accounting ratios-CBSE-chapter-4 class 12 accountancy all formulas and analysis

Accounting Rations-CBSE -chapter-4, for class-12 Accountancy

Meaning of Ratio and accounting ratio

Ratio’ is an arithmetical expression relationship between two interdependent or related items, Ratios, when calculated on the basis of accounting information, are called accounting Ratios, accounting ratio may be expressed as an arithmetical relationship between two accounting variables,

the term accounting ratio is used to describe significant relationship which exist between figures shown in a balance sheet, in a statement of profit and loss, in a budgetary control system or in any part of the accounting organisation,

Meaning of Ratio analysis

An analysis of financial statements with the help of accounting ratio is termed as ratio, analysis ratio analysis is a study of relationship among various financial factors in a business “- ratio analysis is a process of determining and interpreting relationships between the item of financial statements to provide a meaningful understanding of the performance and financial position of an enterprise, thus, it is a technique of analysing the financial statements by computing ratios,

objectives of ratio analysis

1. To simplify the accounting information
2. To determine liquidity (short-term solvency, i;e, ability of the enterprise to meet its short-term financial obligations) and long-term solvency (i;e ability of the enterprise to pay its long-term liabilities) of the business
3. To assess the operating efficiency of the business.
4. To analyse the profitability of the business
5. To help in comparative analsis, i;e ,,inter-firm and intra-firm comparisons.

advantages of ratio analysis

1. useful tool for analysis of financial statements: Accounting ratios are useful for understanding the financial position of an enterprise, bankers investors , creditors, etc, all analysis balance sheet and statement of profit and loss using ratios
2. simplifies Accounting data: Accounting ratio simplifies , summarises and systematises accounting data to make it understandable, its main contribution lies in communicating precisely the interrelationship which exists between various elements of financial statements, in the words of biramn and dribin” financial ratios are useful because they summarise briefly the results of detailed and complicated computation”
3. useful in Assessing the operating efficiency of business:- Accounting ratios are useful for assessing the financial health and performance of an enterprise, it is assessed by evaluating liquidity , solvency , profitability, etc
4. useful for forecasting : ratios are helpful in business planning and forecasting .the trend of ratios is analysed and used as a guide for future planning, what should be the course of action in the immediate future is decide , many a times,, on the basis of trend of ratios, i:e ratios are calculated for a number of years,
5. useful in locating the weak areas: Accounting ratios assist in locating the weak areas of the business even though the overall performance may be good , the management can then pay attention to the weaknesses and take remedial action.
6. useful in Inter-firm comparison:- A firm may compare its performance with that of other firms or with the industry standard is general, The comparison is called Inter-firm comparison or cross-sectional analysis , if the performance of different units belonging to the same firm is to be compared, it is called Intra-firm comparison or Times-series Analysis , Accounting ratios make the comparison simple,

Limitations of ratio analysis

1. False Result; ratios are calculated from the financial statements, so the reliability of ratio and its analysis is dependent upon the correctness of the financial statements, if the financial statements are not true and fair , the analysis will give a false picture of the affairs
2. Qualitative factors and Ignored;- ratio analysis is a technique of quantitative analysis and thus, ignores qualitative factors, which may be important in decision-making
3. Lack of standard Ratio:-there is no single standard ratio against which the ratio can be compared,
4. may not be comparable;- Ratios may not be comparable if different follow different accounting policies and procedures, for Example, one firm may follow straight line method of depreciation while another may follow Diminishing balance method
5. price level changes are not considered :- change in price level affects the comparability of the ratios, but price level changes are not considered in accounting variables from which ratios are computed . this handicaps the utility of accounting ratios
6. Window Dressing;- Ratios may be affected by window dressing, manipulation of accounts is a way to conceal vital facts and present the financial position better than what is actually, is on account of such a situation , presence of particular ratio may not be a definite indicator of good or bad management,
7. Personal bias:- personal judgments play an important role in preparing financial statements and, therefore, the accounting ratios are also not free from this limitation, the ratios have to be interpreted but different people may interpret the same ratio in different ways,

1.Current Ratio:– current ratio is a liquidity ratio that measures ability of the enterprise to pay its short-term financial obligation, i:e current liabilities , it is a relationship of current assets and current liabilities Current ratio, indicates whether the enterprise will be able to meet its short-term financial obligations when they become due for payment, thus , current ratio is a measurement of financial health of the enterprise in a short-term

Current Ratio = current Assets Current liabilities

(2) Liquid Ratio or Quick or Acid test Ratio:– liquid ratio or quick ratio or acid test ratio is a liquidity ratio which measures the ability of the enterprise to meet its short-term financial obligations, i:e current liabilities it is a relationship of liquid assets with current liabilities

Liquid / Quick Ratio = Liquid assets or Quick assets current liabilities

(3) Debt to equity Ratio:- debt to equity ratio is computed to assess long-term financial soundness of the enterprise, The ratio expresses the relationship between long -term external equities, i:e external debts and internal equities (i:e shareholders: fund) of the enterprise

External equities or external debts are the liabilities of the enterprise payable to outsiders, They include long-term borrowings and long-term provision they are shown as non-current liabilities in the equity and liabilities part of the balance sheet.

Debt to Equity Ratio = Debt Equity (shareholder’s fund) Debt to equity ratio is expressed as pure” ratio” say 2:1 Debt = long-term borrowings+long-term provision or =Total debt–current liabilities or = capital employed -Equity or = Non-current assets+working capital-fictitious assets equity / shareholders” fund = share capital+Reserve and surplus or = Non-current assets (tangible assets+Intangible assets+Non-current trade Investments+long-term loans and advances)+working capital*+long-term provision = Total assets–Total debt *working capital = current assets–current liabilities

(4) Total assets to debt Ratio:– Total assets to debt ratio shown relationship between total assets and long-term debts of the enterprise

Total assets to Debt ratio = Total Assets Debt(long-term debt) it is expressed as” pure ratio”say 1:1

(5) Proprietary Ratio:- proprietary ratio establishes the relationship between proprietors” fund and total assets

Proprietary Ratio = proprietors” funds or shareholders” fund or Equity Total Assets

(6) Interest coverage Ratio:– the ratio establishes the relationship between net profit before interest and tax and interest on long-term debts, interest is a charge on profit therefore, net profit before interest and tax is taken to calculate the ratio, it is calculated as follows

Interest coverage Ratio = profit before interest and tax =..Times interest on long-term debt

(7) Inventory Turnover Ratio:– inventory turnover ratio establishes relationship between cost of revenue from operations i:e cost of goods sold and average inventory carried during that period Inventory turnover ratio is an activity as well as efficiency ratio and it measures the number of times an enterprise sells and replaces its inventory, i;e the number of times inventory was converted into sales during the period

Inventory Turnover Ratio: =cost of Revenue from operations (cost of good sold)..= Times, Average Inventory

(8) Trade Receivables Turnover Ratio:– trade receivables is the amount recievable against goods sold or services rendered in the normal course of business by the enterprise, in other words, amount remaining outstanding against sale of goods and/ or services rendered are trade receivables, trade Receivables include debtors bills Recievable ,

trade Receivables turnover ratio establishes the relationship between credit Revenue from operations, i;e Net Credit sales and average trade Receivables, i;e average of debtors and bills receivable of the year, average trade receivables are calculated by dividing the sum of trade receivables in the beginning and at the end by 2.

Trade Receivables Ratio = credit Revenue from operations, i;e Net credit sales =..Times. Average Trade Receivables

(9) Trade payables Turnover Ratio:– trade payables means amount payable for purchase of goods or services taken by the enterprise in the ordinary course of business, It includes creditors and bills payable. trade payables turnover ratio shown the relationship between net credit purchase and total payables or average payables, whereas average payment period or creditors velocity shown the credit period enjoyed by the enterprise in paying creditors,

Trade payables Turnover Ratio = Net credit purchase =.. Times Average trade payables

(10) Working capital Turnover Ratio;– working capital turnover ratio shown the relationship between working capital and Revenue from operations, it shown the number of times a unit a Rupees invested in working capital produces, sales Revenue from operations means revenue earned by the company from its operating activities, i;e revenue producing activities, it includes net sales and commission, etc for non-finance company and interest earned divided profit on sale of securities, etc, in the case of finance companies,

working capital Turnover Ratio = Revenue From operations working capital or = cost of Revenue from operations =.. Times working capital working capital = current assets–current liabilities.

(11) Gross Profit Ratio:– Gross net Ratio establishes the relationship of gross profit and Revenue from operations, i;e net sales of an enterprise . the ratio is calculated and shown in percentage.

Gross Profit Ration = Gross Profit x 100=…% Revenue from operations

(12) Operating Ratio:- operating ratio establishes the relationship between operating costs (i;e cost of Revenue from operations + operating expenses) and Revenue operations, it shown the proportion of cost of Revenue from operations (cost of goods sold) and operating expenses, (i;e operating cost) to Revenue from operations.

operating costs are those costs which are incurred for operating activities of the business examples being employees benefits expense and other expense,

Operating Ratio = cost of Revenue from operations+operating expenses X 100 Revenue from operations or = operating cost X100=…% Revenue from operations

Cost of Revenue from operations

= opening inventory (Excluding spare parts and loose Tools)+net purchase+Direct expenses–closing inventory (Excluding spare parts and loose Tools)

(13) Operating profit Ratio:– operating profit ratio measures the relationship between operating profit and Revenue from operations, i;e Net sales,

Operating profit Ratio = operating profit X100=…% Revenue from operations(net sales)

(14) Net Profit Ratio:– net profit ratio, establishes the relationship between net profit and revenue from operations, i;e net sales, it shown the percentage of net profit earned or Revenue from operations,

Net Profit Ratio = Net profit after Tax X 100=….% Revenue from operations, i;e Net sales