Class 12 Accountancy MCQs Ratio Analysis

1. Two basic measures of liquidity are:

a) Inventory turnover and Current ratio

b) Current ratio and Quick ratio

c) Gross Profit ratio and Operating ratio

d) Current ratio and average Collection period

2. A Company’s liquid assets are ₹4,00,000 and its current liabilities are ₹2,00,000. Thereafter, it paid ₹1,00,000 to its trade payables. Quick ratio will be:

a) 33:1

b) 5:1

c) 67:1

d) 3:1

3. Fixed Assets ₹5,00,000, Current Assets ₹3,00,000, Equity Share Capital ₹4,00,000, Reserve ₹2,00,000, Long –term debts ₹40,000. Proprietory Ratio will be:

a) 75%

b) 80%

c) 125%

d) 133%

4. Equity Share Capital ₹20,00,000, Reserves ₹5,00,000, Debentures ₹10,00,000, Current Liabilities ₹8,00,000. Debt-equity ratio will be:

a) 0.4 : 1

b) 0.32 : 1

c) 0.72 : 1

d) 0.5 : 1

5. Total revenue from operations ₹9,00,000, Cash revenue from operations ₹3,00,000, Debtors ₹1,00,000, Bills Receivable ₹20,000. Trade Receivables Turnover Ratio will be:

a) 5 Times

b) 6 Times

c) 5 Times

d) 9 Times

6. Opening Inventory ₹75,000, Closing Inventory ₹1,25,000, Purchases ₹6,00,000, Carriage ₹25,000, Wages ₹2,00,000. Inventory Turnover Ratio will be:

a) 6.6 Times

b) 7.4 Times

c) 7 Times

d) 7.75 Times

7. A firm’s Credit Revenue from Operations is ₹3,60,000, Cash Revenue from Operations is ₹90,000. Cost of Revenue from Operations is ₹3,60,000. Its Gross Profit Ratio will be:

a) 11%

b) 15%

c) 18%

d) 20%

8. Revenue from Operations ₹8,00,000, Gross Profit 20%, Office Expenses ₹60,000, Selling Expenses ₹40,000. Calculate operating ratio.

a) 80%

b) 85%

c) 92.5%

d) 96.33%

9. The gross profit ratio of a company is 50%. State with reason whether the decrease in rent received by ₹15,000 will……. the ratio.

a) increase

b) decrease

c) not change

10. What will be the impact of issuing ₹5, 00,000 equity shares to vendor for building purchased on the debt and equity of a company?

a) Debt will increase and equity will decrease.

b) Debt will remain same and equity will increase.

c) Debt will decrease and equity will decrease.

d) Debt will remain same and equity will increase.

Class 12 Accountancy MCQs Ratio Analysis

11. Assertion - Ratio analysis is a process of determining and interpreting relationships between the items of financial statements to provide meaningful understanding of the performance and financial position of an enterprise.

Reason - It is a technique of analyzing the financial statements by computing the various ratios.

a) Both Assertion and Reason are true and Reason is the correct explanation of Assertion.

b) Both Assertion and Reason are true and Reason is not the correct explanation of Assertion.

c) Assertion is true, but Reason is false

d) Assertion is false, but Reason is true.

12. Assertion - Accounting Ratio can be used to know the strong and weak points of business.

Reason - Ratio Analysis is a technique of Analysis of Financial Statement

a) Both Assertion and Reason are true and Reason is not the correct explanation of Assertion.

b) Both Assertion and Reason are true and Reason is the correct explanation of Assertion.

c) Assertion is true, but Reason is false

d) Assertion is false, but Reason is true.

13. Which one of the following is correct?

(i) Quick Ratio can be more than Current Ratio.

(ii) High Inventory Turnover ratio is good for the organisation, except when goods are bought in small lots or sold quickly at low margins to realise cash.

(iii) Sum of Operating Ratio and Operating Profit ratio is always 100%.

a) All are correct.

b) Only (i) and (iii) are correct.

c) Only (ii) and (iii) are correct.

d) Only (i) and (ii) are correct

14. Which of the following is not a Solvency Ratio?

a) Interest Coverage Ratio

b) Return on Investment

c) Debt to Capital Employed Ratio

d) Total Assets to Debt Ratio

15. Revenue from Operations ₹6,00,000; Gross Profit 25% on Cost. Gross Profit Ratio will be:

a) 15%

b) 25%

c) 20%

d) 30%

16. Debt-Equity Ratio of CAE Ltd. is 2,1. Which of the following would decrease the ratio:

a) Purchase of Fixed Asset on a credit of 2 months

b) Purchase of Fixed Asset on a long-term deferred payment basis

c) Issue of New Shares for Cash

d) Issue of Bonus Shares

17. Inventory Turnover Ratio of a company is 5 times. Which of the following transactions will decrease this ratio:

a) Purchase of Stock-in-Trade ₹50,000

b) Purchase Returns ₹20,000

c) Revenue from Operations on sale of Stock-in-Trade costing ₹20,000 for ₹25,000

d) Stock-in-Trade costing ₹10,000 distributed as free samples

18. Current ratio of a Ltd. Company is 3:2. Accountant wants to maintain it at 2:1. Following options are available.

(i) He can repay Bills Payable

(ii) He can purchase goods on credit

(iii) He can take short term loan

Choose the correct option:

a) Only (i) is correct

b) Only (ii) is correct

c) Only (i) and (iii) are correct

d) Only (ii) and (iii) are correct

19. ............ is included in current assets while preparing balance sheet as per revised Schedule III but excluded from current assets while calculating Current Ratio:

a) Debtors

b) Cash and Cash Equivalent

c) Loose tools and Stores and spares

d) Prepaid Expense

20. Debt-Equity Ratio of PTD Ltd is 3 is to 1. Which of the following will result in decrease in this ratio:

a) Issue of Debentures for Cash of ₹2,00,000

b) Issue of Debentures of ₹3,00,000 to Vendors from whom Machinery was purchased

c) Goods purchased on Credit of ₹1,00,000

d) Issue of Equity Shares of ₹2,00,000

Class 12 Accountancy MCQs Ratio Analysis

21. Which one of the following is correct?

(i) Aggregate of shareholders' funds and long term debt is known as capital employed.

(ii) The main objective of computing operating profit ratio is to determine the operational efficiency of the management.

(iii) Operating ratio = 100 - Operating profit ratio.

(iv) While calculating Trade Receivables Turnover Ratio, 'Provision for Doubtful Debts' is deducted from the total amount of Trade Receivables.

a) All are Correct

b) All are incorrect

c) Only (i) and (iii) are correct

d) Except (iv) all are correct.

22. Which of the following equations is correct :

a) Cost of Revenue from Operations = Revenue from Operations + Gross Profit

b) Cost of Revenue from Operations = Opening Inventory Net Purchases + Direct Expenses - Closing Inventory

c) Cost of Revenue from Operations = Opening Inventory + Closing Inventory

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

More questions will be added from time to time...

Class 12 Accountancy MCQs Ratio Analysis - Answers

1. b) Current ratio and Quick ratio
2. d) 3:1
3. a) 75%
4. a) 0.4 : 1
5. a) 5 Times
6. d) 7.75 Times
7. d) 20%
8. c) 92.5%
9. c) not change
10. b) Debt will remain same and equity will increase.
11. a) Both Assertion and Reason are true and Reason is the correct explanation of Assertion.
12. b) Both Assertion and Reason are true and Reason is the correct explanation of Assertion.
13. c) Only (ii) and (iii) are correct.
14. b) Return on Investment
15. c) 20%
16. c) Issue of New Shares for Cash
17. a) Purchase of Stock-in-Trade ₹50,000
18. a) Only (i) is correct
19. c) Loose tools and Stores and spares
20. d) Issue of Equity Shares of ₹2,00,000
21. d) Except (iv) all are correct.
22. d) Cost of Revenue from Operations = Revenue from Operations - Gross Profit

Class 12 Accountancy MCQs Comparative Statements

Class 12 Accountancy MCQs Cash Flow Statement

Learning Games and Activities in Business Studies Class 12

MCQs on Analysis of Financial Statements

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Students often get this question in their exams as to ‘What is the effect of a transaction on the given ratio?’

Generally, this question is asked in case of Current Ratio, Quick Ratio and Debt Equity Ratio. They get confused. Moreover, they have to manage time also.

Here are the short cut tricks to judge the effect of a transaction on the given ratio:

Ratio = Numerator/ Denominator               R =N/D

Case 1: There is change in only numerator or denominator (N or D).

Change in Numerator →Ratio moves in same direction (N→R).

Change in Denominator →Ratio moves in opposite direction {D→(-R)}

Case 2: There is equal amount of change in both (N and D).

There are further three situations:

Situation 1: When Numerator < Denominator (N<D)

If both increase/decrease by the same amount, Ratio changes in the same direction.

Situation 2: When Numerator = Denominator(N=D)

If both increase/decrease by the same amount, Ratio does not change.

Situation 3: When Numerator > Denominator(N>D)

If both increase/decrease by the same amount, Ratio changes in the opposite direction.

Case 3: When there is unequal change in both (N and D).

First, check in which Numerator or Denominator, the change is more.

If change in Numerator is more than change in Denominator, Ratio will follow the same direction.

If change in Denominator is more than change in Numerator, Ratio will follow the opposite direction.

Try using this mathematical trick and you will learn to save time, doing this question correctly.

Effect of Transaction on Accounting Ratio

Illustration

The current ratio of ABC Ltd is 2 : 1. State with reason, which of the following transactions would (a) increase, (b) decrease or (c) not change the ratio:
(a) Trade receivables included debtors of ₹20,000 which were received.
(b) Company purchased furniture of ₹25,000. The vendor was paid by issue of 9% Debentures of ₹1,000 each at par.
Answer:
(a) No change in ratio

Reason: Debtors decreased, and cash increased by the same amount, keeping the Trade Receivables same. So, there is no effect on the current ratio.
(ii) No Change the ratio

Reason: Shares issued, and furniture purchased are non-current assets, they do not affect either current assets or current liabilities.

Effect of Transaction on Accounting Ratio

Effect on Current Ratio

Given Current Ratio = 2:1

Current Ratio = Current Assets/Current Liabilities

Transaction - Effect

1. Purchased goods for cash - No Change
2. Cash paid to Trade Payables - Increase
3. Bills Payable discharged - Increase
4. Bills Receivable endorsed to a creditor - Increase
5. Payment of final Dividend already declared - Increase
6. Purchase of Goods for Cash - No Change
7. Purchase of Stock-in-Trade on credit - Decrease
8. Sale of old machine for cash - Increase
9. Bills Receivable endorsed to a Creditor dishonoured - Decrease
10. Purchases of Stock-in-Trade for cash - No Change
11. Sale of Old Furniture (Book Value of ₹5,000) for ₹7,000 - Increase
12. Sale of Old Machine for ₹4,000 (Book Value of ₹3,000) - Increase
13. Issue of Equity Shares - Increase
14. Redemption of 9% Debentures at 10% Premium, ₹1,00,000 - Decrease
15. Purchased Furniture and issued 1,000 Shares of ₹100 each to the vendor - No Change
16. Received from Debtors ₹7,000 - No Change
17. Payment of Dividend already declared - Increase
18. Purchase of Loose Tools for cash - Decrease
19. Payment of Dividend Payable - Increase
20. Accepted Bills of exchange drawn by creditors ₹8,000 - No Change
21. Trade receivables included debtors of ₹40,000 which were received - No Change
22. Cash deposited into bank ₹6,000 - No Change
23. Paid cash ₹3,000 to the creditors - Increase

Effect of Transaction on Accounting Ratio

Effect on Quick Ratio

Given Quick ratio = 1 : 1

Quick Ratio = Quick Assets/Current Liabilities

1. Included in the trade payables was a bills payable of ₹2,000 which was met on maturity - No Change
2. Purchased Goods for cash/ paid by cheque - Decrease
3. Purchased Goods on credit- Decrease
4. Issued Equity Shares ₹1,00,000 - Increase
5. Debentures of ₹40,000 were converted into equity shares - No Change
6. Paid rent ₹3,000 in advance - Decrease
7. Trade receivables included a debtor who paid his entire amount due ₹2,500 - No Change
8. Paid insurance premium in advance ₹8,000 - Decrease
9. Purchased goods on credit ₹6,000 - Decrease
10. Cash collected from Debtors - No Change
11. Issued fully paid equity shares of ₹2,00,000 - Increase
12. Issued 9% debentures of ₹3,00,000 to the vendor for machinery purchased - No change

Given Quick ratio of a company is 0.8 : 1.

1. Purchase of loose tools ₹1,000 - Decrease
2. Insurance premium paid in advance ₹1,700 - Decrease
3. Sale of goods on credit ₹5,000 - Increase
4. Sale of goods costing ₹5,000 for ₹4,000 - decrease

Effect of Transaction on Accounting Ratio

Effect on Inventory Turnover Ratio

Inventory Turnover Ratio = Cost of Revenue from Operations/ Average Inventory

1. Sale of goods for ₹2,000 (Cost 1,600) - Increase
2. Increase in the value of Closing Inventory by 20,000 - Decrease
3. Goods purchased for ₹4,000 - Decrease
4. Purchases return ₹1,000 - Increase
5. Goods costing ₹500 withdrawn for personal use - Increase
6. Goods costing ₹1000 distributed as samples - Increase

Effect of Transaction on Accounting Ratio

Effect on Gross Profit Ratio

Given G.P. Ratio = 20%

Gross Profit Ratio = (Gross Profit/ Revenue from Operations) X 100

1. Purchase of Stock-in-Trade₹ 50,000 - No Change
2. Purchases Return₹15,000 - No Change
3. Sale of Stock-in-Trade costing ₹5,000 - No Change
4. Goods costing ₹2,000 withdrawn for personal use - No Change
5. Goods costing ₹1,000 distributed as samples - No Change

Effect on Operating Ratio

Given Operating Ratio = 80%

Operating Ratio = (Cost of Revenue from Operations + Operating Expenses) / Revenue from Operations

1. Purchases of Stock-in-Trade ₹40,000 - No Change
2. Purchase Return ₹3,000 - No Change
3. Goods costing ₹4,000 drawn for personal use - No Change
4. Office Expenses paid ₹40,000 - Increase
5. Goods costing ₹20,000 distributed as samples - Increase
6. Payment to Creditors ₹30,000 - No Change
7. Building sold for ₹4,00,000 - No Change
8. Income Tax Paid ₹50,000 - No Change
9. Purchase of goods costing ₹16,000 - No Change
10. Purchased goods on credit ₹24,000 - No Change
11. Paid wages ₹4,000 - Increase
12. Redeemed ₹20,000, 9% debentures - No Change
13. Sold goods ₹30,000 for cash - Decrease

Effect of Transaction on Accounting Ratio

Operating Profit Ratio

Given Operating Profit Ratio = 20%.

Operating Profit Ratio = (Operating Profit/ Revenue from Operations) X 100

1. Purchase of Stock-in-Trade ₹20,000 - No Change
2. Purchases Return ₹7,000 - No Change
3. Sale of Stock-in-Trade of ₹12,000 Costing ₹10,000 - No Change
4. Stock-in-Trade costing ₹3,000 withdrawn for personal use - No Change

Effect on Debt Equity Ratio

Given Debt Equity ratio -= 2:1

Debt Equity Ratio = Debt/Equity

1. Borrowed Loan from bank for 4 years - Increase
2. Repayment of long-term loan - Decrease
3. Payment to Creditors - No Change
4. Redemption of Debentures in Cash - No Change
5. Issue of Equity Shares - Decrease
6. Issue of shares to vendor for furniture purchased - Decrease
7. Issue of 9% Debentures to vendor for machinery purchased - Increase
8. Issue of bonus shares - No Change
9. Purchase of a fixed assets by taking loan - Increase
10. (Purchase of Fixed Assets on credit or on deferred payment basis would also mean the same)
11. Purchase of fixed assets on 3 months credit/ cash / cheque - No Change
12. Sale of fixed assets (book value ₹4,000) at loss of ₹1,500 - Increase
13. Sale of Machinery (book value ₹9,000) for ₹10,000 - Decrease
14. Conversion of Debentures into Equity Shares - Decrease
15. Declaration of final dividend - Increase

Effect of Transaction on Accounting Ratio 

Effect on Proprietary Ratio

Given Proprietary ratio = 0.80 : 1.

Proprietary Ratio = Proprietor’s Funds/Total Assets

1. Borrowed a loan from bank ₹1,00,000 payable after 3 years - Decrease
2. Purchased furniture for cash ₹25,000 - No Change
3. Purchased Office Equipment by cheque - No Change
4. Redeemed 6% redeemable preference shares ₹1,00,000 - Decrease
5. Redeemed 9% Debentures ₹2,00,000 - Increase
6. Issued equity shares to the vendors of machinery purchased for ₹2,00,000 - Increase

Debt to Capital Employed Ratio

Given Debt to Capital Employed Ratio = 0.4:1

Debt to Capital Employed Ratio = Debt/ Capital Employed

1. Sale of Machinery at a loss of ₹20,000 - Increase
2. Tax Refund of ₹10,000 during the year - Decrease
3. Purchase of Stock-in-Trade on credit of two months for ₹20,000 - No Change
4. Purchase of Goods on credit for ₹10,000 on 16 months credit basis, operating cycle is of 18 months - Decrease
5. Conversion of Debentures into Equity Shares of ₹1,00,000 - Decrease
6. Purchase of Fixed Assets for ₹3,00,000 on credit - Increase

Effect of Transaction on Accounting Ratio 

Effect on Return on Investment Ratio

Return on Investment = (Net Profit before Interest and Tax /Capital Employed) X 100

1. Purchase of office Equipment of ₹2,00,000 by issue of Equity Shares - Decrease
2. Charging depreciation of ₹12,500 on machinery - Decrease
3. Redemption of 9% Debentures by cheque ₹2,00,000 - No Change
4. Conversion of ₹3,00,000, 9% Debentures into Equity Shares - Decrease

The question of this form can also be there in MCQs, like:

Which of the following transaction will improve the quick ratio?

(a) Purchase of inventory for cash

(b) Cash collected from debtors

(c) Sale of goods (costing ₹4,000 for ₹5,000)

(d) None of the above

Answer:

(c) Sale of goods (costing ₹4,000 for ₹5,000)

Liquidity Ratios

Learning Games and Activities in Business Studies Class 12

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A ratio is a mathematical relationship of two or more numbers and when these two numbers are taken from financial statements, this is called Accounting ratio.

Accounting ratio can be expressed as under:

1. Proportion (pure form): e.g.2:1, 1:1.

All current ratios and solvency ratios are expressed in pure form except Interest Coverage Ratio which is expressed in number of times.

2. Percentage e.g. 15%, 20%.

All profitability ratios are presented in percentage form.

3. Times e.g. 4 times, 3 times.

All turnover ratios are presented in no. of times. But average collection period and average payment period is expressed in number of days or months.

4. Fraction e.g. 3/4 or .75.

All solvency ratios are also presented in fractions except Interest Coverage Ratio which is presented in no. of times.

Objective:

The basic objective of ratio is the analysis of the profitability, liquidity, solvency and efficiency levels in the business to understand the strengths, weaknesses, making inter-firm and intra-firm comparisons for better understanding and decision making.

Check your understanding

Types of Accounting Ratios

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Classification of ratios:

(1) Traditional classification, and (2) Functional classification.

1. Traditional classification (rarely used in practice).

This is on the basis of financial statements to which the determinants (components) of ratios belong. On this basis the ratios are classified as follows:

A. Income Statement Ratios:

A ratio of two variables from the income statement is known as Income Statement Ratio like gross profit ratio, stock turnover ratio.

B. Balance Sheet Ratios:

In case both variables are from balance sheet, it is classified as Balance Sheet Ratios like current ratio, debt equity ratio.

C. Composite Ratios:

If a ratio is computed with one variable from income statement and another variable from balance sheet, it is called Composite Ratio like working capital turnover ratio.

Types of Accounting Ratios

2. Functional classification (mostly used).

It is based on the purpose for which a ratio is computed. Following are the main types of such ratios:

A. Liquidity Ratios:

Liquidity is the capacity of the company to meet its short term liabilities and the ratios calculated to measure it are known as ‘Liquidity Ratios’. They are short-term in nature.

B. Solvency Ratios:

Solvency of business is determined by its ability to meet its contractual obligations towards external stakeholders, and the ratios calculated to measure solvency position are known as ‘Solvency Ratios’. They are long-term in nature.

C. Activity (or Turnover) Ratios:

This refers to the ratios that are calculated for measuring the efficiency of the business to make the effective utilization of resources. So, these are also known as ‘efficiency ratios’.

D. Profitability Ratios:

It refers to the analysis of profits in relation to sales or funds employed in the business. Ratios calculated for this purpose are known as profitability ratios.

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Meaning

Liquidity Ratios are calculated to judge the short-term financial position of the company. It helps to know whether company is able to meet its short-term liabilities.

Main liquidity ratios are:

1. Current ratio.

2. Quick ratio.

1. Current Ratio

Current ratio is the proportion of current assets to current liabilities.

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

Significance:

The excess of current assets over current liabilities provides a measure of safety margin available against uncertainty in realization of current assets and flow of funds. The ratio should be reasonable.

A very high current ratio implies heavy investment in current assets which is not a good sign as it reflects under utilization or improper utilization of resources.

A low ratio endangers the business and puts it at risk of facing a situation where it will not be able to pay its short-term debt on time. Normally, it is advocated to have this ratio as 2:1.

2. Quick Ratio (Acid-Test Ratio/Liquid Ratio)

It is the ratio of quick (or liquid) asset to current liabilities.

Quick ratio = Quick Assets: Current Liabilities.

Quick assets are defined as those assets which are quickly convertible into cash. Quick Assets (Liquid Assets) =Current Assets-(Stock and prepaid expenses).

Significance:

It measures the capacity of the business to meet its short-term obligations. Because of exclusion of non-liquid current assets, it is considered better than current ratio.

Standard of this ratio is 1:1.

A very low ratio is very risky, and a high ratio indicates use of resources in less profitable short-term investments.

Activity or Turnover Ratios

Class 12 Accountancy MCQs Ratio Analysis

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Solvency ratios are calculated to determine the ability of the business to meet its liabilities in the long run. Following are the main ratios computed for evaluating solvency of the business.

1. Debt equity ratio.

2. Debt ratio.

3. Proprietary ratio.

4. Total Assets to Debt Ratio.

5. Interest Coverage Ratio.

1. Debt-Equity Ratio

Debt Equity Ratio measures the relationship between long-term debt and equity.

From security point of view, capital structure with less debt and more equity is considered favorable as it reduces the chances of bankruptcy.

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

Significance:

This ratio gives an idea regarding extent of security of the debt. Standard for this ratio is 2:1. A low debt equity ratio reflects more security.

A high ratio is considered risky as it reflects difficulty in meeting obligations towards outsiders. From the owners’ point of view, greater use of debt may help in ensuring higher returns for them if the rate of earnings on capital employed is higher than the rate of interest payable (benefit of trading on equity can be taken). This, ratio is also known as ‘Leverage Ratio’.

2. Debt to Total Funds ratio (Debt Ratio)

The Debt to Total Funds ratio or Debt Ratio is the ratio of long-term debt to the total of external and Internal funds (capital employed or net assets).

Debt Ratio (Debt to total funds ratio) = Long-term Debt/Capital Employed

1. Capital employed = long-term debt + shareholders’ fund.

2. Capital Employed=Net assets (Total assets – current liabilities-fictitious assets).

Significance:

It shows proportion of long-term debt in capital employed. Low ratio provides security to creditors and high ratio helps management in trading on equity.

3. Proprietary Ratio

This ratio expresses relationship of proprietor’s (shareholders) funds to net assets.

Proprietary Ratio = Shareholders Funds/Capital employed (or net 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 & Loose Tools + Trade Receivables + Cash & Cash Equivalent + Short-Term Loans & Advances +Other Current Assets).

Significance:

Higher ratio provides security to creditors.

Debt Ratio +Proprietary Ratio = 1.

4. Total Assets to Debt Ratio

This ratio measures the extent of the coverage of long-term debt by assets.

Total assets to Debt Ratio = Total Net assets/Long-term 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

Significance:

This ratio primarily indicates the rate of external funds in financing the assets. The higher ratio indicates that assets have been mainly financed by owners’ funds, and the long-term debt is adequately covered by assets.

5. Interest Coverage Ratio:

This ratio establishes relationship between the net profits before interest & tax(PBIT) and interest payable on long term debts.

Interest Coverage Ratio = Net Profit before Interest & Tax/Total Interest charges

Significance:

It helps to ascertain the amount of profit available to cover the interest charge and how easily a company can pay interest expense on outstanding debt.

High Ratio is better for lenders as it indicates higher safety margin.

How to Collect Data for Accountancy Project?

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Meaning of Activity Ratios (Turnover Ratios)

The turnover ratios help in checking the capacity of the business to make more sales or turnover. Higher turnover ratio means better utilization of assets and improved efficiency and profitability, so, also known as efficiency ratios.

The important activity ratios are:

1. Inventory Turnover ratio.

2. Receivables Turnover ratio.

3. Payables Turnover ratio.

4. Net Assets Turnover ratio.

5. Fixed Assets Turnover ratio. (4.a below)

6. Working Capital Turnover ratio. (4.b below)

1. Inventory Turnover Ratio

It expresses the relationship between the cost of goods sold and stock of goods.

Inventory Turnover Ratio = Cost of revenue from operations/ Average Inventory

Average Inventory = (Opening Inventory+ Closing Inventory)/2

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)

Significance:

It helps us to know the frequency of conversion of stock of finished goods into sales. It determines how many times stock is purchased or replaced during a year.

Higher ratio is considered better but very high ratio shows over trading and low ratio means stock is piled up or over investment in stock.

2. Receivables Turnover Ratio

It expresses the relationship between credit sales and debtors.

Receivables Turnover ratio = Credit revenue from operations/ Average Trade Receivables

Where Average Trade Receivable = (Opening Debtors and Bills Receivable + Closing Debtors and Bills Receivable)/2

Precaution: Debtors should be taken before making any provision for doubtful debts.

Significance:

The liquidity position of the firm depends upon the speed with which debtors are realized. This ratio indicates the number of times the receivables are turned over and converted into cash in an accounting period.

Higher turnover ratio means speedy collection from debtors.

Average collection period= (365 days or 12 months)/Debtors turnover ratio.

3. Payables Turnover Ratio

It expresses the relationship between net credit purchases and average accounts payable.

Payables Turnover ratio = Net Credit purchases/ Average accounts payable

Average account payable = (Opening Creditors and Bills Payable + Closing Creditors and Bills Payable)/2

Significance:

Creditors turnover ratio indicates the pattern of payment of accounts payable.

Higher turnover ratio indicates early payments. Whereas low ratio indicates delayed payments to suppliers which is not a very good policy as it may affect the reputation of the business.

Average payment period = (365 days or 12months)/Payables turnover ratio.

Shorter average payment period means credit allowed by the supplier is for a short period and early payments. Longer average payment period means longer period of credit given by the suppliers or delayed payments.

4. Net Assets or Capital Turnover Ratio

It expresses the relationship between net sales and capital employed in the business.

Investment (Net Assets) Turnover ratio = Net Sales/Capital Employed

This ratio is analyzed into two turnover ratios:

(a) Fixed Assets Turnover= Net Sales/Net Fixed Assets

(b) Working Capital Turnover = 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 + Short-term Provisions

Significance:

High turnover ratios indicate efficient utilization of resources resulting in higher liquidity and profitability in the business.

Profitability Ratios

Liquidity Ratios

Solvency Ratios

The post Activity Ratios appeared first on Commerceatease - Website for 11th & 12th Commerce.

Profitability ratios are calculated to judge the earning capacity of the business. Ratios used to judge the profitability of the business are:

1. Gross Profit Ratio.

2. Operating Ratio.

3. Operating Profit Ratio.

4. Net profit Ratio.

5. Return on Investment (ROI) or Return on Capital Employed (ROCE).

6. Return on Net Worth.

7. Earnings per Share.

8. Dividend per share

9. Dividend Payout Ratio.

10. Price Earnings Ratio.

Profitability Ratios

1. Gross Profit Ratio

It is computed to have an idea about gross margin.

Gross Profit Ratio = Gross Profit/Revenue from Operations × 100

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

Significance:

It indicates gross margin. It also indicates the margin available to cover operating expenses, non-operating expenses, etc.

Change in gross profit ratio may result from change in selling price or cost of sales or a combination of both.

A low ratio may indicate unfavorable purchase and sales policy. Higher ratio is always a good sign.

2. Operating Ratio

It is computed to judge cost of operations in relation to sales.

Operating Ratio = [(Cost of Revenue from Operations + Operating Expenses)/ Revenue from Operations] × 100

Cost of Revenue from Operations = 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 & Amortization

Significance:

It indicates the operational efficiency of the business. As it is a cost ratio, lower ratio is considered better.

3. Operating Profit Ratio

It is calculated to reveal operating margin.

Operating Profit Ratio = Operating Profit/ Revenue from Operations × 100

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

This ratio can also be calculated as under:

Operating Profit Ratio = 100 – Operating Ratio

Significance:

It helps to judge the performance and operational efficiency of the business. It is useful for inter-firm as well as intra-firm comparisons.

4. Net Profit Ratio

It expresses the relationship of Net sales to net profit after operating and non-operating expenses and incomes.

Net Profit Ratio = Net Profit before Interest & Tax / Revenue from Operations × 100

Net Profit before Interest & Tax = Gross Profit + Other Incomes – Indirect Expenses

Significance:

It is a measure of net profit margin in relation to sales. It shows the overall efficiency of the business.

5. Return on Investment (ROI)

or Capital Employed (ROCE)

It explains the overall utilization of funds by a business enterprise.

Return on Investment (or Capital Employed) = Profit before Interest and Tax (PBIT)/ Capital Employed × 100

Net Profit before Interest, Tax and Dividend = Gross Profit + other Income – Indirect Expenses

Capital Employed may be calculated by any of the following two Methods.

(1) Liabilities Approach

Shareholder’s Fund (Share Capital + Reserves & surpluses) + Non-Current liabilities (Long term-borrowing + long term Provisions,

(2) Assets Approach

Non-Current Assets (Tangible Assets + Intangible Assets + Non-Current 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 cannot be a part of Non-Current Investments).

Significance:

It shows the efficiency of the business in utilization of funds and is considered a good measure of profitability for inter-firm comparison. It also helps in assessing whether the firm is earning a higher return on capital employed as compared to the interest rate paid.

6. Return on Shareholders’ Funds

This ratio expresses the relationship of profit after tax and shareholders’ funds.

Return on Shareholders’ Fund =Profit after Tax/Shareholders’ Funds

Significance:

This ratio is very important from shareholders’ point of view in assessing whether their investment in the firm generates a reasonable return or not. It should be higher than the return on investment otherwise it would imply that company’s funds have not been employed profitably.

7. Earnings per Share (EPS)

EPS = Profit available for equity shareholders/ No. of Equity Shares

Profit available for equity shareholders = Profit after Tax –Preference Dividend

Significance:

This ratio is very important from equity shareholders point of view and for the share price in the stock market. This also helps in making comparison with that of other firms to ascertain its reasonableness and capacity to pay dividend.

8. Dividend per share (DPS)

DPS=Total Dividend Paid/ No. of Equity shares

9. Dividend Payout Ratio

This refers to the proportion of earning that is distributed against the shareholders.

Dividend Payout Ratio =Dividend per Share/ Earnings per Share

Significance:

This reflects company’s dividend policy and growth in owner’s equity.

10. Price Earning Ratio

P/E Ratio = Market price of a Share/Earnings per Share

Significance:

It reflects investors’ expectation about the growth in the firm’s earnings and reasonableness of the market price of its shares. P/E ratios vary from industry to industry and company to company in the same industry depending upon investors’ perception of their future.

Precaution: All the ratios should be studied in relation to meaningful combinations only, for better conclusions.

Liquidity Ratios

Activity Ratios

Solvency Ratios

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