NCERT Solutions For Class 12 Accountancy Chapter 9 Accounting Ratios

\begin{array}{l}\text{Liquid Ratio = }\frac{\text{Liquid Assets }}{\text{Current Liabilities }}\\ \text{=}\frac{\text{7,60,000}}{\text{6,00,000}}\text{=}\text{1}\text{.27:1}\\ \text{Net Profit Ratio = }\frac{\text{Net }\text{Profit }}{\text{Revenue from operations }}\text{×}\text{100}\\ \text{=}\frac{\text{3,60,000}}{\text{25,20,000}}\text{×}\text{100}\text{=}\text{14}\text{.28\%}\\ \text{Working}\text{Capital}\text{Turnover}\text{Ratio}\text{=}\frac{\text{Revenue}\text{from}\text{operations}}{\text{Working}\text{Capital}}\\ \text{Working}\text{Capital}\text{=}\text{15,60,000}\text{-}\text{6,00,000}\text{=}\text{₹}\text{9,60,00}\\ \text{=}\frac{\text{25,20,000}}{\text{9,60,000}}\text{=}\text{2}\text{.62}\text{times}\end{array}

Current assets = Liquid assets + Inventory

= ₹24,00,000 + ₹6,00,000 = ₹30,00,000

Quick ratio = 2:1,

Let current liability = x

Then current assets = 2x

Equity = Total assets – Total debts

= ₹15,00,000 – ₹12,00,000 = ₹3,00,000

Debt = Total debts – Current liabilities

= ₹12,00,000 – ₹6,00,000 = ₹6,00,000

Current ratio = 4:1

Liquid ratio = 1:1

Current liabilities = ₹75,000

Then liquid assets = ₹75,000

Current assets = ₹75,000 x 4 = ₹3,00,000

Inventory = Current assets – Liquid assets

= ₹3,00,000 – ₹75,000 = ₹2,25,000

Current ratio = 4.5:1

Quick ratio = 3:1

Let current liabilities = X

Then current assets = 4.5X

Current liabilities = 3X

Inventory = 4.5X – 3X = 1.5X

1.5X = ₹36,000

X = Current liabilities = ₹24,000

Current assets = ₹24,000 x 4.5 = ₹1,08,000

Let the current liabilities = X

Then current assets = 3.5X

Working capital = 3.5X– X= 2.5X

2.5X = 90,000

X = Current liabilities = ₹36,000

Current assets = 3.5 x 36,000 = ₹1,26,000.

Current Assets = Inventories + Trade receivables + Cash and cash equivalents + Short term loans and advances

= ₹12,00,000 + ₹9,00,000 + ₹2,28,000 + ₹72,000

= ₹24, 00,000

Liquid Assets = Current Assets – (Inventories)

= ₹24,00,000 – ₹12,00,000 = ₹12,00,000.

Current liabilities = Short-term borrowings + Trade Payables + Short-term provisions

= ₹6,00,000 + ₹23,40,000 + ₹60,000 = ₹30,00,000.

Ratio analysis refers to a technique of analysing the financial statements by computing various types of ratios. In other words, it is a process of determining and interpreting relationship between the items of financial statements to provide a meaningful result of the performance and financial position of a business.

Current Assets = Inventories + Trade receivables + Cash and cash equivalents

= ₹55,800 + ₹28,800 + ₹59,400 = ₹1,44,000

Current liabilities = Trade Payables = ₹72,000

It refers to the analysis of profits in relation to revenue from operations or funds employed in the business and the ratios calculated to meet this objective are known as ‘Profitability Ratios’. They include Gross Profit Ratio, Net Profit Ratio, Operating Ratio, Operating Profit Ratio and Return on Investment Ratio.

Gross profit ratio: This ratio establishes the relationship between gross profit and revenue from operations. This ratio is computed and expressed as a percentage. Following is the formula for calculating the ratio:

Net Profit Ratio: This ratio establishes the relationship between net profit and revenue from operations. This ratio is computed and expressed as a percentage. Following is the formula for calculating the ratio:

\begin{array}{l}\text{Net Profit Ratio = }\frac{\text{Net }\text{Profit }}{\text{Revenue from operations }}\text{x}\text{100}\\ \text{Net Profit =}\\ \text{Gross Profit - Indirect expenses \& losses + Other Incomes }\end{array}

Operating Ratio: This ratio measures the proportion of an enterprise’s cost of revenue from operations and operating expenses in comparison to its revenue from operations. Following is the formula for calculating the ratio:

\begin{array}{l}\text{Operating Ratio = }\frac{\text{Operating}\text{cost }}{\text{Net revenue from operations }}\text{x}\text{100}\\ \text{Oper}\text{.}\text{cost}\text{=}\text{Cost}\text{of}\text{rev}\text{. from oper}\text{.}\text{+}\text{oper}\text{.}\text{}\text{}\text{}\text{}\text{}\text{exp}\text{.}\end{array}

Operating Profit Ratio: This ratio shows the relationship between operating profit and revenue from operations. Following is the formula for calculating the ratio:

\begin{array}{l}\text{Operating Profit Ratio = }\frac{\text{Operating}\text{profit }}{\text{Net revenue from operations }}\text{x}\text{100}\\ \text{Operating }\text{profit }\text{=}\\ \text{Gross}\text{Profit }\text{- Other}\text{oper}\text{.}\text{}\text{}\text{}\text{}\text{}\text{expenses + }\text{Other}\text{oper}\text{.}\text{}\text{}\text{}\text{}\text{}\text{}\text{incomes}\end{array}

Return on Investment Ratio: It is calculated by comparing the profit earned and capital employed to earn it. Following is the formula for calculating the ratio:

\begin{array}{l}\text{Return on Investment = }\\ \frac{\text{Profit before interest, tax and dividend }}{\text{Capital employed }}\text{x}\text{100}\\ \text{Capital employed}\text{= Shareholders funds + Long term loans}\end{array}

Current ratio is the proportion of current assets to current liabilities. It is expressed as follows:

Current assets are those assets which can be easily converted into cash within a short period of time and include current investments, inventories, trade receivables, cash and cash equivalents, short term loans and advances and other current assets. Current liabilities include short term borrowings, trade payables, other current liabilities and short term provisions.

Liquid ratio is the proportion of liquid assets to current liabilities. It is expressed as follows:

\text{Liquid Ratio = }\frac{\text{Liquid Assets }}{\text{Current Liabilities }}

The liquid assets are defined as those assets which are more quickly convertible into cash. Liquid asset exclude inventories and prepaid expenses.

The main difference between the current ratio and the quick ratio is that the latter offers a more conservative view of the company’s ability to meets its short-term liabilities with its short-term assets because it does not include inventory and other current assets that are more difficult to liquidate (i.e., turn into cash). By excluding inventory (and other less liquid assets) the quick ratio focuses on the company’s more liquid assets.

Generally current ratio is preferable for such type of business where the inventories cannot be easily converted into cash like heavy machinery manufacturing companies. This is because heavy inventories cannot be easily sold. But on the other hand, businesses where the inventory is easily realised regard liquid ratio to be more suitable for revealing the liquidity of the business. Therefore, service companies, prefer liquid ratio as a measure of short term financial solvency.

Inventory Turnover Ratio: It determines the number of times inventory is converted into revenue from operations during the accounting period. The formula for its calculation is as follows:  

It studies the frequency of conversion of inventory of finished goods into revenue from operations. It is also a measure of liquidity. It determines how many times inventory is purchased or replaced during a year.

Yes, it is true that the liquidity of a business firm is measured by its ability to pay its long term obligations as they become due. Here the long term obligation means payments of principal amount on the due date and payment of interest on the regular basis. For measuring the long term solvency of any business we calculate the following ratios:

1. Debt-equity ratio
2. Total assets to debt ratio
3. Proprietary ratio and
4. Interest coverage ratio

1. Inventory turnover ratio establishes relationship between Cost of Revenue from Operations and Average Inventory.
2. Trade receivables turnover ratio establishes relationship between Net Credit Revenue from Operations and Average Trade Receivables.
3. Trade payable turnover ratio indicates the relationship between credit purchases and average trade payables.
4. Working capital turnover ratio establishes relationship between Revenue from Operations and Working Capital.

Accounting ratios are classified as follows:

1. Profitability Ratios: They include Gross Profit Ratio, Net Profit Ratio, Operating Ratio, Operating Profit Ratio and Return on Investment Ratio.
2. Turnover or Performance or Activity Ratios: These ratios comprise Inventory Turnover Ratio, Trade Receivables Turnover Ratio, Trade Payables Turnover Ratio and Working Capital Turnover Ratio. 
3. Solvency Ratios: They include Debt Equity Ratio, Total Assets to Debt Ratio, Proprietary Ratio and Interest Coverage Ratio.
4. Liquidity Ratios: These ratios consist of Current Ratio and Liquid Ratio.

The persons who have advanced money to the business on long-term basis are interested in safety of their periodic payment of interest as well as the repayment of principal amount at the end of the loan period. Solvency ratios are calculated to determine the ability of the business to service its debts in the long run. The following ratios are normally computed for evaluating solvency of the business.

1) Debt Equity Ratio: It is computed as follows:

From the security point of view, capital structure with less debt and more equity is considered favourable as it reduces the chances of bankruptcy.

2) Total Assets to Debt Ratio: It is computed as follows:

\begin{array}{l}\text{Debt equity Ratio = }\frac{\text{Total}\text{ Assets }}{\text{Debt (Long term debts)}}\\ \end{array}

This ratio measures the extent of the coverage of long-term debts by assets which indicates the margin of safety available to providers of long-term loans.

3) Proprietary Ratio: It is computed as follows:

\text{Proprietary Ratio = }\frac{\text{Shareholders' Funds }}{\text{Total Assets }}

Higher proportion of shareholders funds in financing the assets is a positive feature as it provides security to the long-term loan providers.

4) Interest Coverage Ratio: It is computed as follows:

\begin{array}{l}\text{Interest Coverage Ratio =}\\ \frac{\text{Profit before charging Interest and Income Tax }}{\text{Fixed Interest Charges }}\end{array}

It reveals the number of times interest on long-term debts is covered by profits available for interest. The higher the ratio, more secure the lender is in respect of payment of interest regularly.

To meet its commitments, business needs liquid funds. The ability of the business to pay the amount due to stakeholders as and when it is due is known as liquidity, and the ratios calculated to measure it are known as ‘Liquidity Ratios’. These ratios are calculated to measure the short-term solvency of the business, i.e. the firm’s ability to meet its current obligations. Liquidity ratios include current ratio and liquid ratio.

Current Ratio: It indicates the amount of current assets available for repayment of current liabilities. Higher the ratio, the greater is the short term solvency of a firm and vice a versa. However, a very high ratio or very low ratio is a matter of concern. If the ratio is very high it means the current assets are lying idle. Very low ratio means the short term solvency of the firm is not good. Thus, the ideal current ratio of a company is 2:1 i.e. to repay current liabilities; there should be twice current assets.

Liquid ratio: This ratio establishes a relationship between liquid assets and current liabilities. Liquid ratio is a measure of the instant debt paying capacity of the business enterprise. It is a measure of the extent to which liquid resources are immediately available to meet current obligations. A quick ratio of 1:1 is considered good/favourable for a company. For the purpose of calculating this ratio, inventory and prepaid expenses are not taken into account as these may not be converted into cash in a very short period.