& BYJU'S NCERT Solutions for Class 12 Accountancy Chapter 5 — Tha Learning Aon ‘Accounting Ratios Short Questions for NCERT Accountancy Solutions Part 2 Class 12 Chapter 5 1, What do you mean by Ratio Analysis? itis a quantitative analysis of data present in a financial statement. It shows the relationship between items present in the Balance sheet and the Income Statement. It helps in calculating operational efficiency and solvency and in determining the profitability of a firm. Ratio is a statistical measure which helps in comparing relationships between two or more figures. Analyzing ratios presents vital pieces of information to accounting users about the firm's financial position, performance and viability. It also helps in setting up new policies and frameworks by the management. 2. What are the various types of ratios? Ratios can be classified into two types: 1. Traditional Classification 2. Functional Classification Traditional Classification: Traditional classification is based on financial statements such as Balance sheets and P & L accounts. The ratios are divided on the basis of accounts of financial statements and are as follows: i. Income Statement Ratios such as Gross Profit Ratios ii, Balance Sheet Ratios such as Debt Equity Ratio, Current Ratio ii, Composite Ratio: Ratios that contain elements from both Trading and P & L Account. Functional Classification: These ratios are based on the functional need of calculating ratios. This ratio helps calculate the solvency, liquidity, profitability and financial performance of a business. Such ratios are: i. Liquidity Ratio: Ratios used to determine the solvency of short term ii, Solvency Ratio: Ratios used to determine the solvency of long term ii, Activity Ratio: Ratios used for determining the operating efficiency of the business. These ratios are related to sales and the cost of goods sold.8 BYJU'S NCERT Solutions for Class 12 Accountaney Chapter 5 — The Learning App Accounting Ratios iv. Probability Ratio: Ratios used to determine the financial performance and viability of the firm, 3. What relationships will be established to study: a. Inventory Turnover b. Trade Receivables Turnover c. Trade Payables Turnover . Working Capital Turnover a. Inventory Turnover Ratio: This ratio is a relationship between the cost of goods sold and the average inventory maintained during a particular time period. It determines the efficiency with which a firm is able to manage its inventory. Cost of Goods Sold Inventory /Stock Turnover Ratio = <7 Cost of Goods Sold = Opening Stock + Purchases + Direct Expenses — Closing Stock or, Cost of Goods Sold = Net Sales— Gross Profit Opening Stock + Closing Stock rr Average Stock = b. Trade Receivables Turnover Ratio: Debtors turnover ratio, also known as the Receivables Tumover Ratio, is a measure used to check how quickly a credit sale is converted into cash. It shows the efficiency of a business firm in collecting debts from customers. Net Credit Sales Average Accounts Receivables Net Credit Sales = Total Sales — Cash Sales i + B/R) + i + Closing B/R) Average Accounts Receivables = (OPEINE Debtors + Opening 1 (Closing Debtors + Closing B/R) Debtors Turnover Ratio = c. Trade Payables Turnover Ratio: It is also known as Creditor's tumover ratio or account payable tumover ratio and is a liquidity ratio that measures the average number of times. firm pays its creditors in the course of an accounting period. It is used to measure the short-term liquidity of the firm.———_———E—— oT & BYJU'S NCERT Solutions for Class 12 Accountancy Chapter 5 ~ The Learning App ‘Accounting Ratios Payable Tuinover Radio = —Net Credit Purchases ‘Average Accounts Payable Net Credit Purchases = Total Purchases ~ Cash Purchases Opening Creditors + Opening B’P) + (Closing Creditors + Closing B/P) — > — AverageAccounts Payable = 4d. Working Capital Turnover Ratio: The working capital turnover ratio is used to measure the efficiency of a company in using its working capital to support sales. It is a ratio based on which a firm's operations are funded, and the corresponding revenue generated from the business is calculated, Net Sales Working Capital Net Sales = Total Sales — Sales Retum Working Capital = Current Assets — Current Liabilities Working Capital Tumover Ratio 4, The liquidity of a business firm is measured by its ability to satisfy its long-term obligations as they become due. What are the ratios used for this purpose? A firm's liquidity is measured by its capability to pay long-term dues. These dues include principal amount payment on the due date and interest payment on a regular basis. Long term solvency of a firm can be determined by the following ratios: a. Debt-Equity Ratio: This ratio shows the relationship between owner funds (equity) and borrowed funds (debt). A lower debt-equity ratio provides more security to the people who are lending to the business. It also shows that a company is able to meet long-term dues or responsibilities. Debt-Equity Ratio = b. Total Assets to Debt Ratio- It is based on the relationship between total assets and long- term loans, It shows what percentage of the company's total assets are financed by creditors. A higher total assets to debt ratio makes the firm able to meet long-term requirements and provides more security to lenders. ‘Total Assets Total Assets to Debt Ratio = —“" OSS _ Long-term Debt& BYJU'S NCERT Solutions for Class 12 Accountancy Chapter 5 — Tatannaiee eS er eis c. Interest Coverage Ratio: This ratio is used to determine the easiness with which a company is able to pay interest on outstanding debts. It is calculated by dividing earnings before interest and taxes with interest payments. Having a higher interest coverage ratio means that company is able to meet its obligations skilfully Net Profit before Interest and Tax Interest Coverage Ratio = = Interest on Long-term Loans 5, The average age of inventory is viewed as the average length of time inventory is held by the firm or as the average number of day's sales in inventory. Explain with reasons. Inventory Turnover Ratio: This ratio is a relationship between cost of goods sold and the average inventory maintained during a particular time period. it determines the efficiency with which a firm is able to manage its inventory. Inventory /Stock Turnover Ratio = Cost of Goods Sold Average Stock Cost of Goods Sold = Opening Stock + Purchases + Direct Expenses ~ Closing Stock or, Cost of Goods Sold = Net Sales ~ Gross Profit Opening Stock + Closing Stock 2 Days in a year Inventory Tumover Ratio Average Stock = Average Age of Inventory It shows the average length for which the firm holds the inventory. Long Questions for NCERT Accountancy Solutions Part 2 Class 12 Chapter 5 4. What are liquidity ratios? Discuss the importance of current and liquid ratio. For determining the short-term solvency of a business liquidity ratios are essential. There are two types of liquidity ratios: 1. Current Ratio 2. Liquid Ratio/ Quick Ratio 1, Current Ratio: This ratio deals with the relationship between current assets and liabilities. It is calculated as: