Class 12 Accountancy Chapter 5 – Accounting Ratios
Short Questions for NCERT Accountancy Solutions Part 2 Class 12 Chapter 5
1. What do you mean by Ratio Analysis?
It is a quantitative analysis of data present in a financial statement. It shows the relationship between items present in Balance sheet and the Income Statement. It helps in calculating operational efficiency, solvency and determining profitability of a firm. Ratio is a statistical measure which helps in comparing relationship between two or more figures. Analyzing ratio presents vital pieces of information to accounting users about the firm’s financial position, performance and viability. It also helps in setting up new policies and framework by the management.
2. What are the various types of ratios?
Ratios can be classified into two types:
1. Traditional Classification
2. Functional Classification
Traditional Classification: Traditional classification is based on the financial statements such as Balance Sheet and P & L Account. The ratios are divided on the basis of accounts of financial statements and are as follows:
i. Income Statement Ratios such as Gross Profit Ratios
ii. Balance Sheet Ratios such as Debt Equity Ratio, Current Ratio
iii. Composite Ratio: Ratios that contain elements from both Trading and P & L Account.
Functional Classification: These ratios are based on the functional need of calculating ratios. These ratio help calculate the solvency, liquidity, profitability and financial performance of a business. Such ratios are:
i. Liquidity Ratio: Ratios used to determine solvency of short term
ii. Solvency Ratio: Ratios used to determine solvency of long term
iii. Activity Ratio: Ratios used for determining operating efficiency of the business. These ratios are related to sales and cost of goods sold.
iv. Probability Ratio: Ratios used to determine financial performance and viability of the firm.
3. What relationships will be established to study:
a. Inventory Turnover
b. Trade Receivables Turnover
c. Trade Payables Turnover
d. Working Capital Turnover
a. Inventory Turnover Ratio: This ratio is a relationship between cost of goods sold and the average inventory maintained during a particular time period. It determines the efficiency with which a firm is able to manage its inventory.
b. Trade Receivables Turnover Ratio: Debtors turnover ratio is also known as Receivables Turnover Ratio is a measure used to check how quickly a credit sale is converted into cash. It shows efficiency of a business firm in collecting debts from customers.
c. Trade Payables Turnover Ratio: It is also known as Creditor’s turnover ratio or account payable turnover ratio and is a liquidity ratio that measures the average number of times a firm pays its creditors in the course of an accounting period. It is used to measure short term liquidity of the firm.
d. Working Capital Turnover Ratio: Working capital turnover ratio is used to measure the efficiency of a company in using its working capital to support the sales. It is a ratio where firms operations are funded and the corresponding revenue generated from business is calculated.
4. The liquidity of a business firm is measured by its ability to satisfy its long-term obligations as they become due. What are the ratios used for this purpose?
A firm’s liquidity is measured by its capability to pay long term dues. These dues include principal amount payment on due date and interest payment on regular basis. Long term solvency of a firm can be determined by the following ratios:
a. Debt-Equity Ratio: This ratio shows the relationship between owner funds (equity) and borrowed funds (debt). A lower debt-equity ratio provides more security to the people who are lending to the business. It also shows that a company is able to meet long term dues or responsibilities.
b. Total Assets to Debt Ratio- It is based on the relationship between total assets and long term loans. It shows what percentage of company’s total assets are financed by creditors. A higher total assets to debt ratio makes the firm able to meet long term requirements and provides more security to lenders.
c. Interest Coverage Ratio: This ratio is used to determine the easiness with which a company is able to pay interest on the outstanding debts. It is calculated by dividing earnings before interest and taxes with interest payments. Having a higher interest coverage ratio means that company is able to meet its obligations skilfully.
5. The average age of inventory is viewed as the average length of time inventory is held by the firm for which explain with reasons.
Inventory Turnover Ratio: This ratio is a relationship between cost of goods sold and the average inventory maintained during a particular time period. It determines the efficiency with which a firm is able to manage its inventory.
It shows the average length for which firm holds the inventory.
Long Questions for NCERT Accountancy Solutions Part 2 Class 12 Chapter 5
1. What are liquidity ratios? Discuss the importance of current and liquid ratio.
For determining the short-term solvency of a business liquidity ratios are essential. There are two types of liquidity ratios:
1. Current Ratio
2. Liquid Ratio/ Quick Ratio
1. Current Ratio: This ratio deals with the relationship between current assets and liabilities. It is calculated as:
Current assets are those assets which can be easily converted into cash whereas Current liabilities are liabilities that need to paid within that accounting period
Importance of Current Ratio
Current ratio helps in determining a firm’s ability to pay off the current liabilities on time. If there is more of current assets as compared to current liabilities, it provides a source of security to the creditors. The ideal ratio is 2:1 (Current Assets: Current Liabilities)
2. Liquid Ratio– It deals with the relationship between liquid assets and current liabilities. This ratio determines if the firm has sufficient funds for paying off the current liabilities on an immediate basis. It can be calculated as:
Importance of Liquid Ratio
It is helpful in determining if a firm has funds that can be sufficient to pay off liabilities. It does not include stock or prepaid expenses as both these are not easily converted to cash. A ratio of 1:1 is ideal for maintaining the liquid ratio.
2. How would you study the solvency position of the firm?
A firm’s solvency position can be best studied with the help of group of ratios called as Solvency Ratios. These ratios measure the financial position of the firm by measuring its ability to pay long term liabilities, these long term liabilities include principal amount payments on due date and interest payments on a regular basis. Following ratios are used to determine long term solvency of a business.
1. Debt-Equity Ratio: This ratio shows the relationship between owner funds (equity) and borrowed funds (debt). A lower debt-equity ratio provides more security to the people who are lending to the business. It also shows that a company is able to meet long term dues or responsibilities.
2. Total Assets to Debt Ratio: It is based on the relationship between total assets and long term loans. It shows what percentage of company’s total assets are financed by creditors. A higher total assets to debt ratio makes the firm able to meet long term requirements and provides more security to lenders.
3. Interest Coverage Ratio: This ratio is used to determine the easiness with which a company is able to pay interest on the outstanding debts. It is calculated by dividing earnings before interest and taxes with interest payments. Having a higher interest coverage ratio means that company is able to meet its obligations skilfully.
d. Proprietary Ratio– This ratio shows the relationship between Total Assets and Shareholders fund. It is helpful in revealing the financial position of a business. A higher ratio ensures a greater degree of security for creditors. It is shown as:
3. What are important profitability ratios? How are these worked out?
Profitability ratios are calculated on the basis of profit earned by a business. This ratio gives a percentage which is used to assess the financial condition of a business
1. Return on Assets: This ratio measures the earning per rupee from assets which are invested in the company. A higher profit ratio is good for the company.
Return on Assets = Net Profit ÷ Total Assets
2. Return on Equity: This ratio deals with measuring profitability of equity fund that is invested by the company. It also measures how owner’s funds are utilized profitably to generate company revenues. A high ratio represents the better position of a company.
Return on Equity = Profit after Tax ÷ Net worth
Where Net worth = Equity share capital, and Reserve and Surplus
3. Earnings per share: This ratio helps in measuring profitability from an ordinary shareholder’s viewpoint. A high ratio represents a well off company.
Earnings per share = Net Profit ÷ Total no of shares outstanding
4. Dividend per share: This ratio measures the amount of dividend that is distributed by the company to its shareholders at the end of an accounting period. A high ratio represents that the company is having surplus cash.
Dividend per share= Amount Distributed to Shareholders ÷ No of Shares outstanding
5. Price Earnings Ratio: A profitability ratio that is used by an investor to check for share price of the company which can be undervalued or overvalued. It also indicates an expectation about the company’s earning and payback period for the investors.
Price Earnings Ratio = Market Price of Share ÷ Earnings per share
6. Return on capital employed: This ratio is all about the returns earned by the company from the funds invested in the business by its owners. A high ratio is indicative of a better position for the company.
Return on capital employed = Net Operating Profit ÷ Capital Employed × 100
7. Gross Profit: Gross profit ratio or GP ratio is a profitability ratio that deals with the relationship between gross profit and the total net sales revenue. This ratio is used to evaluate the operational performance of the business.
8. Net Profit: This is a profitability ratio that deals with relationship between net profit after tax and net sales. It is calculated by dividing the net profit (after tax) by net sales.
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.
Current Ratio: This ratio deals with the relationship between current assets and liabilities. It is calculated as:
Current assets are those assets which can be easily converted into cash whereas Current liabilities are liabilities that need to paid within that accounting period
Importance of Current Ratio
Current ratio helps in determining a firm’s ability to pay off the current liabilities on time. If there is more of current assets as compared to current liabilities, it provides a source of security to the creditors. The ideal ratio is 2:1 (Current Assets: Current Liabilities)
2. Liquid Ratio– It deals with the relationship between liquid assets and current liabilities. This ratio determines if the firm has sufficient funds for paying off the current liabilities on an immediate basis. It can be calculated as:
Importance of Liquid Ratio
It is helpful in determining if a firm has funds that can be sufficient to pay off liabilities. It does not include stock or prepaid expenses as both these are not easily converted to cash. A ratio of 1:1 is ideal for maintaining the liquid ratio.
Current ratio is best suited for businesses where the available stock or inventories cannot be converted to cash easily. Examples of such industries can be locomotive companies, heavy machinery manufacturing companies etc. as heavy machinery, tools which cannot be sold easily. Similarly, businesses that can easily convert or get sold off prefer the liquid ratio as a measure to determine their liquidity. A service company is more likely to use liquid ratio as no stock is maintained.
There will be some instances when companies tend to change the ratio method being used and chose accordingly. If a company is not maintaining any stock or inventory, liquid ratio is the best option, while if stock forms the majority of the company’s assets then current ratio is the best choice as the liquid ratio of such a firm will be very low and that can create a negative impact on creditors. In such case, current ratio is a better choice to determine the overall liquidity.
Numerical Questions for NCERT Accountancy Solutions Part 2 Class 12 Chapter 5
1. Following is the Balance Sheet of Raj Oil Mills Limited as at 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 | |
a) Trade Payables | 72,000 |
Total | 8,97,000 |
II. Assets | |
1. Non-current Assets | |
a) Fixed assets | |
Tangible assets | 7,53,000 |
2. Current Assets | |
a) Inventories | 55,800 |
b) Trade Receivables | 28,800 |
c) Cash and cash equivalents | 59,400 |
Total | 8,97,000 |
Current Assets = Inventories +Trade Receivables + Cash
= 55,800 + 28,800 + 59,400
= ₹ 1, 44,000
Current Liabilities = Trade Payables = ₹ 72,000
2. Following is the Balance Sheet of Title Machine Ltd. as at March 31, 2017.
Particulars | Amount₹. |
I. Equity and Liabilities | |
1. Shareholders’ funds | |
a) Share capital | 24,00,000 |
b) Reserves and surplus | 6,00,000 |
2. Non-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 provisions | 60,000 |
Total | 69,00,000 |
II. Assets | |
1. Non-current Assets | |
a) Fixed assets | |
Tangible assets | 45,00,000 |
2. Current Assets | |
a) Inventories | 12,00,000 |
b) Trade receivables | 9,00,000 |
c) Cash and cash equivalents | 2,28,000 |
d) Short-term loans and advances | 72,000 |
Total | 69,00,000 |
Calculate Current Ratio and Liquid Ratio.
1. Current Ratio
Current Assets = Inventories +Trade Receivables + Cash + Short term Loans and Advances
= 12, 00,000 + 9, 00,000 + 2, 28,000 + 72,000
= ₹ 24, 00,000
Current Liabilities = Trade Payables + Short-term Borrowings + Short-term Provisions
= 23, 40,000 + 6, 00,000 + 60,000
= ₹ 30, 00,000
2. Quick Ratio
Quick Assets = Trade Receivables + Cash + Short term Loans and Advances
= 9, 00,000 + 2, 28,000 + 72,000
= ₹ 12, 00,000
3. Current Ratio is 3.5:1. Working Capital is ₹ 90,000. Calculate the amount of Current Assets and Current Liabilities.
or, Current Assets = 3.5 Current Liabilities (1)
Working Capital = Current Assets − Current Liabilities
Working Capital = 90,000
or, Current Assets − Current Liabilities = 90,000
or, 3.5 Current Liabilities − Current Liabilities = 90,000 (from 1)
or, 2.5 Current Liabilities = 90,000
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.
or,
or, 4.5 Current Liabilities = Current Assets
or,
or, 3 Current Liabilities = Quick Assets
Quick Assets = Current Assets − Inventory = Current Assets − 36,000Quick Assets = Current Assets – Inventory = Current Assets – 36,000
Current Assets − Quick Assets = 36,000
or, 4.5 Current Liabilities − 3 Current Liabilities = 36,000
or, 1.5 Current Liabilities = 36,000
or, Current Liabilities = 24,000
Current Assets = 4.5 Current Liabilities
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 inventory.
Or, 4 × 75,000 = Current Assets
Or, Current Assets = 3, 00,000
Or,
Liquid Assets = 75,000
Inventory = Current Assets − Liquid Assets
= 3, 00,000 − 75,000
= 2, 25,000
6. Handa Ltd. has inventory of ₹ 20,000. Total liquid assets are ₹ 1, 00,000 and quick ratio is 2:1. Calculate current ratio.
or,
Current Assets = Liquid Assets + Inventory
= 1, 00,000 + 20,000
= 1, 20,000
7. Calculate debt equity ratio from the following information:
₹ | |
Total Assets | 15,00,000 |
Current Liabilities | 6,00,000 |
Total Debts | 12,00,000 |
Long Term Debts = Total Debts − Current Liabilities
Or,
8. Calculate Current Ratio if:
Inventory is ₹ 6, 00,000; Liquid Assets ₹ 24, 00,000; Quick Ratio 2:1.
Or,
Current Assets = Liquid Assets + Inventory
9. Compute Stock Turnover Ratio from the following information:
₹ | |
Net Revenue from Operations | 2,00,000 |
Gross Profit | 50,000 |
Inventory at the end | 60,000 |
Excess of inventory at the end over inventory in the beginning | 20,000 |
10. Calculate following ratios from the following information:
(i) Current ratio (ii) Acid test ratio (iii) Operating Ratio (iv) Gross Profit Ratio
₹ | |
Current Assets | 35,000 |
Current Liabilities | 17,500 |
Inventory | 15,000 |
Operating Expenses | 20,000 |
Revenue from Operations | 60,000 |
Cost of Goods Sold | 30,000 |
iv)
11. From the following information calculate:
(i) Gross Profit Ratio (ii) Inventory Turnover Ratio (iii) Current Ratio (iv) Liquid Ratio (v) Net Profit Ratio (vi) Working capital Ratio:
₹ | |
Revenue from Operations | 25,20,000 |
Net Profit | 3,60,000 |
Cast of Revenue from Operations | 19,20,000 |
Long-term Debts | 9,00,000 |
Trade Payables | 2,00,000 |
Average Inventory | 8,00,000 |
Current Assets | 7,60,000 |
Fixed Assets | 14,40,000 |
Current Liabilities | 6,00,000 |
Net Profit before Interest and Tax | 8,00,000 |
(i)
12. Compute Gross Profit Ratio, Working Capital Turnover Ratio, Debt Equity Ratio and Proprietary Ratio from the following information:
₹ | |
Paid-up Share 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 |
Cost of Revenue from Operations | 6,00,000 |
13. Calculate Inventory Turnover Ratio if:
Inventory in the beginning is ₹. 76,250, Inventory at the end is 98,500, Gross Revenue from Operations is ₹. 5, 20,000, Sales Return is ₹. 20,000, and Purchases is ₹. 3, 22,250.
14. Calculate Inventory Turnover Ratio from the data given below:
₹ | |
Inventory in the beginning of the year | 10,000 |
Inventory at the end of the year | 5,000 |
Carriage | 2,500 |
Revenue from Operations | 50,000 |
Purchases | 25,000 |
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 sale, ascertain the profit of the firm.
Let Sale Price be ₹ 100
Then Profit is ₹ 20
Hence, the Cost of Revenue from Operations = ₹ 100 − ₹ 20 = ₹ 80
If the Cost of Revenue from Operations is ₹ 80, then Revenue from Operations = 100
16. You are able to collect the following information about a company for two years:
2015-16 | 2016-17 | |||
Trade receivables on Apr. 01 | ₹. | 4,00,000 | ₹ | 5,00,000 |
Trade receivables on Mar. 31 | ₹ | 5,60,000 | ||
Stock in trade on Mar. 31 | ₹. | 6,00,000 | ₹ | 9,00,000 |
Revenue from operations (at gross profit of 25%) | ₹. | 3,00,000 | ₹ | 24,00,000 |
Calculate Inventory Turnover Ratio and Trade Receivables Turnover Ratio.
17. From the following Balance Sheet and other information, calculate following ratios:
(i) Debt-Equity Ratio (ii) Working Capital Turnover Ratio (iii) Trade Receivables Turnover Ratio
Balance Sheet as at March 31, 2017 | ||
Particulars | Note No. | ₹. |
I. Equity and Liabilities: | ||
1. Shareholders’ funds | ||
a) Share capital | 10,00,000 | |
b) Reserves and surplus | 9,00,000 | |
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 | ||
a) Fixed assets | ||
Tangible assets | 18,00,000 | |
2. Current Assets | ||
a) Inventories | 4,00,000 | |
b) Trade Receivables | 9,00,000 | |
c) Cash and cash equivalents | 5,00,000 | |
Total | 36,00,000 | |
Additional Information: Revenue from Operations ₹. 18, 00,000
1. Debt-Equity Ratio
Debt = Long Term Borrowings = ₹ 12,00,0000
Equity = Share Capital + Reserve and Surplus
= 10, 00,000 + 9, 00,000
= ₹ 19, 00,000
2. Working Capital Turnover Ratio
Revenue from Operations = ₹ 18, 00,000
Working Capital = Current Assets – Current Liabilities
= 18, 00,000 – 5, 00,000
= ₹ 13, 00,000
3. Trade Receivables Turnover Ratio
Net Credit Sales = ₹ 18, 00,000
Average Trade Receivables = ₹ 9, 00,000
18. From the following information, calculate the following ratios:
i) Quick Ratio
ii) Inventory Turnover Ratio
iii) Return on Investment
₹. | |
Inventory in the beginning | 50,000 |
Inventory at the end | 60,000 |
Revenue from operations | 4,00,000 |
Gross Profit | 1,94,000 |
Cash and Cash Equivalents | 40,000 |
Trade Receivables | 1,00,000 |
Trade Payables | 1,90,000 |
Other Current Liabilities | 70,000 |
Share Capital | 2,00,000 |
Reserves and Surplus | 1,40,000 |
(Balance in the Statement of Profit & Loss A/c)
19. From the following, calculate (a) Debt Equity Ratio (b) Total Assets to Debt Ratio (c) Proprietary Ratio.
₹ | |
Equity Share Capital | 75,000 |
Preference Share Capital | 25,000 |
General Reserve | 45,000 |
Balance in the Statement of Profits and Loss | 30,000 |
Debentures | 75,000 |
Trade Payables | 40,000 |
Outstanding Expenses | 10,000 |
20. Cost of Revenue from Operations is ₹ 1, 50,000. Operating expenses are ₹ 60,000. Revenue from Operations is ₹ 2, 50,000. Calculate Operating Ratio.
21. Calculate the following ratio on the basis of following information:
(i) Gross Profit Ratio (ii) Current Ratio (iii) Acid Test Ratio (iv) Inventory Turnover Ratio (v) Fixed Assets Turnover Ratio
₹. | |
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 & Building | 50,000 |
Plant & Machinery | 30,000 |
Furniture | 20,000 |
Average Inventory = 15,000*
Note: As the values for inventory in the beginning and inventory at the end is not given, the amount of inventory is taken as average.
22. From the following information calculate Gross Profit Ratio, Inventory Turnover Ratio and Trade Receivables Turnover Ratio.
₹ | |
Revenue from Operations | 3,00,000 |
Cost of Revenue from Operations | 2,40,000 |
Inventory at the end | 62,000 |
Gross Profit | 60,000 |
Inventory in the beginning | 58,000 |
Trade Receivables | 32,000 |
Note: In this solution, the Trade Receivables are assumed to be as the Average Trade Receivables
Concepts covered in this chapter –
- Meaning of accounting ratios
- Objectives of accounting ratios
- Types of ratios
- Liquidity ratios
- Solvency ratios
- Profitability ratios