-: Accounting :-

“Accounting is the art of recording, classifying and summarizing in a significant manner and in terms of money, transactions and
events which are in part at least, of a financial character and interpreting the results thereof.”

Advantages of Accounting:-

1. Repl aces Memory.

2. Provides Control over Assets .
3. Facilitates the preparation of Financial Statements
4. Works as information Tool .
5. Intra Firm comparison & Inter Firm comparison.
6. Works as safeguard against possible Fraud and/or Theft.
7. Ascertaining value of Business.
8. Acts as Reliable Evidence.
9. Tax matters.
-:Ratio Analysis:-
Ratio Analysis is a very important tool of financial analysis. It is the
process of establishing a significant relationship between the items of
financial statements to provide a meaningful understanding of the
performance and financial position of a firm.

An Accounting Ratio or Financial Ratio may be defined as the

mathematical expression of the relationship between two accounting
figures. But these figures must be related to each other to produce

meaningful and useful ratio.

Ratios can be classified into different categories depending upon the
basis of classification. For easy understanding we can classify the ratios
in the following three groups.
1)Revenue statement ratios.
(Profit and Loss Account Ratios – ratios calculated on the basis of
the item of the Profit and Loss Account only) 1 to 5

2)Balance Sheet Ratios

(Ratios calculated on the basis of the figures of Balance Sheet only)
6 to 10

3)Composite Ratios
(Mix Ratios – Ratios based on the figures of Profit & Loss A/c as well
as the Balance Sheet) 11 to 16
Sr. Ratio Formula Purpose
No
.

1 Gross Profit Ratio Gross Profit x 100 To know whether selling price has
Sales been properly fixed and to know
the profitability

2 Net Profit Ratio Net Profit x 100 To have an idea of profitability

Sales

3 Operating Ratio (Cost of Goods Sold + Operating To ascertain the extent of

Exp.) x 100 operating expenses
Sales

4 Expenses Ratio Expenses x 100 To know the proportion of each

Sales type of expenses to sales

5 Stock Turnover Cost of Goods Sold To know the efficiency of sales

Ratio Average Stock
(Inventory) Avg. Stock = Opening Stock +
Closing Stock
2
6 Current Ratio Current Assets To know the liquid position or
(Working Capital Current Liabilities the working capital position of
Ratio) the business

7 Liquid Ratio Liquid Assets To have better idea of the liquid

position of the business
Liquid Liabilities
= C/A - Stock
C/L – Bank overdraft
8 Proprietary Ratio Total Shareholder’s Funds To ascertain the proportion of
Total Assets – Fictitious Assets owner’s funds in the total funds
employed

9 Debt Equity Ratio Total Long Term Liabilities To know the proportion of long
Total Assets – Fictitious Assets term liabilities in relation to
owner’s funds

10 Gearing Ratio Preference Share Capital + To know the proportion of fixed

Debentures dividend bearing securities to
Equity Share Capital equity capital
11 Debtors Ratio (Debtors + Bills Receivables ) x To know the average period of
365 credit to ascertain the
Sales (On Credit) efficiency of credit department

12 Creditors Ratio (Creditors + Bills Payables) x 365 To know the average period
Purchases (On Credit) within which we make payment
for credit purchases

13 Return on Capital Net Profit (EBIT) x 100 To know the profitability of the
Employed Capital Employed business
(Share Capital + Reserves + Long
Term Loans – Fictitious Assets )
14 Return on Net Profit (PAT) x 100 To know the profitability from
Shareholder’s Fund Shareholder’s Fund the view point of shareholders
(Share Capital + Reserves –
Fictitious Assets)
15 Return on Equity (Net profit – Preference Dividend) To know the profitability from
Shareholder’s Fund x 100 the view point of equity
Equity Shareholder’s Fund shareholders
(Equity Share Capital+ Reserves –
Fictitious Assets)
16 Earning Per Share Net Profit – Preference Dividend To know the profitability per
Number of Equity Shares equity share
Importance of Ratio Analysis (Advantages)
Ratio analysis of the business enterprise is of a interest to a number
of parties, mainly, share-holders, creditors, banks, management,
Government, perspective investors etc. with different aspects.
1.Aid to measure General Efficiency
2. Aid to measure Financial Solvency
3. Aid in Forecasting and Planning
4. Facilitate decision-making
5. Aid in corrective Action
6. Aid in Intra Firm Comparison
7. Act as a Good Communication
8. Evaluation of Efficiency
9. Effective Tool
-: Limitations of Ratios Analysis :-
1. Differences in Definitions
2. Limitations of Accounting Records
3. Lack of Proper standards
4. No allowances for Price Level Changes.
5. Changes in Accounting Procedure
6. Qualitative Factors are ignored.
7. Limited use of Single Ratio
8. Limited use
9. Background is overlooked
10. Personal Bias
11. Arithmetical Window Dressing
12. Changing Policies
Formulas:-
1)Gross Profit=gross profit*100
sales
2)Operating Ratio=cost of good sold + operating expenses*100
net sales
cost of good sold= opening stock
+ net purchase
+ purchase expenses
- closing stock
OR
cost of good sold = net sales
- gross profit
3)Net Profit Ratio=net Profit *100
net sales
4)return on shared holder fund=net profit *100
shared holder’s fund
5) Return on capital employed= net profit*100
capital employed
capital employed = shared capital
+ reserve
+ long term loan
- fixed assets
6) Return on equity share holder fund =
net profit-Preference Dividend *100
ordinary share capital + reserve- fixed assets

7)Current ratio= current assets

current liabilities

Current assets=stock + cash + debtors + prepaid exp + loan & advances

Current Liabilities=Creditors + Bank Over Draft + Unclaimed + dividend

+provisional tax + proposed dividend
8)Liquid Ratio=Liquid Assets
Liquid Liabilities

Liquid Assets=current assets-stock

Liquid Liabilities=current liabilities-Bank over drafts

9)Earning Per share=profit after tax-preference dividend

number of equity share

10)Acid Test(Quick) Ratio=Quick Assets

Current Liabilities

11)Debt equity Ratio= Long Term Liabilities*100

Share holder’s fund