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Short Answer Type Questions
1. What do you mean by Ratio Analysis?
Ans. The ratio analysis is the most powerful tool of financial statement analysis. Ratios simply mean one number expressed in terms of another. A ratio is a statistical yardstick by means of which relationship between two or various figures can be compared or measured. Ratios can be found out by dividing one number by another number.
2. What are various types of ratios?
Ans. Accounting ratios are classified in two ways Categories as follows:
(i) Traditional Classification : Traditional ratios are those accounting ratios which are based on the Financial Statement like Trading and Profit and Loss Account and Balance Sheet. On the basis of accounts of financial statements, the Traditional Classification is further divided into the following categories
(a) Income Statement Ratios: like Gross Profit Ratio, etc.
(b) Balance Sheet Ratios: like Current Ratio, Debt Equity Ratio, etc.
(c) Composite Ratios: like Debtors Turnover Ratio, etc.
(ii) Functional Classification : This classification of ratios is based on the functional need and the purpose for calculating ratio. The functional ratios are further divided into the following categories
(a) Liquidity Ratio: These ratios are calculated to determine short term solvency.
(b) Solvency Ratio: These ratios are calculated to determine long term solvency.
(c) Activity Ratio: These ratios are calculated for measuring the operational efficiency and efficacy of the operations. These ratios relate to sales or cost of goods sold.
(d) Profitability Ratio: These ratios are calculated to assess the profitability conditions of the firm.
3. What relationships will be established to study?
(a) Inventory Turnover
(b) Debtor Turnover or Trade Receivables turnover
(c) Payables Turnover or Trade Payables turnover
(d) Working Capital Turnover
Ans. (a) Inventory Turnover Ratio: This ratio is a relationship between the cost of goods sold during a particular period of time and the cost of average inventory during a particular period. It is expressed in number of times. Stock turnover ratio/inventory turnover ratio indicates the number of time the stock has been turned over during the period and evaluates the efficiency with which a firm is able to manage its inventory.
This ratio indicates whether investment in stock is within proper limit or not. The ratio is calculated by dividing the cost of goods sold by the amount of average stock at cost. The formula for calculating inventory turnover ratio is as follows:
$$\text{Inventory Turnover Ratio =}\frac{\text{Cost of Goods Sold}}{\text{Average Inventory at Cost}}$$
Cost of Goods Sold = Opening Stock + Purchase + Direct Expenses – Closing Stock
Alternatively cost of Goods sold = Net Sales – Gross Profit
$$\text{Average Inventory =}\frac{\text{Opening Stock + Closing Stock}}{2}$$
(b) Debtor Turnover Ratio: Debtor turnover ratio or accounts receivable turnover ratio indicates the velocity of debt collection of a firm. In simple words it indicates the number of times average debtors (receivable) are turned over during a year. The formula for calculating Debtors turnover ratio is as follows:
$$\text{Debtors Turnover Ratio =}\frac{\text{Net credit sales}}{\text{Average trade debtors}}$$
(c) Creditors/Payables Turnover Ratio: It compares creditors with the total credit purchases. It signifies the credit period enjoyed by the firm in paying creditors. Accounts payable include both sundry creditors and bills payable. Same as debtor’s turnover ratio, creditor’s turnover ratio can be calculated in two forms, creditors’ turnover ratio and average payment period. The following formula is used to calculate the creditors Turnover Ratio:
$$\text{Creditors Turnover Ratio =}\frac{\text{Credit Purchases}}{\text{Average trade creditors}}$$
(d) Working Capital Turnover Ratio: Working capital turnover ratio indicates the velocity of the utilization of net working capital. This ratio represents the number of times the working capital is turned over in a year and is calculated as follows:
$$\text{Working Capital Turnover Ratio =}\frac{\text{Sales}}{\text{Net working capital}}$$
4. Why would the inventory turnover ratio be more important when analysing a grocery store than an insurance company?
Ans. Nature of business make inventory turnover ratio more important in case of a grocery store as compare to an insurance company. A grocery store is a trading concern involved in trading i.e., buying and selling of goods and in this regards it is obvious to maintain some inventory in stores. On the other hand, insurance company involved in service business and involved in delivering service there is no question of inventory because service is perishable in nature and cannot be stored. That’s why inventory turnover ratio is more important in case of grocery store than an insurance company.
5. The liquidity of a business firm is measured by its ability to satisfy its long term obligations as they become due? Comment.
Ans. Yes it is true that the liquidity of a business firm is measured by its ability to pay its long term obligations as they become due. Here the long term obligation means payments of principal amount on the due date and payments of interests on the regular basis. For measuring the long term solvency of any business we calculate the following ratios.
Debt Equity Ratio: Debt equity ratio indicates the relationship between the external equities or outsiders funds and the internal equities or shareholders funds. It is also known as external internal equity ratio. It is determined to ascertain soundness of the long term financial policies of the company. Following formula is used to calculate debt to equity ratio:
$$\text{Debt Equity Ratio =}\frac{\text{External Equities}}{\text{Shareholders' Funds}}\text{or}\\\frac{\text{Outsiders Funds}}{\text{Interrnal Equities}}\text{or}\\\frac{\text{Long term debts}}{\text{Shareholder's Funds}}$$
Proprietory Ratio: Proprietory Ratio are a variant of the debt equity ratio. It is also known as equity ratio or net worth to total assets ratio. This ratio relates the shareholder’s funds to total assets. Proprietory / Equity ratio indicates the long-term or future solvency position of the business. Formula of Proprietory/Equity Ratio.
$$\text{Propertory or Equity Ratio =}\frac{\text{Shareholders' Funds}}{\text{Total Assets}}$$
Fixed Assets to Proprietor’s Fund Ratio: Fixed assets to proprietor’s fund ratio establish a relationship between fixed assets and shareholders’ funds. The purpose of this ratio is to indicate the percentage of the owner’s funds invested in fixed assets. The formula for calculating this ratio is as follows:
$$\text{Fixed Assets to Properties Funds =}\frac{\text{Fixed Assets}}{\text{Proprietor's Funds}}$$
Interest Coverage Ratio: This ratio depicts the relationship between amount of profit utilise for paying interest and amount of interest payable. A high Interest Coverage Ratio implies that the company can easily meet all its interest obligations out of its profit.
$$\text{Interest Coverage Ratio =}\frac{\text{Net Profit before Interest and Tax}}{\text{Interest on Long Term loaans}}$$
6. The average age of inventory is viewed as the average length of time inventory is held by the firm or as the average number of day’s sales in inventory. Explain.
Ans. Inventory Turnover Ratio : This ratio is a relationship between the cost of goods sold during a particular period of time and the cost of average inventory during a particular period. It is expressed in number of times. Stock turnover ratio/inventory turnover ratio indicates the number of time the stock has been turned over during the period and evaluates the efficiency with which a firm is able to manage its inventory. The formula for calculating inventory turnover ratio is as follows:
$$\text{Inventory Turnover Ratio =}\frac{\text{Cost of Goods Sold}}{\text{Average Inventory at Cost}}$$
Cost of Goods Sold = Opening Stock + Purchase + Direct Expenses – Closing Stock
Alternatively Cost of Goods Sold = Net Sales – Gross Profit
$$\text{Average Inventory =}\frac{\text{Opening Stock + Closing Stock}}{2}$$
From the above formula, it is clear that this ratio reveals the average length of time for which the inventory is held by the firm.
$$\text{Average age of Inventory =}\frac{\text{Days in a year}}{\text{Inventory Turnover Ratio}}$$
Long Answer Type Questions
1. What are liquidity ratios? Discuss the importance of current and liquid ratio.
Ans. Liquidity ratios are calculated to determine the short-term solvency of the business. Analysis of current position of liquid funds determines the ability of the business to pay the amount due as per commitment to stakeholders. Included in this category are current ratio, Quick ratio and Cash Fund Ratios.
Current Ratio : This ratio establishes relationship between current assets and current liabilities. The standard for this ratio is 2 : 1. It means a ratio 2 : 1 is considered favourable. It is calculated by dividing the total of the current assets by total of the current liabilities. The formula for the current ratio is as follows
Current Ratio = Current Assets/Current Liabilities
OR
Current Assets : Current Liabilities
Importance of Current Ratio : Current Ratio Provides a measure of degree to which current assets cover current liabilities. However, it must be interpreted carefully because window-dressing is possible by manipulating the components of current assets and current liabilities, to creditors. A very high current ratio is not a good sign as it reflects under utilisation or improper utilisation of resources.
Liquid/Acid Test/Quick Ratio : This ratio establishes relationship between Quick assets and Current liabilities. Quick assets are those assets which can get converted into cash easily in case of emergency. The standard for this ratio is 1 : 1. It means if quick assets are just equal to the current liabilities they will be considered favourable with the view point of company’s credibility. The formula for the quick ratio is as follows:
Quick Ratio = Quick Assets/ Current Liabilities
OR
Quick Assets : Current Liabilities
Quick assets = Current assets – Stock + Prepaid Expenses
Importance of Quick Ratio : It helps in determining whether a firm has sufficient funds if it has to pay all its current liabilities immediately. Because of exclusion of non-liquid current assets, it is considered better than current ratio as a measure of liquidity position of the business. Standard for liquid ratio is 1:1.
2. How would you study the solvency position of the firm?
Ans. The solvency position of any firm is determined and measured with the help of solvency ratios. In this way we can say that the ratios which throw light on the debt servicing ability of the businesses in the long run are known as solvency ratios. Solvency of a concern can be measured in two ways first to check the security of Debt and second is to check the security of return on Debt. For calculating the security of debt we calculate Debt-Equity Ratio, Proprietory Ratio, Fixed Assets – Proprietory Fund Ratio, etc. And for calculating Security of Return on Debt we calculate Interest Coverage Ratio. A brief description of the above mentioned ratios is as follows:
Debt Equity Ratio : Debt Equity Ratio indicates the relationship between the external equities or outsiders funds and the internal equities or shareholders funds. It is also known as external-internal equity ratio. It is determined to ascertain soundness of the long term financial position of the company.
$$\text{Debt Equaity Ratio =}\frac{\text{External Equities}}{\text{Shareholder's Funds}}\\\text{or}\frac{\text{Outsiders Funds}}{\text{Internal Equities}}$$
Proprietory Ratio/ Total Assets to Debt Ratio: Total assets to Debt Ratio or Proprietory Ratio are a variant of the debt-equity ratio. It is also known as equity ratio or net worth to total assets ratio. This ratio relates the shareholder’s funds to total assets. Proprietory/Equity Ratio indicates the long-term or future solvency position of the business. Formula of Proprietary/Equity Ratio:
$$\text{Proprietory or Equity Ratio =}\frac{\text{Shareholder's Funds}}{\text{Total Assets}}$$
Fixed Assets to Proprietor’s Fund Ratio: Fixed Assets to Proprietor’s Fund Ratio establish a relationship between fixed assets and shareholders’ funds. The purpose of this ratio is to indicate the percentage of the owner’s funds invested in fixed assets. The formula for calculating this ratio is as follows:
$$\text{Fixed Assets to Proprietors Fund =}\frac{\text{Fixed Assets}}{\text{Proprietor's Funds}}$$
The fixed assets are considered at their book value and the proprietor’s funds consist of the same items as internal equities in the case of debt equity ratio.
Interest Coverage Ratio : This ratio deals only with servicing of return on loan as interest. This ratio depicts the relationship between amount of profit utilise for paying interest and amount of interest payable. A high Interest Coverage Ratio implies that the company can easily meet all its interest obligations out of its profit.
$$\text{Interest Coverage Ratio =}\frac{\text{Net Profit before interest and Tax}}{\text{Interest on Long Term Loans}}$$
3. What are profitability ratios? How are these worked out? ‘
Ans. Profitability Ratios measure the results of business operations or overall performance and effectiveness of the firm. Some of the most Important and popular profitability ratios are as under:
Gross Profit Ratio: Gross Profit Ratio (GP ratio) is the ratio of gross profit to net sales expressed as a percentage. It expresses the relationship between gross profit and sales. The basic components for the calculation of gross profit ratio are gross profit and net sales. Net sales mean sales minus sales returns.
Following formula is used to calculate gross profit ratios:
$$\text{Gross Profit Ratio =}\frac{\text{Gross Profit}}{\text{Net Sales}}×100$$
Gross Profit = Net Sales – Cost of Goods Sold
Net Sales = Sales – Sales Return
Cost of Goods Sold = Opening Stock + Purchase + Direct Expenses – Closing Stock
Net Profit Ratio : Net Profit Ratio is the ratio of net profit to net sales. It is expressed as percentage. The two basic components of the net profit ratio are the net profit and sales.
$$\text{Net Profit Ratio =}\frac{\text{Net Prorfit}}{\text{Net Sales}}×100$$
Net Sales = Sales – Sales Return
Operating Profit Ratio : Operating Profit Ratio is the ratio of operating profit to net sales. There are many non operating expenses and incomes included in the profit and loss account which has nothing to do with the operations of the business such as loss by fire, loss by theft etc. On the other hand in credit side of the P&L account, there are so many incomes which can be considered as operating incomes such as dividend, bank interest, rent etc. In this way net profit ratio will not tell the truth about the profit of the organisation. Hence operating profit ratio will be helpful in that case. The formula for calculating operating ratio is as follows:
$$\text{Operating Profit Ratio =}\frac{\text{Operating Profit}}{\text{Net Sales}}×100$$
Operating Ratio : Operating ratio is the ratio of cost of goods sold plus operating expenses to net sales. It is generally expressed in percentage. This is closely related to the ratio of operating profit to net sales. The two basic components for the calculation of operating ratio are operating cost (cost of goods sold plus operating expenses) and net sales. Operating expenses normally include (a) administrative and office expenses and (b) selling and distribution expenses. The formula for calculating the operating ratio is as follows:
$$\text{Operating Ratio =}\frac{\text{Cost of Goods Sold + Operating Expenses}}{\text{NetSales}}×100$$
Cost of Goods Sold = Opening Stock + Purchase + Direct Expenses – Closing Stock
Net Sales = Sales – Sales Return
4. The current ratio provides a better measure of overall liquidity only when a firm’s inventory cannot easily be converted into cash. If inventory is liquid, the quick ratio is a preferred measure of overall liquidity. Explain.
Ans. The above mentioned statement is true. There are two different ways to measure the liquidity of a firm first through current ratio of the firm and second through quick ratio of the firm. The second one is considered the more refine form of measuring the liquidity of the firm.
The current ratio ‘explains the relationship between current assets and current liabilities. If current assets are quite capable to pay the current liability the liquidity of the concerned firm will be considered good. But here generally one question arises there are certain assets which cannot be converted into cash quickly such as stock and prepaid expenses.
An case of capital goods where stock conversation into cash is not easy. It is advisable to follow current ratio for measuring the liquidity of a firm.
But on the other hand, in case of those firms where the stock can be easily realised or sold off consideration of stock should be avoided and to measure the liquidity of that firm Quick ratio should be calculated, e.g., the inventories of a service sector company are very liquid as there are no stocks kept for sale, so in that case liquid ratio must be followed for measuring the liquidity of the firm.
Numerical Type Questions
1. Following is the Balance Sheet of Raj Oil Mills Limited as March 31, 2017. Calculate current ratio.
Particulars | (₹) |
I. Equity and liabilities | |
1. Shareholders’ Funds: | |
(a) Share Capital | 7,90,000 |
(b) Reserves and Surplus | 35,000 |
2. Current Liabilities | |
Trade Payables | 72,000 |
Total | 8,97,000 |
II. Assets | |
1. Non current assets | |
Fixed assets | |
—Tangible assets | 7,53,000 |
2. Current Liabilities | |
(a) Inventories | 55,800 |
(b) Trade Receivables | 28,800 |
(c) Cash and cash equivalents | 59,400 |
Total | 8,97,000 |
$$\textbf{Ans.}\qquad\text{Current Ratio =}\frac{\text{Current Assets}}{\text{Current Liabilities}}$$
Current Assets = 55,800 + 28,800 + 59,400
= ₹1,44,000
$$\text{Current Ratio =}\frac{\text{1,44,000}}{\text{72,000}}=2:1$$
2. Following is the Balance Sheet of Title Machine Limited as on March 31, 2017.
Particulars | (₹) |
I. Equity and liabilities | |
1. Shareholders’ Funds: | |
(a) Share Capital | 24,00,000 |
(b) Reserves and Surplus | 6,00,000 |
2. Current Liabilities | |
(a) Long-term borrowings | 9,00,000 |
3. Current Liabilities | |
(a) Short-term borrowings | 6,00,000 |
(b) Trade payables | 23,40,000 |
(c) Short-term borrowings | 60,000 |
Total | 69,00,000 |
II. Assets | |
1. Non current assets | |
Fixed assets | |
—Tangible assets | 45,00,000 |
2. Current Assets | |
(a) Inventories | 12,00,000 |
(b) Trade Receivables | 9,00,000 |
(c) Cash and each equivalents | 2,28,000 |
(d) Short-term loans and advances | 72,000 |
Total | 69,00,000 |
Calculate Current Ratio and Liquid Ratio.
Ans.
$$\text{Current Ratio =}\frac{\text{Current Assets}}{\text{Current Liabilities}}$$
Current Assets = Inventories + Trade Receivables + Cash and Cash equivalents + Short-term looms and advances
= 12,00,000 + 9,00,000 + 2,28,000 + 72,000
= ₹24,00,000
Current Liabilities = Short-term borrowings + Trade Payables + Short-term Provisions
= 6,00,000 + 23,40,000 + 60,000
= ₹30,00,000
$$\text{Current Ratio =}\frac{24,00,000}{30,00,000}=0.8:1\\\text{Quick Ratio =}\frac{\text{Quick Assets}}{\text{Current Liabilities}}$$
Quick Assets = Current Assets – Inventories
= ₹24,00,000 – 12,00,000
= ₹12,00,000
$$\text{Quick Ratio =}\frac{\text{12,00,000}}{30,00,000}=0.4:1$$
3. Current Ratio is 3.5 : 1. Working capital is ₹90,000. Calculate the amount of current Assets and current liabilities.
Ans. Let current liabilities be x;
∴ Current Assets = 3.5x
Working capital = Current Assets – Current liabilities
$$x=\frac{90,000}{2.5}=₹36,000$$
∴ Current liabilities = 36,000
Current Assets = 3.5 × 36,000
= ₹1,26,000
4. Shine Limited has a current ratio 4.5 : 1 and quick ratio 3 : 1; if the inventory is 36,000, calculate current liabilities and current assets.
Ans. Current Ratio = 4.5 : 1
Quick Ratio = 3.1
Let current liabilities = x
and then Current assets = 4.5x
and Quick assets = 3x
Stock = Current Assets – Quick Assets'
36,000 = 4.5x – 3x
36,000 = 1.5x
$$\text{x}=\frac{36,000}{1.5}\\=24,000=\text{Current Liabilities}$$
Current Assets = 4.5x = 4.5 × 24,000 = ₹1,08,000
5. Current liabilities of a company are ₹75,000. If Current ratio is 4 : 1 and liquid ratio is 1:1, calculate value of current assets, liquid assets and stock.
Ans. Current Ratio = 4 : 1
Liquid Ratio = 1 : 1
Current Liabilities = 75,000
Current assets = 4 times current liabilities
= 4 × 75,000 = 3,00,000
Liquid Assets = Current Liabilities = 75,000
Stock = Current Assets – Liquid Assets
= 3,00,000 – 75,000 = ₹2,25,000
6. Handa Limited has inventory of ₹20,000. Total liquid assets are ₹1,00,000 and quick ratio is 2:1 Calculate current ratio.
Ans. Quick Ratio = 2 : 1
Let Current Liabilities = x
$$\text{Then Quick Assets = 2x or 1,00,000 = 2x;}\\ x =\frac{1,00,000}{2}=50,000$$
Current Assets = Quick Assets + Stock
= 1,00,000 + 20,000 = 1,20,000
$$\text{Current Ratio =}\frac{\text{1,20,000}}{50,000}=2.4:1$$
7. Calculate debt equity ratio from the following information:
Items | Amount (₹) |
Total Assets | 15,00,000 |
Current Liabilities | 6,00,000 |
Total Debts | 12,00,000 |
$$\textbf{Ans.}\qquad\text{Debt Equity Ratio =}\frac{\text{Debt}}{\text{Equity}}$$
Equity = Total Assets – Total Debts
= 15,00,000 – 12,00,000 = 3,00,000
Debt = Total Debt – Current Liabilities
= 12,00,000 – 6,00,000 = 6,00,000
$$\text{Debt Equity Ratio =}\frac{6,00,000}{3,00,000}=2:1$$
8. Calculate Current Ratio if Stock is ₹6,00,000; Liquid Assets ₹24,00,000; Quick Ratio 2:1.
Ans. Quick Ratio = 2 : 1
Let Current Liability = x
Then, Quick Assets = 2x
or 24,00,000 = 2x
$$x=\frac{24,00,000}{2}=12,00,000\\\text{= Current Liability}$$
Current Assets = Quick Assets + Stock
= 24,00,000 + 6,00,000
= 30,00,000
$$\text{Current Ratio =}\frac{30,00,000}{12,00,000}=2.5:1$$
9. Compute Stock Turnover Ratio from the following information:
Items | Amount (₹) |
Net Sales/Revenue from operations | 2,00,000 |
Gross Profit | 50,000 |
Closing Stock/ Inventory at the end | 60,000 |
Excess of Inventory at the end over inventory at the beginning | 20,000 |
Ans. $$\text{Stock Turnover Ratio =}\frac{\text{Cost of Goods Sold}}{\text{Average Stock}}$$
Cost of Goods Sold = Net sales – Gross Profit
= 2,00,000 – 50,000 = 1,50,000
$$\text{Average Stock =}\frac{\text{Opening Stock + Closing Stock}}{2}$$
Opening Stock = Closing Stock – 20,000
= 60,000 – 20,000
= 40,000
$$\text{Average Stock =}\frac{40,000+60,000}{2}\\=\frac{1,00,000}{2}$$
= 50,000
$$\text{Stock Turnover Ratio =}\frac{\text{1,50,000}}{50,000}=3\space\text{times}$$
10. Calculate following ratios from the following information
(i) Current ratio
(ii) Acid test ratio/Liquid ratio
(iii) Operating Ratio
(iv) Gross Profit Ratio
Items | Amount (₹) |
Current Assets | 35,000 |
Current Liabilities | 17,500 |
Inventories | 15,000 |
Operating Expenses | 20,000 |
Revenue from operations | 60,000 |
Cost of Revenue from operations | 30,000 |
Ans. $$\text{(i)\space Current Ratio =}\frac{\text{Current Assets}}{\text{Current Liabilities}}\\=\frac{35,000}{17,500}\\=\frac{2}{1}=2:1\\\text{(ii)\space Acid Test Ratio =}\frac{\text{Liquid Assets}}{\text{Current Liabilities}}$$
Liquid Assets = Current Assets – Stock
= 35,000 – 15,000 = ₹20,000
$$\text{Acid Test Ratio =}\frac{20,000}{17,500}\\=\frac{1.14}{1}=1.14:1\\\text{(iii)\space \text{Operating Ratio =}}\\\frac{\text{Cost of Goods Sold + Operating Expenses}}{\text{Net Sales}}×100\\=\frac{30,000+20,000}{60,000}×100\\=\frac{50,000}{60,000}×100$$
= 83.3%
$$\text{(iv)\space\text{Gross Profit Ratio =}}\frac{\text{Gross Profit}}{\text{Net Sales}}×100$$
Gross Profit = Sales – Cost of Goods Sold
= 60,000 – 30,000 = 30,000
$$\text{Gross Profit Ratio =}\frac{30,000}{60,000}×100\\=\frac{300}{6}=50\%$$
11. From the following information calculate:
(i) Gross Profit Ratio
(ii) Inventory Turnover Ratio
(iii) Current Rati0
(iv) Liquid Ratio
(v) Net Profit Ratio
(vi) Working Capital Ratio
Items | Amount (₹) |
Revenue from operations | 25,20,000 |
Net Profit | 3,60,000 |
Cost of Revenue from operations | 19,20,000 |
Long Term Debts | 9,00,000 |
Trade Payable | 2,00,000 |
Average Inventory | 8,00,000 |
Liquid Assets | 7,60,000 |
Fixed Assets | 14,40,000 |
Current Liabilities | 6,00,000 |
Net Profit before Interest and Tax | 8,00,000 |
Ans. (i) Gross Profit = Sales – Cost of Goods Sold
= 25,20,000 – 19,20,000 = 6,00,000
$$\text{Gross Profit Ratio}\\ =\frac{\text{6,00,000}}{\text{25,20,000}}×100=23.81\%\\\text{(ii) Inventory Turnover Ratio =}\\\frac{\text{Cost of Goods Sold}}{\text{Average Stock}}\\=\frac{19,20,000}{8,00,000}=2.4\space\text{times}$$
$$\text{Gross Profit Ratio}\\ =\frac{\text{6,00,000}}{\text{25,20,000}}×100=23.81\%\\\text{(ii) Inventory Turnover Ratio =}\\\frac{\text{Cost of Goods Sold}}{\text{Average Stock}}\\=\frac{19,20,000}{8,00,000}=2.4\space\text{times}$$
$$\text{(iii)\space Current Ratio =}\frac{\text{Current Assets}}{\text{Current Liabilities}}\\=\frac{7,60,000+8,00,000}{6,00,000}\\=\frac{15,60,000}{6,00,000}=\frac{2.6}{1}=2.6:1\\\text{(iv) Liquid Ratio }=\frac{\text{Liquid Assets}}{\text{Current Liabilities}}\\=\frac{7,60,000}{6,00,000}\\=\frac{1.27}{1}=1.27:1\\\text{(v)\space}\text{Net Profit Ratio =}\frac{\text{Net Profit}}{\text{Net Sales}}×100\\=\frac{3,60,000}{25,20,000}×100=14.28\%$$
$$\text{(vi) Working Capital Ratio =}\frac{\text{Net Profit}}{\text{Working Capital}}$$
Working Capital = Current Assets – Current Liabilities
= 15,60,000 – 6,00,000 = 9,60,000
$$\text{Working Capital Ratio =}\frac{\text{25,20,000}}{\text{9,60,000}}\\=2.625\space\text{times}$$
12. Compute Working Capitat Turnover Ratio, Dept Equity Ratio and Proprietory Ratio from the following information.
Items | Amount (₹) |
Paid-up Capital | 5,00,000 |
Current Assets | 4,00,000 |
Revenue from operations | 10,00,000 |
13% Debentures | 2,00,000 |
Current Liabilities | 2,80,000 |
Ans. (i) Working Capital Turnover Ratio
$$=\frac{\text{Net Sales}}{\text{Working Capital}}$$
Working Capital = Current Assets – Current Liabilities
= 4,00,000 – 2,80,000 = 1,20,000
Working Capital Turnover Ratio
$$=\frac{10,00,000}{1,20,000}=8.33\space\text{times}$$
$$\text{(ii) Debt Equity Ratio =}\frac{\text{Debt}}{\text{Equity}}\\=\frac{2,00,000}{5,00,000}=2.5=0.4:1\\\text{(iii) Proprietory Ratio =}\frac{\text{Shareholders Funds}}{\text{Total Assets}}$$
Total Assets = Total Liabilities
Total Liabilities = Paid up Capital + Debentures + Current Liabilities
= 5,00,000 + 2,00,000 + 2,80,000 = 9,80,000
$$\text{Proprietory Ratio =}\frac{5,00,000}{9,80,000}\\=25:49=0.51:1$$
13. Calculate Inventory Turnover Ratio if Opening Inventory is ₹76,250, Closing Inventory is 98,500, Sales is ₹5,20,000, Sales Return is ₹20,000, Purchase is ₹3,22,250.
Ans.
$$\text{Stock Turnover Ratio =}\frac{\text{Cost of Goods Sold}}{\text{Average Stock}}$$
Cost of Goods Sold = Opening Stock + Purchase – Closing Stock
= 76,250 + 3,22,250 – 98,500
= 3,00,000
$$\text{Average Stock =}\frac{\text{Opening Stock + Closing Stock}}{2}\\=\frac{76,250+98,500}{2}=87,375\\\text{Stock Turnover Ratio =}\frac{3,00,000}{87,375}\\=3.43\space\text{times}$$
14. Calculate Inventory Turnover Ratio from the data given below:
Inventory in the beginning of the year | ₹10,000 |
Inventory in the end of the year | ₹5,000 |
Carriage | ₹2,500 |
Revenue from operations | ₹50,000 |
Purchases | ₹25,000 |
Ans.
$$\text{Inventory Stock Turnover Ratio =}\frac{\text{Cost of Revenue from operations}}{\text{Average Inventory}}$$
Cost of Revenue from operation = Opening Inventory + Purchases + Carriage – Closing Inventory
= 10,000 + 25,000 + 2,500 – 5,000
= 32,500
$$\text{Average Inventory =}\frac{\text{Opening Inventory + Closing Inventory}}{2}\\=\frac{10,000+5,000}{2}\\=\frac{15,000}{2}=7,500\\\text{Inventory Turnover Ratio =}\frac{32,500}{7,500}\\=4.33\space\text{times}$$
15. A trading firm’s average inventory is ₹20,000 (cost). If the inventory turnover ratio is 8 times and the firm sells goods at a profit of 20% on sales, ascertain the Gross profit of the firm.
Ans.
$$\text{Stock Turnover Ratio =}\frac{\text{Cost of Goods Sold}}{\text{Average Inventory}}\\8=\frac{\text{Cost of Goods Sold}}{20,000}$$
Cost of Goods sold = 20,000 × 8 = 1,60,000
Let sale price be ₹100, then profit is 20
Hence, the Cost of Goods Sold = 100 – 20 = 80
If the Cost of Goods Sold is 80, then Sales = 100
If the Cost of Goods Sold is 1, then Sales = $$\frac{100}{80}$$
If the cost of Goods sold is 1,60,000 than Sales
$$=\frac{100}{80}×1,60,000=2,00,000$$
Gross Profit = Sales – Cost of Goods Sold
= 2,00,000 – 1,60,000 = 40,000
Alternative Method
$$\text{Inventory Turnover Ratio =}\frac{\text{Cost of Goods Sold}}{\text{Average Inventory}}\\8=\frac{\text{Cost of Goods Sold}}{20,000}$$
Cost of Goods Sold = 20,000 × 8 = 1,60,000
Assume Sales as x then
Cost of Goods Sold = Net Sales – Profit on Sale
or 1,60,000 = x – 20% of x
$$\text{or}\space 1,60,000 = x –\frac{20}{100}x\\\text{or}\space 1,60,000=\frac{100x-20x}{100}\text{or 1,60,000}=\frac{80x}{100}\\x=\frac{1,60,000×100}{80}=2,00,000$$
Gross Profit = Sales – Cost of Goods Sold
= 2,00,000 – 1,60,000 = ₹40,000
16. You are able to collect the following information about a company for two years:
Items | Amount(₹) 2015-16 | Amount (₹) 2016-17 |
Trade Receivables on April 1 | 4,00,000 | 5,00,000 |
Trade Receivables on March 30 | 5,60,000 | |
Stock in trade on March 31 | 6,00,000 | 9,00,000 |
Revenue from operation (at gross profit of 25% on cost) | 3,00,000 | 24,00,000 |
Calculate Inventory Turnover Ratio and Trade Receivables Turnover Ratio.
Ans.
$$\text{Inventory Turnover Ratio =}\frac{\text{Cost of Goods Sold}}{\text{Average Inventory}}$$
Let cost of goods sold be x.
∴ Cost of Goods Sold = Sales – Gross Profit
$$x = 24,00,000 –\frac{25}{100}x\\\text{x}=\frac{24,00,000}{125}×100$$
x = 19,20,000
$$\text{Average Inventory }\\=\frac{\text{Opening Inventory + Closing Inventory}}{2}\\=\frac{6,00,000+9,00,000}{2}=₹7,50,000\\\text{Inventory Turnover Ratio =}\frac{19,20,000}{7,50,000}=2.56\space\text{times}\\\text{Trade Receivables Turnover Ratio =}\\\frac{\text{Sales}}{\text{Average Trade Receivables}}=2,400,000\\=\frac{5,00,000 + 5,60,000}{2}\\=\frac{24,00,000}{5,30,000}=4.53\space\text{times}$$
17. The following Balance Sheet and other information, calculate following ratios:
(i) Debt Equity Ratio
(ii) Working Capital Turnover Ratio
(iii) Trade Receivables Turnover Ratio
Particulars | Note No. | (₹) |
I. Equity and liabilities: | ||
1. Shareholders’ Funds | ||
(a) Share Capital | 10,00,000 | |
(b) Reserves and surplus | 7,00,000 | |
(c) Money received against share warrants | 2,00,000 | |
2. Non-current Liabilities | ||
Long-term borrowings | 12,00,000 | |
3. Current Liabilities | ||
Trade payables | 5,00,000 | |
Total | 36,00,000 | |
II. Assets | ||
1. Non current assets | ||
Fixed assets | ||
—Tangible assets | 18,00,000 | |
2. Current Assets | ||
(a) Inventories | 4,00,000 | |
(b) Trade Receivables | 9,00,000 | |
(c) Cash and each equivalents | 5,00,000 | |
Total | 36,00,000 |
Additional Invormation : Revenue from operations ₹ 18,00,000
Ans.
$$\text{(i) Debt Equity Ratio =}\frac{\text{Debt}}{\text{Equity}}$$
Debt = ₹12,00,000
Equity = 10,00,000 + 7,00,000 + 2,00,000
= 19,00,000
$$\text{Debt-equity Ratio =}\frac{12,00,000}{19,00,000}\\=0.63:1\\\text{(ii) Working Capital Turnover Ratio =}\\\frac{\text{Revenue from Operations}}{\text{Working Capital}}\\=\frac{18,00,000}{(18,00,000-5,00,000)}\\=\frac{18,00,000}{13,00,000}=1.38\space\text{time}\\\text{(iii) Trade Receivables Turnover Ratio =}\\=\frac{\text{Credit Revenue from Operations}}{\text{Average Trade Receivables}}\\$$
$$=\frac{\text{18,00,000}}{9,00,000}=2\space\text{time}$$
18. From the following is the information, calculate the following ratios:
(i) Liquid Ratio
(ii) Inventory turnover ratio
(iii) Return on investment
(₹) | |
Inventory in the beginning | 50,000 |
Inventory at the end | 60,000 |
Net Profit | 2,17,900 |
10% Debentures | 2,50,000 |
Revenue from operations | 4,00,000 |
Gross Profit | 1,94,000 |
Cash and Cash Equivalents | 40,000 |
Money received against share warrants | 20,000 |
Trade Receivables | 1,00,000 |
Trade Payables | 1,90,000 |
Other Current Liabilities | 70,000 |
Share Capital | 2,00,000 |
Reserves and Surplus | 1,20,000 |
(Balance in the statement of profit and loss) |
$$\textbf{Ans.}\text{(i) \qquad Quick Ratio =}\frac{\text{Quick Assets}}{\text{Current Liabilities}}$$
Quick Assets = Cash + Debtors
= 40,000 + 1,00,000 = 1,40,000
Current Liabilities = Creditors + Other current liabilities
= 1,90,000 + 70,000
= 2,60,000
$$\text{Quick Ratio =}\frac{1,40,000}{2,60,000}\\=7:13=0.54:1\\\text{(ii) Stock Turnover Ratio =}\\\frac{\text{Cost of Goods Sold}}{\text{Average Stock}}$$
Cost of Goods Sold = Sales – Gross Profit
= 4,00,000 – 1,94,000
= 2,06,000
$$\text{Average Stock}\\ =\frac{\text{Opening Stock + Closing Stock}}{2}\\=\frac{50,000+60,000}{2}\\=\frac{1,10,000}{2}$$
= 55,000
$$\text{Stock Turnover Ratio}\\ =\frac{\text{Profit before Interest and Tax}}{\text{Capital Employed}}×100$$
Capital Employed = Equity Share Capital + Profit and Loss + Money received against share warrants + Debentures
= 2,00,000 + 1,20,000 + 20,000 + 25,0000
= 5,90,000
Profit before interest and tax = 2,17,900 + 25,000
= ₹2,42,900
$$\text{Return on Investment =}\frac{2,42,900}{5,90,000}×100=41.7\%$$
19. From the following,
Calculate
(i) Debt Equity Ratio
(ii) Total Assets to Debt Ratio
(iii) Propietory Ratio.
Items | Amount (₹) |
Equity Share Capital | 75,000 |
Share application money pending allotment | 25,000 |
General Reserve | 45,000 |
Balance in statement of profit and loss | 30,000 |
Debentures | 75,000 |
Trade payable | 40,000 |
Outstanding Expenses | 10,000 |
$$\textbf{Ans.}\space\text{(i)\qquad\text{Debt Equity Ratio =}}\frac{\text{Debt}}{\text{Equity}}$$
Debt = ₹75,000
Equity = Equity Share Capital + Share Application Money Pending Alllotment + General Reserve + Profit and Loss
= 75,000 + 25,000 + 45,000 + 30,000 = 1,75,000
$$\text{Debt Equity Ratio =}\frac{75,000}{1,75,000}\\=0.43:1\\\text{(ii) Total Assets to Debt Ratio =}\frac{\text{Total Assets}}{\text{Debt}}$$
Total Assets = Total Liabilities
Total Liabilities = Share holders Fund (Equity) + Debentures + Trade Payable
+ Oustanding Expenses
= 1,75,000 + 75,000 + 40,000 + 10,000
= ₹3,00,000
$$\text{Total Assets to Debt Ratio =}\frac{3,00,000}{75,000}=4:1\\\text{(iii) Proprietory Ratio =}\frac{\text{Equity}}{\text{Total Assets}}\\=\frac{1,75,000}{3,00,000}=0.58:1$$
20. Cost of Goods Sold is ₹ 1,50,000 Operating expenses are ₹60,000. Sales is ₹2,50,000. Calculate Operating Ratio.
Ans. Operating Ratio = $$\frac{\text{(Cost of Goods Sold + Operating Expenses)}}{\text{Net Sales}}×100$$
$$\text{Operating Ratio =}\frac{(1,50,000+ 60,000)}{2,50,000}×100\\=\frac{2,10,000}{2,50,000}×100=84\%$$
21. Calculate the following ratio on the basis of the following information:
(₹) | |
Gross Profit | 50,000 |
Revenue from Operations | 1,00,000 |
Inventory | 15,000 |
Trade Receivables | 27,500 |
Cash and Cash Equivalents | 17,500 |
Current Liabilities | 40,000 |
Land and Building | 50,000 |
Plant and Machinery | 30,000 |
Furniture | 20,000 |
(i) Gross Profit Ratio
(ii) Current Ratio
(iii) Acid Test Ratio
(iv) Inventory Turnover Ratio
(v) Fixed Assets Turnover Ratio
Ans. (i) Gross Profit Ratio = $$\frac{\text{Gross Profit}}{\text{Revenues from operations}}×100\\=\frac{₹50,000}{₹1,00,000}×100=50\%\\\text{(ii) \qquad Current Ratio =}\frac{\text{Current Assets}}{\text{Current Liabilities}}$$
Current Assets = Inventory + Trade Receivable + Cash and Cash equivalents
= 15,000 + 27,500 + 17,500
= ₹60,000
$$\therefore\space\text{Current Ratio =}\frac{60,000}{40,000}=1.5:1\\\text{(iii) Acid Test Ratio =}\frac{\text{Quick Assets}}{\text{Current Liabilities}}\\=\frac{27,500+17,500}{40,000}\\=\frac{45,000}{40,000}=1.125:1\\\text{(iv) Inventory Turnover Ratio =}\\\frac{\text{Cost of Revenue from Operations}}{\text{Average Inventory}}\\=\frac{(1,00,000-50,000)}{15,000}=3.33\space\text{times}$$
(v) Fixed Assets Turnover Ratio =
$$\frac{\text{Sales}}{\text{Fixed Assets}}$$
Fixed Assets = Land and Building + Plant and Machinary + Furniture
= 50,000 + 30,000 + 20,000 = ₹1,00,000
Fixed Assets Turnover Ratio = $$\frac{1,00,000}{1,00,000}=1:1$$
22. From the following information calcutate Gross Profit Ratio, Stock Turnover Ratio and Debtors Turnover Ratio.
Items | Amount (₹) |
Sales | 3,00,000 |
Cost of Goods Sold | 2,40,000 |
Closing Stock | 62,000 |
Gross Profit | 60,000 |
Opening Stock | 58,000 |
Debtors | 32,000 |
$$\textbf{Ans.}(i)\space\text{Gross Profit Ratio =}\frac{\text{Gross Profit}}{\text{Sales}}×100$$
Gross Profit = Sales – Cost of Goods Sold
= 3,00,000 – 2,40,000
= 60,000
$$\text{Gross Profit Ratio =}\frac{60,000}{3,00,000}×100\\=20\%\\\text{(ii) Stock Turnovr Ratio =}\\\frac{\text{Cost of Goods Sold}}{\text{Average Stock}}\\\text{Average Stock =}\\\frac{\text{Opening Stock + Closing Stock}}{2}\\=\frac{58,000+62,000}{2}\\=\frac{1,20,000}{2}\\=60,000\\\text{Stock Turnover Ratio =}\frac{2,40,000}{60,000}=4\space\text{times}$$
(iii) Debtors Turnover Ratio =
$$\frac{\text{Net Sales}}{\text{Average Debtors}}\\=\frac{3,00,000}{32,000}=9.375\space\text{times}$$
Note: No information is given hence debtors are considered as average debtors.