# Ratio Analysis: Activity and Profitability Ratios

## Profitability ratios are also known as ‘Income Ratios’. They analyse the earning capacity of the business. Gross profit ratio shows the relationship between gross profit and net revenue from operations. Higher the ratio better it is. Net profit ratio shows relationship between Net profit and revenue from operations. This ratio shows overall efficiency of the business and checks operational efficiency of the business. Operating ratio shows relationship between operating cost and net revenue from operations. It helps in determining increase or decrease in cost as compared to revenue from operations. Operating profit ratio shows relationship between operating profit and revenue from operations. Higher the ratio better it is. Return on investment measures overall efficiency of the business. Return on Investment Measures overall efficiency of the business. Earning per share establishes relationship between net profit and number of equity shares. Price earning ratio establishes relationship between current market price per equity share and earning per share. Dividend per share establishes relationship between Equity dividend and Number of Equity Shares. Activity or Turnover Ratio measures how well facilities at the disposal of concern are being utilised. Inventory Turnover Ratio shows efficiency with which inventory is converted  into revenue from operations. Higher the ratio better it is. Working Capital Turnover ratio shows how effectively the working capital has been utilised in making revenue from operations. Trade ReceivablesTurnover Ratio shows relationship between credit revenue from operations and average trade receivables. Average collection period shows the average period for which credit sales remain outstanding. Trade Payables turnover Ratio indicates relationship between net credit purchases and average trade payables. Average payment period shows the period which is normally taken by the firm to make payment to its trade payables. Fixed assets turnover ratio indicates the relationship between net revenue from operations and net fixed assets. Current assets turnover ratio indicates the relationship between Net revenue from operations and Current assets.

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• Q1

What is Trade Receivables Turnover Ratio?

Marks:3

This ratio shows the relationship between credit Revenue from Operations and average trade receivables during the year.

$\begin{array}{l}\text{Trade}\text{ }\text{Receivables}\text{ }\text{Turnover}\text{ }\text{Ratio}\\ \text{=}\text{ }\frac{\text{Net}\text{ }\text{Credit}\text{ }\text{Revenue}\text{ }\text{from}\text{ }\text{Operations}}{\text{Average}\text{ }\text{Trade}\text{ }\text{Receivables}}\end{array}MathType@MTEF@5@5@+= feaahqart1ev3aaatCvAUfeBSjuyZL2yd9gzLbvyNv2CaerbuLwBLn hiov2DGi1BTfMBaeXatLxBI9gBaerbd9wDYLwzYbItLDharqqtubsr 4rNCHbGeaGqiVu0Je9sqqrpepC0xbbL8F4rqqrFfpeea0xe9Lq=Jc9 vqaqpepm0xbba9pwe9Q8fs0=yqaqpepae9pg0FirpepeKkFr0xfr=x fr=xb9adbaqaaeaacaGaaiaabeqaamaabaabaaGceaqabeaacaqGub GaaeOCaiaabggacaqGKbGaaeyzaiaaysW7caqGsbGaaeyzaiaaboga caqGLbGaaeyAaiaabAhacaqGHbGaaeOyaiaabYgacaqGLbGaae4Cai aaysW7caqGubGaaeyDaiaabkhacaqGUbGaae4BaiaabAhacaqGLbGa aeOCaiaaysW7caqGsbGaaeyyaiaabshacaqGPbGaae4Baaqaaiaab2 dacaaMe8+aaSaaaeaacaqGobGaaeyzaiaabshacaaMe8Uaae4qaiaa bkhacaqGLbGaaeizaiaabMgacaqG0bGaaGjbVlaabkfacaqGLbGaae ODaiaabwgacaqGUbGaaeyDaiaabwgacaaMe8UaaeOzaiaabkhacaqG VbGaaeyBaiaaysW7caqGpbGaaeiCaiaabwgacaqGYbGaaeyyaiaabs hacaqGPbGaae4Baiaab6gacaqGZbaabaGaaeyqaiaabAhacaqGLbGa aeOCaiaabggacaqGNbGaaeyzaiaaysW7caqGubGaaeOCaiaabggaca qGKbGaaeyzaiaaysW7caqGsbGaaeyzaiaabogacaqGLbGaaeyAaiaa bAhacaqGHbGaaeOyaiaabYgacaqGLbGaae4Caaaaaaaa@913B@$

Trade Receivables include Debtors and Bills Receivable.

While calculating this ratio, provision for bad and doubtful debts is not deducted from total trade receivables, so that it may not give a wrong impression that trade receivables are fastly collected.

When the amount of credit revenue from operations is not given in the question, the ratio is calculated by taking the figure of revenue from operations.

• Q2

Following is the Balance Sheet of Z Ltd. as at 31st March, 2016:

 Particulars ₹ I. EQUITY AND LIABILITIES 1. Shareholders’ Funds (a) Share Capital 5,50,000 (b) Reserves and Surplus 1,25,000 2. Non-Current Liabilities (a) 12% Long-term Borrowings 4,00,000 (b) Deferred Tax Liabilities (Net) 25,000 3. Current Liabilities (a) Trade Payables (Creditors) 1,50,000 (b) Other Current Liabilities 20,000 Total 12,70,000 II. ASSETS 1. Non-Current Assets (a) Fixed Assets (Tangible Assets) 9,75,000 (b) Non-Current Investments 25,000 2. Current Assets (a) Short-term Investments 50,000 (b) Inventories 2,00,000 (c) Cash and Cash Equivalents 20,000 Total 12,70,000

(i) Non-Current Investments are non-trade investments and bear 10% Interest and have a face value of ₹ 35,000.

(ii) Net Profit after Interest and Tax for the year 2015-16 ₹ 1,21,500. Tax Rate 40%.

Calculate the Return on Investment for the year 2015-16.

Marks:4

$\begin{array}{l}\text{Return}\text{ }\text{on}\text{ }\text{Investment}\text{ }\text{=}\frac{\text{Net}\text{ }\text{Profit}\text{ }\text{before}\text{ }\text{interest}\text{ }\text{and}\text{ }\text{Tax}}{\text{Capital}\text{ }\text{Employed}}\text{ }\text{×}\text{ }\text{100}\\ \text{ }\text{ }\text{ }\text{ }\text{ }\text{ }\text{ }\text{ }\text{ }\text{ }\text{ }\text{ }\text{ }\text{ }\text{ }\text{ }\text{ }\text{ }\text{ }\text{ }\text{ }\text{ }\text{ }\text{ }\text{ }\text{ }\text{ }\text{=}\text{ }\frac{\text{₹}\text{ }\text{2,47,000}\text{ }\text{(WN}\text{ }\text{1)}}{\text{₹}\text{ }\text{10,75,000}\text{ }\text{(WN}\text{ }\text{2)}}\text{ }\text{×}\text{ }\text{100}\\ \text{ }\text{ }\text{ }\text{ }\text{ }\text{ }\text{ }\text{ }\text{ }\text{ }\text{ }\text{ }\text{ }\text{ }\text{ }\text{ }\text{ }\text{ }\text{ }\text{ }\text{ }\text{ }\text{ }\text{ }\text{ }\text{ }\text{ }\text{=}\text{ }\text{22}\text{.98%}\end{array}MathType@MTEF@5@5@+= feaahqart1ev3aaatCvAUfeBSjuyZL2yd9gzLbvyNv2CaerbuLwBLn hiov2DGi1BTfMBaeXatLxBI9gBaerbd9wDYLwzYbItLDharqqtubsr 4rNCHbGeaGqiVu0Je9sqqrpepC0xbbL8F4rqqrFfpeea0xe9Lq=Jc9 vqaqpepm0xbba9pwe9Q8fs0=yqaqpepae9pg0FirpepeKkFr0xfr=x fr=xb9adbaqaaeaacaGaaiaabeqaamaabaabaaGceaqabeaacaqGsb GaaeyzaiaabshacaqG1bGaaeOCaiaab6gacaaMe8Uaae4Baiaab6ga caaMe8Uaaeysaiaab6gacaqG2bGaaeyzaiaabohacaqG0bGaaeyBai aabwgacaqGUbGaaeiDaiaaysW7caqG9aWaaSaaaeaacaqGobGaaeyz aiaabshacaaMe8UaaeiuaiaabkhacaqGVbGaaeOzaiaabMgacaqG0b GaaGjbVlaabkgacaqGLbGaaeOzaiaab+gacaqGYbGaaeyzaiaaysW7 caqGPbGaaeOBaiaabshacaqGLbGaaeOCaiaabwgacaqGZbGaaeiDai aaysW7caqGHbGaaeOBaiaabsgacaaMe8UaaeivaiaabggacaqG4baa baGaae4qaiaabggacaqGWbGaaeyAaiaabshacaqGHbGaaeiBaiaays W7caqGfbGaaeyBaiaabchacaqGSbGaae4BaiaabMhacaqGLbGaaeiz aaaacaaMe8Uaae41aiaaysW7caqGXaGaaeimaiaabcdaaeaacaaMe8 UaaGjbVlaaysW7caaMe8UaaGjbVlaaysW7caaMe8UaaGjbVlaaysW7 caaMe8UaaGjbVlaaysW7caaMe8UaaGjbVlaaysW7caaMe8UaaGjbVl aaysW7caaMe8UaaGjbVlaaysW7caaMe8UaaGjbVlaaysW7caaMe8Ua aGjbVlaaysW7caqG9aGaaGjbVpaalaaabaGaaeOCaiaabggacaqGTb GaaGjbVlaabkdacaqGSaGaaeinaiaabEdacaqGSaGaaeimaiaabcda caqGWaGaaGjbVlaabIcacaqGxbGaaeOtaiaaysW7caqGXaGaaeykaa qaaiaabkhacaqGHbGaaeyBaiaaysW7caqGXaGaaeimaiaabYcacaqG 3aGaaeynaiaabYcacaqGWaGaaeimaiaabcdacaaMe8UaaeikaiaabE facaqGobGaaGjbVlaabkdacaqGPaaaaiaaysW7caqGxdGaaGjbVlaa bgdacaqGWaGaaeimaaqaaiaaysW7caaMe8UaaGjbVlaaysW7caaMe8 UaaGjbVlaaysW7caaMe8UaaGjbVlaaysW7caaMe8UaaGjbVlaaysW7 caaMe8UaaGjbVlaaysW7caaMe8UaaGjbVlaaysW7caaMe8UaaGjbVl aaysW7caaMe8UaaGjbVlaaysW7caaMe8UaaGjbVlaab2dacaaMe8Ua aeOmaiaabkdacaqGUaGaaeyoaiaabIdacaqGLaaaaaa@09D1@$

Working Notes:

 Particulars ₹ 1. Calculation of Net Profit before Interest and Tax 1,21,500 Net Profit after Interest and Tax Add: Tax[₹[(1,21,500/60) X 40] 81,000 Net Profit before Tax 2,02,500 Add: Interest on Long-term Debts (12% of ₹ 4,00,000) 48,000 2,50,500 Less: Interest on Non-trade Investments* (10% of ₹ 35,000) 3,500 Net Profit before Interest and Tax 2,47,000 *Other Investments being not for business, have not been considered. 2. Calculation of Capital Employed Share Capital 5,50,000 Add: Reserves and Surplus 1,25,000 Deferred Tax 25,000 Shareholders’ Funds 7,00,000 Add: Long-term Debts 4,00,000 11,00,000 Less: Non-trade Investments 25,000 Capital Employed (Assets Approach) 10,75,000 Or Fixed Assets (Tangible Assets) 9,75,000 Trade Investments* 50,000 Working Capital (Current Assets – Current Liabilities) 50,000 (₹ 2,20,000 – ₹ 1,70,000) Capital Employed (Liabilities Approach) 10,75,000

• Q3

What is Inventory (or Stock) Turnover Ratio?

Marks:3

Inventory Turnover Ratio determines the number of times stock is turned in sales during the accounting period under consideration. It expresses the relationship between cost of revenue from operations (cost of goods sold) and the average amount of inventory carried during the period.

Inventory Turnover Ratio = Cost of Revenue from Operations (Cost of Goods Sold) / Average Inventory (or Stock)

Cost of Revenue from Operations (or cost of goods sold) = Cost of materials consumed + Purchases of stock in trade + Changes in inventories of finished goods, work in progress and stock in trade + Direct expenses. or Opening inventories + Purchases + Direct expenses - closing inventories or Sales (Revenue from operations) - Gross profits.

• Q4

What do you mean by Accounting Ratio?

Marks:1

Accounting ratio shows arithmetical relationship between two related or interdependent accounting variables.

• Q5

Calculate the Gross Profit Ratio from the Following information:

 Particulars ₹ Credit revenue from operations 1,50,000 Cash revenue from operations: 25% of total revenue from operations Purchases 1,60,000 Excess of Closing Inventory Over opening Inventory 20,000

Marks:3