RATIO

ANALYSIS
MEANING OF RATIO
AND ACCOUNTING
RATIO
• ‘Ratio’ is an arithmetical expression of relationship
between two interdependent or related items.
• “The term accounting ratio is used to describe the
significant relationship which exist between figures
shown in Balance Sheet, in a Statement of Profit
and Loss, in a budgetary control system or in any
part of the accounting organization”.
 EXPRESSION OF RATIOS'
Accounting ratio can be expressed in any of the following terms:
1. Pure: It is expressed as a quotient. For example Current Ratio which expresses the
relationship b/w Current Assets and Current Liabilities is 2.
2. Percentage: It is expressed in percentage. For example , Net profit ratio which relates
Net Profit to Revenue from Operations.
3. Times: It is expressed in number of times a
particular figure is when compared to another figure.
4. Fraction: It is expressed in fraction say ¾ that is 0.75.
 MEANING OF RATIO
•
ANALYSIS
“Ratio Analysis is a study of relationship among various financial factors in a
business”
• Ratio Analysis is a process of determining and interpreting relationship between the
items of financial statements to provide a meaningful understandings of the
performance and financial position of the enterprise.
• Thus it is a technique of analyzing the financial statements by computing ratios.
 ADVANTAGES OF RATIO
ANALYSIS
A. Useful in analysis of Financial Statements: Accounting ratios are useful for
understanding the financial position of an enterprise.
B. Simplifying Accounting Data: Ratios simplifies, summarizes and systematize
accounting data to make it understandable. Its main contribution lies in
communicating precisely the interrelationship which exist between various elements
of financial statements.
C. Useful for Forecasting: Ratios are helpful in
business planning and forecasting. Trend ratios are
analyzed and used as guide to future planning.
 LIMITATION OF RATIO ANALYSIS
A. False result: Ratios are calculated from the financial statements, so the reliability of ratio
and its analysis is dependent upon the correctness of the financial statement.
B. Qualitative Factors are Ignored: Ratio analysis is a technique of quantitative-analysis
and thus ignores qualitative factors which may be important to decision making.
C. Lack of Standard Ratio: There is almost no standard ratio against which the ratio
may be measured and compared.
D. May not be Comparable: Ratios may not be
comparable if different firms allows different accounting policies and procedures.
E. Lack of Standard Ratio : There is almost no
standard ratio against which the ratio may be
measured and compared.
F. May not be Comparable : Ratios may not be
comparable if different firms allows different
accounting policies and procedures.
TYPES OF RATIOS
1. Liquidity Ratio: These ratio show the ability of the enterprise to meet its short term
financial obligations.
2. Solvency Ratio: These ratio are calculated to assess the long term financial position of
the enterprise. Solvency means the ability of the enterprise to meet its long term financial
obligations that is liabilities.
3. Activity or Turnover Ratio: These ratios show how efficiently a company is using its
resources.
4. Profitability Ratios: Profitability of a firm can be measured by its profitability ratios.
LIQUIDITY RATIO

These ratios analyze the short-term financial position of a firm and indicate
the ability of the firm to meet its short-term commitments (current
liabilities) out of its short-term resources (current assets) . These are also
known as 'solvency ratios' The ratios which indicate the liquidity of a firm
are:
CURRENT RATIO
The current ratio is a liquidity ratio that measures a company’s ability to pay short-term
obligations or those due within one year
 Current ratio = Current asset/Current liabilities
 Conventionally a current ratio of 2:1 is considered satisfactory
A ratio of 2: 1 would imply the firm has Rs 2/- of assets to cover every R 1/- in
liabilities
A ratio of 0.75: 1 would suggest the firm has
only 75p in assets available to cover every Rs. 1/- it owes
QUESTION :-

From the following given below calculate the Current Rato:-

Inventory :150,000, cash:50,000, Sundry Debtors:3,00,000, Creditors:350000,Bills
receivable: 30000, Bank overdraft: 30,000

Solution:- Current Ratio= Current Assets/ Current Liabilities

Current Assets = Sundry Debtors + Inventories + Cash-in-hand + Bills Receivable
Current Liabilities = Creditors + Bank Overdraft
Current Assets= 300,000 + 150,000+ 50,000+ 30,000=
530,000
Current Liabilities = 350,000+ 30,000= 380,000

Current Ratio= 530,000 / 400,000= 1.3 :1

ANALYSIS
A current ratio that is lower than the industry average may indicate a
higher risk of distress or default.
The company needs to improve its ratio by the following manner:
Delaying any capital purchases that would require any cash payments
Looking to see if any term loans can be re-amortized Reducing the
personal draw on the business Selling any capital
assets that are not generating a return to the business
(use cash to reduce current debt).
 QUICK RATIO
The Acid -Test ratio or quick ratio measures the ability of a company to use its near cash
or quick assets to extinguish or retire its current liabilities immediately.
Quick assets includes those current assets that can be quickly converted to the cash.
Quick ratio = (current assets - inventories) / current liabilities
OR
Quick ratio= (cash and equivalents + marketable securities +accounts receivable) /
current liabilities
 QUESTION :-

From the following information calculate quick ratio:-

Q.Current liability = 50,000 , current assets = 80,0000 , inventories = 20,000
Advance tax = 5,000 , prepaid expencess = 5,000
Solution:- liquid assets:- current assets-(inventories+prepaid expencess+advance tax)
=80,000-(20,000+5,000+5,000) =50,000
=current liability = 50,000
liquidity ratio = 50,000/50,000
= 1:1
ANALYSIS

A ratio of 1:1 would means the company has the same

amount of liquid assets as current liabilities.
A higher quick ratio signals that a company can be more
liquid and generate cash quickly in case of emergency.
WHAT IS SOLVENCY
RATIOS ?

Solvency ratio are the ratio which

show whether the enterprise will be
able to meet its long-term financial
needs
TYPE OF SOLVENCY
RATIOS
1) Debt to equity ratio
2) Total assets to debt ratio
3) Proprietary ratio
DEBT TO EQUITY
RATIO
Debt to equity ratio shows relationship
between long-term external equities and
internal equities of the enerprise.

debt to equity ratio = debt / equity

QUESTION:-
From the following compute debt equity ratio
share capital – 30,00,000
Security premium reserve – 200,000
Reserve and surplus – 70,00,000
Loan from IFC @8% -20,00,000
9% bonds – 2500,000
Long-term provision – 300,000
Short-term provision – 100,000
Trade payables – 5,00,000

Solution :- debt equity ratio = debt/equity

debt = loan + 9% bonds + long term prov. = 48,00,0000
equity = share capital + res and surplus = 40,00,000
= 48,00,000/40,00,000 = 1.2 : 1
the ratio is satisfactory for the business
TOTAL ASSETS TO
DEBT RATIO

Total assets to debt ratio shows relationship

between total assets and long-term debt of
the enterprise
Total assets to debt ratio =
total assets /debt(long-term)
QUESTION :-
From the following compute total assets to debt ratio
Shareholder funds = 14,00,000
Total debt = 16,00,000
Current liability = 400,000
Solution :-
total asset to debt ratio = total assets /debt
total assets = 14,00,000+16,00,000 = 30,00,000
debt = 16,00,000 – 4,00,000 = 12,00,000
= 30,00,000 / 12,00,000 = 2.5:1
PROPRIETARY
RATIO

Proprietary ratio shows relationship between

proprietor fund and the total assets
Proprietary ratio =
proprietors fund /total assets
QUESTION :-
From the following compute proprietary ratio
Share capital – 5,00,000
Reserves and surplus – 3,00,000
Non-current assets – 22,00,000
Current assets – 10,00,000
Solution :-
proprietary ratio = proprietary fund / total assets
proprietary fund = 5,00,000 + 3,00,000 = 8,00,000
total assets = 22,00,000 + 10,00,000 = 32,00,000
= 8,00,000 / 32,00,000 = 0.25 : 1
Activity Ratio 25

WHAT IS ACTIVITY
RATIO?
Activity ratios are used to determine the efficiency of the
organization in utilizing its assets for generating cash and
revenue. It is used to check the level of investment made on an
asset and the revenue that it is generating.

The role of activity ratio or turnover ratio is in the evaluation of

the efficiency of a business by careful analysis of the
inventories, fixed assets and accounts receivables.
Activity Ratio 26

TYPES OF ACTIVITY
RATIO
• Inventory Turnover Ratio
• Trade Receivable Turnover Ratio
• Trade Payable Turnover Ratio
• Working Capital Turnover Ratio
Activity Ratio 27

INVENTORY
TURNOVER RATIO
Inventory Turnover Ratio establishes relationship between Cost of
Revenue from Operations, i.e., Cost of Goods Sold and average
inventory carried during that period.

It aims to determine the efficiency with which inventory is used.

Activity Ratio 28

Computation: Inventory Turnover Ratio is computed as follows:

Inventory Turnover Ratio
=Cost of Revenue from Operation(Cost of Goods Sold)
Average Inventory
Cost of Revenue from Operation(Cost of Goods Sold)
= Revenue from Operations - Gross Profit
Or
= Revenue from Operations + Gross Loss
Or
=Opening Inventory + Net Purchases + Direct Expenses- Closing
Inventory
Average Inventory
= Opening Inventory + Closing Inventory
2
 Activity Ratio 29

Question:
Calculate Inventory Turnover Ratio from the following information:
Opening Inventory is ₹50,000; Purchases ₹3,90,000; Revenue from
Operations, i.e., Net Sales ₹6,00,000; Gross Profit Ratio 30%.

Solution:
Cost of Goods Sold = Net Sales – Gross Profit
= Rs 6,00,000 – 30% of Rs 6,00,000
= Rs 6,00,000 – Rs 1,80,000 = Rs 4,20,000
Cost of Goods Sold = Opening Inventory + Purchases – Closing Inventory
Rs 4,20,000 = Rs 50,000 + Rs 3,90,000 – Closing Inventory
Closing Inventory = Rs 50,000 + Rs 3,90,000 – Rs 4,20,000
= Rs 20,000
Average Inventory
= Opening Inventory + Closing Inventory = 50000+20000 = Rs. 35000
2 2
Inventory turnover = COGS = 420000 = 12times
Ratio Average Inventory sss 35000
Activity Ratio 30

TRADE RECEIVABLE
TURNOVER RATIO
Trade receivable Turnover Ratio establishes the relationship between
Credit Revenue from Operations, i.e., Net Credit Sales and Average
Trade Receivable, i.e., average of debtors and bill receivable of the
year.

Average Trade Receivables are calculated by dividing the sum of trade

receivables in the beginning and at the end by 2.
Activity Ratio 31

Computation: Trade Receivables Turnover Ratio is computed as

follows:
Trade Receivables Turnover Ratio
=Credit Revenue from Operation(Net Credit Sales)
Average Trade Receivables
Credit Revenue from Operation(Net Credit Sales)
= Revenue from Operations – Cash Revenue from Operation
Or
= Credit Sales – Sales Return
Average Trade Receivable
= Opening Trade Receivables + Closing Trade Receivables
2
Trade Receivables
= Debtors + Bills Receivables
Activity Ratio 32

Question:
Ajay Industries Ltd has a beginning account receivable balance of
₹250,000 and the ending accounts receivable balance of ₹320,000. The
total credit sales for the year was ₹500,000, while returns amounted to
₹30,000. Find the accounts receivable turnover ratio.
Solution:
Net Credit Sales = Total Credit Sales – Returns
= 500,000 – 30,000
= 470,000
Average Trade Receivable
= Opening Trade Receivables + Closing Trade Receivables
2
= 250000 + 320000 = 285000
2
Trade Receivables Turnover Ratio = Net Credit sales
Avg Trade Receivable
= 470000 = 1.65times
285000
Activity Ratio 33

TRADE PAYABLE
TURNOVER RATIO
Trade Payable Turnover Ratio establishes the relationship between Net
Purchase Sales and Average Trade Payables, i.e., average of creditor
and bill payable of the year.

Average Trade Payable are calculated by dividing the sum of trade

payable in the beginning and at the end by 2.
Activity Ratio 34

Computation: Trade Payables Turnover Ratio is computed as

follows:
Trade Payables Turnover Ratio
= Net Credit Purchase
Average Trade Payables
Net Credit Purchase
= Credit Purchase – Purchase Return
Average Trade Payables
= Opening Trade Payables + Closing Trade Payables
2
Trade Payables
=Creditors + Bills Payables
Activity Ratio 35

Question:
Calculate Trade Payables Turnover Ratio from the following
information :
Credit Purchases during the year 6,20,000, Purchase Returns (Out of
credit purchase) 20,000,Opening Creditors 1,00,000, Closing Creditors
1,40,000, Opening Bills Payable 25,000,Closing Bills Payable 35,000
Solution:
Net Credit Purchases = Rs. 6,20,000 - Rs. 20,000 = Rs. 6,00,000
Average Trade Payables
= Opening Trade Payables + Closing Trade Payables
2
= 100000+140000+25000+35000 = Rs. 150000
2
Trade Payables Turnover Ratio
= Net Credit Purchase = 600000 = 4times
Average Trade Payables 150000
Activity Ratio 36

WORKING CAPITAL
TURNOVER RATIO
Working Capital Turnover Ratio helps determine how efficiently the
company is using its working capital (current assets – current
liabilities) in the business and is calculated by dividing the company’s
net sales during the period by the average working capital during the
same period.
 Activity Ratio 37

Computation: Working Capital Turnover Ratio is computed as

follows:
Working Capital Turnover Ratio
= Net Sales
Working Capital
Or
= COGS
Working Capital
Net Sales
= Total Sales – Sales Return
Working capital
= Current assets – Current Liabilities
 COGS
=Net Sales – Gross Profit
Or
= Opening Stock + Purchases – Closing Stock
Activity Ratio 38

Question:
Eastern Company has the following information provided from its
operations.
Sales = ₹500,000, Sales return = ₹80,000, Current assets = ₹100,000,
Current Liabilities = ₹40,000
Calculate the working capital turnover ratio based on the above
information
Solution:
 Net Sales = Total Sales – Sales Return
= 500000 – 80000 = 420000
Working capital = Current assets – Current liabilities
= 100000 – 40000
= 60000
Working Capital Turnover Ratio
= Net Sales = 420000 = 7times
Working Capital 60000
PROFITABILITY RATIOS 39

GROSS PROFIT RATIO

Gross Profit Ratio establishes the relationship of Gross Profit and Revenue from
Operations. The ratio is calculated and shown in percentage.
Gross Profit Ratio is computed as follows
Gross Profit Ratio = Gross Profit x 100 = …%
Revenue from Operations
Revenue from Operations means revenue earned by the enterprise from its
operating activities. It includes net sales (i.e. Sales-Sales return) and commission,
etc., in the case of non-finance companies and interest earned, dividend, profit on
sale of securities, etc.
Gross Profit is the difference between Revenue from Operations, i.e. Net Sales
and Cost of Revenue from Operations (Cost of Goods Sold).
 40

Gross Profit = Revenue from Operations - Cost of Revenue from Operations

Cost of Revenue from Operations (Cost of Goods Sold)
= Opening Inventories (excluding Spare Parts and Loose Tools) + Net
Purchases +Direct Expenses - Closing Inventories (excluding Spare
Parts and Loose Tools)
Or
= Cost of Materials Consumed + Purchases of Stock-in-Trade + Changes in
Inventories0,000;o f Finished Goods, Work-in-Progress and Stock-in-
Trade + Direct Expenses Or Revenue from Operations - Gross Profit.

 Gross Profit Ratio may increase due to the following reasons:

1. Higher selling price with constant Cost of Revenue from Operations (Cost of
Goods Sold).
2. 2. Lower Cost of Revenue from Operations (Cost of Goods Sold) with constant
selling price.
QUESTION 41

From the following information, calculate Gross Profit Ratio:

31st Mar 2019(₹) 31stMar,2020(₹)
Revenue from Operations (Net Sales) 1,60,000 2,00,000

Gross Profit 40,000 60,000

Solution:
Gross Profit Ratio = Gross Profit x 100
Revenue from Operations (Net Sales)
For 31st March, 2019:
Gross Profit Ratio = ₹ 40,000 x 100 = 25%
₹ 1, 60,000

For 31st March, 2020:

Gross Profit Ratio = ₹ 60,000 x100 = 30%
₹ 2,00,000
 42

OPERATING RATIO
Operating Ratio establishes the relationship between Operating Cost (i.e., Cost of
Revenue from Operations + Operating Expenses) and Revenue from Operations .
Operating Cost includes those expenses which are incurred for operating activities
of the business.
Examples being employees benefit expenses and other expenses.

Non-operating incomes and expenses, i.e., incomes and expenses which are not
incurred for operating activities of the business are excluded. Examples being
interest and dividend received, interest on loans and debentures and gain (profit) or
loss on sale of fixed assets .

Non-operating income is shown in the Statement of Profit and Loss as Other

Income. Non-operating expenses are given in the Note to Accounts on 'Other
Expenses' in the Statement of Profit and Loss.
Operating Ratio is computed as follows: 43

Operating Ratio = Cost of Revenue from Operations +

Operating Expenses x 100
Revenue from Operations
Cost of Revenue from Operations
Opening Inventory ( Excluding Spare Parts & Loose Tools
) + Purchases + Direct Expenses - Closing Inventory
(Excluding Spare Parts and Loose Tools)
Operating Expenses = Employees Benefit Expenses +
Depreciation and Amortization Expenses Other Expenses
(Other than Non-operating Expenses)
Office Expenses + Administrative Expenses + Selling and
Distribution Expenses + Employees Benefit Expenses +
Depreciation and Amortization Expenses.
QUESTION
44

From the following information, calculate Operating Ratio:

Cost of Revenue from Operations (Cost of Goods Sold) - ₹6,00,000
Revenue from Operations - ₹800,000,Operating Expenses- ₹40,000

Solution:
Operating Ratio = Cost of Revenue from Operations + Operating
Expenses x 100
Revenue from Operations
= ₹6,00,000+ ₹40,000 x100
₹ 8,00,000
= ₹ 6,40,000 x 100
₹ 8,00,000
= 80%
 45

NET PROFIT RATIO PROFITABILITY

RATIOS

Net profit ratio indicates the overall efficiency of a

business higher the net profit ratio better the
business.

It establishes the relationship between net profit and

revenue from operations that is net sales. It shows
the percentage of net profit earned on Revenue from
operations.
 Q. Gross Profit Ratio Of A Company Was 25%. It’s Cash
Sales Were Rupees 200000 And Credit Sales For 90% Of The
Total Sale If The Indirect Expenses Of The Company 20000
Calculate Net Profit Ratio.

Total Revenue from operations = cash sales + credit sales

200000+1800000= 2000000

Net sales/ Revenue from operations = cash sales

------------------ x100
10
= 20,00,000
GP =25 % of net sales
= 500000
Net profit = Gross profit – indirect exp
= 500000- 20000 = 480000

Net profit
Net Profit ratio = ________________________ x 100
Revenue from operations
4,80,000
= -----------------× 100 = 24%
20,00,000
 RETURN ON INVESTMENT RATIO

Return on investment ratio assesses the overall performance of

the Enterprise. It measures how efficiently the resources
interested to the business are used.

Return investment ratio on return on capital employed shows

the relationship of profit before interest and tax with capital
employed . The net result of operation of a business profit or
loss.
ROI = Profit before Interest , tax and
Dividend
x100
Capital Employed

This Ratio Is Computed By Dividing Net Profit

Before Interest Tax And Dividend By The Capital
Employed This Ratio Is Expressed As A
Percentage.
The objective and significance of return on
investment ratio if that it measures how efficiently
the resources of a business are used the return on
capital employed is a fair measure of profitability of
any concern with the result that the performance of
different industries maybe compared.
Q…With The Help Of The Following Information Calculate Return
On Investment. Net Profit After Interest And Tax 6 Lakhs 10%
Debentures 10 Lakh Rupees Tax 40% Capital Employed 80 Lacs.

ROI = Profit before Interest , tax and

Dividend
x100
Capital Employed

Net profit before tax = 600000 x 100/60

= 10,00,000
Net profit before interest and tax = 10,00,000 +
(10,00,000 × 10/100)
= 11,00,000
ROI = 11,00,000
-------------------x 100 = 13.75%
80,00,000
 CONCLUSION

Conclusion – Importance of Ratio Analysis

These ratios analysis. It provides valuable
information about the organization's profitability,
solvency, operational efficiency and liquidity
positions as represented by the financial statements.
read more are for making important decisions and
forecasting the future.
 Presented By:-
 Neeraj Tomar -121068
 Raghav Shrivastava -121078
 Rahul Pali -121079
 Sarthak Jain -121083 THANK YOU
 Pratyush Sharma – 121076
 Adamya Sharma - 121101