RATIO ANALYSIS
CLASS XII
RATIO ANALYSIS
Relationship between two figures, expressed in arithmetical terms is called a “ratio”.
A Ratio is simply one number expressed in terms of another. It is found by dividing one number into the other.
Expressed in:
1. Proportion or Pure or Simple ratio : eg: 2:1
2. Rate or so many times : eg: 5 times
3. Percentage : eg: 20%
4. Fraction : eg: net profit one-fifth of capital
Cross Sectional analysis: it involves the comparison of a firm’s ratio with that of some selected firms in the same industry
Time series analysis: it means comparison of a firms present ratio with its past ratios
CLASSIFICATION OF RATIOS
A. LIQUIDITY RATIOS
B. SOLVENCY RATIOS
C. ACTIVITY RATIOS
D. PROFITABILITY RATIOS
LIQUIDITY RATIOS/ SHORT TERM SOLVENCY RATIOS
1.CURRENT RATIOS OR WORKING CAPITAL RATIO
FORMULAE : CURRENT ASSETS
-------------------------
CURRENT LIABILITIES
CURRENT ASSETS: Current investments
Inventories
Trade receivables
Cash and cash equivalents
Short term loans and advances
Other current assets(prepaid expenses, accrued income, advance tax)
LIQUIDITY RATIOS/SHORT TERM SOLVENCY RATIOS
NB- Current assets are the assets which are likely to be converted into cash or cash equivalents with in 12 months from the date of Balance sheet or within the period of operating cycle.
ITEMS EXCLUDED FROM CURRENT ASSETS: 1.loose tools, stores and spares
2.provision for doubtful debts
CURRENT LIABILITIES : Short term borrowings
Trade payables
Short term provisions
Other current liabilities (current maturities of long term debts, interest accrued on borrowings, income received in advance, outstanding expenses, unclaimed dividend, calls in advance )
According to accounting principles , a current ratio of 2:1 is supposed to be an ideal ratio
QUICK RATIO OR ACID TEST RATIO OR LIQUID RATIO
Quick ratio indicates whether the firm is in a position to pay its current liabilities within a month or immediately .
Formulae : Liquid Assets
---------------------
Current Liabilities
Liquid assets: Current Assets – inventories –prepaid expenses and advance tax
An ideal quick ratio is 1:1
Following particulars are given to you:
EXERCISES
| ₹ |
Trade Investments | 2,50,000 |
Marketable Securities | 40,000 |
Tangible Fixed Assets | 6,00,000 |
Intangible Assets (Goodwill) | 1,00,000 |
Trade Receivables 2,00,000 Less : Provision for Doubtful Debts 20,000 | 1,80,000 |
Cash and Bank Balance | 80,000 |
Trade Payables | 1,20,000 |
Rent Payable | 10,000 |
Dividend Payable | 30,000 |
Inventories | 3,90,000 |
Long term Borrowings (8% Debentures) | 2,80,000 |
Short term Borrowings (Bank Overdraft) | 25,000 |
Short term Provisions : Provision for Tax | 55,000 |
Income Tax Paid in Advance | 30,000 |
Calculate the Liquidity Ratios and Comment upon the short-term financial position of the company.
SOLUTION:
Liquidity Ratios include the following two ratios:
(a) Current Ratio, and (b) QuickRatio
(a) Current Ratio = Current Assets
Current Liabilities
Current Assets = Marketable Securities + Trade Receivables* + Cash & Balance + + Inventories + Income Tax Paid in Advance
= ₹40,000 + ₹1,80,000 + ₹ 80,000 + ₹ 3,90,000 + ₹30,000
= ₹7,20,000
Current Liabilities = Trade Payables + Rent Payable + Dividend Payable + Bank Overdraft + Provision for Tax
= ₹1.20,000 + ₹10,000 + ₹30,000 + ₹25,000 + ₹ 55,000
= ₹2,40,000
Current Ratio = ₹7,20,000 = 3 : 1
₹2,40,000
SOLUTION:
(b) Quick Ratio = Liquid Assets or Quick Assets
Current Liabilities
Liquid Assets = Current Assets - Inventories - Income Tax Paid in Advance
= ₹ 7,20,000 - ₹ 3,90,000 - ₹ 30,000
= ₹ 3,00,000
Quick Ratio = ₹3,00,000 = 1.25 : 1
₹2,40,000
It is important to note that Provision for Doubtful Debts is deducted from Trade Receivables for calculating Current Ratio and Quick Ratio.
Comments : The short-term financial position of the company is sound because its current ratio is 3: 1, which is more than the ideal ratio of 2 : 1. Liquid ratio of the company is 1.25 : 1, which is also more than the ideal ratio of 1 : 1. Therefore, it can be said that the company is in a position to pay its current liabilities instantly.
SOLUTION:
Current Assets = Total Assets - Fixed Assets - Non Current Investment
= ₹ 8,00,000 + ₹5,40,000 – ₹1,10,000 = ₹1,50,000
Total of Assets side of Balance Sheet will be equal to total of Equity and Liabilities side.
Hence, Current Liabilities = Total Assets - Shareholders Funds
- Non Current Liabilities
= ₹ 8,00,000 - ₹ 6,00,000 - ₹ 80,000
Current Ratio = Current Assets = 1,50,000 = 1.25 : 1
Current Liabilities 1,20,000
| ₹ |
Total Assets | 8,00,000 |
Fixed Assets | 5,40,000 |
Non Current Investments | 1,10,000 |
Shareholder’s Funds | 6,00,000 |
Non Current Liabilities | 80,000 |
Calculate the Current Ratio from the following information :
THANK YOU!