ratio mcom part2

8/10/2019 Ratio mcom part2

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1.INTRODUCTION

A ratio shows the relationship between two numbers. Accounting

ratio shows the relationship between two accounting figures. Ratio analysis is the

process of computing and presenting the relationship between the items in the

financial analysis, because it helps to study the financial performance and position

of a concern.

As aratio are simple to calculate and easy to understand there is a tendency

to employ them profusely. While such statistical calculationstimulate be thinking

and develop understanding there is a danger of accumulation of a mass of data

that obscures rather than clarifies to steer a careful course. His experience and

objectives of analysis help him in determine which of the ratios are moremeaningful in a given situation.

The Parties Interested:- the person interested in the analysis of financial can be

grouped under three heads.

Owners Or Investor

Creditors And

Financial Executives.

Although all these three groups are interested in the financial conditions and

operating results of an enterprises the primary information that each seeks to

obtain forms these statement is to serve. Investors desire a primary basis for

estimating earning capacity. Creditors (trade and financial) are concerned

primarily with liquidity and ability to pay interest and redeem loan within a

specific period. Management is interested in evolving analysis tools that will

measure costs,efficiency, liquidity and profitability with a view to making

intelligent decisions.


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2.FORMS

There are three different forms in which an accounting ratio can be expressed.

1) Pure Ratio 2) Percentage and 3) Rate

1) PURE RATIO:-A pureratio a simple division of one number by another.

The relationship between current assets & current liabilities is expressed

in this way. If the current assets are Rs.2,00,000 and current liabilities

Rs.1,00,000, the ratio is divided by dividing Rs.2,00,000 by Rs.1,00,000. It

will be expressed as 2:1.

2) PERCENTAGE:-certain accounting ratios become more meaningful if

expressed as a percentage. The relationship between profits and sales is

expressed in this way. For example, if sales are Rs.4,00,000 and gross

profits is 50% of sales.

3)

RATE:- sometimes ratios are expressed as rates i.e. number of timesover a certain period. Relationship between stock and sales is expressed

in this way. If stock turnover rate is said to be 8 times in a year. It

means that the stock is converted into sales 8 times in 12 months.


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3. CLASSIFICATION

3.1. BASED ON FINANCIAL STATEMENT

Accounting ratios express the relationship figures taken from financialstatements. Figures may be taken from Balance sheet, Profit & Loss Account or

both. One way of classification of ratios is based upon the source from which

figures are taken. This is known as the conventional classification.

1)

BALANCE SHEET RATIOS: -If ratios are based on figures of Balance sheet,

they are called Balance sheet ratio e.g. ratio of current assets to current

liabilities or ratio of Debt to Equity. While calculating these ratios, there is

no need to refer to the Revenue statement. These ratios judge the liquidity.Solvency and capital structure of the concern. We are going to study the

following six balance sheet ratios in this chapter. Ratio, capital Gearing

Ratio, Debt-Equity Ratio and stockworking Capital Ratio.

2)

REVENUE STATEMENT RATIOS:- Ratios based on the figures from the

Revenue statement are called revenue statement ratios. These ratios study

the relationship between the profitability and the sales of the concern. We

are going to Gross Profit Ratio and Net Operating Profit Ratio and stock

Turnover Ratio.3) COMPOSITE RATIOS:- These ratios indicate the relationship between two

items, of which one is found in the balancesheet and the other in the

revenue statement. There are two types of composite ratios.

a) Same composite ratios study the relationship between the profits and

the investments of the concern. E.g. Return On Capital Employed on

Proprietors Funds, Return of Equity Capital etc.

b) other composite ratios that we going to study are debtors Turnover,

Creditors Turnover, Dividend payout and debt service.

3.2. BASED ON FUNCTION


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Accounting ratio can also be classified according to their functions (i.e. their

purpose) into Liquidity ratios, Leverage ratios, Activity ratios, Profitability ratios

and Coverage ratios.

1.

Liquidity ratios show the relationship between the current assets andcurrent liabilities of the concern.

Examples are Liquidity ratio and current ratio.

2.

Leverage ratios show the relationship between proprietors funds and

debts used in financing the assets of the concern. Examples are capital

Gearing ratio, Debt-Equity ratio and Proprietor ratios. These are also known

as Capital structure ratios or Solvency ratios.

3.

Activity ratios (also known as turnover ratios or productivity ratios) show

the relationship between the sales and the assets. Examples are stockturnover ratio; Debtors turnover ratio etc.

4.

Profitability ratios show the relationship between.

a) Profits and sales; for example, Operating ratio, Gross profit ratio,

Operating net profit ratio, Expenses ratio etc. OR

b) profits and investors; for example, Return on Investments Return on

equity Capital etc.

5.

Coverage ratios show the relationship between the profits on one hand the

claims of outsiders (divided, interest etc.) to be paid out of such profits.

Examples are Dividend payout ratio, Debt service and Debt service

coverage ratio.

3.3. BASED ON USER

1. Ratios for Short Term Creditors: - Current Ratio, Liquidity Ratio and Stock

Working Capital.

2. Ratios for Share Holder: - Return on Proprietors Funds, Return on EquityCapital.

3. Ratios for Management: - Return on capital Employed, Turnover Ratio,

Operating Ratio, Expense Ratios.

4. Ratios for Long Term Creditors: - debt Equity Ratio, Return on Capital

Employed, Proprietor Ratio.


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4. BALANCE SHEET RATIOS

COMPUTATION OF BALANCE SHEET RATIOS AT A GLANCE BALANCE SHEET

ITEM AMOUNTI SOURCE OF FUND

1 Equity Share Capital FC

2 Reserve & Surplus RS

3 Equity Shareholder Funds (1+2) EF

4 Preference Share Capital PC

5 Proprietors Funds (3+4) PE

6 Borrowed Funds BF

7 Capital Employed (5+6) CE

ITEM AMOUNT

II USE OF FUND

1 Fixed Assets FA

2 Debtors DR

3 Bills Receivable BR

4 Other Quick Assets OQA

5 Total Quick Assets (2+3+4) QA6 Closing Stock CST

7 Pre-payments PP

8 Current Assets (5+6+7) CA

9 Creditors CD

10 Bills Payable BP

11 Other Quick Liabilities OQL

12 Total Quick Liabilities (9+10+11) QL

13 Bank Overdraft OD

14 Current Liabilities (12+13) CL

15 Working Capital (8-14) WC

16 Capital Employed (1+15) CE


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Balance Sheet Ratio Equity/ Formula Para

1 Current Ratio CR=CA/CL

4.1

2 Quick/ Liquid Ratio QR=QA/QL

4.2

3 Stock Working CapitalSWC= 4.3

4 Proprietors Ratio

PR=PF/TA*100

[ TA= Total Assets=FA+CA=CE+CL

=Total of Horizontal B/s-factious

Assets]

4.4

5 Debt-Equity Ratio DER=BF/PF

4.5

6 Capital Gearing Ratio CGR=PC+BF/EF

4.6


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4.1. CURRENT RATIO

4.1.1. Meaning: - This ratio compares the current assets with current Liabilities. It

is expressed in the form of a pure Ratio e.g. 2:1.

4.1.2. Formula

Current Ratio= Current Assets =CA/CL

4.1.3. Components

Current Assets [CA] will include:

1) Sundry Debtors (Less Provision]

2) Loose Tools

3) Income Accrued/ due

4) Bills Receivable

5) Cash and Bank Balances

6) Marketable Investors

7) Closing Stock of Raw Material, WIP, FGs, Stores and spares.

8) Pre-Payments (i.e. Pre-paid Expenses and Advance Tax)

9) Short Term Loans and Advances given current Liabilities [CL] will include

a) sundry Creditors

b) Bills Payable

c) Outstanding Expense

d) Unclaimed Dividends and Prosed Dividend

e) Income Received in Advance

f) Bank Overdraft

g) Short Terms Loans


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4.2. QUICK / LIQUID RATIO

4.2.1. Meaning: - Liquid ratio compares quick assets with the quick Liabilities. It is

expressed in the form of a pure ratio. It is also known as Quick ratio or Acid test

ratio.

4.2.2. FORMULA

Liquid Ratio = Quick Assets/Quick Liabilities = QA/QL

4.2.3. Components

Quick Assets [QA] = current Assets Less Closing Stock Less Pre-payments i.e.

1. Debtors

2. Loose Tools

3. Income accrued/ due

4. Bills Receivable

5. Cash & Bank Balances

6. Marketable Investments

Quick Liabilities [QL] = Current Liabilities Less Bank Overdraft/ Cash Credit

i.e.

1) Sundry Creditors

2) Bills Payable

3) Outstanding expenses4) Unclaimed dividend & proposed dividend

5) Provision for Taxation


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4.3. STOCK TO WORKING CAPITAL RATIO

4.3.1. Meaning: - This ratio shows the relationship between the Closing Stock and

the working capital. It helps to judge the quantum of inventories in relation to the

working capital of the business. It is expressed as a percentage. It is also known asInventory Working Capital Ratio.

4.3.2. FORMULA

Stock to Working Capital Ratio= stock/ working capital*100= CST/WC*100

4.3.3. Components

Stock [CST] would mean closing stock.

Working Capital [WC] = Current Assets Less = Current Liabilities (as in Para

4.1.3)

4.4. PROPRIETORY RATIO

4.4.1. Meaning: - Proprietary ratio compares proprietors funds with total

liabilities (or total assets) it is usually expressed in the form of percentage. It is

also known as Net Worth to Total Assets Ratio. Equity Ratio, Net Worth Ratio orAssets Backing Ratio.

4.4.2. FORMULA

Proprietary Ratio = Proprietors Funds OR Shareholder Equity/ TotalAsset

OR Total Liabilities

=PF/TA or TL*100


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4.4.3. Components

Proprietors Funds [PF] will include

1. Paid up Equity Capital (EC)

2. Reserve & Surplus (R&S) including, Capital Reserves, P&L A/c cr.

Less:- Accumulated Losses (i.e. P&L A/c Dr. balance)

Less: - fictitious Assets Like Miscellaneous Expenditure not Written Off.

3. Paid Up Preference Capital (PC)

Thus, PF=EC +RS+PC or EF+PC

Total Assets [TA] (Fixed Assets +Investments + current Assets)

= Total Liabilities [TL] (Own Funds + Loans+ Current Liabilities)

= Total of the (Horizontal) Balance Sheet excluding Fictitious Assets &

Accumulated Losses (if any = Capital Employed +current Liabilities)

4.5. DEBTEQUITY RATIO

Meaning: - this ratio compares the long - term debt with shareholders funds. It is

usually expressed as a pure ratio.

FORMULA

This ratio is calculated in two ways

1. Debt/Equity= Borrowed Funds/Proprietors funds =BF/PF OR

BF/BE+PF

Both ways are acceptable.


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COMPONENTS

Borrowed Funds [BF] includes

1.

Debenture, Loan, etc.

2. Interest accrued and due on such BF

Proprietors Funds [PF] includes

1.

Equity Shares Capital (EC)

2.

Reserve & Surplus (RS)

Less: - a) Profit & Loss A/c Dr. balance (Loss)

b) Miscellaneous Expenditure Not written of if any.

3.

Preference Share Capital

4.6. CAPITAL GEARING RATIO

Meaning: - Gearing means the process of increasing the equity shareholders

return through the use of debt. Equity shareholders earn more when the rate of

return on total capital is more than the rate of interest on debt. This is also known

as Leverage or tradingan equity. The capital Gearing Ratio shows the

relationship between two types of capital viz. i. Equity Capital including reserve

and ii. Preference Capital and Long term borrowings. It is usually expressed as a

pure ratio. This is also known as Capital Structure Ratio.


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FORMULA

Capital Gearing Ratio =

1. = Capital Entitled to Fixed Rate of Interest OR Dividend/

Capital not So Entitled to Fixed Rate of Interest OR Dividend

2. Preference Capital + Debentures/Equity Capital + Share Premium A/c+ CR

Components

Capital entitled to fixed interest or dividend

1.

Preference Capital (PC)2.

Debenture, Long term Loans, i.e. Borrowed funds (BF)

Capital not entitled to fixed interest or dividend (= Equity Funds)

1.

Equity Capital (EC)

2.

Reserve & Surplus (RS)

Less: - Profit & Loss A/c Dr. balance.

Less: - Fictitious Assets

thus, CGR= PC+BF/EF


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5.REVENUE STATEMENT RATIOs

COMPUTATION OF PROFIT & LOSS RATIOs AT A GLANCE

INCOME STATEMENT

ITEM AMOUNT

1. Credit Sales CRS

2. cash Sales CAS

3. Total Sales (1+2) S

4. Opening Stock OST

5. Credit Purchase CRP

6. Cash Purchase CAP

7. Total Purchase (5+6) P8. Direct Expenses DE

9. Less:- Closing Stock (CST)

10. Cost of Goods Sold (4+7+8-9) COGS

11. Gross Profit (3-10) GP

12. Administration Expenses AE

13. Selling expenses SE

14. Finance Expenses (Excl. Interest) FE

15. Operating Expenses (12+13+14) OE

16. Operating Profit(11-15) OP

17. Net Non- Operating Income/ Expenses NO

18. Profit before Interest & Tax (16+17) PBIT

19. Interest On Loans INT

20. Net Profit Before Tax(18-19) NPAT

21. Income Tax IT

22. Net Profit After Tax (20-21) NPAT

23. Preference Dividend PD

24. Profit Available for Equity Shareholders(22-23) PAES

25. Equity Dividends ED

26. Retained Earning(24-25) RET


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Profit & Loss Ratio Equation / Formula Para

1. Gross Profit Ratio GPR=GP/S*100 5.1

2. Opening Ratio OR=COGS+DE/S*100 5.2

3. Expenses Ratio ER=AE or SE or FE/S*100 5.3

4. Operating Profit Ratio OPR=OP/S*100 5.4

5. Net Profit Ratio NPR= NPBT/S*100 5.5

6. Stock Turnover ratio

STR = COGS/OST + CST/2

OR

COGS/ Avg. Stock

5.6

Average Stock AS = Opening Stock + Closing Stock/2


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5.1 GROSS PROFIT RATIO

5.1.1. Meaning: - this ratio compares gross profit with net sales. It is usually

expressed in the form of percentage.

5.1.2. Formula

Gross profit = Gross Profit/Net Sales * 100 = GP/S * 100

5.1.3. Components

Gross profit [GP] = Sales Less Cost of goods Sold

Cost of goods sold [COGS] [In case of a Trading Concern]

1.

Opening stock

2.

Add: - Purchase

3.

Add: - Direct Expenses

4.

Less; - Closing Stock

= COGS

[In case of a Manufacturing Concern]

1.

Opening stock of finished goods

2.

Add: - Cost of goods produced

[Direct/ Price Cost (Materials + Labor + Expenses)]

3.

Less: - Closing stock of finished goods

=COGS

Net Sales [S]

= Sales Less return Less Allowances.

5.2 OPERATING RATIO

5.2.1

Meaning: -Operating ratio expenses the relationship between total

operating costs and net sales. It is expensed by way of a percentage.


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5.2.2

Formula

Operating Ratio: - Cost of Goods Sold + Operating Expenses/Net Sales*100

= COGS + OE/S * 100

5.2.3

Components: - Cost of Goods Sold [COGS] [as per Para 5.1.3]

operating Expenses [OE] =

1. Office and Administration Expenses

2. Selling and Distribution Expenses

3. Finance Expenses Excluding Interest on Loans and Debenture Net Sales

[S] [as per Para 5.1.3]

5.3 EXPENSES RATIO

5.3.1 Meaning: - this ratio expenses the relationship between each item of

expenditure and net sales. It is expressed as a percentage. Total of all

Expenses ratios will be each in Operating Ratio.

5.3.2

FORMULA

Any Expenses Ratio = Expenditure/Net Sales*100

e.g. Administrative Expenses Ratio= Administration Expenses/Net sales*100

Selling Expenses Ratio = Selling Expenses/Net Sales * 100Finance Expenses Ratio = Finance Expenses/Net Sales*100

(Excluding Interest on Loans & Debentures)

5.4 OPERATING PROFIT RATIO

5.4.1 Meaning: - Operating profit ratio indicates the relationship between

operating profit and the sales. It is usually expressed in the form of apercentage. It is also known as Net Operating Profit Ratio.

5.4.2 FORMULA

Operating Profit = Operating Profit/Net Sales * 100 = OP/S * 100


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5.4.3

Components

Operating profit [OP]

1. Gross Profit

2. Less: - Operating expenses [OE] (as per Para 5.2.3)

(Net per Para 5.2.3)

Net Sales [S] =

Sales Less Returns Less Allowances.

5.5 NET PROFIT RATIO

5.5.1

Meaning: - Net ratio indicates the relationship between net profit and the

sales. It is usually expensed in the form of a percentage.

5.5.2

FORMULA

Net Profit = Net Profit ( before Tax)/Net Sales * 100 = NEPBT/S * 100

5.5.3

Components: -

Net Profit before tax [NPBT] =

1. Operating net profit [as per Para 5.4.3]

2. Add: - NonOperating income

3. Less: - NonOperating Expenses = NPBT

Net Sales [S] = Sales Less Returns Less Allowances.

5.6 STOCK TURNOVER RATIO

5.6.1 Meaning: - Stock turnover ratio shows the relationship between the cost of

Goods Sold and the average stock. This ratio is normally expressed as arate.

5.6.2 FORMULA

A. Stock turnover Ratio = Cost of Goods Sold/Average Stock = COGS/AS =

COGS/ OST + CST/2


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If Stock is valued at sales price, formula will be

= Net Sales/Average Stock (at Selling Price)/2

Note: -In the absence of information, Closing Stock can be used instead of

average stock in the above formula.

B. Stock Velocity Stock [Stock Holding Period]

Stock velocity means the period (months or days) taken for converting

average stock into sales. It shows the Stock Holding Period.

12/Stock Turnover Ratio = Number Of months production on band or

Number of months it takes for converting stock into sales

365/Stock Turnover Ratio = Number of days production on band or

Number of days it takes for converting stock into sales

5.6.3

Components

Cost of Goods Sold [ COGS] = Sales Tess Gross Profit

Average Stock [AS] = Opening Stock + Closing Stock/2


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6. COMPOSITE RATIO

COMOSEITE RATIOS AT A GLANCE

Composite Ratios Formula / equation Para

1.Return on Investment/ Capital

EmployedROI = PBIT/CE * 100 6.1

2. Return on proprietors Fund RPF = NPAI / PF * 100 6.2

3. Return on Equity Capital ROE = PAES / EF * 100 6.3

4. Dividend Payout DP = ED / PAES * 100 6.4

5. Debt Service Ratio DSR = PBIT/INT 6.5

6. Debt Service Coverage RatioDSCR = Cash Profit/ Interest +

Investments6.6

7. Debtors Turnover Ratio DTR = CRS / DR + BR 6.7

8. Credit Turnover Ratio CTR = CRP/ CD + BP 6.8


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6.1 RETURN ON CAPITAL EMPLOYED

6.1.1 Meaning: - This ratio measures the Relationship Between net profit (before

interest and tax) and the capital employed to earn it. It is expressed as a

percentage. This ratio is also known as Return on Investment [ROI].

6.1.2. FORMULA

Return on Capital Employed: - Profit (before Interest & Tax * 100 / CE

6.1.3. Components

Profit (before Interest, Tax [PBIT =

1. Profit before interest on long term borrowing, tax & dividends.

2.

Less abnormal, nonrecurring items

Capital Employed [CE]

1.

Equity Capital

2.

Add: - Preference Capital + Reserve & Surplus

3.

Add: - Long term Borrowings ( Terms Loans + Debentures)

4.

Less: - fictitious assets like Miscellaneous Expenses not written Off

5.

Less: -Profit & Loss A/c Dr. Balance (Loss)

note: -Capital employed may be taken to mean Assets Employed, in whichcase.

Capital Employed [CE] can also be computed as

1.

Fixed Assets (Less depreciation) (including investments)

2.

Add: -Current Assets

3.

Less: - Current Liabilities

4.

Exclude Fictitious Assets.

6.2 RETURN ON PROPRITORS FUNDS

6.2.1 Meaning: - This ratio measures the relationship between net profit (after

interest and tax) and the Proprietors capital. It is usually expressed as a

percentage. It is also known as Return on Proprietors Equity or Return on Net

Worth.


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6.2.2. FORMULA

Return Proprietors Funds: -Net Profit (after Tax)/ Proprietors Funds *100

NPAT/PF * 100

6.23. ComponentsNet Profit [NPAT] = Profit after interest and tax proprietors funds [PF] =

1.

Equity Capital [EC]

2.

Add: - Reserve & Surplus [RS]

Less: - Fictitious Assets like Miscellaneous Expenses not written off

Less: - Profit & Loss A/c Dr. Balance (loss)

3.

Add: -Preference Capital [PC]

ratio mcom part2

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