Class-12 - Accounting Ratios

Introduction
The main purpose of Financial Statements is to provide the accounting information to its users. Financial
Statements are used for analysis, comparison and interpretation purpose. Accounting ratios are used to
analyse the financial statements for assessing the profitability, solvency, efficiency and liquidity of the
business. Accounting ratios are an important tool of financial statements analysis. Accounting ratios help
in presenting the data in summarized form and in an effective manner.
Classification or types of ratios
Ratios are classified into 4 categories
1. Liquidity Ratios also called as short term solvency ratios.
2. Solvency Ratios
3. Activity ratios also known as Turnover ratios or Performance ratios
4. Profitability ratios
Liquidity Ratios
(1) Current Ratio = Current Assets
Current Liabilities
Current Assets = Current Investments + Inventories (Excluding Spare Parts and Loose Tools)
+ Trade Receivables + Cash and Cash Equivalents + Short Term Loans and
Advances + Other Current Assets
Current Liabilities = Short-Term Borrowings + Trade Payables + Other Current Liabilities
+ Short-term Provisions
(2) Liquid Ratio = Liquid Assets
Current Liabilities
Liquid Asset = Current Assets - Inventories - Prepaid expenses.
Current Liabilities = Short-Term Borrowings + Trade Payables + Other Current Liabilities
+ Short-term Provisions
Solvency Ratios
(1) Debt Equity Ratio = Debt
Equity
Debt =Long Term Borrowings + Long Term Provisions
Equity / Shareholder’s Funds = Share Capital + Reserves and Surplus
OR
Non-Current Assets (Tangible Assets + Intangible Assets +
Non-Current Trade Investments + Long-Term Loans &
Advances) + Working Capital - Non-Current Liabilities
(Long-Term Borrowings + Long-Term Provisions)
Where Working Capital = Current Assets - Current Liabilities
(2) Total Assets to Debt Ratio = Total Assets
Debt
Total Assets = Non-Current Assets (Tangible Assets + Intangible Assets + Non-Current
Investments + Long-Term Loans & Advances) +Current Assets (Current
Investments + Inventories including Spare Parts & Lose Tools +
Trade Receivables + Cash & Cash Equivalent + Short-Term Loans &
Advances + Other Current Assets).
Debt =Long Term Borrowings + Long Term Provisions
(3) Proprietary Ratio = Proprietors Funds
Total Assets
Proprietors Funds = Share Capital + Reserves and Surplus
OR
Non-Current Assets (Tangible Assets + Intangible Assets + Non-Current
Trade Investments + Long-Term Loans & Advances) + Working Capital -
Non-Current Liabilities (Long-Term Borrowings + Long-Term
Provisions)
Total Assets = Non-Current Assets (Tangible Assets + Intangible Assets + Non-Current
 Investments + Long-Term Loans & Advances) + Current Assets (Current
Investments + Inventories excluding Spare Parts & Lose Tools + Trade
Receivables + Cash & Cash Equivalent + Short-Term Loans & Advances +
Other Current Assets).
(4) Interest Coverage Ratio = Profit before interest and tax
Interest on Long term debt
Significance/Objectives/Importance
> This ratio indicates that a firm can pay interest due on long term debts or not.
> Higher ratio indicates that firm can pay interest on long term debts without any hurdle.
> Low ratio indicates that firm may face problem in paying the interest due on long term debts.
Activity Turnover Ratios
(1) Inventory Turnover Ratio = Cost of Revenue from operations
Average Inventory
Cost of Revenue from Operation = Revenue from Operation - Gross Profit
OR
Opening Inventory + Net Purchases + Direct Expenses
(Assume to be given) - Closing Inventories
OR
Cost of materials consumed + purchase of stock-in-trade
+ change in Inventory (Finished Goods; Work in Progress
& Stock-in-trade) + Direct Expenses (Assume to be given)
Average Inventory = Opening Inventory + Closing Inventory
2
(2) Trade Receivable Turnover Ratio = Credit Sales fNetl
Average Trade Receivable
Net Credit Sales = Total Sales - Cash Sales
OR
Credit Revenue from Operation = Revenue from Operation - Cash Revenue from Operation
Average Trade Receivables = Opening Trade Receivable + Closing trade Receivable
2
Trade Receivable = Debtors + Bills Receivables
(3) Trade payable Turnover Ratio = Net Credit Purchase
Average Trade Payable
Net Credit Purchase = Total Purchases - Cash Purchases
Average Trade Payables = Opening Trade Payables + Closing trade Payables
2
Trade Payables = Creditors + Bills Payable
(4) Working Capital Turnover Ratio = Revenue from Operations
Working Capital
Working Capital = Current Assets - Current Liabilities
Current Asset = Current Investments + Inventories (Excluding Spare Parts and Loose Tools)
+ trade Receivables + Cash and Cash Equivalents + Short Term Loans and
Advances + Other Current Assets
Current Liabilities = Short-Term Borrowings + Trade Payables + Other Current Liabilities
+ Shortterm Provisions
Profitability Ratios
(1) Gross Profit Ratio = Gross profit x 100
Revenue from Operations
Gross Profit = Revenue from Operation - Cost of Revenue from Operations
Cost of Revenue from Operation = Opening Inventory (excluding Spare Parts and Loose
Tools) + Net Purchases + Direct Expenses – Closing
Inventory (excluding Spare Parts and Loose Tools)
OR
Revenue from Operation - Gross Profit
 (2) Operating Ratio = Cost of Revenue from operation + Operating cost x 100
Revenue from operations
Cost of Revenue from Operation = Opening Inventory (excluding Spare Parts and Loose
Tools) + Net Purchases + Direct Expenses - Closing
Inventory (excluding Spare Parts and Loose Tools)
OR
Revenue from Operation - Gross Profit
Operating Expenses = Office, Administrative, Selling and Distribution Expenses, Employees
Benefit expenses, Depreciation & Amortisation
(3) Operating Profit Ratio = Operating Profit x 100
Revenue from operations
Operating Profit = Net Profit (After Tax) + Non Operating Expenses / Losses - Non Operating
Incomes
OR
Gross Profit + Operating Income - Operating Expenses
Non Operating Expenses = interest on Long Term Borrowing + Loss on sale of Fixed or
Non Current Assets
Non Operating Income = Interest received on investments + Profit of sale of Fixed Assets
or Non- Current Assets
(4) Net Profit Ratio = Net Profit x 100
Revenue from operations
Net Profit before Interest & Tax = Gross Profit + Other Incomes - Indirect Expenses
(5) Return on Investment (ROI) = N/P before interest, tax & dividend x 100
Capital Employed

Net Profit before Interest,Tax and Dividend = Gross Profit + other Income - Indirect Expenses
Formula of Capital Employed
Liabilities side approach Assets Side Approach

Shareholder’s Fund ( Share Capital + Reserves Non-Current Assets (Tangible Assets +

& surpluses) + Non-Current liabilities ( Long Intangible Assets + Non-Current
term-borrowing + long term Provisions, investment + Long-term Loans & Advances) +
Working Capital
Working Capital = Current Assets - Current
Liabilities
(It is Assumed that all Non-Current
Investments are Trade Investments only)
(Interest on Non-Trade Investments should be
Deducted from Profit before Interest, Tax and
Dividend. Therefore it can not be a part of
Non-Current Investments).

Ratio Analysis : A tool used by individuals to conduct a quantitative analysis of

infomation in a company's financial statements.
Expression of ratios : Ratios are expressed in :

1. Pure form like 2:1 al current ratios are expressed in pure form.

2. Percentage e.g. 15% al profitability ratios are presented in percentage form

3. Times like 4 times al turnonver ratios are presented in no. of times

4. Fraction like 3/4 or .75 al solvency ratios are presented in fractions except Interest Coverage Ratio
which is presented in Number of times.