Liquidity Ratios

1. Current ratio
2. Liquid ratio/ quick ratio/ acid test ratio
3. Cash ratio or absolute liquid ratio
4. defensive interval ratio
5. cash conversion cycle
Answer
i) current ratio = Current assets / Current liabilities
Current assets = 16000+50000+59000+1000+4000 = 130000
Current Liabilities = 48000+10000+5000+2000 = 65000
CR = CA/CL = 130000/65000 = 2/1
CR 2:1

Note: Liquidity ratios will be based upon current liabilities for all ratios

ii) Absolute liquid ratio = (CA - Stock - Prepaid expenses - Debtors - BR)/CL
CL = 65000
Absolute liquid assets = 130000 - 50000 - 1000 - 59000 = 20000
Cash ratio = 20000/65000 = 0.308 : 1
ALR = 0.31:1

iii) Liquid ratio = Liquid assets / CL = (CA-Stock - Prepaid exp)/CL

LA = 130000 - 50000 - 1000 = 79000
CL = 65000
LR = 79000/65000 = 1.22
LR 1.22: 1

Answer
i) Current ratio = CA/CL
CA = 12000+ 12000+4000+12000=40000
CL = 16000+4000+4000+4000 = 28000
CR = 40000/28000 = 1.43

ii) Quick ratio = LA/CL

LA = CA - Stk = 40000 - 12000 = 28000
CL = 28000
QR = 1

iii)Absolute Liquid ratio = ALA/CL

ALA = LA - Debtors = 28000-12000 = 16000
CL = 28000
 ALR = 0.57

Note: Taxation - Expense

Current taxation in BS = Outstanding tax
Future taxation in BS = Provision for taxation

Answer
CR = 3:1
Working capital = 200000

CA/CL = 3:1
CA = 3CL …...(1)

CA - CL = 200000
CA - 200000 = CL …..(2)

Substituting CL value in equ (1)

CA = 3 (CA - 200000)
2CA = 600000
CA = 300000

Liquid assets = CA - Inventory

LA = 300000 - 220000 = 80000

Answer i) CR = 4.5:1
CA/CL = 4.5:1
CA = 4.5CL ….. (1)

QR = 3:1
LA/CL = 3:1
LA = 3CL…... (2)
CA - 60000 = 3CL
CA = 3CL + 60000 … (3)

Substituting value of CA in eqn (1)

3CL + 60000 = 4.5CL
4.5CL - 3CL = 60000
CL = 60000 / 1.5 = 40000
CA = 4.5CL = 4.5*40000 = 180000

ii) CR = 2.5
CA = 2.5CL …. (1)

LR = 1.5
LA = 1.5CL….. (2)
 WC = 50000
CA = 50000 + CL …. (3)

susbtituting values in eqn (1)

50000+CL = 2.5CL
CL = 50000/1.5 = 33333.
CA = 2.5*33333 = 83333

from eqn(2)
LA = 1.5CL
CA - Inv = 1.5CL
Inv = CA - 1.5CL
Inv = 83333 - 1.5*33333 = 33333

iii) CR = 3:1
CA/CL = 3:1 implies CA = 3CL … (1)

LR = 1:1
LA / CL = 1:1 implies LA = CL ….. (2)

CL = 150000 CA = 3*150000 = 450000 ….from eqn (1)

By using eqn (2)

LA = CL
CA - Stk = 150000
STK = 450000 - 150000 = 300000

iv) CR = 4:1
CA = 4CL … (1)

LR = 3:1
LA = 3CL …(2)
CA - 36000 = 3CL
CA = 3CL + 36000 …. (3)

Substituting in eqn 1
3CL + 36000 = 4CL
36000 = 4CL - 3CL
CL = 36000/1 = 36000
CA = 4*36000 = 144000
QA = CA - Stk = 144000-36000 = 108000

Answer
Cash conversion cycle = Days of inventory in hand + Days of sales outstanding - number of days of payable

Option A is true or is a correct conclusion as inventory days have reduced over the
years and contributed to increased liquidity

Option B is true as the number of days of payables has reduced over the period

Option C is false as receiveble days has incresed leading to decreased liquidity

Computation of Cash conversion cycle

Particulars 2003 2004 2005
Days of inventory in hand 40 34 32
Add: Days of sales outstanding ' 23 25 28
63 59 60
Less: days of Payable 35 35 40
Cash conversion cycle 28 24 20

The organisations liquidity position has improved over a period of 3 years

as the cash conversion cycle has reduced by 8days (28-20).
bilities for all ratios

nses - Debtors - BR)/CL

paid exp)/CL
0000 ….from eqn (1)

r of days of payable
Solvency Ratio BS IS
Debt- assets Interest coverage
Debt - capital Fixed charge coverage
debt - equity
Financial leverage

Answer

i) Debt - Assets ratio = 9

ii) Debt - Capital ratio =

iii) Debt - Equity ratio =

iv) Interest coverage ra

Answer
6-A
7-C

Answer
D-E = 1:2
Debt = 100000
Equity = 200000

a) lets assume eq share

ratio = 100000/250000
Decrease
b) no change

c)Lets assume redempti

Ratio = 50000/200000=
Decrease

d) no change

e) Lets assume 50000 d

Ratio = 50000/250000 =
decrease

f) Decrease

g) Increase
 Answer
Note: Accrued pension is a current liability hence not considered for ratio calculation

1A)Computation of company's financial leverage ratio for 2009

Financial leverage = Average total assets/Average equity
Average total assets = (Value of assets at the beginning + Value of assets at the end )/2
Average total assets = (27311+23848)/2 = 25579.5

Average equity = (value of equity at the beginning + Value of equity at the end)/2
Average equity = (5224+4309)/2 = 4766.5

Financial leverage ratio = 25579.5/4766.5 = 5.37

1B) Interpretation
in the year financial year 2009, on an average for every 1euro in equity there was 5.37euro
in assets. Which implies it is a highly leveraged organisation.

2A) Computation of Solvency ratios for the 2 years

Particulars Formula Working 2008
Debt- assets ratio total debt / total assets (3998/27311)*100 14.64
Debt - capital ratio total debt /(total debt + equity) 3998/(3998+5224)*100 43.35
Debt to equity ratio total debt/total equity (3998/5224)*100 76.53

2B)Trend
The solvency ratios show an increseing trend which implies the organisations debt has
incresed over a period of a year. Hence we may conclude that the organisation has a
weaker solvency position and is riskier investment.

i) Debt - Assets ratio = 920000/7700000 = 11.95%

ii) Debt - Capital ratio = 920000/(920000+4800000)*100 = 16.08%

iii) Debt - Equity ratio = 920000/4800000*100 = 19.16%

iv) Interest coverage ratio= EBIT/ Interest = 554000/92000 = 6.02times

 Debt = Long term debt + Interest bearing short term debt
Debt = 100000
Equity = 200000

a) lets assume eq shares issued is 50000

ratio = 100000/250000 = 0.4
b) no change

c)Lets assume redemption of 50000 debentures

Ratio = 50000/200000= 0.25

d) no change

e) Lets assume 50000 deb redemmed and converted

Ratio = 50000/250000 = 0.2

f) Decrease

g) Increase
Working 2009
(4179/23848)*100 17.52
4179/(4179+4309)*100 49.23
(4179/4309)*100 96.98
Calculate ROA, ROTC and ROE
Self Study
Answer
Computation Of net Income
Particulars Working Amount
Revenue 150%*480000 720000
Less: Direct Cost 480000
Gross Profit 240000
Less: Operating expenses 80000
Operating Profit 160000
Total assets - 800000
50% is borrowed capital - 8L *50% = 4L
Less: non-operating expenses Interest - 8% *4L 32000
EBT 128000
Less: Tax 50%*128000 64000
Net income / EAT 64000

i) Net profit margin = net income / net sales *100 = 64000/720000*100 = 8.8%
ii) Return on assets = net income / total assets * 100 = 64000/800000*100 = 8%
iii) assets Turnover ratio = Turnover / total assets *100 = 720000/800000*100 = 90%
iv)return on owners equity = net income / owner equity *100 = 64000/400000*100 = 16%

Answer
Computation of Net Income
Particulars Working Amount
Net operating profit before tax 280000
Less: non-operating expenses 200000*8% 16000
EBT 264000
Less: tax 264000*50% 132000
Net income 132000

i) ROA = net income / toatl assets *100 = 132000/1360000*100 = 9.7%

ii) ROTC = net income / total capital*100 = 132000/(8L+2L+2L)*100 = 11%
iii) ROE = net income / equity capital *100 = 132000/(8L+2L)*100 = 13.2%

Note : Capital employed

Source = Equity + Debt
Application = total assets - Cl
Answer
Gross Profit ratio = GP/Sales*100 = 200000/500000*100 = 40%
Operating profit ratio = Op profit / net sales *100 = GP - Op exp /Net sales *100 = (200000-101000-12000)/500000*100 = 17.4
NPR = NP/Net sales *100 = 84000/500000*100 = 16.8%

Stock turnover ratio = COGS / Avg stk

COGS = Opening stk + Purchses + Direct exp - Closing stock or Sales - GP
COGS = 76250 + 315250 + 7000 - 98500 = 300000
Avg stock = (opening stk + Closing stk) /2 = (76250+98500)/2= 87375
STR = 300000/87375 = 3.43 times
No. of days of inventory in hand = 365/STR = 365/3.43 = 106days
0-12000)/500000*100 = 17.4%
Answer
Receivables Turnover Ratio = Credit Sale
RTR = 16604815/[(482086+1021062)/2]
Days of receivables outstanding = 365/2
es Turnover Ratio = Credit Sales / Avg recievables
04815/[(482086+1021062)/2] = 22.01times
ceivables outstanding = 365/22.01 = 17days.

8) Answer
STR = COGS / Avg stk
A - increses the ITR
B - increse the ITR
C - decrease in the ITR

9) Answer
RTR = CR Sales / Avg Receivables
A- decrese as customers will not pay back faster
B- Increases the ratio
C- decrease your ratio

Answer
a) Current ratio = CA/CL
CA = 150000+ 60000+144000+120000+96000 = 570000
CL = 30000+105000 = 135000
CR = 570000/135000 = 4.22

b) Acid test ratio = LA /CL

LA = 570000 - 144000 = 426000
ATR = 426000/135000 = 3.15

c) Stock turnover ratio = COGS/Avg inventory

COGS = O/stk + Purchses - C/stk or Sales - GP
Note: Purchses and sales only cash info is available
credit info has to be calculated

COGS = Sales - Returns - GP = 600000 -150000= 450000

GPR = 25%
GP = 25% on sales
150000 = 25% on sales
Sales = 150000/25% = 600000
 STR = 444000/[ (96000+144000)/2] = 3.7times
Credit sales = total sales - cash sales = 600000 - 150000 = 450000
Net credit sales = 450000
RTR = Net sales / avg receivables = 450000 / [(120000+30000+150000+60000)/2]
RTR = 2.5times

450000 = 96000 + Purchases - 144000

Purchases = 450000+144000-96000 = 498000
Credit purchses = 498000 - 138000 = 360000
PTR = net credit purchases / avg creditors
PTR = 360000 / (75000+60000+105000+30000)/2
PTR = 2.67 times

Avg debt collection period = 365/RTR = 365/2.5 = 146days

Answer
Total sales (Cr.) = 640000
GPR = 15%
CR = 2.5 times ITR = 5times

i) Avg inventory ??
ITR = 5times
COGS/Avg inventory = 5times

COGS = Sales - GP
COGS = 640000 - 15%*640000
COGS = 640000 - 96000 = 544000

544000/Avg inventory = 5
Avg inventory = 544000/5 = 108800

ii) Avg collection period ??

ACP = 360/ Receivables turnover ratio
Receivables turnover ratio = credit sales / avg receivables

Avg receivbales =( opening receivables + closing receivables )/2

CA/CL = 2.5
CA = 2.5*96000 = 240000
CA = Stk + Cash + Receivables
240000 = 48000 + 16000 + Receivable
Closing receivables = 176000

Avg receivables = (80000+176000)/2 = 128000

RTR = 640000/128000 = 5times
ACP = 360/5 = 72days
50000+60000)/2]
Answer

Note:
Turnover ratios are calculated using cos
Denominator for activity ratio is the clos
i) CR = 2.5
CA/CL = 2.5
Working capital = 300000
CA-CL = 300000
CA = 300000+CL
By substituting in CR formula
300000+CL = 2.5CL
CL = 300000/1.5 = 200000
CA = 300000+200000 = 500000

ii) Liquidity ratio = 1.5

LA/CL = 1.5
CA - Stk = 1.5*200000
500000 - Stk = 300000
Stk = 5L - 3L = 2L

v) FA/NW = 0.8
NW = 600000/0.8
NW = 750000

vi) Reserves : SC = 0.5:1

Reserves = 750000*0.5/1.5
SC = 750000*1/1.5
Answer
Computation of ratios
Particulars Remarks Working Amount
Debt-Equity Total debt/ total equity TD = 300
TE = 250+280+30
DE ratio = 300/560 53%

Current ratio CA / CL CA = 460+460+10+20

CL = 360+150+30
CA/CL = 950/540 1.75925926

Interest coverage ratio EBIT / Interest Interest = 120

WN1(EBIT) 320
Ratio = 320/120 2.6times

WN1: Computation of EBIT

Particulars Working Amount
P/l A/c (current year) 30
Add: Transfer to GR in
the CY 90
Earnings after tax 60% 120
Add: tax deducted 40% 80
Earnings before tax 100% 200
Add: Interest 120
EBIT 320
 Answer

Balance Sheet
Liabilities Amount (in lakhs) Assets Amount (in lakhs)
Net worth (v) 4.8 Fixed Assets (i) 7.2
Long Term Debt 4.8 Current Assets (ii) 4.8
Current Liabilities (vii) 2.4 Stock - 1.8lkhs
Debtors - 2.4lakhs
Liquid assets - 0.6lakhs
Total Liabilities 12 Total Assets (iii) 12

Working
i) Sales / Fixed Assets = 5 vi) sales /inv = 20
36/FA = 5 inv = 36/20 = 1.8
FA = 36/5 = 7.2
vii) CR = 2
ii) Sales /CA = 7.5 CA/CL = 2
CA = 36/7.5 = 4.8 CL = 4.8/2 = 2.4

iii) Sales / TA = 3 viii) Debt/equity = 1

36/12 = 3 debt / 4.8 = 1
TRUE debt = 4.8

iv) Sales /Drs = 15 ix) Liquid assets = CA - stk - Drs

Drs = 36/15 = 2.4 LA = 4.8 - 1.8 - 2.4 = 0.6

v) TA/NW = 2.5
NW = 12/2.5 = 4.8

ratios are calculated using cost of sales as given in the question

ator for activity ratio is the closing balance and not average

Balance Sheet
Liabilities Amount Assets Amount
Share Capital 500000 Fixed assets (iv) 600000
Reserves 250000 Current assets (i) 500000
 Net worth (v) 750000 Stock - 200000
Long term liabilities (b/f) 150000 Debtors - 250000
Current liability (i) 200000 Cash - 50000 (b/f)

Total liabilities 1100000 Total Assets 1100000

iii) STR = 6
Cost of Sales / Closing stk = 6
capital = 300000 COS = 6 * 200000 = 1200000

iv) FA turnover ratio = COS / FA

uting in CR formula 2 = 1200000/FA
FA = 1200000/2 = 600000
00/1.5 = 200000
000+200000 = 500000 v) Sales = COS +GP
Sales = 1200000 + GP
y ratio = 1.5
GP = 20% on Sales Sales COS GP
1.5*200000 COS = 80% on sales 100 80 20
Stk = 300000 1200000 X
300000

Sales = 1200000+300000 = 1500000

Lets assume sales is x

x = 1200000+ 0.2x
es : SC = 0.5:1 x = 1200000/0.8 = 1500000
= 750000*0.5/1.5
vi) ACP = 2months
RTR = 12/2 = 6times
Sales / Closing receivables =6times
1500000/6 = Receivables
Closing receivables = 250000
 Calculate ; P/E ratio and Divid

P/E ratio = MP/EPS

EPS = Net income / # of eq sh
EPS = (215000-16000)/8000 =
P/E ratio = 90/24.875 = 3.6

Divedend payout ratio = divid

DPR = (80000+16000)/21500

Retentio ratio = 1-DPR = 1-0.

DPS = Dividend paid / # of sh

DPS for eq sharholders = 800

Calculate; P/E ratio and dividend payout ratio

 Answer
EPS = Earnings attributable to equity shareholders /# of eq shares

Earnings to Eq shares = Profit After tax - Preference dividend

Earnings = 50000 - 10%*100000 = 50000 - 10000 = 40000

# of eq shares = 100000/10 = 10000

EPS = 40000/10000 = Rs.4 per share

Dividend Per share = Dividend amount / # of shares

Dividend amount = Profit *50% = 1110000*50% = 555000
# of shares = 10000
Dividend per share = 555000/10000 = 55.5 per share

Dividend payout ratio = dividend / net income

Dividend = 555000
net income = 1110000
DPR = 555000/1110000*100 = 50%

P/E ratio = Mkt price of the share / EPS

P/E ratio = 1110/111 = Rs. 10 per share

1RS of earning im paying 10Rs mkt price

Mkt price of the share is 10times its earnings
greater P/E ratio is always a good sign but assets are not over valued

Answer
Earnings per share = Earnings attributable to eq shares/ # of eq share
EPS = PAT - Pref dividend /# of eq shares = [270000 - 9%*300000]/ 80000 = 3.04

Price earnings ratio = Mkt price / EPS

P/E ratio = 40/3.04 = 13.16 times
Dividend per share = Divedend income / # of equity shares
DPS = 60000/80000 = 0.75 per share

Dividend payout ratio = dividend income / net income available to eq shares

DPR = 60000/ (270000-27000) = 25%

Answer

P/E ratio = Mkt price / EPS

mkT PRICE = 50

EPS = Income aviable to eq shares/ # of shares

Particulars Amount Amount

Operating profit 2500000
Secured loan 15%
Less: interest Unsecured loan 10% 500000
EBT 2000000
Less: Tax 50% 1000000
PAT 1000000
Less: Pref dividend 0
Profit to eq share 1000000

EPS = 1000000/ 500000 = 2

Note: eq shares of 10 each

PE ratio = 50/2 = 25 times

P/E Ratio = MP/EPS

MP = 50

EPS = Net income availbel to eq shareholders / # of shares

Net income availebl to Eq sh = EBIT - Interest to Deb - Tax - Dividend to Pref capital
Computation of Income available to Equity;
Particulars Working Amount
EBIT 330000
Less: Interest 200000*9% 18000
 EBT 312000
Less: Tax 50% *312000 156000
PAT 156000
Less: Pref dividend 10%*250000 25000
Net income 131000

# of eq shared = 250000/10 = 25000

EPS = 131000/25000 = 5.24

P/E ratio = 50/5.24 = 9.54

Calculate ; P/E ratio and Dividend payout ratio, Dividend per share

P/E ratio = MP/EPS

EPS = Net income / # of eq shares
EPS = (215000-16000)/8000 = 24.875
P/E ratio = 90/24.875 = 3.6

Divedend payout ratio = dividend paid / net income

DPR = (80000+16000)/215000 = 96000/215000= 44.6%

Retentio ratio = 1-DPR = 1-0.446 = 55.4%

DPS = Dividend paid / # of shares

DPS for eq sharholders = 80000/8000 = 10 per share
Answer
3point dupont analysis = Profi
ROE = (NI/Revenue)*(revenu
ROE = (215000/1200000)*(12
ROE = 0.18*0.44*2.5
ROE = 19.8%

5point dupont analysis = Tax

ROE = NI/EBT*EBT/EBIT*EBIT
ROE = 215000/265000*2650
ROE = 0.81*0.76*0.29*0.44*
ROE = 19.63%

ROE = Net income / equity

ROE = 215000/1104000
ROE = 19.475%
 Answer;
Current ROE = 2.5%
ROE = net income/ avg equity shareholding

Dupont analysis - 3 point analysis or 5 point analysis

3 point Dupont analysis = Profit margin * Assets turnover ratio * leverage ratio
5 point dupont analysis = Tax burden * Interest burdent * EBIT margin * Assets turnover * Leverage

Computation of net income

Particulars Working Amount
Sales 8000
COGS
EBIT 800
Less: Interest 240
EBT 560
Less: Tax 560*40% 224
Net income 336

Profit margin = Net income / Net revenue = 336/8000 = 0.042

Assets turnover ratio = 1.6
Leverage ratio = Average total assets/ Average equity shareholding

Computation of leverage ratio

Debt ratio = 50%
Debt / total assets = 50%
Implies Equity / total assets = 50%
Leverage ratio = 1/ (Equity /totalassets)
Leverage ratio = 1/50% = 1/0.5 = 2

ROE = 0.042*1.6*2 = 0.1344 = 13.44%

ROE = (Net income / EBT) * (EBT/EBIT) * (EBIT/Revenue)* 1.6*2

ROE = (336/560)*(560/800)*(800/8000)*1.6*2
ROE = 0.6*0.7*0.1*1.6*2
ROE = 13.44%

3point dupont analysis = Profit margin * Assets turnobver * leverage

ROE = (NI/Revenue)*(revenue/total assets)*(total assets / total equity)
ROE = (215000/1200000)*(1200000/2750000)*(2750000/1104000)
ROE = 0.18*0.44*2.5
ROE = 19.8%

5point dupont analysis = Tax burden * interest burden * EBIT Margin* Assets turnover* Leverage
ROE = NI/EBT*EBT/EBIT*EBIT/Revenue*Revenue?total assets*total assets/equity
ROE = 215000/265000*265000/347000*347000/1200000*0.44*2.5
ROE = 0.81*0.76*0.29*0.44*2.5
ROE = 19.63%

ROE = Net income / equity

ROE = 215000/1104000
ROE = 19.475%
Calculate
Current ratio
Quick ratio
Absolute liquid ratio

Debt to assets
Debt to capital
Interest covergae ratio

ROA
ROE

EPS

5 point dupont analysis(consider provisi

Receivables turnover ratio (consider tot

Payables turnover ratio ( consider total
Inventory turnover ratio( opening inven
Payables outstanding days
Recievables outstanding days
overgae ratio

upont analysis(consider provision as tax paid)

es turnover ratio (consider total sales is on credit basis and opening recievables is 200000)
turnover ratio ( consider total purchases is on credit basis and opening creditors is 60000)
turnover ratio( opening inventory - 150000)
outstanding days
es outstanding days