The document discusses various financial ratios used for analysis. It begins by defining ratio analysis and its importance. It then categorizes ratios into liquidity ratios, activity ratios, profitability ratios, and leverage ratios. Specific ratios discussed in detail include current ratio, quick ratio, inventory turnover ratio, debtors turnover ratio, gross profit ratio, net profit ratio, operating profit ratio, EPS, and debt-equity ratio. Formulas for calculating these ratios are provided. Examples are given to demonstrate calculating some of these ratios.

1. 1

2. Unit-V
Preparation of Financial
Statements and Ratio Analysis
2
Financial Analysis Through Ratios- Computation,
Analysis and Interpretation of Liquidity Ratios
(Current and Quick Ratios), Activity Ratios
(Inventory Turnover Ratio and Debtors Turnover
Ratio), and Profitability Ratios (Gross Profit
Ratio-Net Profit Ratio-Operating Profit Ratio –
P/E Ratio and EPS), Leverage Ratio (Debt-Equity
Ratio).

3. RATIO ANALYSIS
wall who
INTRODUTION
Ratio Analysis was pioneered by Alexander
presented a system of ratioanalysis in theyear 1909.
relationship between two items
RATIO
A Ratio is a mathematical
expressed in a Quantitativeform.
RATIO ANALYSIS
It is “The process of determining and presenting the relationship
of items and groups of items in the financial statements”.

4. STEPS IN RATIO ANALYSIS
Selection of relevant information
Comparison of calculated Ratio
Interpretation and Reporting

5. CLASSIFICATION OF RATIOS
LIQUIDITY RATIO
ACTIVITY OR
TURNOVER
RATIO
PROFITABILITY
RATIO
CAPITAL
STRUCTURE
OR LEVERAGE
RATIO
CURRENT
RATIO
QUICK
RATIO
INVENTORY
TURNOVER
RATIO
DEBTOR
TURNOVER
RATIO
GROSS
PROFIT
RATIO
NET
PROFIT
RATIO
OPERATI
NG
PROFIT
RATIO
EPS
Ratio
P/E
RATIo
EPS = Earnings Per Share
DEBT
EQUITY
RATIO

6. LIQUIDITY RATIO
The term liquidity refers to the ability of the
company to meet its current liabilities.
Liquidity ratios assess capacity of the firm to
repay its short term liabilities.
Thus, liquidity ratios measure the firms’
ability to fulfil short term commitments out
of its liquid assets. The important liquidity
ratios are
(i) Current ratio
(ii) Quick ratio

7. CURRENT RATIO
Current ratio is a ratio between current assets
and current liabilities of a firm for a particular
period.
The objective of computing this ratio is to
measure the ability of the firm to meet its
short term liability.
It compares the current assets and current
liabilities of the firm. This ratio is
calculated as under :
Current Ratio =
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠

8. LIQUIDITY RATIO
a) Current Ratio
It indicates the abilityof a concern to meet its current
obligationsas and when theyare due forpayment.
Current Ratio =
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
Standard : Current Ratio is 2:1. current Assets
shall be 2 times to currents Liabilities.
b) Quick Ratio
It is also called “Quick” or “Acid Text” ratio. This ratio
establishes a relationship between quick assets and
current liabilities.
Quick Ratio =
𝑪𝒖𝒓𝒓𝒆𝒏𝒕 𝑨𝒔𝒔𝒆𝒕𝒔 −(𝑺𝒕𝒐𝒄𝒌+𝑷𝒓𝒆𝒑𝒂𝒊𝒅 𝑬𝒙𝒑𝒆𝒏𝒔𝒆𝒔)
𝑪𝒖𝒓𝒓𝒆𝒏𝒕 𝑳𝒊𝒂𝒃𝒊𝒍𝒊𝒕𝒊𝒆𝒔
Standard : Quick Ratio is 1.5 :1. currentAssets shall be 1.5 times to
currents Liabilities.

9. Problem
Calculate a) Current Ratio b) Quick Ratio from the
following table
PARTICULARS AMOUNT IN
RUPEES
LAND AND BUILDINGS 50,000
PLANT AND MACHINARY 1,00,000
FURNITURE AND FIXUTURES 25,000
CLOSING STOCK 25,000
SUNDRY DEBTORS 12,500
WAGES PREPAID 2,500
SUNDRY CREDITORS 8,000
RENT OUTSTANDING
(UNPAID)
2,000

10. Solution
Calculate a) Current Ratio b) Quick Ratio from the
following table
PARTICULARS AMOUNT IN
RUPEES
LAND AND BUILDINGS 50,000 FA
PLANT AND MACHINARY 1,00,000 FA
FURNITURE AND FIXUTURES 25,000 FA
CLOSING STOCK 25,000 CA
SUNDRY DEBTORS 12,500 CA
WAGES PREPAID 2,500 CA
SUNDRY CREDITORS 8,000 CL
RENT OUTSTANDING
(UNPAID)
2,000 CL
FA- Fixed Assets CA – Current Assets CL – Current Liabilities

11. SOLUTION
CURRENT ASSETS = SUNDRY DEBTORS + CLOSING STOCK + WAGES PREPAID
= 12,500 + 25,000 + 2,500
= 40,000
CURRENT LIABILITIES = SUNDRY CREDITORS + RENT OUTSTANDING
= 8,000 + 2,000
= 10,000
Current Ratio =
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
= 40,000 / 10,000
= 4
The Ratio is 4: 1 is more than the standard ratio of 2:1

12. SOLUTION
CURRENT ASSETS = SUNDRY DEBTORS + CLOSING STOCK + WAGES PREPAID
= 12,500 + 25,000 + 2,500
= 40,000
CURRENT LIABILITIES = SUNDRY CREDITORS + RENT OUTSTANDING
= 8,000 + 2,000
= 10,000
= 40,000- (25,000+ 2500) / 10,000
= 1.25
The Ratio is 1.25: 1 is less than the standard ratio of 1.50:1
Quick Ratio =
𝑪𝒖𝒓𝒓𝒆𝒏𝒕 𝑨𝒔𝒔𝒆𝒕𝒔 −(𝑺𝒕𝒐𝒄𝒌+𝑷𝒓𝒆𝒑𝒂𝒊𝒅 𝑬𝒙𝒑𝒆𝒏𝒔𝒆𝒔 )
𝑪𝒖𝒓𝒓𝒆𝒏𝒕 𝑳𝒊𝒂𝒃𝒊𝒍𝒊𝒕𝒊𝒆𝒔

13. Activity Turnover Ratio
Activity ratios measure the efficiency or effectiveness
with which a firm manages its resources.
These ratios are also called turnover ratios because
they indicate the speed at which assets are converted
or turned over in sales.
These ratios are expressed as ‘times’ and should
always be more than one. Some of the important
activity ratios are :
(i) Inventory or Stock turnover ratio
(ii) Debtors turnover ratio

14. Activity Turnover Ratio
 It is alsocalled stockvelocity Ratio.
 More the turnover more the profit for the company
to meet the
 It Indicateswhetherthe investment is optimum.
 The quantity of stock should be enough
requirements of thebusiness.
 But itshould not be tooexcessive
 In short, the number of times the inventory is turned over
during a particular accounting period.
Inventory Turnover Ratio

15. stock Turnover Ratio = Cost of Goods Sold
Avg. Inventory (or)
= NetSales- Gross profit
(Opening + Closing Stock )/2 (or)
Cost of GoodsSold = (op. stock+ purchase+direct exp) - cls. Stock
(or)
= (Total cost of production+ op. Stock of
finished goods) – cls.Stock
(or)
= sales - Grossprofit.
High ratio = Efficient Inventory mgt.
Average Stock Inventory = (opening stock + closing stock) / 2

16. B. Stock turnover period/ inventory turnover
period
 InventoryturnoverRatiocan be related to “time”
 The ratiocan beexpressed in termof “ Daysor Months”.
 It refers with in a particular days or months the stock can used
orsold.
Avg.InventoryTurnover =
Ratio
Days or Months in the year
InventoryTurnover Ratio

17. Problem
Calculate Inventory Turnover Ratio from following
table
PARTICULARS AMOUNT IN
RUPEES
Opening Stock 9,000
Closing Stock 7,000
Sales 75,000
Gross Profit 35,000

18. Solution
Inventory Turnover Ratio =
Cost of Goods Sold
Avg. Inventory
Cost of goods sold = Sales – Gross Profit
= 75,000 – 35,000 = 40,000
Average Stock Inventory = (opening stock + closing stock) / 2
= (9000+ 7000) / 2
= 8,000
inventory Turnover ratio = 40000 / 8000
= 5
PARTICULARS AMOUNT IN RUPEES
Opening Stock 9,000
Closing Stock 7,000
Sales 75,000
Gross Profit 35,000

19. Solution
= 365 days / 5 times
= 73 days
The company will take 73 days to sell average inventory.
PARTICULARS AMOUNT IN RUPEES
Opening Stock 9,000
Closing Stock 7,000
Sales 75,000
Gross Profit 35,000
Avg.InventoryTurnover =
Ratio
Days or Months in the year
InventoryTurnover Ratio
Average selling period is computed by dividing 365 by
inventory turnover ratio:

20. Debtors Turnover Ratio
Debtors turnover ratio is an indication of the
speed with which a company collects its debts.
The higher the ratio, the better it is because it
indicates that debts are being collected quickly.
In general, a high ratio indicates the shorter
collection period which implies prompt
payment by debtor and a low ratio indicates a
longer collection period which implies delayed
payment for debtors

21. DEBTORS TURNOVER R
A
T
I
O
 It is alsocalled, Receivable turnoverRatioordebtorsvelocity.
 It measures the numberof times the receivables are rotated in ayear in
terms of sales.
 It is relationship between total sales and closing balance of debtors.
D.T.R = Net Credit sales (total sales- [cash sales + sales
returns])
Avg. Trade receivables (net)
Note :
Avg. Trade Receivables (Net) = (opening receivables + Closing Receivables ) / 2
The higher ratio indicates that the debts are
being collected promptly.
AVERAGE COLLECTION PERIOD ( Avg. No of days for which a firm
has to wait before its receivables are collected into cash).
A.C.P= Months or days in a year
Debtors turnoverRatio

22. Problem
Calculate Debtor Turnover Ratio from following
table
PARTICULARS FIRM “X”
TOTAL SALES 1,60,000
CASH SALES 80,000
ACCOUNTS RECEIVABLES-OPENING 32,000
ACCOUNTS RECEIVABLES-CLOSING 26,000
Formula

23. Solution
Net Credit Sales = Total Sales – Cash Sales
= 160000 - 80000
= 80000
AverageTrade Receivables = (Opening receivables + Closing Receivables) / 2
= ( 32000 + 26000)/2
= 29000
Debtors turnover ratio = 80,000 / 29,000 = 2.75
Avg Time Period of Debtor = No of days in a year / debtors turnover ratio
= 365 / 2.75
= 132 days
Generally, a high ratio indicates that the receivables are more liquid and
are being collected promptly. A low ratio is a sign of less liquid receivables
and may reduce the true liquidity of the business

24. Profitability Ratio
 “Profit” is an absolute measure of earning capacity. “Profitability”
depends on sales, costand utilisationof resources.
The profitability Ratioare
Gross ProfitRatio
Net ProfitRatio
Operating Profit Ratio
Earnings Per Share Ratio
Price-Earning Ratio
A profitability ratio is a measure of profitability, which is a way to
measure a company's performance.
Profitability is simply the capacity to make a profit, and a profit is what
is left over from income earned after you have deducted all costs and
expenses related to earning the income.

25. Profitability Ratio Formulas
X 100
𝐺𝑟𝑜𝑠𝑠 𝑃𝑟𝑜𝑓𝑖𝑡 𝑅𝑎𝑡𝑖𝑜 =
𝐺𝑟𝑜𝑠𝑠 𝑃𝑟𝑜𝑓𝑖𝑡
𝑆𝑎𝑙𝑒𝑠
𝑁𝑒𝑡 𝑃𝑟𝑜𝑓𝑖𝑡 𝑅𝑎𝑡𝑖𝑜 =
𝑁𝑒𝑡 𝑃𝑟𝑜𝑓𝑖𝑡
𝑆𝑎𝑙𝑒𝑠
X 100
𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑃𝑟𝑜𝑓𝑖𝑡 𝑅𝑎𝑡𝑖𝑜 =
𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔𝑃𝑟𝑜𝑓𝑖𝑡
𝑆𝑎𝑙𝑒𝑠
X 100
Net Profit After Tax
No. of shares
Earnings Per Share =
Price – Earning Ratio =
Market value per share
Earnings Per Share
Higher Ratio Indicates HigherProfitability

26. Profitability Ratio - Proforma
SALES XXXX
LESS COST OF GOODS XXXX
GROSS PROFIT XXXX
LESS ADMN. & SALES EXPENSES XXXX
OPERATING PROFIT XXXX
ADD NON OPERATING PROFIT XXXX
LESS NON OPERATING EXPENSES XXXX
NET PROFIT XXXX
NOTE :
NON OPERATING PROFIT : Interest, Dividend, Discounts
NON OPERATING EXPENSES : Loss on Sales, Tax

27. Profitability Ratio Problem
The Net sale of a company is Rs.50,000, cost of goods sold is
Rs 20,000. The details of expenditure is given in the table.
PARTICULARS FIRM “X”
ADMINISTRATIVE EXPENSES 3000
SELLING & DISTRIBUTION 4000
LOSS ON SALES - EXPENSES 2000
INTEREST ON INVESTMENTS 3000
TAX @20% @20%
CALCULATE 1) a) Gross Profit Ratio b) Net Profit Ratio c) Operating
Profit Ratio
2) The company capital investment is Rs.30,000 @ Rs. 10 per share and
market value per share is Rs.80.
Calculate i) EPS ii) P-E Ratio

28. Profitability Ratio- solution
SALES 50,000
LESS COST OF GOODS 20,000
GROSS PROFIT 30,000
LESS ADMN. & SALES EXPENSES
Admn exp 3000
Selling & Distr 4000 7,000
OPERATING PROFIT 23,000
ADD NON OPERATING PROFIT 2,000
-----------------
LESS NON OPERATING EXPENSES 3,000
PROFIT BEFORE TAX 22,000
LESS TAX @20% 4,400
NET PROFIT 17,600

29. Profitability Ratio - SOLUTION
X 100
𝐺𝑟𝑜𝑠𝑠 𝑃𝑟𝑜𝑓𝑖𝑡 𝑅𝑎𝑡𝑖𝑜 =
𝐺𝑟𝑜𝑠𝑠 𝑃𝑟𝑜𝑓𝑖𝑡
𝑆𝑎𝑙𝑒𝑠
𝑁𝑒𝑡 𝑃𝑟𝑜𝑓𝑖𝑡 𝑅𝑎𝑡𝑖𝑜 =
𝑁𝑒𝑡 𝑃𝑟𝑜𝑓𝑖𝑡
𝑆𝑎𝑙𝑒𝑠
X 100
𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑃𝑟𝑜𝑓𝑖𝑡 𝑅𝑎𝑡𝑖𝑜 =
𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔𝑃𝑟𝑜𝑓𝑖𝑡
𝑆𝑎𝑙𝑒𝑠
X 100
Net Profit After Tax
No. of shares
Earnings Per Share =
Price – Earning Ratio =
Market value per share
Earnings Per Share
= 17,600 / 50,000 X 100 = 35.2%
= 30,000 / 50,000 X 100 = 60%
= 23,000 / 50,000 X 100 = 46%
= 17,600 / (30,000/10) = 5.86
= 80/5.86 = 13.65

30. Rs. Rs.
To Opening Stock 26,000 By Sales 1, 60,000
To Purchases 80,000 By Closing Stock 38,000
To Wages 24,000
To Manufacturing Exp. 16,000
To Gross Profit 52,000
1, 98,000 1, 98,000
To Selling and distribution
Expenses 4,000 By Gross profit 52,000
To Admin. Expenses 22,800 By Profit on sale of land 4,800
To General Expenses 1,200
To Bad Debts 800
To Net Profit 28,000
56,800 56,800
You are required to find out
a) Gross Profit ratio b) Operating expenses ratio
c) Operating profit ratio d) Net profit ratio.
Problem : 2
Alpha Manufacturing Company Ltd. has drawn up the following profit and loss
account for the year ended March 31, 2018.

31. Profitability Ratio - SOLUTION
X 100
𝐺𝑟𝑜𝑠𝑠 𝑃𝑟𝑜𝑓𝑖𝑡 𝑅𝑎𝑡𝑖𝑜 =
𝐺𝑟𝑜𝑠𝑠 𝑃𝑟𝑜𝑓𝑖𝑡
𝑆𝑎𝑙𝑒𝑠
𝑁𝑒𝑡 𝑃𝑟𝑜𝑓𝑖𝑡 𝑅𝑎𝑡𝑖𝑜 =
𝑁𝑒𝑡 𝑃𝑟𝑜𝑓𝑖𝑡
𝑆𝑎𝑙𝑒𝑠
X 100
𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝐸𝑥𝑝𝑒𝑛𝑠𝑒𝑠 𝑅𝑎𝑡𝑖𝑜 =
𝐶𝑂𝐺𝑆 + 𝑂𝑡ℎ𝑒𝑟 𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝐸𝑋𝑝𝑒𝑛𝑠𝑒𝑠
𝑆𝑎𝑙𝑒𝑠 X 100
= 28,000 / 1,60,000 X 100 = 17.5%
= 52,000 / 1,60,000 X 100 =
32.5%
COGS = Cost of Goods Sold = Sales – Gross Profit
= 1,60,000 – 52,000 = 1,08,000
=
1,08,000+28,800
1,60,000
= 0.855
Operating Profit Ratio = (1 - Operating Expenses Ratio) x 100
= (1 – 0.855) x 100
= 14.145%

32.  Debt Equity Ratio
The ratio of the total long term debt to equity
capital in the business is called the debt-equity
ratio.
The D/E ratio indicates how much debt a company
is using to finance its assets relative to the value of
shareholders’ equity.
The formula for calculating D/E ratios is:
Debt/Equity Ratio = Total Liabilities or Debt
Shareholders' Equity
The standard ratio is 1:1

33. Important points to remember
in Debt Equity Ratio
Debt is outsiders fund
Equity is insiders fund
Debt = Debentures or bonds + bank loan + Mortgage
Equity = Shareholders Equity + Reserve Fund + Owners
Capital

34. Debt Equity Ratio Problem
Calculate Debt equity ratio from the following table
PARTICULARS FIRM “X”
DEBENTURES 4,20,000
EQUITY SHARES 3,00,000
RESERVE FUNDS 2,40,000

35. Debt Equity Ratio Problem
Calculate Debt equity ratio from the following table
Debt = outsiders funds = 4,20,000
Equity = Equity shares + Reserve funds
= 3,00,000 + 2,40,000
= 5,40,000
Debt/Equity Ratio = Total Liabilities or Debt
Shareholders' Equity
= 4,20,000 / 5,40,000
= 0.77
CONCLUSION : THE DEBT EQUITY RATIO IS 0.77 : 1 IS LESS THAN THE
STANDARD RATIO 1:1.

36. Debt Equity Ratio Problem
Calculate Debt equity ratio from the following table

37. Debt Equity Ratio Problem
Calculate Debt equity ratio from the following table
Debt/Equity Ratio = Total Liabilities or Debt
Shareholders' Equity
= 7250 / 8500
= 0.85
CONCLUSION : THE DEBT EQUITY RATIO IS 0.85 : 1 IS LESS
THAN THE STANDARD RATIO 1:1.