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Accounting Ratio : It is arithmetical relationship between two accounting variables.
Ratio Analysis : A tool used by individuals to conduct a quantitative analysis of infomation in a company's financial statements
Expression of ratios : Ratios are expressed in
1. Pure form like 2:1 all current ratios are expressed in pure form.
2. Percentage e.g. 15% all profitability ratios are presented in percentage form
3. Times like 4 times all turnonver ratios are presented in no. of times
4. Fraction like 3/4 or .75 all solvency ratios are presented in fractions except Interest Coverage Ratio which is presented in Number of times :
Classification or types of ratios
Ratios are classified into 4 categories
1. Liquidity Ratios also called as short term solvency ratios.
2. Solvency Ratios
3. Activity ratios also known as Turnover ratios or Performance ratios
4. Profitability ratios
Note : For Calculation of ratios Formula must be written as it carries marks Liquidity Ratios : Thesemeasure short term solvency, i.e. the firm's ability to pay current dues. These are
1. Current Ratio also called as working capital ratio
2. Liquid Ratio also called as quick ratio or acid test ratio.
Current ratio is relationship of current assets with current liabilities.
1. CURRENT RATIO = CURRENT ASSETS/CURRENT LIABILITIES
Current assets are assets that can be converted into cash or cash equivalent within short period of time usually a year and current liabilities are those are to be paid in short period.
Example : Current assets are : Cash, Bank, Debtor, Stock (also called as Inventory), Perpaid Expenses and Marketable Securities (highly liquid investment with very little risk of changes in value), Accrued income.
Current Liabilities are : Creditors, Bills Payable, Bank Overdraft, Outstanding Expenses,Advance Income, Unclaimed Dividend, Provision for taxation.
Significance : It assesses ability of business to pay short term liability promptly. Ideal Ratio : 2:1 Low ratio indicates cannot meet short term liability. High ratio indicates funds not used effciently and lying idle or poor investment (important for Project work)
Example : XYZ Company's total current assets are Rs.10,000,000 and its total current liabilities are Rs.8,000,000 then its current ratio would be Rs.10,000,000 divided by Rs.8,00,000 which is equal to 1.25 XYZ Company would be in relatively good shortterm financial standing.
Computation of ratio
Current Ratio = Current Assets/ Current Liabilities
= Stock+Debtors+Cash/Bank Overdraft+ Sundry Creditors
= Rs.16,000/Rs.8,000= 2:1
Alternatively current assets can be calculated as
Current Assets = Working Capital + Current Liabilities
Current Assets = Total Assets Fixed Assets
Current Liabilities = Total AssetsCapital Employed
On payment of current liablity Current Assets and Current Liability reduce to same extent, in such cases ratio change e.g. If current assets are Rs.40,000 and current liabilities are Rs.20,000 on payment of Rs.10,000 to creditors the cash (current asset) will decrease to Rs.30,000 (Rs.40,000 Rs. 10,000) & current liabilities will decrease to Rs.10,000 (Rs.20,000 -Rs.10,000)
In first case current ratio is 2:1 Rs.40,000/Rs.20,000
And is second case it is 3:1 Rs.30,000/Rs.10,000
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