CHAPTER- 4

RATIO ANALYSIS

Meaning of Ratio Analysis

Ratio Analysis is the relationship between two terms of financial data expressed in the form of ratios and then
interpreted with a view to evaluating the financial condition and performance of a firm.
Ratio Analysis can also help us to check whether a business is doing better this year than it was last year; and
it can tell us if our business is doing better or worse than similar type of business.

Example: Firm A earns a profit of Rs. 50,000 while Firm B earns a profit of Rs. 1,00,000. Which of them is

more efficient? We could tend to believe that firm B is more efficient than firm A.

But in order to understand correctly , we need to find out their sales figure. Say firm A’s sales are Rs. 5,00,000

while firm B’s sale are Rs. 50,00,000. Now let’s compare the percentage of profit earned by them on sales.

For A: 50,000 X 100 = 10 %

5,00,000
For B: 1,00,000 X 100 = 2 %
50,00,000
This clearly shows that firm A is doing better than Firm B.
This example shows that figure assumes significance only when expressed in relation to other related figures.

Objective of Ratio Analysis

The main objective of analyzing financial statement with the help of ratios are:
1. The analysis would enable the calculation of not only the present earning capacity of the business but
would also help in the estimation of the future earning capacity.
2. The analysis would help the management to find out the overall as well as the department – wise
efficiency of the firm on the basis of the available financial information.
3. The short term as well as the long tem solvency of the firm can be determined with the help of ration
analysis.
4. Inter – firm comparison becomes easy with the help of ratios.

Advantages of Ration Analysis

1. Help in Financial statement analysis: It is easy to understand the financial position of a business
enterprise in respect of short term solvency, liquidity and profitability with the help of ratio. It tells us the
changes taking place in the financial condition of the business.

DR. SAMIR M. VOHRA, ASSISTANT PROFESSOR, B.J.V.M. COMMERCE COLLEGE, VALLABH VIDYANAGAR. 1
 2. Simplified accounting figures: Absolute figures are not of mush use. They become important when
relationships are established say between gross profit and sales.
3. Helps in calculating operation efficiency of the business enterprise: Ratio enable the user of
financial information to determine operating efficiency of a firm by relating the profit figure to the capital
employed for a given period.
4. Facilities inter- firm comparison: Ratio analysis provides data for inter- firm comparison. It revels
strong and weak firms, overvalues and undervalues firms as well as successful and unsuccessful firms.
5. Makes inter- firms comparison possible: Ratio Analysis helps the firm to compare its own
performance over a period of time as well as the performance of different divisions of the firm. It helps
in deciding which division is more efficient than other.
6. Helps in forecasting: Ratio Analysis helps in planning and forecasting. Ratios provide clues on trends
and futures problems. e.g if the sales of a firm during the year are Rs. 10 lakhs and he average stock
kept during the year Rs. 2 lakhs, it must be ready to keep a stock of Rs. 3 lakhs which is 20 % of the
Rs. 15 lakhs.

Limitations of Ratio Analysis

1. Historical Analysis: Ratio Analysis is historical in nature the financial statement on the basis of which
ratios are calculated are historical in nature.
2. Price Level Change: Changes in price level often make comparison of figures of the previous years
difficult. E.g ratio of sales to fixed assets in 2006 would be much higher than in 2000 due to rising
prices, fixed assets being expressed on cost.
3. Not Free from bias: In many situations, the accountant has to make a choice out of the various
alternatives available . e.g choice of the method depreciation, choice in the method of inventory
valuation etc. Since there is a subjectivity inherent in the choice , ratio analysis cannot be said to be
free from bias.
4. Window dressing: Window dressing is slowly the position better than what it is. Some companies , in
order to cover up their bad financial position resort to window dressing. By hiding important facts, they
try to depict a better financial position.
5. Qualitative factors ignored: Ratio Analysis is a quantitative analysis. It ignores qualitative factors like
debtors character, honesty, past record etc.
6. Different accounting practices render ratios incomparable: The result of two firms are comparable
with the help of accounting ratios only if they follow the same accounting methods . e.g. if one firm
changes depreciation on straight line method while another is charging on diminishing balance method,
accounting ratios will not be strictly comparable.

DR. SAMIR M. VOHRA, ASSISTANT PROFESSOR, B.J.V.M. COMMERCE COLLEGE, VALLABH VIDYANAGAR. 2
 Classification/Types of Ratios
There is a two way classification of ratios: (1) Traditional classification, and (2) Functional classification.
On the basis of Tradition the ratios are classified as follows:
1. Income Statement Ratios: A ratio of two variables from the income statement is known as Income
Statement Ratio. For example, ratio of gross profit to sales known as gross profit ratio is calculated
using both figures from the income statement.
2. Balance Sheet Ratios: In case both variables are from balance sheet, it is classified as Balance Sheet
Ratios. For example, ratio of current assets to current liabilities known as current ratio is calculated
using both figures from balance sheet.
3. Composite Ratios: If a ratio is computed with one variable from income statement and another
variable from balance sheet, it is called Composite Ratio. For example, ratio of credit sales to debtors
and bills receivable known as debtor turnover ratio is calculated using one figure from income
statement (credit sales) and another figure from balance sheet (debtors and bills receivable).
The alternative classification (functional classification) based on the purpose for which a ratio is computed,
is the most commonly used classification which reach as follows:
1. Liquidity Ratios: To meet its commitments, business needs liquid funds. The ability of the business to pay
the amount due to stakeholders as and when it is due is known as liquidity, and the
ratios calculated to measure it are known as ‘Liquidity Ratios’. They are essentially short-term in nature.
2. Profitability Ratios: It refers to the analysis of profits in relation to sales or funds (or assets) employed in
the business and the ratios calculated to meet this objective are known as ‘Profitability Ratios’.
3. Turnover or Activity Ratios: This refers to the ratios that are calculated for measuring the efficiency of
operation of business based on effective utilisation of resources. Hence, these are also known as ‘efficiency
ratios’.
4 . Leverage or Solvency Ratios: Solvency of business is determined by its ability to meet its contractual
bligations towards stakeholders, particularly towards external stakeholders, and the ratios calculated to
measure solvency position are known as ‘Solvency Ratios’. They are essentially long-term in nature, and

Classification of Ratio
Liquidity Profitability Turnover or Activity Leverage or Solvency
Ratios Ratios Ratios

Current Ratio Gross Profit Ratio Stock Turnover Ratio Debt Equality Ratio
Liquid Ratio Net Profit Ratio Debtors Turnover Ratio Proprietary Ratio
Quick Ratio. Operating Ratio Creditors Turnover Ratio Long Term Funds To Fixed
Assets Ratio
Return On Capital Employed Fixed Assets Turnover Interest Coverage Ratio
Ratio
Return On Shareholders’ Funds Working Capital Turnover Total Assets To Debt Ratio
Or Earnings Per Share Ratio
Price Earnings Ratio
Dividend payout ratio

DR. SAMIR M. VOHRA, ASSISTANT PROFESSOR, B.J.V.M. COMMERCE COLLEGE, VALLABH VIDYANAGAR. 3
(A) LIQUIDITY RATIOS: Liquidity is the short term solvency of the enterprise. I.e. the ability of the business
enterprise to meet its short term obligation as and when they are due. The liquidity ratios, therefore , are also
called the short- term solvency ratios.
The most common ratios which measures the extent of liquidity or the lack of it are:
a) Current ratio
b) Liquid /Quick ratio/ Acid test ratio

1. Current Ratio: Current ratio establishes the relationship between current assets and Current liability. It
measures the ability of the firm to meet its short term obligation as and when they become due. It is
calculated as:
Generally, a current ratio of 2:1 is considered satisfactory.
Interpretation: It provides a measure of degree to which current assets cover current liabilities. The higher the
ratio , the greater the margin of safety for the short term creditors. However, the ratio should neither be very
high nor very low. A very high current ratio indicates idle funds , piled up stocks, locked amount in debtors
while a low ratio puts the business in a situation where it will not be able to pay its short- term debt on time.

2. Liquid /Quick Ratio or Acid test ratio : Quick ratio establishes the relationship between quick/ liquid
assets and current liabilities. It measures the ability of the firm to meet its short term obligations as and
when they become due without relying upon the realization of stock. It is calculated as:
Quick ratio = Quick Assets/Current Liabilities
Generally, a liquid ratio of 1:1 is considered satisfactory.
Interpretation: Quick ratio is considered better than current ratio as a measure of liquidity position of the
business because of exclusion of inventories. The idea behind this ratio is that stock is sometimes a problem
because they can be difficult to sell or use. It us a more penetrating test of liquidity than current ratio yet it
should be used cautiously as all debtors may not be liquid or cash may be required immediately for certain
expenses.

(B) PROFITABILITY RATIOS: Every business must earn sufficient profits to sustain the operations of the
business and to fund expansion and growth.
Profitability ratios are calculated to analysis the earning capacity of the business which is the outcom e of
utilisation of resources employed in the business. There is a close relationship between the profit and the
efficiency with which the resources employed in the business are utilised. There are two major types of
Profitability Ratios.: Profitability in relation to sales and Profitability in relation to investment.
Following are the important Profitability ratio
1. Gross Profit Ratio
2. Net profit Ratio
3. Operating Profit Ratio
4. Return on Investment (ROI) or Return on Capital Employed (ROCE)
5. Return on Shareholders Fund or Earnings per Share

DR. SAMIR M. VOHRA, ASSISTANT PROFESSOR, B.J.V.M. COMMERCE COLLEGE, VALLABH VIDYANAGAR. 4
1. Gross Profit Ratio or Gross margin: Gross profit ratio establishes relationship between Gross Profit and
net sale. It determines the efficiency with which production, purchase and selling operations are being
carried on. It is calculated as percentage of sales. It is computed as follows:
Gross Profit Ratio = Gross Profit/Net Sales × 100
Interpretation: Gross Profit is the difference between sale and cost of goods sold. Gross Profit margin reflects
the efficiency with which the management produces each unit of output. It also includes the margin available to
cover operating expenses and non-operating expenses. A high Gross Profit margin relative to the industry
average employees that the firm is able to produce at comparatively at lower cost.

2. Net Profit Ratio or Net Margin: This ratio establishes the relationship between net profit and net sale . It
indicates managements’ efficiency in manufacturing, administering and selling the product. It calculates as
a percentage of sale. it is computed as under:
Net Profit Ratio = Net profit / Net Sales × 100
Generally, net profit refers to Profit after Tax (PAT)

Interpretation: This ratio measures the firms’ ability to turn each rupee sales into net profit. A firm with high net
profit margin would be in an advantageous position to survive in the face of falling selling prices, rising cost of
production or declining demand for the product.

3. Operating Profit Ratio: Operating Profit Ratio establishes the relationship between Operating Profit and
net sales. It can be computed directly or as a residual of operating ratio.
Operating Profit Ratio = Operating Profit/ Sales × 100
Where Operating Profit = Sales – Cost of Operation

Interpretation: Operating Ratio determine the operational efficiency of the management. It helps in knowing
the amount of profit earned from regular business transactions on a sale of Rs. 100. It is very useful for inter
firm as well as intra firm comparisons. Higher operating ratio indicates that the firm has got enough margins to
meet its non-operating expenses well as to create reserve and pay dividends.
4. Return on Capital Employed or Return on Investment (ROCE or ROI): This ratio establishes the
relationship between net profit before Interest and Tax and capital employees. It measures how efficiently
the long-term funds supplied by the long-term creditors and shareholders are being used. It is expressed
as a percentage.
Return on Investment = Profit before Interest and Tax/Capital Employed × 100
Where capital employed = Debt + equity
Or
Capital Employed = Fixed Assets + Working Capital

Interpretation: It explains the overall utilization of fund by a business. It reveals the efficiency of the business
in utilization of funds entrusted to it by, shareholders, debenture-holders and long-term liabilities. For inter-firm
comparison, it is considered good measure of profitability.

DR. SAMIR M. VOHRA, ASSISTANT PROFESSOR, B.J.V.M. COMMERCE COLLEGE, VALLABH VIDYANAGAR. 5
5. Return on Shareholder’s Fund / Earnings per Share: This ratio measures the earning available to equity
shareholders per share. It indicates the profitability of the firm on a per share basis.
Earning Per Share = Profit available for equity shareholders/ No. of Equity Shares
In this context, earnings refer to profit available for equity shareholders which are worked out as Profit after Tax
– Dividend on Preference Shares.
Interpretation: This ratio is very important from equity shareholders point of view and so also for the share
price in the stock market. This also helps comparison with other firm’s to ascertain its reasonableness and
capacity to pay dividend. But increase in Earnings per share does not have always indicate increase in
profitability because sometimes, when bonus shares are issued, earning per share would decrease. In these
cases, the earning per share is misleading as the actual earning has not decreased.

(C) Activity (or Turnover) Ratios: The Activity (or Turnover) Ratios measures how well the facilities at the
disposal of the concern are being utilized. They are known as turnover ratios as they indicate the speed with
which the assets are being converted or turned over into sales. A proper balanced between sales and assets
generally reflects tat assets are being managed well. They are expressed as ‘number of times’. Some of the
important activity ratios are:
1. Stock Turn-over;
2. Debtors (Receivable) Turnover;
3. Creditors (Payable) Turnover;
4. Fixed Assets Turnover

1. Stock (or Inventory) Turnover Ratio: It establishes a relationship between cost of goods and average
inventory. It determines the efficiency with which stock is converted into sales during the accounting period
under consideration. It is calculated as:
Stock Turnover Ratio = Cost of Goods Sold/ Average Stock
Where - Average stock = (opening + closing stock) /2 and
Cost of goods sold = Net Sales - gross profit or
Cost of goods sold = opening stock + net purchases + direct expenses – closing stock

Interpretation: It indicates the speed with which inventory is converted into sales. A higher ratio indicated that
stock is selling quickly. Low stock turnover ratio indicates that stock is not selling quickly and remaining idle
resulting in increased storage cost and blocking of funds. High turnover is good but it must be carefully
interpreted as it may be due to buying in small lots or selling quickly at low m argin to realize cash. Thus , a firm
should have neither a very high nor a vet low stock turnover ratio.
2. Debtors Turnover Ratio or Receivables Turnover Ratio: It establishes a relationship between net credit
sales and average debtors or receivables. It determines the efficiency with which the debtors are converted
into cash.
Debtors Turnover ratio = Net Credit sales/ Average Accounts Receivable
Where Average Account Receivable = (Opening Debtors and Bills Receivable + Closing Debtors and Bills
Receivable)/2

DR. SAMIR M. VOHRA, ASSISTANT PROFESSOR, B.J.V.M. COMMERCE COLLEGE, VALLABH VIDYANAGAR. 6
Note: Debtors should be taken before making any provision for doubtful debts.
Interpretation : The ratio indicated the number of times the receivables are turned over and converted into
cash in an accounting period. Higher turnover means that the amount from debtors is being collected more
quickly. Quick collection from debtors increases the liquidity of the firm. This ratio also helps in working out the
average collection period as follows:

Debt collection period: This shows the average period for which the credit sales remain outstanding or the
average credit period enjoyed by the debtors. It indicates how quickly cash is collected from the debtors.
Debt collection period = 12 months/52 weeks/365 days / Debtors’ turnover ratio

3. Creditors Turnover Ratio or Payable Turnover Ratio: This ratio establishes a relationship between net
credit purchases and average creditors or payables. It determines the efficiency with which the Creditors
are paid.
Creditors turnover ratio = Net credit purchase / Average accounts payable.
Where Average accounts payable = (Opening Creditors and Bills Payable + Closing Creditors and Bills
Payable)/2
Interpretation: It indicated the speed with which the creditors are paid. A higher ratio indicates a shorter
payment period. In this case, the enterprise needs to have sufficient funds as working capital to meet its
creditors. Lower ratio means credit allowed by the supplier is for a long period or it may reflect delayed
payment to suppliers which is not a very good policy as it may affect the reputation of the business. Thus , an
enterprise should neither have a very high nor a very low ratio.

Debt payment period/Creditors collection period: This shows the average period for which the credit
purchases remain outstanding or the average credit period availed of. It indicates how quickly cash is paid to
the creditors.
Debt collection period = 12 months/52 weeks/365 days/Debtors’ turnover

4. Fixed Assets Turnover Ratio: This ratio establishes a relationship between net sales and net fixed
assets. It determined the efficiency with which the firm is utilizing its fixed assets.

Fixed Assets Turnover= Net sales/ Net Fixed Assets

Where Net Fixed Assets =Fixed Assets- Depreciation

Interpretation: This ratio reveals how efficiently the fixed assets are being utilised. It indicates the firms’ ability
to sales per rupee of investment in fixed assets. A high ratio indicates more efficient utilization of fixed assets.

DR. SAMIR M. VOHRA, ASSISTANT PROFESSOR, B.J.V.M. COMMERCE COLLEGE, VALLABH VIDYANAGAR. 7
(D) LEVERAGE OR SOLVENCY RATIOS: Solvency ratio are used to judge the long term financial
soundness of any business. Long term Solvency means the ability of the Enterprise to meet its long term
obligation on the due date. Long term lenders are basically interested in two things: payment of interest
periodically and repayment of principal amount at the end of the loan period. Usually the following ratios are
calculated to judge the long term financial solvency of the concern.
1. Debt equity ratio;
2. Proprietary ratio;
3. Long Term Funds to Fixed Assets Ratio

1. Debt-Equity Ratio: It measures the relationship between long-term debt and shareholders’ funds. It
measures the relative proportion of debt and equality in financing the assets of a firm.
Debt-Equity ratio = Long-term Debt’s/ Shareholder funds
Long- term Debt = Debentures + Long term loans
Shareholders’ Funds = Equity Share Capital + Pref. Share Capital + Res. & Surplus– Fictitious Assets
Interpretation: A low debt equity ratio reflects more security to long term creditors. From security point of
view, capital structure with less debt and more equity is considered favourable as it reduces the chances of
bankruptcy. A high ratio, on the other hand, is considered risky as it may put the firm into difficulty in meeting
its obligations to outsiders. But it is considered risky and so , with the exception of a few business , the
prescribed ratio is limited to 2:1.

2. Proprietary Ratio: Proprietary ratio establishes a relationship between shareholders funds to total assets.
It measures the proportion of assets financed by equity. It is calculated as follows :
Proprietary Ratio = Shareholders Funds/ Total assets

Interpretation: A higher proprietary ratio indicated a larger safety margin for creditors. It tests the ability of the
shareholders’ funds to meet the outside liabilities. A low Proprietary Ratio, on the other hand , indicated a
greater risk to the creditors. To judge whether a ratio is satisfactory or not, the firm should compare it with its
own past ratios or with the ratio of similar enterprises or with the industry average.

3. Long Term Funds to Fixed Assets Ratio/ Total Assets to Debt Ratio: This Ratio established a relationship
between total assets and long debts. It measures the extent to which debt is being covered by assets. It is
calculated as
Total Assets to Debt Ratio = Total assets/Long-term Debt
Interpretation: This ratio primarily indicated the use of external funds in financing the assets and the margin of
safety to long-term creditors. The higher ratio indicated that assets have been mainly financed by owners’
funds, and the long- term debt is adequately covered by assets. A low ratio indicated a greater risk to creditors
as it means insufficient assets for long term obligations.

DR. SAMIR M. VOHRA, ASSISTANT PROFESSOR, B.J.V.M. COMMERCE COLLEGE, VALLABH VIDYANAGAR. 8
 EXAMPLE S
EX . 1 Calculate current ratio from the following information:
Stock Rs .60,000 ; Cash 40,000; Debtors 40,000; Creditors 50,000
Bills Receivable 20,000; Bills Payable 30,000; Advance Tax 4,000
Bank Overdraft 4,000; Debentures Rs. 2,00,000; Accrued interest Rs. 4,000.

ANS . 1 Current Assets = Rs.60,000 + Rs.40,000 + Rs.40,000 + Rs.20,000 + Rs.4,000 + Rs.4,000

= Rs.1,68,000
Current Liabilities = Rs.50,000 + Rs.30,000 + Rs.4,000 = Rs. 84,000
Current Ratio = Rs.1,68,000 : Rs.84,000 = 2 : 1.

EX. 2 Calculate quick ratio from the information given in illustration 1.

ANS . 2
Quick Assets = Current Assets – Stock – Advance Tax
Quick Assets = Rs. 1,68,000 – (Rs. 60,000 + Rs. 4,000) = Rs. 1,04,000
Current Liabilities = Rs. 84,000
Quick ratio = Quick Assets / Current Liabilities
= Rs. 1,04,000 : Rs. 84,000
= 1.23:1
Ex. 3

ANS. 3

DR. SAMIR M. VOHRA, ASSISTANT PROFESSOR, B.J.V.M. COMMERCE COLLEGE, VALLABH VIDYANAGAR. 9
Ex. 4

ANS. 4

Ex. 5

ANS. 5

EX. 6 Following information is available for the year 2006, calculate gross profit ratio:
Sales Rs. 1,20,000
Gross Profit Rs. 60,000
Return inwards Rs 20,000
ANS. 6 Net Sales = Sales - Return inwards
= Rs. 1,20,000- 20,000
= Rs. 1,00,000
Gross Profit Ratio = Gross Profit/Net Sales × 100
= Rs.60,000/Rs.1,00,000 × 100 = 60%.

DR. SAMIR M. VOHRA, ASSISTANT PROFESSOR, B.J.V.M. COMMERCE COLLEGE, VALLABH VIDYANAGAR. 10
EX. 7 Calculate Gross Profit ratio from the following information:
Opening stock Rs. 50,000; closing stock Rs. 75,000; cash sale Rs. 1,00,000; credits sales Rs 1,70,000;
Returns outwards Rs. 15,000; purchased Rs. 2,90,000; advertisement exp. Rs. 30,000; carriage inwards Rs. 10,000.
ANS. 7 Cost of goods sold = Opening stock + net purchases + direct expenses – closing stock
= Rs. 50,000 + (Rs. 2,90,000- Rs. 15,000) + Rs. 10,000 - Rs. 75,000
= Rs. 2,60,000
Total Sales = Cash Sales + Credits Sales
= Rs. 1,00,000 + Rs 1,70,000
= Rs. 2,70,000
Gross profit = Total Sales - Cost of goods sold
= Rs. 2,70,000- Rs. 2,60,000
= Rs. 10,000
Gross profit Ratio = 10,000 X 100 = 2,70,000 = 3.704 %

EX. 8 Sales Rs. 6,30,000; sales Returns Rs. 30,000; Indirect expenses Rs. 50,000; cost of goods sold Rs.2,50,000
. Calculate Net Profit Ratio.
ANS. 8 Net Sales = Total Sales – sales Returns
= Rs. 6,30,000 – Rs. 30,000
= Rs.6,00,000
Gross Profit = Net Sales – Cost of goods sold
= Rs. 6,30,000 - Rs.2,50,000
= Rs. 3,50,000
Net Profit = Gross Profit - Indirect expenses
= Rs. 3,50,000 – Rs. 50,000
= Rs. 3,00,000
Net Profit Ratio= Net Profit
Net sale
= Rs. 3,00,000 X 100
Rs. 6,00,000
= 50 %

EX. 9 Calculate the Gross profit Ratio, Net Profit Ratio and Operating Ratio from the given the following information:
Sales Rs. 4,00,000
Cost of Goods Sold Rs. 2,20,000
Selling expenses Rs. 20,000
Administrative Expenses Rs. 60,000

ANS. 9 Gross Profit = Sales – Cost of goods sold

= Rs. 4,00,000 – Rs. 2,20,000
= Rs. 1,80,000
Gross Profit Ratio = Gross s Profit X 100
Sales
= Rs. 1 ,80,000 X 100
Rs 4 ,00,000
= 45 %
Net Profit = Gross Profit – Indirect expenses
= Rs. 1,80,000 – (Rs. 20,000 + Rs. 60,000)
= Rs. 1,00,000

DR. SAMIR M. VOHRA, ASSISTANT PROFESSOR, B.J.V.M. COMMERCE COLLEGE, VALLABH VIDYANAGAR. 11
 Net Profit Ratio = Net profit / Sales × 100
= Rs.(1,00,000/ 4,00,000) X 100 = 25 %
Operating Expenses = Selling Expenses + Administrative Expenses
= Rs. 20,000 + 60,000 = Rs. 80,000
Operating Ratio = Cost of goods + Operating Expenses X 100
Net Sa les
= Rs. 2 ,20,000 + Rs. 80,000 X 100
Rs4, 00,000
= 75 %
Ex. 10

ANS . 10

EX. 11 Calculate Return on Capital employed

Liabilities Rs. Assets Rs.
Equity Share Capital 10,00,000 Fixed assets (Net) 14,00,000
(1,00,000 equity share of
Rs. 10 each)
Reserves 2,50,000 Current Assets 12,50,000
10 % Debentures 5,00,000 Preliminary Expenses 1,00,000
Current Liability 7,50,000
Profit for the year 2,50,000
27,50,000 27,50,000
ANS. 11
Return on Investment = Profit before Interest and Tax/Capital Employed × 100
Profit before Interest and Tax:
Profit for the year = Rs. 2,50,000
Add interest (10 % of 5,00,000) = Rs. 50,000
Profit before interest and tax = 3,00,000

Capital Employed = Net Assets + working Capital

= Rs. 14,00,000 + Rs( 12,50,000 – Rs. 7,50,000)
= Rs. 19,00,000

DR. SAMIR M. VOHRA, ASSISTANT PROFESSOR, B.J.V.M. COMMERCE COLLEGE, VALLABH VIDYANAGAR. 12
EX. 12 Calculate earnings per share from the following information:
50,000 equity shares of Rs. 10 each Rs 5,00,000
10 % Preference share capital Rs 1,00,000
9 % Debentures Rs. 2,00,000
Net Profit after tax Rs. 2,00,000

ANS . 12 Earning per share = Profit available for equity shareholders/ No. of Equity Share
= Rs( 1,10,000 – 10,000) / 50,000
= Rs. 2 per share
EX. 13

ANS. 13

EX.14 From the following information, calculate stock turnover ratio :

Opening Stock Rs.20,000;Closing Stock Rs.10,000;Purchases Rs. 50,000 Wages Rs. 13,000; sales Rs. 80,000 ;
Carriage Inwards Rs. 2,000 ; Carriage outwards Rs. 6,000

ANS.14 Stock Turnover Ratio = Cost of Goods Sold/ Average Stock

Cost of Goods Sold = Opening Stock + Purchases – Closing Stock + Direct Expenses
= Rs. 20,000+ Rs.50,000+ Rs.15,000–Rs.10,000 = Rs. 75,000
Average Stock = (Opening Stock + Closing Stock) /2
= (Rs. 20,000 + Rs. 10,000) /2 = Rs. 15,000
Stock Turnover Ratio = Rs. 75,000/Rs. 15,000 = 5 Times.

EX.15 From the following information, calculate stock turnover ratio. Opening stock Rs 58,000; Excess of Closing stock
opening stock Rs. 4,000; sales Rs. 6,40,000; Gross Profit @ 25% on cost
ANS.15 Cost of goods Sold = Sales - Gross Loss
= Rs. 6,40,000 – 25/125(6,40,000) = Rs. 5,12,000
Closing stock = Opening stock + Rs. 4000
= Rs. 58,000 + Rs 4,000 = Rs. 62,000
Average stock = (Opening stock + Closing Stock )/2
= (58,000 +62,000)/2 = Rs. 60,000
Stock Turnover Ratio = Cost of Goods Sold/ Average Stock
= Rs.5,12,000/Rs. 60,000 = 8.53 times.

DR. SAMIR M. VOHRA, ASSISTANT PROFESSOR, B.J.V.M. COMMERCE COLLEGE, VALLABH VIDYANAGAR. 13
EX.16 Calculate the Debtors Turnover Ratio and debt collection period (in months) from the following information:
Total sales = Rs. 2,00,000
Cash sales = Rs. 40,000
Debtors at the beginning of the year = Rs. 20,000
Debtors at the end of the year = Rs. 60,000
ANS. 16
Average Debtors = (Rs. 20,000 + Rs. 60,000)/2 = Rs. 40,000
Net credit sales = Total sales - Cash sales
= Rs.2,00,000 - Rs.40,000 = Rs. 1,60,000
Debtors Turnover Ratio = Net Credit sales/Average Debtors
= Rs. 1,60,000/Rs. 40,000 = 4 Times.
Debt collection period = 12 months/52 weeks/365 days
Debtors’ turnover
= 12/4 = 3 months

EX.17 From the following information, calculate Fixed Assets Turnover Ratio: Gross fixed asset Rs. 4,00,000;
Accumulated Depreciation Rs. 1,00,000; Marketable securities Rs. 20,000; Current Assets Rs. 1,30,000; Miscellaneous
expenditure Rs, 20,000; Current Liabilities Rs. 50,000; Gross sales Rs. 18,30,000; sale return Rs. 30,000
ANS.17 Net fixed asset = Gross fixed asset- Depreciation = Rs. 4,00,000 - Rs. 1,00,000 = Rs.3,00,000
Net Sale = Gross sale – Sale Returns = Rs. 18, 30,000 - Rs. 30,000 = Rs. 18,000
Fixed Asset Turnover Ratio= Net Sale/ net Fixed assets = Rs. 18,30,000/ Rs.3,00,000 = 6 times.

EX.18 Calculate Debt Equity , from the following information:

10,000 preference share of Rs. 10 each Rs. 1,00,000
5,000 equity shares of Rs. 20 each Rs. 1,00,000
Creditors Rs. 45,000
Debentures Rs. 2,20,000
Profit and Loss accounts(Cr.) Rs. 70,000
ANS. 18
Debt = Debentures = Rs. 2,20,000
Equity = Equity share capital + Preferences Share Capital + profit and Loss accounts
= Rs. 1,00,000 + Rs. 1,00,000 + Rs. 70,000 = Rs. 2,70,000
Debt Equity Ratio = Long term debt/ shareholders’ funds = Rs. 2,20,000 / Rs. 2,70,000 = 0.81:1

EX. 19 From the following information, calculate Debt Equity Ratio, Debt Ratio,Proprietary Ratio and Ratio of Total
Assets to Debt.
Balance Sheet as on December 31, 2006
Equity share Capital 3,00,000 Fixed Assets 4,50,000
Preference Share Capital 1,00,000 Current Assets 3,50,000
Reserves 50,000 Preliminary Expenses 15,000
Profit & loss A/C 65,000
11 % Mortgage Loan 1,80,000
Current liabilities 1,20,000
8,15,000 8,15,000

ANS.19 Shareholders Funds = Equity Shares capital + Pref. Shar. Capital + Res. + P & L A/c (–) Prel. Exp.
= Rs. 3,00,000 + Rs. 1,00,000 + Rs.50,000 + Rs. 65,000- Rs. 15,000
= Rs. 5,00,000
Debt Equity Ratio = Debt / Equity = Rs. 1,80,000/Rs. 5,00,000 = 0.36: 1
Proprietary Ratio = Proprietary funds / Total Assets = Rs. 5,00,000/Rs. 8,00,000 = 0.625:1
Total Assets to Debt Ratio = Total Assets / Debt = Rs. 8,00,000/Rs. 1,80,000 = 4.44:1

DR. SAMIR M. VOHRA, ASSISTANT PROFESSOR, B.J.V.M. COMMERCE COLLEGE, VALLABH VIDYANAGAR. 14
EX. 20 The debt equity ratio of X Ltd. is 1:2.
Which of the following would increase/ decrease or not change the debt equity ratio?
(i) Issue of new equity shares
(ii) Cash received from debtors
(iii) Sale of fixed assets at a profit
(iv) Redemption of debentures
(v) Purchase of goods on credit.
ANS. 20
a) The ratio will decrease. This is because the debt remains the same, equity increases.
b) The ratio will not change. This is because neither the debt nor equality is affected.
c) The ratio will decrease. This is because the debt remains unchanged while equity increases by the amount of profit.
d) The ratio will decrease. This is because debt decreases while equity remains same .
e) The ratio will not change. This is because neither the debt nor equity is affected.

EX. 21 Shareholders’ funds Rs. 80,000; Total debts Rs. 1,60,000; Current liabilities Rs. 20,000.
Calculate Total assets to debt ratio.
ANS. 21 Long term debt = Total Debt - Current liabilities
= Rs. 1,60,000- Rs. 20,000 = Rs. 1,40,000
Total Assets= Shareholders’ funds + Total debt
= Rs. 80,000 + Rs. 1,60,000 = Rs. 2,40,000
Total Assets to debt ratio = Total Assets/ Debt
= Rs. 2,40,000 / Rs. 1,40,000 = 12:7 = 1.7:1

EX. 22 From the following Balance Sheet and additional information, you are required to calculate:
(i) Return on Total Resources
(ii) Return on Capital Employed
(iii) Return on Shareholders’ Fund

ANS. 22

DR. SAMIR M. VOHRA, ASSISTANT PROFESSOR, B.J.V.M. COMMERCE COLLEGE, VALLABH VIDYANAGAR. 15
 EX. 23

ANS. 23

DR. SAMIR M. VOHRA, ASSISTANT PROFESSOR, B.J.V.M. COMMERCE COLLEGE, VALLABH VIDYANAGAR. 16
 EX. 24

ANS. 24

DR. SAMIR M. VOHRA, ASSISTANT PROFESSOR, B.J.V.M. COMMERCE COLLEGE, VALLABH VIDYANAGAR. 17
Comments:
1. Liquidity and Solvency Position: Current Ratio is 2.9. It means current assets of Rs.2.90 are available against each
rupee of current liability. The position is satisfactory on the basis of current ratio. However, the Liquid Ratio is 0.65: 1. It
means greater part of current assets constitute stock; the stock is slow-moving. Therefore, the liquidity position is not
satisfactory.
2. Credit Terms: The collection system is faulty because debtors enjoy a credit facility for 96 days, which is beyond
normal period. The performance of Debt Collection Department is poor.
3. Profitability: Gross Profit Ratio is 20% which is a healthy sign. But the Net Profit Ratio is only 5%. It means operating
expenses are higher.
4. Investment Structure: Debt-Equity Ratio is 0.34: 1. It means the firm is not dependent on outside liabilities. The
position is satisfactory. Capital Gearing Ratio is also satisfactory. However, the fixed assets to proprietorship ratio reveals
that the entire fixed assets were not purchased by the proprietors’ equity. It means the firm depends on outside liabilities.
It is not desired.
5. Return on Proprietors’ Fund: 5% of the sales is net profit and are available for the proprietors. The state of low return
is not desirable. Stock Turnover Ratio and Turnover to fixed assets indicate an unhealthy sign. Fixed assets are not used
properly. It is a sign of under trading. The economic condition of the firm is not sound. The firm can increase the rate of
return on investment by increasing production.

DR. SAMIR M. VOHRA, ASSISTANT PROFESSOR, B.J.V.M. COMMERCE COLLEGE, VALLABH VIDYANAGAR. 18