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Accounting Ratios

This document defines and classifies various accounting ratios used to analyze the financial performance and position of a business. It discusses four main types of ratios: liquidity ratios, solvency ratios, activity ratios, and profitability ratios. Specific ratios covered include the current ratio, quick ratio, debt-equity ratio, inventory turnover ratio, trade receivables turnover ratio, gross profit ratio, operating ratio, net profit ratio, and return on investment ratio. Formulas for calculating each ratio are provided along with explanations of the components.

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Rakesh Kumar
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232 views4 pages

Accounting Ratios

This document defines and classifies various accounting ratios used to analyze the financial performance and position of a business. It discusses four main types of ratios: liquidity ratios, solvency ratios, activity ratios, and profitability ratios. Specific ratios covered include the current ratio, quick ratio, debt-equity ratio, inventory turnover ratio, trade receivables turnover ratio, gross profit ratio, operating ratio, net profit ratio, and return on investment ratio. Formulas for calculating each ratio are provided along with explanations of the components.

Uploaded by

Rakesh Kumar
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
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Accounting ratios

Meaning of Raio: Relationship between to figures,


expressed in earthmatical terms is called a ratio
Ratio is expressed the four ways
proportion or pure ratio: it is expressed by a simple division of on number by another

(1)

Rate Or So Many Times: in this type it is calculated how many times a figure is in comparison
to another figure.
(3)
Percentage: in this type the relation between two figures in hundredth.
(4)
Fraction : while calculation a ratio it should be understood that it is desirable to divide the
more fabourable figure by less then figure.
(2)

Classification of Ratios
Ratios may be classified in to four catagories
(A)
Liquidity Ratios
(B)
Solvency Ratios
(C)
Activity Ratios
(D)
Profitability Ratios

Liquidity Ratios
(i)

Current ratio or working capital ratio: This ratio explains the relationship between current
assets and current liabilities of a business. The formula for calculating the ratio is:
Current ratio=

current assets
current liabilities

*Current Assets: C.A.are those assets which are likely to be converted into cash or cash equivalent within 12
months from the date of balance sheet.
*Current Liabilities:C.L. are those liabilities payable within 12 months from the date of balance sheet.
(ii)

Quick Ratio or acid test ratios: it means those assets which will be converted into cash and
cash equivalents very shortly.

QUICK RATIO=

quick assets
current liabilities

The other name is quick assets is liquid assets.


Liquid assets= current assets- inventories- other current assets such as prepaid
expenses,advance tax etc.
(iii)

Ideal standard in the case of current ratio 2:1, whereas in the case of quick ratio it is 1:1.

. (B) SOLVENCY
(I)

RATIOS

DEBT EQUITY RATIOS: This ratios expresses the relationship between long term debts and
shareholder funds.

DEBT EQITY RATIO

debt
equity

or

long term debts


share holder funds

Long term debt: It include debentures mortgage loan, bank loan, loan from financial institution and public
deposits etc.
. Share holder fund: It include equity share capital,preference share capital, reserve & surplus.
*Reserve &surplus include capital reserve, securities premium, general reserve and balance in statement of
profit
&loss.
Significance: This ratio is calculated to assess the ability of the firm to meet its long term liabilities. Generally
debt equity ratio of 2:1 is considered safe.
(2) Total assets to debt ratio=

(3)

TOTAL ASSETS
DEBTS

TOTAL ASSETS

Proprietary Ratio =
EQUITY

(4) INTEREST COVERAGE RATIO =

NET PROFIT BEFORE INTEREST TEX


INTEREST CHARGES

Fixed interest charges= interest on loan, interest on debenture

(C)ACTIVITY RATIOS OR TURNOVER RATIOS


These ratios measure the efficiency and rapidity of the resources of the company like stock, fixed assets,
working capital, trade receivable etc.

(1)

INVENTORY TURNOVER RATIO:

cost of revenue

operat ion
average invenory

*Cost of revenue from operation can be calculated by two ways


(i)cost of revenue from operation= opening inventory+purchases+carriage+wages+other direct chargesclosing inventory
OR
Revenve from operation- gross profit
Average Inventory=

OPENING INVENTORY +CLOSING INVENTORY


2

AVERAGE AGE OF INVENTORY=

DAYS A YEAR
INVENTORY TURNOVER RATIO

Significance: This ratio indicate weather inventory has been efficiently used or not. The higher ratio show
that the inventory is selling quickly. This ratio can be used for comparing the efficiency of
sales policies of two firms doing same type of business.

NET CREDIT REVENUE

OPERATION
AVERAGE TRADE RECEIVABLES

(ii) TRADE RECEIVEABLE TURNOVER RATIO:

..

Times
Net Cr.Rev. from operation= Total revenue from operation- cash revenue from operation

Average trade receivable=

openingtrade receivables+ closing trade receivables


2
DAYS A YEAR
TR ADE RECEIVABLE TURNOVER RATIO

Average collection period=

(iii)TRADE PAYABLE TURNOVER RATIO=

NET CREDIT PURCHASES


AVERAGE TRADE PAYABLES

..TIMES

NET CREDIT PUR. Total Purchase- Cash Purchases

AVERAGE TRADE PAYABLE

OPENING CREDITOR+CLOSING CREDITOR


2

AVERAGE PAYMENT PERIOD=

365 DAYS
TRADE PAYABLES TURNOVER RATIO

NET REVENUE

(iv)WORKING CAPITAL TURNOVER RATIO = OPERATION


W ORKING CAPITAL

..times

Working C apital = current assets current liabilities


Significance: It show the number of times working capital has been rotated in producing
revenue from operation . A high w.c. turnover ratio shows efficient use of working capital and
a low working capital turnover indicate under utilization of working capital .

(D)PROFITABILITY RATIOS OR INCOME RATIO


The main object of every business to earn more profit . A business must be able to earn
adequate profit in related to the capital invested in it . the efficiency and success of a
business can be measure with the help of profitability ratios.
(A) GROSS PROFIT RATIO
(B) OPERATNG RATIO
(C) OPERATING PROFIT RATIO
(D) NET PROFIT RATIO
(E) RETURN ON INVESTMENT

(i)Gross profit ratio=

Revenue
Gross profit
operation i. e . net sales 100

*Gross profit= Revenue from operation Cost of revenue from operation


*Cost of revenue from operation: opening inventory + net purchases + direct
expenses( carriage, wages etc.) closing inventory.
OR Revenue from operation
gross profit.

cost of revenue
revenue
Operating ratio :
operation+opearing expenses operation 100

*Operating exp. Employee benefit exp.+ depreciation and amortization exp.+ other exp.
(office and administration exp., selling and distribution exp. Discount, bad debts, interest on
short term loan)

(iii)OPERATING PROFIT RATIO:

REVENUE
OPERATING PROFIT
OPERATION 100

*Operating profit = gross profit- other operating expenses + other operating exp.
Other operating exp. Same above
*Other operating income: Commission received+ Discount received

(IV)NET PROFIT RATIO=

REVENUE
NET PROFIT
OPERATION 100

NET PROFIT: Gross profit indirect exp.& losses + other income tax
*Indirect exp. & losses= office exp + selling exp.+ interest on long term borrowing +
accidental losses.
(V)RETURN ON INVESTMENT:

NET PROFIT INTEREST , TAX DIVIDENDS


100
CAPITAL EMPLOYED

*CAPITAL EMP. (liabilities side approach)


Share holder fund + non current liabilities(long term borrowing + long term provision)
*Second method (assets side approach)
Capital employed= non current assets + working capital
Non current assets = tangible and intangible assets + non current investment + loan &
advance
*Working capital = current assets current liabilities.

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