Summary of Ratios

Ration Formula Purpose or Use

Liquidity Ratios Current assets Measures short-term
1. Current ration Current Liabilities debt-paying ability.
2. Acid-test (quick) Cash+ Short−term Investments + Receivables (netMeasures
) immediate
ratio Current Liabilities short-term liquidity
3. Receivables Net credit sales Measures liquidity of
turnover Average net receivablesties receivables
4. Inventory Cost of Goods sold Measures liquidity of
turnover Average inventory inventory
Profitability Ratios Net inc ome Measures net income
5. Profit margin Net sales generated by each dollar
of sales.
6. Asset turnover Net sales Measures how
sAverage assets efficiently assets are
used to generate sales.
7. Return on assets Net income Measures overall
Average a ssets profitability of assets
8. Return on Net income Measures profitability of
common Average common stockholders equity owners investment
stockholders
equity
9. Earnings per Net income Measure net income
share (EPS) Weighted average common shares qutstanding earned on each share of
common stock
10. Price earnings Market price per share of stock Measures the ratio of
(P.E) ratio Earnings per share the market price per
share to earnings per
share
11. Payout ratio Cash Dividends Measures percentage of
Net Income earning distributed in
the form of cash
dividends.
Solvency Ratios Total debt Measures the
12. Debt to toal Total Assets percentage of total
assets ratio assets provided by
creditors
13. Times interest Income before income taxes∧interest expenses Measures ability to meet
earned Interest expense interest payments as
they come due.
SOLVED PROBLEM -1

You have been furnished with the financial information of Aditya Mills Limited as under

Liabilities (Rs) Assets (Rs)

Equity share capital 10,00,000 Plant and equipment 6,49,000

(Rs 100 each) Land and building 80,000

Retained earning 3,08,000 Cash 1,60,000

Sundry creditors 1,04,000 Sundry

Bills payable 2,00,000 debtors Rs 3,60,000

Other current liabilities 20,000 - allowance 40,000 3,20,000

Stock/inventory 4,80,000

Prepaid insurance 12,000

16,92,000 16,92,000

Statement of profit for the year ended 31st Dec….

Sales Rs 40,00,000

Less cost of goods sold 30,00,000

Gross profit on sales 9,20,000

Less operating expenses 6,80,000

Net Profit 2,40,000

Less taxes 1,20,000

Net Profit after taxes 1,20,000

Sundry debtors/ Accounts receivable and stock/ inventory at the beginning of the year were Rs3,00,000
and Rs 4,00,000 respectively.

Determine the following ratios of Aditya Mills Ltd.

(a) Current ratio

(b) Acid test ratio
(c) Stock turnover
(d) Debtors turnover
(e) Gross profit ratio
(f) Net profit ratio
(g) Operating ratio
(h) Earning per shares (EPS)
 (i) Rate of return on equity capital
(j) Market value of the share if price earning ratio is 10 times

Solution

(1) (a) Current ratio = Current assets

Current Liabilities
= Cash+ Debtors+ Stock + Prepaid Insurance
Creditors+ Bills Payable +Other current liabilities
= Rs 1 , 60,000+ Rs 3 , 20,000+ Rs 4 ,80,000=Rs 12,000
Rs 1 ,04,000+ Rs 2, 00,000+ Rs 20,000
= Rs 9 ,72,000
= 3: 1
3 , 24,000
(b) Acid- test ratio = Liquid assets
Current Labilities
= Current assets−Stock prepaid insurance
Current liabilities
= LRs 9 ,72,000−Rs 4 ,92,000 Rs 4 , 80,000
= = 1: 48: 1
Rs 2 ,24,000 Rs 3 , 24,000
(c) Stock turnover = Cost of goods sold Rs 3 , 80,000
= = 7.1 times
Average stock Rs 4 , 40,000
(d) Debtors turnover = Credit sales Rs 4 , 00,000
= = 12.0 times
Av erage debors Rs 3 , 10,000
(e) Gross Profit ratio = Gross Profit Rs 9 , 20,000
X100 = X 100 = 23%
Sales Rs 4 , 00,000
(f) Net Profit ratio = Net Profit Rs 1 , 20,000
X100 = X 100 = 3%
Sales Rs 4 , 00,000
(g) Operating ratio = Cost of goods sold +Operating expenses
X100
Sales
= Rs 30 , 80,000+ Ps 6 ,80,000
X 100 = 94%
Rs 4 , 00,000
(h) Earning per share = Earnings available ¿ equity holders ¿
Number of Equity shares
(EPS)
= Rs 1 , 20,000
=Rs 12
Rs 10,000
(i) Rate of return = Rs1 , 20,000
X 100 = 8.8%
Rs 13 , 65,000
(j) Market Value of = = EPS x P/E Ratio = Rs 12 X 10 times = Rs 120
the share
Solved problem -2

Previous year (Rs) Current year (Rs)

Cash 2,00,000 1,60,000
Sundry debtors 3,20,000 4,00,000
Temporary investments 2, 00,000 3, 20,000
Stock 18,40,000 21,60,000
Prepaid expenses 28,000 12,000
Total Current assets 25,88,000 30,52,000
Total assets 56,00,000 64,00,000
Current liabilities 6,40,000 8,00,000
10% Debentures 16,00,000 16,00,000
Equity share capital 20,00,000 20,00,000
Retained earnings 4,68,000 8,12,000

Statement of profit for the current year

Rs
Sales 40,00,000
Less cost of goods sold 28,00,000
Less interest 1,60,000
Net profit 10,40,000
Less taxes @ 50% 5,20,000
Profit after taxes 5,20,000
Dividends declared on equity shares 2,20,000

From the above appraise the financial position of the company from the points of view of (i) liquidity, (ii)
solvency, (iii) Profitability and (iv) Activity.

Solution
(i) Liquidity ratios

(a) Current ratio = CA = Rs 25 ,88,000 = 4.04: 1 Previous year

CL Rs 6 , 40,000
= Rs 30 , 52,000
Rs 8 , 00,000
= 3.815:1 current year
(b) Acid test ratio = CA Rs 25 ,88,000−RS 18 ,68,000
=
CL Rs 6 , 40,000
= Rs 7 , 20,000
Rs 6 , 40,000
= 1.125: 1 Previous year
= Rs 30 , 52,000−Rs21 , 72,000
Rs 8 , 00,000
= Rs 8 ,80,000
Rs 8 ,00,000
= 1.1: 1 current year
(ii) Salvency ration
(a) Debt-equity
ratio
Total outsider debts
(1) Equity funds
 Longterm debts
(2) Equity funds
Rs 22, 40,000
= Rs 24 , 68,000 =
0.91previous year
Rs16 ,00,000
= Rs 24 , 68,000 =
0.65previous year
Rs 24 , 00,000
= Rs 28 ,12,000 =
0.85current year
Rs 16 ,00,000
= Rs 28 ,12,000 =
0.957current year

(b) Interest coverage ratio

EBIT Rs 12 , 00,000
= Interest Charges = = Rs 1 , 60 , , 000 =7.5 times (current year)

(iii) Proftablity rations (current year)

Gross profit Rs 12 ,00,000
(a) Gross Profit ration = Sales
X100= Rs 40 , 00,000
x 100 = 30%
Net profit Rs 5 ,20,000
(b) Net Profit ration = Sales X100= Rs 40 , 00,000 x 100 = 13%
EAT + Interest −Tax saving on interest
(c) Return on Total Resources = Total assets
X100

Rs 5 , 20,000+ Rs 1 , 60,000−Rs 80,000

= Rs 64 ,00,000
X 100 =9.40%

EAT + Interest −Tax saving on interest

(d) Return of capital employed = Total capital employed
X100
Rs 5 , 20,000+ Rs 1 , 60,000−Rs 80,000
= Rs 44 , 12,000
X 100 =13.6%
Net profit after taxes Rs 5 , 20,000
(e) Return on equity funds= Equity funds
X 100 =
Rs 28 ,12,000
x 100 =
18.5%

Note: Ratios (c), (d) and (e) can also be determined by taking average
total assets/capital employed/equity funds.

(iv) Activity rations

Rs 40 , 00,000
(a) Debtors turnover = Rs 3 ,60,000
= 11.1 times
 Rs 28 ,00,000
(b) Stock turnover = Rs 20 ,00,000 = 1.4 times
Rs 28 , 00,000
(c) Total assets turnover = Rs 64 , 00,000 = 0.44 times

The company’s position is quite sound from the point of view of liquidity solvency
and profitability. However, its activity ratios, particularly in term of the utilization
of total assets an holding of stocks, do not seem to be satisfactory.
Self test problem - 1

The comparative statements of Dillon Company are presented below.

DILLON COMPANY
Income Statement
For year Ended December 31
2009 2008
Net sales (all on account) $600,00 $520,000
Expenses:
Cost of goods sold 415,000 354,000
Selling and administrative 120,800 114,800
Interest expenses 7,800 6,000
Income tax expenses 18,000 14,000
Total Expenses 561,600 488,800
Net income $38,400 $31,200

DILLON COMPANY
Balance Sheets
December 31
2009 2008
Current assets
Cash $21,000 $18,000
Short-term investments 18,000 15,000
Account receivable (net) 86,000 74,000
Inventory 90,000 70,000
Total current assets 215,000 177,000
Plant assets (net) 423,000 383,000
Total assets $638,000 $560,000

Liabilities and Stockholders Equity

Current liabilities $ 122,000 $110,000
Accounts payable 23,000 20,000
Total current liabilities 145,000 130,000
Long-term liabilities
Bonds payable 120,000 80,000
Total liabilities 265,000 210,000
Stockholders equity
Common stock ($5 par) 150,000 150,000
Retained earnings 230,000 200,000
Total stockholders equity 373,000 350,000
Total liabilities and stockholders equity $638,000 $560,000

Additional data:
The common stock recent sold at $19.50 per share
The year end balance in the allowance for doubtful accounts was $3,000 for 2009 and $2,400 for 2008

Instruction
Compute the following ratios for 2009
(a) Current (b) Acid-test (c) Receivables turnover
(d) Inventory turnover (e) Profit margin. (f) Asset turnover (g) Return on assets
(h) Return on common stockholders equity (i) Earnings per share. (j) Price earnings
(k) payout (l) Debt to total assets (m) Times interest earned.