DECISION ACCOUNTING

ASSIGNMENT - 2

SUBMITTED TO,
DR. P. NATARAJAN

SUBMITTED BY,
KUMARAGURU. P
22351039
MCOM (BF
 FORMULAS FOR VARIOUS ACCOUNTING
RATIOS
ACCOUNTING RATIOS:

Accounting Ratio is a mathematical representation of two or more data either interrelated or

independent to analyse the financial condition of any business. These are the group of
metrics used to measure the efficiency and profitability of a company based on its financial
reports. They provide a way of expressing the relationship between one accounting data
point to another and are the basis of ratio analysis.

OBJECTIVES OF ACCOUNTING RATIOS

To know the areas of the business which need more attention

To know about the potential areas which can be improved with the effort in the desired
direction

To provide a deeper analysis of the profitability, liquidity, solvency and efficiency levels in
the business

To provide information for making cross-sectional analysis by comparing the performance

with the best industry standards and

To provide information derived from financial statements useful for making projections and
estimates for the future.
TRADITIONAL CLASSIFICATION

STATEMENT OF PROFIT AND LOSS RATIOS:

A ratio of two variables from the statement of profit and loss is known as statement of
profit and loss ratio. For example, ratio of gross profit to revenue from operations is known
as gross profit ratio. It is calculated using both figures from the statement of profit and loss.

BALANCE SHEET RATIOS:

In case both variables are from the balance sheet, it is classified as balance sheet ratios. For
example, ratio of current assets to current liabilities known as current ratio. It is calculated
using both figures from balance sheet.

COMPOSITE RATIOS:

If a ratio is computed with one variable from the statement of profit and loss and another
variable from the balance sheet, it is called composite ratio. For example, ratio of credit
revenue from operations to trade receivables

(Trade receivables turnover ratio) is calculated using one figure from the statement of profit
and loss (credit revenue from operations) and another figure (trade receivables) from the
balance sheet.
FUNCTIONAL CLASSIFICATION

LIQUIDITY RATIO

Liquidity ratio determines the paying capacity of a business to meet short-term liabilities.
A business having a liquid type of ratio in accounting of 2 or more is considered ideal.
Ratios which are coming under liquidity ratios are

CURRENT RATIO

This is the most commonly used liquidity ratio that helps a business in comparing their
current assets with their current liabilities. The current ratio helps a business to analyse
whether they will be able to pay their due debts in the next twelve months or not.

Current ratio = Current Assets ÷ Current Liabilities

QUICK RATIO

The quick ratio is like current ratio except quick assets are compared with current liabilities.
The other name of Quick Ratio is Acid test Ratio

Quick ratio = Quick Assets ÷ Current Liabilities

CASH RATIO

This ratio takes those current assets into account that is instantly accessible to a business to
meet its debts. Any business having a Cash Ratio of one or more is considered financially
stable.

Cash ratio = (Cash + Marketable securities) ÷ Current Liabilities

SOLVENCY RATIO

The leverage ratio helps a business to determine its long-term solvency. Generally, these
ratios are used to analyse the debt-paying capacity of the company. Different types of
solvency ratios are

DEBT TO EQUITY RATIO

The leverage ratio helps a business to determine its long-term solvency. Generally, these
ratios are used to analyse the debt-paying capacity of the company.

Debt to equity ratio = Total Debt ÷ Total Equity

DEBT TO ASSET RATIO

The debt to Asset ratio helps a business to determine how many total assets are financed by
the creditors. Less than 1 debt to asset ratio indicates that assets can be further financed and
vice-versa.

Debt to asset ratio = Total Debt ÷ Total Asset

PROPRIETARY RATIO

The proprietary ratio shows a relationship between the Proprietor's fund/shareholder's

funds with the total assets of a business. This ratio helps in determining the financial
strength of a business.

Proprietary ratio = Proprietor's fund/shareholder's funds ÷ Total Asset

FIXED ASSET RATIO

Fixed Asset Ratio helps a business to understand the relationship between fixed assets of the
business with long term debts. This ratio indicates a business capacity to discharge its
liabilities and ensures long-term survival.

Fixed asset ratio = Net Fixed Assets ÷ Long-term debt

INTEREST COVERAGE RATIO

The Interest coverage ratio determines the relationship between the Earnings before interests
and taxes with interest on long-term debts. Higher interest coverage ratios lower the risk of
financial default.

Interest coverage ratio = Earnings before interest and taxes (EBIT) ÷Interest on long-term
debts
PROFITABILITY RATIO

The profitability ratio helps in analysing how much profit is earned by a business from its
operations. In other words, the Profitability ratio determines the earning capacity of a
business using through the resources employed. Here is a list of profitability ratios that are
normally used.

GROSS PROFIT MARGIN

Through Gross Profit ratio any business can compare its performance with its competitors or
its own previous performance. It defines the percentage of factory cost in relation to the sales
amount. Higher gross profit margin indicates that business is more efficient in its operation.

Gross profit margin = Gross Profit ÷ Revenue

OPERATING MARGIN

Using Operating Margin ratio any can easily measure how much amount is earned through
operating income. The other name of Operating Margin Ratio is Operating Profit Margin.

Operating margin = Operating Income ÷ Net Sales

PROFIT MARGIN

Through Profit Margin ratio any business can determine the amount of profit earned from
its total generated revenue and can easily assess its overall profitability to compare it with its
competitors.

Profit margin = Net Income ÷ Net Sales

EARNINGS PER SHARE

EPS is a business profit portion allotted to every share indicating its profitability which helps
the shareholder to determine their return on investment.

Earnings per share = (Net Income – Preferred Dividend) ÷Common Outstanding Shares
ACTIVITY RATIO/EFFICIENCY RATIO

Activity ratios in accounting shows the revenue generated from a particular asset type
by comparing cost, sales, and asset data. Types of ratios in management accounting help
the business inefficient management and effective utilization of the assets. Different
types activity ratios are

STOCK TURNOVER RATIO

Stock turnover ratio helps a business to understand the relationship between Inventory
and COGS. It makes the stock reordering task easy and business comes to know its stock
conversion rate.

Stock turnover ratio = COGS ÷ Average Stock/Inventory

DEBTOR TURNOVER RATIO

Debtor turnover ratio helps a business to determine the relationship between net credit
sales and average debtors or bills receivables. A company having higher debtor turnover
ratio indicates an effective credit strategy.

Debtor turnover ratio = Net credit sales ÷ Average debtors or bills receivables

CREDITORS TURNOVER RATIO

Creditors Turnover ratio provides an understanding regarding the relation between net
credit purchase and average creditors or bills payable. Generally, a higher ratio indicates
efficient asset utilization and management by the business.

Creditors turnover ratio = Net credit purchase ÷ Average Creditors or Bills payable

WORKING CAPITAL TURNOVER RATIO

Working Capital Turnover Ratio helps in determining the relationship between net
sales and working capital. A higher ratio of Working Capital Turnover indicates efficient
use of working capital.

Working capital turnover ratio = Sales or COGS ÷ Working Capital

Ratio analysis and accounting ratios are indispensable part of interpretation of
results revealed by the financial statements and it helps to analyse the
performance of business. But on the contrary, they are calculated at a specific
time and date. Hence, it is important to do an in-depth evaluation instead of
completely relying on the accounting ratio.