Search for notes by fellow students, in your own course and all over the country.
Browse our notes for titles which look like what you need, you can preview any of the notes via a sample of the contents. After you're happy these are the notes you're after simply pop them into your shopping cart.
Document Preview
Extracts from the notes are below, to see the PDF you'll receive please use the links above
RATIO ANALYSIS
INTRODUCTION:
The use of ratios was started by banks for ascertaining the liquidity /financial
position and profitability / earning capacity of companies business for the purpose
of giving loans to companies
...
Now , even the investors calculate ratios from the
published accounts of the company in order to get an idea about the solvency and
profitability of the company ,before investing their savings
...
WHAT IS RATIO ? :“ The relation between two related items of financial statements is known as ratio”
OR
“A ratio is one number expressed in terms of another”
...
g
...
The figure so obtained is called
ratio
...
e
...
- If the current assets are twice the current liabilities it can be said that the
current ratio is 2:1
...
e
...
-The rate of return on capital employed is 30%
(3) Rate of return :Third method is to express it as rates
...
g
...
CLASSIFIACATION OF RATIOS / ACCOUNTING RATIOS :Accounting ratios are classified as follows :
(1) Traditional Classification or classification according to the type financial
Statements
...
(1) TRADITIONAL CLASSIFICATION :The ratios are grouped into three categories on the basis of the statements from
which the figures are taken for computing the ratios
...
The ratios
according to this classification are :
(a) Revenue statement Ratios :These are the ratios computed on the basis of items taken from revenue statement
i
...
Profit & Loss Account
...
g
...
Here ,both net
profit and sales are items appearing in Profit & Loss Account
...
e
...
-A ratio established relationship between current assets and current liabilities
is a balance sheet ratio
...
A return on capital
employed shows the proportion of net profit to capital employed and it is a
composite ratio
...
On this basis there are four
categories of ratios
...
They are computed to ascertain
whether the company is capable of meeting its short-term obligations from its
short-term resources
...
g
...
e
...
- (1) Current Ratio , (2) Liquidity ratio (3) Acid -Test Ratio
(2) Profitability Ratios :A number of ratios are designed to indicate the profitability of the business and
are grouped into the category of profitability ratios
...
g
...
e
...
- (1) Gross Profit Ratio (2) Net Profit Ratio (3) Expenses ratio
(4) Expenses Ratio (5) Return on capital employed Ratio (6) Return on Shareholders
Funds (7) Debt Services Coverage ratio
(c) Leverage Ratios :The composition of capital of business and the proportion of owners’ capital and
capital provided by outsiders are reflected by leverage ratios
...
g
...
e
...
- (1) Proprietary ratio (2) Debt –Equity Ratio (3) Gearing Ratio (4) Fixed
capital – Fixed Assets Ratio
...
It signifies the efficiency of the management
...
g
...
e
...
- Debtors Ratio , Creditors ratio , Total Assets turnover , Fixed Assets turnover
etc
...
Hence ,profitability ratios are the most important ratios
...
The shareholders ,who have invested their money in the company’s business ,
desire to get good return on their investment
...
This is possible only when
business is profitable
...
(B) Ratios based on investments , showing profitability
...
It is
an useful indication of the profitability of business
...
g
...
4,00,000 , and Gross Profit is Rs
...
Gross Profit Ratio = Gross Profit *100 /Sales
= 1,00,000*100/ 4,00,000 = 25 %
This ratio is usually expressed as a percentage
...
100 , a margin of 25 rupees is available from which operating
expenses of business are to be recovered
...
If this ratio is higher than it is profitable and if it is lower than it is less
profitable
...
(2)It shows efficiency of the management
...
(4) Formula of operating Profit ratio :
Operating ratio = Cost of goods sold + Operating Expenses* 100 / Net sales
Cost Of Goods Sold = Opening Stock + Net Purchase (Purchase – Purchase Return)
+ Purchase Expenses – Closing Stock
OR
Cost Of Goods Sold = Net Sales(Sales – Sales Return) – Gross Profit
Operating Expenses = Administrative Expense + Interest + Selling Expenses
For Example : Suppose the sales are Rs
...
76250 ;
Purchases RS
...
10,250; Closing
Stock Rs
...
98,000; Interest
RS
...
10,000
...
Cost Of Goods Sold = Opening Stock + Purchases + Purchases Expenses – Closing
Stock
...
Operating Expenses = Administrative Expenses + Interest + Selling Expenses
= 98,000 + 12000 + 10,000
= Rs
...
100 ,Rs
...
16 is left in the hands of Proprietor
...
(3) EXPENSES RATIO :(1) It shows relationship between expenses and Net sales
...
6%
Financial Expenses Ratio = 12,000*100 / 5,00,000 = 2
...
(4) NET PROFIT RATIO :(1) This ratio shows relationship between Net Profit and Net Sales
...
(3) FORMUL :Net Profit Ratio = Net Profit*100 / Net Sales
For Example :
Suppose the net profit of the business after taxes is Rs
...
5,00,000 then the Net Profit Ratio will be :
Net Profit Ratio = 80,000*100 / 5,00,000
= 16 %
(4) The higher the ratio , the better will be the profitability
The lower the ratio ,the lower will be the profitability
...
Four different ratios are used in profitability ratios based on investment, which are
as follows :
(1) Return on capital employed
(2) Return on shareholders’ funds
(3) Return on equity shareholders’ funds
(4) earnings per share
...
(2) The success of the company is judged with the help of this ratio
...
(4) FORMULA :Return on capital employed = Net Profit (EBIT)*100 / Capital Employed
Capital Employed = Share Capital + Reserve + Long Term Loans (Debentures )
It must be remembered that in this ratio Net Profit before deducting
Interest and Taxes = EBIT (Earning before Interest and Taxes )
...
2,00,000; Reserves Rs
...
80,000 and the Net Profit before interest and taxes is Rs
...
3,36,000
(2) RETURN ON SHAREHOLDERS’ FUNDS :(1) It shows relationship between Net Profit and Shareholders’ funds
...
(3) By using this ratio one can compared the profitability of one company with the
other company
...
(5) FORMULA :Return on shareholders’ funds = Net Profit* 100 / Shareholders’ Funds
(6) Here , Net Profit means Profit After Tax ( PAT )
...
(3)
RETURN ON EQUITY SHAREHOLDERS’ FUNDS :(1) This ratio shows what percentage of profit is earned on the capital invested by
ordinary shareholders
...
(4) Higher the ratio , more profitable
Lower the ratio , Less profitable
...
Of Equity Shares
...
(3) It is not the actual amount paid paid to shareholders as dividend but is the
maximum that can be paid to them
...
Dividend / No
...
Dividend is Rs
...
Of
Equity shares is Rs
...
2
...
(8) The limitation of EPS is that it does not show how much dividend is actually
paid to shareholders and how much profit is retained in business
...
Are such
assets which are readily available for paying current liabilities as and when
they arise
...
Where such assets are in
sufficient proportion as compared to current liabilities , the “Liquid
Position” of business is said to be satisfactory
...
(2) It is also known as “Working Capital Ratio” , because it is a measure of
working capital available at a particular time
...
(4) Current Liabilities :- Which will mature within a period of 12 months
Is a current Liabilities
...
(6) Current Liabilities :- It include :
(1) creditors
(2) Bills Payable
(3) Bank Overdraft
(4) Outstanding Expenses
(5) Provision for taxation etc
...
(8) FORMULA :Current Ratio = Current Assets / Current Liabilities
For Example :Suppose ,the current assets are worth Rs
...
1,00,000 ,then the current ratio will be as under :
Current ratio = Current Assets / Current Liabilities
(9)
(10)
= 2,00,000 / 1,00,00
= 2 OR 2:1
It means that for every Re
...
It also indicates that the current assets the
current Assets should be twice the current liabilities
...
Sometimes ,the current ratio seems to be high ,because of excessive stock included
in current assets, because of low sales
...
(4) why to deduct Stock from Current Assets :(a) Stock is not treated as a liquid asset because it cannot be readily converted
into cash as and when required
...
(5) Liquid Liabilities = Current Liabilities – Bank Overdraft
...
(8) FORMULA :
Liquid Ratio = Liquid Assets / Liquid liabilities
(10) For Example :Suppose ,the liquid assets of a business are worth Rs
...
1,00,000 then Liquid Ratio or Quick Ratio will be as follows:
Liquid Ratio = Liquid Assets / Liquid Liabilities
= 1,20,000 / 1,00,000
= 1
...
(12) The Ideal /Standard Liquid Ratio is 1:1
(3)
Acid – Test Ratio / Quick Ratio :(1) It shows relationship between Quick Assets and Liquid Liabilities
(2) This ratio is also called Absolute Liquidity Ratio or Absolute Cash Ratio
...
1,00,000 ; Bank balance Rs
...
25,000
...
67 : 1
(4) Quick Assets do not include both Stock and Debtors ,because payments from
debtors would not be converted immediately when liquid liabilities are to be paid
...
5 :1
ADVANTAGES / UTILITY/MERITS OF RATIO ANALYSIS :(1)
Profitability :(a) From profitability ratios we can know the trend of profitability
...
(c) On the basis of these ratios ,investors get an idea about the overall efficiency of
business
...
(2) Liquidity :(a) By this ratio we can know the Liquidity or financial position of the company
...
(c) Banks and other lenders will be able to conclude from these ratios whether
the firm will be able to pay regularly the interest and principle amount
...
e
...
- The stock turnover will indicate how efficiently the sale is being made
...
The Assets turnover shows efficiency with which the assets are used in
business
...
(4) Inter – firm comparison :(a) The ratios of one firm are compared with the similar ratios of other firms
belonging to the same industry
...
(5) Indicate Trend :(a) The ratios of the last three to five years will indicate the trend in the respective
fields
...
g
...
A particular ratio of a company for one year may compare favourably with
industry average but, if its trend shows a deteriorating position , it is not desirable
...
(6) Useful for Decision –making :Ratios guide the management in making some of the important decisions
...
Even for capital expenditure decisions ,the ratio of
return on investment will guide the management
...
DEMSRITS / LIMITATION OF RATIO ANALYSIS :(1) Single year’s ratios have limited utility :The utility of ratios computed from the financial statements of one year only is
limited
...
(2) Other factors must be considered :While comparing ratios of different firms , different firms follow different accountancy
plans and policies
...
g
...
Hence , great care has to be exercised before any conclusions are drawn from such
comparison
...
If some conclusions
are to be drawn , then the combined effect of a few related ratios must be considered
...
The satisfactory level of various ratios may differ from one industry to another
only because circumstances differ from industry to industry even from firm to firm
...
If the accounting data is not accurate ,the accounting ratios
based on these figures would give misleading results
...
Dividend* 100 / Eq
...
Dividend*100 / Eq
...
Dividend*100 / Eq
...
Dividend * 100 / Eq
...
(c) There is practically no standard ratio against which the actual performance
can be compared
...
(4)
The current ratio of a company is 2:1 ,which of the following suggestions would improve
the ratio ?
(a) To pay a current liability
(b) To borrow money for a short time on an interest bearing promissory note
(c) To purchase stock for cash
(d) To give an interest bearing promissory note to a creditor to whom money
was payable
...
shows the relationship between one item taken
from Balance Sheet and another taken from Trading or Profit & loss Account?
(a) Operating Ratio
(b) Propriety Ratio
(c) Gearing ratio
(d) Debtors Ratio
(10) From the following which ratio is not profitability ratio ?
(a) Gearing Ratio
(b) Expenses Ratio
(c) operating Ratio
(d) Return on capital employed
(11) Profitability ratio is related to –
(a) Sales
(b) Creditors
(c) Debtors
(d) Assets
(12) Which assets is not included while calculating the rate of Return on Investment ?
(a) Fixed
(b) Current
(c) Fictitious
(d) Intangible
(13) To find the expenses ratio ,expenses are generally divided by ?
(a) Capital employed
(b) Sales
(c) Profit
(d) Assets
(14) Which assets can not be included in current assets while calculating the current
ratio ?
(a) Trade Investment
(b) Stock in Trade
(c) Prepaid Expenses
(d) Loan and Advances
(15) From the following
...
Is 80% , sales is Rs
...
(a) Rs
...
5,000
(c) Rs
...
(18) If the Gross Profit is 20% of total cost ,then what is the Gross Profit Ratio ?
(a) 50/3%
(b) 25%
(c) 33%
(d) 47/3%
(19) If Current Ratio =1
...
2 ,Current Assets = Rs
...
10,000 ,then Current Liabilities =
...
1,44,000
(b) Rs
...
51,000
(d) Rs
...
12,00,000 , sales return is
Rs
...
If the cost of sales is Rs
...
Find out operating Expanses
...
6,00,000
(b) Rs
...
3,00,000
[ANS