Textbook for CBSE Class XII

ANALYSIS OF FINANCIAL STATEMENTS

KAUSHIK NAGARAJAN
 CONTENTS
S. No PARTICULARS PAGE #
1. Chapter Weightage – Blue Print 1
2. Chapter Summary – Quick Notes 1-7
3. Points to Remember / Exemptions 8 - 10
4. Formulas 11 - 18
5. Mind Map 19
6. DPP – Daily Practice Paper 20 – 25
7. FAQ’s / HOTS – Questions 26 - 50
8. Alternate Accounting Terms & Terminologies 51
 CHAPTER 4 – ACCOUNTING RATIOS
Chapter Weightage – 9 Marks
Blue Print
S. No Type of Question No of Questions Internal Choice Weightage
(Yes / No) (Marks)
1. 1 Mark 2 1 Question has 2
internal choice
2. 3 Marks 1 No 3
3. 4 Marks 1 Yes 4
Total 9
 MEANING OF KEY TERMS USED IN THE CHAPTER

1. Ratio It is an arithmetical expression of relationship between two

interdependent or related items.

2. Accounting Ratio Accounting Ratio means ratio calculated on the basis of

accounting information.

3. Pure Ratio It is a ratio expressed as quotient. For example, 2 : 1.

4. Percentage It is a ratio expressed in percentage. For example, 25%.

5. Times It is a ratio expressed in number of times. For example, 3 Times.

3
6. Fraction It is a ratio expressed as fraction. For example, or .75.
4
7. Liquidity Ratios These ratios measure the ability of the enterprise to meet its
short-term financial commitments. These include: Current Ratio
and Quick Ratio/Liquid Ratio/Acid Test Ratio.

8. Solvency Ratios These ratios measure long-term financial position of the enterprise.
These include: Debt to Equity Ratio; Total Assets to Debt Ratio;
Proprietary Ratio and Interest Coverage Ratio.

9. Activity or Turnover Ratios These ratios measure efficiency in use of assets of the enterprise
in generating sales. These include: Inventory Turnover Ratio;
Trade Receivables Turnover Ratio; Trade Payables Turnover
Ratio, Working Capital Turnover Ratio.

10. Profitability Ratios These ratios show the profitability of the enterprise. These include:
Gross Profit Ratio; Operating Ratio; Operating Profit Ratio;
Net Profit Ratio and Return on Investment (ROI).

C H A P T E R S U M M A RY

• Accounting Ratio is a mathematical expression of the relationship between two related or interdependent
items or group of items shown in the financial statements.

• Ratio Analysis is the process of computing, determining and presenting the relationship of related or
interdependent items or group of items in the financial statements. It is an important technique of financial
analysis.

• Objectives of Ratio Analysis

1. To assess the earning capacity, financial soundness and operating efficiency of an enterprise.
2. To simplify the accounting information.
3. To help in comparative analysis.

1
• Uses of Ratio Analysis: Ratio Analysis is useful in:
1. Analysis of financial statements.

2. Assessing the profitability of the business.

3. Assessing the liquidity or short-term solvency of the business.

4. Assessing the long-term solvency of the business.

5. Assessing the operating efficiency of the business.

6. Intra-firm and inter-firm comparison.

7. Locating the weak areas of the business.

• Limitations of Ratio Analysis

1. Qualitative Factors are Ignored: Ratio analysis is a technique of quantitative analysis and thus, ignores
qualitative factors, which may be important in decision-making.

2. Lack of Standard Ratio: There is almost no single standard ratio against which the actual ratio may be
measured and compared.

3. False Results if Based on Incorrect Information: Conclusions drawn may be misleading if ratios are based
on incorrect accounting information.

4. May not be Comparable: Ratios may not be comparable if different firms follow different accounting
policies and procedures.

• Classification of Accounting Ratios

1. Liquidity Ratios: (i) Current Ratio; and (ii) Quick Ratio.

2. Solvency Ratios: (i) Debt to Equity Ratio; (ii) Proprietary Ratio; (iii) Total Assets to Debt Ratio; and

(iv) Interest Coverage Ratio.

3. Activity Ratios: (i) Inventory Turnover Ratio; (ii) Trade Receivables Turnover Ratio; (iii) Trade Payables
Turnover Ratio; and (iv) Working Capital Turnover Ratio.

4. Profitability Ratios: (i) Gross Profit Ratio; (ii) Operating Ratio; (iii) Operating Profit Ratio; (iv) Net Profit
Ratio; and (v) Return on Investment.

2
 Table Showing Summary of Accounting Ratios
Description of the Ratio Formula Significance How Expressed Remarks

I. LIQUIDITY RATIOS
1. Current Ratio Current Assets Current Assets = Current Investments + Inventories
This ratio shows short-term financial
Current Liabilities soundness of the business. Higher Pure Ratio (Excluding Stores and Spares and Loose
ratio means better capa­city to meet its Tools) + Trade Receivables (Net of
Provision for Doubtful Debts) + Cash and
current obligation.
Cash Equivalents + Short-term Loans
The ideal current ratio is 2 : 1. In case it is and Advances + Other Current Assets +
very high it shows the idleness of funds. Short-term Investments
Current Liabilities = Short-term Borrowings + Trade Payables
+ Other Current Liabilities + Short-term
Provisions.
2. Liquid Ratio/Acid Test Liquid Assets or Quick Assets Liquid Ratio is a fairly stringent measure Pure Ratio Quick Assets = Current Assets – Inventories – Prepaid Expenses
Ratio/Quick Ratio Current Liabilities of liquidity. It is based on those current Current Liabilities as per Current Ratio.
assets which are highly liquid, i.e., can be Note: Inventories and prepaid expenses are not considered as
converted into Cash and Cash Equiva-
Quick Assets.
lents quickly.
Quick Ratio of 1 : 1 is considered as
ideal. Higher the Quick Ratio better the

3
short-term financial position.
II. SOLVENCY RATIOS
Debt
1. Debt to Equity Ratio Equity (Shareholders’ Funds) This ratio assesses the long-term Debt = Long-term Borrowings, (i.e., debentures, mortgage loans,
Pure Ratio
financial position and soundness of public deposits) + Long-term Provisions
enter­prises. In general, lower the Debt Equity (Shareholders’ Funds) = Share Capital + Reserves and Surplus
to Equity Ratio higher the degree of Or
protection enjoyed by the lenders. Non-current Assets (Property, Plant and Equipment + Intangible
Assets + Non-current (Trade) Investments + Long-term Loans and
Advances) + Working Capital – Non-current Liabilities (Long-term
Borrowings + Long-term Provisions).
Working Capital = Current Assets – Current Liabilities

2. Total Asset to Debt Ratio Total Assets This ratio measures the safety margin Pure Ratio, Total Assets = Non-current Assets (Property, Plant and Equipment
Debt available to lenders of long-term debts. e.g., 2 : 1 + Intangible Assets + Non-current Investments + Long-term
It measures the extent to which debt is Loans and Advances) + Current Assets [Current Investments +
being covered by assets. Inventories (including Stores and Spares and Loose Tools) + Trade
Receivables + Cash and Cash Equivalents + Short-term Loans and
Advances + Other Current Assets]
Debt = Long-term Borrowings + Long-term Provisions
 3. Proprietary Ratio Shareholders’ Funds or This ratio shows the extent to which total Fraction Shareholders’ Funds = Share Capital + Reserves and Surplus
Proprietors’ Funds or Equity assets have been financed by the propri- Shareholders’ Funds = Non-Current Assets + Working Capital
Total Assets etor. Higher the ratio, higher the safety – Non-Current Liabilities
margin for lenders and creditors. Total Assets as per Total Assets to Debt Ratio.

4. Interest Coverage Ratio Profit before Interest and Tax This ratio shows how many times the Times Profit before Interest and Tax = Profit after Tax + Tax + Interest
Interest on Long-term Debt interest charges are covered by the profits
available to pay interest. Higher the ratio,
more secure the lender is in respect of
payment of interest regularly.

III. ACTIVITY RATIOS/TURNOVER RATIOS

1. Inventory (Stock) Cost of Revenue from This ratio measures how fast Inventory Times Average Inventory or Stock =
Operations or is moving and generating sales. Higher
Turnover Ratio Cost of Goods Sold
the ratio, more efficient management of Opening Inventory or Stock + Closing Inventory or Stock
Average Inventory (Stock) 2
inventories and vice versa.

2. Trade Receivables or Debt- Credit Revenue from This ratio shows efficiency in the col- Times Trade Receivables means debtors plus bills receivable.
ors’ Turnover Ratio Operations lection of amount due from trade Provision for Doubtful Debts is not deducted.

4
Average Trade Receivables receivables. Higher the ratio, better it is Average Trade Receivables =
since it indicates that debts are being Opening Trade Receivables + Closing Trade Receivables
collected more quickly. 2

3. Trade Payables or Creditors’ Net Credit Purchases It shows the number of times the creditors Times Trade Payables means creditors plus bills payable.
Turnover Ratio Average Trade Payables are turned over in relation to purchases.
Average Trade Payables =
A high turnover ratio or shorter payment
Opening Trade Payables + Closing Trade Payables
period shows the availability of less credit
2 .
or early payments.

4. Working Capital Turnover Revenue from Operations This ratio shows the number of times Times Working Capital = Current Assets – Current Liabilities
Ratio Working Capital working capital has been employed Current Assets = As per Current Ratio
in the process of carrying on business. Current Liabilities = As per Current Ratio.
Higher the ratio, better the efficiency in
the utilisation of working capital.
 IV. PROFITABILITY RATIOS
1. Gross Profit Ratio Gross Profit This ratio indicates the relationship % Gross Profit = Revenue from Operations – Cost of Revenue from Operations
 100
Revenue from Operations between gross profit and net sales. Cost of Revenue from Operations
Higher the Ratio, lower the cost of = Opening Inventory (excluding Stores and Spares and Loose Tools) + Net Purchases
Or goods sold. + Direct Expenses – Closing Inventory (excluding Stores and Spares and Loose
Tools) Or
Operating Cost Revenue from Operations – Gross Profits
 100 Or
Revenue from Operations
Cost of Materials Consumed + Purchases of Stock-in-Trade + Changes in Inventories
of Finished Goods, WIP and Stock-in-Trade + Direct Expenses.
If direct expenses are not given, assume them to be nil.
2. Operating Ratio Cost of Revenue from Operations This ratio is calculated to assess % Cost of Revenue from Operations
+ Operating Expenses the operational efficiency of the = Opening Inventory (excluding Stores and Spares and Loose Tools) + Net Purchases
× 100
Revenue from Operations business. A decline in the operating + Direct Expenses – Closing Inventory (excluding Stores and Spares and Loose
ratio, is better because it means Tools) Or
Or Revenue from Operations – Gross Profit
higher margin, and thus, more profit.
Operating Cost Or
 100
Revenue from Operations Cost of Revenue from Operations = Cost of Materials Consumed + Purchases of
Stock-in-Trade + Changes in Inventories of Finished Goods, WIP and Stock-in-Trade
+ Direct Expenses.
If Direct Expenses are not given, assume them to be nil.

5
Operating Expenses = Employees Benefit Expenses + Depreciation and Amortisation
Expenses + Other Expenses (Other than Non-operating Expenses)
Revenue from Operations = Sales – Sales Return
3. Operating Profit Ratio Operating Profit The objective of computing this % Operating Profit
 100 = Net Profit (Before Tax) + Non-operating Expenses – Non-operating Income
Revenue from Operations ratio is to determine the operational
efficiency of management. Or
= Gross Profit + Other Operating Income – Other Operating Expenses
Non-operating Expenses = Interest on Long-term Borrowings + Loss on Sale of Fixed
Assets or Non-current Assets
Non-operating Income = Interest received on investments + Gain (Profit) on Sale of
Fixed Assets or Non-current Assets
4. Net Profit Ratio Profit after Tax It indicates overall efficiency of the % Profit after Tax
 100 business. Higher the net profit ratio,
Revenue from Operations = Gross Profit + Other Income – Indirect Expenses – Tax
better the business.
5. Return on Investment Profit before Interest, It assesses the overall performance % Capital Employed: Liabilities Approach: Share Capital + Reserves and Surplus
or Return on Capital Tax and Dividend of the enterprise. It measures, how + Long-term Borrowings + Long-term Provisions
 100 Assets Approach: Non-Current Assets (Tangible Assets + Intangible Assets)
Employed Capital Employed efficiently the resources entrusted to
the business are used. + Non-current Investments + Long-term Loans and Advances) + Working Capital.
Working Capital = Current Assets – Current Liabilities
(Assume that all Non-current Investments are Trade Investments)
Note: 1. Non-operating Assets do not form part of Capital Employed, e.g., Non-
Trade Investments, Capital Work-in-progress, etc.
2. Interest on Non-trade Investments should be deducted from Profit
before Interest, Tax and Dividend.
 CHAPTER 4: ACCOUNTING RATIOS
➢ Meaning:
Ratio is an arithmetical expression of relationship between two important or related items.
Ratio when calculated on the basis of accounting information are called Accounting Ratios.

➢ Types of Ratios:
There are 4 important types of ratios, they are as follows.

SLAP

Solvency Ratio Liquidity Ratio Activity Ratio Profitability Ratio

1. Solvency Ratio: Shows the proportion of Debt and Equity in financing the Firm’s Assets.
2. Liquidity Ratio: Measures the Firm’s ability to meet current obligations.
3. Activity Ratio: Reflects Firm’s efficiency in utilizing the Assets.
4. Profitability Ratio: Measures the overall performance and effectiveness of the firm.

➢ Expression of Ratios:
Ratios can be expressed in any of the following manner. (4 Ways)
1. Pure - Eg. 4:1
2. Percentage - Eg. 25%
3. Times - Eg. 4 Times
4. Fraction - Eg. 3/4

➢ Liquidity Ratio:
Liquidity Ratio refers to the capacity of the business to pay its short-term liability as and
when it becomes due. So, The liquidity ratios are used to know the Company’s capacity to pay its short-term
liabilities.
Classification of Liquidity Ratio (2 Types)
Liquidity Ratio

Current Ratio Liquid Ratio

➢ Solvency Ratio:
A Solvency ratio is a Key Metric used to measure an enterprise’s ability to meet its long-
term debt obligations. Solvency ratio indicates whether a company’s Cash flow is sufficient to meet its long-
term liabilities.

Classification of Solvency Ratio (5 Types)

Solvency Ratio

Debt to Equity Total Asset to Debt Debt to Proprietary Ratio Interest Coverage
Ratio Ratio Capital Employed Ratio

DDPIT
Debt to Capital Employed Ratio: If Debt to Capital Employed Ratio is high it indicates less security to the
lenders. If Debt to Capital Employed Ratio is low it ensures more safety to the lenders.

➢ Activity Ratios:
Activity Ratio is a Financial indicator that shows how effectively a company is generating
revenue and cash by using its assets on its Balance sheet. Activity ratio is also termed as Performance or
Turnover ratio.
Classification of Activity Ratio (6 Types)
Activity Ratio

Inventory Turnover Trade Receivable Turnover Fixed Assets Trade Payable Turnover Working Capital
Ratio Ratio Turnover Ratio Ratio Turnover Ratio
Net Asset
Turnover Ratio

Net Asset Turn Over Ratio: High Net Assets Turnover Ratio leads to better and efficient utilisation of Capital
Employed & Net Assets which in turn leads to Better Profitability.
Fixed Asset Turnover Ratio: High Fixed Assets Turnover ratio indicates the efficient utilisation of Fixed
Assets and Low Fixed Assets Turnover ratio indicates inefficient utilisation of Fixed Assets.

➢ Profitability Ratios:
Profitability ratios assess a company’s ability to earn profits from its sales or
operations. It is expressed in percentage.

Classification of Profitability Ratio (5 Types)

Profitability Ratio

Gross Profit Operating Profit Operating Cost Net Profit Return on Investment
Ratio Ratio Ratio Ratio (ROI)

Special Note: Students must be more cautious with respect to the usage of words.
1) There is a difference between the statements ‘Closing inventory was 2 time that of the opening inventory’
and ‘Closing inventory was 2 times more than that of in the beginning’. The earlier statement means that
if Opening inventory is x, then Closing Inventory will be 2x, and the latter means that if Opening
Inventory is x, then closing inventory will be 3x (i.e., x+2x).

2) There is a difference between the statements ‘Trade Receivables at the end were 3 times that of in the
beginning’ and ‘Trade Receivables at the end were 3 times more than that of in the beginning’. The earlier
statement means that if Opening Trade Receivables are x, then Closing Trade Receivables will be 3x, and the
latter means that if Opening Trade Receivables are x, then Closing Trade Receivables will be x+3x, i.e., 4x.
➢ Important Points to Remember:

1. If GP is 1/4th (i.e.,25%) on sales then GP will be 1/3rd on Cost.

2. If GP on cost is 33 1/3 % then it is taken as 1/3rd on Cost.
3. COGS = Sales + Gross Loss.
4. Whenever COGS is to be computed at 1/5 on sales then in such cases make it as 1/10 and later multiply
by 2.
5. If given in the question "Inventory in the beginning is" then indicates that inventory is Equal to.
6. When information with respect to opening trade receivable is not given in the question separately then in
such cases we take closing trade receivable as Average Trade Receivables.
7. If given in the question GP 20% without mentioning whether it is on cost or on sales then in such cases
always take it as GP on sales itself.
8. If given in the question GP 20% on cost but no information is provided with respect to cost, then GP is
computed at 1/6 on Sales.
9. Operating Ratio can go beyond 100% also, this indicates that the company is running at a loss.
10. Operating Cost and Operating Expenses are not one and the same; they are different
11. If information with respect to Non-Operating expenses are not given in the question then derive the
value of Operating Profit ratio using the equation - Operating Ratio + Operating Profit Ratio = 100%.
12. Operating Ratio + Operating Profit Ratio = 100%.
13. If Net Profit Ratio is more then it is favourable for the company / Higher the Net Profit Ratio the
Company is performing better.
14. Operating Expenses is within the Operating Cost.
15. Round off can be done in Ratios.
16. When Net Sales i.e., Revenue from operations is given in the question along with Return inwards in
such cases do not consider Return inwards (i.e., Sales Returns).
17. When Net Fixed Assets are given in the question along with Accumulated Depreciation / Depreciation
it should not be considered.
18. Ratios are broadly classified into 4 types, and they can be expressed in 4 different ways such as Pure,
Percentage, Fractions and Times.

**************************************************************************************
 CHAPTER 4: ACCOUNTING RATIOS

Formulas:
1. Liquidity Ratio
a) Current Ratio
Current Ratio = Current Assets
Current Liabilities
Note:
Ideal Current Ratio – 2:1
Expressed in terms of Pure.
Current Asset includes:
Current investments, Trade Receivables, Inventories, Cash and Cash Equivalents,
Short term loans and advances, Other Current Assets, Short term investments.

Current Asset doesn’t include:

1. Inventories – Excluding stores and spares and Loose Tools
2. Trade Receivable – Net of Provision for Doubtful Debts

Special Note: When the value of Current Asset is given in the question along with the value of Inventories,
in such cases the value of Inventories shouldn’t be considered for computing Current Ratio since
Inventories are already included in the value of Current Assets.

Current Assets = Total Assets – Non-Current Assets

Current Assets = Inventories + Quick Assets
Inventories = Current Assets – Quick Assets (or) Current Assets – Liquid Assets

Current Liabilities includes:

Short term borrowings; Trade payables; Other Current liabilities and Short
term Provisions.

Current Liability = Total Debts – Non-Current liabilities

b) Liquid Ratio / Acid Test Ratio / Quick Ratio

Liquid Ratio = Liquid Assets / Quick Assets

Current Liabilities

Note:
Ideal Current Ratio – 1:1
Expressed in terms of Pure.
Quick Assets = Current Assets – Inventories – Prepaid Expenses
Quick Assets = Current Assets – Inventories
Quick Assets = Current Liabilities

Inventories and Prepaid Expenses are not considered as Quick Assets.

✓ All Quick Assets are Current Assets; however, all Current Assets are not Quick Assets.

Working Capital = Current Assets – Current Liabilities

Current Assets:
Current Assets = Working Capital + Current Liabilities
Current Assets = Total Assets – Fixed Assets (Non-Current Assets) – Investment

Current Liability:
Current Liability = Current Assets – Working Capital
Current Liability = Total Liability – Long term debts
(Other than Shareholders’ funds)
Current Liability = Total Liability – Shareholders Fund – Non-Current Liability
Total Liability = Non-Current Liability + Current Liability
Current Liability before payment:
Current Liability before payment = Current Liability after payment + Payment Made

Current Liability after payment:

Current Liability after payment = Current Asset after payment
Current Ratio
Working Capital before payment:
Working Capital before payment = Current Asset before payment – Current Liabilities before payment
Working Capital after payment:
Working Capital after payment = Current Asset after payment – Current Liabilities after payment
Balance Sheet (An Extract)
Liabilities ₹ Assets ₹
Shareholders Fund xxx Non-Current Assets xxx

Total Debts xxx Non-Current Investments xxx

Current Assets xxx

xxx xxx
Total Assets = Total Liabilities
Total Assets = Non-Current Assets + Non-Current Investments + Current Assets
Total Assets = Non-Current Assets + Current Assets
Total Assets = Property plant Equipment + Trade Investments + Current Assets
Total Liabilities = Shareholders’ Funds + Total Debts
Note: Shareholders’ Funds: Internal Liability and Total Debts: External Liability
Shareholders’ Fund = Share Capital + Reserves & Surplus
Total Liabilities = Share Capital + Reserves & Surplus + Total Debts
Total Liabilities = Shareholders Funds+ Reserves & Surplus + Total Debts
Total Debts = Long term Debts + Short term Debts
Total Debts = Non-Current Liabilities + Current Liabilities
Short term Debts = Current Liabilities
Total Liabilities = Capital Employed + Current Liabilities
Capital Employed = Shareholders’ Funds + Long term Debts
Capital Employed = Share Capital + Reserves & Surplus + Long term Debts
Capital Employed = Equity Share Capital + Preference Share Capital + Reserves & Surplus + Long term Debts
Capital Employed = Total Liability – Current Liability
Capital Employed = Total Assets – Current Liabilities
Capital Employed = Net Fixed Assets - Working Capital (used only when there is no long-term investments)

2. Solvency Ratio
a) Debt to Equity Ratio:
Debt to Equity Ratio = Debt
Equity
Debt Long term Debts only
Long Term Debts = Long term loan + Long term Provisions + % Debentures
Long Term Debts = Capital Employed – Shareholders’ Funds
Long Term Debts = Total Debts – Current Liabilities
Equity / Shareholders’ Funds = Equity Share Capital + Preference Share Capital + Reserves & Surplus
Equity = Total Liability – Total Debts
Equity = Total Assets – Total Debts (Non-current & Current debts)
Equity = Share Capital + Reserves and Surplus

Equity = Non-Current Assets (Tangible + Intangible + Non-Current trade investments + Long term loans and Advances)
+ Working Capital – Non-Current Liabilities (Long term borrowings + Long term provisions)

Note:
Ideal Current Ratio – 2:1
Expressed in terms of Pure.
Whenever Gross value is given in the question, we need derive the Net value
b) Total Assets to Debt Ratio:
Total Assets to Debt Ratio = Total Assets
Long term Debts
c) Proprietary Ratio:
Proprietary Ratio = Shareholders Funds
Total Assets
Proprietor Funds = Shareholders Funds = Equity
Liabilities Side Approach:
Proprietors’ Funds = Share Capital (Equity + Preference) + Reserves & Surplus
Assets Side Approach:
Proprietors’ Funds = Non-Current Assets + Working Capital – Non-Current Liabilities
Non-Current Assets = Tangible Assets (PPE) + Intangible Assets + Non-Current Investments + Long term loans
and advances
Current Assets = Current investments + inventories + Trade Receivables + Cash and Cash Equivalents +
Short term loans and advances + Other Current Assets (Prepaid expenses + Accrued income)
Current Liabilities = Short term borrowings + Trade Payables + Other Current Liabilities + Short term Provisions
Non-Current Liabilities = Long term borrowings + Long term Provisions
Note:
1. Expressed in terms of Pure / Percentage.
2. Sometimes instead of providing a Balance Sheet, information might be given in the question, in such
cases the students have to compute Proprietors’ Funds using anyone of the above two methods.
(i.e., Liabilities side approach / Assets Side approach). It should be noted that the Proprietors’ funds
computed by the above two methods may not be same.
d) Interest Coverage Ratio:
Interest Coverage Ratio = Profit before interest and Tax
Interest on long term Debts
Note:
Expressed in terms of Times.
Interest Interest paid on Loans and Debentures
Profit Before Interest & Tax xxx
Less: Interest xxx
Profit before tax xxx
Less: Tax xxx
Profit after Tax xxx
Profit before interest and tax = Profit after tax + Tax + Interest

e) Debt to Capital Employed Ratio:

Debt to Capital Employed Ratio = Debt
Capital Employed
Note:
Expressed in terms of Pure.

3. Activity Ratio:
a) Inventory Turnover Ratio:
Inventory Turnover Ratio = Cost of Goods Sold (COGS)
Average Inventory
COGS Cost of Goods Sold = Opening Stock + Purchases + Direct Expenses – Closing Stock
COGS = Sales – Gross Profit
COGS = Sales + Gross Loss
Sales = COGS + Gross Profit / Cost of Revenue from Operations + Gross Profit
Sales = COGS – Gross Loss
Sales = Cash Revenue from operations + Credit Revenue from Operations
Average Inventory = Opening Inventory + Closing Inventory
2
Direct Expenses Wages; Factory rent; Carriage Inward; Dock charges; Octroi duty; Custom Duty; Coal;
Water and Gas; Manufacturing expenses’ etc.
Note:
Expressed in terms of Times.

b) Trade Receivable Turnover Ratio:

Trade Receivable Turnover Ratio = Net Credit Sales / Credit Revenue from Operations
Average Trade Receivable

Net Credit Sales = Total Sales – Cash Sales – Sales Returns

 (or)
Net Credit Sales = Total Sales – Cash Sales – Returns Inward
(or)
Credit Revenue from Operations = Credit Sales – Sales Returns /Returns Inward
(or)
Credit Revenue from Operations = Revenue from Operations – Cash Revenue from Operations

Average Trade Receivable = Opening Bills receivable + Opening Debtors + Closing Bills receivable + Closing Debtors
2
(or)
Average Trade Receivable = Opening Trade receivable + Closing Trade receivable
2

Debt collection period = 1 x 12 / 1 x 365 .

Trade Receivable Turnover Ratio

Days Months
(Multiply with 365) (Multiply with 12)
(Or)

Debt collection period = Average Trade Receivables x 12 (For Months)

Net Credit Sales

Debt collection period = Average Trade Receivables x 365 (For Days)

Net Credit Sales

Note:
1. Expressed in terms of Times.
2. If the accounting year is a leap year, then we need to multiply with 366 in case if the debt collection
period is to derived in days.

c) Trade Payable Turnover Ratio:

Trade Payable Turnover Ratio = Net Credit Purchases

Average Trade Payable

Net Credit Purchases = Total Purchases – Cash Purchases – Purchase Returns

(or)
Net Credit Purchases = Total Purchases – Cash Purchases – Returns Outward

Average Trade Payable = Opening Bills Payable + Opening Creditors + Closing Bills Payable + Closing Creditors
2

Debt payment period = 1 x 12 / 1 x 365 .

Trade Payable Turnover Ratio

Days Months
(Multiply with 365) (Multiply with 12)
(Or)

Debt Payment period = Average Trade Payable x 12 (For Months)

Net Credit Purchases
Debt Payment period = Average Trade Payables x 365 (For Days)
Net Credit Purchases

Note:
1. Expressed in terms of Times.
2. If the accounting year is a leap year, then we need to multiply with 366 in case if the debt collection
period is to derived in days.
d) Working Capital Turnover Ratio:
Working Capital Turnover Ratio = Revenue from operations
Working Capital / Net Working Capital
Or
Working Capital Turnover Ratio = Sales
Working Capital / Net Working Capital
Or
Working Capital Turnover Ratio = Cost of Revenue from operations
Working Capital / Net Working Capital

Working Capital = Current Assets – Current Liability

Note:
1. Expressed in terms of Times.
2. If given in the question GP 20% without mentioning whether it is on cost or on sales then in such
cases GP will always be calculated on sales.
e) Fixed Assets Turnover Ratio:
Fixed Assets Turnover Ratio = Revenue from Operations
Net Fixed Assets
Or
Fixed Assets Turnover Ratio = Net Sales
Net Fixed Assets
Net Fixed Assets = Gross Fixed Assets - Depreciation

Note:
1. Expressed in terms of Times.

f) Net Assets Turnover Ratio:

Net Assets Turnover Ratio = Revenue from Operations
Capital Employed
(Or)
Net Assets Turnover Ratio = Net Sales
Capital Employed
Note:
1. Expressed in terms of Times.

4. Profitability Ratios:
a) Gross Profit Ratio:
Gross Profit Ratio = Gross Profit x 100
Revenue from operations
Gross Profit = Revenue from Operations (Net Sales) – Cost of Revenue from Operations (COGS)
Gross Profit = Sales (Net Sales) - COGS
Cost of Revenue from Operations = Average Inventory x Inventory Turnover Ratio
Credit Sales = Average Trade Receivables x Inventory Turnover Ratio
Note:
1. Expressed in terms of Percentage.
b) Operating Ratio / Operating Cost Ratio:
Operating Ratio = Operating Cost x 100
Revenue from operations
(or)
Operating Ratio = Operating Cost x 100
Net Sales
Net Sales = Cash Sales + Credit Sales – Sales Returns /Returns Inward
Net Sales = Sales – Sales Returns / Returns Inward
Revenue from Operations = Cash Revenue from operations + Credit Revenue from Operations - Returns Inward
Operating Cost = COGS + Operating expenses
COGS = Operating Cost – Operating expenses
COGS = Sales – Gross Profit / Revenue from Operations – Gross Profit
COGS = Opening Inventories (excluding Spare parts & Loose Tools) + Net Purchases + Direct Expenses –
Closing Inventories (excluding Spare parts & Loose Tools)
COGS = Cost of Materials Consumed + Purchases of Stock in Trade + Changes in Inventories of Finished
Goods, Work in Progress and Stock in Trade + Direct Expenses
Note:
1. Expressed in terms of Percentage.
2. Operating Expenses includes: i) Depreciation
ii) Office & Administration Expenses and
iii) Selling & Distribution Expenses
3. Operating cost and Operating expenses are not one and the same, they are different.
4. While computing COGS if there exists an Excess of Closing Inventory over Opening Inventory it
denotes a negative change, hence it should be deducted. On the other hand, if there exists an Excess of
Opening Inventory over Closing Inventory (i.e., Decrease in Inventory) it denotes a positive change,
hence it should be added.

c) Operating Profit Ratio:

Operating Profit Ratio = Operating Profit x 100
Revenue from operations
(or)
Operating Ratio = Operating Profit x 100
Net Sales
Operating Profit = Net Profit – Non-Operating income + Non-Operating expenses x 100
Revenue from Operations

Operating Profit = Net Profit – Non-Operating income + Non-Operating expenses x 100

Net Sales
Operating Profit = Gross Profit + Other Operating Income – Other Operating Expenses
Operating Profit = Net Profit (Before Tax) + Non-Operating Expenses / Losses – Non-Operating Income
Operating Profit = Revenue from Operations – Operating Cost
Operating Ratio + Operating Profit Ratio = 100%
Note:
Expressed in terms of Percentage.

d) Net Profit Ratio:

Net Profit Ratio = Net Profit x 100
Revenue from operations

Net Profit Ratio = Net Profit x 100

Net Sales

Net Profit = Gross Profit – All indirect expenses + All indirect incomes

Total Sales = Cash Sales + Credit Sales

If Total Sales not given, however Percentage of Cash Sales / Credit Sales are given in the question then then t
formula to derive Total Sales are as follows:

Total Sales (When amount of Cash sales and Percentage of Credit Sales are given)

Total Sales = Cash Sales x 100

Rate of Credit Sales

Total Sales (When amount of Credit sales and Percentage of Cash Sales are given)
Total Sales = Credit Sales x 100
Rate of Cash Sales

Note:
1. Expressed in terms of Percentage.
2. Net Profit refers to Net Profit after Tax

e) Return on Investment (ROI):

Return on Investment = Net Profit before interest and tax x 100
Capital Employed
Net Profit before interest and Tax = Net Profit after Interest and Tax + Tax + Interest on long term Debt

Tax Amount = Net Profit after Interest and Tax x Tax Rate
Rate after Tax

******************************************************************************************
 Mind map : learning made simple Chapter-4

Cost of Goods Sold

• Capital Turnover Ratio =
Capital Employed
• Fixed Assets Cost of Goods Sold • To measure profitability, Access the short-term financial
=
Turnover Ratio Net Fixed Assets • To ascertain operating efficiency, position of the firm.
• Working capital= Cost of Goods Sold • To access business solvency,
Turnover Ratio Working Capital • To facilitate comparative analysis. Access the ability of the firm
• Stock Turnover Cost of Goods Sold o
to pay its long- term
= Average Stock
Ratio liabilities in time.
• Debtors Net Credit Sales
=
Turnover Ratio Av. Debtors + Av. B/R
365 Measure various aspects of
• Average
the profitability or the capacity
Collection Period = Debtors Turnover Ratio
to earn a stable return.

Gross Profit
• Gross Profit Ratio =  100 Indicate how efficiently &
Net Sales
profitably the total capital,
Net Profit
• Net Profit Ratio =  100 working capital, fixed assets
Net Sales Accounting and inventory of the business
Cost of Goods Sold+ Operating Exp. Ratios are used.
• Operating Ratio =  100
Net Sales
E.B.I.T.  100
• Return on Investment=
Capital Employed Current Assets
• Current Ratio=
N.P. after Int. Tax and Dividend Current Liabilities
• Return on Equity=  100 Quick Assets
Equity shareholders’ fund Quick Ratio=
• Current Liabilities
N.P. - Dividend on Preference Shares
• Earnings Per Share=  100
No. of Equity Shares
Given Expenses Debt
• Debt to Equity Ratio=
• Expenses Ratio = __________________  100 Equity
Net Sales
Proprietors’ funds
• Proprietary Ratio=
Total Assets
Debt
• Debt to Total Funds Ratio= Equity + Debt
N.P. before Int. and Tax
• Debt Service Ratio=
Fixed Interest Charges
 1. On the basis of the following information, calculate Total Assets to Debt Ratio:
Particulars
` Particulars `
Capital Employed 50,00,000 Share Capital 35,00,000
Current Liabilities 20,00,000 10% Debentures 10,00,000
Land and Building 60,00,000 General Reserve 3,00,000
Trade Receivable 4,00,000 Surplus, i.e., Balance in Statement of
Cash and Cash Equivalents 5,00,000 Profit & Loss 2,00,000
Investment (Trade) 1,00,000

[Ans.: Total Assets to Debt Ratio = 7 : 1.]

[Hint: Long-term Debts = Capital Employed – Shareholders’ Funds.]

2. From the following information, calculate Proprietary Ratio:

BALANCE SHEET OF FORTUNE LTD. as at 31st March, 2022

Particulars Note No. `

I. EQUITY AND LIABILITIES

1. Shareholders’ Funds
(a) Share Capital 6,00,000
(b) Reserves and Surplus 1,50,000
2. Current Liabilities
(a) Trade Payables 1,00,000
(b) Other Current Liabilities 50,000
(c) Short-term Provisions (Provision for Tax) 1,00,000
Total 10,00,000
II. ASSETS
1. Non-Current Assets
Property, Plant and Equipment and Intangible Assets:
Property, Plant and Equipment 5,00,000
2. Current Assets
(a) Current Investments 1,50,000
(b) Inventories 1,00,000
(c) Trade Receivables 1,50,000
(d) Cash and Cash Equivalents 1,00,000
Total 10,00,000

[Ans.: Proprietary Ratio = 0.75 : 1 or 75%.]

3. Calculate Current Ratio, Quick Ratio and Debt to Equity Ratio from the information given below:
Particulars `
Inventory 30,000
Prepaid Expenses 2,000
Other Current Assets 50,000
Current Liabilities 40,000
12% Debentures 30,000
Accumulated Profits 10,000
Equity Share Capital 1,00,000
Non-current Investments 15,000

[Ans.: Current Ratio = 2.05 : 1; Quick Ratio = 1.25 : 1; Debt to Equity Ratio = 0.27 : 1.]

1
 4. Calculate Inventory Turnover Ratio from the data given below:
` `
Inventory in the beginning of the year 20,000 Carriage Inwards 5,000
Inventory at the end of the year 10,000 Revenue from Operations, i.e., Net Sales 1,00,000
Purchases 50,000
State the significance of this ratio.

[Ans.: Inventory Turnover Ratio = 4.33 Times.]

5. From the following information, calculate any two of the following ratios:
(i) Current Ratio; (ii) Debt to Equity Ratio; and (iii) Operating Ratio.
Revenue from Operations (Net Sales) ` 1,00,000; Cost of Revenue from Operations (Cost of Goods Sold)
was 80% of sales; Equity Share Capital ` 7,00,000; General Reserve ` 3,00,000; Operating Expenses
` 10,000; Quick Assets ` 6,00,000; 9% Debentures ` 5,00,000; Closing Inventory ` 50,000; Prepaid
Expenses ` 10,000 and Current Liabilities ` 4,00,000. (Foreign 2008)

[Ans.: Current Ratio = 1.65 : 1; Debt to Equity Ratio = 0.5 : 1; Operating Ratio = 90%.]

6. State, giving reasons, which of the following transactions would improve, reduce or not change the
Current Ratio, if Current Ratio of a company is (i) 1 : 1; or (ii) 0.8 : 1:
(a) Cash paid to Trade Payables.
(b) Purchase of Stock-in-Trade on credit.
(c) Purchase of Stock-in-Trade for cash.
(d) Payment of Dividend payable.
(e) Bills Payable discharged.
(f ) Bills Receivable endorsed to a Creditor.
(g) Bills Receivable endorsed to a Creditor dishonoured.
[Ans.: (i) (a) No Change; (b) No Change; (c) No Change; (d) No Change; (e) No Change;
(f) No Change; (g) No Change; (ii) (a) Reduce; (b) Improve; (c) No Change;
(d) Reduce; (e) Reduce; (f) Reduce; (g) Improve.]

7. Calculate Inventory Turnover Ratio in each of the following alternative cases:

Case 1: Cash Sales 25% of Credit Sales; Credit Sales ` 3,00,000; Gross Profit 20% on Revenue from
Operations, i.e., Net Sales; Closing Inventory ` 1,60,000; Opening Inventory ` 40,000.
Case 2: Cash Sales 20% of Total Sales; Credit Sales ` 4,50,000; Gross Profit 25% on Cost; Opening
Inventory ` 37,500; Closing Inventory ` 1,12,500. [Ans.: Case (1) 3 Times; Case (2) 6 Times.]

[Hint: Profit 25% of Cost = Profit 20% on Sales. Profit on Cost = 25/100 or 1/4 or 25%.

Let the Cost = ` 100; Profit = ` 25; Revenue from Operations, i.e., Net Sales = ` 125.

Profit on Sales = ` 25/` 125 = 1/5 or 20%.]

2
 8. From the following Statement of Profit & Loss for the year ended 31st March, 2022 of Rex Ltd., calculate
Inventory Turnover Ratio:
STATEMENT OF PROFIT & LOSS for the year ended 31st March, 2022
Particulars Note No. `
I. Revenue from Operations (Net Sales) 6,00,000
II. Expenses:
(a) Purchases of Stock-in-Trade 3,00,000
(b) Change in Inventory of Stock-in-Trade 1 50,000
(c) Employees Benefit Expenses 60,000
(d) Other Expenses 2 45,000
Total Expenses 4,55,000
III. Profit before Tax (I – II) 1,45,000
IV. Less: Tax 45,000
V. Profit after Tax (III – IV) 1,00,000

Notes to Accounts
Particulars `
1. Change in Inventory of Stock-in-Trade
Opening Inventory 1,25,000
Less: Closing Inventory 75,000
50,000
2. Other Expenses
Carriage Inwards 15,000
Miscellaneous Expenses 30,000
45,000

[Ans.: Inventory Turnover Ratio = 3.65 Times.]

[Hint: Cost of Revenue from Operations (Cost of Goods Sold) = Purchases of Stock-in-Trade + Change
in Inventory of Stock-in-Trade + Carriage Inwards = ` 3,65,000.]
9. From the following particulars, determine Trade Receivables Turnover Ratio:
`
Revenue from Operations (Net Sales) 20,00,000
Credit Revenue from Operations (Credit Sales) 16,00,000
Trade Receivables 2,00,000
[Ans.: Trade Receivables Turnover Ratio = 8 Times.]
10. Following is the Balance Sheet of the Bharati Ltd. as at 31st March, 2022:
Particulars Note No. `
I. EQUITY AND LIABILITIES
1. Shareholders’ Funds
(a) Share Capital 7,50,000
(b) Reserves and Surplus:
Surplus, i.e., Balance in Statement of Profit & Loss:
Opening Balance 6,30,000
Add: Transfer from Statement of Profit & Loss 14,58,000 20,88,000
2. Non-Current Liabilities
15% Long-term Borrowings 24,00,000
3. Current Liabilities 12,00,000
Total
64,38,000

3
II. ASSETS
1. Non-Current Assets

(a) Property, Plant and Equipment and Intangible Assets:

—Property, Plant and Equipment
27,00,000
(b) Non-current Investments:
(i) 10% Investments 3,00,000
(ii) 10% Non-trade Investments 1,80,000
2. Current Assets
32,58,000
Total
64,38,000

You are required to calculate Return on Investment for the year ended 31st March, 2022 with reference
to Opening Capital Employed. [Ans.: Return on Investment (ROI) = 50%.]

[Hint: 10% Investments are Trade Investments.]

11. From the following information of Green Star Ltd., Calculate Debt to Equity Ratio:
` `
Trade Payables 3,00,000 Trade Receivables 3,00,000
Other Current Liabilities (12.5% of Current Assets) Net Fixed Assets 30,00,000
Total Debts 28,00,000 Long Term Loans and Advances 1,60,000
Other Quick Assets 80,000 Non-Current Investments 40,000
Prepaid Expenses 20,000 Opening Inventory 3,20,000

Note: Closing Inventory 25% more than Opening Inventory.

[Ans.: Debt to Equity Ratio = 2 : 1.]

[Hint: (i) Closing Inventory = ` 4,00,000; (ii) Current Assets = ` 8,00,000; (iii) Current Liabilities = ` 4,00,000;
(iv) Total Assets = ` 40,00,000; (v) Equity = Total Assets – Total Debts = ` 12,00,000; (vi) Long-term
Debts = ` 24,00,000.]

12. Calculate Revenue from Operations of King Ltd. from the following information:

Current Assets ` 20,00,000; Quick Ratio is 1.5 : 1; Current Ratio is 2 : 1; Inventory Turnover Ratio is
6 Times; Goods are sold at a profit of 25% on cost.
[Ans.: Revenue from Operations = ` 37,50,000.]

[Hint: Current Liabilities = ` 10,00,000; Quick Assets = ` 15,00,000; Inventory = ` 5,00,000; Cost of Revenue
from Operations = ` 30,00,000.]

13. Quick Ratio 1.5, Current Ratio 2, Total Current Assets ` 20,00,000, Inventory Turnover Ratio 6 Times.
Goods are sold on 20% Profit on Sales. Calculate Revenue from Operations.
[Ans.: Revenue from Operations = ` 37,50,000.]

[Hint: Current Liabilities = ` 10,00,000; Quick Assets = ` 15,00,000; Inventory = ` 5,00,000; Cost of Revenue
from Operations = ` 30,00,000.]

4
 14. The motto of Yash Ltd., an advertising company is ‘Service with Dignity’. Its management and work force
is hard working, honest and motivated. The net profit of the company doubled during the year ended
31st March, 2014. Encouraged by its performance company decided to give one month extra salary to all
its employees. Following is the Comparative Statement of Profit & Loss of the company for the years ended
31st March, 2013 and 2014:

COMPARATIVE STATEMENT OF PROFIT & LOSS

Particulars Note 2012–13 2013–14 Absolute Percentage
No. ` ` Change (`) Change (%)
Revenue from Operations 10,00,000 15,00,000 5,00,000 50.00
Less: Employees Benefit Expenses 6,00,000 7,00,000 1,00,000 16.67
Profit before Tax 4,00,000 8,00,000 4,00,000 100.00
Less: Tax Rate 25% 1,00,000 2,00,000 1,00,000 100.00
Profit after Tax 3,00,000 6,00,000 3,00,000 100.00

Calculate Net Profit Ratio for the years ending 31st March, 2013 and 2014. (Delhi 2015, Modified)

Net Profit after Tax
[Ans.: Net Profit Ratio = ×100
Revenue from Operations

` 3,00 ,000
For the year ending 31st March, 2013 = ×100 = 30%;
`10 ,00 ,000
` 6 ,00 ,000
For the year ending 31st March, 2014 = 100 = 40%.]
`15 ,00 ,000

15. Wintex Products Ltd.

COMMON-SIZE STATEMENT OF PROFIT & LOSS
for the years ended 2021 and 2022
Particulars Note Absolute Amounts Percentage of Revenue from
No. Operations (Net Sales)
31st March, 31st March, 31st March, 31st March,
2021 (`) 2022 (`) 2021 (%) 2022 (%)

I. Revenue from Operations (Net Sales) 10,00,000 12,50,000 100.00 100.00

II. Expenses
(a) Purchases of Stock-in-Trade 7,20,000 8,70,000 72.00 69.60
(b) Change in Inventories of Stock-in-Trade 30,000 (20,000) 3.00 (1.60)
(c) Depreciation and Amortisation Expenses 20,000 30,000 2.00 2.40
(d) Other Expenses 30,000 50,000 3.00 4.00
Total Expenses 8,00,000 9,30,000 80.00 74.40
III. Profit before Tax (I – II) 2,00,000 3,20,000 20.00 25.60
IV. Less: Income Tax 60,000 96,000 6.00 7.68
V. Profit after Tax (III – IV) 1,40,000 2,24,000 14.00 17.92

From the above Common-size Statement of Profit & Loss for the years ended 31st March, 2021 and
31st March, 2022, compute Gross Profit Ratio.

5
[Ans.:
Gross Profit Ratio 31st March, 2021 31st March, 2022
Gross Profit ` 2 ,50 ,000 ` 6 ,17 ,500
= ×100 = ×100 = ×100
Revenue from Operations `10 ,00 ,000 ` 7 ,50 ,000
= 25% = 32%
Gross Profit: ` `
Revenue from Operations 10,00,000 12,50,000
Less: Cost of Revenue from Operations 7,50,000 8,50,000
2,50,000 4,00,000
]

6
 CHAPTER 4 – ACCOUNTING RATIOS
Daily Practice Problems – (DPP):
 CHAPTER 4 – ACCOUNTING RATIOS
FAQ’s:
Question 1.
State how personal bias can get reflected in ratio analysis. (All India (C) 2011)
Answer:
In many situations, the accountant has to make the choice out of various alternatives available, e.g. choice
in the method of depreciation (straight line or written down), choice in the method of inventory valuation
(LIFO, FIFO or HIFO). Since the subjectivity is inherent in personal judgement, the financial statements
are therefore not free from personal bias. As a result, ratio analysis cannot be said to be free from bias.
Question 2.
State any two limitations of ratio analysis. (All India (C) 2010)
Answer:
The two limitations of ratio analysis are
• Accounting ratios ignore qualitative factors.
• Affected by personal bias and ability of the analyst.
Question 3.
What is meant by accounting ratios? (Delhi (C) 2010)
Answer:
An accounting ratio is a mathematical expression of the relationship between two items or group of items
shown in the financial statements.
Question 4.
State with reason whether repayment of long-term loan will result in increase, decrease or no change of
debt equity ratio. (All India 2012)
Answer:
Debt-equity ratio will decrease as repayment of long-term loan will reduce the long- term debt but the
shareholders’ funds will remain same.
Question 5.
A company had current assets ₹ 3,00,000 and current liabilities ₹ 1,40,000. Afterwards, it purchased goods
worth ₹ 20,000 on credit. Calculate the current ratio after the purchase of goods. (All India 2019)
Answer:
New current assets = 3,00,000 + 20,000
New current liabilities = 1,40,000 + 20,000 = ₹ 1,60,000
Current Ratio = Current assets
Current liabilities
= 320000
160000 = 2 : 1
Question 6.
From the following information calculate interest coverage ratio. Net profit after interest and tax ₹
1,20,000; Rate of income tax 40% ; 15% debentures ₹ 1,00,000; 12% mortgage loan ₹ 10,000. (All
India2019)
Answer:
Rate of tax 40%
Profit after tax = 100 – 40 = 60% and according to question profit after tax is ₹ 1,20,000.
So, profit before tax = 12000060 = 2,00,000 60%

Question 7.
What is meant by ‘profitability ratios’? (All India 2016)
Answer:
Profitability ratios measure the profitability of a business. Profitability ratios help in assessing the . overall
efficiency of the business. These ratios are calculated to analyse the earning capacity of the business which
is the outcome of utilisation of resources employed in the business. Various profitability ratios commonly
used to analyse the earning capacity of the business are gross profit ratio, net profit ratio, operating ratio,
return on investment, operating profit ratio.
Question 8.
The current ratio of Y Ltd is 2 : 1. State with reason, which of the following transactions would (a)
increase, (b) decrease or (c) not change the ratio
(i) Trade receivables included debtors of ₹ 40,000 which were received Company purchased furniture of ₹
45,000. The vendor was paid by issue of equity shares of ₹ 10 each at par (Delhi 2014)
Answer:
(i) Not change the ratio Simultaneous increase and decrease by same amount in current assets will not
affect the value of current assets or current liabilities, therefore, there is no effect on the current ratio.
(ii) Not Change the ratio Issue of shares for furniture purchased do not affect either current assets or current
liabilities. Therefore, current ratio will not be affected.
Question 9.
The quick ratio of Z Ltd is 1 : 1 State with reason which of the following transactions would (a) increase,
(b) decrease or (c) not change the ratio
(i) Included in the trade payables was a bills payable of ₹ 3,000 which was met on maturity.
(ii) Debentures of ₹ 50,000 were converted into equity shares. (Delhi 2014)
Answer:
(i) Not change the ratio Simultaneous decrease in both current assets and current liabilities will not affect
the quick ratio.
(ii) Not change the ratio Debentures converted into shares do not effect either quick assets or current
liabilities. Therefore, quick ratio will not be affected.
Question 10.
X Ltd has a current ratio of 3 : 1 and quick ratio of 2 : 1. If the excess of current assets over quick assets as
represented by inventory is ₹ 40,000, calculate current assets and current liabilities. (All India 2012)
Answer:
Let the current liabilities = x

Therefore, quick or liquid assets = 2x

Liquid Assets = Current Assets – Inventory
2x = 3x – 40,000
2x – 3x = -40,000
-x = -40,000
x = 40,000
Current Liabilities = ₹ 40,000
Current Assets = 3 × ₹ 40,000 = ₹ 1,20,000
Question 11.
OM Ltd has a current ratio of 3.5 : 1 and quick ratio of 2 : 1. If the excess of current assets over quick
assets as represented by inventory is ₹ 1,50,000, calculate current assets and current liabilities. Delhi 2012
Answer:
Solve as Q no. 7 on page 433.
Current Liabilities = ₹ 1,00,000
Current Assets = ₹ 3,50,000
Question 12.
On basis of the following information, calculate
(i) Debt equity ratio
(ii) Working capital turnover ratio. (Delhi 2011)

Information Amount
₹

Revenue from operations 60,00,000

Cost of revenue operations 45,00,000

Other current assets 11,00,000

Current liabilities 4,00,000

Paid-up share capital 6,00,000

6% debentures 3,00,000

9% loan 1,00,000

Debenture redemption
2,00,000
reserve

Closing inventory 1,00,000

Answer:
(i) Debt equity ratio

Long-term Debts = 6% Debentures + 9% Loan

= 300000 +100000 = ₹ 400000
Shareholders Funds = Paid-up Share Capital + Debenture Redemption Reserve
= 600000 + 200000 = ₹ 800000
(ii) Working Capital Turnover Ratio

*Working Capital = Current Assets** – Current Liabilities***

= 12,00,000 – 4,00,000
= ₹ 8 00 POO
**Current Assets = Other Current Assets + Closing Inventory
= 1100000 + 1,00,000
= ₹ 12,00,000
***Current Liabilities = ₹ 4,00,000
Question 13.
The quick ratio of a company is 2 : 1. State giving reasons, (for any four) which of the following would
improve, reduce or not change the ratio
(i) Purchase of machinery for cash
(ii) Purchase of goods on credit
(iii) Sale of furniture at cost
(iv) Sale of goods at a profit
(v) Cash received from debtors. (Delhi (C) 2011)
Answer:
(i) Purchase of Machinery for Cash:
Effect Reduce
Reason Purchase of machinery for cash will decrease the quick assets, but the current liabilities will remain
unchanged.
(ii) Purchase of Goods on Credit:
Effect Reduce
Reason Purchase of goods on credit will increase the current liabilities, but the quick assets will remain
unchanged.
(iii) Sale of Furniture at Cost:
Effect Improve
Reason Sale of furniture at cost will increase the quick assets, but the current liabilities will remain
unchanged.
(iv) Sale of Goods at a Profit:
Effect Improve
Reason Sale of goods at a profit will increase the quick assets, but the current liabilities will remain
unchanged.
(v) Cash Received from Debtors:
Effect No change
Reason Cash received from debtors will not change the quick assets because the quick assets are increased
and decreased with the same amount, and the current liabilities remain unchanged.
Question 14.
The debt equity ratio of a company is 1:1 state giving reasons, (any four) which of the following would
improve, reduce or not change the ratio
(i) Purchase of machinery for cash
(ii) Purchase of goods on credit
(iii) Sale of furniture at cost
(iv) Sale of goods at a profit
(v) Redemption of debentures at a premium (All India (C) 2011)
Answer:
(i) Purchase of Machinery for Cash:
Effect No change
Reason Neither the long-term debt nor the shareholders’ funds are affected by purchase of machinery for
cash.
(ii) Purchase of Goods on Credit:
Effect No change
Reason Neither the long-term debt nor the shareholders’ funds are affected by purchase of goods on credit.
(iii) Sale of Furniture at Cost:
Effect No change
Reason Neither the long-term debt nor the shareholders’ funds are affected by sell of furniture at cost.
(iv) Sale of Goods at a Profit:
Effect Reduce
Reason Shareholders’ funds are increased by the amount of profit on sale of goods, but the long-term debts
remain unchanged.
(v) Redemption of Debentures at a Premium:
Effect Reduce
Reason Redemption of debentures will reduce the long-term debts, but shareholders’ funds remain
unchanged. Here, it is assumed that premium payable on redemption of debenture is written-off through
existing securities premium reserve.
Question 15.
Assuming that the debt equity ratio is 2 : 1. State giving reasons whether this ratio would increase, decrease
or remain unchanged in the following cases. (Any four)
(i) Purchase of fixed assets on a credit of two months
(ii) Purchase of fixed assets on long-term deferred payment basis
(iii) Issue of new shares for cash
(iv) Issue of bonus shares
(v) Sale of fixed assets at a loss of ₹ 3,000. (Delhi All India 2010)
Answer:
(i) Purchase of Fixed Assets on a Credit of Two Months
Effect No change
’Reason Neither the long-term debt nor the shareholders’ funds are affected by purchase of fixed assets on
a credit of two months.
(ii) Purchase of Fixed Assets on a Long-term Deferred Payment Basis
Effect Increase
Reason The long-term debts are increased by the purchase of fixed assets on a long-term deferred payment
basis, but the shareholders’ fund remains unchanged.
(iii) Issue of New Shares for Cash:
Effect Decrease
Reason Shareholders’ funds are increased by the issue of new shares for cash, but the long-term debts
remain unchanged.
(iv) Issue of Bonus Shares:
Effect No change
Reason Shareholders’ funds increase and decrease by the same amount.
(v) Sale of Fixed Assets at a Loss of ₹ 3,000:
Effect Increase
Reason The shareholders’ funds will reduce by the amount of loss of 3,000, but the long-term debt remain
unchanged.
Question 16.
From the following information, calculate any two of the following ratios
(i) Current ratio
(ii) Debt equity ratio
(iii) Inventory turnover ratio
Information:
Revenue from operations (Net sales) ₹ 5,00,000, opening inventory ₹ 7,000, closing inventory ₹ 4,000
more than the opening inventory, net purchase ₹ 1,00,000 less than revenue from operations, operating
expenses ₹ 30,000, liquid assets ₹ 75,000, prepaid expenses ₹ 2,000, current liabilities ₹ 60,000, 9%
debentures ₹ 3,00,000, long-term loan from bank ₹ 1,00,000, equity share capital ₹ 10,00,000 and 8%
preference share capital ₹ 2,00,000. (Delhi 2010)
Answer:
(i) Current ratio = Current Assets
Current Liabilities
= 88000
60000 = 1.47 : 1
‘Current Assets = Liquid Assets + Closing Inventory** + Prepaid Expenses
= 75000 + 11000 + 2000
= ₹ 88000
Closing Inventory = Opening Inventory + 4,000
= 7000 + 4000 = ₹ 11000

‘Long-term Debts = 9% Debentures + Long-term Loan from Bank

= 3,00,000 +1,00000 = ₹ 400000
‘‘Shareholders’ Funds = Equity Share Capital + Preference Share Capital
= 1000000 + 200000 = ₹ 1200000

‘Cost of Revenue from Operations = Opening Inventory + Net Purchases – Closing Inventory
= 7000 + (500000 -100000) -11000 = ₹ 3,96000

Question 17.
From the following information, calculate any two of the following ratios
(i) Liquid ratio
(ii) Gross profit ratio
(iii) Debt equity ratio
Information:
Revenue from operations (Net sales) ₹ 4,00,000, opening inventory ₹ 10,000, closing inventory ₹ 3,000
less than the opening inventory, net purchase 80% of revenue from operations, direct expenses ₹ 20,000,
current assets ₹ 1,00,000, prepaid expenses ₹ 3,000, current liabilities ₹ 60,000, 9% debentures ₹ 4,00,000,
long-term loan from bank ₹ 1,50,000, equity share capital ₹ 8,00,000 and 8% preference share capital ₹
3,00,000. (All India (c) 2010)
Answer:

Closing Inventory = Opening Inventory – 3,000 = 10000 – 3000 = ₹ 7000

Net Purchases = 80% of Revenue from Operations = 400000 × 80100 = ₹ 3,20000

Cost of Revenue from Operations = Opening Inventory + Net Purchases + Direct Expenses – Closing
Inventory
= 10000 + 3,20000 + 20000 – 7000 = ₹ 3,43000
‘Gross Profit = Revenue from Operations – Cost of Revenue from Operations
= 400000 – 3,43000 = ₹ 57000

‘Long-term Debts = 9% Debentures + Long-term Loan from Bank

= 400000 + 1,50000 = ₹ 550000
“Shareholders’ Funds = Equity Share Capital + 8% Preference Share Capital
= 800000 + 300000 = ₹ 1100000

Question 18.
Quick ratio of a company is 1 : 1. State, with reason, whether the following transactions will increase,
decrease or not change the ratio
(i) Paid insurance premium in advance ₹ 10,000.
(ii) Purchased goods on credit ₹ 8,000.
(iii) Issued fully paid equity shares of ₹ 1,00,000.
(iv) Issued 9% debentures of ₹ 5,00,000 to the vendor for machinery purchased. (All India 2019)
Am. (i) Decrease
As payment of insurance premium will decrease the quick assets.
(ii) Decrease
As purchase of goods on credit will increase the current liabilities.
(iii) Increase
As issue of equity shares will increase quick assets.
(iv) No change
As issue of debentures to vendor of machinery would have no impact on quick assets and current liabilities.
Question 19.
From the following information of Shiva Ltd, calculate total assets to debt ratio (All India 2019)

Information Amount ₹

Equity Share Capital 5,00,000

9% Preference Share Capital 4,00,000

Fixed Assets 12,00,000

Non-current Investments 1,50,000

 Reserves and Surplus 2,40,000

Current Assets 1,90,000

Current Liabilities 1,00,000

Answer:
Total Assets = Fixed Assets + Non-current Investments + Current Assets = 12,00,000 + 1,50,000 +
1,90,000 = ₹ 15,40,000
Now, Total Liabilities = Total Assets
“Equity Share Capital + 9% Preference Share Capital + Reserve and Surplus + Non-current Liabilities
(Debt) + Current Liabilities = ₹ 15,40,000
5,00,000 + 4,00,000 + 2,40,000 + 1,00,000 + Non-current Liabilities = ₹ 15,40,000
Non-current Liabilities (Debt) = 15,40,000 -12,40,000 = ₹ 3,00,000
Now, Total Assets to Debt Ratio = Total Assets = 1540000 = 5.133 : 1
Debt 300000
Question 20.
(a) Calculate revenue from operations of BN Ltd. From the following information

Current assets ₹ 8,00,000

Quick ratio is 1.5 : 1

Current ratio is 2:1

Inventory turnover ratio is 6 times

(b) The operating ratio of a company is 60%. State whether ‘Purchase of goods costing ₹ 20,000’ will
increase, decrease or not change the operating ratio. Qalhi 2019
Answer:
(a) Current assets = ₹ 800000

Quick Assets = ₹ 600,000

Inventory = Current Assets – Quick Assets
= 800000 – 600000 = ₹ 200000

Cost of Revenue from Operations = ₹ 12,00,000

Profit = 25% on cost = 12,00,000 × 25% = ₹ 3,00,000
Revenue from Operations = 12,00,000 + 3,00,000 = ₹ 15,00,000
(b) No Change
As purchase of goods will increase operating cost as well as cost of goods sold.
Question 21.
(a) Calculate ‘Total assets to debt ratio’ from the following information

Information Amount
₹

Equity Share Capital 4,00,000

Long-term Borrowings 1,80,000

Surplus, i.e. Balance in Statement of Profit and Loss 1,00,000

General Reserve 70,000

Current Liabilities 30,000

Long-term Provisions 1,20,000

(b) The debt equity ratio of a company is 1 : 2. State whether ‘Issue of bonus shares’ will increase, decrease
or not change the debt equity ratio. (Delhi 2019)
Answer:
(a) Total Liabilities = Equity Share Capital + Long-term Borrowings + Surplus + General Reserve +
Current Liabilities + Long-term Provisions
= 4,00,000 + 1,80,000 + 100000 + 70,000 + 30,000 + 1,20,000 = ₹ 900,000
Total Assets = Total Liabilities = ₹ 900000
Long-term Debt = Long-term Borrowings + Long-term Provisions
= 100000 + 1,20000 = ₹ 300000
Total Assets to Debt Ratio = Total Assets = 900000 = 3 : 1
Long term Debt 300000
(b) Decrease
As issue of bonus shares will increase the shareholders’ funds/equity.
Question 22.
The operating ratio of a company is 80%. State whether the following transactions will increase, decrease
or not change the ratio
(i) Purchased goods on credit ₹ 20,000
(ii) Paid wages ₹ 5,000
(iii) Redeemed ₹ 8,000, 9% debentures
(iv) Sold goods ₹ 50,000 for cash. (All Indio 2019)
Answer:
(i) Purchased goods on credit ₹ 20,000
⇒ No change
As both purchase and closing stock will increase, so there will be no effect on cost of goods sold.
(ii) Paid wages ₹ 5,000
⇒ Increase
As wages paid will increase the operating cost.
(iii) Redeemed ₹ 8,000, 9% Debentures
⇒ No change
As redemption of debentures is a non-operating activity.
(iv) Sold goods ₹ 50,000 for cash
⇒ Decrease
As goods sold will increase the net sales.
Question 23.
From the following information obtained from the books of Kundan Ltd, calculate the inventory turnover
ratio for the years 2015-16 and 2016-17.

Particulars 2015-16 2016-17

(₹) (₹)

Inventory on 31st March 700000 1700000

Revenue from
5000000 7500000
Operations

(Gross profit is 25% on cost of revenue from operations)

In the year 2015-16, inventory increased by ₹ 2,00,000. (CBSE 2018)
Answer:
For 2015-16

Question 24.
Y Ltd’s profits after interest and tax was ₹ 1,00,000. Its current assets were ₹ 4,00,000 current liabilities ₹
2,00,000; fixed assets ₹ 6,00,000 and 10% long-term debt ₹ 4,00,000. The rate of tax was 20%. Calculate
‘Return on Investment of Y Ltd. (Comportment 2018)
Answer:

Working Capital = Current Assets – Current Liabilities

= 400000 – 200000 = ₹ 200000
Capital Employed = Fixed Assets + Working Capital
= 600000 + 200000
= ₹ 800000
Return on Investment

Question 25.
A company earn gross profit 25% on cost. For the year ended 31st March, 2017 its gross profit was ₹
5,00,000; equity share capital of the company was ₹ 1,00,00,000; reserves and surplus ₹ 2,00,000; long-
term loan ₹ 3,00,000 and non-current assets were ₹ 10,00,000.
Compute the ‘working capital turnover ratio of the company. (Comportment 2018)
Answer:
Gross Profit = 25% on cost
Gross profit ₹ 500000
∴ Revenue from Operation = 12525 × 500000
= ₹ 25,00,000
Working Capital = Equity Share Capital + Reserve and Surplus + Long-term Loan – Non-current Assets
= 1000000 + 200000 + 300000 -1000000 = ₹ 500000
Working Capital Turnover Ratio

Question 26.
The proprietary ratio of M Ltd is 0.80 : 1.
State with reasons whether the following transactions will increase, decrease or not change the proprietary
ratio
(i) Obtained a loan from bank ₹ 2,00,000 payable after five years.
(ii) Purchased machinery for cash ₹ 75,000
(iii) Redeemed 5% redeemable preference shares ₹ 1,00,000.
(iv) Issued equity shares to the vendors of machinery purchased for ₹ 4,00,000. (All India 2017)
Answer:
(i) Decrease Loan obtained from bank will increase the total assets but the shareholders’ funds will remain
the same, so proprietary ratio will decrease.
(ii) No change Machinery purchased for cash will increase and simultaneously decrease the total assets
therefore proprietary ratio will remain unchanged.
(iii) Decrease Redemption of preference shares will decrease total assets and shareholders’ funds
simultaneously, so proprietary ratio will decrease.
(iv) Increase Machinery purchased by issue of equity shares will increase total assets and shareholders’
funds simultaneously, so proprietary ratio will increase.

Question 27.
The quick ratio of a company is 0.8 : 1. State with reason whether the following transactions will increase,
decrease or not change the quick ratio
(i) Purchase of loose tools ₹ 2,000.
(ii) Insurance premium paid in advance ₹ 500.
(iii) Sale of goods on credit ₹ 3,000.
(iv) Honoured a bills payable ₹ 5,000 on maturity. (Delhi 2017)
Answer:
(i) Decrease Purchasing loose tools will decrease the current assets but the current liabilities will remain
unaffected, so quick ratio will decrease.
(ii) Decrease Insurance premium paid in advance will decrease the current assets but the current liabilities
will remain unaffected, so quick ratio will decrease.
(iii) Increase Goods sold on credit will increase the quick ratio as current liabilities will remain unchanged
and quick assets will increase, so quick ratio will increase.
(iv) Decrease Bills payable honoured on maturity will decrease the quick assets and current liabilities
simultaneously, so quick ratio will decrease.
Question 28.
(i) What is meant by ‘activity ratios’?
(ii) From the following information calculate inventory turnover ratio, revenue from operations ₹
16,00,000, average inventory ₹ 2,20,000, gross loss ratio 5%. (All India 2016)
Answer:
(i) Activity ratios show how efficiently a company is using its assets to generate sales. These ratios express
the number of times assets employed or for that matter, any constituents of assets, is turned into sales
during an accounting period. These ratios are also known as turnover ratios or performance ratios. These
ratios are calculated on the basis of sales or cost of sales. The various activity ratios are inventory turnover
ratios, trade receivables or debtors turnover ratio, trade payables or creditors turnover ratio, working capital
turnover ratio.
(ii) Inventory Turnover Ratio

⇒ Gross Loss = 5% of 16,00,000 = ₹ 80,000

Cost of Revenue from Operations = Revenue from Operations + Gross Loss
= 16,00,000 + 80,000 = ₹ 16,80,000
Question 29.
(i) What is meant by ‘solvency of business?
(ii) From the following details obtained from the financial statements of Jeev Ltd, calculate interest
coverage ratio Net profit after tax ₹ 1,20,000 12% long-term debt ₹ 20,00,000 Tax rate 40% (Delhi 2016)
Answer:
(i) Solvency of a business means the ability of business to pay off its long-term liabilities. Solvency ratios
such as debt equity ratio, total ‘assets to debt ratio, interest coverage ratio etc are some of the important
solvency ratios that help the investors to know about the credibility of business and accordingly take
rational investment decisions. Better the solvency position of the business, the better the market standing of
such firms.
(ii) Interest Coverage Ratio

Calculation of net profit before interest and tax Net profit after tax = 1,20,000; Tax = 40%
If profit after tax is 60, profit before tax is 100 and if profit after tax is ₹ 1,20300
Profit before tax would be
= 10060 × 1,20300 = ₹ 2,00,000
Interest on long-term debt
= 2,00,000 × 12% = ₹ 2,40,000
Therefore, Profit before interest and tax = 2,00,000 + 2,40,000 = ₹ 4,40,000
Question 30.
(i) What is meant by ‘profitability of business’?
(ii) From the following information, calculate operating profit ratio.
Opening stock ₹ 10,000, purchases ₹ 1,20,000, revenue from operations ₹ 4,00,000, purchase returns ₹
5,000, returns from revenue from operations ₹ 15,000, selling expenses ₹ 70,000, administrative expenses ₹
40,000, closing stock ₹ 60,000. (Delhi 2016)
Answer:
(i) Profitability is the basic objective of every business. Profitability is the measure of efficiency and
success of the business. It is related to the income of the business, i.e. how much a concern is earning in
relation to the capital invested by it. The various ratios which helps to measure the profitability of a
business are gross profit ratio, net profit ratio, operating ratio etc. All these ratios are used to assess a
business ability to generate earnings as compared to its expenses and other relevant cost during a specific
period of time.
(ii) Operating Profit Ratio

‘Operating Profit = Revenue from Operations** – Cost of Revenue from Operations (Opening stock +
Purchases – Closing stock) – Selling Expenses – Administrative Expenses
= 3,85,000 – [10800 +1,15,000 (1,20000 – 5000) – 60000] – 70,000 – 40000
= 385000 – 65000 – 70000 – 40000 = ₹ 2,10,000
“Revenue from Operations = Revenue from Operations – Returns from Revenue from Operations
= 400000 -15000 = ₹ 385000
Question 31.
(i) What is meant by “liquidity of business’?
(ii) From the following information calculate operating ratio
Revenue from operations ₹ 7 6,80,000, rate of gross profit on cost 25%, selling expenses ₹ 1,44,000,
administrative expenses ₹ 73,000. (Delhi 2016)
Answer:
(i) Liquidity of business refers to the ability of the firm to meet its short-term obligations. It’s the ability of
an organisation to meet its current financial obligations. Liquidity ratios measure the ability of a company
to meet its short-term debt obligations. The various liquidity ratios used for this purpose are current ratio
and acid test ratio/quick ratio.

Operating Cost = Cost of Goods Sold + Operating Expenses

= 5,44000 + 1,44000 + 73000 = ₹ 781000
Gross profit = 1/4 on cost Or 1/5 on sales = 1/5 × 680000 = ₹ 136000
Let cost of goods sold be = x ⇒ 136000 = 1/4 × x ⇒ x = ₹ 5,44,000
NOTE: Operating expenses include selling and administrative expenses.
Question 32.
(i) From the following, calculate ‘Trade receivables turnover ratio”.
Total revenue from operations for the year – ₹ 8,40,000
Cash revenue from operations – 40% of credit revenue from operations
Closing trade receivables – ₹ 2,00,000
Excess of closing trade receivables over opening trade receivables ₹ 80,000
(ii) From the following information calculate ‘Interest coverage ratio’
Profit after interest and tax – ₹ 4,97,000
Rate of income tax – 30%
12% debentures – ₹ 6,00,000 (All India (C) 2016)
Answer:

Let, credit revenue from operations be x

Cash revenue from operations be x × 40% = 0.4x
Total Revenue from Operations = Cash Revenue from Operations + Credit Revenue from Operations
8,40,0 = 0.4x + x
8,40,000 = 14x
‘Credit revenue from operations ⇒ x ⇒ 6,00,000
Average Trade Receivables

Opening trade receivables

= 200000 – 80,000 = ₹ 1,20,000
(ii) Interest Coverage Ratio

Question 33.
From the given information calculate the following
(i) Cost of revenue from operations
(ii) Opening and closing inventory
(iii) Quick assets
(iv) Current assets
Information Inventory turnover ratio 6 times, inventory at the end is ₹ 6,000 more than the inventory in the
beginning, revenue from operations (all credits) ₹ 2,40,000, Gross profit 25% on cost, current liabilities ₹
80,000, quick ratio 080 : 1. (Delhi (C) 2016)
Answer:
(i) Let cost be 100
Gross profit be = 25
Revenue from operations = 100 + 25 = 125
Revenue from operations (all credits) = 2,40,000
∴ Cost of revenue from operations
= 2,40,000 × 100125
Cost of revenue from operations = ₹ 1,92,000
(ii) Let opening inventory be = x
Closing inventory be = x + 6000
Average Inventory
= x+x+60002=2x+6,0002 = x + 3000
Inventory Turnover Ratio
Cost of Revenue from Operations

6x + 18,000 = 1,92,000
6x = 1,92,000 – 18,000
x = 1740006 = 29,000
‘Opening inventory ⇒ x ⇒ 29,000 = x + 6,000
Closing inventory = 29,000 + 6,000 = ₹ 35,000

Quick Assets = ₹ 64,000

(iv) Current Assets = Quick Assets + Inventory
= 64,000 + 35,000
Current Assets = ₹ 99,000
Question 34.
The current ratio of a company is 2.1 : 1.2. State with reasons which of the following transactions will
increase, decrease or not change the ratio
(i) Redeemed 9% debentures of ₹ 1,00,000 at a premium of 10%.
(ii) Received from debtors ₹ 17,000.
(iii) Issued ₹ 2,00,000 equity shares to the vendors of machinery.
(iv) Accepted bills of exchange drawn by the creditors ₹ 7,000. (All India 2015)
Answer:
(i) Decrease Current assets will decrease because of outflow of cash but current liabilities will remain
unchanged therefore current ratio will decrease.
(ii) Not change the ratio Simultaneous increase and decrease in the value of current assets i.e. cash and
debtors by the same amount will not affect the ratio.
(iii) Not change the ratio Issue of shares for purchase of machinery do not effect either current assets or
current liabilities, therefore current ratio will not be effected.
(iv) Not change the ratio In this case one current liability (i.e. creditors) is getting converted into another
current liability (i.e. bills payable), therefore current ratio will not be effected.

Question 35.
From the following information related to Naveen Ltd, calculate (i) Return on investment (ii) Total assets
to debt ratio. Information Fixed assets ₹ 75,00,000; current assets ₹ 40,00,000; current liabilities ₹
27,00,000; 12% debentures ₹ 80,00,000 and net profit before interest, tax and dividend ₹ 14,50,000. (Delhi
2015)
Answer:
(i) Return on Investment
Net Profit before Interest,
Capital Employed = Fixed Assets + Currents Assets – Current Liabilities
= 75,00,000 + 40,00,000 – 27,00,000 = ₹ 88,00,000
(ii) Total Assets to Debt Ratio = Total Assets = 1,15,00,000 = 1.44 : 1
Debt 80,00,000
*Total Assets = Fixed Assets + Current Assets = 7500000 + 4000000 = ₹ 1,15,00,000
Question 36.
The current ratio of a company is 2.5 : 1.5. State with reasons which of the following transactions will
increase, decrease or not change the ratio
(i) Discounted a bills receivable of ₹ 10,000 from bank. Bank charged discount of ₹ 200.
(ii) A bill receivable ₹ 8,000 discounted with bank was dishonoured.
(iii) Cash deposited into bank 7,000.
(iv) Paid cash ₹ 5,000 to the creditors. (Foreign 2016)
Answer:

Effect Explanation

Discounting a bills receivable from bank reduces asset by ₹ 10,000 (bills receivable) and
(i) Decrease
increases asset by ₹ 9,800 (bank balance).

Dishonour of discounted bills receivable results in increase in asset (debtors) and

(ii) No change
decrease in asset (bank) with the same amount.

Increase in one current asset (bank) with a simultaneous decrease in other current asset
(iii) No change
(cash) with the same amount leaves current ratio unaffected.

Payment of current liabilities (creditors) will improve the current ratio from 1.67 (2.5 :
(iv) Increase
1.5) to 2 (2 : 1).

Question 37.
From the following information, calculate total assets to debt ratio

Information Amt (₹)

Capital Employed 25,00,000

Investments 2,10,000

Land 8,50,000

Trade Receivables 2,75,000

Cash and Cash Equivalents 1,50,000

Equity Share Capital 14,30,000

 8% Debentures 4,00,000

Capital Reserve 2,75,000

Surplus, i.e. Balance in Statement of Profit and

1,50,000
Loss

Answer:
Total Assets to Debt Ratio = Total Assets =1485,000 = 2.30 : 1
Debt 6,45,000
Total Assets = Investments + Land + Trade Receivables + Cash and Cash Equivalent
= 2,10000 + 8,50,000 + 2,75,000 + 1,50,000 = ₹ 14,85,000
Debt = Capital Employed – (Equity share capital + Reserves + Surplus)
= 25,00,000 – 18,55,000 (1430,000 + 2,75000 + 130000)
= ₹ 6,45,000
Question 38.
With the help of the following information, calculate return on investment. Net profit after interest and tax
₹ 6,00,000; 10% debentures ₹ 10,00,000; tax @ 40%; capital employed ₹ 80,00,000. (Delhi (C) 2015)
Answer:
Return on Investment

Question 39.
From the following calculate the ‘gross profit ratio’ and ‘working capital turnover ratio’ (Delhi (C) 2014)

Information Amount (₹)

Revenue from Operations 30,00,000

Cost of Revenue from Operations 20,00,000

Current Assets 6,00,000

Current Liabilities 2,00,000

Paid-up Share Capital 5,00,000

Answer:
(i) Gross Profit Ratio

*Gross Profit = Revenue from Operations – Cost of Revenue from Operations

= 3000000 – 2000000 = ₹ 1000000
(ii) Working Capital Turnover Ratio

‘Working Capital = Current Assets – Current Liabilities

= 600000 – 200000 = ₹ 400000
Question 40.
(i) From the following information, compute ‘debt equity ratio’

Items Amount (₹)

Long-term Borrowings 2,00,000

Long-term Provisions 1,00,000

Current Liabilities 50,000

Non-current Assets 3,60,000

Current Assets 90,000

(ii) The current ratio of X Ltd is 2 : 1.

State with reason which of the following transaction would increase, decrease or not change the ratio
(a) Included in the trade payables was a bills payable of ₹ 9,000 which was met on maturity.
(b) Company issued 1,00,000 equity shares of ₹ 10 each to the vendors of machinery purchased. (Delhi
2014)
Answer:
(i) Debt Equity Ratio

‘Long-term Debt = Long-term Borrowings + Long-term Provisions

= 200000 +100000 = ₹ 300000
“Shareholders’ Funds = Total Assets – Total Liabilities
= 4,50,000 – 3,50,000 = ₹ 1,00,000
Total Assets = Non-current Assets + Current Assets
= 300000 + 90000 = ₹4,50,000
Total Liabilities = Long-term Borrowings + Long-term Provisions + Current Liabilities
= 200000 +100000 + 50000 = ₹ 300000
(ii) (a) Increase in the ratio Simultaneous decrease in both current assets and current liabilities, i.e. cash and
trade payable will increase the current ratio.
(b) No change in the ratio Issue of shares for machinery purchased do not affect either current assets or
current liabilities, therefore, the current ratio will not be affected.

Question 41.
(i) The quick ratio of a company is 1.5 : 1. State with reason which of the following transactions would
increase, decrease or not change the ratio
(a) Paid rent ₹ 3,000 in advance.
(b) Trade receivables included a debtor Shri Ashok who paid his entire amount due ₹ 9,700.
(ii) From the following information compute ‘proprietary ratio’ (All India 2014)

Information Amount (₹)

Long-term Borrowings 2,00,000

Long-term Provisions 1,00,000

Current Liabilities 50,000

Non-current Assets 3,60,000

Current Assets 90,000

Answer:
(i) (a) Not change the ratio:
Reason As there is a simultaneous increase and decrease in current assets by the same amount, i.e. prepaid
expenses and cash, therefore it will not affect the value of current assets.
(b) Not change the ratio:
Reason As there is a simultaneous increase and decrease in current assets by the same amount, i.e. cash and
trade receivables, therefore it will not affect the value of current assets.
(ii) Proprietary Ratio:
Question 42.
From the following calculate
(i) Operating profit ratio
(ii) Working capital turnover ratio. (All India (C) 2014)

Information Amount (₹)

Revenue from Operations 2,00,000

Gross Profit 75,000

Office Expenses 15,000

Selling Expenses 26,000

Interest on Debentures 5,000

Accidental Losses 12,000

Income from Rent 2,500

Commission Received 2,000

Current Assets 60,000

Current Liabilities 10,000

Answer:
(i) Operating Profit Ratio

Operating Profit = Gross Profit – Other Operating Expenses + Other Operating Incomes
= 75,000 – 41,000 + 2,000
= ₹ 36,000
Other Operating Expenses = Office Expenses + Selling Expenses
= 15,000 +26,000
= ₹ 41,000
Other Operating Incomes = Commission
Received
= ₹ 2,000
(ii) Working Capital Turnover Ratio
‘Working Capital = Current Assets – Current Liabilities
= 60,000 – 10,000 = ₹ 50,000
Question 43.
From the following, calculate
(a) Current ratio; and (b) Working capital turnover ratio

Particulars Amount (₹)

Revenue from Operations 1,50,000

Total Assets 1,00,000

Shareholders’ Funds 60,000

Non-current Liabilities 20,000

Non-current Assets 50,000

Answer:

Total Assets = Current Assets + Non-current Assets

1,00,000 = Current Assets + 50,000
Current Assets = 100,000 – 50000 = ₹ 50000
Current liabilities = Total Assets – Shareholders Funds – Non-current Liabilities
= 100000 – 60000 – 20000 = ₹ 20000

Working Capital = Current Assets – Current Liabilities = 50000 – 20000 = ₹ 30,000

Question 44.
(i) Compute ‘debtors turnover ratio’ from the following information
Revenue from operations (Total sales) ₹ 5,20,000, cash revenue from operations 60% of the credit revenue
from operations, closing debtors ₹ 80,000, opening debtors are 3/4th of closing debtors.
(ii) Current liabilities of a company are ₹ 1,60,000. Its liquid ratio is 1.5 : 1 and current ratio is 2.5 : 1.
Calculate quick assets and current assets. (All India 2013)
Answer:

Let Credit revenue from operations be y

Cash revenue from operations = 60% of credit revenue from operations Revenue from Operations = Cash
Revenue from Operations + Credit Revenue from Operations
5,20,000 = 60% of y + y
5,20,000 = 0.6y + y
Quick Assets = 1.5 × 1,60,000 = 2,40,000

Current Assets = 1,60,000 × 2.5 = ₹ 4,00,000

Question 45.
(i) Compute ‘working capital turnover ratio’ from the following information
Cash revenue from operations ₹ 1,30,000, credit revenue from operations ₹ 3,80,000, returns from revenue
from operations ₹ 10,000, liquid assets ₹ 1,40,000, current liabilities ₹ 1,05,000 and inventory ₹ 90,000.
(ii) Calculate ‘debt equity ratio’ from the following information
Total assets ₹ 3,50,000, total debt ₹ 2,50,000 and current liabilities ₹ 80,000. (Delhi 2013)
Answer:

Revenue from Operations = Cash Revenue from Operations + Credit Revenue from Operations – Returns
from Revenue from Operations
= 130,000 + 3,80,000 – 10,000
= ₹ 5,00,000
Current Assets = Liquid Assets + Inventory = 1,40,000 + 90,000 = ₹ 230,000
Working Capital = Current Assets – Current Liabilities = 2,30,000 – 1,05,000 = ₹ 1,25,000

Long-term Debt = Total Debts – Current Liabilities

= 2,50,000 – 80,000
= ₹ 1,70,000
Equity or Shareholders’ Funds = Total Assets – Total Debt
= 3,50,000 – 2,50,000
= ₹ 1,00,000

Question 46.
From the following information, calculate any two of the following ratios
(i) Debt equity ratio
(ii) Working capital turnover ratio
(iii) Return on investment
Information Equity share capital ₹ 10,00,000, general reserve ₹ 1,00,000, balance of statement of profit and
loss after interest and tax ₹ 3,00,000, 12% debentures ₹ 4,00,000, creditors ₹ 3,00,000, land and buildings ₹
13,00,000, furniture ₹ 3,00,000, debtors ₹ 2,90,000, cash ₹ 1,10,000.
Revenue from operations, i.e. sales for the year ended 31st March, 2011 was ₹ 30,00,000. Tax paid is 50%.
(All India 2012: Modified)
Answer:
Long-term debts = 12% debentures = 4,00,000
Shareholders’ Funds = Equity Share Capital + General Reserve + Balance of Statement of Profit and Loss
= 10,00,000 +1,00,000 + 3,00,000 = ₹ 14,00,000

Working Capital = Current Assets – Current Liabilities = 4,00,000 – 3,00,000 = ₹ 1,00,000

Current Assets = Cash + Debtors = 1,10,000 + 2,90,000 = ₹ 4,00,000
Current Liabilities = Creditors = ₹ 3,00,000

Profit before Interest and Tax = 6,00,000 + 48,000 (Interest on debentures) = ₹ 6,48,000
Capital Employed = Equity Share Capital + General Reserve + Balance in Statement of Profit and Loss +
12% Debentures
= 10,00,000 + 1,00,000 + 3,00,000 + 4,00,000
= ₹ 18,00,000
Question 47.
From the following information, calculate any two of the following ratios
(i) Debt equity ratio
(ii) Working capital turnover ratio
(iii) Return on investment
Information Equity share capital ₹ 50,000; general reserve 15,000; statement of profit and loss after tax and
interest ₹ 15,000; 9% debenture ₹ 20,000; creditors ₹ 15,000; land and building ₹ 65,000; equipment ₹
15,000; debtors ₹ 14,500 and cash ₹ 5,500; revenue from operations for the year ended 31st March, 2011
was ₹ 50,000. Tax rate 50%. (Delhi 2012 (Modified))
Answer:
Solve as Q no. 43 as page 448 and 449.
Debt Equity Ratio = 0.286 : 1 Working Capital Turnover Ratio = 30 times; Return on Investment = 35.33%
Question 48.
Cross-sectional analysis is related
(a) to take a correct action
(b) to compare firm’s present ratio with past
(c) to compare of a firm ratio with other
(d) None of the above
Answer:
(c) to compare of a firm ratio with other
Question 49.
Current ratio is

Answer:
(b)
Question 50.
Working capital is the
(a) difference between current assets and current liabilities
(b) difference between current assets and quick liabilities
(c) capital and liabilities difference
(d) cash and bank difference
Answer:
(a) difference between current assets and current liabilities

Question 51.
From the following, calculate current assets?
Cash balance – ₹ 5,000
Trade payable – ₹ 40,000
Inventory – ₹ 50,000
Trade receivable – ₹ 65,000
Prepaid expenses – ₹ 10,000
Creditors – ₹ 30,000
(a) ₹ 1,25,000
(b) ₹ 1,30,000
(c) ₹ 1,60,000
(d) ₹ 1,20,000
Answer:
(b) ₹ 1,30,000
Question 52.
If inventory is ₹ 1,00,000, current assets ₹ 8,00,000 and current liabilities ₹ 4,00,000, then what will be the
liquid ratio?
(a) 1.75 : 1
(b) 2 : 1
(c) 2 : 3
(d) 3 : 1
Answer:
(a) 1.75 : 1
Question 53.
Which of the following transaction will improve the quick ratio?
(a) Purchase of inventory for cash
(b) Cash collected from debtors
(c) Sale of goods (costing 10,000 for ₹ 50,000)
(d) None of the above
Answer:
(c) Sale of goods (costing 10,000 for ₹ 50,000)
Question 54.
A firm has current ratio of 4 : 1 and quick ratio of 2.5 : 1. Assuming inventories are ₹ 15,000, find out total
current assets?
(a) ₹ 10,000
(b) ₹ 25,000
(c) ₹ 40,000
(d) ₹ 15,000
Answer:
(c) ₹ 40,000
Question 55.
Ideal debt ratio is
(a) 1 : 2
(b) 2 : 2
(c) 3 : 2
(d) 2 : 1
Answer:
(d) 2 : 1
Question 56.
Assuming that debt to equity ratio is 2 : 1, then which of the following transaction will have no effect on it?
(a) Purchase of a fixed assets by taking loan
(b) Sale of fixed assets (book value ₹ 40,000) at loss of 15,000
(c) Issue of bonus share
(d) Declaration of final dividend
Answer:
(c) Issue of bonus share
Question 57.
Calculate the interst coverage ratio
If profit after interest and tax ₹ 2,10,000, Rate of tax 40% 15% debenture ₹ 3,00,000.
(a) 6 times
(b) 8.8 times
(c) 11 times
(d) 4 times
Answer:
(b) 8.8 times
Question 58.
A firm’s current assets are ₹ 1,60,000, current ratio is 2 : 1, cost of revenue from operations is 2,40,000, its
working capital turnover ratio will be
(a) 3 times
(b) 2 times
(c) 4 times
(d) 8 times
Answer:
(a) 3 times

Question 59.
From the following information, calculate operating profit ratio.
Opening stock ₹ 10,000; purchases ₹ 1,20,000; revenue from operations ₹ 4,00,000; purchase returns ₹
5,000; returns from revenue from operations ₹ 15,000; selling expenses ₹ 70,000; administrative expenses
₹ 40,000; closing stock ₹ 60,000.
(a) 54.5%.
(b) 62.8%.
(c) 90.2%.
(d) None of the above
Answer:
(a) 54.5%

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 Other Alternate Accounting Terms / Terminologies
S.No Particulars Other Name
1 Liquid Assets Quick Assets
2 Quick Ratio Acid Test Ratio / Liquid Ratio
3 Non-Current Assets Fixed Assets
4 Revenue From Operations Net Sales
5 Cost of Revenue from Operations Cost of Goods Sold - COGS
6 Prepaid Expenses Unexpired Expenses
7 Stock Inventory / Goods
8 Proprietors' Funds Shareholders' Funds / Equity
9 Accrued Income Income Earned but not Received
10 Income Received in Advance Unearned Income
11 Provision for Depreciation A/c Accumulated Depreciation A/c
12 Short Term Debt Current Liability
13 Equity Shareholders’ Funds / Share Capital
14 Trade Receivable Debtors + Bills Receivable
15 Average Trade Receivable Closing Trade Receivable
16 Net Working Capital Working Capital
17 33 1/3 % 100/3 % or 1/3
18 Operating Cost Ratio Operating Ratio
19 Return on Investment (ROI) Return on Capital Employed
20 Net Assets Turnover Ratio Capital Employed Turnover Ratio