Chapter-10

Ratio Analysis

1. Meaning of Ratio

A ratio is one figure expressed in terms of another figure. It is mathematical yardstick of

measuring relationship of two figures or items or group of items, which are related, is each
other and mutually inter-dependent. It is simply the quotient of two numbers. It can be
expressed in fraction or in decimal point or in pure number.

Accounting ratio is an expression relating to two figures or two accounts or two set
accounting heads or group of items stated in financial statement.

2. Objectives of Ratios

The accounting ratios are very useful in assessing the performance of business enterprise i.e.
financial position and profitability. This is possible to achiever by comparison of ratios of the
year or with the previous year.

The ratios are worked out to analyse the following aspect or areas of business organization.

1. Solvency: -

a. Long-term solvency
b. Short-term solvency
c. Immediate solvency

2. Stability
3. Profitability
4. Operational efficiency
5. Credit standing
6. Structural analysis.
7. Utilization of resources and
8. Leverage or external financing.

3. Classification of Ratios

The ratios are used for different purposes, for different users and for different analysis.

The ratios can be classified as under:

a. Traditional classification
b. Functional classification
c. Classification from user‘s point of view

Traditional Classification:

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As per this classification, the ratios readily suggest through their names, their respective
resources. From this point of view, the ratios are classified as follows.

a) Balance Sheet Ratio: This ratio is also known as financial ratios. The ratios which express
relationships between two items or group of items mentioned in the balance sheet at the end
of the year.

Example: Current ratio, Liquid ratio, Stock to Working Capital ratio, Capital Gearing ratio,
Proprietary ratio, etc.

b) Revenue Statement Ratio:- This ratio is also known as income statement ratio which
expresses the relationship between two items or two groups of items which are found in the
income statement of the year.

Example: Gross Profit ratio, Operating ratio, Expenses Ratio, Net Profit ratio, Stock Turnover
ratio, Operating Profit ratio.

c) Combined Ratio:-This ratio shows the relationship between two items or two groups of
items, of which one is from balance sheet and another from income statement (Trading A/c
and Profit & Loss A/c and Balance Sheet).

Example: Return on Capital Employed, Return on Proprietors' Fund ratio, Return on Equity
Capital ratio, Earning per Share ratio, Debtors' Turnover ratio, Creditors Turnover ratio.

Functional Classification of Ratios:

The accounting ratios can also be classified according their functions as follows.

a) Liquidity Ratios:- These ratios show relationship between current assets and current
liabilities of the business enterprise.

Example: Current Ratio, Liquid Ratio.

b) Leverage Ratios:- These ratios show relationship between proprietor's fund and debts used
in financing the assets of the business organization.

Example: Capital gearing ratio, debt-equity ratio, and proprietary ratio.

This ratio measures the relationship between proprietors fund and borrowed funds.

c) Activity Ratio: - This ratio is also known as turnover ratio or productivity ratio or
efficiency and performance ratio. These ratios show relationship between the sales and the
assets. These are designed to indicate the effectiveness of the firm in using funds, degree of
efficiency, and its standard of performance of the organization.

Example : Stock Turnover Ratio, Debtors' Turnover Ratio, Turnover Assets Ratio, Stock
working capital Ratio, working capital Turnover Ratio, Fixed Assets Turnover Ratio.

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Example: i) Profits and Sales: Operating Ratio, Gross Profit Ratio, Operating Net Profit
Ratio, Expenses Ratio etc.
ii) Profits and Investments: Return on Investments, Return on Equity Capital etc.

e) Coverage Ratios:- These ratios show relationship between profit in hand and claims of
outsiders to be paid out of profits.

Example: Dividend Payout Ratio, Debt Service Ratio and Debt Service Coverage Ratio.

d) Profitability Ratio: - These ratios show relationship between profits and sales and profit &
investments. It reflects overall efficiency of the organizations, its ability to earn reasonable
return on capital employed and effectiveness of investment policies.

Classification from the view point of user:

Ratio from the users’ point of view is classified as follows.

a) Shareholders' point of view:-These ratios serve the purposes of shareholders.

Shareholders, generally expect the reasonable return on their capital. They are interested in
the safety of shareholders investments and interest on it.

Example: Return on proprietor's funds, Return on capital, Earning per share.

b) Long term creditors: - Normally leverage ratios provide useful information to the long
term creditors which include debenture holders, vendors of fixed assets, etc. The creditors
interested to know the ability of repayment of principal sum and periodical interest payments
as and when they become due.

Example: Debt equity ratio, return on capital employed, proprietary ratio.

c) Short term creditors: - The short-term creditors of the company are basically interested to
know the ability of repayment of short-term liabilities as and when they become due.
Therefore, the creditors has important place on the liquidity aspects of the company's assets.

Example: a) Liquidity Ratios - Current Ratio, Liquid Ratio.

b) Debtors Turnover Ratio.
c) Stock working capital Ratio.

d) Management: Management is interested to use borrowed funds to improve the earnings.

Example: Return on capital employed, Turnover Ratio, Operating Ratio, and Expenses Ratio.

Some Important Ratios and Their significance:

A) To test the solvency: (Ratio)

1. Short term solvency:
I) Current Ratio;
II) Quick Ratio/Acid Test ratio;
III) Super Quick Ratio.
2. Long-term Solvency/ Capital Structure Ratio/Leverage Ratio

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 i) Debt-Equity ratio.
B) To test the Profitability: (Percentage)
i) Gross Profit Ratio;
ii) Net Profit ratio;
iii) Return on Capital Employed/Overall profitability;
iv) Return on Net worth;
C) To test the Managerial Efficiency/ Turnover Ratio/Activity Ratio: (Times)
i) Inventory Turnover ratio;
ii) Accounts Receivable/Debtors Turnover Ratio
iii) Average Collection Period
iv) Assets Turnover Ratio;
v) Accounts Payable/Creditors Turnover ratio
D) Market ratio: (Tk.)
i) Earnings per Share (EPS);
ii) Price earnings Ratio (P/E)
iii) Dividend Payout Ratio

A. Solvency Ratios

Current Ratio:

This ratio is also known as working capital ratio. This expresses the relationship between
current assets and current liabilities. This ratio is calculated by dividing current assets by
current liabilities. It is expressed as pure ratio standard current ratio is 2:1. Means current
assets should be double the current liabilities.
Current Assets
Current Ratio = Current Liabilities

a) Current assets includes I) Inventories of raw materials, finished goods, work-in-progress,

stores & spare, loose tools, II) Sundry debtors, III) Short-term loan, deposits, advance, IV)
Cash on hand and bank, V) Prepaid expenses, accrued income, VI) Bills receivables, VII)
Marketable investments, short term securities.

b) Current liabilities includes sundry creditors, bills payables, outstanding expenses,

unclaimed dividends, interest accrued but not due on secured and unsecured loans, advances
received, income received in advance, provision for tax, purposed dividend loan installment
of secured and unsecured loan payable within 12 months.

Significance: This ratio tests the credit strength and solvency of an organization. It shows
strength of working capital, it indicates ability to discharge short term liabilities.

Liquid Ratio/ Acid Test Ratio/ Quick Ratio:

This ratio expresses the relationship between liquid assets and liquid liabilities. This ratio is
also known as quick ratio or acid test ratio. This ratio is calculated by dividing liquid assets
by liquid liabilities. Standard quick ratio is 1:1.

Quick Assets
Liquid Ratio = Current/Quick Liabilities

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a) Liquid assets = Current assets less (Inventory, prepaid expenses and advance tax etc)
b) Liquid liabilities = Current liabilities less (Bank overdraft and cash credit etc)

Significance:-

1) Indicate immediate solvency of enterprise.

2) Unlike CR it is more qualitative concept
3) As it eliminates inventories, it is rigorous test of liquidity.
4) More important for financial institutions.
What is Super Quick Ratio?

The Super Quick Ratio, also known as the Absolute Liquidity Ratio, is a stringent
(rigorous) measure of liquidity. It assesses a company’s most liquid assets (cash,
marketable securities) to see if it can immediately meet its short-term liabilities without
relying on receivables or inventory.

Formula of Super Quick Ratio:

Super Quick Ratio=Cash + Cash Equivalents + Marketable Securities/Current Liabilities
Components Explained:
 Cash & Cash Equivalents: Currency, bank balances, short-term highly liquid
investments.
 Marketable Securities: Easily sellable financial instruments like treasury bills,
commercial paper, etc.
 Current Liabilities: Obligations due within one year (accounts payable, short-term
loans, accrued expenses, etc.)
Note: Receivables and Inventory are excluded because they may not be quickly converted
into cash.
Significance of Super Quick Ratio:
Aspect Description
💧 Liquidity Measures the purest form of liquidity; more conservative than quick
Stringency ratio.
🔍 Risk Evaluation Helps assess a company’s ability to pay urgent obligations instantly.
Low ratio may indicate cash flow issues or poor liquidity
📉 Warning Indicator
management.
Useful for banks, investors, or creditors evaluating short-term
🏢 Applicable For
solvency.
Debt Equity Ratio:

This ratio express the relationship between external equities and external equities i.e. owners'
capital and borrowed capital.

Debt Longterm Debt Longterm Debts

or or
Debt Equity Ratio = Equity Shareholders Fund Shareholders Fund + Longterm Debts

Components:-

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 1) Debts include all liabilities including short term & long term i.e. mortgage loan and
debentures.
2) Shareholders' funds consist of Preference share capital, Equity share capital, Capital
and Revenue Reserves, Surplus, etc.

Significance:
1) It shares favorable or non favorable capital structure of the company.
2) It shows long term capital structure.
3) It reveals high margin of safety to creditors.
4) It makes us understand the dependence on long terms debts.

A. Profitability Ratio

Profitability refers to the expression of profits in relation to sales, investment and equity of a
firm. Whenever profits are related to any one of these parameters; then we get profitability
ratio. These ratios are calculated to enlighten the end results of business activities which are
the sole criterion of the overall efficiency of a business concern. Some important profitability
ratios that are used in the study are as follows:

Gross Profit Ratio: This ratio tells gross margin on trading and is calculated as under:
Gross Profit
X 100
Gross Profit Ratio = Net Sales

Significance:

1) This ratio analyzes the basic profitability of business.

2) It shows the degree to which the selling price per unit may decline without resulting
in loss from operations.
3) Yearly comparisons of gross profit ratio reveal the trend of trading results.

Operating Profit Margin: This ratio establishes the relationship between operating profit
and sales and is calculated as follows:
Operating Profit
x 100
Operating Profit Margin = Net Sales
Significance:-
1) It is used to test operational efficiency of business.
2) This ratio is the yardstick which measures the efficiency of all operational activities of
business i.e. production, management, administration, sales, etc.

Net Profit Ratio: This ratio is measured by dividing profit after tax by net sales.
Net Profit
x 100
Net Profit Ratio = Net Sales
Significance:-
1) It measures overall profitability of business.
2) It is very useful in judging return on investments.
3) It provides useful inferences as to the efficiency and profitability of business.
4) It indicates the portion of net sales is available for proprietors.

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 5) It is clear index of cost control, managerial efficiency, sales promotion, etc.

Return on Capital Employed: This ratio is an indicator of the earning capacity of the capital
employed in the business. This ratio is calculated as follows:

Net Profit
x100
Return on Capital Employed = Capital Employed

Capital employed =
i) Equity share capital
ii) Add. Preference share capital reserve & surplus
iii) Add. Long term borrowings (Term loan + Debentures)
iv) Less: Fictitious assets like miscellaneous expenses not written off.
Less profit & loss A/c Dr. Balance (loss)

Return on Total Assets: This ratio is calculated to measure the profit after tax against the
amount invested in total assets to ascertain whether assets are being utilized properly or not.
It is calculated as under:

Net profiit
x 100
Return on Total Assets = Total Assets

Cost of Goods Sold

x 100
Average Stock
Stock Turnover Ratio =

Components:-

1) Cost of goods sold = Sales – Gross Profit

Net Profit after Tax and Interest

x 100
Return on Proprietors Fund = Proprietors Fund

Significance: -
1) This ratio is effective tools to measure overall managerial efficiency of business.
2) Comparison of this ratio with other company and this information can be obtained for
determining future course of action.
3) This ratio indicates the productivity of capital employed and measure the operating
efficiency of the business.

Earnings per share:

Earnings per share are calculated to find out overall profitability of the organization. It
represents earnings of the company whether or not dividends are declared. Earnings per
share are determined by dividing net profit by the number of equity shares.

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 Net Profit after Tax - Preference Dividend
Earnings per share = Number of Equity Share

Components:-
1) Net profit after tax & interest - less preference dividend.
2) No. of equity shares.
Purpose:
Purpose of this ratio is to calculate the amount of profits available on each equity share to
take care of equity dividend, transfer to reserves, etc.
Significance:
1) This ratio helps the investors or shareholders to take decision while purchasing or
selling shares.
2) This ratio shows the possibilities of issue of bonus shares.
3) Higher ratio indicates overall profitability.

Price earnings Ratio (P/E Ratio):

This ratio measures relationship between market price of equity shares and earnings per
share. It is usually expressed as a fraction.

a) Formula: -
Market price per Equity
Price Earnings Ratio = Earning per Equity shares
b) Components:
1. Market price per equity share = quoted price of a listed equity share.
2. Earnings per equity share
c) Purpose: -
1) Purpose of this ratio is to show the effect of the earning on the market price of
the share.
2) It helps the investors while deciding whether to purchase, keep or sell the equity
shares.
3) It helps to ascertain the value of equity share.

Dividend payout Ratio:

This ratio shows relationship between dividends paid to equity shareholders out of profit
available to the equity share holders.

a) Formula: -
This ratio is calculated as [Link] equity shares
Dividend
Dividend payout ratio =Earning per shares

b) Components: -
1) Dividend per equity shares means total dividend paid to equity shareholder dividend
by number of equity shares.
2) Earning per shares

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c) Purpose: - Purpose of this ratio is to measure the dividend paying capacity of the
company.

d) Significance: -
1) Higher ratio signifies that the company has utilized the larger portion of its earning for
payment of dividend to equity shareholders.
2) It says lesser amount of earning has been retained.

Problems Related to Ratio Analysis

Problem:-01

You are given the following figures relating to XYZ Ltd.

Gross Profit (25% of Sales) Tk. 1,00,000

Credit Sales to Total Sales 75%
Total Assets Turnover 2 Times
Inventory Turnover (to cost of goods sold) 8 Times
Average Collection Period (360 day’s a year) 36 Day’s
Current Ratio 3:1
Long-term Debt to Equity 40%

Balance Sheet

Capital & Liabilities Taka Assets Taka

Shareholders’ Equity 1,20,000 Fixed Assets ****
Long-term Debt **** Inventory ****
Creditors **** Debtors ****
Cash ****
Total **** Total ****

Based on the above information you are required to prepare the Balance sheet of the company
as on 31.12.2010.

Solution:
Gross profit
1. Gross profit ratio = Net Sales x 100
Gross profit
Net sales = Gross Profit Ratio x 100
1,00,000
Net sales = 25 x 100 = 4, 00,000

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 So, Credit sales = 4, 00,000 x 75% = 3, 00,000
Total Sales
2. Assets Turnover = Total assets
4,00,000
→ 2 = Total Assets
→ Total assets = 2, 00,000
Cost of goods sold
3. Inventory Turnover Ratio = Inventory
Cost of goods sold
→ 8 = Inventory
4,00,000 - 1,00,000
→ 8 = Inventory
→ Inventory = 37,500

Credit sales
4. Debtors Turnover ratio = Debtors
Credit sales
Debtors = Debtors Turnover Ratio
3,00,000
= 360/36
= 30,000
Long-term Debt
5. Long-term Debt to Equity = Equity
Long-term Debt
1,20,000
→0.40=

Long-Term debt = 48,000

So, Current Liabilities = Total Liabilities – Shareholders Equity – Long term Debt
= 2, 00,000 – 1, 20,000 – 48,000
= 32,000
Current Assets 3
6. Current Ratio = Current Liabilities = 1

→ Current Assets = 3 x Current Liabilities

= 3 x 32,000
= 96,000
7. Current Assets = Inventory + Cash + Debtors
→ 96,000 = 37,500 + Cash + 30,000

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 → Cash = 28,500
8. Fixed Assets = Total Assets – Current assets
= 2, 00,000 – 96,000
=1, 04,000

Problem:-02

Mariland Ltd. gives you the following information. Prepare Income Statement for the year
ended 31st March 2017 and Balance Sheet as on that date:

Opening stock Tk. 45,000

Stock turnover ratio 10 times
Net profit ratio on turnover 15%
Gross profit ratio on turnover 20%
Current ratio 4:1
Long term loan Tk. 1,00,000
Depreciation on fixed assets @ 10% Tk. 10,000
Closing stock Tk. 51,000

Credit period allowed by suppliers one month. Average debt collection period two months.
On 31st March 2017 current assets consists of stock, debtors and cash only. There was no
bank overdraft. All purchases are made on credit. Cash sales were 1/3rd of credit sales.

Problem:-03

Following is the abridged Balance Sheet of the Consolidated Co. Ltd. As at 31st March, 2014.
Balance Sheet

Particulars Taka Particulars Taka

Paid-up share capital 5,00,000 Freehold property 4,00,000
Profit and loss account 85,000 Plant and machinery:
2,50,000
Current liabilities 2,00,000 Less: Depreciation
75,000
1,75,000
Stock 1,05,000
Debtors 1,00,000
Bank 5,000
7,85,000 7,85,000

From the following information you are required to prepare Profit and Loss Account and
Balance Sheet as at 31st March, 2015:

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 a) The composition of the total of liabilities side of the company’s Balance sheet as at
31st March 2015 (the paid-up capital remaining the same as at 31st March, 2014) was:

Share capital 50 percent

Profit and loss account 15 percent
10 percent Debentures 10 percent
Creditors 25 percent

The debentures were issued on 1st April, 2014, interest being paid on 30th September
2014 and 31st March 2015;
b) During the year ended on 31st March 2015, additional Plant and Machinery had been
bought and a further Tk. 25,000 depreciation written off. Freehold property remained
unchanged. The total fixed assets then constituted 60 percent of total fixed and current
assets.
c) The current ratio was 1.6:1. The quick assets ratio was 1:1.
d) The debtors (four-fifths of the quick assets) to sales ratio revealed a credit period of
two months.
e) Gross profit was at the rate of 15 percent of selling price and return on net worth as at
31st March 2015 was 10 percent.
f) Ignore taxation.

Problem:-04

The comparative statements of two companies belonging to the same industry are
presented below:

Income Statement
For the Year ended December-31
Particulars A Co. B Co.
Net Sales 28,00,000 41,00,000
Cost of goods sold 21,00,000 34,00,000
Other expenses 5,40,000 4,30,000
Interest expenses 20,000 30,000
Income tax 70,000 1,20,000
Dividends 50,000 80,000

Balance Sheet
December-31
A Co. B Co.
Cash 1,40,000 3,20,000
Accounts Receivable 2,20,000 6,30,000
Inventories 8,20,000 9,50,000
Plant assets 11,30,000 24,00,000
23,10,000 43,00,000
Current liabilities 6,70,000 10,50,000

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 Debentures 3,80,000 5,00,000
Ordinary share capital 11,00,000 22,50,000
Retained earnings 1,60,000 5,00,000
23,10,000 43,00,000

Required:
Answer each of the following questions by making a comparison of one or more ratios:
a) Which company is using the shareholders investment more profitably?
b) Which company is better able to meet its current obligations?
c) Which company collects its receivable faster?
d) Which company is earning the higher rate of return on its investment?
e) If you are going to buy the shares of one or more company, which one would you
choose? Why?

Solution:
Calculation of net income:

Income Statement
For the Year ended December-31

Particulars A Co. B Co.

(Tk.) (Tk.)
Sales 28,00,000 41,00,000
Cost of goods sold 21,00,000 34,00,000
Gross Profit 7,00,000 7,00,000
Other expenses (5,40,000) (4,30,000)
Interest expense (20,000) (30,000)
Net profit before tax 1,40,000 2,40,000
Income tax (70,000) (1,20,000)
Dividends (50,000) (80,000)
Retained Earnings 20,000 40,000

Required-a)

The name of such ratio is Return on Shareholders Fund

Net Profit
We Know, Return on Shareholders Fund = Net worth X 100

A. Co. B. Co.
1,40,000 2,40,000
Share Capital + Retained Earnings X 100 Share Capital + Retained Earnings X 100

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 1,40,000 2,40,000
= 11,00,000 + 1,60,000 X 100 = 22,50,000 + 5,00,000 X 100
= 11.11% = 8.73%

Comments: A co. is using the shareholders’ fund more profitably.

Required-b)

The name of such ratio is Current Ratio

Current Assets
We Know, Current Ratio = Current Liabilities

A. Co. B. Co.
1,40,000 + 2,20,000 + 8,20,000 3,20,000+ 6,30,000 + 9,50,000
6 ,70 , 000 10 , 50 , 000
= 1.76 : 1 = 1.81: 1
Comments: B co. is better able to meet its current obligation.

Required- c)
The name of such ratio is Average Collection Period

Accounts Receivable
We Know, Average Collection Period = Credit Sales X 360

A. Co. B. Co.
2,20,000 6,30,000
28 , 00 , 000 X 360 41 ,00 ,000 X 360
= 28 day’s = 55 day’s

Comments: A co. collects its receivable faster.

Required- d)
The name of such ratio is Return on Investment

Net Profit
We Know, Return on Investment = Total Assets X 360

A. Co. B. Co.
1,40,000 2,40,000
23 , 10 , 000 X 100 43 ,00 , 000 X 100
= 6.06% = 5.58%

Comments: A co. is earning the higher rate of return on its total assets investment.

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Required- e)
The name of such ratio is Return on Equity Shareholders’ Investment

Net Profit after Tax

We Know, Return on Equity Shareholders’ Investment = Equity Shareholders' Fund X 100

A. Co. B. Co.
1,40,000-70,000 2,40,000 - 1,20,000
12 , 60 ,000 X 100 27 , 50 , 000 X 100
= 5.55% = 4.44%

Comments: If we are going to buy the share of one company, I would choose the share
of A co., as the rate of return on equity shareholders’ fund of A co. is higher than that of
B co.

Problem:-05

Gose Sanchez owns and operates Nestern Gear, a small merchandiser in outdoor recreational
equipment. You are hired to review the three most recent years of operations for Nestern
Gear. Your financial statement analysis reveals the following results:
2023 2020 2019
Sales index-number trend 138.0 135.0 100.0
Selling expenses to net sales 10.8% 15.7% 15.4%
Sales to plant assets 4.5 to 1 5.3 to 1 4.00 to 1
Current ratio 2.5 to 1 2.7 to 1 2.2 to 1
Acid-test ratio 0.9 to 1 1.3 to 1 1.5 to 1
Merchandise inventory turnover 8.5 times 9.7 times 10.9 times
Accounts receivable turnover 6.7 times 7.4 times 8.2 times
Total asset turnover 2.6 times 2.6 times 3.0 times
Return on total assets 18.8% 19.4% 20.1%
Return on owner’s equity 10.75% 12.50% 13.25%
Net profit margin 4.3% 5.5% 4.7%

Required:
Use these data to answer each of the following questions with explanations:
(i) Is it becoming easier for the company to meet its current debts on time and to take
advantage of cash discounts?
(ii) Is the company collecting its accounts receivable more rapidly over time?
(iii) Is the company’s investment in accounts receivable decreasing?
(iv) Are dollars invested in inventory increasing?
(v) Is the company’s investment in plant assets increasing?
(vi) Is the owner’s investment becoming more profitable?
(vii) Is the company using its assets efficiently?
(viii) Did the dollar amount of selling expenses decrease during the three-year period?

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Problem:-06
Given below are the summarized income statement and Statement of Financial Position of
PQR Ltd.
PQR Ltd.
Income Statement

Particulars Taka (‘000)

Sales 1600
Less: Cost of goods sold 1310
Gross margin 290
Less: Selling and Administrative expenses 40
Net operating income 250
Less: Interest expenses 45
Income before taxes 205
Income tax 82
Net income after tax 123

PQR Ltd.
Statement of Financial Position

Particulars Taka (‘000) Taka (‘000)

ASSETS
Non-current Assets 800
Current Assets:
Inventory 400
Accounts Receivable 175
Marketable Securities 75
Cash 50 700
Total Assets 1500
CAPITAL AND LIABILITIES
Paid up capital (40,000 shares @ Tk. 10) 400
Retained earnings 120
Debentures 700
Accounts Payable 180
Bills Payable 20
Other current liabilities 80
Total capital and liabilities 1500

Market price per share Tk. 15.00

Industry Average

Current ratio 2.4:1

Quick ratio 1.5:1

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 Sales to inventory 8 times
Average collection period 36 day’s
Debt to assets 40%
Time interest earned 6
Profit margin 7%
Price to earnings ratio 15
Return to total assets 11%

Instructions:
a) PQR ltd. would like to borrow Tk. 5, 00,000 from a bank for less than a year.
Evaluate the firms current financial position by calculating ratios that you feel would
be useful for the banks evaluation?
b) What problem areas are suggested by your ratio analysis? What are the possible
reasons for them?
c) Do you think the bank should grant the loan?

Solution:
Requirement-a)

Bank, as a short-term lender, would be interested in evaluating the liquidity position of the
company. Such a position can be evaluated by current ratio, quick ratio, average collection
period and inventory turnover ratios. Besides these ratios, net income before interest and
taxes/ interest ratio and debts to total assets ratio may have some bearing on the decision of
the bank. Other profitability ratios are not as significant from the point of view of the bank, as
the time period involved is less than one year.
Following is a list of the relevant ratios of the company along with those industries:

Ratios PQR Ratio Industry

a) Current ratio 2.5:1 2.4:1
b) Quick ratio 1.07:1 1.5:1
c) Sales to Inventory 4.00 times 8.00 times
d) Average collection period 40 day’s 36 day’s
e) Debts to total assets ratio 46.7% 40%

Requirement-b)
Company’s position both in terms of liquidity ratios [(a) to (d)] and solvency ratio (e) are
almost at par with industry average. Apart from industry’s comparison, the company’s ratio
are also very satisfactory in as much as current ratio is more than the desired norm of 2:1;
quick ratio is also slightly more than the desired norm of 1:1. More than half of the total
assets are financed out of owned funds; signify satisfactory level of debt amount.
The problem area suggested by the ratio analysis is low inventory turnover ratio. It is
reflected in the stock turnover ratio, which is 4 times only compared to 8 times that of the
industry. There is accumulation of stocks with the company. It may be due to holding of
damaged or obsolete goods (now not in demand).

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Requirement-c)
The bank should grant the loan to the company for the following reasons:
i. Its current and quick ratios are very satisfactory;
ii. Its debt-equity ratio is not high. However, the bank should probe in-depth about the
causes of high investment inventory.

Problem:-07
The comparative statements of two companies belonging to the same industry are presented
below:
Income Statement
For the Year ended December-31

Target Co. Wal-Mart Co.

Net Sales (all on account) Tk. 6,00,000 Tk. 5,20,000
Expenses:
Cost of goods sold 4,15,000 3,54,000
Selling and administrative 1,20,800 1,14,800
Interest expenses 7,800 6,000
Income tax expenses 18,000 14,000
Total expenses 5,61,600 4,88,800
Net Income 38,400 31,200

Balance Sheet
December-31

Target Co. Wal-Mart Co.

Assets
Current Assets
Cash Tk. 21,000 Tk. 18000
Short-term investment 18,000 15000
Accounts Receivable (net) 86,000 74000
Inventories 90,000 70000
Total Current Assets 2,15,000 1,77000
Plant Assets (net) 4,23,000 3,83000
Total Assets 6,38,000 5,60000

Liabilities and Stockholder’s Equity

Current liabilities
Accounts Payable 1,22,000 1,10,000
Income tax payable 23,000 20,000
Total Current Liabilities 1,45,000 1,30,000
Long-term Liabilities

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 Bonds Payable 1,20,000 80,000
Total Liabilities 2,65,000 2,10,000
Stockholder’s Equity
Common stock (Tk.5 par) 1,50,000 1,50,000
Retained earnings 2,23,000 2,00,000
Total Stockholder’s Equity 3,73,000 3,50,000
6,38,000 5,60,000

Additional Data:
The common stock recently sold at Tk. 19.50 per share.
Required:
Answer each of the following questions by making a comparison of one or more ratios:
a) Which company is using the shareholders investment more profitably?
b) Which company is better able to meet its current obligations?
c) Which company collects its receivable faster?
d) Which company is earning the higher rate of return on its investment?
e) Which company is efficient for its inventory turnover?
f) Which company is better regarding earnings per share?
g) If you are going to buy the shares of one or more company, which one would you choose?
Why?

Problem:-08

Following is the Trading and Profit and Loss Account and Balance Sheet for the year ended 31 st
December 2014:

Particulars Taka Particulars Taka

Opening stock 40,000 Sales 9,00,000
Purchase 4,00,000 Closing stock 1,60,000
Wages 1,00,000
Factory expenses 1,40,000
Gross Profit 3,80,000
10,60,000 10,60,000

Administrative expenses 1,20,000 Gross profit 3,80,000

Selling expenses 80,000 Interest received 10,000
Interest on Loan 10,000
Debenture interest 16,000
Net profit 1,64,000
3,90,000 3,90,000

Provisions for taxation 40,000 Net profit 1,64,000

Proposed dividend 40,000
Balance profit 84,000
1,64,000 1,64,000

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 Balance sheet as at 31st December, 2014

Liabilities Taka Assets Taka

Equity share capital (Tk. 4,00,000 Land and building 3,50,000
10)
9% preference share capital 3,00,000 Machinery 3,00,000
8% Debenture 2,00,000 Furniture 2,00,000
Reserve 1,00,000 Goodwill 1,00,000
Profit and loss account 60,000 Patents 1,00,000
Short term loan 2,00,000 Vehicles 2,80,000
Bank overdraft 1,50,000 Investment 1,00,000
Sundry creditors 2,80,000 Stock 1,60,000
Bills payable 60,000 Debtors 1,80,000
Provision for tax 40,000 Bills receivable 60,000
Proposed dividend 40,000
18,30,000 18,30,000

Market price of equity share is Tk. 8.

a) You are required to calculate the following ratios:
i) Acid Test Ratio; ii) Stock Turnover Ratio; iii) Return on Capital Employed; iv)
Earnings Per Share; v) Price Earnings Ratio; vi) Debt equity Ratio; vii) Debtors
Collection Period; viii) Net Profit Ratio.
b) Draft a report to the top level management about the performance of the company’s of the
year 2014 on the basis of the above ratios.

Problem:-08
Presented below is an incomplete income statement and an incomplete comparative balance sheet
of Denis Corporation.

Denis Corporation
Income Statement
For the year ended December 31, 2015

Sales Tk. 2,20,00,000

Cost of goods sold ?
Gross profit ?
Operating expenses 33,30,000
Income from operations ?
Other expenses and losses:
Interest Expenses ?
Income before income taxes ?
Interest expenses 11,20,000
Net Income ?

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 Denis Corporation
Balance Sheet
December 31

2015 (Tk.) 2014 (Tk.)

Assets
Current Assets:
Cash 9,00,000 7,50,000
Accounts receivable (net) ? 19,00,000
Inventory ? 34,40,000
Total current assets ? 60,90,000
Plant assets (net) 92,40,000 79,10,000
Total assets ? 1,40,00,000
Liability and Stockholders’ Equity
Current liabilities ? 16,50,000
Long term payables ? 56,00,000
Total liabilities ? 72,50,000
Common stock, Tk. 1 par 60,00,000 60,00,000
Retained earnings 8,00,000 7,50,000
Total stockholders’ equity 68,00,000 67,50,000
Total liabilities and stockholders’ equity ? 1,40,00,000

Additional Information:
i. The receivable turnover for 2015 is 10 times;
ii. All sales are on account;
iii. The profit margin for 2015 is 14.5%;
iv. Return on assets is 22% for 2015;
v. The current ratio on December 31, 2015, is 3.0;
vi. The inventory turnover for 2015 is 4.8 times.

Instructions:
Compute the missing information given the ratios above and complete the Income Statement and
Balance Sheet. Show computations.

Solution:
22,000,000
1. Receivable Turnover = 10 = Average Receivables
22,000,000
Average Receivables = 10 = 22, 00,000
Net Receivables (31. 12. 2015 )+ 19,00,000
2 = 22, 00,000
Net Receivables (31.12.2015) = 25, 00,000

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 Net Income
2. Profit Margin = 14.5% = 0.145 = Sales (22,000,000) x100
Net Income = 31, 90,000
Income before income taxes = 31, 90,000 + 11, 20,000 = 43, 10,000
31,90,000
3. Return on Assets = 22% = 0.22 = Average Assets
Average Assets = 31, 90,000/0.22 = 1, 45, 00,000
Assets (31 . 12. 2015)+ 1, 40, 00,000
2 = 1, 45, 00, 000
Assets (31.12.2015) = 1, 50, 00,000
Total Current Assets = 1, 50, 00,000 - 92, 40,000 = 57, 60,000
Inventory = 57, 60,000 - 25, 00,000- 9, 00,000 = 23, 60,000
Total Liabilities and Stockholders’ Equity = 1, 50, 00,000
Total Liabilities = 1, 50, 00,000 - 68, 00,000 = 82, 00,000
57,60,000
4. Current Ratio = 3.0 = Current Liabilities
Current Liabilities = 57, 60,000/3 = 19, 20,000
Long-term notes payable = 82, 00,000 – 19, 20,000 = 62, 80,000
Cost of goods sold
34,40,000 + 23,60,000
5. Inventory Turnover = 4.8 = 2
Cost of goods sold = 29, 00,000 x 4.8 = 1, 39, 20,000
Gross Profit = 2, 20, 00,000 - 1, 39, 20,000 = 80, 80,000
Income from operations = 80, 80,000 - 33, 30,000 = 47, 50,000
Interest Expense = 47, 50,000 - 43, 10,000 = 4, 40,000

Problem:-9
Pecunious Products, Inc.’s financial results for the past three years are summarized below:

Year 3 Year 2 Year 1

Sales trend 128.0 115.0 100.0
Current ratio 2.5 2.3 2.2
Acid-test ratio 0.8 0.9 1.1
Accounts receivable turnover 9.4 10.6 12.5
Inventory turnover 6.5 7.2 8.0
Dividend yield 7.1% 6.5% 5.8%
Dividend payout ratio 40% 50% 60%
Return on total assets 12.5% 11.0% 9.5%
Return on equity 14.0% 10.0% 7.8%
Dividends paid per share * Tk.1.50 Tk.1.50 Tk.1.50

*There have been no changes in common stock outstanding over the three-year period.
Your boss has asked you to review these results and then answer the following questions:
a. Is it becoming easier for the company to pay its bills as they come due?

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 b. Are customers paying their accounts at least as fast now as they were in Year
1?
c. Is the total of the accounts receivable increasing, decreasing, or remaining
constant?
d. Is the level of inventory increasing, decreasing, or remaining constant
e. Is the market price of the company’s stock going up or down?
f. Is the earnings per share increasing or decreasing?
g. Is the price-earnings ratio going up or down?
h. Is the company employing financial leverage to the advantage of the common
stockholders?
Required:
Provide answers to each of the questions raised by your boss.
Answer:
Financial Analysis of Pecunious Products, Inc.
The following analysis addresses the financial results of Pecunious Products, Inc. over a
three-year period (Year 1 to Year 3), based on the data provided.
a. Is it becoming easier for the company to pay its bills as they come due?
Yes. The current ratio has increased from 2.2 in Year 1 to 2.5 in Year 3, indicating
improved short-term liquidity. However, the acid-test ratio has decreased from 1.1 to 0.8,
implying more reliance on inventory. Overall, it is becoming easier for the company to
pay its bills, but with some caution due to lower quick assets.
b. Are customers paying their accounts at least as fast now as they were in Year 1?
No. The accounts receivable turnover has declined from 12.5 in Year 1 to 9.4
in Year 3, indicating that receivables are being collected more slowly.
c. Is the total of the accounts receivable increasing, decreasing, or remaining
constant?
Increasing. A lower accounts receivable turnover, along with increasing sales,
suggests that accounts receivable balances are growing.
d. Is the level of inventory increasing, decreasing, or remaining constant?
Increasing. Inventory turnover has declined from 8.0 in Year 1 to 6.5 in Year
3, suggesting that inventory levels are rising.
e. Is the market price of the company’s stock going up or down?
Down. Although dividends per share have remained constant at Tk.1.50, the
dividend yield has increased from 5.8% to 7.1%, implying a decrease in
market price.
f. Is the earnings per share increasing or decreasing?
Increasing. With a constant dividend of Tk.1.50 and a declining payout ratio
from 60% to 40%, earnings per share have increased (e.g., Tk.1.50 / 0.60 =
Tk.2.50 in Year 1; Tk.1.50 / 0.40 = Tk.3.75 in Year 3).
g. Is the price-earnings ratio going up or down?
Down. Since earnings per share are increasing and the stock price is
decreasing, the price-earnings ratio is also decreasing.
h. Is the company employing financial leverage to the advantage of the common
stockholders?
Yes. Return on equity has increased more sharply than return on total assets,
indicating effective use of financial leverage to boost shareholder returns.

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