Subject: Advance Accounting
Class : BCom II
Chapter: Accounting Ratios
(1) Profitability Ratios/General Profitability Ratios:-
These ratios measure the result of business operations or overall performance and
effectiveness of the firm.
(a) Gross Profit Ratio:
Gross profit ratio is the ratio of gross profit to net sales;
Formula: Gross Profit Ratio = Gross Profit x100
* Net Sales = Total sales – Sales Return
* Gross Profit = Net Sales – Cost of goods sold
* Cost of goods sold = Opening Stock+ Purchases – Closing Stock + All direct
expenses related to purchases
(Note:- This cost of goods sold method will be adopted in case of trading concern.)
* Cost of goods sold = Cost of raw material + Wages + Direct expenses
+ Manufacturing expenses
(Note:- This method to find the cost of goods sold will be used in case of manufacturing
(b) Net Profit Ratio:
This is the ratio of net profit (after tax) to net sales. It is also expressed as a percentage.
Formula: Net Profit Ratio = Net profit after taxes x100
* Net Profit are obtained after deducting income tax and generally, non operating incomes
and expenses, e.g interest on investment outside the business, Profit on sale of fixed asset
etc. are excluded from the net profit for calculating this ratio.
(c) Operating Ratio:
This is the ratio of cost of goods sold plus expenses operating to net sales. It is generally
expressed in percentage.
Formula: Operating Ratio = Operating Cost x100
Operating Ratio = Cost of goods sold + Operating expenses x100
* Operating Expenses = Administrative/Office expenses+Selling/Distribution/Marketing exp.
Note:- Financial charges such as interest, provision for taxation etc. are generally excluded from
(d) Operating Profit Ratio:
This ratio can be obtained operating profit dividing by Net Sales.
Formula: Operating Profit Ratio = Operating Profit x100
* Operating Profit = Gross Profit – Operating expenses
(e) Expense Ratio:
Expense ratio indicates the relationship of various expenses to net sales.
Formula: Expense Ratio = Particular Expense x100
(2) Overall Profitability Ratios:-
Profits are the measure of overall efficiency of a business. Thus, overall profitability or
efficiency of a business can be measured in terms of profits related to investments made in
(a) Return on Shareholder’s Investment or Net Worth:
This ratio is the relationship between Net Profit (after interest & tax) and Shareholder’s
Formula: Net Profit (after interest & tax) x100
* Shareholder’s fund = Equity share capital + Preference share capital + All reserves and
surplus – accumulated losses/Deferred expenses
(b) Return on Equity Capital:
It is the relationship between profits of a company and its equity.
Formula: Net Profit after tax – Preference dividend x100
Equity Share Capital
* Equity share capital = Total called up value of equity shares
(c) Earnings Per Share:
It can be obtained by dividing net profit after tax and preference dividend by total number
of equity shares.
Formula: Dividend per share
Market value per share
(e) Dividend Pay-out Ratio/ Pay out Ratio:
This is calculated to find out the extent to which earnings per share have been used for
paying dividend and to know what portion of earnings has been retained in the business.
Formula: Dividend pay out ratio= Dividend per equity share
Earnings per share
(f) Price Earning Ratio (PER):
It is the ratio between market price per equity share and earnings per share.
Formula: Price earning ratio = Market price per equity share
Earnings per share
(3) Liquidity Ratios/Short-term Solvency or Short-term Financial
(a) Liquidity Ratios.
(b) Current Assets movement/ Efficiency Ratios/ Activity Ratios.
(a) Liquidity Ratios:
Liquidity refers to the ability of a firm to meet its current obligations as and when they
(i) Current Ratio/ Working Capital Ratio:
It is the relationship between current assets and current liabilities.
Formula: Current Assets : Current Liabilities
Current Ratio = Current Assets
* Current Assets = Cash in hand + Cash at bank + Marketable securities or readity realisable
investment + Bill receivable + Sundry debtors(excluding bad debts and
provision) + Inventories + Work-in-Progress + Prepaid expenses.
* Current Liabilities = Outstanding expenses + Bills payable + Sundry creditors + Bank over-
draft + Accrued expenses + Short-term advances + Income Tax payable
+ Dividend payable.
(ii) Liquid Ratio/ Acid Test Ratio/ Quick Ratio:
It is the ratio of liquid assets to current liabilities.
Formula: Liquid Ratio = Liquid Assets
* Liquid Assets = Cash + Bank + Sundry debtors + Bills Receivable + Marketable securities
* Liquid Assets = Current Assets – Inventories (Stock) – Prepaid expenses.
(iii) Absolute Liquidity Ratio:
It is ratio of absolute liquid assets to current liabilities.
Formula: Absolute Liquidity Ratio = Absolute Liquid Assets
* Absolute Liquid Assets = Cash + Bank + Marketable Securities
* Absolute Liquid Assets = Liquid Assets + Bills receivable – Sundry Debtors (excluding bad
debts & Provisions)
(b) Current Assets Movement/ Efficiency Ratios:-
It is the other dimension of liquidity which determines the rate at which various short
term assets are converted into cash.
(i) Stock Turnover Ratio/Inventory Turnover Ratio:
It is relationship between the cost of goods sold during a particular period of time and
the cost of average inventory during the period.
Formula: Inventory Turnover Ratio = Cost of goods sold
Average stock at cost
* Average Stock = Opening Stock + Closing Stock
Note:- If Cost Of Goods Sold is not given, then we can use the Net Sales. But if
Opening Inventory is not given, then Closing Inventory may be taken as Average
Average Turnover Ratio = Net Sales
Note:- If Average Inventory at Cost is not given, then we can use the Average inventory
at Selling Price.
Average Turnover Ratio = Net Sales_________
Average inventory at selling price
Note:- In case of monthly balances of stock are given, then all the monthly balances are
added and total is divided by the number of months for which the average is calculated.
(ii) Debtors or Receivables Turnover Ratio:
It means the number of times average debtors (receivables) are turned over
During a year. Thus;
Formula: Debtors Turnover Ratio = _ Net Credit Sales__
Average trade debtors
* Trade Debtors = Bills Receivable + Debtors
* Average Trade Debtors = Opening trade debtors + Closing trade debtors
Note:- Here provision for bad and doubtful debts should not be deducted.
Note:- If opening and closing balances of trade debtors and credit sales is not given,
then debtors turnover ratio can be calculated by this;
Debtors Turnover Ratio = Total sales
* Debtors means only debtors not Bills Receivable.
(iii) Average Collection Period:
The debtors/receivable turnover ratio, when calculated in terms of days known
as Average Collection Period or Debtors Collection Period Ratio. This represents the
average number of days for which a firm has to wait before its debtors are converted
Formula: Average Collection Period = _No. of Working days_
Debtors turnover ratio
(iv) Creditors/Payable Turnover Ratio:
It signifies the credit period enjoyed by the firm in paying creditors.
Formula: Creditors Turnover Ratio = ___Credit Purchases___
Average Trade Creditors
* Trade Creditors = Creditors + Bills Payable
(v) Average Payment Period Ratio:
This represents the number of days taken by the firm to pay its credits.
Formula: Average Payment Period Ratio= __No. of working days__
Creditors turnover ratio
Note:- Total purchases may be used, when credit purchases are not given.
(vi) Working Capital Turnover Ratio:
It represents the number of times the working capital is turned over in the
course of a year.
Formula: Working Capital Turnover Ratio = ___Cost of sales___
Net working capital
* Net Working Capital = Current Assets – Current Liabilities
Note:- If cost of sales is not available, then sales figure can be used.
Working Capital Turnover Ratio = _____Sales______
Net working capital
(vii) Fixed Assets Turnover Ratio:
It is also known as Sales to Fixed Assets Ratio. This ratio measures the efficiency
and profit earning capacity of the firm.
__Cost of Sales__ OR _________Sales_________
Net Fixed Assets Fixed Assets – Depreciation
(4) Long Term Solvency Position Ratios:
These ratios are also used to analyze the capital structure of the company.
(i) Debt Equity Ratio/ External-Internal Equity Ratio:
It indicates the relationship between the external equities or outsiders funds
and internal equities or shareholder’s funds.
Formula: Debt Equity Ratio = External equities
Debt Equity Ratio = _Outsider’s funds_
* Outsider’s funds = Current liabilities + Long term liabilities
* Shareholder’s funds = Equity share capital + Preference share capital + Capital reserve
+ Accumulated profits – Accumulated losses and Deferred expenses
(ii) Proprietary Ratio or Equity Ratio:
It is also known as Equity Ratio or Net Worth to Total Assets Ratio. This ratio
relates the Shareholder’s Funds to Total Assets.
Formula: Proprietary Ratio = Shareholder’s Funds
(iii) Fixed Assets to Proprietor’s Fund Ratio:
This ratio establishes the relationship between fixed assets and shareholder’s
Formula: _Fixed Assets (after depreciation)_
Proprietor’s funds / Shareholder’s funds
(iv) Current Asset to Proprietor’s Fund Ratio:
This ratio establishes the relationship between current assets and shareholder’s
Formula: _Current Assets_
(v) Debt Service Ratio or Interest Coverage Ratio:
This ratio relates the fixed interest charges to the income earned by the business
Formula: Net Profit before Interest and Tax
Fixed Interest Charges
(M.Com. M.A Eco.)