BEFA UNIT V

RATIOS
Absolute figures are valuable but they standing alone convey no meaning unless
compared with another. Accounting ratio show inter-relationships which exist
among various accounting data. When relationships among various accounting data
supplied by financial statements are worked out, they are known as accounting
ratios.
What is a ratio?
Ratio analysis is a means for financial analysis. Ratio is a mathematical relationship
between two accounting figures. They show the relationship between two items in a
more meaningful way which help us to draw certain conclusions. Ratios may be
used to compare the previous data, to compare one firm with another firm etc. the
ratios can be expressed as percentage or proportion or times based on the nature
of ratio.

TYPES OF
RATIOS

Liquidity Liverage Turnover Profitability

Ratios Ratios Ratios Ratios

LIQUIDITY RATIOS
Liquidity ratios express the ability of the firm to meet its short-term Obligations as
when they become due. Creditors are interested to know whether the firms is in a
position to meet its commitments on time or not. These ratios help in identifying
the danger signals for the firm in advance. The important liquidity ratios are given
below.
1. Current Ratio:- It is also called as working capital ratio. It is the ratio between
current assets and current liabilities. The firm is in comfortable position if its current
ratio is 2:1. It means for every rupee of current liability, there should be two rupees
worth of current assets.
𝐂𝐮𝐫𝐫𝐞𝐧𝐭 𝐀𝐬𝐬𝐭𝐞𝐬
𝐂𝐮𝐫𝐫𝐞𝐧𝐭 𝐑𝐚𝐭𝐢𝐨 =
𝐂𝐮𝐫𝐫𝐞𝐧𝐭 𝐋𝐢𝐚𝐛𝐢𝐥𝐭𝐢𝐞𝐬
155
 BEFA UNIT V
Current assets = Cash + cash in bank + marketable securities + short term
investments + bills receivables +debtors + inventory + stock +
work-in-progress + pre-paid expenses + incomes receivable
(accrued income) etc.
Current liabilities = Expenses payable + bills payable + creditors + short term
loans + income tax to be paid + dividend payable + bank
overdraft + long term loans and debentures to be paid within one
year + provision for tax + short term advances etc.
2. Quick Ratio:- It is also called as working Acid test ratio or liquid ratio. It is the
ratio between quick assets and current liabilities. The firm is in comfortable position
if its current ratio is 1:1. It means for every rupee of current liability, there should
be one rupee worth of quick assets. Quick assets can be converted into cash
quickly.
𝐐𝐮𝐢𝐜𝐤 𝐀𝐬𝐬𝐭𝐞𝐬
𝐐𝐮𝐢𝐜𝐤 𝐑𝐚𝐭𝐢𝐨 =
𝐂𝐮𝐫𝐫𝐞𝐧𝐭 𝐋𝐢𝐚𝐛𝐢𝐥𝐭𝐢𝐞𝐬
Quick assets = All current assets except stock and prepaid expenses.
Example 1:
From the Balance Sheet of XYZ Co. Ltd., calculate liquidity ratios.
(Rs. in thousands)
Capital & Liabilities Amount Assets Amount
Land and
Preference share capital 100 225
Buildings
Plant and
Equity share capital 150 250
machinery
Furniture and
General reserve 250 100
Fixtures
Debentures 400 Stock 250
Creditors 200 Debtors 125
Bills payable 50 Cash at Bank 250
Outstanding expenses 50 Cash in hand 125
Profit and loss account 100 Prepaid expenses 50
Marketable
Bank loan(Long term) 200 125
securities
1500 1500

156
 BEFA UNIT V
Solution:
𝐂𝐮𝐫𝐫𝐞𝐧𝐭 𝐀𝐬𝐬𝐭𝐞𝐬
𝐂𝐮𝐫𝐫𝐞𝐧𝐭 𝐑𝐚𝐭𝐢𝐨 =
𝐂𝐮𝐫𝐫𝐞𝐧𝐭 𝐋𝐢𝐚𝐛𝐢𝐥𝐭𝐢𝐞𝐬
Current assets = Stock + Debtors + Cash at Bank + Cash in hand + Prepaid
expenses + Marketable securities.
= 250 + 125 + 250 + 125 + 50 + 125 = 925
Current liabilities = Creditors + Bills payable + Outstanding expenses.
= 200+ 50 + 50 = 300
925
𝐂𝐮𝐫𝐫𝐞𝐧𝐭 𝐑𝐚𝐭𝐢𝐨 = 300 = 3.08: 1
Quick assets = Debtors + Cash at Bank + Cash in hand + Marketable securities.
= 125 + 250 + 125 + 125 = 625
625
𝐐𝐮𝐢𝐜𝐤 𝐑𝐚𝐭𝐢𝐨 = = 2.08: 1
300

ACTIVITY RATIOS/TURNOVER RATIOS

Activity ratios are classed as Turnover ratios. These ratios tell how active the firm is
in selling stocks, collecting money from debtors and paying to creditors. They are
given below.
1. Inventory Turnover Ratio:- It is also called as Stock turnover ratio. It
indicates the number of times the average stock is being sold during a given
accounting period. The higher the ratio, the better is the performance of the firm in
selling its stock. It is the rate at which inventories are converted into sales and then
to cash.
𝐂𝐨𝐬𝐭 𝐨𝐟 𝐠𝐨𝐨𝐝𝐬 𝐬𝐨𝐥𝐝
𝐚) 𝐈𝐧𝐯𝐞𝐧𝐭𝐨𝐫𝐲 𝐓𝐮𝐫𝐧𝐨𝐯𝐞𝐫 𝐑𝐚𝐭𝐢𝐨 =
𝐀𝐯𝐞𝐫𝐚𝐠𝐞 𝐒𝐭𝐨𝐜𝐤
Cost of goods sold = Opening stock + Purchases + Manufacturing expenses –
Closing stock
(or)
= Sales – Gross profit
Opening stock + Closing stock
𝐀𝐯𝐞𝐫𝐚𝐠𝐞 𝐬𝐭𝐨𝐜𝐤 =
2
Note 1. When cost of goods sold is not given, sales amount should be taken into
account.
2. When opening stock is not given, closing stock is considered as ‘average
stock’.
𝟑𝟔𝟓 𝐝𝐚𝐲𝐬
𝐛) 𝐈𝐧𝐯𝐞𝐧𝐭𝐨𝐫𝐲 𝐇𝐨𝐥𝐝𝐢𝐧𝐠 𝐏𝐞𝐫𝐢𝐨𝐝 =
𝐈𝐧𝐯𝐞𝐧𝐭𝐨𝐫𝐲 𝐓𝐮𝐫𝐧𝐨𝐯𝐞𝐫 𝐑𝐚𝐭𝐢𝐨
Example 1:
A firm sold goods worth Rs. 500000 and its gross profit is 20% of sales value.
The inventory at the beginning of the year was Rs. 16000 and at end of the year
was 14000. Compute inventory turnover ratio and also the inventory holding
period.

157
 BEFA UNIT V
Solution:
Cost of goods sold 400000
𝐚) 𝐈𝐧𝐯𝐞𝐧𝐭𝐨𝐫𝐲 𝐓𝐮𝐫𝐧𝐨𝐯𝐞𝐫 𝐑𝐚𝐭𝐢𝐨 = = = 26.66 times
Average Stock 15000
Cost of goods sold = Sales – Gross profit = 500000 – (500000 x 20%) =
400000
Opening stock + Closing stock 16000 + 14000
𝐀𝐯𝐞𝐫𝐚𝐠𝐞 𝐬𝐭𝐨𝐜𝐤 = = = 15000
2 2
365 days 365
𝐛) 𝐈𝐧𝐯𝐞𝐧𝐭𝐨𝐫𝐲 𝐇𝐨𝐥𝐝𝐢𝐧𝐠 𝐏𝐞𝐫𝐢𝐨𝐝 = = = 14 days
Inventory Turnover Ratio 26.66
2. Debtors Turnover Ratio:- It reveals the number of times the average debtors
are collected during a given accounting period. The firms usually prepare the aged
list of debtors showing the details of when to collect and how much to collect from
debtors. The higher the ratio, the better is the performance of the firm in collecting
money from debtors.
𝐍𝐞𝐭 𝐜𝐫𝐞𝐝𝐢𝐭 𝐬𝐚𝐥𝐞𝐬
𝐚) 𝐃𝐞𝐛𝐭𝐨𝐫𝐬 𝐓𝐮𝐫𝐧𝐨𝐯𝐞𝐫 𝐑𝐚𝐭𝐢𝐨 =
𝐀𝐯𝐞𝐫𝐚𝐠𝐞 𝐃𝐞𝐛𝐭𝐨𝐫𝐬
Net Credit Sales = Credit sales – Returns
Note: 1. When credit sales are not given, total sales are taken.
Opening debtors + Closing debtors
𝐀𝐯𝐞𝐫𝐚𝐠𝐞 𝐝𝐞𝐛𝐭𝐨𝐫𝐬 =
2
Note: 1. If opening debtors are not given, closing debtors should be considered as
average debtors.
𝟑𝟔𝟓 𝐝𝐚𝐲𝐬
𝐛) 𝐃𝐞𝐛𝐭 𝐂𝐨𝐥𝐥𝐞𝐜𝐭𝐢𝐨𝐧 𝐏𝐞𝐫𝐢𝐨𝐝 =
𝐃𝐞𝐛𝐭𝐨𝐫𝐬 𝐓𝐮𝐫𝐧𝐨𝐯𝐞𝐫 𝐑𝐚𝐭𝐢𝐨
Example:
A firm’s sales during the year was Rs. 400000 of which 60% were credit sales.
The balance of debtors at the beginning and ending year were 25000 and 15000
respectively. Calculate debtors turnover ratio of the firm. Also find out debt
collection period.
Solution:
Net credit sales 240000
𝐚) 𝐃𝐞𝐛𝐭𝐨𝐫𝐬 𝐓𝐮𝐫𝐧𝐨𝐯𝐞𝐫 𝐑𝐚𝐭𝐢𝐨 = = = 12 times
Average Debtors 20000
Net credit sales = Sales x 60/100 = 400000 x 60/100 = 240000
Opening debtors + Closing debtors 25000 + 15000
𝐀𝐯𝐞𝐫𝐚𝐠𝐞 𝐝𝐞𝐛𝐭𝐨𝐬 = = = 20000
2 2
365 days 365 days
𝐛) 𝐃𝐞𝐛𝐭 𝐂𝐨𝐥𝐥𝐞𝐜𝐭𝐢𝐨𝐧 𝐏𝐞𝐫𝐢𝐨𝐝 = = = 30.41 days
Debtors Turnover Ratio 12
3. Creditors Turnover Ratio:- It reveals the number of times the average
creditors are paid during a given accounting period. The firms usually prepare the
aged list of creditors showing the details of when to pay and how much to pay to its
creditors. It shows how promptly the firm is in a position to pay its creditors.
𝐍𝐞𝐭 𝐜𝐫𝐞𝐝𝐢𝐭 𝐩𝐮𝐫𝐜𝐡𝐚𝐬𝐞𝐬
𝐚) 𝐂𝐫𝐞𝐝𝐢𝐭𝐨𝐫𝐬 𝐓𝐮𝐫𝐧𝐨𝐯𝐞𝐫 𝐑𝐚𝐭𝐢𝐨 =
𝐀𝐯𝐞𝐫𝐚𝐠𝐞 𝐂𝐫𝐞𝐝𝐢𝐭𝐨𝐫𝐬
Net Credit Purchases = Credit Purchases – Returns

158
 BEFA UNIT V
Note: 1. When credit purchases are not given, total purchases are taken.

Opening creditors + Closing creditors

𝐀𝐯𝐞𝐫𝐚𝐠𝐞 𝐜𝐫𝐞𝐝𝐢𝐭𝐨𝐫𝐬 =
2
Note: 1. If opening creditors are not given, closing creditors should be considered
as average creditors.
𝟑𝟔𝟓 𝐝𝐚𝐲𝐬
𝐛) 𝐂𝐫𝐞𝐝𝐢𝐭𝐨𝐫𝐬 𝐏𝐚𝐲𝐦𝐞𝐧𝐭 𝐏𝐞𝐫𝐢𝐨𝐝 =
𝐂𝐫𝐞𝐝𝐢𝐭𝐨𝐫𝐬 𝐓𝐮𝐫𝐧𝐨𝐯𝐞𝐫 𝐑𝐚𝐭𝐢𝐨
Example:
A firm’s purchases during the year was Rs. 400000 of which 50% were credit
purchases. The balance of creditors at the beginning and ending year were 30000
and 10000 respectively. Calculate creditors turnover ratio of the firm. Also find out
creditors payment period.
Solution:
Net credit purchases 200000
𝐚) 𝐂𝐫𝐞𝐝𝐢𝐭𝐨𝐫𝐬 𝐓𝐮𝐫𝐧𝐨𝐯𝐞𝐫 𝐑𝐚𝐭𝐢𝐨 = = = 10 times
Average Creditors 20000
Net credit purchases = Purchases x 50/100 = 400000 x 50/100 = 200000
Opening creditors + Closing creditors 30000 + 10000
𝐀𝐯𝐞𝐫𝐚𝐠𝐞 𝐜𝐫𝐞𝐝𝐢𝐭𝐨𝐫𝐬 = = = 20000
2 2
365 days 365 days
𝐛) 𝐂𝐫𝐞𝐝𝐢𝐭𝐨𝐫𝐬 𝐏𝐚𝐲𝐦𝐞𝐧𝐭 𝐏𝐞𝐫𝐢𝐨𝐝 = = = 36.5 days
Creditors Turnover Ratio 10
CAPITAL STRUCTURE RATIOS:
Capital structure ratios are also called as leverage ratios. These ratios focus on the
long term solvency of the firm. The long term solvency of the firm always reflected
in its ability to meet its long term commitments such as payment of interest
periodically without fail, repayment of principal as and when the become due. The
below are the most commonly used capital structure rations.
1. Debt-Equity Ratio:- It is the ratio between outsider’s funds(Debt) and insider’s
funds (Equity). It is a measure of solvency. This ratio is used to measure the
firm’s obligations to creditors in relation to the owners’ funds. The standard ratio
is 1:1. this means for every rupee of debt, there should be one rupee worth
internal funds. A high D/E ratio implies that the creditors stake is more as
compared to that of owners.
𝐃𝐞𝐛𝐭 𝐎𝐮𝐭𝐬𝐢𝐝𝐞𝐫𝐬 𝐅𝐮𝐧𝐝𝐬 𝐋𝐨𝐧𝐠 𝐭𝐞𝐫𝐦 𝐥𝐨𝐚𝐧𝐬
𝐃𝐞𝐛𝐭 − 𝐄𝐪𝐮𝐢𝐭𝐲 𝐑𝐚𝐭𝐢𝐨 = = =
𝐄𝐪𝐮𝐢𝐭𝐲 𝐈𝐧𝐬𝐢𝐝𝐞𝐫 ′ 𝐬 𝐅𝐮𝐧𝐝𝐬 𝐒𝐡𝐚𝐫𝐞𝐡𝐨𝐥𝐝𝐞𝐫𝐬 𝐅𝐮𝐧𝐝𝐬 𝐨𝐫 𝐍𝐞𝐭 𝐰𝐨𝐫𝐭𝐡
Debt = Debentures + bonds + mortgage loan + other long term loans.
Equity = Equity share capital + preference share capital + capital reserve +
revenue reserve + sinking fund + contingent reserve – artificial assets.
Note: Artificial assets = preliminary expenses + deferred revenue expenses +
discount on issue of shares/ debentures + profit and loss A/C debit balance +
underwriting commission
. Example 1: Calculate Debt – Equity ratio from the following data.

159
 BEFA UNIT V
Debentures Rs. 400000, Long term loans Rs. 200000, Preference share capital
Rs. 100000, Equity share capital Rs. 150000, General reserve Rs. 250000, Profit &
Loss account Rs. 100000.
Solution:
Debt 600000
𝐃𝐞𝐛𝐭 − 𝐄𝐪𝐮𝐢𝐭𝐲 𝐑𝐚𝐭𝐢𝐨 = = = 1: 1
Equity 600000
Debt = 400000 + 200000 = 600000
Equity = 100000 + 150000 + 250000 + 100000 = 600000
2. Interest Coverage Ratio:- This ratio judges the firm’s capacity to pay the
interest on debt it borrows. The higher the ratio, better it is. A ratio implies that the
company has no problems in paying interest.
𝐄𝐁𝐈𝐓 𝐏𝐁𝐈𝐓
𝐈𝐧𝐭𝐞𝐫𝐞𝐬𝐭 𝐂𝐨𝐯𝐞𝐫𝐚𝐠𝐞 𝐑𝐚𝐭𝐢𝐨 = =
𝐈𝐧𝐭𝐞𝐫𝐞𝐬𝐭 𝐈𝐧𝐭𝐞𝐫𝐞𝐬𝐭
EBIT = Earnings Before Interest and Tax
PBIT = Profit Before Interest and Tax
Interest = Fixed interest on long term loans
Example: EBIT of a company is Rs. 560000. Its fixed commitments include
payment of 10 percent on 7000 debentures of Rs. 100 each. It is subject to tax of
30 percent per annum. Calculate interest coverage ratio.
Solution:
EBIT 560000
𝐈𝐧𝐭𝐞𝐫𝐞𝐬𝐭 𝐂𝐨𝐯𝐞𝐫𝐚𝐠𝐞 𝐑𝐚𝐭𝐢𝐨 = = = 8 times
Interest 70000
EBIT = Rs. 560000
Debentures Amount = 7000 debentures x Rs. 100 each = Rs. 700000
Fixed interest charges on debentures = 700000 x 10/100 = 70000
3. Proprietor’s Funds to Total Assets Ratio
Proprietors’ Funds = Equity share capital + Preference share capital + General
reserve + Employee Provident Fund + profit and loss
account.
Total Assets = Tangible assets and Current assets
′
𝐏𝐫𝐨𝐩𝐫𝐢𝐞𝐭𝐨𝐫𝐬′ 𝐅𝐮𝐧𝐝𝐬
𝐏𝐫𝐨𝐩𝐢𝐞𝐭𝐨𝐫𝐬 𝐅𝐮𝐧𝐝𝐬 𝐭𝐨 𝐓𝐨𝐭𝐚𝐥 𝐀𝐬𝐬𝐞𝐭𝐬 𝐑𝐚𝐭𝐢𝐨 =
𝐓𝐨𝐭𝐚𝐥 𝐀𝐬𝐬𝐞𝐭𝐬
Proprietors’ Funds = Equity share capital + Preference share capital + General
reserve + Employee Provident Fund + profit and loss account.
Total Assets = Tangible assets and Current assets

Example 1:
From the Balance Sheet of XYZ Co. Ltd., calculate liquidity
ratios.
(Rs. in thousands)
Capital & Liabilities Amount Assets Amount
Preference share capital 100 Land and Buildings 225
Equity share capital 150 Plant and machinery 250

160
 BEFA UNIT V
Furniture and
General reserve 250 100
Fixtures
Debentures 400 Stock 250
Creditors 200 Debtors 125
Bills payable 50 Cash at Bank 250
Outstanding expenses 50 Cash in hand 125
Profit and loss account 100 Prepaid expenses 50
Bank loan(Long term) 200 Marketable securities 125
1500 1500
Solution:
Proprietors ′ Funds 600
𝐏𝐫𝐨𝐩𝐢𝐞𝐭𝐨𝐫𝐬′ 𝐅𝐮𝐧𝐝𝐬 𝐭𝐨 𝐓𝐨𝐭𝐚𝐥 𝐀𝐬𝐬𝐞𝐭𝐬 𝐑𝐚𝐭𝐢𝐨 = = x 100 = 40%
Total Assets 1500
Proprietors’ Funds to Total Assets = 100+150+250+100=600
Total assets = 225+250+100+250+125+250+125+50+125=1500
PROFITABILITY RATIOS
Profitability ratios indicate how well the firm is operating its Activities in a
profitability manner. Owners want a reasonable rate of return on their investment.
So, the firm has to generate profits to meet the expectations of shareholders and
also for further expansion of the business. The following are the common
profitability ratios.
1. Gross Profit Ratio:- It is the ratio between gross profit and net sales. It is
expressed in percentage.
𝐆𝐫𝐨𝐬𝐬 𝐏𝐫𝐨𝐟𝐢𝐭
𝐆𝐫𝐨𝐬𝐬 𝐏𝐫𝐨𝐟𝐢𝐭 𝐑𝐚𝐭𝐢𝐨 = 𝐱 𝟏𝟎𝟎
𝐍𝐞𝐭 𝐬𝐚𝐥𝐞𝐬
Gross profit = Net sales – Cost of goods sold
(or)
=(sales+closing stock)-(opening stock+purhases)
Net sales = Total sales – Sales returns
Cost of goods sold = Opening stock + Net purchases + Production expenses
+Closing sotck
(or)
= Net sales – Gross profit
Example: Net sales is Rs. 50000 for a firm and cost of goods sold is Rs. 20000.
Calculate gross profit ratio.
Solution:
Gross Profit 30000
𝐆𝐫𝐨𝐬𝐬 𝐏𝐫𝐨𝐟𝐢𝐭 𝐑𝐚𝐭𝐢𝐨 = x 100 = x 100 = 60%
Net sales 50000
Gross profit = Net sales – Cost of goods sold = 50000-20000 = 30000
2. Net Profit Ratio:- It is the ratio between net profit after tax and net sales. It is
expressed in percentage.
𝐍𝐞𝐭 𝐏𝐫𝐨𝐟𝐢𝐭 𝐚𝐟𝐭𝐞𝐫 𝐭𝐚𝐱
𝐍𝐞𝐭 𝐏𝐫𝐨𝐟𝐢𝐭 𝐑𝐚𝐭𝐢𝐨 = 𝐱 𝟏𝟎𝟎
𝐍𝐞𝐭 𝐬𝐚𝐥𝐞𝐬

161
 BEFA UNIT V
Net Profit after Tax = (Operating Profit + Non-operating Income) – (Non-
operating Expenses + Taxes)
Operating Profit = (Net Sales – Operating Cost)
Operating Cost = (Cost of goods sold + Operating expenses)
Operating Expenses = (Office and Administration expenses + Sales and
Distribution expenses)
(or)
Net Profit after Tax = Gross profit – All expenses and losses + All incomes –Tax
Example : Calculate net profit ratio from the following data.
Net sales Rs. 50000
Cost of goods sold Rs. 20000
Administration Expenses Rs. 3000
Selling and Distribution expenses Rs 4000
Loss on sale of fixed assets Rs. 3000
Interest on investment received Rs. 2000
Tax 20%
Solution:
Particulars Rs Rs
Sales 50000
Less: Cost of goods sold 20000
Gross Profit 30000
Less: Administration expenses
3000
Selling and Distribution 7000
4000
expenses
Net Profit 23000
Add: Interest on investments 2000
25000
Less: Loss on sale of Asset 3000
22000
Tax 20% (22000x20/100) 4400
Net Profit After Tax 17600

Net Profit after tax 17600

𝐍𝐞𝐭 𝐏𝐫𝐨𝐟𝐢𝐭 𝐑𝐚𝐭𝐢𝐨 = x 100 = x100 = 35.2%
Net sales 50000
3. Operating Ratio:- It is the ratio between cost of goods sold plus operating
expenses and net sales. It is expressed as percentage to sales.
𝐎𝐩𝐞𝐫𝐚𝐭𝐢𝐧𝐠 𝐜𝐨𝐬𝐭
𝐎𝐩𝐞𝐫𝐚𝐭𝐢𝐧𝐠 𝐑𝐚𝐭𝐢𝐨 = 𝐱 𝟏𝟎𝟎
𝐍𝐞𝐭 𝐬𝐚𝐥𝐞𝐬
Operating Cost = (Cost of goods sold + Operating expenses)
Operating Expenses = (Office and Administration expenses + Sales and
Distribution expenses)
Operating Profit Ratio = 100 – Operating Ratio

162
 BEFA UNIT V
Example: Calculate operating ratio from the following data.
Net sales Rs. 50000
Cost of goods sold Rs. 20000
Administration Expenses Rs. 3000
Selling and Distribution expenses Rs 4000
Loss on sale of fixed assets Rs. 3000
Interest on investment received Rs. 2000
Tax 20%
Solution:
Operating cost 27000
𝐎𝐩𝐞𝐫𝐚𝐭𝐢𝐧𝐠 𝐑𝐚𝐭𝐢𝐨 = x 100 = x100 = 54%
Net sales 50000
Operating cost = (cost of goods sold + Operating Expenses)
= (20000+3000+4000) = 27000
4. Return On Investment (ROI):- This ratio is also called as Return On Capital
Employed (ROCE). The firm is interested to assess the return on capital
employed.
𝐏𝐁𝐈𝐓
𝐑𝐞𝐭𝐮𝐫𝐧 𝐎𝐧 𝐈𝐧𝐯𝐞𝐬𝐭𝐞𝐦𝐞𝐧𝐭 = 𝐱 𝟏𝟎𝟎
𝐍𝐞𝐭 𝐀𝐬𝐬𝐞𝐭𝐬 𝐨𝐫 𝐂𝐚𝐩𝐢𝐭𝐚𝐥 𝐄𝐦𝐩𝐥𝐨𝐲𝐞𝐝
Profit Before Interest and Tax (PBIT) = Gross profit – All expenses and losses
+ All incomes
Capital employed = Equity share capital + Preference share capital + Reserves +
Long term loans + Debentures – Intangible assets
(or)
= Fixed assets + Current assets – Current liabilities
5. Return On Equity (ROE):- The equity shareholders are interested to assess the
return on equity capital employed.
𝐏𝐀𝐓 − 𝐏𝐫𝐞𝐟𝐞𝐫𝐞𝐧𝐜𝐞 𝐝𝐢𝐯𝐢𝐝𝐞𝐧𝐝
𝐑𝐞𝐭𝐮𝐫𝐧 𝐎𝐧 𝐄𝐪𝐮𝐢𝐭𝐲 = 𝐱 𝟏𝟎𝟎
𝐄𝐪𝐮𝐢𝐭𝐲 𝐬𝐡𝐚𝐫𝐞𝐡𝐨𝐥𝐝𝐞𝐫𝐬′ 𝐅𝐮𝐧𝐝𝐬
Equity Shareholders Funds = Equity Share capital + Reserves and Surpluses
6. Earnings Per Share (EPS):- EPS is the relationship between net profit and the
number of equity shares outstanding at eth end of the given period.
𝐏𝐀𝐓 − 𝐏𝐫𝐞𝐟𝐞𝐫𝐞𝐧𝐜𝐞 𝐝𝐢𝐯𝐢𝐝𝐞𝐧𝐝
𝐄𝐚𝐫𝐧𝐢𝐧𝐠𝐬 𝐏𝐞𝐫 𝐒𝐡𝐚𝐫𝐞 =
𝐍𝐨. 𝐨𝐟 𝐞𝐪𝐮𝐢𝐭𝐲 𝐬𝐡𝐚𝐫𝐞𝐬
Example 1: Given that the number of share is 10000 and the net profit after taxes
for a given period is Rs. 450000, the EPS can be calculated as follows:
Solution:
𝐏𝐀𝐓 − 𝐏𝐫𝐞𝐟𝐞𝐫𝐞𝐧𝐜𝐞 𝐝𝐢𝐯𝐢𝐝𝐞𝐧𝐝 𝟒𝟓𝟎𝟎𝟎𝟎 − 𝟎
𝐄𝐚𝐫𝐧𝐢𝐧𝐠𝐬 𝐏𝐞𝐫 𝐒𝐡𝐚𝐫𝐞 = = = 𝐑𝐬. 𝟒𝟓
𝐍𝐨. 𝐨𝐟 𝐞𝐪𝐮𝐢𝐭𝐲 𝐬𝐡𝐚𝐫𝐞𝐬 𝟏𝟎𝟎𝟎𝟎
7. Dividend Yield Ratio (D/Y Ratio):- Yield means the amount of total return the
investor will receive for a given period of time for the amount of his investment.
Dividend yield refers to the percentage return on he price paid for shares. It is
calculated as given below:

163
 BEFA UNIT V
𝐃𝐢𝐯𝐢𝐝𝐞𝐧𝐝 𝐏𝐞𝐫 𝐒𝐡𝐚𝐫𝐞
𝐃𝐢𝐯𝐢𝐝𝐞𝐧𝐝 𝐘𝐢𝐞𝐥𝐝 𝐑𝐚𝐭𝐢𝐨 = 𝐱 𝟏𝟎𝟎
𝐌𝐚𝐫𝐤𝐞𝐭 𝐕𝐚𝐥𝐮𝐞 𝐏𝐞𝐫 𝐒𝐡𝐚𝐫𝐞
Example: Given that current market price of a share Rs. 300; face value of the
share is Rs. 100; percentage of dividend declared is 20%, the yield is;
Solution:
Dividend Per Share 20
𝐃𝐢𝐯𝐢𝐝𝐞𝐧𝐝 𝐘𝐢𝐞𝐥𝐝 𝐑𝐚𝐭𝐢𝐨 = x 100 = x 100 = 6.67%
Market Value Per Share 300
Dividend Per Share = Face value of share * 20/100 = 100 * 20/100 = 20
8. Price Earnings Ratio (P/E Ratio):- This is the ratio of the market value of a
share and Earnings Per Share.
𝐌𝐚𝐫𝐤𝐞𝐭 𝐕𝐚𝐥𝐮𝐞 𝐨𝐟 𝐄𝐪𝐮𝐢𝐭𝐲 𝐒𝐡𝐚𝐫𝐞
𝐏𝐫𝐢𝐜𝐞 − 𝐄𝐚𝐫𝐧𝐢𝐧𝐠𝐬 𝐑𝐚𝐭𝐢𝐨 =
𝐄𝐚𝐫𝐧𝐢𝐧𝐠𝐬 𝐩𝐞𝐫 𝐒𝐡𝐚𝐫𝐞
Example: Given that market price of a share is Rs. 340 and EPS is 10, calculate
P/E ratio.
Solution:
Market Value of Equity Share 340
𝐏𝐫𝐢𝐜𝐞 − 𝐄𝐚𝐫𝐧𝐢𝐧𝐠𝐬 𝐑𝐚𝐭𝐢𝐨 = = = 34
Earnings per Share 10
Problem 1:- The following an extract of a balance sheet of a company
during the last year. Compute current ratio and quick ratio.
Land and buildings 50000 Plant and 100000
machinery
Furniture and 25000 Closing stock 25000
fixtures

Sundry debtors 12500 Wages prepaid 2500

Sundry creditors 8000 Rent outstanding 2000

164
 BEFA UNIT V

Problem 2:- Calculate inventory turnover ratio and Average period of

holding the stocks.
Sundry debtors 45000 Closing stock 30000

Sales 400000 Sales returns 20000

Stock as on 1-1- 40000 Stock as on 31-12- 60000

2014 2014

165
 BEFA UNIT V

Problem 3:- Given the following data, calculate debtors and creditors
turnover ratios.
Debtors as on 1-1-2014 8000 Debtors as on 31-12-2014 16000

Creditors as on 1-1-2014 32000 Purchases (60% credit) 150000

Furniture and fixtures 25000 Cash 5000

Creditors as on 31-12-2015 26000

Sales (75% credit) 250000

166
 BEFA UNIT V

Problem 4:- Given the following data, calculate current ratio and quick
ratio
Capital 360000 Debentures 420000
Reserve fund 240000 Creditors 36000
Bank over draft 60000 Rent outstanding 6000
Provision for 78000 Land and buildings 440000
taxation
Plant and 235000 Furniture and fixtures 140000
machinery
Motor vehicles 105000 Stock 60000
Sundry debtors 90000 Short term 75000
investments
Cash at bank 30000 Cash in hand 25000

167
 BEFA UNIT V

Problem 5:- Given the following data, calculate Debt-equity ratio, Interest
coverage ratio and Proprietary funds to total assets ratio.
Liabilities and Capital Rs Assets Rs
Share Capital: Motor vehicles 105000
10% Preference Capital 60000 Plant and machinery 235000
Equity shares Capital 300000 Sundry debtors 90000
Reserve fund 240000 Land and buildings 440000
Bank over draft 60000 Furniture and 140000
fixtures
Provision for taxation 78000 Stock 60000
15% Debentures 420000 Short term 75000
investments
Creditors 36000 Cash in hand 25000
Rent outstanding 6000 Cash at bank 30000
1200000 1200000
EBIT = Rs. 204000

168
 BEFA UNIT V

Example 6: Calculate Gross Profit Margin, Net Operating Margin and

Operating Ratio given the following information.
Sales 1000000 Cost of goods 600000
sold

Selling and Administrative 200000 Depreciation 100000

costs

169
 BEFA UNIT V

Example 7: prepare a balance sheet from the following particulars.

Stock velocity :6
Gross profit margin : 20%
Capital turnover ratio :2
Fixed assets turnover :4
Debt collection period : 2 months
Creditors payment period : 73 days
Gross profit : Rs. 60000
Excess of closing stock over opening was : Rs. 5000

Solution

170
BEFA UNIT V

171
BEFA UNIT V

172
 BEFA UNIT V

USES OR ADVANTAGES OR IMPORTANCE OF RATIO ANALYSIS

Ratio Analysis stands for the process of determining and presenting the relationship
of items and groups of items in the financial statements. It is an important
technique of financial analysis. It is a way by which financial stability and health of
a concern can be judged. The following are the main uses of Ratio analysis:
(a) Useful in financial position analysis: Accounting reveals the financial position
of the concern. This helps banks, insurance companies and other financial
institution in lending and making investment decisions.
(ii) Useful in simplifying accounting figures: Accounting ratios simplify,
summaries and systematic the accounting figures in order to make them more
understandable and in lucid form.

(iii) Useful in assessing the operational efficiency: Accounting ratios helps to

have an idea of the working of a concern. The efficiency of the firm becomes
evident when analysis is based on accounting ratio. This helps the management
to assess financial requirements and the capabilities of various business units.
(iv) Useful in forecasting purposes: If accounting ratios are calculated for
number of years, then a trend is established. This trend helps in setting up
future plans and forecasting.
(v) Useful in locating the weak spots of the business: Accounting ratios are of
great assistance in locating the weak spots in the business even through the
overall performance may be efficient.
(vi) Useful in comparison of performance: Managers are usually interested to
know which department performance is good and for that he compare one
department with the another department of the same firm. Ratios also help him
to make any change in the organisation structure.

LIMITATIONS OF RATIO ANALYSIS

1. False results if based on incorrect accounting data: Accounting ratios
can be correct only if the data (on which they are based) is correct.
Sometimes, the information given in the financial statements is affected by
window dressing, i. e. showing position better than what actually is.
2. No idea of probable happenings in future: Ratios are an attempt to make
an analysis of the past financial statements; so they are historical documents.
Now-a-days keeping in view the complexities of the business, it is important
to have an idea of the probable happenings in future.
3. Variation in accounting methods: The two firms’ results are comparable
with the help of accounting ratios only if they follow the some accounting
methods or bases. Comparison will become difficult if the two concerns follow
the different methods of providing depreciation or valuing stock.

173
 BEFA UNIT V
4. Price level change: Change in price levels make comparison for various
years difficult.
5. Only one method of analysis: Ratio analysis is only a beginning and gives just
a fraction of information needed for decision-making so, to have a
comprehensive analysis of financial statements, ratios should be used along
with other methods of analysis.
6. No common standards: It is very difficult to by down a common standard
for comparison because circumstances differ from concern to concern and the
nature of each industry is different.
7. Different meanings assigned to the some term: Different firms, in order
to calculate ratio may assign different meanings. This may affect the
calculation of ratio in different firms and such ratio when used for comparison
may lead to wrong conclusions.
8. Ignores qualitative factors: Accounting ratios are tools of quantitative
analysis only. But sometimes qualitative factors may surmount the
quantitative aspects. The calculations derived from the ratio analysis under
such circumstances may get distorted.
9. No use if ratios are worked out for insignificant and unrelated figure:
Accounting ratios should be calculated on the basis of cause and effect
relationship. One should be clear as to what cause is and what effect is before
calculating a ratio between two figures.

FUNDS FLOW ANALYSIS

INTRODUCTION

Balance sheet and profit and loss A/C show the financial status and profitability of the firm respectively.
Balance sheet discloses the value of fixed assets as well as current assets, the decrease or increase of all
assets and liabilities can be ascertained by comparing with the previous balance sheet. But it does not
disclose the reasons for increasing or decreasing the assets/liabilities. However, the “ Funds flow
statement” is to be prepared to know such reasons. In this concept fund means “ net working”.

What is ‘FUND’ and ‘FLOW’ ?

A layman can describe word FUND as cash or cash equivalents. In technical terms, the word FUND
means „Net Working Capital‟.

Funds may mean:

 Cash only
 Net working capital, i.e. current assets less current liabilities
 Total resources or total funds

174
 BEFA UNIT V
 Internal resources only
 Net worth, i.e. owner‟s equity capital plus reserves

The term FLOW refers to change or transfer. The term „Fund flow‟ or „Flow of funds‟ may thus mean
transport of:

 One asset to another

 One liability to another
 Assets to liabilities or vice versa
 The changes in working capital is also an inflow or outflow of funds, and thus it is called fund
flow.

“ Fund” is considered as working capital while preparing “ Funds flow statement”. Fund flow
means change in the working capital. In other words, any increase or decrease in working capital means
“flow of funds”. Any transaction which has one current account and the other non-current account results
in change in the working capital.

Current accounts:- Current assets accounts and current liabilities accounts are called current accounts.
Assets which are converted into cash within a year are called current assets. Liabilities which are to be
paid within a year are called current liabilities.

Non-current account:- Accounts which are not current accounts are called non-current accounts. For
example, fixed assets accounts long term liabilities accounts, and capital & reserves accounts.

175
 BEFA UNIT V
Preparation of funds flow statements

Funds flow statement is prepared by observing the items taken place during the periods of two
balance sheets along with the adjustments into consideration.

Three statements are to be prepared.

I. Statement of changes in working capital

II. Statement of funds from operations
III. Funds flow statement
I. Statement of changes in working capital:- this statement reveals the net change in the working
capital (CA – CL) . Current assets and current liabilities are as follows.

FORMAT OF STATEMENT OF CHANGES IN WORKING CAPITAL

Previous Current Working capital
Particulars
year year Increase Decrease
A. Current Assets
Cash in hand xxx xxx
Cash at bank xxx xxx
Bills receivables xxx xxx
Debtors etc xxx xxx
A xxx xxx
B. Current Liabilities
Bills payables xxx xxx
Creditors xxx xxx
Bank overdraft etc. xxx xxx
xxx xxx
B

176
 BEFA UNIT V
Working capital (A – B) xxx xxx
Increase/Decrease in working capital
xxx xxx
B/F
xxx xxx xxx xxx

Procedure for preparation

1. The figures of current assets and current liabilities of two balance sheets given are recorded in
the respective columns provided. Don‟t take the adjustments. Then find working capital and
increase/decrease in working capital.
2. By observing the current assets and current liabilities, the differences are shown in the working
capital columns against to the each account and balance those columns. Increase or decrease in
working capital can be recognized as follows:

II. Statement of funds from operations

FORMAT OF FUNDS FROM OPERATIONS

Particulars Rs Rs
Net profit xxx
Add:
Provision for depreciation xxx
Amortization of goodwill, patents,
xxx
etc.
Preliminary expenses xxx
Loss on sale of investments xxx
Loss on sale of fixed assets xxx
Provision for tax xxx
Discount on issues of debentures xxx xxx
Less:
Dividend from investments xxx
Profit on sale of investments xxx
Profit on sale of fixed assets xxx
Interest received xxx xxx
Funds from operations xxx

Procedure for preparation

1. Prepare the accounts for the items given in the adjustments to know the hidden information.
Generally, the hidden information is as follows:

177
 BEFA UNIT V
a) Purchase price of a fixed asset
b) Sale value of a fixed asset
c) Profit/loss on sale of a fixed asset
d) Depreciation provided on a fixed asset
e) Depreciation of the asset sold
f) Provision for tax for the year
g) Tax paid during the year
h) Dividend proposed during the year
i) Dividend paid during the year
2) By observing balance sheets and accounts for adjustments, non-Operating expenses and non-cash
payment items (debit items of profit and loss account ) are to be added to given net profit and all
non-operating incomes & non-cash received items (credit items of profit and loss A/C) are to be
deducted from given net profit to find the funds from operations.

Dr Fixed Asset A/C Cr

Particulars Amount Particulars amount
To Balance b/d *** By Depreciation ***
(opening) *** ( for asset sold)
To P/L A/C (profit) *** By Bank ( sale value) ***
To Bank (purchase) By P/L A/C (loss) ***
By Balance c/d ***
*** ***

Dr Cumulative Depreciation A/C Cr

Particulars Amount Particulars amount
To Fixed Asset A/C *** By Balance b/d ***
(Depreciation of Asset (opening) ***
sold) *** By P/L A/C (provided)
To Balance c/d (closing) *** ***

Dr Provision for Tax A/C Cr

Particulars Amount Particulars amount
To Bank A/C (paid) *** By Balance b/d ***
To Balance c/d (closing) *** (opening) ***
*** By P/L A/C (provided) ***

Note:- When tax paid is not given, it is considered that the tax provided in the previous
year is paid in the current year.

178
 BEFA UNIT V
Dr Proposed Dividend A/C Cr
Particulars Amount Particulars amount
To Bank A/C (paid) *** By Balance b/d ***
To Balance c/d (closing) *** (opening) ***
*** By P/L A/C (provided) ***

Note:- When dividend paid is not given, it is considered that the dividend proposed in the previous year
is paid in the present year.
Note:- It can be found even if any one of the items is not given in the above said accounts.
2. In case provision for tax and proposed dividend are taken as current liabilities, there is no need to
prepare those accounts. These should be shown in the “ statement of changes in working capital”
only.
If these both are taken as an appropriation of profit (unlike current liabilities), there is a
need to prepare their accounts to know the hidden information. Provision for tax and proposed
dividend are to be added to the net profit to know the funds from operations and tax paid &
dividend paid are shown on the applications‟ side in the funds flow statement.

III. Funds Flow Statement

FORMAT OF FUNDS FLOW STATEMENT
Particulars Amount
SOURCES OF FUND
Issue of shares xxx
Issue of debentures xxx
Sale of investments xxx
Long-term loans xxx
Non-operating incomes xxx
Funds from operations xxx
Decrease in working capital xxx
Total Sources xxx
APPLICATION OF FUND
Redemption of pref. shares xxx
Redemption of debentures xxx
Purchase of investments xxx
Purchase of fixed assets xxx
Payment of long-term loans xxx
Payment of tax xxx
Payment of dividend xxx
Increase in working capital xxx
Total Uses xxx

Procedure for preparation

1. By examining the non-current assets and liabilities, show as a source if cash comes and as an
application if cash goes out.

179
 BEFA UNIT V
2. Show non-operating income as a source and non-operating expenses as an application.
3. Through adjustment items, if cash comes in show as a source and if cash goes out show as an
application.
4. If goodwill shows increase, take on the applications‟ side.
Note:- In order to say in single sentence, except the items taken in the “ statements of changes in
working capital and funds from operations”, take as a source when cash comes through all other
items and take as an application when cash goes out through all other items.

PRACTICE PROBLEMS

1. Prepare:
1. Statement of changes in working capital and
2. Funds flow statement from following balance sheets of Vijaya Mitra Ltd., as on 31-03-2016
and 31-03-2017:
Liabilities 31-03-2016 31-03-2017
Equity capital 200000 300000
Preference capital 200000 100000
Profit and loss 50000 75000
account 40000 60000
General resource 10000 50000
Unsecured loans 40000 5000
Current liabilities
Total 540000 590000
Assets 31-03-2016 31-03-2017
Land and buildings 100000 80000
Plant and Machinery 90000 120000
Cash at Bank 60000 40000
Stock 120000 140000
Sundry Debtors 30000 50000
Vehicles 140000 160000
Total 540000 590000

Adjustments:
1. Dividend declared and paid Rs. 25000
2. Additional plant purchased Rs. 5000
3. Tax paid during the year Rs. 45000

180
 BEFA UNIT V
Solution:

STATEMENT OF CHANGES IN WORKING CAPITAL

Previous Current Working capital
Particulars
year year Increase Decrease
A. Current Assets
Cash at bank 60000 40000 20000
Stock 120000 140000 20000
Debtors 30000 50000 20000
A 210000 230000
B. Current Liabilities
Current liabilities 40000 5000 35000
40000 5000
B
Working capital (A – B) 170000 225000
Increase in working capital B/F 55000 - 55000
225000 225000 75000 20000

FUNDS FROM OPERATIONS

Particulars Amount Amount
Net profit (75000-50000) 25000
Add:
General reserve 20000
Provision for dividend 25000
Provision for tax 45000
Depreciation on plant 20000 110000
Funds from
135000
operations

FUNDS FLOW STATEMENT

Particulars Amount
SOURCES OF FUND
Issue of equity capital 100000
Unsecured loans procured 40000
Sale of land and building 20000
Funds from operations 135000
Total Sources 295000
APPLICATION OF FUND
Redemption of pref. capital 100000
Purchase of vehicles 20000
Purchase of plant 50000
Dividend paid 25000
Tax paid 45000
Increase in working capital 55000
Total Uses 295000

181
 BEFA UNIT V

Working notes:
Plant and Machinery A/C
Particulars Amount Particulars Amount
To Opening By P&L A/C (Depn.)
balance 90000 b/f 20000
To Bank
(purchase) 50000 By Closing balance 120000
140000 140000

Dividend A/C
Particulars Amount Particulars Amount
By P&L A/C (provi.)
To Bank A/C 25000 b/f 25000
25000 25000

Tax A/C
Particulars Amount Particulars Amount
By P&L A/C (provi.)
To Bank A/C 45000 b/f 45000
45000 45000

2. Prepare a funds flow statement from the following balance sheets

Liabilities 31-3-16 31-3-17 Assets 31-3-16 31-3-17
E.S.C 100000 200000 Machinery 120000 160000
P.S.C 170000 180000 Furniture 240000 140000
P & L A/C 260000 350000 Goodwill 12000 4000
G.R 110000 230000 Patents 8000 1000
9% Debentures 60000 140000 Cash 415000 1023000
Creditors 80000 200000 Preliminary 5000 2000
Bills payable 20000 30000 exp.
800000 1330000 800000 1330000

1. Depreciation on Machinery Rs. 15000 and on Furniture Rs. 12000

2. Dividend paid Rs. 18000

182
 BEFA UNIT V
Solution:
STATEMENT OF CHANGES IN WORKING CAPITAL
Previous Current Working capital
Particulars
year year Increase Decrease
A. Current Assets
Cash 415000 1023000 608000
A 415000 1023000
B. Current Liabilities
Credotors 80000 200000 120000
Bills payables 20000 30000 10000
100000 230000
B
Working capital (A – B) 315000 793000
Increase in working capital B/F 478000 - 478000
793000 793000 608000 608000

FUNDS FROM OPERATIONS

Particulars Amount Amount
Net profit (350000-260000) 90000
Add:
General reserve 120000
Provision for dividend 18000
Depreciation on furniture 12000
Depreciation on machinery 15000
Goodwill written off 8000
Patents written off 7000
Preliminary expenses 183000
3000
written off
Funds from operations 273000

FUNDS FLOW STATEMENT

Particulars Amount
SOURCES OF FUND
Issue of equity capital 100000
Issue of preference capital 10000
Issue of debentures 80000
Sale of furniture 88000
Funds from operations 273000
Total Sources 551000
APPLICATION OF FUND
Purchase of machinery 55000
Dividend paid 18000
Increase in working capital 478000
Total Uses 551000

183
 BEFA UNIT V
Working Notes:
Machinery A/C
Particulars Amount Particulars Amount
To Opening balance 120000 By P&L A/C (Depn.) 15000
To Bank (purchase)
b/f 55000 By Closing balance 160000
175000 175000

Furniture A/C
Particulars Amount Particulars Amount
To Opening balance 240000 By P&L A/C (Depn.) 12000
By Bank (Sale) b/f 88000
By Closing balance 140000
240000 240000

Dividend A/C
Particulars Amount Particulars Amount
By P&L A/C (provi.)
To Bank A/C 18000 b/f 18000
18000 18000

3. Balance sheets of M/s. Divya as on 1st January 2016 and 1st January 2017 were as follows:
Liabilities 2016 2017 Assets 2016 2017
Creditors 40000 44000 Cash 12000 27000
Overdraft 2000 3000 Debtors 30000 50000
Long term loan 40000 50000 Stock 35000 25000
Capital 125000 150000 Machinery 80000 55000
Reserves 10000 10000 Land 40000 50000
P& L 15000 30000 building 35000 80000

232000 287000 232000 287000

During the year machine costing Rs. 10000 (accumulated depreciation Rs. 3000) was sold
for Rs. 5000.

184
 BEFA UNIT V
Solution:
STATEMENT OF CHANGES IN WORKING CAPITAL
Previous Current Working capital
Particulars
year year Increase Decrease
A. Current Assets
Cash 12000 27000 15000
Debtors 30000 50000 20000
Stock 35000 25000 10000
A 77000 102000
B. Current Liabilities
Credotors 40000 44000 4000
Overdraft 2000 3000 1000
42000 47000
B
Working capital (A – B) 35000 55000
Increase in working capital B/F 20000 20000
55000 55000 35000 35000

FUNDS FROM OPERATIONS

Particulars Rs Rs
Net profit (30000-15000) 15000
Add:
General reserve
Provision for dividend
Depreciation on furniture
Depreciation on machinery 18000
Loss on sale of machinery 2000 20000
Funds from operations 35000

FUNDS FLOW STATEMENT

Particulars Amount
SOURCES OF FUND
Issue of capital 25000
Long-term loan 10000
Sale of machinery 5000
Funds from operations 35000
Total Sources 75000
APPLICATION OF FUND
Purchase of land 10000
Purchase of building 45000
Increase in working capital 20000
Total Uses 75000

185
 BEFA UNIT V
Working Notes:
Machinery A/C
Particulars Amount Particulars Amount
To Opening
balance 80000 By P&L A/C (Depn.) 3000
By P&L A/C (loss on sale) 2000
By Bank (sale) 5000
By Closing balance 55000
By P&L A/C (Depn.) b/f 15000
80000 80000

4. Prepare a funds flow statement from the following:

Liabilities 2002 2003 Assets 2002 2003
Share capital 200000 250000 Cash 30000 47000
Creditors 70000 45000 Debtors 120000 115000
Retained 10000 23000 Stock 80000 90000
earnings Land 50000 66000

280000 318000 280000 318000

Solution:
STATEMENT OF CHANGES IN WORKING CAPITAL
Previous Current Working capital
Particulars
year year Increase Decrease
A. Current Assets
Cash 30000 47000 17000
Debtors 120000 115000 5000
Stock 80000 90000 10000
A 230000 252000
B. Current Liabilities
Creditors 70000 45000 25000
B 70000 45000
Working capital (A – B) 160000 207000
Increase in working capital B/F 47000 - 47000
207000 207000 52000 52000

FUNDS FROM OPERATIONS

Particulars Rs Rs
Net profit (23000-10000) 13000
Funds from operations 13000

186
 BEFA UNIT V
FUNDS FLOW STATEMENT
Particulars Amount
SOURCES OF FUND
Issue of capital 50000
Funds from operations 13000
Total Sources 63000
APPLICATION OF FUND
Purchase of land 16000
Increase in working capital 47000
Total Uses 63000

5. From the information given below, prepare funds flow statement of Global Co. Ltd.
Liabilities I year II year Assets I year II year
Share capital Goodwill 190000 140000
Equity capital 450000 600000 Plant 160000 250000
Preference capital 225000 150000 Building 240000 195000
Profit and loss A/C 60000 75000 Inventories 92000 235000
Proposed dividend 55000 67000 trade 175000 125000
Trade creditors 72000 90000 Debtors 45000 57000
Bills payable 32000 25000 Bills receivables 52000 77000
Provision for tax 60000 72000 cash
954000 1079000 954000 1079000
Additional information:
1. An interim dividend of Rs. 35000 has been paid in II year.
2. Payment of income tax Rs. 52000 was paid during II year.
[Link] of Rs. 35000 and Rs. 42000 have been charged on plant and building
respectively in II year.
4. A part of the plant worth Rs. 20000was sold for Rs. 30000.

Solution:
STATEMENT OF CHANGES IN WORKING CAPITAL
Previous Current Working capital
Particulars
year year Increase Decrease
A. Current Assets
Cash 52000 77000 25000
Inventories 92000 235000 143000
Debtors 175000 125000 50000
Bills receivables 45000 57000 12000
A 364000 494000
B. Current Liabilities
Credotors 72000 90000 18000
Bills payables 32000 25000 7000
104000 115000
B
Working capital (A – B) 260000 379000
Increase in working capital B/F 119000 119000
379000 379000 187000 187000

187
 BEFA UNIT V

FUNDS FROM OPERATIONS

Particulars Rs Rs
Net profit (75000-60000) 15000
Add:
Goodwill written off 50000
Provision for dividend 47000
Provision for tax 64000
Depreciation on plant 35000
Depreciation on building 42000 238000
Less: 253000
Profit on sale of plant 10000 10000
Funds from operations 243000

FUNDS FLOW STATEMENT

Particulars Amount
SOURCES OF FUND
Issue of equity capital 150000
Sale of building 3000
Sale of plant 30000
Funds from operations 243000
Total Sources 426000
APPLICATION OF FUND
Redemption of preference shares 75000
Purchase of plant 145000
Dividend paid 35000
Tax paid 52000
Increase in working capital 119000
Total Uses 426000

Working Notes:
Plant A/C
Particulars Amount Particulars Amount
By P&L A/C
To Opening balance 160000 (Depn.) 35000
To P & L A/C
(porofit) 10000 By Bank (Sale) 30000
To Bank (purchase)
b/f 145000 By Closing balance 250000
315000 315000

Building A/C
Particulars Amount Particulars Amount
To Opening balance 240000 By P&L A/C (Depn.) 42000
By Bank (Sale) b/f 3000
By Closing balance 195000
240000 240000

188
 BEFA UNIT V

Proposed dividend A/C

Particulars Amount Particulars Amount
To Bank A/C 35000 By Opening balance 55000
To Closing By P&L A/C (provi.)
balance 67000 b/f 47000
102000 102000

Provision for tax A/C

Particulars Amount Particulars Amount
To Bank A/C 52000 By Opening balance 60000
To Closing By P&L A/C (provi.)
balance 72000 b/f 64000
124000 124000

ADVANTAGES OF FUND FLOW STATEMENTS

1. Funds flow statement reveals the net result of Business operations done by the company during the
year.

2. In addition to the balance sheet, it serves as an additional reference for many interested parties like
analysts, creditors, suppliers, government to look into financial position of the company.

3. The Fund Flow Statement shows how the funds were raised from various sources and also how those
funds were deployed by a company.

4. It reveals the causes for the changes in liabilities and assets between the two balance sheet dates.

5. Funds flow statement helps the management in deciding its future course of plans and also it acts as a
control tool for the management.

Disadvantages of Fund Flow Statements

1. Funds Flow statement has to be used along with balance sheet and profit and loss account for
inference of financial strengths and weakness of a company it cannot be used alone.

2. Fund Flow Statement does not reveal the cash position of the company, and that is why company has
to prepare cash flow statement in addition to funds flow statement.

3. Funds flow statement only rearranges the data which is there in the books of account and therefore it
lacks originality.

4. Funds flow statement is basically historic in nature, that is it indicates what happened in the past and it
does not communicate anything about the future, only estimates can be made based on the past data
and therefore it cannot be used the management for taking decision related to future.

189
 BEFA UNIT V
CASH FLOW ANALYSIS

INTRODUCTION

A Cash Flow Statement is a statement showing changes in cash position of the firm from one period to
another. It explains the inflows (receipts) and outflows (disbursements) of cash over a period of time. The
inflows of cash may occur from sale of goods, sale of assets, receipts from debtors, interest, dividend,
rent, issue of new shares and debentures, raising of loans, short-term borrowing, etc. The cash outflows
may occur on account of purchase of goods, purchase of assets, payment of loans loss on operations,
payment of tax and dividend, etc

The cash flow statement shows how much cash comes in and goes out of the company over the quarter or
the year. At first glance, that sounds a lot like the income statement in that it records financial
performance over a specified period. But there is a big difference between the two.

What distinguishes the two is accrual accounting, which is found on the income statement. Accrual
accounting requires companies to record revenues and expenses when transactions occur, not when cash
is exchanged. At the same time, the income statement, on the other hand, often includes non-cash
revenues or expenses, which the statement of cash flows does not include.

Just because the income statement shows net income of Rs.10 does not mean that cash on the balance
sheet will increase by Rs.10. Whereas when the bottom of the cash flow statement reads Rs.10 net cash
inflow, that's exactly what it means. The company has Rs.10 more in cash than at the end of the last
financial period. You may want to think of net cash from operations as the company's "true" cash profit.

Because it shows how much actual cash a company has generated, the statement of cash flows is critical
to understanding a company's fundamentals. It shows how the company is able to pay for its operations
and future growth.

Indeed, one of the most important features you should look for in a potential investment is the company's
ability to produce cash. Just because a company shows a profit on the income statement doesn't mean it
cannot get into trouble later because of insufficient cash flows. A close examination of the cash flow
statement can give investors a better sense of how the company will fare.

OBJECTIVES OF CASH FLOW STATEMENT

1. Highlighting cash flow from different activities

2. Short-term Planning
3. Cash Flow information helps to understand liquidity
4. Efficient cash management
5. Prediction of sickness
6. Comparison with budget
7. Cash position

CURRENT ASSESTS AND CURRENT LIABILITIES

CURRENT ASSETS CURRENT LIABILITIES

1. Cash in hand 1. Bills payables
2. Cash at bank 2. Creditors
3. Bills receivables 3. Outstanding expenses
4. Debtors 4. Dividends to be paid

190
 BEFA UNIT V
5. Short term advances 5. Bank over draft
6. Short term investments 6. Short term loans
7. Inventories or stock 7. Provisions for current assets (ex: RBD)
8. Pre- paid expenses 8. Taxes to be paid
9. Incomes to be received 9. Provision for tax
10. Loose tools, etc. 10. Proposed dividend

The general rules that develop from the above discussion are:

1. An increase in current assets leads to decrease in cash.

2. A decrease in current assets leads to an increase in cash.

3. An increase in current liabilities leads to an increase in cash.

4. A decrease in current liabilities leads to a decrease in cash.

PREPARING A CASH FLOW STATEMENT

Cash flow statements have three distinct sections, each of which relates to a particular component –
operations, investing and financing – of a company's business activities.

The indirect method of presentation is very popular, because the information required for it is
relatively easily assembled from the accounts that a business normally maintains in its chart of
accounts. The indirect method is less favoured by the standard-setting bodies, since it does not give a
clear view of how cash flows through a business. The alternative reporting method is the direct
method.

Three Sections of the Cash Flow Statement

Companies produce and consume cash in different ways, so the cash flow statement is divided into
three sections: cash flows from operations, financing and investing. Basically, the sections on
operations and financing show how the company gets its cash, while the investing section shows how
the company spends its cash.

1. Operating Activities: Operating activities include cash flows from all standard business operations.
Cash receipts from selling goods and services represent the inflows. The revenues from interest and
dividends are also included here. The operational expenditures are considered as outflows for this
section. Although interest expenses fall under this section but the dividends are not included
.Dividends are considered as a part of financing activity in financial accounting terms.
2. Investing Activities: Investing activities include transactions with assets, marketable securities and
credit instruments. The sale of property, plant and equipment or marketable securities is a cash inflow.
Purchasing property, plant and equipment or marketable securities are considered as cash outflows.
Loans made to borrowers for long-term use is another cash outflow. Collections from these loans,
however, are cash inflows.

3. Financing Activities: Financing activities on the statement of cash flows are much more defined in
nature. The receipts come from borrowing money or issuing stock. The outflows occur when a
company repays loans, purchases treasury stock or pays dividends to stockholders. As the case with

191
 BEFA UNIT V
other activities on the statement of cash flows depend on activities rather than actual general ledger
accounts.
CASH FLOW STATEMENT FORMAT
Cash Flow Statement of -------------- Company for the year ended -------
Particulars Rs. Rs.
A. Cash Flow from Operating Activities
Net Profit xxx
Adjustments: (to convert net profit to cash provided by
operating activities)
Goodwill written off xxx
Loss on sale of investments xxx
Loss on sale of fixed assets xxx
Preliminary expenses written off xxx
Discount on issue of debentures xxx
Provision for tax xxx
Patents written off xxx
Transfer to reserve xxx
Provision for dividend xxx
Loss on sale of fixed assets/investments xxx
Profit on sale of fixed assets/investments (xxx)
Profit from investments (xxx)
Increase in current liabilities xxx
Decrease in current liabilities (xxx)
Increase in current assets (xxx)
Decrease in current assets xxx
Cash from operations xxx
B. Cash Flows from Investing Activities
Purchase of fixed assets (xxx)
Proceeds from sale of fixed assets xxx
Purchase of long-term investments (xxx)
Proceeds from sale of long-term investments xxx
Cash from investing activities xxx
C. Cash Flows from Financing Activities
Issue of shares xxx
Issue of debentures xxx
Share capital repaid (xxx)
Debentures repaid (xxx)
Cash from financing activities xxx
Net increase/decrease in cash xxx
Cash at the beginning of the year xxx
Cash at the end of the year xxx

Procedure for preparation

1. Prepare accounts for adjustments to find hidden information.
2. Observe balance sheets and accounts for adjustments. Adjust non-cash items, non-operating items
and current assets & current liabilities to net profit except cash and bank balances.
3. Observe all fixed assets and their adjustment accounts. Show purchase and sale of assets.

192
 BEFA UNIT V
4. Observe all capital & long-term liabilities and their adjustment accounts. Show capital & loans
received and repaid.

ADVANTAGES OF CASH FLOW STATEMENT

1. It shows the actual cash position available with the company between the two balance sheet dates
which funds flow and profit and loss account are unable to show. So it is important to make a cash
flow report if one wants to know about the liquidity position of the company.

2. It helps the company in accurately projecting the future liquidity position of the company enabling
it arrange for any shortfall in money by arranging finance in advance and if there is excess than it can
help the company in earning extra return by deploying excess funds.

3. It acts like a filter and is used by many analyst and investors to judge whether company has prepared
the financial statements properly or not because if there is any discrepancy in the cash position as
shown by balance sheet and the cash flow statement, it means that statements are incorrect.

DISADVANTAGES OF CASH FLOW STATEMENT

1. Since it shows only cash position, it is not possible to deduce actual profit and loss of the company by
just looking at this statement.

2. In isolation this is of no use and it requires other financial statements like balance sheet, profit and
loss etc…, and therefore limiting its use.

PRACTICE PROBLEMS AND SOLUTIONS

1. From the following balance sheets as on 31-12-2016 and 31-12-2017. You are required to prepare
a cash flow statement.
Liabilities 31-12-2016 31-12-2017
Share capital 100000 150000
Profit and loss A/C 50000 80000
General reserve 30000 40000
12% Bonds 50000 60000
Sundry creditors 30000 40000
Outstanding expenses 10000 15000
Total 270000 385000
Assets 31-12-2016 31-12-2017
Fixed assets 100000 150000
Goodwill 50000 40000
Inventories 50000 80000
Bank 10000 15000
Bills receivables 10000 20000
Sundry debtors 50000 80000
Total 270000 385000

193
 BEFA UNIT V

Solution:

Cash Flow Statement for the year ended 31-12-2017

Particulars Rs. Rs.
A. Cash Flow from Operating Activities
Net Profit (80,000 - 50,000) 30000
Adjustments:
Goodwill written off 10000
Transfer to reserve 10000
Increase in creditors 10000
Increase in outstanding expenses 5000
Increase in inventory (30,000)
Increase in receivables (10,000)
Increase in debtors (30,000)
Cash from operations (5,000)

B. Cash Flows from Investing Activities

Purchase of fixed assets (50,000)
Cash from investing activities (50,000)

C. Cash Flows from Financing Activities

Issue of shares 50,000
Issue of bonds 10,000
Cash from financing activities 60,000
Net increase in cash 5,000
Bank at the beginning of the year 10,000
Bank at the end of the year 15,000

2. Prepare a cash flow statement from the following balance sheets of Kumar Ltd.
Liabilities 2016 2017 Assets 2016 2017
Capital 150000 175000 Land & Building 110000 150000
Loan from bank 160000 100000 Machinery 200000 140000
Creditors 85000 93000 Stock 50000 45000
Outstanding expenses 5000 7000 Debtors 70000 80000
Bills payable 50000 40000 Cash 15000 22000
Long term loan -------- 25000 Pre – paid expenses 5000 3000
450000 440000 450000 440000
Net profit during the year 2017 was Rs/ 60000. During 2017 machinery costing Rs. 25000
( accumulated depreciation Rs. 10000) was sold for Rs. 25000. The tax payable and dividend
payable were Rs. 50000 and Rs. 35000 respectively during 2017.

194
 BEFA UNIT V

Solution:

Cash Flow Statement for the year ended 31-12-2017

Particulars Rs. Rs.
A. Cash Flow from Operating Activities
Net Profit 60000
Adjustments:
Depreciation on machinery 45000
Profit on sale of machinery (10000)
Provision for tax 50000
Provision for dividend 35000
Increase in creditors 8000
Increase in outstanding expenses 2000
Decrease in bills payable (10000)
Decrease in stock 5000
Increase in debtors (10000)
Decrease in prepaid expenses 2000
Cash from operations 177000

B. Cash Flows from Investing Activities

Purchase of land and building (40000)
Sale of machinery 25000
Cash from investing activities (15000)
C. Cash Flows from Financing Activities
Bank loan repaid (60000)
Long-term loan repaid 25000
Tax paid (50000)
Dividend paid (35000)
Drawings (35000)
Cash from financing activities (155000)
Net increase/decrease in cash 7000
Cash at the beginning of the year 15000
Cash at the end of the year 22000

Working notes:
Note: For working notes given in the problem, accounts are to be prepared to extract the hidden
information.
Machinery Account
Particulars Amount Particulars Amount
To Opening balance 200000 By Bank (Sales) 25000
To P & L A/C (Profit) 10000 By Depreciation B/F 45000
By Closing balance 140000
210000 210000

195
 BEFA UNIT V

Tax Account
Particulars Amount Particulars Amount
To Bank Account 50000 By P & L A/C (provided) B/F 50000
50000 50000

Dividend Account
Particulars Amount Particulars Amount
To Bank Account 35000 By P & L A/C (provided) B/F 35000
35000 35000

3. From the following balance sheets of 1993 and 1994, prepare the cash flow statement.
Liabilities 2016 2017 Assets 2016 2017
Equity capital 20000 25000 Plant 46000 45000
Debentures 15000 12000 Debtors 9000 7000
Creditors 16000 18000 Stock 5000 9000
Profit and loss A/C 11000 14000 Cash 2000 8000
62000 69000 62000 69000

Solution:
Cash Flow Statement for the year ended 31-12-2017
Particulars Rs. Rs.
A. Cash Flow from Operating Activities
Net Profit (14000-11000) 3000
Adjustments:
Increase in creditors 2000
Decrease in debtors 2000
Increase in stock (4000)
Cash from operations 3000

B. Cash Flows from Investing Activities

Sale of plant 1000
Cash from investing activities 1000
C. Cash Flows from Financing Activities
Issue of equity capital 5000
Debentures repaid (3000)
Cash from financing activities 2000
Net increase/decrease in cash 6000
Cash at the beginning of the year 2000
Cash at the end of the year 8000

196
 BEFA UNIT V

4. Prepare a cash flow statement from the following balance sheets as on 31-12-2016 and 31-12-
2017.
Liabilities 2016 2017 Assets 2016 2017
Share capital 100000 150000 Fixed assets 100000 150000
Profit and loss A/C 50000 80000 Goodwill 50000 40000
General reserve 30000 40000 Inventories 50000 80000
6% bonds 50000 60000 Debtors 50000 80000
Creditors 30000 40000 Bills receivables 10000 20000
Outstanding 10000 15000 Bank 10000 15000
expenses 270000 385000 270000 385000

Solution:
Cash Flow Statement for the year ended 31-12-2017
Particulars Rs. Rs.
A. Cash Flow from Operating Activities
Net Profit (80000-50000) 30000
Adjustments:
General Reserve 10000
Goodwill written off 10000
Interest on bonds (50000x6/100) 3000
Increase in creditors 10000
Increase in outstanding expenses 5000
Increase in inventory (30000)
Increase in debtors (30000)
Icrease in bills receivables (10000)
Cash from operations (2000)

B. Cash Flows from Investing Activities

Purchase of fixed assets (50000)
Cash from investing activities (50000)
C. Cash Flows from Financing Activities
Issue of equity capital 50000
Issue of bonds 10000
Interest on bonds paid (3000)
Cash from financing activities 57000
Net decrease in cash 5000
Bank at the beginning of the year 10000
Bank at the end of the year 15000

197
 BEFA UNIT V

5. Financial statements of Mr. Ram are as follows

Liabilities 2016 2017 Assets 2016 2017
Bills payable 29000 25000 Cash 40000 30000
Capital 731000 615000 Debtors 20000 17000
Stock 8000 13000
Buildings 92000 80000
machinery 600000 500000
760000 640000 760000 640000
Additional information:
a) Proprietor has not taken any drawings.
b) There are no purchases and sales in buildings and machinery.
Prepare cash flow statement.

Cash Flow Statement for the year ended 31-12-2017

Particulars Rs. Rs.
A. Cash Flow from Operating Activities
Net Profit (116000)
Adjustments:
Depreciation on buildings 12000
Depreciation on machinery 100000
Decrease in bills payable (4000)
Decrease in debtors 3000
Increase in stock (5000)
Cash from operations (10000)

B. Cash Flows from Investing Activities

0
Cash from investing activities 0
C. Cash Flows from Financing Activities
0
Cash from financing activities 0
Net decrease in cash (10000)
Cash at the beginning of the year 40000
Cash at the end of the year 30000

Working Notes:

Capital Account
Particulars Amount Particulars Amount
To P & L A/C (loss) By Opening
B/F 116000 balance 731000
To Closing balance 615000
731000 731000

198
 BEFA UNIT V

DIIFERENCES BETWEEN FUNDS FLOW STATEMENT AND CASH FLOW STATEMENT

Table of Difference between Funds Flow Statement and Cash Flow Statement

Basis of
Cash Flow Statement Funds Flow Statement
Difference

1. Meaning of Funds means only cash which is a Fund means net working capital (i.e. current
fund component of net current assets. assets minus current liabilities).

2. Objective Its objective is to know about the Its objective is to know about the changes
changes occurred in cash position occurred in net working capital between
between two balance sheet dates. two balance dates.
3. Basis of Increase in current liability or Increase in current liability and decrease in
preparation decrease in current asset (except cash) current asset results in a decrease in net
results in an increase in cash. working
4. Effect of Effect of a transaction on cash is Effect of a transaction on net working
transaction considered. capital is considered.

5. Utility Cash flow statement is useful for Fund flow statement is useful for long-term
short-term analysis. analysis

6. Statement of No such statement is prepared A separate statement for changes in

changes in separately in cash flow statement. working capital is prepared in fund flow
Working statement or analysis.
Capital

7 Cash Opening and closing balances of cash Such balances of cash are shown in
Balances are shown in this statement statement of changes in working capital.

199