Chapter 16
Accounting Ratios
LEARNING OBJECTIVES
After studying this chapter, you would be able to understand
Meaning of Ratio and Ratio Analysis
Objective of Ratio Analysis
Advantages and Uses of Ratio Analysis
Limitations of Ratio Analysis
Classification of Ratios
Liquidity Ratios – Computations
Solvency Ratios – Computations
Profitability Ratios – Computations
Activity Ratios – Computations
Ratios
INTRODUCTION
Usually the accounting goal in preparing financial statements is to provide valuable information to its different types of users. They mainly concentrate on collecting financial data and preparing financial statements — Balance Sheet and Income Statement. These statements provide only certain figures for its components. In order to make the information more useful, these financial statements are analysed by applying different techniques. One such technique or tool employed for analysing financial statements is “Ratio Analysis”, the corner stone of financial analysis is the use of ratios. As ratios capture critical dimension of the economic performance of business entities, the study of ratio analysis has gained much importance nowadays. Numbers depicted in financial statements are hard to understand out of context. For example, “Profit Rs 2,50,000” — shown in income statement cannot reveal the exact real meaning unless it is analysed with other items (components), that is, how much capital is employed to achieve this profit. Likewise, this may be analysed by comparing with other components — sales, total assets, selling expenses, administration expenses and so on. Role of ratio analysis is vital, in such scenario. A financial ratio is computed by dividing one number (component/item) by another number. For a set of financial statements, a number of ratios can be computed. Only such ratio analysis can help give true meaning to the numbers in the Balance Sheet as well as income statements. The basic financial ratios help us to put numbers in perspective. By relating one part of the financial statements to another, they facilitate to answer a number of questions. In this chapter, important ratios, namely Liquidity Ratios, Solvency Ratios, Activity Ratios and Profitability Ratios are dealt with in analysis of financial statements.
OBJECTIVE 1: MEANING OF RATIO ANALYSIS–A SYSTEMATIC USE OF RATIOS TO INTERPRET THE PERFORMANCE OF ENTITIES
1.1 Meaning of Ratio and Ratio Analysis
A “Ratio” is described as arithmetical expression of relationship between two related items. Here, items represent the various components that constitute the financial statements. As these components have cause and effect relationship, arithmetical relationship between such components attains much significance. Accounting Ratios are nothing but ratios that are compared on the basis of accounting information provided by financial statements.
Ratio Analysis is a tool or technique employed to analyse the financial statements. Ratio Analysis is a process of interpreting relationship between the components (item) of financial statements thereby extending a meaningful information about business entities. Ratio Analysis is an accounting tool utilised in analysis, interpreting the various items in financial statements and reporting in understandable terms to its users. Myers explained it as, “Ratio Analysis is a study of relationship among various financial factors in a business”.
Ratio Analysis is a systematic use of ratios to interpret the financial statements in order to determine the performance and financial condition of the business enterprises. The term Accounting Ratios refers to the numerical relationship between two components/items/variables of the financial statements. This relationship can be expressed as
 Proportion say, for example the relationship between two variables – current assets and current liabilities (assuming current assets of Rs 1,50,000 and current liabilities of Rs 50,000). Current assets/Current liabilities
= Rs 1,50,000/Rs 50,000 = 3:1.
The relationship between two variables is expressed in the ratio form as 3:1 (proportion of numbers).
 The relationship can be expressed in terms of percentage say, net profits are 20 percent of sales (assuming net profit of Rs 20,000 and sales of Rs 1,00,000).
Net Profit/Sale× 100 = Rs 20,000/Rs 1,00,000×100 = 20%
(or)
 The same relationship can be expressed in fraction:
Net Profit is 1/5th of Sale = 20,000/1,00,000 =1/5 (or) 0.2
(or)
 The relationship can be expressed in “a number of times” – say the relationship between two items, net sales and current assets (assuming net sales of current assets turnover ratio) = Net Sales/Current Assets = 1,00,000/20,000 is expressed in “a number of times” as 5.
These alternative methods of expressing variables which are related to each other (interdependent) are referred to as Ratio Analysis. Such analysis facilitates to make better decisions on the overall performance of business organisations.
1.2 Ratio Analysis
The main objectives are:
 To judge the earning capacity of enterprises
 To ascertain the financial position (liquidity and solvency) and
 To determine the operating efficiency of business entities.
One would be able to understand broad objectives from the advantages of Ratio Analysis.
OBJECTIVE 2: ADVANTAGES AND USES OF RATIO ANALYSIS
1. Effective Tool in Analysis of Financial Statements: Final accounts of any enterprise is analysed by means of ratios, thereby all of them – bankers, investors, creditors etc.,are in a position to understand the financial position of such enterprises.
2. Easy and Simple in Application: These ratios summarise briefly the results of detailed and complicated accounting computation.
3. Liquidity Position: Ratios are an effective tool in assessing the firm‘s ability to meet its shortterm obligations. Liquidity Ratios play an important role.
4. Longterm Solvency: Ratio Analysis is useful in analysing the longterm financial strengthness of a business entity. Profitability Ratio‘s role is significant in determining such capacity of a firm.
5. Judging Operating Efficiency: Activity Ratios are very useful in assessing the operating efficiency of a business concern. Sales revenue mobilised by effective utilisation of assets –is best ascertained by using Activity Ratios.
6. Tools for Forecasting: Ratios are very much useful in planning, execution and forecasting of any business related activities. Trend Ratios facilitate these tasks.
7. Overall Profitability: The management of any business enterprise is interested in the overall capability, i.e. (i) ability to meet its shortterm and longterm needs to its creditors (ii) to ensure a reasonable return to its owners and (iii) to secure optimum and effective utilisation of the assets of the firm. All the ratios play an effective role in assessing the overall profitability of a concern.
8. Diagnosis and Remedial Measures: Even though the overall profitability is said to be normal, these ratios act effectively in spotting out the weak spots in the business components and suggesting measures to be taken to plug the loopholes.
9. Intrafirm Comparison: The performance of different units belonging to the same business firm can be easily compared with Ratio Analysis. In an unit of the same firm, progress can be motivated and slackness can be averted by such intrafirm comparisons.
10. Interfirm Comparison: Comparison of a firm‘s performance with other business firms is called interfirm comparison. Such comparison exposes a firm‘s position against its competitors. Adverse results will help to rectify and modify its planning to achieve the desired results in the industry.
11. Trend Analysis: To sail among the other industries, to know the direction of movement, this trend analysis can render the necessary assistance.
OBJECTIVE 3: LIMITATIONS OF RATIO ANALYSIS
1. Results not Reliable: Reliability of ratio and its analysis depends on the correctness of financial statements. So the results obtained on the basis of any defective financial statements may also be not reliable.
2. Difficulty in Comparison: Various firms may adopt different procedures for the various activities of the enterprise. Differences may be due to
 Method of inventory valuation (FirstInFirstOut (FIFO), LastInFirstOut (LIFO) etc.)
 Method of computing depreciation (WDV, Straight Line)
 Working life of assets estimation
 Amortisation of intangible assets (goodwill, patents)
 Capitalisation of certain items
 Treatment of extraordinary items etc.
 Different accounting period, procedures
Due to such variations among the industries, comparisons may not be easy, reliable and accurate.
3. Price Level Changes: Frequent changes in price level will affect the compatibility of ratios. At times of inflation, such comparison will not yield the desired results.
4. Different Concepts: There are always different opinions about accounting concepts and computation techniques of various ratios. This conceptual diversity affects the effectiveness of Ratio Analysis. Different meanings and different approaches affect comparison.
5. Not Qualitative Analysis: As Accounting Ratios are tools of quantitative analysis, qualitative factors are ignored or overrided.
6. Window Dressing: Manipulation of values are always in practice by concealing the real facts. Ratios are affected by window dressing of figures.
7. Not a Standard Yardstick: There is no standard ratio in practice to compare any of the components of business enterprise. It is difficult to evolve a common standard ratio, which is acceptable by all and at all times.
8. Insignificant Factors: Even if the figures of a business entity are not really significant, Accounting Ratios are computed. Such ratios may not be of much use for any financial analyst.
9. Personal Bias: While preparing financial statements, personal judgment plays a crucial role and as such these ratios are also not free from this limitation. So, such conclusions based on personal bias will be a standard one.
OBJECTIVE 4: CLASSIFICATION OF RATIOS OR TYPES OF RATIOS
Ratios may be classified as:
 Liquidity Ratios (Shortterm solvency)
 Solvency Ratios
 Profitability Ratios
 Activity Ratios
OBJECTIVE 5: LIQUIDITY RATIOS
These ratios measure the shortterm solvency of a concern. These ratios measure the firm‘s ability to pay off current dues (i.e., repayable in a year). In other words, liquidity means the ability to meet shortterm obligations. (A liquid asset is one that can very easily be converted in to assets.) Liquidity Ratios may further be classified as:
 Current Ratio
 Liquid Ratio
 Absolute Liquid Ratio
5.1 Current Ratio – Relationship of Current Assets to Current Liabilities
 The relationship of current assets to current liabilities is termed as “Current Ratio”.
 Shortterm financial position is assessed by computing this ratio.
 Current Ratio serves also as an indicator to assess shortterm obligations of a concern.
 This is calculated at a particular date and NOT for a particular PERIOD.
 The ratio is computed as: Current Ratio = Current Assets/Current Liabilities.
 Current Assets: The assets, which are in the form of cash or cash equivalents or can be converted into cash in a short time are current assets. These are
 Current Liabilities: Liabilities, which are repayable in short time. These are:
 Sundry creditors
 Bills payable
 Overdraft (Bank/Bills)
 Shortterm loans
 Outstanding expenses
 Provision for Tax
 Unclaimed Dividend
 Any enterprise should have a reasonable Current Ratio, satisfactory level is 2:1. A higher ratio indicates poor investment policy, and a lower ratio reveals lack of liquidity and shortage of working capital.
 The excess of current assets over current liabilities is known as working capital.
Computation of Current Ratio
Illustration: 1
From the following, compute Current Ratio.


Rs 

Stock 
36,500 

Sundry Debtors 
63,500 

Cashinhand and Cash in Bank 
10,000 

Bills Receivable 
9,000 

Shortterm Investments 
30,000 

Prepaid Expenses 
1,000 

Bank Overdraft 
20,000 

Sundry Creditors 
25,000 

Bills Payable 
16,000 

Outstanding Expenses 
14,000 
Solution
Step 1: 
Students have to classify and list out the Current Assets. They are: Stock, Sundry Debtors, Cashinhand/Bank, Bills Receivable, Shortterm Investments, Prepaid Expenses. 
Step 2: 
Value of all these Current Assets have to be added and total value of Current Assets is calculated. 
Step 3: 
Now, Current Liabilities have to be sorted out. They are: Bank Overdraft, Sundry Creditors, Bills Payable and Outstanding Expenses. 
Step 4: 
Value of all these Current Liabilities have to be added together and total value of Current Liabilities is arrived at. 
Step 5: 
Current Assets/Current Liabilities = Current Ratio 
(a)Total value computed as in Step 2 and Step 4 to be taken into account.

Here, value of Current Assets 
= 
Rs 1,50,000 

Current Liabilities 
= 
Rs 75,000 

Current Ratio 
= 
Rs 1,50,000/Rs 75,000 


= 
2:1 
Step 6: 
Conclusion: Current Ratio is at normal level. 
Computation of Current Ratio from Balance Sheet
Illustration: 2
From this Balance Sheet of Prasadh and Co. Ltd, compute the Current Ratio.
Balance Sheet as on Mar 31, 2006
Solution
Step 1: 
Total value of all Current Assets have to be calculated first. 
Step 2: 
Here, if Balance Sheet is given, students have to pick up from the assets side, items belonging to current assets. 
Step 3: 
Here, except Fixed Assets, all the other items, that is, Stock, Debtors and Cash are Current Assets. Its total value = Rs 12,000 + Rs 7,500 + Rs 10,500 = Rs 30,000/ 
Step 4: 
Next step is to pick up the Current Liabilities alone from the Liabilities side of the Balance Sheet. Here Bank Overdraft and Creditors are Current Liabilities. Its total value = Rs 7000 +Rs 8000 = Rs 15,000 
Step 5: 
Current Ratio: Current Assets/Current Liabilities 
Step 6: 
Conclusion: The Current Ratio is at normal level. 
Current Ratio from Working Capital
Illustration: 3
From the following, calculate the Current Ratio.



Rs 

Liquid Assets 
: 
40,000 

Stock 
: 
30,000 

Prepaid Expenses 
: 
10,000 

Debtors 
: 
20,000 

Working Capital 
: 
75,000 
Solution
Here, working capital is given.
Step 1: So, students have to find out the value of Current Liabilities by using the formula:
(As Working Capital 
= 
Current Assets – Current Liabilities) 
Current Liabilities 
= 
Current Assets – Working Capital 
Value of Current Assets 
= 
Liquid Assets × Stock Debtors × Prepaid Expenses 

= 
Rs 40,000 × Rs 30,000 × Rs 20,000 × Rs 10,000 = Rs 1,00,000 
= 
Current Assets — Working Capital 


= 
Rs 1,00,000−Rs 75,000 (given) 

= 
Rs 25,000 
Step 3: Current Ratio 
= 
Current Assets/Current Liabilities 

= 
1,00,000/25,000 

= 
4:1 
Step 4: 
Conclusion: Current Ratio is at a higher level. It indicates poor investment policy of the concern, as huge amount of assets lie idle. 
Current Ratio from Capital Employed
Illustration: 4
A company has Total Assets of Rs 3,00,000, Fixed Assets: Rs 1,50,000, Capital Employed: Rs 2,70,000. Calculate the Current Ratio.
Solution
Step 1: Total assets and fixed assets are given. So Current Assets have to be worked out.
Current Assets 
= 
Total Assets − Fixed Assets 

= 
Rs 3,00,000 − Rs 1,50,000 

= 
Rs 1,50,000 
Step 2: From the value of capital employed and total assets, Current Liabilities have to be computed.
Current Liabilities 
= 
Total Assets − Capital Employed 

= 
Rs 3,00,000 − Rs 2,70,000 

= 
Rs 30,000 
Step 3: Current Ratio 
= 
Current Assets/Current Liabilities 

= 
1,50,000/30,000 

= 
5:1 
Step 4: Conclusion: Current Ratio is 5:1. It is above normal level.
Current Ratio from Debts
Illustration: 5
Calculate Current Ratio from the following:


Rs 
Working Capital 
: 
80,000 
Total Debt 
: 
60,000 
Longterm Debt 
: 
40,000 
Solution
Step 1: Value of current liabilities is to be calculated first, if these datas alone are given.
Current Liabilities 
= 
Total Debt − Longterm Debt 
(i.e., Shortterm Debt) 


= 
Rs 60,000 − Rs 40,000 

= 
Rs 20,000 
Step 2: Next step is to find the value of Current Assets.
Current Assets 
= 
Working Capital + Current Liabilities 

= 
Rs 80,000 + Rs 20,000 

= 
Rs 1,00,000 
= 
Current Assets/Current Liabilities 


= 
1,00,000/20,000 

= 
5:1 
Step 4: Current Ratio is at a higher level.
Treatment of Value of Goods Purchased
Illustration: 6
A company has Current Assets of Rs 2,50,000 and Current Liabilities Rs 1,50,000. Afterwards it purchased goods for Rs 50,000 on credit. Calculate Current Ratio after the purchase.
Solution
Note: Value of Current Assets and Current Liabilities, value of goods purchased are given.
* Value of goods purchased is on credit.
Important: So, it comes under both Current Assets and Current Liabilities.
* So, this value has to be added with liabilities and assets.
So Current Assets 
= 
Rs 2,50,000 + Rs 50,000 
Current Liabilities 
= 
Rs 1,50,000 + Rs 50,000 
Current Ratio 
= 
3,00,000/2,00,000 

= 
3:2 
Treatment of Creditors
Illustration: 7
Current Liabilities of a company are Rs 2,00,000/, Current Ratio = 2.5:1. After this, it paid to X, a creditor of Rs 50,000. Calculate Current Ratio after payment to the creditor.
Solution
Step 1: 
Current Ratio and Current Liabilities are given. From this, Current Assets have to be calculated. 
Current Ratio 
= 
Current Assets/Current Liabilities 
Current Assets 
= 
Current Ratio × Current Liabilities 

= 
2.5 × Rs 2,00,000 

= 
Rs 5,00,000 
Step 2: 
Payment of Rs 50,000 is given to the creditor. This has to be adjusted on both Current Assets and Current Liabilities. 
So, after payment
Current Assets = Rs 5,00,000 − Rs 50,000 = Rs 4,50,000
Current Liabilities = Rs 2,00,000 − Rs 50,000 = Rs 1,50,000
Step 3: Current Ratio 
= 
4,50,000/1,50,000 

= 
3:1 
Treatment of Value of Current Assets
Illustration: 8
The ratio of Current Assets to Current Liabilities is 3:1, value being Rs 3,00,000 and Rs 1,00,000 respectively. The accountant of that firm is firm to maintain Current Ratio at 2:1 by acquiring Current Assets on credit being standard levels. You are required to assist him by suggesting the amount of Current Assets to be bought.
Step 1: Let the value of Current Assets to be required be = X (assumed)
Step 2: Current Ratio 
= 
Current Assets /Current Liabilities 




= 
(1,00,000 + X) 2 = (3,00,000 + X) 1 

= 
2,00,000 + 2X = 3,00,000 + X 
2X − X 
= 
3,00,000 − 2,00,000 
X 
= 
1,00,000 
Current Assets to be acquired to maintain 2:1 Current Ratio = Rs 1,00,000.
5.2 Liquid Ratio or Quick Ratio or Acid Test Ratio
 Liquid Ratio is a relationship of liquid assets with current liabilities.
 This ratio is used to assess the firm‘s shortterm liquidity. (Solvency)
 Liquid Assets = Current Assets – (Stock + Prepaid Expenses)
 This ratio is an indicator to assess the shortterm debt paying capacity of a concern.
 This ratio is of high importance for Banks and other financial institutions.
 Liquid Ratio is computed as:
 Liquid Ratio = Liquid Assets/Current Liabilities
 Liquid Ratio of 1:1 is generally taken as a favourable one.
 A high Liquid Ratio indicates understocking.
 A low Liquid Ratio indicates overstocking.
Treatment of Liquid Assets
Illustration: 9
Calculate “Liquid Ratio” from the following:


Rs 

Current Liabilities 
80,000 

Current Assets 
1,20,000 

Stock 
30,000 

Prepaid Expenses 
10,000 

Sundry Debtors 
50,000 
Solution
Step 1: First, Liquid Assets have to be calculated

Liquid Assets
=
Current Assets − (Stock + Prepaid Expenses)
=
Current Assets − (Stock + Prepaid Expenses)
=
Rs 1,20,000 − (Rs 30,000 + Rs 10,000)
=
Rs 1,20,000 − Rs 40,000
=
Rs 80,000
or
 It may also be deducted one by one from current assets, as
Current Assets – Stock – Prepaid Expenses. [Students may choose whichever is easier for them, either (i) or (ii).]
Step 2: Liquid Ratio 
= 
Liquid Assets/Current Liabilities 

= 
Rs 80,000/Rs 80,000 

= 
1:1 
Conclusion: Liquid Ratio is said to be at a normal and satisfactory level.
Computation of Current Ratio and Liquid Ratio
Illustration: 10
Sonali Ltd furnished the following information regarding its Current Assets and Current Liabilities:

Current Assets 
Rs 

Cash 
5,000 

Sundry Debtors 
35,000 

Bills Receivable 
10,000 

Marketable Securities 
20,000 

Prepaid Expenses 
8,000 

Stock 
62,000 

Total 
1,40,000 

Current Liabilities 


Sundry Creditors 
40,000 

Bills Payable 
25,000 

Outstanding Expenses 
5,000 

Total 
70,000 
You are required to compute
 Current Ratio,
 Liquid Ratio,
 And as an accountant, pass your opinion on the result of these ratios.
Solution
Step 1: First Current Ratio is to be calculated.
Current Ratio 
= 
Current Assets/Current Liabilities 

= 
Rs l,40,000/Rs 70,000 = 2:1 
Step 2: Liquid Ratio is to be calculated.
So, Liquid Assets have to be computed.
Liquid Assets 
= 
Current Assets − Stock − Prepaid Expenses 

= 
Rs 1,40,000 − Rs 62,000 − Rs 8,000 = Rs 70,000 
Liquid Ratio 
= 
Liquid Assets/Current Liabilities 

= 
1:1 
Opinion
 Current Ratio is 2:1 which is ideal one.
 Liquid Ratio is 1:1 which is also ideal.
So, the position of Sonali Ltd is said to be satisfactory and ideal, based on liquidity point of view.
Treatment of Value of Stock
Illustration: 11
Current Liabilities of a company: Rs 2,50,000
Current Ratio: 2:1
Liquid Ratio: 1:1
Compute the value of stock assuming there are no other current assets.
Step 1: First, value of Liquid Assets has to be calculated, as Liquid Ratio is given.
Liquid Ratio: 1:1 



= 
Liquid Assets/Current Liabilities = 1/1 

= 
Liquid Assets/Rs 2,50,000 = 1/1 
∴ Liquid Assets  = 
Rs 2,50,000 
Step 2: Value of Current Assets to be calculated, as Current Ratio is given.
Current Ratio 
= 
Current Assets/Current Liabilities = 2/1 

= 
Current Assets/2,50,000 = 2/1 
(Current Assets × 1) 
= 
(2 × 2,50,000) 

= 
Rs 5,00,000 
Step 3: Value of stock is to be found out.
Value of Stock = Current Assets − Liquid Assets (Stockintrade)
Because, stock is the only current asset, as per the assumption given in the problem.
= Rs 5,00,000 – Rs 2,50,000
= Rs 2,50,000
Computation of Current Liabilities from Ratios
Illustration: 12
The Current Ratio of a company is 3:1 and Liquid Ratio is 1:1. Stock is Rs 5,00,000. Compute Current Liabilities.
Solution
Step 1: Since two various ratios are given, from that ratio, Current Liabilities is to be calculated.
Current Ratio 
= 
Current Assets/Current Liabilities 

= 
3/1 
Liquid Ratio 
= 
Liquid Assets/Current Liabilities = 1/1 
Current Assets − Liquid Assets 
= 
Stock 
3 − 1 
= 
Stock 
2 
= 
Stock 
Current Liabilities = 5,00,000/2 
= 
Rs 2,50,000 
Computation of Current Assets and Current Ratio
Illustration: 13
Total Current Liabilities of a company is Rs 3,00,000, Liquid Ratio is 4:1, Stock is Rs 3,00,000. Find the Current Assets and Current Ratio.
Solution
Step 1: Current Liabilities = Rs 3,00,000 (Given)
Liquid Ratio = 4:1 (Given)
Step 2: Liquid Ratio = Liquid Assets/Current Liabilities
= 4:1
That means Liquid Assets are 4 times as that of Current Liabilities
∴ Liquid Assets 
= 
4 × Rs 3,00,000 

= 
Rs 12,00,000 
= 
Liquid Assets + Stock 


= 
Rs 12,00,000 + Rs 3,00,000 

= 
Rs 15,00,000 
Step 4: Current Ratio 
= 
Current Assets/Current Liabilities 

= 
Rs l5,00,000/Rs 3,00,000 

= 
5:1 
Illustration: 14
Sharma Ltd has Liquid Ratio 2:1, stock is Rs 50,000. Total Current Liabilities is Rs 1,00,000. Compute Current Ratio.
Solution
Step 1: Liquid Ratio = 2:1 (Given)
Liquid Ratio = Liquid Assets/Current Liabilities = 2/1
This means that the value of Liquid Assets is twice as that of Current Liabilities.
Liquid Assets 
= 
2 – Rs 1,00,000 

= 
Rs 2,00,000 
Step 2: Value of Current Assets has to be calculated.
Current Assets 
= 
Liquid Assets + Stock 

= 
Rs 2,00,000 + Rs 50,000 

= 
Rs 2,50,000 
Step 3: Current Ratio 
= 
Current Assets/Current Liabilities 

= 
Rs 2,50,000/Rs 1,00,000 

= 
2.5:1 
Computation of Value of Stock
Illustration: 15
Liquid Ratio: 2:1; Current Assets: Rs 2,50,000; Current Liabilities: Rs 60,000. Compute the value of stock.
Solution
Step 1: Liquid Ratio = 2:1 (Given)
Liquid Ratio 
= 
Liquid Assets/Current Liabilities = 2/1 
Liquid Assets 
= 
Current Liabilities × 2 

= 
Rs 60,000 × 2 

= 
Rs 1,20,000 
Step 2: Value of stock 
= 
Current Assets − Liquid Assets 

= 
Rs 2,50,000 − Rs 1,20,000 

= 
Rs 1,30,000 
Relationship of Working Capital with Current Ratio and Liquid Ratio
Illustration: 16
Working capital of a limited company is Rs 1,20,000. Current Ratio is 3:1, Stock is Rs 60,000. Compute (a) Current Liabilities (b) Current Assets (c) Liquid Ratio
Solution
From Working Capital and Current Ratio, other values are computed as follows:
Step 1: Working Capital = Current Assets – Current Liabilities
Rs 1,20,000 = Current Assets − Current Liabilities
Step 2: Current Ratio = Current Assets/Current Liabilities = 3/1
Step 3: Assume Current Liabilities = X
Then, Current Assets = 3 × X (as ratio is = 3:1)
Step 4: Go to first step,
i.e., Current Assets – Current Liabilities 
= 
1,20,000 
3X – X 
= 
1,20,000 
2X 
= 
1,20,000 
X 
= 
Rs 60,000 (Current Liabilities) 
Step 5: Current Assets 
= 
Rs 60,000 × 3 

= 
Rs 1,80,000 
Step 6: Liquid Assets 
= 
Current Assets − Stock 

= 
Rs 1,80,000 − Rs 60,000 

= 
Rs 1,20,000 
Step 7: Liquid Ratio 
= 
Liquid Assets/Current Liabilities 

= 
1,20,000/60,000 = 2/1 

= 
2:1 
5.3 Absolute Liquid Ratio – Relationship of Absolute Liquid Assets to Liquid Liabilities
The relationship of absolute liquid assets to liquid liabilities is termed as “Absolute Liquid Ratio”. It is calculated as:
Absolute Liquid Ratio = Absolute Liquid Assets/Liquid Liabilities
Absolute Liquid Assets = Cash, Bank and Shortterm Investments.
Liquid Liabilities = Current Liabilities – Bank overdraft. Satisfactory level of ratio is 1:1.
Computation of Absolute Liquid Ratio
Illustration: 17
A limited company has Current Liabilities of Rs 1,00,000. It has Cashin hand Rs 5,000, Cash at Bank Rs 45,000, Shortterm Investments Rs 50,000. Further Bank Overdraft is Rs 25,000. Compute Absolute Liquid Ratio.
Solution
Step 1: First, value of absolute Liquid Assets has to be calculated.
Absolute Liquid Assets 
= 
Cash + Bank + Shortterm Investment 

= 
Rs 5,000 + Rs 45,000 + Rs 50,000 

= 
Rs 1,00,000 
Step 2: Value of Liquid Liabilities has to be calculated, now.
Liquid Liabilities 
= 
Current Liabilities − Bank Overdraft 

= 
Rs 1,00,000 − Rs 25,000 

= 
Rs 75,000 
Step 3: Absolute Liquid Ratio 
= 
Absolute Liquid Assets/Liquid Liabilities 

= 
Rs 1,00,000/Rs 75,000 

= 
1 : 0.75 
OBJECTIVE 6: SOLVENCY RATIOS (LONGTERM SOLVENCY)
 Solvency Ratios deals with entity’s ability to meet its longterm obligations.
 Solvency refers to the firm’s ability to meet its longterm indebtedness.
 The following are important Solvency Ratios:
 Debt Equity Ratio
 Total Assets to Debt Ratio
 Proprietary Ratio
6.1 Debt Equity Ratio
6.1.1 Debt Equity Ratio – Relationship between Debt and Equity
 This ratio is computed to ascertain the soundness of the longterm financial position of the concern.
 This ratio indicates the proportion between debt (external equities) and the equity (internal equities).
 Debt Longterm loans: Debentures, longterm loans from Banks and financial institutions. Equity: Shareholder’s funds: Equity Share capital, Preference share capital, Reserves and surplus loss, Losses and fictitious assets (e.g.: Preliminary expenses).
 This ratio is calculated as:
Debt Equity Ratio = Debt (Longterm Loans)/Equity (Shareholder’s Funds)
 If it is 2:1, then the concern is said to be at a satisfactory level.
 A higher ratio than this normal level, i.e. 2:1 then the concern is facing a risky financial position, where as a lower ratio indicates safer financial position.
 It also indicates the extent to which the concern depends upon outsiders for its existence.
Computation of Debt Equity Ratio
Illustration: 18
From the following, compute Debt Equity Ratio:

Equity Share Capital 
1,00,000 

General Reserve 
80,000 

6¼% Debentures 
75,000 

Current Liabilities 
90,000 

Preliminary Expenses 
30,000 
Solution
Debt Equity Ratio = Debt/Equity
Step 1: Debt = Rs 75,000
(∴ Debentures only here)
Step 2: Equity 
= 
Equity Share Capital + General Reserve − Preliminary Expenses 

= 
Rs 1,00,000 + 80,000 − Rs 30,000 

= 
Rs 1,50,000 
Step 3: Debt Equity Ratio 
= 
Rs 75,000/Rs 1,50,000 

= 
1:2 
6.2 Total Assets to Debt Ratio
6.2.1 Total Assets to Debts Ratio – Relationship between Total Assets and Debt
The components of this ratio:
(i) Total Assets and (ii) Debt
 Total Assets: This include both Fixed and Current Assets. But this does not include fictitious assets as preliminary expenses, underwriting commission discount on issue of shares/debentures etc. and debit balance of Profit and Loss A/c.
 Debts: Longterm debts, which usually gets matured after 1 year. This includes bonds, debentures and other loans from financial institution.
 Total Assets to Debt Ratio = Total Assets/Longterm Debts
 Normal level is said to be at 2:1 ratio.
 A higher ratio indicates higher security to lenders.
 A low ratio indicates a risky financial position.
Computation of Total Assets to Debt Ratio
Illustration 19
Following is the Balance Sheet of a company as on Mar 31, 2006:
You are required to compute Total Assets to Debt Ratio.
Solution
Step 1: Total Assets = Rs 5,00,000
Step 2: Debt (Long term) = Rs 2,00,000 (Debentures only)
Step 3: Total Assets to Debt Ratio 
= 
Total Assets/Longterm Debt 

= 
Rs 5,00,000/Rs 2,00,000 

= 
5:2 
6.3 Proprietary Ratio
6.3.1 Proprietary Ratio – Relationship between Proprietor’s Funds and Total Assets
 This ratio establishes the relationship between Proprietor’s funds and total tangible assets.
 This ratio reflects the general financial position of a concern.
 This is computed as:
Proprietor’s Funds Proprietary Ratio = (Shareholder’s Fund)/Total Assets
 Proprietor’s Funds: Share capital, Reserves and surplus (loss to be deducted, payment to others not included)
 Tangible Assets: Good will, Preliminary expenses etc.
 Normal level = 100
 A high level indicates safety to creditors.
 A low (usually < 50) level assets the (investors) creditors.
From the following, calculate Proprietary Ratio:
Rs  

Equity Share Capital 
1,00,000 
reference Share Capital 
30,000 
Reserves and Surplus 
20,000 
Debentures 
2,00,000 
Sundry Creditors 
50,000 

3,00,000 
Fixed Assets 
2,00,000 
Current Assets 
30,000 
Investments 
70,000 

3,00,000 
Solution
 Shareholder’s Funds: Rs 1,00,000 + Rs 30,000 + Rs 20,000= Rs 1,50,000 (excluding debentures and creditors)
 Total Assets = Rs 3,00,000
 Proprietary Ratio = Rs l,50,000/Rs 3,00,000 = 1/2 = 0.5 or 5:1 (or) 0.5 × 100 = 50%
Computation of Proprietary Ratio from Balance Sheet
Illustration: 21
Balance Sheet of Dabar Ltd as on Mar 31, 2006 is given. From this, compute (a) Debt Equity Ratio, (b) Proprietary Ratio and (c) Total Assets to Debt Ratio
Solution
(a) Value of Debentures = Rs 5,00,000 

Shareholder’s Funds (Equity) 
= 
Equity Share Capital + General Reserve 

= 
Rs 12,00,000 + Rs 8,00,000 (Debentures) 
Debt Equity Ratio 
= 
Longterm Debts/Shareholder’s Funds 

= 
Rs 5,00,000/Rs 20,00,000=0.25:1 
(b) Proprietary Ratio 
= 
Shareholder’s Funds/Total Assets 

= 
Rs 20,00,000/Rs 40,00,000 = 0.5:1 or 0.5% = 50% 
(c) Total Assets to Debt Ratio 
= 
Total Assets/Longterm Debt 

= 
Rs 40,00,000/Rs 5,00,000 

= 
8:1 
OBJECTIVE 7: PROFITABILITY RATIOS
 Efficiency of a concern is measured by profitability.
 Profit as compared to the capital employed indicates profitability of a concern.
 Some important Profitability Ratios are: Gross Profit Ratio, Net Profit Ratio, Operating Profit Ratio and Operating Ratio.
7.1 Gross Profit Ratio
7.1.1 Gross Profit Ratio – Relationship of Gross Profit to Sales
 The relationship of gross profit to sales is termed as Gross Profit Ratio.
 This ratio is calculated as:
Gross Profit Ratio = Gross Profit/Net Sales × 100
 Gross Profit is taken from Trading Account of an enterprise.
Gross Profit
=
Sales − Cost of Goods Sold
Cost of Goods Sold
=
Opening Stock × Purchases − Closing Stock (or)
=
Sales − Gross Profit
Net Sales
=
Gross Sales (Cash Sale × Credit Sale) − Sales Returns
 This ratio is a good indicator to maintain the correct selling price and efficiency of trading activities.
 It may also be compared to previous years, which will assist the management to take vital policies.
Illustration: 22
From the following, calculate Gross Profit Ratio.


Rs 

Cash Sales 
50,000 

Credit Sales 
60,000 

Sales Return 
10,000 

Gross Profit 
50,000 
Solution
Step 1: Value of Net Sales to be computed.
Net Sales 
= 
Cash Sale + Credit Sale − Sales Return 

= 
Rs 50,000 + Rs 60,000 − Rs 10,000 

= 
Rs 1,00,000 
Step 2: Gross Profit = Rs 50,000 (Given)
Step 3: Gross Profit Ratio 
= 
Gross Profit/Net Sales × 100 

= 
Rs 50,000/ Rs l,00,000 × 100 = 50% 
Illustration: 23
From the following data, compute Gross Profit Ratio.
2008 Rs  2009 Rs  

Sales 
2,00,000 
2,40,000 
Gross Profit 
50,000 
80,000 
Gross Profit Ratio = Gross Profit/Net Sales × 100 

Year 
Year 
2008 
2009 
Gross Profit Ratio = Rs 50,000/Rs 2,00,000 × 100 
= Rs 20,000/Rs 2,40,000 × 100 
= 25% → 
= 33 1/3% 
Conclusion = Profit rose from 25% to 33 1/3% this year. 
Treatment of Cost of Goods Sold and Gross Profit (G.P.)
Illustration: 24
Sales of a company is Rs 7,20,000.
Gross Profit is 20% on cost. Compute Gross Profit Ratio.
Solution
Step 1: Cost of goods sold has to be calculated as:
Let the cost be 
= 
Rs 100 
Then Sales 
= 
Rs 120 (100 + 20%) 
Cost of Goods Sold 
= 
100/120 × Rs 7,20,000 

= 
Rs 6,00,000 
Step 2: Next, Gross Profit has to be calculated.
Gross Profit 
= 
Sales − Cost of Goods Sold 

= 
Rs 7,20,000 − Rs 6,00,000 

= 
Rs 1,20,000 
Step 3: Gross Profit Ratio 
= 
Gross Profit/Net Sales × 100 

= 
Rs 1,20,000/Rs 7,20,000 × 100 

= 
16.66% 
7.2 Net Profit Ratio
7.1.2 Net Profit Ratio – The Relations hip of Net Profit to Net Sales
 The relationship of Net Profit to Net Sales is termed as “Net Profit Ratio”.
 Net Profit Ratio is calculated as
Net Profit Ratio = Net Profit/Net Sales ×100
 This ratio reflects the overall efficiency of a concern.
 This ratio also helps to determine operational efficiency of an enterprise.
 Higher the Net Profit Ratio, better the efficiency of a concern.
 At times, Net Profit Ratio is calculated either Profit Before Tax (P.B.T.) (or) Profit After Tax (P.A.T.), then Net Profit Ratios will be
P.B.T./Net Sales × 100 (or) P.A.T./Net Sales×100
 Net Profit is taken from P and L Account or to Gross profit less administration expenses, selling and distribution expenses, financial expenses, nonoperating expenses and adding nonoperating incomes.
Computation of Net Profit Ratio
Illustration: 25
Compute Net Profit Ratio from these.
Net Profit = Rs 75,000
Sales = Rs 3,00,000
Net Profit Ratio= Net Profit/Net Sales × 100
Illustration: 26
Gross Profit Ratio of a company is 20%. Its cash sales are Rs 5,00,000 and its credit sales are 80% of total sales. The indirect expenses are Rs 50,000. Calculate Net Profit Ratio.
Solution
Step 1: Total sales have to be computed.
Total Sales 
= 
Cash Sales + Credit Sales 

= 
Rs 5,00,000 + 80% of Total Sales 
This means cash sales = 20% (100% − 80%) of Total Sales  
∴ Total Sales 
= 
Cash Sales ×100/20 

= 
Rs 5,00,000 × 100/20 

= 
Rs 25,00,000 
Step 2: Next, value of Gross Profit is to be computed.
Gross Profit 
= 
Rs 25,00,000 × 20/100 

= 
Rs 5,00,000 
Step 3: Value of Net Profit is to be computed.
Net Profit 
= 
Gross Profit − Indirect Expenses 

= 
Rs 5,00,000 − Rs 50,000 

= 
Rs 4,50,000 
Step 4: Net Profit Ratio 
= 
Net Profit/Net Sales × 100 

= 
Rs 4,50,000/Rs 25,00,000 × 100 

= 
18% 
7.3 Operating Profit Ratio
7.3.1 Operating Profit Ratio – Relationship between Operating Profit and Net Sales
 This ratio measures the relationship between operating profit and net sales.
 This ratio helps in determining the operational efficiency of an enterprise.
 This ratio is calculated as:
Operating Profit Ratio = Operating Profit/Net Sales × 100
 Operating Profit = Net Profit+ Nonoperating Expenses –Nonoperating Income
Nonoperating Expenses = Interest on Loan and Loss on sale of assets
Nonoperating Income = Dividend, Interest received and Profit on sale of asset
Or  Operating Profit = Gross Profit –Operating Expenses
 Net Sales = Gross Sales = Cash Sales + Credit Sales – Sales Revenue
Computation of Operating Profit Ratio
Illustration: 27
Compute Operating Profit Ratio from the following:


Rs 

Net Profit 
6,00,000 

Loss on Sale of Furniture 
20,000 

Profit on Sale of Investments 
60,000 

Rs 


Interest paid on Loan 
60,000 

Interest from Investment 
40,000 

Sales 
11,60,000 
Solution
Step 1: Nonoperating expenses have to be calculated.
Nonoperating Expenses 
= 
Interest on Loan + Loss on Sale of Furniture 

= 
Rs 60,000 + Rs 20,000 

= 
Rs 80,000 
Step 2: Nonoperating income to be computed.
Nonoperating Income 
= 
Interest received from Investments + Profit on Sale of Investment 

= 
Rs 40,000 + Rs 60,000 

= 
Rs 1,00,000 
Step 3: Operating profit is to be computed.
Operating Profit 
= 
Net Profit + Nonoperating Expenses − Nonoperating Income 

= 
Rs 6,00,000 + 80,000 − 1,00,000 

= 
Rs 5,80,000 
Step 4: Operating Profit Ratio 
= 
Operating Profit/Net Sales × 100 

= 
5,80,000/11,60,000 × 100 

= 
50% 
Treatment of G.P. with Sales
Illustration: 28
Calculate Operating Profit Ratio if
Case (a) Net sales Rs 10,00,000, Gross profit 20%on Sales and Operating expenses Rs 20,000
Case (b) Net sales Rs 6,00,000, Gross profit 20% on Sales and Operating expenses Rs 20,000
Solution
Case (a): Operating Profit 
= 
Gross Profit—Operating Cost 

= 
Rs 2,00,000−Rs 20,000 

= 
Rs 1,80,000 
Operating Profit Ratio  = 
Operating Profit/Net Sales × 100 

= 
Rs 1,80,000/Rs 10,00,000 × 100 = 18% 
Case (b): Operating Profit 
= 
Gross Profit—Operating Expenses 
Gross Profit 
= 
20% of Sales 

= 
20/100 × Rs 6,00,000 

= 
Rs 1,20,000 
∴ Operating Profit 
= 
Rs 1,20,000−Rs 20,000 

= 
Rs 1,00,000 
Operating Profit Ratio 
= 
Operating Profit/Net Sales × 100 

= 
Rs 1,00,000/Rs 6,00, 000 × 100 = 16.66% 
7.4 Operating Ratio
7.4.1 Operating Ratio – Relationship between Operating Cost and Net Sales
 This ratio establishes relationship between operating cost and net sales.
 This measures the operating efficiency of the enterprise.
 This ratio measures the amount of expenditure incurred in production, sales and distribution of output.
 Operating Ratio = Cost of Goods Sold + Operating Expenses/Net Sales × 100
or
Operating Ratio = Operating Cost/Net Sales × 100
 Cost of Goods Sold =Opening Stock + Purchases + Direct Expenses + Manufacturing Expenses – Closing Stock (or) Sales – Gross Profit
 Operating Expenses = Administrative Expenses + Selling and Distribution Expenses
 Operating Ratio and Net Profit Ratio are interrelated.
Operating Ratio + Net Profit Ratio = 100
Example: 
20% + 80% = 100 



or 

40% + 60% = 100 



or 

70% + 30% = 100 

 Higher Operating Ratio indicates poor performance, so lower the better.
 It is an indicator to determine the cost content, and which element of cost has gone up.
Computation of Operating Ratio
Illustration: 29
From the following, compute Operating Ratio:


Rs 

Cost of Goods Sold 
4,50,000 

Operating Expenses 
50,000 

Sales 
10,60,000 

Sales Returns 
60,000 
Solution
Step 1: Add Cost of Goods Sold and Operating Expenses
= Rs 4,50,000 + Rs 50,000
= Rs 5,00,000
Step 2: Value of Net Sales has to be calculated.
Net Sales 
= 
Sales — Sales Return 

= 
Rs 10,60,000 − Rs 60,000 

= 
Rs 10,00,000 
Step 3: Operating Ratio is to be found out.
Operating Ratio 
= 
Cost of Goods Sold + Operating Expenses/Net Sales × 100 

= 
Rs 5,00,000/Rs l0,00,000 × 100 

= 
50% 
OBJECTIVE 8: ACTIVITY RATIOS
 Activity Ratios measure the effectiveness of entities.
 These ratios are also called as “Performance or Turnover Ratios”.
 These ratios measures the effectiveness of a business concern.
 It can also be known how effectively a concern utilises its resources, by using these ratios.
 The following are some important Activity Ratios:
8.1 Inventory Turnover Ratio
8.1.1 Inventory Turnover Ratio – Relationship between the Cost of Goods Sold and Average Inventory
 This ratio establishes relationship between the cost of goods sold (during a given period) and the average amount of inventory carried (during that period).
 This indicates whether stock has been efficiently used or not.
 The ratio is calculated as follows:
Inventory or Stock Turnover Ratio
= Cost of Goods Sold/Average Inventory (or) Stock
 Cost of Goods Sold = Opening Stock + Purchase + Direct Expenses – (Less) Closing Stock
or
Cost of Goods Sold =Sales– Gross Profit
Average Stock = (Opening Stock + Closing Stock)/2
Note: If information to calculate average stock is not given in the problem then students are expected to take the closing stock as average stock.
 Higher ratio indicates the unit functions on a comparatively low margin of profit. More sales are on with (that unit of investment in stocks) a rupee of investment in stocks.
 This ratio also helps to invest minimum in stock.
 It helps business enterprises to earn a reasonable margin of profits.
Computation of Inventory Turnover Ratio
Illustration: 30
From the following, compute Inventory Turnover Ratio.


Rs 

Cost of Sales 
9,00,000 

Stock at the beginning of the year 
2,50,000 

Stock at the end of the year 
3,50,000 
Solution
Step 1: First, average stock is to be calculated.
Average Stock
Step 2: Cost of Goods Sold = Cost of Sales = Rs 9,00,000
Step 3: Inventory Turnover Ratio = Rs 9,00,000/Rs 3,00,000 = 3 times
Computation of Stock Turnover Ratio from Trading A/c
Illustration: 31
Following is the Trading A/c of Jam Ltd. Compute Inventory Turnover Ratio.
Solution
Step 1: Cost of goods sold has to be calculated.
Cost of Goods Sold 
= 
Sales — Gross Profit 

= 
Rs 3,00,000 − Rs 1,00,000 

= 
Rs 2,00,000 
Step 2: Average stock is to be calculated.
Average Stock
Step 3: Stock Turnover Ratio 
= 
Cost of Goods Sold/Average Stock 

= 
Rs 2,00,000/Rs 25,000 = 8 times 
Treatment of Cost of Sales
Illustration: 32
From the following, calculate Stock Turnover Ratio.
Total Sales: Rs 10,00,000, Opening Stock: Rs 2,20,000 and Closing Stock: Rs 1,80,000.
Loss Ratio = 20%.
Solution
Step 1: From Sales, Cost of Sales is to be computed.
Sales = Rs 10,00,000
Gross Loss: 20%
20% of Sales (10,00,000) = Rs 2,00,000
∴ Cost of Sales 
= 
Sales + Gross Loss 

= 
Rs 10,00,000 + Rs 2,00,000 

= 
Rs 12,00,000 
Step 2: Average Stock has to be calculated.
Average Stock
Step 3: Inventory Turnover Ratio 
= 
Cost of Sales/Average Stock 

= 
Rs 12,00,000/Rs 2,00,000 = 6 times 
From the following, calculate Inventory Turnover Ratio.

Rs 
Opening Stock 
1,00,000 
Purchases 
3,50,000 
Sales 
5,00,000 
Gross Profit Ratio 
20% on Sales 
Solution
Step 1: First, cost of sales has to be computed.
Cost of Sales 
= 
Sales − Gross Profit 

= 
Rs 5,00,000 − (20% of 5,00,000) 

= 
Rs 5,00,000 − Rs 1,00,000 

= 
Rs 4,00,000 
Step 2: Value of Closing Stock has to be calculated.
Closing Stock 
= 
Opening Stock + Purchases + Gross Profit − Sales 

= 
Rs 1,00,000 + Rs 3,50,000 + Rs 1,00,000 − Rs 5,00,000 

= 
Rs 5,50,000 − Rs 5,00,000 

= 
Rs 50,000 
Step 3: Value of Average Stock
Step 4: Inventory Turnover Ratio 
= 
Cost of Goods Sold/Average Stock 

= 
Rs 4,00,000/Rs 75,000 

= 
5.33 times 
8.2 Debtors Turnover Ratio or Receivables Turnover Ratio
8.2.1 Debtors Turnover Ratio –Relationship between Net Credit Sales and Average Debtors
 This ratio indicates the relationship between net credit sales and average debtors or receivables in a year.
 This ratio is calculated as:
Debtors Turnover Ratio = Net Credit Sales/Average Accounts Receivable
 Accounts Receivable includes “Trade Debtors” and “Bills Receivables”.
 Average Debtors
 Doubtful debts are not deducted from total debtors.
 If details regarding opening and closing receivables and credit sales are not given in the problem, the Debtors Turnover Ratio =Total Sales/Accounts Receivable
 This ratio is calculated to determine the number of times the receivables are turned over in a period in relation to sales.
 It indicates how quickly debtors are converted into cash.
 A high ratio indicates the quickness of debts collected. Lower ratio would mean otherwise.
Debtors Turnover Ratio — Computation
Illustration: 34
The following data are taken from Shah Ltd.

Rs 
Total Sales for the year 2009 
4,00,000 
Cash Sales for the year 2009 
1,00,000 
Debtors as on Jan 1, 2009 
45,000 
Debtors as on Dec 31, 2009 
55,000 
Compute Debtors Turnover Ratio.
Solution
Step 1: First, Credit Sales have to be calculated.
Credit Sales 
= 
Total Sales − Cash Sales 

= 
Rs 4,00,000 − Rs 1,00,000 

= 
Rs 3,00,000 
Step 2: Next, average debtors have to be computed.
Average Debtors
Step 3: Finally,
Debtors Turnover Ratio 
= 
Credit Sales/Average Debtors 

= 
Rs 3,00,000/Rs 50,000 = 6 times 
8.3 Working Capital Turnover Ratio
8.3.1 Working Capital Turnover Ratio – Relationship between Sales and Working Capital
 This ratio indicates the efficiency of working capital of a concern.
 This also indicates if there is over trading.
 This ratio is calculated as:
 Working Capital Turnover Ratio = Sales/Working Capital
Working Capital = Current Assets − Current Liabilities
 This ratio is better than Stock Turnover Ratio.
 It measures the rate of working capital utilisation.
Illustration: 35
Compute Working Capital Turnover Ratio.

Rs 
Cost of Goods Sold 
2,80,000 
Current Assets 
2,05,000 
Current Liabilities 
1,65,000 
Solution
First, working capital is to be calculated.
Working Capital 
= 
Current Assets — Current Liabilities 

= 
Rs 2,05,000 − Rs 1,65,000 

= 
Rs 40,000 
Note: As no sales figures are given, ratio is to be calculated on the basis of cost of sales.
So Working Capital Turnover Ratio 
= 
Cost of Sales/Net Working Capital 

= 
Rs 2,80,000/Rs 40,000 

= 
7 times 
Computation of Working Capital Turnover Ratio from Balance Sheet
Illustration: 36
Following is the Balance Sheet of Chopra Ltd. Compute Working Capital Turnover Ratio.
Further Information
 Total Sales during the year = Rs 46,00,000
 Sales Returns during the year = Rs 6,00,000
Solution
Step 1: First, Net Sales (or) turnover is to be computed.
Net Sales 
= 
Total Sales − Sales Return 

= 
Rs 46,00,000 − Rs 6,00,00 

= 
Rs 40,00,000 
Step 2: Next, Current Assets have to be added.
Current Assets 
= 
Shortterm Investment + Stock + Debtors + Bills Receivable + Cash at Bank + Cashinhand 
Current Assets 
= 
Rs 2,30,000 + Rs 1,80,000 + Rs 2,20,000 + Rs 1,10,000 + Rs 60,000 + Rs 1,00,000 

= 
Rs 9,00,000 
Step 3: Next, Current Liabilities should be added together.
Current Liabilities 
= 
Creditors + Bills Payable + Provision for Income Tax 

= 
Rs 2,80,000 + Rs 80,000 + Rs 40,000 

= 
Rs 4,00,000 
Step 4: Working Capital 
= 
Current Assets — Current Liabilities 

= 
Rs 9,00,000 − Rs 4,00,000 

= 
Rs 5,00,000 
Step 5: Finally,
Working Capital Turnover Ratio 
= 
Net Sales/Working Capital 

= 
Rs 40,00,000/Rs 5,00, 000 

= 
8 times 
Notes
* Both Operating Profit Ratio and Operating Ratio are complementary to each other.
* If one such ratio is deducted from 100, the other ratio can easily be obtained.
* Postmortem Analysis: Ratio Analysis is based on past records, i.e. what happened on a particular date. Nothing is revealed in the interim period. No facts about the future is disclosed.
* Not conclusive result: A single ratio cannot be relied upon to take decisive action. Interrelated and overall analysis of all the concerned ratios can only yield the desired result to some extent. Ratios obtained by a single ratio analysis is not reliable and conclusive.
OBJECTIVE 9: RATIOS: ADVANCED LEVEL
9.1 Turnover Ratio
The ratios to determine how quickly certain current assets are converted into cash are termed as Turnover Ratios.
Some important Turnover Ratios are:
 Inventory Turnover Ratio
 Debtors Turnover Ratio
 Creditors Turnover Ratio
9.1.1 Inventory Turnover Ratio
Formula = Inventory Turnover Ratio = Cost of Goods Sold/Average Inventory
Remember
Cost of Goods Sold = Sales – Gross Profit
Average Inventory
This ratio is expressed by………times.
High ratio indicates status of liquidity of a concern.
Low ratio indicates that the inventory stays for a long time in the warehouse, which is not advisable.
Computation of Inventory Turnover Ratio
Illustration: 37
A firm has sold goods worth Rs 4,00,000 with a gross profit margin of 25%. The stock at the beginning and at the end of the period are Rs 45,000 and Rs 55,000 respectively. Compute the Inventory Turnover Ratio.
Solution
Step 1: Cost of Goods Sold = Sales – Gross Profit
Sales 
= 
Rs 4,00,000 (Given) 
Gross Profit (G.P.) 
= 
25% of Rs 4,00,000 

= 
Rs 1,00,000 (Profit) 

= 
(Rs 4,00,000 – Rs 1,00, 000) = Rs 3,00,000 
Step 2: Average Inventory = (Rs 45,000 + Rs 55,000)/2→(Stock in the beginning + Stock at the end)/2
Step 3: Inventory Turnover Ratio = Rs 3,00,000/Rs 50,000 =6 times
Step 4: Inventory Holding Period = 12 Months/Inventory Turnover Ratio
= 12/6 = 2 months
9.1.2 Debtors Turnover Ratio
Formula
Debtors Turnover Ratio 
= 
Net Credit Sales/Average Debtors 
Net Credit Sales 
= 
Gross Credit Sales – Sales Returns 
Average Debtors 
= 
Note: Debtors include Bills Receivable.
High ratio indicates short time lag between credit sales and cash collection. A low ratio shows the slackness in debt recovery.
Computation of Debtors Turnover Ratio
Illustration: 38
A firm has made credit sales of Rs 2,00,000 during the year. The outstanding amount of debtors at the beginning and at the end of the year were Rs 20,000 and Rs 30,000 respectively. What is the Debtors Turnover Ratio?
Solution
Formula
Debtors Turnover Ratio 
= 
Net Credit Sales/Average Debtors 








9.1.3 Creditors Turnover Ratio
It is a ratio between net credit purchases and the average amount of creditors outstanding during the year.
Formula
Creditors Turnover Ratio 
= 
Net Credit Purchases/Average Creditors 
Net Credit Purchases 
= 
Gross Credit Purchases – Returns 


Creditors include bills payable.
A low ratio shows the liberal credit policy.
A high ratio shows the speedy settlement of credit.
Computation of Creditors Turnover Ratio
Illustration: 39
A firm has made credit purchases of Rs 3,00,000. The amount payable to the creditors at the beginning and the end of the year is Rs 70,000 and Rs 80,000 respectively. Compute the Creditors Turnover Ratio.
Solution
Creditors Turnover Ratio 
= 
Net Credit Purchases/Average Creditors 








9.2 Cash Cycle – Combined Effect of Turnover Ratios
Cash cycle shows the interrelationships of sales, collections from debtors and payment to creditors. It reveals the combined effect of all these Turnover Ratios.
Assume that in the above three illustrations, the data showed relate to a single and same firm, then cash cycle.
Inventory Holding Period 
= 2 months 
Add: Debtors Collection Period 

Less: Creditor s Payment Period 

Shorter the cash cycle,, better the liquidity status. 

[The liquidity position of a firm, nowadays, at international level, is also examined in relation to its ability to meet projected daily expenditure from operations. Such ratios – Defensive Interval Ratio (a ratio between quick assets and projected daily cash recruitments), Cash Flow from operations ratios are not dealt with here.]
9.3 Leverage Ratios
The other category of financial ratios is also termed as Leverage Ratios or Capital Structure Ratios. A modern approach is to express Debt Equity Ratio in terms of the relative proportion of longterm debt and shareholder’s equity.
Debt Equity Ratio = Longterm Debt/Shareholder’s Equity
In this approach, Current Liabilities are excluded in longterm debt. So, by including the Current Liabilities in the debt structure, Debt Equity Ratio is computed differently as
Debt Equity Ratio = Total Debt/Shareholder’s Equity
The Debt Equity Ratio has wider implications, affecting the creditors, owners and even the firm itself. Do judicious combination of Creditors Funds and Owners Funds, that is, the proportion of debt in the financial structure plays a crucial role in determining financial status of a firm. Technically this is termed as Leverage or Trading on Equity %.
This is further interrelated to Coverage Ratios, which measure the firm’s ability to pay certain fixed charges. The Coverage Ratios measure the relation between what is normally available from operations of the firms and the claims of outsiders. Coverage Ratios –interest coverage, dividend coverage, total fixed charge coverage, total cash flow coverage, capital expenditure ratio, debt–service coverage ratio are not dealt with here.
9.4 Profitability Ratios
9.4.1 Profitability Ratios relating to Sales
We have discussed Profitability Ratios in the earlier part of the chapter. Now a slight advance step on Profitability Ratios is to be seen here. Profitability Ratios relating to sales is termed as Expense Ratio. There are different variants of Expense Ratios, depending upon the nature of expense. They are
 Cost of Goods Sold = Cost of Goods Sold/Net Sales × 100
 Operating Expenses Ratio = Administrative Expenses + Selling Expenses/Net Sales ×100
 Administrative Expenses Ratio = Administrative Expenses/Net Sales × 100
 Selling Expenses Ratio = Selling Expenses/Net Sales× 100
 Operating Ratio = Cost of Goods Sold + Operating Expenses/Net Sales × 100
 Financial Expenses Ratio=Financial Expenses/Net Sales × 100
Note: Expenses on taxes, dividends and extraordinary losses (theft, stock devasted by natural calamities) are not included.
Thus, specific Expenses Ratio for each of such items may be calculated. These Expense Ratios are interrelated with Profit Margin Ratio (G.P. Ratio, N.P. Ratio etc.). The Profitability Ratios based on sales (Expenses Ratio) is a very important tool for ana1ysing the operational efficiency – the profitability of a manufacturing concern.
9.4.2 Profitability Ratios relating to Investments
Return on Investment Ratio: Profitability Ratios relating to Investments, measures the relationship of the profit of the firm to its Investments. These ratios are termed as Return on Investments (ROI).
Return on Assets: (based on assets) measure the relationship between net profit assets. The net profit may be (a) net profits after taxes (b) net profits after taxes + interest and (c) net profits after taxes + interest – tax savings and the assets may be (a) total assets (b) fixed assets and (c) tangible assets. As such, there are different variants in computation of return on assets.
Formulae for computing different return on assets:
 Return on Assets (ROA) = Net Profit after Taxes/Average Total Assets × 100
 ROA = Net Profit after Taxes + Interest/Average Total Assets × 100
 ROA = Net Profit after Taxes + Interest/Average Tangible Assets × 100
 ROA = Net Profit after Taxes + Interest/Average Fixed Assets ×100
The above formulae can be substituted by the following to ascertain the operating performance of a business entity.
Return on Capital Employed (ROCE): Here the capital employed is the base to test the profitability of a concern, relating to sources of longterm funds.
As the concepts of profits and capital employed vary, ROCE also can be computed in various ways:
 ROCE = Earnings Before Interest and Taxes (EBIT) /Average Total Capital Employed + 100
 ROCE = Net Profit after Taxes + Interest – Tax advantage on Interest/Average Total Capital Employed ×100
 ROCE = Net Profit after Taxes + Interest – Tax advantage on Interest/Average Total Capital Employed – Average Intangible Assets × 100
ROCE, in total, assess the firm’s profitability, taking owners’ funds and lenders’ funds together.
9.4.3 Return on Shareholder’s Equity
Profit is based on return on shareholder’s equity and its different variants. Moving one step up, profitability of firm may be ascertained by computing Return on Shareholder’s Equity.
There are different variants of the Return on Shareholder’s equity. They are:
 Rate of return on:
 Total Shareholders’ Equity
 Equity of Ordinary Shares
 Earnings Per Share (EPS)
 Dividend Per Share (DPS)
 Dividend Payout Ratio (D/P Ratio)
 Dividend and Earnings Yield
 Price Earnings Ratio (P/E Ratio)
 Return on Investment (ROI) and (h) Computing of ROI Ratio
9.4.3.1a Return on Total Shareholders’ Equity: Return on Total Shareholders’ Equity = Net Profit after Taxes/ Average Total Shareholders’ Equity × 100
Total Shareholders’ Equity = Preference Share Capital + Ordinary Shareholders’ Equity (equity share capital + share premium +reserves and surplus – accumulated loss)
This ratio indicates how profitably the owners’ funds have been utilised by the business entities.
9.4.3.1b Rate of Return on Equity of Ordinary Shareholders: It is also called as Net Worth. This ratio measures the return on the total equity funds of ordinary shareholders.
Return on Equity Funds
This is the most essential and vital ratio for equity shareholders of a company. Since equity shareholders are real owners, this ratio plays a crucial and significant role in industries.
9.4.3.2 Earnings Per Share (EPS):This measures the extent of profit available to the equity shareholders. Profit is computed as per share basis.
Earnings Per Share = Net Profit (after taxes and dividend on performance shares)/No. of Ordinary Shares Outstanding × 100
These ratios can be analysed by (i) intrafirm results (past records) (ii) interfirm comparisons and (iii) overall industry results.
Besides these,
 Cash Earnings Per Share,
 Book Value Per Share and
 Price to Book Value Shares
are also useful in analysing and predicting future returns from Stock.
9.4.3.3 Dividend Per Share (DPS):DPS = Dividend paid to ordinary shareholders/No. of Ordinary Shares Outstanding
DPS may be a better indicator than EPS, as it shows the distribution of net profit to ordinary shareholders.
9.4.3.4 Dividend Payout Ratio (D/P Ratio):This ratio measures the proportion of dividends paid to earning available to shareholders.
From this, Retention Ratio is computed.
Retention Ratio = 100 − D/P Ratio
This is useful to measure how much is retained in the business from the net profits earned.
These two ratios, i.e. EPS and DPS are generally based on book value of shares (per share).
9.4.3.5 Earnings and Dividend Yield: Yield of a firm may also be expressed on the basis of market value of shares (per share). These are (i) Earnings Yield (ii) Dividend Yield
They are computed as:
 Earnings Yield = EPS/Market Value Per Share × 100
 Dividend Yield = DPS/Market Value Per Share × 100
9.4.3.6 Price Earnings Ratio (P/E Ratio):This ratio measures the amount that investors are willing to pay for each rupee of earnings.
 This ratio measures investors’ expectations and the market appraisal of the performance of a business entity.
 As investors on firm’s performance is assessed, this is very useful to the investors.
 Further advanced concepts such as Return on Equity (ROE), Growth Rates, Internal Growth Rate (IGR) and Sustainable Growth Rates (SGR) are not dealt with here.
9.4.3.7 Return on Investment (ROI):This ratio measures the relationship of profit with capital employed.
Formula:
 This ratio is expressed in percentage.
 This is useful to ascertain how much income the use of Rs 100 of Capital generates.
 This ratio measures how efficiently the sources entrusted to the business are used.
 This ratio also ascertains the efficiency of different units within a business concern.
9.4.3.8 Computation of ROI Ratio: Capital employed is to be computed, first. For this, any of the following methods can be adopted.
Method 1: Sum of (1) Share Capital (includes preference and equity) (2) Reserves and (3) Longterm loans has to be done.
From this total, the following items have to be deducted: (1) Fictious Assets (e.g. preliminary expenses) and (2) Nonoperating assets.
Net result will be the Capital employed.
Method 2: Capital employed will be ascertained by adding all the fixed assets (less depreciation) and the working capital of a concern.
Illustration: 40
Following is the Balance Sheet of Raj Ltd as on Mar 31, 2009: Compute ROI:
Solution
Step 1: Profit before interest has to be computed.

Rs 

Profit (as shown in the question) 
4,00,000 
Add: Interest (10% on Rs 10,00,000) 
1,00,000 
Profit before interest 
5,00,00 
Step 2: Capital employed is to be computed.
Method 1:Fixed Assets (Net) 
25,00,000 
Add: Working Capital 

Current Assets –Current Liabilities 
5,00,000 
(Rs 15,00,000 – Rs 10,00,000) 

Capital Employed 
________ 
This can be ascertained by another way. 

Method 2: Share Capital 
10,00,000 
Add: (Reserves + Profits) 

Rs 7,00,000 + Rs 4,00,000 
11,00,000 

21,00,000 
Add: Loans 
10,00,000 

31,00,000 
Less: Underwriting Commission 
1,00,000 
Capital Employed 
30,00,000 
Step 3: → ROI 
= 
Profit before Interest/Capital Employed × 100 

= 
Rs 5,00,000/Rs 30,00,000 × 100 

= 
16.66% 
Calculation of Capital Employed
Illustration: 41
The Balance Sheet of X Ltd as on Mar 31, 2009.
Additional Information
Net profit for the year was Rs 1,00,000 after charging interest of Rs 20,000 on secured term loan, but before tax.
Calculate Return on Capital Employed for the year.
Solution
[Note: As Net profit and interest are shown in additional information they may straight away be taken for the computation of the Profit Before Interest (PBI).
Step 1: Here profit is shown after charging interest. So profit is added to interest here to arrive at Profit Before Interest.
Therefore, Profit Before Interest = Rs 1,00,000 + Rs 20,000 = Rs 1,20,000
Step 2: Capital Employed is now calculated.
Method 1: Fixed Assets
(Rs 1,00,000 + Rs 1,00,000 + Rs 1,77,500 + Rs 37,500 + Rs 25,000) 
= 
Rs 4,40,000 
Add → Working Capital (C.A.. C.L.) 
= 
Rs 60,000 
(Rs 4,70,000 – Rs 4,10,000) 

__________ 
Method 2

Rs 
Share Capital 
2,50,000 
Preference Share Capital 
1,00,000 
Add: Reserves and Surplus 
1,25,000 
Add: Longterm Loan 
1,50,000 

6,25,000 
Less: Miscellaneous Expenditure 
25,000 

6,00,000 
Less: Investment 
1,00,000 
Capital Employed 
5,00,000 
Step 3: Return on Capital Employed: PBI/Capital Employed × l00
= 1,20,000/5,00,000 × 100 = 24%
Note: Investments not taken into account here assuming it is not exclusively for the business concern.
Computation of EPS
Illustration: 42:
Calculate the Earnings Per Share from the following data.

Rs 
Net Profit after Tax 
6,00,000 
10% Preference Share Capital (Rs 10 each) 
10,00,000 
Equity Share Capital (Rs 10 per share) 
10,00,000 
Solution

Rs 
Preference Dividend: 10% of Rs 10,00,000 
1,00,000 
Number of Equity Shares 
10,00,000/10 

1,00,000 
Net Profit after Tax 
6,00,000 
Substitute the figures in the equation or formula:
Earnings Per Share
Computation of DPS
Illustration: 43
Net Profit after interest and tax Rs 5,00,000. Profit distributed as dividend 50%. Equity Share Capital (25,000 equity shares Rs 100 per share) Rs 25,00,000. Calculate Dividend Per Share.
Solution
DPS 
= 
Profit distributed as Dividend/No. of Equity Shares 

= 
(50% of Rs 5,00,000)/25,000 = Rs 2,50,000/25,000 

= 
Rs 10 
DPS 
= 
Rs 10 per Share 
Illustration: 44
Earnings per share Rs 25. Market Price per share Rs 400. Calculate Price Earning Ratio.
Solution
Illustration: 45
The Capital of Vasanth Co. Ltd is as follows:

Rs 
10% Preference Share of Rs 10 each 
5,00,000 
Equity Shares of Rs 10 each 
20,00,000 

________ 
Further Information

Rs 
Profit after Tax 
2,50,000 
Equity Dividend Paid 
1,00,000 
Market price per Equity Share 
50 
Calculate: (i) Earnings Per Share and (ii) Price Earning Ratio.
Solution
 EPS
P/E Ratio
=
Market Price per Share/Earning per Share
=
Rs 50/Re. 1 = 50 : 1
(Combining these two ratios, that is, EPS and P/E, market value of share in future may be computed, which means forecast.)
[Here Market Price per Share 
= 
EPS × P/E 

= 
1 × 50 = Rs 50] 
Illustration: 46

Rs 
Equity Share Capital (Rs 10 per Share) 
25,00,000 
Reserves and Surplus 
2,50,000 
Secured Loan (15%) 
12,50,000 
10% Unsecured Loan 
6,25,000 
Fixed Assets 
15,00,000 
10% Investments 
2,50,000 
Operating Profit 
12,50,000 
Income Tax Rate 
50% 
Market Price per Share 
50 
Calculate Price Earning Ratio (P/E) 

Solution
Step 1: First, EPS has to be ascertained.
Rs 

Operating Profit 
12,50,000 
Less:

2,50,000 
Profit before Tax 
10,00,000 
Less: Income Tax 50% 
5,00,000 
Profit after Tax 
5,00,000 
Step 2: No. of Equity Shares
= Rs 25,00,000/Rs 10 = 2,50,000 shares
Step 3: EPS = Profit after Tax/No. of Equity Shares
= Rs 5,00,000/2,50,000 = Rs 2
Step 4: Calculation of P/E Ratio

P/E Ratio 
= 
Market Price per Share/EPS 



SOLVED PROBLEMS FOR PROFESSIONAL COURSES – COMPREHENSIVE
Construction of Trading and Profit A/c
Illustration: 47
You are given the following information for the year 2008–09 from the books of a firm engaged in trading operations.
Average monthly sales for the year amounted to Rs 30,000
Goods are sold at cost plus 25%
Stockintrade on Mar 31,2009: Rs 29,000
Stock Turnover Ratio: 10
Operating Ratio: 85% Turnover
Depreciation charged on fixed assets for the year: Rs 10,000
Nonoperating income for the year consisted of Bank Interest Rs 1,500 and Dividends received from investments Rs 2,500.
Nonoperating expenses amounted to Rs 2,500 towards the sale of fixed assets.
You are required to construct the Trading and Profit and Loss Account of the firm for the year ended Mar 31, 2009.
(ICWA Inter – Modified)
Solution
The following have to be computed in the order of sequence: (1) G.P. (2) Opening Stock (3) Purchases (4) Net Operating Profit (5) Total Operating Expenses to construct the Trading and Profit and Loss A/c.
Step 1: Calculation of Gross Profit
Gross Profit 
= 
25% of Sales 

= 
25/100 × (Rs 30,000 × 12) 

= 
1/4 × Rs 3,60,000 

= 
Rs 90,000 
Step 2: Calculation of Opening Stock
Cost of Goods Sold 
= 
Sales – G.P. 

= 
Rs 3,60,000 – Rs 90,000) 

= 
Rs 2,70,000 
Stock Turnover 
= 
Cost of Goods Sold/Average Stock 
10 (Given) 
= 
Rs 2,70,000/Average Stock 
Let Average Stock be X. 


Then 10 
= 
Rs 2,70,000/X 
10 × X 
= 
Rs 2,70,000 
X = Rs 2,70,000/10 = Rs 27,000 


Average Stock 
= 
(Opening Stock + Closing Stock)/2 
Rs 27,000 
= 
(Opening Stock + Closing Stock)/2 
(Opening Stock + Closing Stock)/2 
= 
Rs 27,000 
Let Opening Stock be taken as “Y” 


Y + Closing Stock 
= 
Rs 27,000 × 2 
Y + Rs 29,000 
= 
Rs 54,000 
(Given) 


Y 
= 
Rs 54,000 – Rs 29,000 
Therefore, Opening Stock 
= 
Rs 25,00 
Step 3
Purchases 
= 
C.G.S. + Opening Stock – Closing Stock 
Purchases 
= 
Rs 2,70,000 + Rs 29,000 – Rs 25,000 

= 
Rs 2,74,000 
Step 4: Calculation of Net Operating Profit


85 (Given) 
Therefore, Total Operating Expenses 
= 
85 × 3,60,000/100 

= 
Rs 3,06,000 
Therefore, Net Operating Profit 
= 
Sales – Total Operating Expenses 

= 
Rs 3,60,000 – Rs 3,06,000 

= 
Rs 54,000 
Step 5: Calculation of Operating Expenses
Operating Expenses other than Depreciation = Total Operating Expenses — C.G.S. — Depreciation
Step 6: Construction of Trading and Profit and Loss Account
Trading and Profit and Loss Account
For the Year Ending Mar 31, 2009
Construction of Balance Sheet
Illustration: 48
From the particulars furnished here under, you are required to prepare the Balance Sheet: Stock Velocity: 6; Gross Profit Margin = 20%; Capital Turnover Ratio: 2; Fixed Assets Turnover Ratio: 4; Debt Collection Period: 2 months; Creditors Payment Period: 73 days; Gross Profit was Rs 3,00,000; Excess of Closing Stock over Opening Stock was Rs 25,000; Difference in Balance Sheet represents Bank balance.
C.A. Inter – Modified)
Solution
(Assumption: The entire sales and purchases were made on credit.)
Note: Missing figures which are interrelated with other items are to be ascertained in the following sequences.
Step 1: Computation of Sales
Gross Profit Margin 
= 
20% 
Gross Profit (Given) 
= 
Rs 3,00,000 
Therefore, Sales 
= 
100/20 × Rs 3,00,000 

= 
Rs 15,00,000 
Step 2: Cost of Goods Sold has to be computed.
Cost of Goods Sold 
= 
Sales – Gross Profit 

= 
Rs 15,00,000 − Rs 3,00,000 

= 
Rs 12,00,000 
Step 3: Calculation of Opening Stock and Closing Stock.
Stock Velocity 
= 6 (Given) 
Remember: Average Stock = Cost of Goods Sold/Stock Velocity

= 
Rs 12,00,000/6 = Rs 2,00,000 
Let Opening Stock be taken as X Rs 

Then Closing Stock 
= 
Rs (X + 25,000) 
Remember another Equation: 










2X + Rs 25,000 
= 
Rs 2,00,000 × 2 
2X 
= 
Rs 4,00,000 − Rs 25,000 

= 
Rs 3,75,000 
X 
= 
Rs 3,75,000/2 = Rs 1,87,500 
Therefore, Opening Stock 
= 
Rs 1,87,500 
Closing Stock 
= 
Rs 1,87,500 + Rs 25,000 

= 
Rs 2,12,500 
Step 4: Computation of Capital
Remember: Capital = Sales/Capital Turnover Ratio
= Rs 15,00,000/2 = Rs 7,50,000
Step 5: Computation of Fixed Assets
Remember: Fixed Assets = Sales/Fixed Assets Turnover Ratio
= Rs 15,00,000/4 = Rs 3,75,000
Step 6: Calculation of Debtors
Debt Collection Period 
= 
2 months 
Debtors 
= 
Credit Sales × 2/12 

= 
Rs (15,00,000) × (2/12) 

= 
Rs 2,50,000 
Step 7: Computation of Purchases
Purchases 
= 
Cost of Goods Sold + Excess of Closing Stock over Opening Stock 

= 
Rs 12,00,000 + Rs 25,000 

= 
Rs 12,25,000 
Step 8: Computation of Creditors
Creditors Payment Period 
= 
73 days 
Creditors 
= 
(Credit Purchases) × 73/365 

= 
(Rs 12,25,000) × 73/365 

= 
Rs 2,45,000 
Step 9: Finally, Preparation of Balance Sheet
Balance Sheet as on….
Calculation of Missing Figures
Illustration: 49
Complete the following annual financial statements on the basis of ratios provided as under.
Profit and Loss Account for the Year Ended Mar 31, 2009
 Net Profit to Sales 5%
 Current Ratio 1.5
 Return on Net worth 20%
 Inventory Turnover 15 times
(based on Cost of Goods Sold)
 Share Capital to Reserves 4:1
 Rate of Income Tax 50%
(C.A. Inter – Modified)
Solution
Missing figures have to be ascertained in the following sequence (as the particulars relating to ratio are interrelated).
Step 1: Profit after Tax (PAT)
PAT 
= 
Sales × Net Profit Ratio 
= 
10,00,000 × 5% = Rs 50,000 
Step 2: Provision for Tax
Income Tax Rate is 50%
Income Tax 50% of PBIT and
Profit after Tax = Balance 50%
(PAT)
Therefore PAT and Income Tax are equal
Hence Income Tax = (same as PAT) Rs 50,000 (Step 1)
Step 3: Debentures
Debentures 
= Interest on Debentures/Rate of Interest 
Step 4: EBIT
EBIT 
= Net Profit after Tax + Provision for Tax + Debentures interest 
Step 5: Net Worth
Net Worth 
= Return/Rate of Return on Net Worth 
Step 6: Share Capital
Share Capital 
= Net Worth × 4/5 
Step 7: Reserves
Reserves 
= Net Worth – Share Capital 
Step 8: Current Assets
Current Assets  =  Current Liabilities × 1.5 
=  (Given as Sundry Creditors)Rs 30,000 × 1.5 = Rs 45,000 
Step 9: Closing Stock
Closing Stock 
= Cost of Goods Sold/Inventory Turnover Ratio 
Profit and Loss Account for the Year Ended Mar 31, 2009
Balance Sheet as on Mar 31, 2009
Preparation of Final Accounts
Illustration: 50
From the following ratios and further information, you are required to prepare a Trading and Profit and Loss Account:
 Fixed Assets/Capital = 5/4
 Fixed Assets Rs 2,50,000
 Capital/Liabilities = 1/2
 Net Profit/Capital = 1/5
 Gross Profit Ratio 20%
 Stock Turnover Ratio = 10
 Fixed Assets/Total Current Assets = 5/7
 Net Profit to Sales 20%
 Closing Stock Rs 25,000
Out of Current Assets, Sundry Debtors are Rs 3,00,000.
The balance represents Cash.
(CA – Modified)
Solution
Note: In ratio analysis, the particulars are interrelated. As such, missing figures have to be computed in the sequence as follows:
Step 1: Calculation of Capital
Fixed Assets/Capital = 5/4
Rs 2,50,000/Capital = 5/4
Capital × 5 = 4 × Rs 2,50,000
Therefore, Capital = 4 × Rs 2,50,000/5 = Rs 2,00,000
Step 2: Liabilities value is to be computed
Capital/Liabilities 
= 
1/2 
Rs 2,00,000/Liabilities 
= 
1/2 
2 × Rs 2,00,000 
= 
1 × Liabilities 
Therefore, Liabilities 
= 
Rs 4,00,000 
Step 3: Computation of Net Profit
Net Profit/Capital 
= 
1/5 
Net Profit/2,00,000 
= 
1/5 
Net Profit × 5 
= 
1 × Rs 2,00,000 
Net Profit 
= 
Rs 2,00,000/5 

= 
Rs 40,000 
Step 4: Computation of Sales
Net Profit/Sales × 100 
= 
20 (Given: Particular No. (viii)) 
Rs 40,000/Sales × 100 
= 
20 
Therefore, Sales 
= 
Rs 40,000 × 100/20 = Rs 2,00,000 
Step 5: Computation of Gross Profit
Gross Profit Ratio 
= 
20% (Given) 
Gross Profit/Sales × 100 
= 
20 
Gross Profit/Rs 2,00,000 × 100 
= 
20 
Therefore, Gross Profit 
= 
Rs 2,00,000 × 20/100 = Rs 40,000 
Step 6: Computation of Opening Stock
Take the equation,
Cost of Goods Sold 
= 
Sales – Gross Profit 

= 
Rs 2,00,000 – Rs 40,000 = Rs 1,60,000 
Going to other related equation:
Cost of Goods Sold/Average Stock 
= 
Stock Turnover Ratio 
Rs 1,60,000/Average Stock 
= 
10 (Given) 
Rs 1,60,000 
= 
10 × Average Stock 
Average Stock = Rs 1,60,000/10 
= 
Rs 16,000 



Opening Stock + Closing Stock 
= 
2 × Average Stock 

= 
2 × Rs 16,000 

= 
Rs 32,000 
Opening Stock + Rs 25,000 
= 
Rs 32,000 
Therefore, Opening Stock 
= 
Rs 32,000 − Rs 25,000 

= 
Rs 7,000 
Step 7: Cash Balance
Fixed Assets/Total Current Assets 
= 
5/7 
Rs 2,50,000/Total Current Assets 
= 
5/7 
5 × Total Current Assets 
= 
7 × Rs 2,50,000 
Total Current Assets 
= 
7 Rs 2,50,000/5 

= 
7 × Rs 50,000 

= 
Rs 3,50,000 
But Total Current Assets 
= 
Closing Stock + Debtors + Cash 
Cash 
= 
Total Current Assets – Closing Stock – Debtors 

= 
Rs 3,50,000 – Rs 25,000 – Rs 3,00,000 

= 
Rs 25,000 
Step 8: Finally, after obtaining all the figures, we have to prepare first, Trading and Profit and Loss Account and then the Balance Sheet.
Trading and Profit and Loss Account for the Year Ended
Balance Sheet as at
Construction of a Proforma Balance Sheet
Illustration: 51
From the following information, compute the Proforma Balance Sheet of a public limited company:
Sales = Rs 20,00,000
Sales to Net Worth = 2 times
Current liabilities to Net Worth = 40%
Total liabilities to Net Worth= 60%
Current Ratio= 3 times
Sales to Closing Inventory =5 times
Average Collection Period = 73 days
Proforma Balance Sheet
(C.A. Inter, Modified)
Solution
Note: Proforma Balance Sheet itself is a hint to ascertain the missing figures. It is done as follows:
Step 1: Computation of Net Worth
Sales to Net Worth 
= 
2 times (given) 
Rs 20,00,000/Net Worth 
= 
2 
Net Worth × 2 
= 
Rs 20,00,000 
Net Worth 
= 
Rs 20,00,000/2 

= 
Rs 10,00,000 
Step 2: Computation of Current Liabilities
Current Liabilities to Net Worth 
= 
40% (given) 
Current Liabilities/Net Worth 
= 
40/100 
Current Liabilities/Rs 10,00,000 
= 
40/100 
100 × Current Liabilities 
= 
40 × Rs 10,00,000 
Current Liabilities 
= 
40 Rs 10,00,000/100 

= 
Rs 4,00,000 
Step 3:Computation of Longterm Liabilities
Total Liabilities to Net Worth 
= 
60% (given) 
Total Liabilities/Net Worth 
= 
60/100 
100 × Total Liabilities 
= 
60 × Rs 10,00,000 
Total Liabilities 
= 
60 × Rs 10,00,000/100 

= 
Rs 6,00,000 
Therefore, Longterm liabilities 
= 
Total Liabilities – Current Liabilities 

= 
Rs 6,00,000 – Rs 4,00,000 

= 
Rs 2,00,000 
Step 4: Computation of Current Assets
Current Ratio 
= 
Current Assets/Current Liabilities = 3 (Given) 

= 
Current Assets/Rs 4,00,000 = 3 (Given) 
Therefore, Current Assets 
= 
3 × Rs 4,00,000 

= 
Rs 12,00,000 
Step 5: Calculation of Stock
Sales to Closing Inventory 
= 
5 times (Given) 
Sales/Stock 
= 
5 times 
Rs 20,00,000 
= 
5 × Stock 
Therefore, Stock 
= 
Rs 20,00,000/5 

= 
Rs 4,00,000 
Step 6: Computation of Sundry Debtors
Average Collection Period 
= 
73 days 
Sundry Debtors/Sales/365 
= 
73 
Therefore, Sundry Debtors 
= 
Rs 20,00,000 × 73/365 

= 
Rs 4,00,000 
Step 7: Computation of Cash
Cash 
= 
Current Assets – Stock – Debtors 

= 
Rs 12,00,000 – Rs 4,00,000 – Rs 4,00,000 

= 
Rs 4,00,000 
Step 8: Finally, Proforma Balance Sheet has to be drawn.
Proforma Balance Sheet
SOLVED PROBLEMS (COMPREHENSIVE)
Comprising different ratios
Illustration: 52
Net Profit Ratio of a business concern is 20%. The indirect expenses are Rs 80,000 and cash sales are Rs 3,00,000. The credit are 80% of total sales. Calculate the Gross Profit Ratio.
Solution
Step 1: Value of Total Sales has to be calculated.
Credit Sales = 80% of total sales (given in the question)
∴ Cash Sales = 100% – 80%
(Total Sales – Credit Sales)
Step 2: After this, we have to calculate Net Profit..
Formula: Net Profi t Ratio = Net Profi t/Net Sales × 100
Substitute the values in the formula:
20% 
= 
Net Profit/Rs 15,00,000 
i.e., 20/100 
= 
Net Profit/Rs 15,00,000 
Net Profit × 100 
= 
20 × Rs 15,00,000 
Net Profit 
= 
20 × 15,00,000/100 
∴ Net Profit 
= 
Rs 3,00,000 
Step 3: Next, Gross Profit has to be found out.
Remember: Gross Profit = Net Profit + Indirect Expenses

= 
Rs 3,00,000 + Rs 80,000 (given) 

= 
Rs 3,80,000 
Step 4: Finally, Gross Profit Ratio has to be computed.
Formula: Gross Profit Ratio = Gross Profit/Net Sales × 100
Substitute the values in the formula:
Gross Profit Ratio 
= 
Rs 3,80,000/Rs 15,00,000 × 100 

= 
25.33% 
Illustration: 53
From the following information, calculate
(i) Stock Turnover Ratio (ii) Operating Ratio and (iii) Capital Turnover Ratio

Rs 
Opening Stock 
28,000 
Closing Stock 
22,000 
Purchases 
46,000 
Sales 
90,000 
Sales Returns 
10,000 
Carriage Inwards 
4,000 
Office Expenses 
4,000 
Selling and Distribution Expenses 
2,000 
Capital Employed 
2,00,000 
Solution
(i) Computation of Stock Turnover Ratio
Step 1: Formula: Stock Turnover Ratio = Cost of Goods Sold/Average Stock
 From the given information, we have to calculate Cost of Goods Sold.
 Remember: Cost of Goods Sold = Opening Stock × Purchases × Carriage Inwards – Closing Stock
 Substitute the figures in the equation from the information given in the question.
 Cost of Goods Sold = Rs 28,000× Rs 46,000 × Rs 4,000– Rs 22,000 = Rs 56,000
Step 2: Then Average Stock has to be computed.






Average Stock 
= 
Rs 25,000 
Step 3: Final Step
Formula: Stock Turnover Ratio 
= 
Cost of Goods Sold/Average Stock 

= 
Rs 56,000/Rs25,000 
∴ Stock Turnover Ratio 
= 
2.24 times 
(ii) Computation of Operating Ratio
For this, Operating Expenses have to be computed.
Step 1: Here, Operating Expenses = Office Expenses + Selling and Distribution Expenses

= 
Rs 4,000 + Rs 2,000 

= 
Rs 6,000 
Step 2: Cost of Goods Sold (As worked out in Step 1) = Rs 56,000
Step 3: Net Sales = Sales – Sales Returns

= 
Rs 90,000 − Rs 10,000 (Given) 

= 
Rs 80,000 
Step 4: Formula: Operating Ratio

= 
Rs 56,000 + Rs 6,000/Rs 80,000 × 100 
∴ Operating Ratio 
= 
77.5% 
(iii) Computation of Capital Turnover Ratio
Formula 
= 
Net Sales/Capital Employed × 100 

= 
Rs 80,000/Rs 2,00,000 × 100 

= 
40% 
Illustration: 54
Rs 2,40,000 is the Cost of Goods Sold.
Inventory Turnover is 8 times.
Stock at the beginning is 1.5 times more than the stock at the end.
Calculate the value of opening and closing stock.
Solution
Step 1: Let the Closing Stock be X. (Assumption)
Then Opening Stock will be = 1.5X (As per question)
i.e., Opening Stock is 1.5 times more than Closing Stock.
Step 2: Formula: Inventory Turnover Ratio = Cost of Goods Sold/Average Stock
8 
= 
Rs 2,40,000/(X + l.5X/2) 
(Average Stock = (Opening Stock + Closing Stock)/2) 

8 
= 
Rs 2,40,000 × 2/(X + l.5X) 
8(X + 1.5X) 
= 
Rs 2,40,000 × 2 
8(2.5X) 
= 
Rs 4,80,000 
20X 
= 
Rs 4,80,000 
X 
= 
Rs 4,80,000/20 = Rs 24,000 
Closing Stock 
= 
Rs 24,000 
Step 3: Opening Stock = Rs 24,000 × 1.5
= Rs 36,000
Illustration: 55
 The ratio of Current Assets (Rs 3,00,000) to Current Liabilities (Rs 2,00,000) is 1.5:1. The accountant of the business concern is interested in maintaining a Current Ratio at the level 2:1 by paying off a part of Current Liabilities. Compute the amount of current liabilities that should be paid off in order to maintain the Current Ratio at the level 2:1.
 Compute the Gross Profit Ratio. Sales: Rs 6,00,000; Gross Profit 25% on Cost.
Solution
(A) Let the Current Liabilities that should be paid off be Y (assumed).
Substitute the figure in the formula :


2(2,00,000 − Y) 
= 
1(3,00,000 − Y) 
4,00,000 − 2Y 
= 
3,00,000 − Y 
−2Y + Y 
= 
3,00,000 − 4,00,000 
−Y 
= 
−1,00,000 
Y 
= 
Rs 1,00,000 
So Current Liabilities that should be paid to maintain the Current Ratio at the level 2:1 will be Rs 1,00,000.
(B) Step 1: Let the Cost of Goods Sold be Rs 100 (assumed).
Then Sales = Rs 100 + 25 (Given) = 125
If Sales are Rs125, Cost of Goods Sold is Rs 100.
Step 2: If Sales are Rs 6,00,000 (given in question),
Cost of Goods Sold will be 
= 
100/125 × 6,00,000 

= 
Rs 4,80,000 
Step 3: Gross Profit = Sales – Cost of Goods Sold

= 
Rs 6,00,000 – Rs 4,80,000 

= 
Rs 1,20,000 
Step 4: Formula: Gross Profit Ratio = Gross Profit/Net Sales × 100
Substitute the values in the formula:
Gross Profi t Ratio = Rs l,20,000/Rs 6,00,000 × 100

= 
20% 
Illustration: 56
Net Sales: Rs 4,00,000; Cost of Goods Sold: Rs 2,00,500; Administrative Expenses: Rs 45,000; Selling Expenses: Rs 57,000; Share Capital: Rs 8,50,000; Reserves and Surplus: Rs 3,00,000; Longterm Loans: Rs 8,20,000; Fixed Assets (Net): Rs 4,62,000; Investments: Rs 2,42,500; Debtors: Rs 72,000; Opening Stock; Rs 2,40,000; Closing Stock: Rs 2,10,000; and Bank Balance: Rs 3,00,000.
From the above details, you are required to compute:
 Gross Profit Ratio
 Stock Turnover Ratio
 Proprietary Ratio
Solution
(a) Computation of Gross Profit Ratio
Remember: Gross Profit 
= 
Net Sales – Cost of Goods Sold 

= 
Rs 4,00,000 – Rs 2,00,500 

= 
Rs 1,99,500 
 Formula: Gross Profit Ratio = Gross Profit/Net Sales × 100

= 
Rs l,99,500/Rs 4,00,000 × 100 

= 
49.87% 
(b) Computation of Stock Turnover Ratio
Step 1: First, Average Stock is to be calculated.







= 
Rs 4,50,000/2 = Rs 2,25,000 
Step 2: Formula = Stock Turnover Ratio = Cost of Goods Sold/Average Stock
Substitute the values in the formula,
= Rs 2,00,500/Rs 2,25,000 = 0.89 times
(c) Calculation of Proprietary Ratio
Step 1: Shareholder’s Funds should be calculated.
Remember: Shareholder’s Funds 
= 
Share Capital + Reserves and Surplus 

= 
Rs 8,50,000 + Rs 3,00,000 (Given) 

= 
Rs 11,50,000 
Step 2: Total Assets should be calculated.
Remember: Total Assets: Sum of all assets given in question
Here, Total Assets 
= 
Fixed Assets + Investments + Debtors + Closing Stock + Bank Balance 

= 
Rs 4,62,000 + Rs 2,42,500 + Rs 72,000 + Rs 2,10,000 + Rs 3,00,000 

= 
Rs 12,86,500 
Step 3: Formula:
Proprietary Ratio 
= 
Shareholder’s Funds/Total Assets 

= 
Rs l1,50,000/Rs 12,86,000 

= 
0.89 


Or 

= 
89.42% 
Illustration: 57
On the basis of the following information, you are required to calculate the following ratios:
 Gross Profit Ratio
 Debt Equity Ratio
 Working Capital Turnover Ratio
Net Sales: Rs 5,65,000; Bank Loan; Rs 1,25,000; Cost of Goods Sold: Rs 3,75,000.00; Current Assets: Rs 3,25,000; Current Liabilities: Rs 1,75,000; Equity Share Capital: Rs 3,95,000; Debentures: Rs 1,29,000.
Solution
(a) Calculation of Gross Profit Ratio
Step 1: Gross Profit has to be worked out first.
Remember: Gross Profit 
= 
Net Sales – Cost of Goods Sold 

= 
Rs 5,65,000 – Rs 3,75,000 

= 
Rs 1,90,000 
Step 2: Now, Gross Profit Ratio = Gross Profit/Net Sales × 100

= 
Rs 1,90,000/Rs 5,65,000 × 100 

= 
33.62% 
(b) Calculation of Debt Equity Ratio
Step 1: Total Longterm Debts have to be determined first.
Remember: Total Longterm Debts 
= 
Debentures + Loan 

= 
Rs 1,29,000 + Rs 1,25,000 

= 
Rs 2,54,000 
Step 2: Formula:
Debt Equity Ratio = (Total) Longterm Debts/Shareholder’s Funds
Remember: Shareholder’s Funds = Equity Share Capital
∴ Ratio 
= 
Rs 2,54,000/Rs 3,95,000 

= 
0.64:1 
(c) Calculation of Working Capital Turnover Ratio
Step 1: First Net Working Capital has to be ascertained.
Remember: Working Capital 
= 
Current Assets – Current Liabilities 

= 
Rs 3,25,000 – Rs 1,75,000 

= 
Rs 1,50,000 
Step 2: Formula:
Working Capital Turnover Ratio 
= 
Net Sales/Net Working Capital 

= 
Rs 5,65,000/Rs 1,50,000 

= 
3.76 times 
Illustration: 58
Calculate the Cost of Goods Sold from the following information:
Sales: Rs 12,00,000; Sales Returns: Rs 80,000;
Operating Expenses: Rs 1,82,000; Operating Ratio: 92%
Solution
Formula:
Operating Ratio = Cost of Goods Sold + Operating Expenses/Net Sales × l00
Substitute the values
92/100 = Cost of Goods Sold + Rs 1,82,000/Rs 11,20,000
100 × (Cost of Goods Sold + Rs 1,82,000) 
= 
92 × Rs 11,20,000 
Cost of Goods Sold + Rs 1,82,000 
= 
92 × Rs l1,20,000/100 

= 
Rs 10,30,400 
Cost of Goods Sold 
= 
Rs 10,30,400 − Rs 1,82,000 

= 
Rs 8,48,400 
Illustration: 59
Calculate the amount of Gross Profit from the following information:
Average Stock 
= 
Rs 80,000 
Stock Turnover Ratio 
= 
6 times 
Selling Price 
= 
25% above cost 
Solution
This problem can be solved in either of the following two methods:
Method 1
Step 1: Formula: Stock Turnover Ratio = Cost of Goods Sold/Average Stock
6 
= 
Cost of Goods Sold/Rs 80,000 
6 × Rs 80,000 
= 
Cost of Goods Sold 
Rs 4,80,000 
= 
Cost of Goods Sold 
Step 2: Selling Price is given 25% above cost.
∴ Gross Profit 
= 
25% of Cost of Goods Sold 

= 
25/100 – Rs 4,80,000 

= 
Rs 1,20,000 
Method 2
Let the Cost Price be taken as Rs 100 (assumption)
Sale Price 
= 
25% above cost 

= 
Rs 100 + 25 = Rs 125 
If Sale Price is Rs 125, Cost Price = 100 

If Sale Price is Rs 4,80,000, Cost Price = 125/100 × Rs 4,80,000 

(Cost Price) Sales Cost = Rs 6,00,000 

Gross Profit = Sales – Cost of Goods Sold 


= 
Rs 6,00,000 – Rs 4,80,000 

= 
Rs 1,20,000 
Note: Depending on the particulars provided in the problem, students can choose any of the above methods to ascertain Gross Profit.
Illustration: 60
Calculate Opening Stock and Closing Stock from the following information:
Total Sales = Rs 6,00,000
Gross Profit = 25% on Sales
Stock Turnover Ratio = 5 times
Closing Stock is Rs 12,000 more than the Opening Stock
Solution
The following stages has to be followed one by one to compute the Opening Stock and Closing Stock.
Step 1: First, Gross Profit has to be ascertained.
Step 2: From Gross Profit value, Cost of Goods Sold has to be worked out.
Step 3: From Cost of Goods Sold, value of Average Stock is ascertained by applying Stock Turnover Ratio.
Step 4: From the Stock Turnover Ratio, that is, after knowing Average Stock, Opening Stock and Closing Stock amounts have to be ascertained, finally.
Note: The factors are interrelated. So we have to unlock the secret information, i.e. indirect particulars to solve the problem.
Step 1: First Gross Profit is to be ascertained.
Gross Profit 
= 
25% on Sales 
(Given in Problem) 


= 
25/100 × Rs 6,00,000 

= 
Rs 1,50,000 
Step 2: From this value, Cost of Goods Sold has to be found out.
Remember: Cost of Goods Sold 
= 
Sales – Gross Profit 

= 
Rs 6,00,000 – Rs 1,50,000 

= 
Rs 4,50,000 
Step 3: After computing the value of Cost of Goods Sold, value of Average Stock is to be ascertained by applying the Stock Turnover Ratio.
Formula:
Stock Turnover Ratio 
= 
Cost of Goods Sold/Average Stock 
5 
= 
Rs 4,50,000/Average Stock 
Average Stock × 5 
= 
Rs 4,50,000 
Average Stock 
= 
Rs 4,50,000/5 

= 
Rs 90,000 
Step 4: Finally, the value of Opening and Closing Stock has to be ascertained.
Let Opening Stock be Z (assumption).
Then Closing Stock = (Z + Rs 12,000)
(Given in the problem, i.e. Closing Stock is Rs 12,000 more than Opening Stock)
Remember:

= 
Average Stock 


Z + (Z + Rs 12,000) 
= 
Average Stock × 2 

Z + (Z + Rs 12,000) 
= 
Rs 90,000 × 2 (From Step 3) 

2Z + Rs 12,000 
= 
Rs 1,80,000 

2Z 
= 
Rs 1,80,000 − Rs 12,000 


= 
Rs 1,68,000 

Z 
= 
Rs l,68,000/2 = Rs 84,000 

i.e., Opening Stock 
= 
Rs 84,000 

Closing Stock 
= 
(Rs 84,000 + Rs 12,000) 


= 
Rs 96,000 
Illustration: 61
 Calculate Stock Turnover Ratio from the following information: Sales: Rs 2,00,000; Gross Profit Ratio: 25%
Opening Stock was 1/4^{th} value of Closing Stock. Closing Stock was 40% of Sales.
 A business firm has a Current Ratio of 4:1 and a Quick Ratio of 1.2:1. Working Capital: Rs 1,80,000. Compute the Total Current Assets and Stock.
Solution
On the basis of information, the following has to be computed one by one:
Step 1: Gross Profit from Gross Ratio.
Step 2: Cost of Goods Sold from Gross Profit.
Step 3: Closing Stock, Opening Stock and Average Stock have to be worked out.
Step 4: Finally, Stock Turnover Ratio is to be found out.
Step 1: Gross Profit = 25% on Sales (Given)

= 
25/100 × Rs 2,00,000 

= 
Rs 50,000 
Step 2: Remember: Cost of Goods Sold = Sales – Gross Profit

= 
Rs 2,00,000 – Rs 50,000 

= 
Rs 1,50,000 
Step 3: Closing Stock = 40% of Sales (Given)

= 
40/100 × Rs 2,00,000 

= 
Rs 80,000 
Opening Stock is ¼th value of Closing Stock.
(Given in the Problem)
∴ Opening Stock 
= 
¼ Rs 80,000 

= 
Rs 20,000 
Average Stock 
= 


= 


= 
Rs 50,000 
Step 4: Only after computing values for the above, Stock Turnover Ratio can be ascertained.
Formula: Stock Turnover Ratio 
= 
Cost of Goods Sold/Average Stock 

= 
Rs 1,50,000/Rs 50,000 

= 
3 times 
Computation of Total Current Assets
Step 1: Current Ratio is 4:1 (Given)
Remember: Current Ratio 
= 
Current Assets/Current Liabilities 
4/1 
= 
Current Assets/Current Liabilities 
* 1 × Current Assets 
= 
4 × Current Liabilities 
Working Capital 
= 
Rs 1,80,000 (Given) 
Remember: Current Assets – Current Liabilities 
= 
Working Capital 
Current Assets – Current Liabilities 
= 
Rs 1,80,000 
4 × Current Liabilities – Current Liabilities 
= 
Rs 1,80,000 
(As worked out in *) 


3 Current Liabilities 
= Rs 1,80,000 
Current Liabilities 
= Rs 1,80,000/3 

= Rs 60,000 
∴ Current Assets 
= 4 × Current Liabilities 

= 4 × Rs 60,000 
Total Current Assets 
= Rs 2,40,000 
(ii) Computation of Stock
Quick Ratio formula is applied to compute Quick Assets first.
Remember: Quick Ratio 
= Quick Assets/Current Liabilities 
1.2/1 
= Quick Assets/Rs 60,000 
Quick Assets 
= Rs 60,000 × 1.2 

= Rs 72,000 
Remember: Stock 
= Current Assets – Quick Assets 

= Rs 2,40,000 – Rs 72,000 

= Rs 1,68,000 
Summary
Part A: Theory
 Accounting Ratio – Meaning and uses
 Ratio Analysis – Advantages – Limitations of Accounting Ratios
 Classification of Ratios:
 Various Ratios – Significance – Calculation (Refer the summarised form attached separately)
Part B:
 Remember formula to calculate various ratios.
 Once again remember various items included for each such category.
For example: Liquid Assets: Various items to be included in this: Cashinhand, Bank, Sundry Debtors, Bills Receivable, Shortterm investments etc.
Note: The author does not want to repeat once again here. Students are asked to refer the main part of the chapter and remember the steps involved in the calculation of various ratios.
 Remember also, the standard parameter for each ratio. Based on that, suggest your ideas on the basis of results obtained.
Key Terms
Current Assets: Assets that can be converted to cash or sold or consumed within a year.
Current Liabilities: Liabilities that fall due within a year.
Current Ratio: Relationship between Current Assets and Current Liabilities.
Debt Equity Ratio: Common dividends per share divided by market price per share.
Earning Per Share (EPS): Net income divided by average no. of outstanding common share.
Inventory: Stock or Goods held by an entity for sale.
Inventory Turnover: The Cost of Goods Sold divided by the average inventory held during the period.
Owner’s Fquity: The residual interest in the company’s assets after deducting liabilities.
Price Earning (P/E) Ratio: Market Price per Share divided by Earning per Share.
Return on Sales Ratio: Net income divided by sales.
Shortterm liquidity: A business entity’s ability to meet current liabilities on maturity date.
Shareholder’s Equity: Equity Assets over liabilities of company.
Total Assets Turnover: Sales divided by Average Total Assets.
Working Capital: The excess of Current Assets over Current Liabilities.
References
White Gerald I, “The analysis and use of financial statements”, John Wiley & Sons, New York 1998.
Helbert E.A., “Techniques of financial analysis”, Richard. D. Irwin, Homewood 911, 1972.
Horngreen, Sundem & Elliott, “Introduction to Financial Accounting”, Pearson Education, New Delhi, 2005.
A Objectivetype Questions
I Fill in the blanks with opt terms
 Ratio is a ___________ relationship between two items expressed in a quantitative form.
 Ratio Analysis is a study of relationship among various ________ factors in a business.
 Ratio Analysis is a useful device for analyzing __________ statements.
 Ratio Analysis is a __________ device to spot out weak areas and take remedial measures quickly.
 Liquidity Ratios measure the _____________ solvency of a concern.
 The relationship of current assets to current liabilities is termed as _______ Ratio.
 By computing Current Ratio ______________ solvency of a concern is assessed.
 Satisfactory level of Current Ratio is _____________
 The excess of current assets over current liabilities is known as __________
 Liquid Ratio is a relationship of liquid assets with ________.
 Liquid Ratio is an indicator to assess the shortterm _______ paying capacity of a concern.
 Favourable level of Liquid Ratio is __________
 ___________ Ratio studies the concern’s ability to meet its longterm financial position.
 ___________ Ratio indicates the proportion between debt and equity.
 Satisfactory level of Debt Equity Ratio is _________.
 Components of Total Assets to Debts Ratio are Total Assets and _________.
 Normal level of Total Assets to Debts Ratio is __________.
 Proprietary Ratio establishes the relationship between ______ and Total Tangible Assets.
 Normal level of Proprietary Ratio is ________.
 The relationship of Gross Profit to Sales is termed as _________.
 The relationship of Net Profit to Net Sales is termed as ________.
 Operating Profit Ratio measures the relationship between ___________ and Net Sales.
 Operating Ratio establishes relationship between __________ and Net Sales.
 Activity Ratios are also known as __________.
 __________ Ratios establish relationship between the Cost of Goods Sold and the average amount of inventory carried during the period.
 Debtors Turnover Ratio is also called as _______.
 __________ Ratio indicates how quickly debtors are converted into cash.
 Working Capital Turnover Ratio studies the relationship between _________ and working capital.
 Both Operating Profit Ratio and Operating Ratio are _________ to each other.
 Net result of Probability Ratios are expressed in __________.
Answers
 Mathematical
 Financial
 Financial
 Diagnostic
 Shortterm
 Current
 Shortterm
 2:1
 Working Capital
 Current Liabilities
 Debt
 1:1
 Solvency
 Debt Equity
 2:1
 Debt
 2:1
 Proprietor’s Funds
 100
 Gross Profit Ratio
 Net Profit Ratio
 Operating Profit
 Operating Cost
 Turnover
 Inventory Turnover
 Receivables Turnover
 Debtors Turnover
 Sales
 complementary
 percentage
II State whether the following statements are True or False
 Ratio Analysis helps in financial forecasting.
 Liquidity Ratios measure the longterm solvency of a concern.
 A liquid asset is one that can very easily be converted into asset.
 Current Ratio is calculated for a particular period.
 Marketable securities are Current Assets.
 Overdraft (Bank/Bills) is current liability.
 Current Liabilities = Working Capital – Current Assets
 Liquid Ratio is used to assess the firm’s shortterm solvency.
 A high Liquid Ratio indicates under stocking.
 Solvency Ratios study the concern’s ability to meet shortterm indebtedness.
 A higher Debt Equity Ratio indicates safer financial position of an equity.
 In computing Solvency Ratios, fictitious assets do not form part of total assets.
 Longterm Debts, generally get matured after 1 year.
 A higher Total Assets to Debts Ratio indicates a risky financial position of the concern.
 In proprietor’s funds, payments to others are not included.
 A high level Proprietary Ratio indicates safety to creditors.
 Higher the Net Profit Ratio, better the efficiency of a concern.
 Loss on sale of assets is operating expenses.
 Higher Operating Ratio indicates poor performance of a concern.
 Higher Inventory Ratio indicates the concern’s high margin of profit.
Answers
1. True 
2. False 
3. True 
4. False 
5. True 
6. True 
7. False 
8. True 
9. False 
10. False 
11. False 
12. True 
13. True 
14. False 
15. True 
16. True 
17. True 
18. False 
19. True 
20. False 
B Multiple Choice Questions
III Choose the correct answer
 Ratio which measures the shortterm solvency of a concern is
 Gross Profit Ratio
 Operating Ratio
 Proprietary Ratio
 Current Ratio
 Ratio to assess the shortterm debt paying capacity of a concern is
 Liquid Ratio
 Debt Equity Ratio
 Creditors Turnover Ratio
 None of the above
 The ratio which is used to ascertain the soundness of the longterm financial position is
 Debt Equity Ratio
 Current Ratio
 Absolute Liquid Ratio
 Gross Profit Ratio
 Normal level for Proprietary Ratio is expected to be at
 1:1
 2:1
 100
 50
 If the Current Assets and Working Capital of a concern are Rs 80,000 and Rs 50,000 respectively then Current Liabilities will be
 Rs 1,00,000
 Rs 70,000
 Rs 1,30,000
 Rs 30,000
 The ratio which is a good indicator to maintain the correct selling price and efficiency of trading activities is
 Net Profit Ratio
 Gross Profit Ratio
 Current Ratio
 Liquid Ratio
 The relationship of Net Profit to Net Sales is termed as
 Gross Profit Ratio
 Net Profit Ratio
 Operating Profit Ratio
 None of the above
 If the value of Gross Profit and Indirect Expenses of a concern are Rs 4,00,000 and Rs 1,00,000 respectively the value of Net Profit will be
 Rs 5,00,000
 Rs 4,00,000
 Rs 3,00,000
 None of the above
 The Operating Profit and Net Sales of a firm are Rs 2,00,000 and Rs 10,000 respectively, then Operating Profit Ratio will be
 20%
 5%
 50%
 10%
 The ratio which indicates how quickly debtors are converted into cash is
 Receivables Turnover Ratio
 Inventory Turnover Ratio
 Working Capital Turnover Ratio
 Creditors Turnover Ratio
Answers
 (d),
 (a),
 (a)
 (c),
 (d),
 (b),
 (b),
 (c),
 (a),
 (a)
C Short Answer Questions
 What do you mean by “Ratio”?
 What is Ratio Analysis?
 Enlist the important objectives of Ratio Analysis.
 Enumerate the significance of Ratio Analysis.
 Mention the broad classification of ratios.
 How can Liquidity Ratios be classified?
 What do you mean by Current Ratio?
 How can Current Ratio be computed?
 Give examples for Current Assets.
 Mention items relating to Current Liabilities.
 What is the satisfactory level of Current Ratio?
 How can Working Capital be computed?
 Current Assets and Current Liabilities of a firm are Rs 3,00,000 and Rs 1,50,000. Calculate the Current Ratio and interpret the result.
 What is meant by Absolute Liquid Ratio?
 What are the Solvency Ratios?
 How can Debt Equity Ratio be calculated?
 How can Liquid Ratio be computed?
 How will you calculate Total Assets to Debts Ratio?
 What is the formula to compute Proprietary Ratio?
 What are the components of Proprietor’s funds?
 How can Gross Profit Ratio be computed?
 How will you calculate Net Profit Ratio?
 How Operating Profit Ratio can be found out?
 Write down the formula to calculate Operating Ratio.
 Mention the classification of Turnover Ratios.
 How Inventory Turnover Ratio can be computed?
 Mention the formula to compute Debtors Turnover Ratio.
 How can Working Capital Turnover Ratio be calculated?
D Essaytype Questions
 Explain Ratio Analysis. Enlist the objectives of Ratio Analysis. Explain its significance.
 What are the advantages and disadvantages of Ratio Analysis?
 Explain Liquidity Ratio. How are they useful in financial accounting? How the results of various Liquidity Ratios may be interpreted?
 How “Solvency” of a concern is determined? Explain the significance of various “Solvency Ratios”. Discuss their role in a concern to take important decisions.
 Enumerate the important role of some “Profitability Ratio”. Explain how they are helpful in determining the profit aspects of a concern.
 Mention some important “Activity Ratios”. Explain each of their role in decision making process of a growing concern.
E Exercises
1. The Current Assets of a company are Rs 1,26,000 and the Current Ratio is 3:2 and the value of inventories is Rs 2,000. Find out the Liquid Ratio.
Answer: 1.48:1
2. Inventory Turnover Ratio is 3 times sales are Rs 1,80,000. Opening Stock is Rs 2,000 more than the Closing Stock. Calculate the Opening and Closing Stock when goods are sold at 20% profit on cost.
Answer: Opening Stock: Rs 51,000
Closing Stock: Rs 49,000
3. A company had a Liquid Ratio of 1.5 and Current Ratio of 2 and Inventory Turnover Ratio 6 times. It had total Current Assets of Rs 8,00,000 in the year 2008. Find out the annual sales if goods are sold at 25% profit on cost.
Answer: Sales: Rs 15,00,000
4. A company earns a gross profit of 20% on cost. Its credit sales are thrice its cash sales. It credit sales are Rs 4,00,000. Calculate the Gross Profit Ratio of the company.
Answer: 16.67%
5. A company earns a gross profit of 25% on cost. Its credit sales are twice its cash sales. If the credit sales are Rs 8,00,000, compute the Gross Profit Ratio of the company.
Answer: 20%
6. Current Liabilities of a company are Rs 5,60,000, Current Ratio is 5:2, Quick Ratio is 2:1. Find the value of stock.
Answer: Rs 2,80,000
7. Calculate the Current Assets of a company from the following information:
 Stock Turnover: 4 times
 Gross Profit 20% on sales
 Stock in the end is Rs 20,000 more than stock in the beginning
 Sales: Rs 3,00,000
 Current Liabilities: Rs 40,000
 Quick Ratio: 0.75
Answer: Rs 1,00,000
8. X Ltd has a Liquid Ratio 7:3, value of stock is Rs 25,000 and its Current Liabilities Rs 75,000. Compute the Current Ratio.
Answer: 8:3
9. Cost of Goods Sold is Rs 2,00,000. Inventory Turnover is 8 times. Stock at the beginning is 1.5 times more than stock at the end. Compute the value of opening and closing stocks.
Answer: Opening Stock: Rs 20,000
Closing Stock: Rs 30,000
10. The ratio of Current Assets (Rs 6,00,000) to Current Liabilities (Rs 4,00,000] is 1.5:1. The accountant of the firm is interested in maintaining Current Ratio at 2:1 by paying off a part of Current Liabilities. Compute the Current Liabilities that should be paid off so as to maintain the Current Ratio at the level of 2:1.
Answer: Rs 2,00,000
11. Sales: Rs 4,00,000
Gross Profit: 25% on cost
Compute Gross Profit Ratio.
Answer: 20%
12. Rs 3,00,000 is the Cost of Goods Sold. Inventory Turnover is 8 times. Stock at the beginning is 2 times more than the stock at the end. Calculate the value of opening and closing stock.
Answer: Closing Stock: Rs 25,000
Opening Stock: Rs 50,000
13. Rs 4,00,000 is the Cost of Goods Sold. Inventory Turnover is 5 times. Stock at the beginning is 1.5 times more than the stock at the end. Calculate the values of opening and closing stock.
Answer: Opening Stock: Rs 25,000
Closing Stock: Rs 16,667
14. Compute the Gross Profit Ratio:
Sales: Rs 5,00,000; Gross Profit: 25% on cost
Answer: Gross Profit: Rs 1,00,000
Gross Profit Ratio: 20%
15. The Current Liabilities of a company are Rs 3,50,000. Its Current Ratio is 3 and Liquid Ratio is 1.75. Calculate (i) Current Assets (ii) Liquid Assets and (iii) Inventory
Answer:
 Current Assets: Rs 10,50,000
 Liquid Assets: Rs 6,12,500
 Inventory: Rs 4,37,500
16.

Rs 
Net Sales 
3,75,000 
Cost of Goods Sold 
2,50,000 
Current Liabilities 
1,20,000 
Loan 
60,000 
Current Assets 
4,25,000 
Equity Share Capital 
1,90,000 
Debentures 
75,000 
From the above information calculate (i) Gross Profit Ratio (ii) Debt Equity Ratio and (iii) Working Capital Turnover Ratio.
Answer:
 Gross Profit Ratio: 33 1/3%
 Debt Equity Ratio: 27:38
 Working Capital
Turnover Ratio: 1.22 times
17. The Current Assets of a company are Rs 15,00,000. Its Current Ratio is 3.00 and Liquid Ratio is 1.25. Calculate the amount of (i) Current Liabilities (ii) Liquid Assets and (iii) Inventory.
Answer:
 Current Liabilities: Rs 5,00,000
 Liquid Assets: Rs 6,25,000
 Inventory: Rs 8,75,000
18. The Current Ratio of a company is 3.0 and its Liquid Ratio is 1.15. Its Current Liabilities are Rs 3,00,000. Compute (i) Current Assets (ii) Liquid Assets and (iii) Inventory.
Answer:
 Current Assets Rs 9,00,000
 Liquid Assets: Rs 3,45,000
 Inventory: Rs 5,55,000
19. The Current Assets of a company are Rs 17,00,000. Its Current Ratio is 2.50 and Liquid Ratio is 0.95. Calculate (i) Current Liabilities (ii) Liquid Assets and (iii) Inventory.
Answer:
 Current Liabilities: Rs 6,80,000
 Liquid Assets: Rs 6,46,000
 Inventory: Rs 10,54,000
20. From the following details, compute (i) Gross Profit Ratio (ii) Stock Turnover Ratio and (iii) Operating Ratio:

Rs 
Sales 
1,50,000 
Cost of Goods Sold 
1,20,000 
Opening Stock 
29,000 
Closing Stock 
31,000 
Debtors 
16,000 
Net Fixed Assets 
1,10,000 
Answer:
 Gross Profit Ratio: 20%
 Stock Turnover Ratio: 4 times
 Operating Ratio: 90.66%
21. From the following information, calculate (i) Current Ratio (ii) Quick Ratio and (iii) Working Capital Turnover Ratio:

Rs 
Sundry Debtors 
4,00,000 
Stock 
1,60,000 
Marketable Securities 
80,000 
Cash 
1,20,000 
Prepaid Expenses 
40,000 
Bills Payable 
80,000 
Sundry Creditors 
1,60,000 
Debentures 
2,00,000 
Expenses Payable 
1,60,000 
Net Sales 
20,00,000 
Answer:
 Current Ratio: 2:1
 Quick Ratio: 1.5:1
 Working Capital Turnover Ratio = 5 times
22. From the particulars given below, calculate (i) Current Ratio (ii) Acid Test Ratio (iii) Working Capital Turnover Ratio:

Rs 
Fixed Assets 
1,00,000 
Stock 
37,200 
Debtors 
19,200 
Cash 
39,600 
Prepaid Expenses 
10,000 
Creditors 
36,000 
Bank Overdraft 
17,000 
Reserves 
10,000 
Net Sales 
31,800 
Answer:
 Current Ratio: 2:1
 Acid Test Ratio: 1.11:1
23.
 From the given information, calculate the Stock Turnover Ratio.
Sales: Rs 2,00,000; G.P.: 25% on Cost; Operating Stock: 1/3rd of the value of closing stock; Closing Stock: 30% of Sales.
 A business has a Current Ratio of 3:1 and Quick Ratio of 1.2:1. The Working Capital is Rs 1,80,000. Compute the Total Current Assets and Stock.
Answer:
 4 times

 Rs 2,70,000
 Rs 1,62,000
24. From the given information, calculate the Stock Turnover Ratio:
Sales: Rs 2,00,000; G.P.: 25%; Opening Stock was 1/4th value of closing stock. Closing Stock was 20% of Sales.
Answer: 6 times
25. A business has a Current Ratio of 2:1 and a Quick Ratio of 1.2:1. Working Capital is Rs 1,50,000. Calculate Total Current Assets and Stock.
Answer:
 Total Current Assets: Rs 3,00,000
 Stock: Rs 1,20,000
26. On the basis of the particulars given below, calculate (i) Operating Ratio (ii) Liquid Ratio and (iii) Proprietary Ratio.
Cash Sales: Rs 3,00,000; Credit Sales: Rs 2,80,000; Sales Returns: Rs 20,000; Cost of Goods Sold: Rs 4,00,000; Selling and Distribution Expenses: Rs 7,000; Administrative Expenses: Rs 8,000; Current Liabilities: Rs 2,30,000; Current Assets: Rs 4,00,000; Closing Stock: Rs 40,000; Equity Share Capital: Rs 5,00,000; 8% Preference Share Capital: Rs 2,00,000; Fixed Assets: Rs 5,50,000.
Answer:
 Operating Ratio: 74.1%
 Liquid Ratio: 36:23
 Proprietary Ratio: 73.68%
27. On the basis of the following information you are required to calculate (i) Operating Ratio (ii) Liquid Ratio and (iii) Proprietary Ratio. Cash Sales: Rs 4,00,000; Credit Sales: Rs 2,75,000; Sales Returns: Rs 27,000; Cost of Goods Sold: Rs 3,90,000; Selling and Distributive Expenses: Rs 7,000; Administrative Expenses: Rs 3,000; Current Liabilities: Rs 1,95,000; Current Assets: Rs 3,94,000; Closing Stock: Rs 23,000; Equity Share Capital: Rs 4,37,000; Preference Share Capital: Rs 1,74,000; Fixed Assets: Rs 4,30,000.
Answer:
 Operating Ratio: 61.72%
 Liquid Ratio: 1.9:1
 Proprietary Ratio: 74.15%
EXERCISES (CONTINUED – MODELWISE)
Model 1: Current Ratio
28.
 From the following, calculate the Current Ratio:
Rs
Cashinhand
2,50,000
Sundry Debtors
1,50,000
Stockintrade
2,00,000
Sundry Creditors
2,00,000
Bills Payable
1,00,000
 From the following, compute Current Ratio:
Rs
Stock
30,000
Sundry Debtors
20,000
Cash or Bank
8,000
Bills Receivable
15,000
Shortterm Investments
25,000
Prepaid Expenses
2,000
Bank Overdraft
15,000
Sundry Creditors
20,000
Bills Payable
10,000
Outstanding Expenses
5,000
Answer:
 2:1
 2:1
Model 2: Liquid Ratio or Acid Test Ratio or Quick Ratio
29. Calculate Liquid Ratio from the following:

Rs 
Cash 
15,000 
Bills Receivable 
20,000 
Stock 
22,000 
Creditors 
17,000 
Outstanding Expenses 
2,000 

Rs 
Debtors 
20,000 
Shortterm Investment 
20,000 
Prepaid Expenses 
3,000 
Bills Payable 
6,000 
Answer: 47:26
30. Calculate Current Ratio and Liquid Ratio from the following balance sheet:
Balance Sheet of Swarna Ltd as on Mar 31, 2007
Answer:
 Current Ratio = 8:5
 Liquid Ratio = 5:7
Model 3: Absolute Liquid Ratio
31. Calculate Absolute Liquid Ratio.

Rs 
Cashinhand 
2,000 
Cash at Bank 
3,000 
Shortterm Investments 
5,000 
Current Liabilities 
30,000 
Bank Overdraft 
10,000 
Answer: 5:1
Model 4: Debt Equity Ratio
32. Calculate Debt Equity Ratio from the following:

Rs 
Debentures 
3,00,000 
Loan from Banks 
2,00,000 
Equity Share Capital 
1,75,000 
Reserves and Surpluses 
75,000 
Answer: 2:1
Model 5: Proprietary Ratio
33. Calculate Proprietary Ratio from the following:

Rs 
Equity Share Capital 
2,00,000 
Preference Share Capital 
1,00,000 
Reserves and Surpluses 
1,00,000 
Machinery 
1,00,000 
Goodwill 
40,000 
Cash at Bank 
40,000 
Stock 
60,000 
Answer: 16.66%
34. Calculate Gross Profit Ratio from the following:

Rs 
Purchases 
3,15,000 
Opening Stock 
15,000 
Closing Stock 
30,000 
Sales 
4,00,000 
Answer: 25%
Model 7: Net Profit Ratio
35. Calculate Net Profit Ratio from the following:

Rs 
Net Profit 
50,000 
Sales 
2,50,000 
Answer: 20%
36. From the given data, calculate
 Gross Profit Ratio
 Net Profit Ratio
 Current Ratio

Rs 
Sales 
6,00,000 
Net Profit 
60,000 
Current Liabilities 
60,000 
Cost of Goods Sold 
4,00,000 
Current Assets 
1,20,000 
Answer:
 33⅓%
 10%
 2:1
Model 8: Operating Profit Ratio
37. From the following data, compute the Operating Profit Ratio:

Rs 
Net Profit 
2,00,000 
Loss on Sale of Machine 
10,000 
Profit on Sale of Investment 
40,000 
Interest Paid on Loan 
40,000 
Interest from Investments 
60,000 
Sales 
3,00,000 
Answer: 50%
38. Calculate Operating Profit Ratio from the following:

Rs 
Gross Profit 
1,50,000 
Sales 
9,07,500 
Operating Expenses 
60,000 
Sales Return 
7,500 
Answer: 10%
39. Calculate Operating Ratio from the following:

Rs 
Cost of Goods Sold 
4,50,000 
Operating Expenses 
50,000 
Sales 
10,12,500 
Sales Returns 
12,500 
Answer: 50%
40. From the following, calculate Operating Ratio:

Rs 
Cost of Goods Sold 
6,25,000 
Operating Expenses 
75,000 
Sales 
14,13,900 
Sales Returns 
13,900 
Answer: 50%
Model 10: Capital Turnover Ratio
41. Compute Capital Turnover Ratio, from the following:

Rs 
Cash Sales 
2,40,000 
Credit Sales 
2,72,000 
Sales Return 
12,000 
Equity Share Capital 
1,00,000 
Longterm Loan 
90,000 
Reserves and Surpluses 
60,000 
Answer: 2 Times
42. From the following, compute Capital Turnover Ratio:

Rs 
Cash Sales 
3,10,000 
Credit Sales 
3,97,600 
Sales Return 
7,600 
Equity Share Capital 
2,00,000 
Longterm Loan 
1,00,000 
Reserves and Surpluses 
50,000 
Answer: 2 Times
Model 11: Fixed Assets Turnover Ratio
43. Compute Fixed Assets Turnover Ratio from the following:

Rs 
Fixed Assets 
5,50,000 
Depreciation on Fixed Assets 
50,000 
Sales 
10,08,750 
Sales Return 
8,750 
Answer: 2 Times
44. Calculate Fixed Assets Turnover Ratio from the following:

Rs 
Sales 
16,19,875 
Sales Return 
19,875 
Fixed Assets 
4,60,000 
Depreciation on Fixed Assets 
60,000 
Answer: 4 Times
Model 12: Stock Turnover Ratio
45. Calculate Stock Turnover Ratio from the following:

Rs 
Cost of Goods Sold 
6,00,000 
Opening Stock 
1,00,000 
Closing Stock 
2,00,000 
Answer: 4 Times
46. Compute Stock Turnover Ratio from the following:

Rs 
Sales 
4,50,000 
Gross Profit 
50,000 
Stock 
75,000 
Answer: 5.3 Times
Model 13: Debtors Turnover Ratio
47. Calculate Debtors Turnover Ratio from the following data:

Rs 
Cash Sales 
60,000 
Total Sales 
2,20,000 
Debtors at the beginning of the year 
75,000 
Debtors at the closing of the year 
85,000 
Answer: 2 Times
48. Compute Debtors Turnover Ratio from the following:

Rs 
Total Sales 
12,50,000 
Sales Return 
50,000 
Opening Debtors 
1,05,000 
Closing Debtors 
95,000 
Answer: 12 Times
Model 14: Creditors Turnover Ratio
49. Compute Creditors Turnover Ratio from the following:

Rs 
Credit Purchases 
4,80,000 
Opening Creditors 
55,000 
Closing Creditors 
65,000 
Answer: 8 Times
50. Compute Creditors Turnover Ratio from the following:

Rs 
Total Purchases 
2,05,000 
Cash Purchases 
40,000 
Purchases Return 
5,000 
Opening Creditors 
55,000 
Closing Creditors 
25,000 
Answer: 4 Times
Model 15: Miscellaneous (Comprehensive) (Combination of Ratios)
51. From the following balance sheet, calculate Current Ratio and Proprietary Ratio: Balance Sheet of Felix Ltd as on Mar 31, 2007.
 Current Ratio = 0.8:1
 Proprietary Ratio = 2.3:3.5
52. The following is the Profit and Loss Account of a company for the year ending Mar 31, 2007.
You are required to prepare
 Gross Profit Ratio
 Net Profit Ratio
 Operating Ratio
 Stock Turnover Ratio
Answer:
 28.5%
 57%
 71.4%
 5 Times
53. From the following balance sheet of X Ltd, you are required to calculate
 Debt Equity Ratio
 Proprietary Ratio
 Current Ratio
 Fixed Assets Turnover Ratio
 1:8
 4:5
 2:1
54. From the following, calculate
 Operating Profit Ratio
 Operating Ratio
 Gross Profit Ratio
 Net Profit Ratio

Rs 
Sales 
2,00,000 
Gross Profit 
40,000 
Administrative Expenses 
3,000 
Selling Expenses 
2,000 
Loss on Sale of Investments 
2,000 
Dividend Received 
1,000 
Net Profit 
30,000 
Answer:
 15.5%
 82.5%
 l20%
55. Following is the summarised Trading and Profit and Loss A/c for the year ending Mar 31, 2007 and the Balance Sheet as on that date:
Balance Sheet as on Mar 31, 2007
Calculate :
 Gross Profit Ratio
 Operating Ratio
 Return on Capital Employed
Answer:
 60%
 67.5%
 50%
56. Calculate the amount of Gross Profit:
Average Stock: Rs 50,000
Stock Turnover Ratio: 10 times
Selling Price: 20% above Cost
Answer: Rs 1,00,000
57. Calculate Cost of Goods Sold:
Sales: Rs 15,00,000; Sales Return: Rs 1,00,000
Operating Expenses: Rs 50,000; Operating Ratio = 90%
Answer: Rs 12,10,000
58. Calculate Opening Stock and Closing Stock:
Total Sales: Rs 10,00,000
Gross Profit: 20% on Sales
Stock Turnover Ratio: 5 times
Closing Stock is Rs 20,000 more than Opening Stock
Answer:
 Cost of Goods gold: Rs 8,00,000
 Opening Stock: Rs 1,50,000
 Closing Stock: Rs 1,70,000
59. A trader carries an average stock of Rs 20,000. His Stock Turnover is 5 times. If he sells goods at a profit of 25% on sales, calculate the profit.
Answer: Rs 25,000
60. Debt collection period of X Ltd is 36 days. Sales affected during the year were Rs 5,00,000. Assuming 360 days in a year, calculate Debtors Turnover Ratio; Average Debtors; Debtors on Jan 01, 2006 and Dec 31, 2006, if the debtors at the end are Rs 20,000 more than those in the beginning.
Answer:
 Debtors Turnover Ratio = 10 Times
 Debtors on 1. 1. 2006: Rs 40,000
 Debtors on 31. 12. 2006: Rs 60,000
61. Current Liabilities are Rs 50,000; Liquid Ratio is 2:1; Current Ratio is 3:1. Calculate Quick Assets, Stockintrade and Current Assets.
Answer:
 Quick Assets: Rs 1,00,000
 Stockintrade: Rs 50,000
 Current Assets: Rs 1,50,000
62. Calculate Return on Equity:

Rs 
Equity Share Capital 
1,50,000 
10% Prof. Share Capital 
1,00,000 
Reserves and Surpluses 
5,00,000 
Net Profit after Tax 
2,10,000 
Answer: 28%
63.

Rs 
Share Capital 
1,00,000 
General Reserve 
50,000 
12% Loan 
50,000 
Sales for the year 
2,00,000 
Tax paid 
10,000 
Profit after Tax and Dividend 
20,000 
From the above information, you are required to calculate:
 Debt Equity Ratio
 Capital Turnover Ratio
 Interest Coverage Ratio
 Return on Equity
 Debt to Total Fund Ratio
Answer:
 Debt Equity Ratio = 1:2
 Capital Turnover Ratio = 2 Times
 Interest Coverage Ratio = 6 Times
 Return on Equity = 30%
 Debt to Total Fund Ratio = 1:3
64. The following data relates to Shree Ltd.

2008 (Rs) 
2009 (Rs) 
Sales 
20,00,000 
25,00,000 
Cost of Goods Sold 
10,00,000 
12,00,000 
Gross Profit 
2,00,000 
2,50,000 
The Manager claims that he has worked more efficiently during the year 2006 because the Gross Profit has increased by Rs 50,000 and should be rewarded for his efficiency of service.
Give your opinion to the management to decide upon manager’s claim.
65. From the following information, comment on the efficiency of the working of the company:
2008 (Rs)  2009 (Rs)  

Sales 
4,00,000 
6,00,000 
Cost of Goods Sold 
3,00,000 
4,00,000 
Gross Profit 
2,00,000 
2,50,000 
Operating Expenses 
50,000 
1,00,000 
Operating Profit 
1,00,000 
1,00,000 