012 = x = 18.63%
, ,
b) i) Calculation of average inventory holding period:
Average Inventory holding period = /
,
2013 = = 64.14 days
, /
,
2012 = = 84.31 days
, /
i) Calculation of average collection period:
Average collection period =

/
,
2013 = , /
= 147.46 days
,
2012 = = 192.8 days
, /
c) Calculation of Return on equity (ROE):
33 | P a g e
Return on equity =
,
2013 = = 14.55%
,
,
2012 = ,
= 13.61%
ROA (post-tax) = ROCE ( 1 − t)
2013 = 22.06%(1 − 0.35) = 14.34%
2012 = 18.63%(1 − 0.35) = 12.11%
Analysis: ROE is better than ROA, since debt equity employed is minimal.

Following are the financial details of two farmers Mr. M and Mr. N, who belongs to the
same area at the end of financial year 2071-72:
Income Statement Rs. in lakhs
M N
Gross Revenue (Value from farm production) 125 80
Cost of Production 64 56
Gross Farm Income 61 24
Operating Expense attributable to agriculture 24 12
Interest Expense on Agricultural Loans 4 1
Net Farm Income from Operations 33 11
Tax 0 0
Net Farm Income 33 11
Balance Sheet Rs. in lakhs
M N
Assets
Biological Assets 49 22
Non-Current Assets 75 40
Current Assets 9 3
Total Assets 133 65
Previous year Total Assets 97 48
Equity and Liabilities

Equity 63 37
Non-Current liability (full debt) 14 8
Current Liability (80% renewable debt) 56 20
34 | P a g e
Total Equity and Liabilities 133 65
The increase in total assets of Mr. M owed to increase in Non-current asset (80% of total
assets increment), whereas increase in total assets of Mr. N owed to increase in biological
asset (75% of total asset increment). Furthermore, the current asset of Mr. M and Mr. N
grew by Rs. 2 lakhs and Rs.1 lakh respectively.
Required
i) Calculate profit margin ratio, asset turnover and debt-equity ratio.
ii) Calculate return on equity using Du Pont formula.
Solution:
Income Statement:
i) Calculation of profit margin ratio, asset turnover and debt-equity ratio.
M N
Profit Margin ratio 26.4% 13.75%
(Profit / Sales) (33 / 125) (11 / 80)
Asset Turnover 1.09 1.42
(Turnover / Average Assets) (125 / 115) (80 / 56.5
Debt Equity ratio 0.93 0.65
(Debt / Equity) (58.8 / 63) (24 / 37)
ii) Calculation of return on equity using Du Pont formula.

Return on Equity (M) = Net profit margin x Assets turnover x asset to equity ratio
= 0.264 x 1.09 x (115 / 63) = 52.66%
Return on Equity (N) = Net profit margin x Assets turnover x asset to equity ratio
= 0.1375 x 1.42 x (56.5 / 37) = 29.87%
Other Miscellaneous Questions:

Question No. – 3A (June. 2009 – 12 Marks)
Saleways Ltd. purchased a retail store in Kathmandu Valley and commenced the business
on Shrawan 1, 2064. Following information is also available regarding the operations of the
retail store:
Particulars Amount (Rs.)

Capital introduced on Shrawan 1 2,350,000
Drawings during the year 250,000
Working Capital (current assets less current liabilities) 1,150,000
Depreciation of fixed assets during the year, based on a rate of 20 per cent
per annum on cost 150,000
Ratio of annual sales to "year-end values of fixed assets plus working
capital" 2:1
Ratio of current assets to current liabilities at the year-end 2:1
35 | P a g e
Ratio of liquid assets (cash plus debtors) to current liabilities on year-end 5:4
Debtors at the year-end as per cent of annual sales 12
General expenses (excluding depreciation) as per cent of annual sales 20
The current assets consist of stocks (which is unchanged throughout the year), debtors and
cash. Stocks were turned over (stock turnover) four times during the year. The current
liabilities consisted only of creditors.
After considering all the information provided above, you are required to prepare the
following in as much details as possible:
i) Trading and profit and loss account for the year ended 32 Ashadh 2065, and
ii) Balance sheet as at Ashadh end 2065.
Solution:
Trading and profit and loss account for the year ended 32 Ashadh 2065
Particular Amount Particular Amount
To Cost of Sales 3,450,000 By Sales 3,500,000
To Gross Profit c/d 50,000
Total 3,500,000 Total 3,500,000
To General Expenses 700,000 By Gross Profit b / f 50,000
To Depreciation 150,000 By Net Loss c/d 800,000
Total 850,000 Total 850,000
Balance sheet as at Ashadh end 2065

Equity and Liabilities Amount Assets Amount
Opening Capital 2,350,000 Fixed Assets 750,000
Add: Capital Introduction (b/f) 450,000 Less: Depreciation (150,000)
Less: Net Loss (800,000)
Less: Drawings (250,000)
Current Liabilities Current assets

Creditors 1,150,000 Cash and cash equivalent 1,017,500
Debtors 420,000
Inventories 862,500
Total 2,900,000 Total 2,900,000
Workings:
a) Working Capital (Current Assets – Current Liabilities) = Rs. 1,150,000

Hence, Current Assets = Rs. 1,150,000 + Current liabilities ------------ (1)
Current Ratio (Current Assets / Current Liabilities) = 2:1

Or, Current Assets = 2 Current Liabilities --------------- (2)
36 | P a g e
Hence by equation (1) and (2)

2 Current Liabilities = 1,150,000 + Current Liabilities
Or, Current Liabilities = Rs. 1,150,000
And Current Asset = 1,150,000 * 2 = Rs. 23,00,000
b) Depreciation (20% of Fixed Asset) = Rs. 150,000

Hence, Fixed Asset = Rs. 150,000 / 20% = Rs. 750,000
c) Ratio of annual sales to 'year-end values of fixed assets plus working capital' = 2
Or, Sales = 2 * (750,000 – 150,000 + 1,150,000)
Or, Sales = Rs. 3,500,000
d) Ratio of liquid assets = 5:4
Or, ==
Or, ==
, ,
Or, Liquid Assets = Rs. 1,437,500
e) Debtor = Sales * 12% = Rs. 3,500,000 * 12% = Rs. 420,000

Hence, Cash = Liquid Assets – debtor = Rs. 1,437,500 – 420,000 = Rs. 1,017,500
f) General Expenses = Sales * 20% = Rs. 3,500,000 * 20% = Rs. 700,000
g) Stock = Current Assets – Liquid Assets = Rs. 2,300,000 – 1,437,500 = Rs. 862,500
h) Stock Turnover ratio = Cost of sales / Stock

Or, 4 = Cost of sales / 862,500
Or, Cost of Sales = Rs. 3,450,000
Question No. – 3B (Dec. 2009 – 15 Marks)

The summarized accounts of New Ideas Ltd. are as follows:
Balance Sheet as at Ashadh End
Year 2 (Rs. 000) Year 1 (Rs. 000)
Fixed asset (Net) 6,401 2,519
Current Assets
Stock 25,426 20,231
Debtors 21,856 20,264
Bank 2,917 6,094
Total 56,600 49,108
Ordinary Shares of Rs. 100 5,000 5,000
Revenue Reserves 14,763 12,263
Deferred Taxation 5,433 3,267
10% Debenture Loans 10,000 10,000
37 | P a g e
Current Liabilities
Trade Creditors 18,762 16,431
Taxation 1,642 1,247
Dividends 1,000 900
Total 56,600 49,108
Results for the year ended Ashadh

Year 2 (Rs. 000) Year 1 (Rs. 000)
Sales 264,626 220,393
Trading Profit 9,380 8,362
Interest Payable 1,000 1,000
Taxation 4,380 3,642
Dividend 1,500 1,400
The following additional information is provided:

 The ordinary shares are quoted as Rs. 240.
 The Company requires Rs. 16 million for an investment project and is considering
one of the following:
o The issue of Rs. 16 million 10% debentures.
o A right issue at par.
You are required to:
a) Calculate for both years (i) two ratios particularly significant to creditors, (ii) two ratios
particularly significant to management, and (iii) two ratios particularly significant to
shareholders. And, express a brief comment on the trend of ratios.
b) Calculate the immediate effect of the two schemes of fund raising on the gearing of the
company and comment.
c) Calculate the effect of the two schemes on the earnings per share, on the assumption that
the Year 2 profits from the existing assets will be maintained and that Rs.16 million net
investments will produce profits of Rs.3.5 million before tax and interest. The rate of tax
can be assumed at 25%.
Solution:
a) Calculation of two ratios for both years:
i) Significant to creditors:
Year 2 (Rs. 000) Year 1 (Rs. 000)
Current Ratio = 2.35 2.51

(50,199 / 21404) (46,589 / 18,578)
Quick Ratio = 1.16 1.42

(24,773 / 21404) (26,358 / 18,578)
38 | P a g e
ii) Significant to management:

Year 2 (Rs. 000) Year 1 (Rs. 000)
Return on capital employed 26.7% 27.4%

= (9,380 / 35,196) (8,362 / 30,530)
Return on assets (pre-tax) 16.6% 17.0%

= (9,380 / 56,600) (8,362 / 49,108)
iii) Significant to shareholders:

Year 2 (Rs. 000) Year 1 (Rs. 000)
Return on equity 20.2% 21.6%

= (4,000 / 19,763) (3,720 / 17,263)
Dividend coverage ratio = 2.7 2.7

(4,000 / 1,500) (3,720 / 1,400)
Comment on trend of ratios: As sales and operating is increased in compare to last year,
accordingly increment of ratio can be seen from last year to current year.
b) Calculation of the immediate effect of the two schemes of fund raising on the gearing of
the company:
Capital Gearing Ratio =
,
i) Current Gearing ratio = = 50.6%
, ,
, ,
ii) Gearing ratio at after issue of Rs. 16 M 10% debenture = , ,
= 131.6%
,
iii) Gearing ratio at after issue of Rs. 16 M right share = = 28%
, , ,
Comment: The first scheme will lead to high level of gearing.
c) Calculation of the effect of the two schemes on the earnings per share
EPS = .
,
i) Current EPS = = Rs. 80
39 | P a g e
,
ii) EPS after issue of Rs. 16 M 10% debenture = = Rs. 108.5
Where,
Total operating profit (9,380 + 3,500) 12,880
Less: interest (1,000 + 1,600) 2,600
Profit before tax 10,280
Less: tax 4,855 (4,380 + 475)
,
iii) EPS at after issue of Rs. 16 M right share = = Rs. 31.55
Where,
Total operating profit (9,380 + 3,500) 12,880
Less: interest 1,000
Profit before tax 11,880
Less: tax 5,255 (4,380 + 875)

The clients of an accounting firm wherein you are employed are concerned about the fall in
dividend from a company whose shares they hold as investment. The abridged profit and
loss account and balance sheet of the company for two years are given as follows:
Abridged P & L A/C (year ended Ashadh 31) Rs. in lakhs
Particulars Current Year Previous year
Income:
Sales and other income 19,200 15,500
Expenditure:
Operating and other expenses 15,600 11,900
Less: Interest 1,850 1,750
18,150 14,300
Profit for the year 1,050 1,200
Taxes 500 200
Profit after taxes 550 1,000
Proposed Dividend 200 400
Abridged Balance-sheet as on Ashadh 31 Rs. in lakhs

Source of Funds:
Share Capital 4,200 2,600
Reserve and Surplus 7,550 1,200
Convertible portion of 12% Debentures - 500
Loan Funds:
40 | P a g e
Secured Loans (16%) 10,100 8,700

Unsecured Loans (15%) 1,000 3,300
Total 22,850 16,300
Application of funds:
Fixed Assets:
Cost 14,800 11,200
Less: Depreciation 2,700 2,000
12,100 9,200
Advances on Capital A/c & Work in progress 1,000 200
13,100 9,400
Current Assets, Loan and Advances
Inventories 8,600 7,100
Sundry Debtors 1,400 550
Cash and Bank Balances 850 680
Loans and Receivables 3,000 1,600
13,850 9,930
Less: current liabilities 4,100 3,030
9,750 6,900
Total 22,850 16,300
Compute the following: Interest Cover, return on net worth, earning per share, dividend
cover.
Solution:
Calculation of Net worth and No. of shares: (Rs. in lakhs)
Share Capital 4,200 2,600
Reserve and Surplus 7,550 1,200
Net worth 11,750 3,800
No. of Shares 420 260
Income Statement:
Sales and other income 19,200 15,500
Less:
Operating and other expenses 15,600 11,900
EBIT 2,900 2,950
Less: Interest 1,850 1,750
EBT 1,050 1,200
Less: Tax 500 200
EAT 550 1,000
Proposed Dividend (D) 200 400
Now,
41 | P a g e
i) Interest Coverage Ratio (EBIT / Interest) 1.57 1.69

ii) Return on net worth (EAT / Net Worth) 0.047 0.263
iii) Earnings per share (EAT / No. of shares) 1.31 3.85
iv) Dividend Cover (EAT / Dividend) 2.75 2.5
Question No. – 3D (Dec. 2010 – 20 Marks)

The following are the financial statements of PQR Ltd. for 2066/67.
Balance Sheet of PQR Ltd. as on Ashadh end 2066/67
Liabilities Amount (Rs.) Assets Amount (Rs.)
Equity Share Capital 210,000 Cash 105,000
Reserves 420,000 Debtors 525,000
Preference Share Capital 420,000 Stock 735,000
Long-term Debts 1,260,000 Fixed Assets (Net) 1,575,000
Creditors 420,000 Goodwill 210,000
Bills Payable 210,000
Outstanding Expenses 60,000
Provision for Tax 150,000
3,150,000 3,150,000
Income Statement of PQR Ltd.

for the year ending Ashadh, 2067
Rs. Rs.
Sales
Cash 420,000
Credit 1,680,000 2,100,000
Less: Expenses
Cost of Goods Sold 1,260,000
Selling, Administration and General Expenses 210,000
Depreciation 147,000
Interest on Long-term Debt 63,000 1,680,000
Profit Before Taxes 420,000
Taxes 210,000
Profit After Taxes 210,000
Less: Preference Dividend 25,500
Net Profit for Ordinary Shareholders 184,500
Add: Reserve at 1 Shrawan 2066 273,000
Profit Available to Ordinary Shareholders 457,500
Less: Dividend Paid to Equity Shareholders 37,500
Reserve at Ashadh end 2067 420,000
The ratios for the previous two years relating to the company and the industry ratios are
given below:
42 | P a g e
2064/065 2065/066 Industry

Current Ratio 2.54 2.1 2.3
Acid-test Ratio 1.1 0.96 1.2
Debtors Turnover 6 4.8 7
Stock Turnover 3.8 3.05 3.85
Long-term Debt to Total Capital 37% 42% 34%
Gross Profit Margin 38% 41% 40%
Net Profit Margin 18% 16% 15%
Return on Equity 24% 29% 19%
Return on Total Assets 7% 6.80% 8%
Tangible Assets Turnover 0.8 0.7 1
Interest Coverage 10 9 10
Based on the above financial statement and ratios of the company and the industry
provided above, you are required to:
a) Calculate the same ratios as provided above for 2066/067,
b) Evaluate the company‘s financial position of the company on the basis of these ratios and
past ratios of the company and the industry,
c) Using relevant ratios, indicate what decision would be taken in the following situations:
i) PQR Ltd. wants to buy materials of Rs. 210,000 on a three months credit from a
domestic supplier company.
ii) PQR Ltd. wants to issue 15% debentures of Rs. 600,000 with a 10 year maturity period.
Solution:
a) Calculation of the same ratios for 2066/067:
Formula workings ratio
(Current Asset)/(Current
Current Ratio Liability) 13,65,000 / 840,000 1.63
(Quick Asset)/(Current
Acid-test Ratio Liability) 630,000 / 840,000 0.75
(Credit Sales)/(Average
Debtors Turnover account receivable) 16,80,000 / 525,000 3.20
Stock Turnover (Cost of Sales)/(Closing Stock) 12,60,000 / 7,35,000 1.71

Long-term Debt to
Total Capital long term debt / total capital 12,60,000 / 23,10,000 54.5%
Gross Profit
Margin Gross Profit / Sales 8,40,000 / 21,00,000 40.0%
Net Profit Margin Net Profit / Sales 2,10,000 / 21,00,000 10.0%
Profit for equity shareholders /
Return on Equity equity 1,84,500 / 6,30,000 29.3%
Return on Total
Assets EBIT ( 1 - tax) / Total Assets 2,41,500 / 31,50,000 7.7%
Tangible Assets
Turnover Turnover / tangible assets 21,00,000 / 29,40,000 0.71
43 | P a g e
Interest Coverage EBIT / Interest 4,83,000 / 63,000 7.67
b) Based on the ratios computed above, evaluation of the company’s position is presented
below:
 The liquidity position of the firm is falling which is evident from the Ratios 1 to 4
computed above.
 The gross profit margin is constant and matches with the industry average, but the net
profit margin ratio is declining. The two ratios together imply that the company‘s selling
and administrative expenses, depreciation and interest charges are on the rise.
 The decline in the net margin is partly due to rapid increase in debt (Ratio 5). This
increase also explains why the return on equity (Ratio 8) has been rising while the
return on assets is declining (Ratio 9).
 The decline in the net margin and the return on assets can also be attributed to the
decline in assets turnover (Ratio 10).
 The impact of the increase in debt and overall decline in profitability are also shown by
reduction in the interest coverage (Ratio 11).
c) Decision under Different Situations:

i) The supplier would be more concerned with the liquidity of current assets of the
company. Therefore, Ratios 1 to 4 are more relevant to the supplier. In view of the
deteriorating liquidity position and the increasing terms of payment due to deteriorating
liquidity position, the credit may not be granted to the company.
ii) Revised Debt equity after issue of debenture = 1,860,000 / 2,910,000 = 63.92%
Revised interest coverage ratio = 483,000 / (63,000 + 90,000) = 3.15
The company may find difficulty in selling the debentures. Already, it has a high
leverage ratio. If the debentures are issued its leverage ratio (debt to total capital) will
increase to 63.92 percent and the interest coverage ratio at the same level of earning will
decline to 3.15. In addition, the liquidity and the profitability of the company are also
declining. Therefore, it is not proper time to issue the debentures.
Question No. – 3E (June. 2012 – 7 Marks)

Assume that RCT Limited has owner's equity of Rs. 100,000. The ratios for the firm are as
follows:
Current Debt to total debt 0.40

Total Debt to owner's equity 0.60
Fixed Assets to owner's equity 0.60
Total assets turnover 2 times
Inventory turnover 8 times
Required: Complete the following balance sheet:

Liabilities and Capital Amount (Rs.) Assets Amount (Rs.)
Current Debt .......... Cash `
Long Term Debt ........... Inventory ...........
44 | P a g e
Total Debt ........... Total Current Assets ...........

Owners’ Equity ........... Fixed Assets ...........
Total Capital and Liabilities ........... Total Assets ...........
Solution:
Balance-sheet:

Current Debt 24,000 Cash 60,000
Long Term Debt 36,000 Inventory 40,000
Total Debt 60,000 Total Current Assets 100,000
Owners Equity 100,000 Fixed Assets 60,000
Total 160,000 Total 160,000
a) Total debt to owner's equity = 0.6

Total debt = Rs. 100,000 * 0.6 = Rs. 60,000
b) Current debt to total debt = 0.4
Current debt = 60,000 * 0.4 = Rs. 24,000
c) Fixed Assets to owner's equity = 0.6
Fixed Assets = 100,000 * 0.6 = Rs. 60,000
d) Current Assets = Total assets – Fixed assets = 100,000 + 60,000 – 60,000 = Rs. 100,000
e) Total assets turnover = 2 times
Sales = Rs. 160,000 * 2 = Rs. 320,000
f) Inventory sales = 8
Inventory = Rs. 320,000 / 8 = Rs. 40,000
g) Cash = Current assets – Inventory = 100,000 – 40,000 = Rs. 60,000
h) Long term debt = Total debt – Current debt = 100,000 – 24,000 = 36,000
Question No. – 3F (June. 2013 – 8 Marks)

Following are the ratios of the business of Ganesh Traders Ltd., dealing in the machineries,
for the year ended 31st Ashadh, 2069:
Average Collection Period 3 months

Stock Turnover 1.5 times
Average Payment Period 2 months
Gross Profit Ratio 25%
Opening Receivable Rs. 600,000
Gross Profit for the year ended 31st Ashadh, 2069 amounted to Rs. 800,000. Closing stock
of the year is Rs. 20,000 above the opening stock. Closing bills receivable amounted to Rs.
50,000 and bills payable to Rs. 20,000.
Required: calculate
i) Sales
ii) Sundry Debtors
iii) Closing Stock
iv) Sundry Creditors
45 | P a g e
Solution:
i) Calculation of Sales:
Gross Profit ratio = 25%
Sales = 800,000 / 25% = Rs. 3,200,000
ii) Sundry Debtors

Average collection period = Average Account Receivable / Average credit sales per month
Or, 3 months = Average account receivable / (3,200,000 / 12)
Or, Average account receivable = Rs. 800,000
Or, (Opening receivable + closing receivable) / 2 = 800,000
Or, (600,000 + closing receivable) = 1,600,000
Or, Closing receivable = 1,000,000
Now,
Closing Receivable = Sundry Debtor + Closing bill receivable
Or, Sundry Debtor = 1,000,000 – 50,000 = Rs. 9,50,000
iii) Calculation of closing stock

Cost of sales = 75% of 3,200,000 = Rs. 2,400,000 (since, GP ratio = 25%)
Stock Turnover = cost of sales / average stock

Or, 1.5 times = 2,400,000 / average stock
Or, Average stock = Rs. 1,600,000
Let, Opening stock be x

Or, (x + 20,000 + x) / 2 = 1,600,000
Or, x = 1,590,000
Hence, Closing stock = 1,590,000 + 20,000 = 1,610,000
iv) Calculation of Sundry Creditors

Credit Purchase = Cost of sales + closing stock – opening stock
= 2,400,000 + 1,610,000 – 1,590,000 = Rs. 2,420,000
Average payment period = Average account payable / average credit purchase per day
Or, 2 months = Average account payable / (2,420,000 / 12)
Or, Average account payable = Rs. 403,000
Hence, Sundry Creditors = Account payable – bills payable
= Rs. 403,333 – 20,000 = Rs. 383,333
Question No. – 3G (Dec. 2013 – 10 Marks)

You are provided with the following information of Zinc Ltd.:
Fixed assets (After writing off 30% value) Rs. 1,050,000
Fixed assets turnover ratio (on cost of sales) 2
Finished goods turnover ratio (on cost of sales) 6
Gross profit rate on sales 25%
Net profit (before interest) to sales 8%
Fixed charges cover (debenture interest 7%) 8
Debt collection period 1.5 months
46 | P a g e
Materials consumed to sales 30%

Stock of raw materials (in terms of month's consumption) 3 months
Current ratio 2.4
Quick ratio 1.0
Reserves to capital ratio 0.21
Required:
a) Use the above information and prepare the balance sheet of Zinc Ltd.
b) The statement showing working capital requirement, if the company wants to make
a provision for contingencies @ 10 percent of net working capital including such
provision.
Solution:
a) Balance-sheet of Zinc Ltd:
Capital 1,000,000 Fixed Assets 1,050,000
Reserve 210,000 Current Assets:
Cash 50,000
7% Debenture 400,000 Inventory 560,000
Current Liability 400,000 Debtor 350,000
Total 2,010,000 Total 2,010,000
b) Calculation of working capital requirement including 10% provision:

Working capital = current assets – current liabilities = 960,000 – 400,000 = 560,000
Now, working capital including provision = 560,000 / (1 – 0.10) = Rs. 622,222
Workings:
a) Fixed assets turnover ratio = 2=
Hence, Cost of sales = 1,050,000 * 2 = Rs. 2,100,000
b) Finished goods turnover ratio = 6
Hence, Finished Goods = 2,100,000 / 6 = Rs. 350,000
c) GP ratio = 25%, i.e. cost of sales ratio = 75%
Hence, Sales = 2,100,000 / 75% = Rs. 2,800,000
Hence, Gross Profit = 2,800,000 * 25% = 700,000
d) Net profit before interest to sales = 8%
Hence, Net profit before interest = 224,000
e) Interest cover = 8
Hence, Interest = 224,000 / 8 = Rs. 28,000
Hence, Value of 7% debenture = 28,000 / 7% = Rs. 400,000
f) Debt collection period = 1.5 months
Debtor = 2,800,000 / 12 * 1.5 = Rs. 350,000
g) Material consumed to sale = 30%
Material consumed = 2,800,000 * 30% = 840,000
h) Ram material stock = 840,000 * 3 / 12 = 210,000
i) Total inventory = finished goods + ram material stock = 350,000 + 210,000 = Rs. 560,000
j) Current ratio = 2.4
47 | P a g e
Quick ratio = 1
Hence, value of stock = 2.4 -1 = 1.4 times = Rs. 560,000
Hence, Current liabilities = 560,000 / 1.4 = Rs. 400,000
Current assets = 400,000 * 2.4 = Rs. 960,000
k) Cash = 960,000 – 350,000 – 560,000 = 50,000
l) Net worth = 2,010,000 – 400,000 – 400,000 = Rs. 1,210,000
m) Reserve to capital ratio = 0.21
Net worth = 1 + 0.21 = 1.21 times = Rs. 1,210,000
Hence, Reserve = 210,000
Capital = 1,000,000
Question No. – 3H (Dec. 2015 – 5 Marks)

MNP Limited has made plans for the year 2015-16. It is estimated that the company will
employ total assets of Rs. 25 lakh. Thirty percent of the assets would be financed by debt at
an interest rate of 9% p.a. The total direct cost for the year is estimated at Rs. 15 lakhs and
all other operating expenses are estimated at Rs. 240,000. The sales revenue is estimated
at Rs. 2,250,000. The tax rate is 25%.
Required: Calculate
i) Return on assets
ii) Assets turnover
iii) Return on equity
Solution:
Income Statement:
Sales 2.250,000
Less: Direct cost 1,500,000
Other operating expenses 240,000
EBIT 510,000
Less: Interest 67,500
EBT 442,500
Less: Tax 110,625
EAT 331,875
i) Return on assets = (510,000 * 0.75) / 25,00,000 = 15.3%

ii) Assets turnover = 22,50,000 / 25,00,000 = 0.9
iii) Return on equity = 3,31,875 / (25,00,000 * 70%) = 18.96%
Question No. – 3I (Dec. 2014 – 6 Marks)

Explain the important ratios that would be used in each of the following situations:
i) A bank is approached by a company for a loan of Rs. 50 lakhs for working capital purpose.
ii) A long term creditor interested in determining whether his claim is adequately secured.
iii) A shareholder who is examining his portfolio to decide whether he should hold or sell his
holdings in a company.
48 | P a g e
Solution:
Important Ratios used in different situations:
i) Liquidity Ratios –
Liquidity or short term solvency ratios would be used by the bank to check the ability of
the company to repay its short-term liabilities. A Bank may use current ratio or Quick
ratio to judge short term solvency of the company. Further interest coverage ratio shall
also be analyzed to ensure the interest repayment security.
(ii) Capital Structure or Leverage Ratios –

The long-term creditor would use the capital structure or leverage ratios to ensure the
long term stability and structure of the firm. A long term creditor interested in
determining whether his claim is adequately secured may use Debt-servicing coverage
and interest coverage ratio.
(iii) Profitability Ratios –

The shareholder would use the profitability ratios to measure the operational efficiency
of the company to see the final results of business operations. A shareholder may use
return on equity, earning per share and dividend per share ratios. Price earnings ratio
and book value per share are also analyzed to decide whether a particular share is to sell
or hold.
49 | P a g e

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CA CAPII – FM (Ratio Analysis) CA Suraj Kumar Dhakal

Chapter 8 Ratio Analysis

 Financial ratios are relationship between financial statement's two figures.

Ratio Analysis: Types

Liquidity Ratio Leverage Ratio Activity Ratio Profitability Ratio

Liquidity Ratios (Short term solvency ratio):

1 Current ratio: Formula:

2 Quick ratio (Acid Test Ratio): Formula:

3 Cash Ratio (Super Quick Ratio / Absolute Liquidity Formula:

4 Basic Defense Interval: Formula:

5 Net Working Capital Ratio: Formula:

Leverage Ratios (Long term solvency ratio):

1 Equity ratio (Propriety Ratio): Formula:

2 Debt Ratio: Formula:

3 Debt Equity Ratio Formula:

1 Debt Service Coverage Ratio (Debt coverage ratio): Formula:

2 Interest Coverage Ratio(Times Interest earned): Formula:

3 Preference Dividend Coverage Ratio: Formula:

4 Capital Gearing Ratio: Formula:

Activity Ratios (Turnover / Performance Ratios):

1 Capital Turnover ratio: Formula:

2 Fixed Assets Turnover Ratio: Formula:

3 Working Capital Turnover Ratio: Formula:

4 Inventory Turnover Ratio: Formula:

5 Debtor Turnover Ratio: Formula:

6 Debtor Velocity: Formula:

Where, Average daily credit sales

7 Creditor Turnover Ratio: Formula:

8 Creditor Velocity: Formula:

Where, Average daily credit

Profitability Ratio from Owner's Point of View:

1 Return on Equity (ROE): Formula:

2 Earnings per Share (EPS): Formula:

3 Dividend per share (DPS): Formula:

4 Price Earnings Ratio (PE Ratio): Formula:

Profitability Ratio based on Assets and Investments:

1 Return on Capital Employed (ROCE) / Formula:

2 Return on Assets (ROA): Formula:

Profitability Ratio based on Sales of firm:

1 Gross Profit Ratio (GP Ratio): Formula:

2 Operating Profit Ratio: Formula:

3 Net Profit Ratio: Formula:

1 Dividend Yield: Formula:

2 Earning Yield: Formula:

3 Dividend Payout ratio: Formula:

4 Retention ratio: Formula:

1 Du Pont Analysis of Return on Equity: Formula,

2 ROE due to use of Debt and Preference Share: Formula,

3 Du Pont Analysis of ROCE: Formula,

= Operating profit margin x

ii) Quick ratio:

iii) Net working capital ratio:

iv) Equity ratio:

vi) Debt equity ratio:

Preference Share Capital (12%) (10,000 preference shares of 10.00

ii) Earning per share:

iii) Preference Dividend Cover:

iv) Equity Dividend Cover:

Retained Earnings 6.84

Question No. – 1C (June. 2017 – 5 Marks)

ii) Calculation of Operating Expenses:

iii) Calculation of Interest Coverage: