Summary of Ratios

Ration Formula Purpose or Use

Liquidity Ratios Measures short-term
1. Current ration debt-paying ability.
2. Acid-test (quick) Measures immediate
ratio short-term liquidity
3. Receivables Measures liquidity of
turnover receivables
4. Inventory Measures liquidity of
turnover inventory
Profitability Ratios Measures net income
5. Profit margin generated by each dollar
of sales.
6. Asset turnover Measures how efficiently
assets are used to
generate sales.
7. Return on assets Measures overall
profitability of assets
8. Return on Measures profitability of
common owners investment
stockholders
equity
9. Earnings per Measure net income
share (EPS) earned on each share of
common stock
10. Price earnings Measures the ratio of the
(P.E) ratio market price per share to
earnings per share
11. Payout ratio Measures percentage of
earning distributed in the
form of cash dividends.
Solvency Ratios Measures the percentage
12. Debt to toal of total assets provided
assets ratio by creditors
13. Times interest Measures ability to meet
earned 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 =

=
= 3: 1

(b) Acid- test ratio =

=
= = 1: 48: 1

(c) Stock turnover =

= = 7.1 times

(d) Debtors turnover =

= = 12.0 times

(e) Gross Profit ratio =

X100 = X 100 = 23%

(f) Net Profit ratio =

X100 = X 100 = 3%

(g) Operating ratio =

X100

=
X 100 = 94%

(h) Earning per share =

(EPS)

=
=Rs 12

(i) Rate of return =

X 100 = 8.8%

(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 =

= = 4.04: 1 Previous year

=
= 3.815:1 current year

(b) Acid test ratio =

=

=
= 1.125: 1 Previous year

=
= 1.1: 1 current year

(ii) Salvency ration

(a) Debt-equity
 ratio

(1)

(2)

= =

0.91previous year

= =

0.65previous year

= =

0.85current year

= =

0.957current year

(b) Interest coverage ratio

= == =7.5 times (current year)

(iii) Proftablity rations (current year)

(a) Gross Profit ration = X100= x 100 = 30%

(b) Net Profit ration = X100= x 100 = 13%

(c) Return on Total Resources = X100

= X 100 =9.40%
 (d) Return of capital employed = X100

= X 100 =13.6%

(e) Return on equity funds= = 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

(a) Debtors turnover = = 11.1 times

(b) Stock turnover = = 1.4 times

(c) Total assets turnover = = 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.

ESSENCE:
1) What is allowance in accounting ?
Ans : An allowance is a reserve that is set aside in the expectation of expenses that will be incurred
at a future date.
An allowance is created for bad debts that are expected to arise from invoices sent to customers.

An allowance is created for sales returns that are expected from current shipments to customers.

An allowance is created for warranty claims expected from current shipments to customers.

2) What is bad debt?

Ans: Bad debt is an account receivable that has been determined to be uncollectible, meaning a
creditor will not be repaid. This debt is written off as an expense on a company's financial statements,
negatively impacting profitability and reducing assets. Bad debts occur for various reasons, such as a
customer's insolvency, refusal to pay, or disappearance, and can also arise from credit fraud or
misrepresentation.

3) What is inventory in accounting?

Ans: In accounting, inventory refers to the goods and materials a company holds for sale, production,
or future use, including raw materials, work-in-progress, and finished products. It's considered a
current asset on a company's balance sheet because it is expected to be sold or used within one year.

4) What is equity share capital in accounting?

Ans: In accounting, equity share capital is the total amount of money a company raises by selling its
shares to investors, representing the funds provided by owners in exchange for ownership stakes in the
business.
5) What is retained earnings in accounting?
Ans: Retained earnings are the accumulated profits of a company that are not paid out to shareholders
as dividends but are reinvested back into the business for future growth, debt repayment, or other
expenses.
6) Who are Sundry Creditors?
Ans: A person who gives goods or services to the business in credit or does not receive the payment
immediately from the business and is liable to receive the payment from the business in future is called
a Sundry Creditor.