0Types of Ratios:
Accounting ratio can be classified as
- Liquidity Ratio
- Solvency Ratio
- Activity or Turnover Ratio and
- Profitability Ratio
- Liquidity Ratios:
It measures short term financial position of a firm and also to know upon the short term paying capacity of the firm.
- Current Ratio:
It is the relationship between Current Assets and Current Liabilities.
Current Assets include Cash, Bank, Debtors, Bills Receivables, Stock, Prepaid Expenses, Accrued Income and Short Term Investments.
Current Liabilities include Creditors, Bills Payable, Outstanding Expenses, Provision for Taxation, Tax Payable, Bank Overdraft, Short Term Loans, Income received in Advance.
It is calculated as Current Ratio = Current Assets
Current Liabilities
- b) Quick Ratio:
It is the ratio of quick or liquid assets to current liabilities.
Quick Assets = Current assets-Stock-Prepaid Expenses.
It is calculated as
Quick Ratio = Quick Assets
Current Liabilities
Solvency Ratios
The term “Solvency” refers to the ability of a concern to meet its long term obligations.
Important Solvency Ratios are:
- Debt Equity Ratio:
This measures the relationship between long term debts and equity. This ratio indicates the relationship between the external equities and the shareholders fund.
Debt Equity Ratio = Long Term Debt
Shareholders Fund
Long Term Debt= Debentures + Long term Loans
Shareholders Fund = (Equity Share Capital + Reserves and Surplus +Preference Share Capital)-Fictitious assets.
- Proprietary Ratio:
Proprietary Ratio expresses the relationship of proprietor’s funds to total assets.
It is calculated as
Proprietary Ratio = Shareholders fund
Total Assets
- Activity Ratios/Performance Ratios / Turnover Ratios:
These ratios measure the effectiveness with which a firm uses its available resources. They are as follows:
- Capital Turnover Ratio:
This ratio establishes the relationship between Net Sales and Capital Employed. The aim of computing this ratio is to determine the efficiency with which the capital employed is utilised.
Capital Turnover ratio = Net Sales
Capital Employed
Net Sales means Gross Sales less sales returns.
Capital Employed means net fixed assets +Trade Investments +current Assets less Current Liabilities.
- Fixed Assets Turnover Ratio:
This ratio establishes a relationship between net sales and fixed assets. The aim of computing this ratio is to determine the efficiency with which the fixed assets are used.
Fixed Assets Turnover Ratio = Net Sales
Net Fixed Assets
Net Sales means cash sales + credit sales-sales returns.
Fixed Assets means Long Term assets-depreciation.
- Working Capital Turnover Ratio:
This ratio establishes a relationship between net sales and working capital. The aim of computing the ratio is to determine the efficiency with which the working capital is utilised.
Working Capital Turnover Ratio = Net Sales
Working Capital
Working Capital is obtained by subtracting current liabilities from current assets.
- Stock Turnover Ratio:
This ratio establishes a relationship between cost of goods sold and average inventory.
Stock Turnover Ratio= Cost of Goods Sold
Average Stock
Cost of Goods Sold= Sales-Gross Profit
Average Stock = opening stock + closing Stock
- Debtors Turnover Ratio:
This ratio establishes a relationship between net credit sales and average trade debtors.
The aim of calculating this ratio is to determine at what efficiency trade debtors are managed.
Debtors Turnover Ratio = Net Credit sales
Average Trade Debtors
Net Credit sales = Credit Sales-Sales Returns
Average trade debtors = (Opening debtors + opening Bills receivables) + (Closing debtors+ Closing Bills Receivables)
- Average Debt Collection Period:
Average Debt Collection Period = 12 months/52 week/365 Days
Debtors Turnover Ratio
(Or)
Average Trade Debtors
Average Net Credit Sales per Day
Creditors Turnover Ratio:
This ratio establishes a relationship between net credit purchases and average trade creditors. The aim of calculating this ratio is to determine how effectively the creditors are managed.
Creditors Turnover Ratio = Net Credit Purchases
Average trade Creditors
Net credit purchases = credit purchases- purchases returns
Average trade creditors = (Opening Creditors + Opening Bills Payable) + (Closing Creditors + Closing Bills Payable)
PROFITABILITY RATIOS:
- Gross Profit Ratio:
The aim of calculating this ratio is to determine the efficiency with which production and purchases operations are carried on.
Gross profit ratio =Gross Profit * 100
Net sales
Gross profit = Net sales – Cost of Goods sold
(Opening stock + purchases – purchases returns + Direct Expenses – Closing Stock)
Net Profit Ratio:
The aim of calculating this ratio is to measure the relationship between net sales and net profit. It determines operational efficiency.
Net Profit ratio = Net Profit * 100
Net Sales
Net Profit = Gross Profit- Indirect Expenses
- Operating Profit Ratio:
This measures relationship between operating profits and net sales.
Operating Ratio = Operating Profit * 100
Net Sales
