INSTITUTE OF COMMERCE BY GAURAV SIR (SINCE 2007)

ACCOUNTING RATIOS

MEANING OF RATIO: Mathematical relationship b/w two figures are known as Ratio.
MAJOR HEADS OF RATIOS: 1. Liquidity ratio (Short Term Solvency).
2. Capital Structure Ratio (Long Term Solvency)
3. Coverage ratio.
4. Turnover ratio.
5. Profitability ratio.
I. LIQUIDITY RATIOS - These ratios are used to measure the short term solvency of the business
i.e. the ability of the business to meet short term commitments.
i. Current ratio (CR) = Current Assets Ideal ratio = 2:1
Current Liab.
This ratio reflects the ability of the company to meet CL from CA.
In practical world there is no such ratio.
ii. Liquid/Quick/Acid Test Ratio = Liquid/Quick Assets
Current Liab.
This ratio reflects the ability to meet short obligations immediately. Ideal ratio = 1:1
Liquid/quick assets= CA – stock – prepaid expenses.
Note – 1.Stock cannot be converted onto cash at the will of the firm and there is no
certainty at what amount stock will be sold.
2. Prepaid Expenses are excluded because they cannot be converted into cash.
II. CAPITAL STRUCTURE RATIOS–These ratios are used to measure the short term solvency of
the business, i.e. the ability of the business to meet long term obligations.
i. Debt-equity ratio = Debt (long term debts) Ideal ratio = 2:1
Equity (shareholder’s fund)
Long term debts = % debentures + long term bank loan + other LT debts.
Shareholders fund = Share Capital + Reserve & Surplus – Fictitious Assets
This ratio measures the relative proportion of debt and equity in financing the assets.
ii. Total assets to debt ratio = Total Assets Preliminary expenses
LT Debts Profit & Loss A/c (dr.)
Total assets = All assets excluding Fictitious Assets Advertisement suspense
Long term debts = % debentures + long term bank loan + other LT debts.
This ratio indicates the extent, to which LT Debts is covered by Total Asset,
Safety Point of View, how much amount is invested by LT Debts in total assets.
iii. Proprietary Ratio = Shareholder’s Fund
Total Assets
This ratio measures the relative proportion of shareholder’s fund in financing the assets.

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III. COVERAGE RATIOS - These ratios are used to measure the ability to meet the financial
obligations. PBIT - xxxx
- Interest - xxxx
i. Interest Coverage Ratio = Profit Before Interest And Tax (PBIT) PBT - xxxx
Interest on LT Borrowing - Tax - xxxx
This ratio is used to determine how easily a company can pay
PAT - xxxx
interest on outstanding debts.

III. TURNOVER/ACTIVITY/ PERFORMANCE RATIO - These ratios refer to the effectiveness with
which the resources are being utilized.
They are known as turnover ratios since they indicate the speed with which the resources are
moved over a period of time. They are generally expressed in terms of rate or time.
i. Stock/Inventory Turnover Ratio (STR) = Cost of goods sold (COGS)
Avg. Stock
COGS = Sales – Gross Profit OR
Opening Stock + Purchases + Direct Expenses – Closing Stock.
Average stock = Opening Stock + Closing Stock
2
This ratios implies at what speed the inventory is converted into Sales.
ii. Debtor Turnover Ratio (DTR) = Net Credit Sales
Avg. Trade rec.
Net Credit Sales = Total Sales – Cash Sales – Sales Returns
Average Trade Receivable = Opening (Debtors+B/R) + Closing (Debtors+B/R)
2
This ratio indicates the speed of collection of Credit Sales.
iii. Avg. Collection period (ACP) = 365 days / 12 month / 52 weeks
DTR
This ratio shoes the collection period within debtors pays us, generally lower ACP is
better, since payment comes faster, i.e. Cash inflow is fast.
Note = Provision for DD is not deducted from Debtors, because the purpose here is to find the
days in which collection will take place and not to ascertain the realizable of debtors.
iv. Creditors Turnover Ratio(CTR) = Net Credit Purchase
Avg. Trade payable
Net credit purchase = Total Purchase – Cash Purchase – Purchase Return
Average Trade Payable = Opening (Creditor+B/P) + Closing (Creditor+B/P)
2
This ratio indicates the speed of payment of Credit Purchase.
iv. Avg. Payment Period (APP) = 365 days/12 month/52 weeks
CTR
This ratio indicates the no. of days in which payment is being made.
v. Working Capital Turnover Ratio (WCTR) = Net Sales/COGS
Working Capital
This ratio is used to find out how effectively a company is using its working capital to
generate sales.

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III. PROFITABILITY RATIO – This ratio refers to the ability of the firm to earn profit.

i. Gross Profit Ratio = Gross Profit X 100

Net Sales
Net sales = Sales – Sales Return
Gross profit = Sales – COGS
Note: Higher the ratio better it is.
ii. Operating Profit Ratio = Operating Profit X 100
Net sales
Operating profit = Sales – COGS – Other Operating Expenses Admin expenses
This ratio determines the operational efficiency of the firm. Sales expenses.
Higher the ratio better it is.
Admin expenses
iii. Operating Ratio = COGS + Other Operating Expenses
Net sales Sales expenses.
Lower the ratio better it is.
iv. Net profit ratio = Net profit X 100
Net sales
Higher the ratio better it is.
v. Return on Investment / Capital Employed = Profit Before Interest And Tax (PBIT)
Capital Employed
Capital employed = It can be calculated from both side of balance sheet.
a. Liabilities side = Share Capital + Reserve & Surplus – Fictitious Assets
b. Assets side = Fixed Assets + Working Capital (CA-CL)
This ratio indicates the amount of capital employed which is used to generate profit
before interest and tax.

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