Ratio Analysis

Ratio A ratio is an arithmetical

expression of relationship between two related or interrelated items.

The term accounting ratio is used to describe significant relationships that exist between figures shown in a balance sheet, in a profit and loss account or in any part of accounting organization.

Ratio analysis

Ratio analysis is the study of relationship among various financial factors in a business.

Objective of ratio analysis is to judge the earning capacity, financial soundness, operating efficiency of a business organization.

Advantages of ratio analysis

Useful in inter and intra firm comparisonUseful in analysis of financial statementsUseful in simplifying accounting figures

Useful in forecastingUseful in judging operating efficiency

Limitations of ratio analysis

False results if statements incorrect

Not comparable if different policies adopted

Ratios may be worked out for insignificant figures

Personal bias

Window dressing

Liquidity Ratios

Current ratio

Liquid ratio (Acid or quick

ratio)

Absolute liquid ratio

1. Current Ratio = Current Assets

Current liabilities

Current assets Current liabilities

Cash and bank balance Creditors

Debtors Bills payable

Bills receivable Bank overdraft

Stock Short term loans

Marketable securities Outstanding expenses

Prepaid expenses Provision for tax

Advance payments Unclaimed dividend

Question 1 Calculate current ratio from the

following:Sundry debtors 1,00,000

Prepaid expenses 10,000

Cash in hand 30,000

Short term investments

20,000

Machinery 7,000

Bills payable 20,000

Debentures 40,000

Expenses payable 2,00,000

Stock 40,000

Sundry creditors 40,000

Question 2Working capital – Rs 15,000Total debt – Rs. 32,500Long term debt – Rs. 25,000

Calculate current ratio.

Question 3.Working capital – Rs. 7,20,000Creditors – Rs. 40,000Other current liabilities – Rs.

2,00,000

Calculate current ratio.

Question 4Current assets – Rs. 4,00,000Stock – Rs. 2,00,000Working capital – Rs 2,40,000

calculate current ratio.

Question 5.Calculate current ratio, acid ratio and

absolute liquid ratio. What conclusions you draw about the company on the basis of these ratios.Liabilities Assets

Equity share capital

24,000 Machinery and equipment

45,000

Profit and loss a/c

6,000 Stock 12,000

10% debentures

15,000 Sundry debtors 9,000

Sundry creditors

23,400 Cash at bank 2,280

Provision for taxation

600 Prepaid expenses

720

Question 6The current ratio of A Ltd. Is 4.5:1

and liquid ratio is 3:1. stock is Rs. 3,00,000. What are the current liabilities?

Question 7Quick ratio is 1.5; current assets

Rs. 1,00,000; Current liabilities Rs. 40,000. Calculate the value of the stock.