Isc Accounts Ratio Analysis

Rohit Agarwal 9883248954

Chapter 18 : Ratio Analysis Meaning: Ratio Analysis is the process of determining and interpreting the numerical relationship between figures of financial statements. The objectives of using ratios are to test the profitability, financial position (liquidity and solvency) and the operating efficiency of a concern. Ratio analysis is one of the techniques of financial analysis to evaluate the financial condition and performance of a business concern. Advantages: The advantages of accounting ratios are as follows: 1. To workout the profitability & solvency: Accounting ratio help to measure the profitability of the business by calculating the various profitability ratios. With the help of solvency ratios, solvency of the company can be measured. 2. Helpful in analysis of financial statement: Ratio analysis help the outsiders just like creditors, shareholders, debenture-holders, bankers to know about the profitability and ability of the company to pay them interest and dividend etc. 3. Helpful in comparative analysis of the performance: Ratio analysis facilitates inter firm and intra firm comparative analysis of the performance. Limitations: It suffers from the following limitations. 1. Limited Comparability: Different firms apply different accounting policies. Therefore the ratio of one firm can not always be compared with the ratio of other firm. 2. Effect of Price Level Changes: Price level changes often make the comparison of figures difficult over a period of time. A change in price affects the cost of production, sales and also the value of assets. 3. Qualitative factors are ignored: Ratio analysis is a technique of quantitative analysis and thus, ignores qualitative factors, which may be important in decision making. For example, average collection period may be equal to standard credit period, but some debtors may be in the list of doubtful debts, which is not disclosed by ratio analysis. Write answer of these questions in your copy: 1. What is meant by current Assets & Current Liabilities? 2. Explain the term: a. Capital Gearing Ratio b. Interest Coverage Ratio c. Return on Equity Shareholders’ Fund. [ISC 2007] 3. What is Quick ratio? State its significance. [ISC 2005] 4. When calculating the Acid Test Ratio, name two items that are excluded from current assets. [ISC 2008]

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Rohit Agarwal 9883248954 Classification of Ratios Liquidity Measure firms’ ability to pay off current dues. They are otherwise called as Short Term Solvency Ratios

Solvency Solvency refers to the firms ability to meet its long term indebtedness. Solvency ratio studies the firms ability to meet its long term obligations.

Profitability Efficiency of a business is measured by profitability. Profitability ratio measures the profit earning capacity of the business concern.

1. Current Ratio 2. Liquid Ratio

1. Debt-Equity Ratio 2. Proprietary Ratio

1. Gross Profit Ratio 2. Net Profit Ratio 3. Operating Profit Ratio 4. Operating Ratio

3.Total Asset to Debt Ratio

4. Capital Gearing Ratio

Activity (Turnover) Activity ratios indicate the performance of the business. The performance of a business is judged with its sales or cost of goods sold. These ratios are thus referred to as turnover ratios. 1. Working Capital Turnover Ratio 2. Fixed Asset Turnover Ratio 3. Debtors Turnover Ratio 4.Creditors Turnover Ratio

Which Ratio?

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How to Calculate? What is the Objective? Balance Sheet Ratios It refers to those Ratios which are calculated from the information and data from the Balance Sheet. This ratio shows the relationship between Proprietary Shareholders’ Fund proprietors or shareholders funds and total Total Asset Ratio assets. Shareholders’ Fund = Equity Share Capital + Preference Share Capital + Reserves & Surplus – Fictitious Assets (Preliminary Expenses, etc.) This ratio is used to assess the firm’s ability to meet its current liabilities. The relationship of Current Assets Current Ratio Current Liabilities current assets to current liabilities is known as current ratio. Current Assets = Cash + Bank + Marketable Securities + Short term Investments + Debtors + Bills Receivable + Accrued Income + Prepaid Expenses + Stock in Trade. Current Liabilities = Creditors + Bills Payable + Liability for Taxes + Outstanding Expenses + Income received in Advance + Provision for taxation + Proposed Dividend + Bank Overdraft. This ratio is used to assess the firm’s short term liquidity. The relationship of liquid assets to Quick Assets Quick Ratio quick liabilities is known as liquid ratio. It is Quick Liabilities otherwise called as Quick ratio or Acid Test ratio. Quick Assets = Current Assets – Stock – Prepaid Expenses. Quick Liabilities = Current Liabilities – Bank Overdraft. This ratio helps to ascertain the soundness of the long term financial position of the concern. It indicates the proportion between total long-term Debt Equity Long Term Debt Shareholders’ Fund debt and shareholders funds. This also indicates Ratio the extent to which the firm depends upon outsiders for its existence. Long Term Debt = Debentures + Bonds + Loan from Financial Institutions This ratio measures the safety margin available Total Asset to Total Assets to the suppliers of long term debts. It measures Long Term Debt Debt Ratio the extent to which debt is covered by assets.

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Rohit Agarwal 9883248954 Revenue Statement Ratios It refers to those Ratios which are calculated from the information and data from the Revenue Statement (Trading, Profit and Loss Account). This ratio indicates the efficiency of trading Gross Profit Gross Profit X 100 activities. The relationship of Gross profit to 1 Net Sales . Ratio Sales is known as gross profit ratio. This ratio determines the overall efficiency of Net Profit Net Profit X 100 the business. The relationship of Net profit to 2 Net Sales . Ratio Sales is known as net profit ratio. This ratio is an indicator of the operational Operating Operating Profit X 100 efficiency of the management. It establishes the 3a Net Sales . Profit Ratio relationship between Operating profit and Sales. ƒ Operating Profit = Gross profit – Operating expenses = Net profit + Non-operating expenses(for e.g. interest on loan and loss on sale of assets) - Non-operating income (for e.g. dividend, interest received

and profit on sale of asset} This ratio determines the operating efficiency of the business concern. Operating ratio measures (Cost of Goods Sold + . Operating the amount of expenditure incurred in 3b Operating Expenses) X 100 Ratio production, sales and distribution of output. The Net Sales . relationship between Operating cost to Sales is known as Operating Ratio ƒ Cost of Goods Sold = Sales – Gross profit = Op Stock + Purchases + Wages, etc – Cl Stock. ƒ Operating Expenses = Administrative Expenses + Selling & Distribution Expenses (Financial Expenses & Non-operating Expenses are to be ignored.) This ratio is otherwise called as inventory turnover ratio. It indicates whether stock has been efficiently used or not. It establishes a Stock Cost of Goods Sold 4a Average Stock Turnover Ratio relationship between the cost of goods sold during a particular period and the average amount of stock in the concern. ƒ Average = (Opening + Closing)/2 This measures the average age of stock i.e. the Stock Holding 365 Days OR 12 Months expected time between purchase of stocks and 4b Stock Turnover Ratio Period sales of those stocks. Balance Sheet & Revenue Statement Ratios It refers to those Ratios which are calculated from the combined information and data from the Balance Sheet and the Revenue Statement (Trading, Profit and Loss Account). This establishes the relationship between credit sales and average accounts receivable. Debtors Debtors Net Credit Sales turnover ratio indicates the efficiency of the 1a Avg Drs + Avg B/R Turnover Ratio business concern towards the collection of amount due from debtors. It provides a rough approximation of the average Average Debt 365 Days OR 12 Months 1b Debtors Turnover Ratio time taken to collect from the debtors. Collection Pd. This establishes the relationship between credit purchases and average accounts payable. Creditors’ Net Credit Purchases 2a Avg Crs + Avg B/P Creditors turnover ratio indicates the period in Turnover Ratio which the payments are made to creditors. Average Debt 365 Days OR 12 Months It provides a rough approximation of the average 2b Payment Pd. Creditors Turnover Ratio time taken to pay back the creditors. Working Capital Turnover Ratio determines the Working Net Sales efficiency with which the working capital is 3 Capital Working Capital utilized. Turnover Ratio ƒ Working Capital = Current Assets - Current Liabilities

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