OM

DEVS BANKING ACADEMY

RATIO ANALYSIS

Example 1:

From the following information, calculate current ratio.

Trade Receivables (sundry Debtors) 1,00,000 prepaid Expenses 10,000

cash and cash Equivalents 30,000 short term Investments 20,000

inventories40,000

Bills Payable  20000 sundry creditors 40000   expenses payable  40000

Solution:

Current Ratio = Current Assets / Current Liabilities = 2, 00,000 / 1, 00,000 = 2 : 1

Current Assets = Trade Receivables (sundry Debtors) + prepaid Expenses + cash and cash Equivalents + short term Investments + inventories

= 1,00,000 + 10,000 + 30,000 + 20,000 + 40,000 = 2,00,000

Current Liabilities: trade payables (Bills Payable + sundry creditors) + expenses payable

= 20,000 + 40,000 + 40,000 = 1, 00,000

Example 2:

Calculate ‘Liquidity Ratio’ from the following information:

 Current liabilities = Rs. 50,000

 Current assets = Rs. 80,000

 Inventories = Rs. 20,000

 Advance tax = Rs. 5,000

 Prepaid expenses = Rs. 5,000

Solution:

Liquidity Ratio = Liquid Assets/Current Liabilities

Liquidity Assets = Current assets − (Inventories + Prepaid expenses + Advance tax)

= Rs. 80,000 − (Rs. 20,000 + Rs. 5,000 + Rs. 5,000) = Rs. 50,000

Liquidity Ratio = Rs. 50,000 / 50,000 = 1 : 1.

Example 3:

X Ltd., has a current ratio of 3.5 : 1 and quick ratio of 2 : 1. If excess of current assets over quick assets represented by inventories is Rs. 24,000, calculate current assets and current liabilities.

Solution:

Current Ratio = 3.5 : 1  Quick Ratio = 2 : 1

Let Current liabilities = x

Current assets = 3.5x and

Quick assets = 2x

Inventories = Current assets − Quick assets

24,000 = 3.5x − 2x

24,000 = 1.5x

Current Liabilities = Rs. 16,000

Current Assets = 3.5x = 3.5 × Rs. 16,000 = Rs. 56,000.

Verification:

Current Ratio = Current assets : Current liabilities

= Rs. 56,000 : Rs. 16,000

= 3.5: 1

Quick Ratio = Quick assets : Current liabilities

= Rs. 32,000 : Rs. 16,000 = 2 : 1

Solvency Ratios

(a) Debt-Equity Ratio: Debt-Equity Ratio measures the relationship between long-term debt and equity. If debt component of the total long-term funds employed is small, outsiders feel more secure.

Debt-Equity Ratio = Long term Debts / Shareholders' Funds

Where:

 Shareholders’ Funds (Equity) = Share capital + Reserves and Surplus + Money received against share warrants

Share Capital = Equity share capital + Preference share capital

Or

Shareholders’ Funds (Equity) = Non-current assets + Working capital − Non-current liabilities Working Capital = Current Assets − Current Liabilities

Example 4:

From the following information calculate Debt equity Ratio:-

Share capital:10,000 shares of 10 each

General Reserve 45000

Surplus 30,000

Debentures = 75,000  

Long term provisions  25,000

Solution:

Debt to equity ratio = Debt / Equity (shareholder funds) = 1,00,000 / 1,75,000 = 0.57 : 1

Debt = Debentures + Long term provisions = 75,000 + 25,000 = 1,00,000

Equity = Share Capital + General Reserve + Surplus = 1,00,000 + 45,000 + 30,000 = 1,75,000

(b) Total Assets to Debt Ratio This ratio measures the extent of the coverage of long-term debts by assets

Total assets to Debt Ratio = Total assets/Long-term debts

Example 5:

Shareholders’ funds Rs. 14,00,000

Total Debts (Liabilities) Rs. 18,00,000

Current Liabilities = Rs. 2,00,000.

Calculate total assets to debt ratio.

Solution:

Total Assets to debt ratio = Total Assets / Long term Debts

= 32,00,000 / 16,00,000 = 2 : 1

Long term debts = total debts (Liabilities) − Current Liabilities

= 18,00,000 − 2,00,000 = 16,00,000

Total assets = shareholder funds + total debts (liabilities)

(c) Proprietary Ratio: Proprietary ratio expresses relationship of proprietor’s (shareholders) funds to net assets and is calculated as follows:

Proprietary Ratio = Shareholders, Funds / Capital employed (or net assets)

Significance: Higher proportion of shareholders’ funds in financing the assets is a positive feature as it provides security to creditors. This ratio can also be computed in relation to total assets instead of net assets (capital employed)

(d) Interest Coverage Ratio: It is a ratio which deals with the servicing of interest on loan. It is a measure of security of interest payable on long-term debts. It expresses the relationship between profits available for payment of interest and the amount of interest payable.

It is calculated as follows:

Interest Coverage Ratio = Net Profit before Interest and Tax / Interest on long-term debts

Significance: It reveals the number of times interest on long-term debts is covered by the profits available for interest. A higher ratio ensures safety of interest on debts.

Example 6:

From the following details, calculate interest coverage ratio:

Net Profit after tax Rs. 60,000; 15% Long-term debt 10,00,000; and Tax rate 40%.

Solution:

Net Profit after Tax = Rs. 60,000

Tax Rate = 40%

Net Profit before tax = Net profit after tax × 100/ (100 − Tax rate)

= Rs. 60,000 × 100/(100 − 40)

= Rs. 1,00,000

Interest on Long-term Debt = 15% of Rs. 10,00,000 = Rs. 1,50,000

Net profit before interest and tax = Net profit before tax + Interest

= Rs. 1,00,000 + Rs. 1,50,000 = Rs. 2,50,000

Interest Coverage Ratio = Net Profit before Interest and Tax/Interest on long-term debt

= Rs. 2,50,000/Rs. 1,50,000

= 1.67 times

Activity (or Turnover) Ratio

These ratios indicate the speed at which, activities of the business are being performed. The activity ratios express the number of times assets employed. Higher turnover ratio means better utilisation of assets and signifies improved efficiency and profitability, and as such is known as efficiency ratios.

(a) Inventory Turnover Ratio: It determines the number of times inventory is converted into revenue from operations during the accounting period under consideration. It expresses the relationship between the cost of revenue from operations and average inventory

The formula for its calculation is as follows:

Inventory Turnover Ratio = Cost of Revenue from Operations / Average Inventory

Example 7:

From the following information, calculate inventory turnover ratio:

 Inventory in the beginning = 18,000

 Inventory at the end = 22,000

 Net purchases = 46,000

 Wages = 14,000

 Revenue from operations = 80,000

 Carriage inwards = 4,000

Solution:

Inventory Turnover Ratio = Cost of Revenue from Operations / Average Inventory

Cost of Revenue from Operations = Inventory in the beginning + Net Purchases + Wages + Carriage inwards − Inventory at the end

= Rs. 18,000 + Rs. 46,000 + Rs. 14,000 + Rs. 4,000 − Rs. 22,000 = Rs. 60,000

Average Inventory = Inventory in the beginning + Inventory at the end / 2

= Rs. 18,000 + Rs. 22,000/ 2 = Rs. 20,000

∴ Inventory Turnover Ratio = Rs. 60,000/ Rs. 20,000 = 3 Times

(b) Trade Receivables Turnover Ratio: It expresses the relationship between credit revenue from operations and trade receivable. It is calculated as follows:

Trade Receivable Turnover ratio = Net Credit Revenue from Operations / Average Trade Receivable

Where Average Trade Receivable = (Opening Debtors and Bills Receivable + Closing Debtors and Bills Receivable)/2

Example 8:

Calculate the Trade receivables turnover ratio from the following information:

Total Revenue from operations 4,00,000

Cash Revenue from operations 20% of Total Revenue from operations

Trade receivables as at 1.4.2014 40,000

Trade receivables as at 31.3.2015 1,20,000

Solution:

Trade Receivables Turnover Ratio = Net Credit Revenue from Operations / Average Trade Receivables

Credit Revenue from operations = Total revenue from operations − Cash revenue from operations

Cash Revenue from operations = 20% of Rs. 4,00,000

= Rs. 4,00,000 × 20 / 100 = Rs. 80,000

Credit Revenue from operations = Rs. 4,00,000 − Rs. 80,000 = Rs. 3,20,000

Average Trade Receivables = Opening Trade Receivables + Closing Trade Receivables / 2

= Rs. 40,000 + Rs. 1,20,000 / 2 = Rs. 80,000

= Net Credit Revenue Form Operations / Average Inventory

= Rs. 3,20,000 / Rs. 80,000 = 4 times.

(c) Trade Payable Turnover Ratio: Trade payables turnover ratio indicates the pattern of payment of trade payable. As trade payable arise on account of credit purchases, it expresses relationship between credit purchases and trade payable.

It is calculated as follows:

Trade Payables Turnover ratio = Net Credit purchases / Average trade payable

Where,

Average Trade Payable = (Opening Creditors and Bills Payable + Closing Creditors and Bills Payable)/2

Average Payment Period = No. of days/month in a year ÷Trade Payables Turnover Ratio

Example 9:

Calculate the Trade payables turnover ratio from the following figures:

 Credit purchases during 2014-15 = 12,00,000

 Creditors on 1.4.2014 = 3,00,000

 Bills Payables on 1.4.2014 = 1,00,000

 Creditors on 31.3.2015 = 1,30,000

 Bills Payables on 31.3.2015 = 70,000

Solution:

Trade Payables Turnover Ratio = Net Credit Purchases / Average Trade Payables

Average Trade Payables = Creditors in the beginning + Bills payables in the beginning + Creditors at the end + Bills payables at the end / 2

= Rs. 3,00,000 + Rs. 1,00,000 + Rs. 1,30,000 + Rs. 70,000 2 = Rs. 3,00,000

∴ Trade Payables Turnover Ratio = Rs. 12,00,000 / Rs. 3,00,000 = 4 times