GSEB Class 12 Accounts Solutions Chapter 5 Accounting Ratios and Analysis

Exercise 1. Select The Correct Option For Each Question :

Question 1. Which of the following is correct for accounting ratios?
(A) Comparison with ratios developed by the firm
(B) Comparison with ratios of industry
(C) Comparison with ratios of competitors
(D) All of the above
Answer: (D) All of the above
In simple words: Accounting ratios are effective when compared against various benchmarks, including internal company trends, industry averages, and competitor performance, to provide comprehensive insights.

🎯 Exam Tip: Understanding the various comparison bases for accounting ratios is crucial for analyzing a firm's financial health relative to its internal goals and external environment.

 

Question 2. In which terms ratios are presented?
(A) Proportion
(C) Time
(D) All of the above
Answer: (D) All of the above
In simple words: Financial ratios can be expressed in multiple ways such as proportions (e.g., 2:1), percentages (e.g., 20%), or in terms of "times" (e.g., 5 times), each providing a different perspective on financial relationships.

🎯 Exam Tip: Familiarity with different presentation formats of ratios (proportion, percentage, times, days) is important for interpreting their meaning accurately in financial statements.

 

Question 3. For which of the following items the ratio is computed in days?
(A) For total purchase
(B) For credit sales
(C) For credit purchase
(D) Both (B) and (C)
Answer: (D) Both (B) and (C)
In simple words: Ratios like "days of debtors" (from credit sales) and "days of creditors" (from credit purchases) are calculated in days to show the average collection or payment period.

🎯 Exam Tip: Ratios expressed in days are typically used for liquidity and efficiency measurements, focusing on how quickly a company converts sales to cash or pays its suppliers.

 

Question 4. Which of the following ratios are included in traditional classification?
(A) Composite ratios
(B) Liquidity ratios
(C) Profitability ratios
(D) Solvency ratios
Answer: (A) Composite ratios
In simple words: In the traditional method of classifying ratios, categories such as composite ratios are included, distinguishing them from classifications based on specific financial objectives like liquidity or profitability.

🎯 Exam Tip: Be aware of the distinctions between traditional and functional classifications of ratios, as this impacts how they are grouped and analyzed.

 

Question 5. Which of the following ratios is revenue-based profitability ratio?
(A) Gross profit ratio
(B) Net profit ratio
(C) Operating ratio
(D) Both (A) and (B)
Answer: (C) Operating ratio
In simple words: The operating ratio is a profitability metric that assesses a company's efficiency by comparing its operating costs to its revenue, indicating how much revenue is consumed by operating activities.

🎯 Exam Tip: Differentiate between profitability ratios that focus on gross profit, net profit, and operating profit as they each highlight different aspects of a company's earning efficiency.

 

Question 6. A company has the purchase of Rs. 90,000, the purchase expenses of Rs. 15,000, the changes in stock (Rs. 15,000) and sales of Rs. 1,50,000. Determine the gross profit ratio.
(A) 40%
(C) 20%
(D) None of the above
Answer: (A) 40%
In simple words: To calculate the gross profit ratio, first determine the cost of goods sold (purchases + purchase expenses + change in stock), then calculate gross profit (sales - cost of goods sold), and finally divide gross profit by sales.

🎯 Exam Tip: Always remember that the "change in stock" for calculating Cost of Goods Sold can be positive (addition) or negative (subtraction) depending on whether it's an increase or decrease in stock.

 

Question 7. Which of the following is not included in operating expenses?
(A) Loss on sale of asset
(B) Loss due to fire
(C) Interest paid
(D) All of the above
Answer: (D) All of the above
In simple words: Operating expenses are those incurred in the normal course of business operations; extraordinary losses or financial costs like interest are generally excluded from this category.

🎯 Exam Tip: Accurately classifying expenses into operating, non-operating, and financial categories is critical for calculating ratios such as operating profit ratio and net profit ratio correctly.

 

Question 8. The cost of goods sold of a company is Rs. 10,00,000. Operating expenses are Rs. 2,00,000. Non-operating expenses are Rs. 3,00,000. Financial expenses are Rs. 1,00,000. If total sales is Rs. 20,00,000, determine operating profit ratio.
(A) 20%
(B) 40%
(C) 30%
(D) 28%
Answer: (B) 40%
In simple words: The operating profit ratio is found by taking operating profit (Sales - Cost of Goods Sold - Operating Expenses) and dividing it by total sales, expressing the result as a percentage.

🎯 Exam Tip: Remember that operating profit specifically excludes non-operating and financial expenses, focusing purely on core business performance when calculating the operating profit ratio.

 

Question 9. Liquidity ratio is ..................... .
(A) measurement of solvency
(B) measurement of short-term profitability
(C) measurement of profitability
(D) measurement of liquidity
Answer: (D) measurement of liquidity
In simple words: Liquidity ratios primarily measure a firm's ability to cover its short-term financial obligations with its current assets.

🎯 Exam Tip: Liquidity ratios are distinct from solvency ratios; liquidity focuses on immediate, short-term obligations, while solvency addresses long-term financial viability.

 

Question 10. Which of the following is not included to compute current ratio?
(B) Stock
(C) Bills receivables
(D) Furniture
Answer: (D) Furniture
In simple words: When calculating the current ratio, only current assets and current liabilities are considered; fixed assets like furniture are excluded as they are not expected to be converted to cash within one year.

🎯 Exam Tip: Ensure a clear understanding of what constitutes a 'current asset' and a 'current liability' for accurate calculation of the current ratio and other liquidity measures.

 

Question 11. Working capital means ..................... .
(A) difference between current assets and non-current assets
(B) difference between current liabilities and non-current assets
(C) difference between current assets and non-current liabilities
(D) difference between current assets and current liabilities.
Answer: (D) difference between current assets and current liabilities.
In simple words: Working capital is the difference between a company's current assets and its current liabilities, representing the funds available for day-to-day operations after meeting short-term debts.

🎯 Exam Tip: A positive working capital indicates healthy short-term financial strength, while negative working capital can signal potential liquidity problems.

 

Question 12. To arrive at liquid assets which of the following is deducted from current assets?
(A) Stock
(B) Cash and cash equivalent
(C) Debtors
(D) Bills receivables
Answer: (A) Stock
In simple words: To determine liquid assets from current assets, typically stock (inventory) and prepaid expenses are subtracted because they are not easily convertible into cash quickly without affecting business operations.

🎯 Exam Tip: The quick ratio (or acid-test ratio) uses liquid assets to provide a more conservative measure of a company's ability to meet immediate obligations compared to the current ratio.

 

Exercise 2. Answer The Following Questions In One Sentence :

Question 1. What is ratio?
Answer: A ratio represents the mathematical relationship between two accounting figures, which is valuable for making qualitative judgments about a firm's financial performance.
In simple words: A ratio shows how one financial number relates to another, helping us understand a company's financial health.

🎯 Exam Tip: Define a ratio clearly, emphasizing its role in financial analysis beyond just numerical calculation.

 

Question 2. When ratio is useful?
Answer: Ratios become useful when compared against established benchmarks, such as those developed by the business entity itself, industry averages, or competitor ratios, facilitating meaningful financial performance evaluations.
In simple words: Ratios are helpful when you compare them to standards, like past company performance or industry averages, to see how well a business is doing.

🎯 Exam Tip: Stress the importance of comparison (benchmarking) for ratios to yield actionable insights, rather than just isolated values.

 

Question 3. In which forms ratios can be presented?
Answer: Ratios can be presented in various forms:
- In terms of proportion
- In terms of percentage
- In terms of times
- In terms of fraction
- In terms of days/weeks/months.
In simple words: Ratios can be shown as proportions (like 2:1), percentages (like 50%), "times" (like 3 times), fractions, or time units (like 30 days).

🎯 Exam Tip: List the common formats of ratio presentation; this shows a complete understanding of how financial relationships are quantified.

 

Question 4. What is cost of goods sold?
Answer: The cost of goods sold (COGS) is determined by either subtracting gross profit from sales (or adding gross loss to sales) or by calculating wages, factory expenses, and the cost of goods consumed.
In simple words: Cost of goods sold is what it costs to produce the goods a company sells; it includes raw materials, labor, and manufacturing overhead.

🎯 Exam Tip: Provide both methods of calculating COGS, illustrating a comprehensive grasp of this fundamental accounting concept.

 

Question 5. The gross profit ratio and the net profit ratios are revenue-based ratios or expense based ratios?
Answer: Both the gross profit ratio and the net profit ratio are classified as revenue-based ratios.
In simple words: Both gross profit and net profit ratios show how much profit a company makes for every rupee of revenue it earns.

🎯 Exam Tip: Clearly state that these are revenue-based ratios, as their calculation directly relates profit figures to sales revenue.

 

Question 6. When the changes in stock is positive whether it will be added to cost of goods sold or deducted?
Answer: When a positive change in stock occurs (meaning opening stock is less than closing stock), it will be added to the cost of goods sold computation.
In simple words: If the stock increased during the period, that increase is added to the cost of goods available for sale when calculating the cost of goods sold.

🎯 Exam Tip: Accurately treating changes in stock (inventory) is crucial for the correct calculation of Cost of Goods Sold, directly impacting profitability ratios.

 

Question 7. [Question text appears truncated as "ration of financial expense." in the source OCR]
Answer: Interest expense serves as an example of a financial expense.
In simple words: Financial expense is the cost associated with borrowing money, like interest.

🎯 Exam Tip: Distinguish between operating, non-operating, and financial expenses to categorize them correctly in financial statements.

 

Question 8. Are financial expenses included to determine operating ratio?
Answer: No, financial expenses are not included when determining the operating ratio.
In simple words: Financial costs like interest payments are not part of the operating ratio because it only focuses on expenses related to core business operations.

🎯 Exam Tip: Remember that the operating ratio specifically aims to measure efficiency from core business activities, thus excluding financial and non-operating items.

 

Question 9. What is indicated by liquidity ratio?
Answer: The liquidity ratio signifies a business entity's capacity to settle its short-term liabilities.
In simple words: Liquidity ratios show how easily a company can pay its immediate debts using its readily available assets.

🎯 Exam Tip: Focus on the "short-term" aspect when explaining liquidity ratios; this is their primary characteristic.

 

Question 10. Will the current ratio increase or decrease when the current assets increase and the current liabilities remain unchanged?
Answer: If current assets increase while current liabilities stay constant, the current ratio will increase.
In simple words: When a company has more current assets and its current debts stay the same, its ability to pay those debts improves, so the current ratio goes up.

🎯 Exam Tip: Understand the direct relationship between current assets and the current ratio; an increase in current assets (ceteris paribus) will always improve liquidity.

 

Question 11. What is shareholder's funds?
Answer: Shareholder's funds consist solely of owner's funds, encompassing equity share capital, preference share capital, reserves and surplus, with any debit balance from the Profit & Loss Account being deducted.
In simple words: Shareholder's funds represent the money invested by owners and accumulated profits, minus any losses, showing the owners' total stake in the company.

🎯 Exam Tip: Be precise about the components of shareholder's funds, including both equity and retained earnings, and the deduction of accumulated losses.

 

Question 12. What is indicated by interest coverage ratio?
Answer: The interest coverage ratio illustrates the relationship between profit before tax and interest on long-term debts, thereby indicating the company's earning capacity to meet its interest obligations.
In simple words: The interest coverage ratio tells you how easily a company can pay its interest expenses using its operating profits.

🎯 Exam Tip: The interest coverage ratio is a key solvency metric, highlighting a company's ability to service its debt obligations from its earnings.

 

Question 13. Which is better out of high-interest coverage ratio and low-interest coverage ratio?
Answer: A high-interest coverage ratio is preferable because it indicates a strong capacity of the business to pay its interest obligations.
In simple words: A higher interest coverage ratio is better because it shows the company has plenty of earnings to cover its interest payments, making it less risky for lenders.

🎯 Exam Tip: A higher ratio generally signals lower risk for lenders and better financial health for the company regarding its debt servicing capacity.

 

Question 14. By which ratios efficiency is measured?
Answer: Efficiency is measured using the following ratios:
- Stock Turnover
- Working capital turnover
- Debtors turnover
- Creditors turnover.
In simple words: Efficiency in a business is measured by how quickly it manages its inventory, working capital, customer payments, and supplier payments.

🎯 Exam Tip: List the primary turnover ratios as they are the key indicators of a company's operational efficiency in managing its assets and liabilities.

 

Question 15. In order to arrive at trade, receivables is bad debt reserve deducted from debtors?
Answer: No, bad debt reserves are generally not deducted from debtors to arrive at trade receivables for ratio analysis purposes.
In simple words: Bad debt reserves are usually not subtracted from total debtors when calculating trade receivables because ratios typically use the gross amount before allowances.

🎯 Exam Tip: Understand the accounting treatment of bad debt reserves and how it impacts the calculation of trade receivables for different financial ratios.

 

Exercise 3. Answer The Following Questions In Brief :

Question 1. Explain three objectives of ratio analysis.
Answer: The primary objectives of ratio analysis include:
1. **To understand the entity's profitability:** Ratio analysis, in various forms, helps measure the financial profitability of a business.
2. **For financial statement review:** Ratios serve as valuable indicators for users of financial statements. Different stakeholders utilize ratio analysis to derive meaningful and useful insights from profit and loss statements and balance sheets.
3. **To ascertain the entity's liquidity position:** Liquidity ratios explain the business's capacity to fulfill its short-term liabilities, effectively measuring its short-term solvency.
In simple words: Ratio analysis helps us understand if a business is making enough profit, makes financial reports easier to understand for everyone, and shows if the company can pay its immediate debts.

🎯 Exam Tip: When explaining objectives, ensure a balance between financial performance (profitability), utility for stakeholders (analysis), and financial position (liquidity/solvency).

 

Question 2. Describe three limitations of ratio analysis.
Answer: Key limitations of ratio analysis include:
1. **Absence of standard ratios:** An individual ratio alone provides limited insight. Ratios are truly useful only when compared against established standards. Without these benchmarks, computed ratios lack interpretive value.
2. **Impact of price fluctuations:** Financial statements, the basis for ratio analysis, are prepared using historical information. They often do not account for inflation, which can distort ratio comparisons over time.
3. **Difficulty in comparison:** Comparisons can be misleading when similar businesses employ different accounting policies (e.g., depreciation methods, stock valuation), rendering information obtained through ratio analysis less useful.
In simple words: Ratios aren't perfect because there aren't always standard numbers to compare them to, they don't always account for changing prices like inflation, and comparing companies can be hard if they use different accounting rules.

🎯 Exam Tip: Highlight the contextual nature of ratios; they are most effective when applied with an understanding of external factors and company-specific accounting practices.

 

Question 3. When are computed ratios useful?
Answer: An individual ratio alone does not necessarily indicate a favorable or unfavorable situation. Computed ratios become truly useful when compared against certain standards, such as previous performance, industry benchmarks, or certified ratios. For instance, knowing a net profit ratio is 25% is just a result; its usefulness emerges when compared to last year's 20% or industry average, allowing for meaningful conclusions.
In simple words: Ratios are useful when you compare them to something, like a company's past performance or industry averages, to see if the current numbers are good or bad.

🎯 Exam Tip: Emphasize that context and comparison are paramount for ratio analysis to be insightful; an isolated ratio holds little value.

 

Question 4. Explain the traditional classification of ratios.
Answer: In the traditional classification system, accounting ratios are computed based on the financial statements, which include the trading account, profit and loss account, and balance sheet.
ℹ️ चित्र व्याख्या (Diagram Explanation): यह आरेख अनुपातों के पारंपरिक वर्गीकरण को दर्शाता है, जिसमें ट्रेडिंग खाते और लाभ-हानि खाते के अनुपात, बैलेंस शीट के अनुपात और मिश्रित अनुपात शामिल हैं। यह बताता है कि अनुपात गणना के लिए विभिन्न वित्तीय विवरणों से डेटा कैसे प्राप्त किया जाता है।

	Traditional Classification
Ratio of Trading A/c and Profit and Loss A/c	Ratio of Balance Sheet	Composite Ratio

- For ratios derived from the Trading Account and Profit-Loss Account, both numerator and denominator values are taken exclusively from these accounts. Similarly, for Balance Sheet ratios, all computational values are sourced solely from the balance sheet.
- For composite ratios, one component is typically drawn from the Trading Account or Profit and Loss Account, while the other component is obtained from the Balance Sheet.
In simple words: Traditional ratio classification groups ratios based on the financial statement they come from, like ratios from the income statement, ratios from the balance sheet, or mixed ratios that use figures from both.

🎯 Exam Tip: Focus on how traditional classification links ratios directly to their source financial statements (Trading A/c, P&L A/c, Balance Sheet), and the concept of composite ratios. Present the table cleanly.

 

Question 5. [Question text appears truncated as "hctional classification of ratios." in the source OCR]
Answer: The functional classification of ratios categorizes them based on the specific aspect of a business they evaluate:
1. **Profitability Ratios:** These ratios measure a business unit's earning capacity. Examples include Gross profit ratio, Operating ratio, Operating profit ratio, and Net profit ratio.
2. **Liquidity Ratios:** These ratios indicate a business unit's ability to meet its short-term or current liabilities. Current ratio and Liquid ratio are examples.
3. **Solvency Ratios:** These ratios assess a business unit's capacity to pay its long-term liabilities, reflecting its financial or economic solvency. Examples include Debt to equity ratio, Total assets to debt ratio, Proprietary ratio, and Interest coverage ratio.
4. **Efficiency (Activity) Ratios:** These ratios determine how effectively a business entity utilizes its acquired resources and equipment to enhance profitability. Examples include Stock turnover, Working capital turnover, Debtor turnover, and Creditors turnover.
In simple words: Functional classification organizes ratios by what they measure: profitability (how much money is made), liquidity (ability to pay short-term debts), solvency (ability to pay long-term debts), and efficiency (how well assets are used).

🎯 Exam Tip: When explaining functional classification, list the main categories (Profitability, Liquidity, Solvency, Efficiency) and provide at least two examples for each to demonstrate understanding.

 

Question 6. Explain any one ratio of profitability.
Answer: Profitability refers to a business's ability to earn profits. Profitability ratios include:
1. Gross profit ratio
2. Operating ratio
3. Operating profit ratio
4. Net profit ratio.
**Explanation of Gross Profit Ratio:**
The Gross Profit Ratio illustrates the relationship between a company's gross profit and its total net sales. As an income-based ratio, it expresses the gross profit as a percentage of sales, indicating the revenue generated from core operations before deducting operating expenses. Sales, in this context, refers to revenue from operations, and net sales specifically means sales after accounting for sales returns.
In simple words: The Gross Profit Ratio shows how much money a company makes from its sales after covering the direct cost of making or buying the goods, before other business expenses.

🎯 Exam Tip: Choose one ratio and explain it comprehensively, covering its purpose, calculation, and what it indicates about the business.

 

Question 7. Explain any one ratio of liquidity.
Answer: Liquidity denotes a business unit's capability to settle its short-term or current liabilities. The main liquidity ratios are:
1. Current ratio
2. Liquid ratio.
**Explanation of Current Ratio:**
The Current Ratio indicates the relationship between current assets and current liabilities. A higher proportion of current assets relative to current liabilities suggests a strong liquidity position for the business entity, signifying greater short-term solvency. Current assets are items in cash form, cash equivalents, or those convertible into cash within 12 months. Examples include current investments, stock (excluding loose tools), trade receivables, cash and cash equivalent, short-term lendings and advances, prepaid expenses, outstanding incomes, and advance tax payments. Current liabilities are obligations payable within a 12-month period, such as short-term borrowings, trade payables, interest payable on long-term liabilities, due but unpaid liabilities, outstanding expenses, uncalled dividends, installments received in advance, and short-term provisions. A desirable current ratio is typically 2:1. The difference between current assets and current liabilities is known as working capital.
\[ \text{Formula: Current ratio} = \frac{\text{Current Assets}}{\text{Current Liabilities}} \]In simple words: The Current Ratio shows if a company can pay its immediate bills with its immediate assets. A good ratio means it has enough quick money to cover its short-term debts.

🎯 Exam Tip: For liquidity ratios, clearly define current assets and current liabilities, provide the formula, and explain what a favorable ratio indicates.

 

Question 8. Explain any one ratio of solvency.
Answer: Solvency ratios are utilized to gauge a business entity's capacity to meet its long-term liabilities. Key solvency ratios include:
- Debt to equity ratio
- Total assets to debt ratio
- Proprietary ratio
- Interest coverage ratio.
**Explanation of Debt-equity ratio:**
The Debt-Equity Ratio's objective is to reveal the proportion of owner's capital and borrowed funds employed by the business as long-term financing sources. Here, long-term liabilities include long-term borrowings, deferred tax liabilities, other long-term liabilities, and long-term provisions. Shareholder's funds are calculated as Equity share capital + Preference share capital + Reserves and surplus - Debit balance of Profit & Loss A/c. A high debt-to-equity ratio implies greater reliance on borrowed funds, signaling higher risk from the lenders' perspective. Conversely, a low debt-to-equity ratio indicates less dependence on borrowed funds, making it less risky for lenders.
\[ \text{Formula:} \frac{\text{Debt (Non-Current / Long-Term Liabilities)}}{\text{Equity (Shareholder's Funds)}} \]In simple words: The Debt-Equity Ratio shows how much of a company's assets are financed by debt versus owner's money; a higher ratio means more debt and higher risk.

🎯 Exam Tip: When explaining solvency ratios, clearly distinguish between debt (long-term liabilities) and equity (shareholder's funds), provide the formula, and discuss the implications of high vs. low ratios.

 

Question 9. Explain any one ratio of efficiency.
Answer: The profitability of a business improves when all its resources and equipment are used efficiently. Efficiency or activity ratios are developed in this context. Examples of efficiency ratios are as follows:
- Stock turnover
- Working capital turnover
- Debtors turnover
- Creditors turnover.
**Explanation of Stock turnover:**
The stock turnover ratio measures the efficiency of converting stock into sales. This ratio indicates how many times a company's inventory is sold and replaced over a period. Cost of goods sold (COGS) can be derived from Sales - Gross profit (or Sales + Gross loss). Alternatively, COGS = Opening stock of goods + Purchase of raw material + Purchase expense + Wages + Factory expenses - Closing stock of raw material. Average stock is calculated as (Opening stock of goods + Closing stock) / 2. A higher stock turnover ratio generally signifies higher sales and increased profit.
\[ \text{Formula: Stock turnover} = \frac{\text{Cost of goods sold}}{\text{Average stock}} \]
\[ \text{Average stock} = \frac{\text{Opening stock of goods + Closing stock}}{2} \]In simple words: The Stock Turnover ratio shows how quickly a company sells its inventory; a higher ratio usually means efficient sales and good profits.

🎯 Exam Tip: When describing an efficiency ratio, provide its formula, explain its components (like COGS and average stock for stock turnover), and interpret what a high or low value means for business operations.

 

Question 10. What are included in operating expenses?
Answer: Operating expenses are costs incurred during a business's primary operating activities. These include office/administrative expenses, sales distribution expenses, employee benefit expenses, depreciation, and amounts written off.
In simple words: Operating expenses are the regular costs a business has to run its day-to-day activities, like rent, salaries, and utility bills.

🎯 Exam Tip: Clearly list the common categories of operating expenses to show an understanding of costs directly related to core business functions.

 

Question 11. Explain operating incomes.
Answer: Operating income or revenue arises from the core business activity of an entity. Non-operating incomes, such as interest received, dividends received, or profit on the sale of an asset, are specifically excluded when determining operating costs.
In simple words: Operating income is the money a business earns directly from its main activities, like selling its products or services, not from other sources like investments.

🎯 Exam Tip: Distinguish operating income from non-operating income, emphasizing that the former is derived from the core business activities.

 

Question 12. Do we consider current investments for current ratio?
Answer: Yes, current investments are considered for the current ratio calculation. This is because current assets, which include current investments, are factored into the current ratio.
In simple words: Yes, current investments are included in current assets when calculating the current ratio because they are expected to be converted to cash within a year.

🎯 Exam Tip: Confirm that current investments are indeed part of current assets, a common point of confusion in liquidity ratio calculations.

 

Question 13. Explain the approaches of proprietary funds.
Answer: There are two approaches to determining owner's funds, both yielding identical results:
1. **Liabilities-Based Approach:**
\[ \text{Owner's funds} = \text{Equity share capital} + \text{Preference share capital} + \text{Reserves and surplus} - \text{Debit balance of P \& L A/c (if any)} \]
2. **Assets-Based Approach:**
\[ \text{Owner's funds} = \text{Non-current Assets} + \text{Current Assets} - \text{Non-current liabilities} - \text{Current liabilities} \]In simple words: Proprietary funds (owner's funds) can be calculated in two ways: by adding up equity, preference shares, and reserves while subtracting P&L debit balance, or by subtracting all liabilities (current and non-current) from total assets.

🎯 Exam Tip: Provide both the liabilities-based and assets-based approaches for calculating proprietary funds, as this demonstrates a complete understanding of its composition.

 

Question 5.
From the following information calculate operating ratio :

Particulars	(Rs.)	Particulars	(Rs.)
Non-operating other expenses	35,000	Income of interest-dividend	45,000
Depreciation	48,000	Sales expenses	52,000
Administrative expenses	75,000	Cost of goods sold	3,25,000
Sales	6,00,000	Financial expenses	85,000
Tax rate	30%

Answer:
To determine the operating ratio, we first calculate the total operating expenses. Operating expense = Administrative expense + Sales expense + Depreciation
Operating expense = Rs. 75,000 + Rs. 52,000 + Rs. 48,000 = Rs. 1,75,000
The formula for the Operating Ratio is: \[ Operating \: Ratio = \frac{Cost \: of \: goods \: sold \: + \: Operating \: expense}{Net \: Sales} \times 100 \] Substituting the given values: \[ Operating \: Ratio = \frac{3,25,000 \: + \: 1,75,000}{6,00,000} \times 100 \] \[ Operating \: Ratio = \frac{5,00,000}{6,00,000} \times 100 \] \[ Operating \: Ratio = 83.33\% \]In simple words: The operating ratio is found by adding the cost of goods sold to the operating expenses and dividing that sum by net sales, then multiplying by 100 to get a percentage. This calculation helps understand how efficiently a company manages its operations relative to its sales.

🎯 Exam Tip: Remember to correctly identify all operating expenses and distinguish them from non-operating or financial expenses before calculating the operating ratio. Ensure accurate aggregation of all relevant costs in the numerator and use net sales as the denominator.

 

Question 6.
From the following information calculate (i) operating ratio and (ii) operating profit ratio:

Particulars	(Rs.)	Particulars	(Rs.)
Sales	39,00,000	Wages	2,00,000
Cost of goods consumed	25,00,000	Administrative expenses	1,75,000
Sales expenses	75,000	Interest on loan	60,000
Loss due to accident	40,000	Dividend received on investments	1,00,000
Factory expenses including depreciation	50,000	Tax rate	30%

Answer:
First, we calculate the Cost of Goods Sold (COGS) and Operating Expenses.
Cost of goods sold = Cost of goods consumed + Wages
Cost of goods sold = Rs. 25,00,000 + Rs. 2,00,000 = Rs. 27,00,000
Operating Expense = Administrative expense + Sales expense + Factory expenses (including depreciation)
Operating Expense = Rs. 1,75,000 + Rs. 75,000 + Rs. 50,000 = Rs. 3,00,000

(i) Operating Ratio:
\[ Operating \: Ratio = \frac{Cost \: of \: goods \: sold \: + \: Operating \: expenses}{Net \: Sales} \times 100 \] \[ Operating \: Ratio = \frac{27,00,000 \: + \: 3,00,000}{39,00,000} \times 100 \] \[ Operating \: Ratio = \frac{30,00,000}{39,00,000} \times 100 \] \[ Operating \: Ratio = 76.92\% \]
(ii) Operating Profit Ratio:
Operating cost = Cost of goods sold + Operating expenses
Operating cost = Rs. 27,00,000 + Rs. 3,00,000 = Rs. 30,00,000
Operating Profit = Sales - Operating Cost
Operating Profit = Rs. 39,00,000 - Rs. 30,00,000 = Rs. 9,00,000
The formula for Operating Profit Ratio is: \[ Operating \: Profit \: Ratio = \frac{Operating \: Profit}{Net \: Sales} \times 100 \] \[ Operating \: Profit \: Ratio = \frac{9,00,000}{39,00,000} \times 100 \] \[ Operating \: Profit \: Ratio = 23.08\% \] Alternatively, Operating Profit Ratio can be calculated as: Operating Profit Ratio = 100% - Operating Ratio
Operating Profit Ratio = 100% - 76.92% = 23.08%
In simple words: The operating ratio shows the proportion of sales consumed by operational costs, while the operating profit ratio indicates the profit generated from core operations relative to sales. These ratios are key indicators of a business's operational efficiency.

🎯 Exam Tip: For these calculations, ensure all direct costs and relevant operating expenses are included in the 'Cost of goods sold' and 'Operating expenses' respectively. Net sales should always be used as the denominator, and non-operating items like interest and dividends are excluded from operating calculations.

 

Question 7.
Calculate net profit ratio from information of questions no. 5 and 6.

Answer:
To determine the profit after tax using information from Question 5:

Particulars	Amt. (Rs.)	Amt. (Rs.)
Sales		6,00,000
Less: Sales return		-
Net Sales		6,00,000
Add: Non-operating income
Income from interest and dividend	45,000
Total Income		6,45,000
Less: Cost of goods sold	3,25,000
Operating expense :
Administrative expense	75,000
+ Sales expense	52,000
+ Depreciation	48,000	1,75,000
Financial expense	85,000
Non-operating expense :	35,000	6,20,000
Profit before tax		25,000
Less: Tax @30%		7,500
Profit after tax / Net Profit		17,500

Net Profit Ratio \( = \frac{Net \: profit \: after \: tax}{Net \: sales} \times 100 \) Net Profit Ratio \( = \frac{17,500}{6,00,000} \times 100 = 2.92\% \)
To determine the profit after tax using information from Question 6:

Particulars	Amt. (Rs.)	Amt. (Rs.)
Sales		39,00,000
Less: Sales return		-
Net Sales		39,00,000
Add: Dividend received on investments		1,00,000
Total Income		40,00,000
Less: Cost of goods consumed	25,00,000
+ Operating expense :
Administrative expense	1,75,000
+ Sales expense	75,000
+ Depreciation	50,000
+ Wages	2,00,000	5,00,000
+ Financial expense - Loan interest	60,000
+ Other expense: Loss due to accident	40,000	31,00,000
Profit before tax		9,00,000
Less: Tax @30%		2,70,000
Profit after tax / Net Profit		6,30,000

Net Profit Ratio \( = \frac{Net \: profit \: after \: tax}{Net \: sales} \times 100 \) Net Profit Ratio \( = \frac{6,30,000}{39,00,000} \times 100 = 16.15\% \)In simple words: The Net Profit Ratio indicates the percentage of net profit (after all expenses and taxes) earned for every rupee of sales. It is calculated by dividing the net profit after tax by net sales and multiplying by 100.

🎯 Exam Tip: When calculating Net Profit Ratio, ensure that all income (operating and non-operating) and all expenses (cost of goods sold, operating, financial, and non-operating) are accounted for, and taxes are deducted, before relating the final profit to net sales.

 

Question 8.
From the following information calculate current ratio and liquid ratio:

Particulars	(Rs.)	Particulars	(Rs.)
Stock	3,00,000	Bills receivables	75,000
Debtors	2,50,000	Bad debts reserve	20,000
Cash and cash equivalent	1,20,000	Expenses paid in advance	60,000
Furniture	1,60,000	Creditors	2,00,000
Bills payable	60,000	Outstanding expenses	50,000
Short-term loan	40,000

Answer:
First, calculate Current Assets and Current Liabilities.
Current Assets:
Debtors: Rs. 2,50,000
Bills receivables: Rs. 75,000
Expenses paid in advance: Rs. 60,000
Stock: Rs. 3,00,000
Cash and cash equivalent: Rs. 1,20,000
Total Current Assets = Rs. 2,50,000 + Rs. 75,000 + Rs. 60,000 + Rs. 3,00,000 + Rs. 1,20,000 = Rs. 7,85,000
Current Liabilities:
Bills Payables: Rs. 60,000
Short-term loan: Rs. 40,000
Outstanding expenses: Rs. 50,000
Creditors: Rs. 2,00,000
Total Current Liabilities = Rs. 60,000 + Rs. 40,000 + Rs. 50,000 + Rs. 2,00,000 = Rs. 3,50,000

Current Ratio:
\[ Current \: Ratio = \frac{Current \: Assets}{Current \: Liabilities} \] \[ Current \: Ratio = \frac{7,85,000}{3,50,000} = 2.24 \]
Liquid Ratio:
To calculate Liquid Assets, we deduct Stock and Expenses paid in advance from Current Assets.
Liquid Assets = Current Assets - Stock - Expenses paid in advance
Liquid Assets = Rs. 7,85,000 - Rs. 3,00,000 - Rs. 60,000 = Rs. 4,25,000
Current Liabilities are also known as Liquid Liabilities for this purpose.
\[ Liquid \: Ratio = \frac{Liquid \: Assets}{Liquid \: Liabilities} \] \[ Liquid \: Ratio = \frac{4,25,000}{3,50,000} = 1.21:1 \]In simple words: The current ratio assesses a company's ability to cover its short-term debts with its short-term assets, while the liquid ratio (or quick ratio) offers a stricter measure by excluding less liquid assets like stock and prepaid expenses. Both ratios gauge a firm's short-term financial health.

🎯 Exam Tip: When computing liquidity ratios, correctly classify current assets and liabilities. Remember that for the liquid ratio, inventory (stock) and prepaid expenses are typically excluded from current assets because they are not easily convertible to cash to meet immediate obligations.

 

Question 9.
From the following information of 'H' Limited, calculate debt-equity ratio :

Particulars	(Rs.)	Particulars	(Rs.)
Long-term liabilities	8,00,000	Equity share capital	8,00,000
Long-term provisions	4,00,000	Preference share capital	2,00,000
Debit balance of profit-loss A/c	50,000	Creditors	1,25,000
Bills payables	25,000	Outstanding expenses	10,000

Answer:
First, we need to calculate Debt (Non-current liabilities) and Equity (Shareholder's funds).
Debt (Non-current liabilities):
Long-term debt/liabilities: Rs. 8,00,000
Long-term provisions: Rs. 4,00,000
Total Debt = Rs. 8,00,000 + Rs. 4,00,000 = Rs. 12,00,000
Equity (Shareholder's funds):
Equity share capital: Rs. 8,00,000
Preference share capital: Rs. 2,00,000
Less: Debit balance of profit-loss A/c: Rs. 50,000
Total Equity = Rs. 8,00,000 + Rs. 2,00,000 - Rs. 50,000 = Rs. 9,50,000

Now, calculate the Debt-equity ratio:
\[ Debt \text{-} equity \: ratio = \frac{Debt \: (Non \text{-} current \: liabilities)}{Equity \: (Shareholder's \: funds)} \] \[ Debt \text{-} equity \: ratio = \frac{12,00,000}{9,50,000} \] \[ Debt \text{-} equity \: ratio = 1.26:1 \]In simple words: The debt-equity ratio measures how much debt a company uses to finance its assets compared to the value of shareholders' equity. A ratio of 1.26:1 indicates that the company uses slightly more long-term debt than equity for its financing.

🎯 Exam Tip: For the debt-equity ratio, correctly identify all long-term debts as 'Debt' and shareholder contributions (equity capital, reserves, and surplus, less any debit balance in P&L) as 'Equity'. Ensure that current liabilities are not included in the 'Debt' component.

 

Question 10.
From the following information of 'M' Limited, calculate debt-equity ratio :

Particulars	(Rs.)	Particulars	(Rs.)
Current liabilities	4,50,000	Long-term liabilities	8,00,000
Long-term provisions	6,00,000	Total assets	30,00,000

Answer:
First, calculate Debt (Non-current liabilities) and Equity (Shareholder's funds).
Non-current liabilities (Debt):
Long-term liabilities: Rs. 8,00,000
Long-term provisions: Rs. 6,00,000
Total Debt = Rs. 8,00,000 + Rs. 6,00,000 = Rs. 14,00,000
Equity (Shareholder's funds):
Equity can be calculated using the accounting equation: Total Assets = Total Liabilities (Debt + Equity).
Total assets = Rs. 30,00,000
Total Liabilities = Long-term liabilities + Long-term provisions + Current liabilities
Total Liabilities = Rs. 8,00,000 + Rs. 6,00,000 + Rs. 4,50,000 = Rs. 18,50,000
Equity = Total Assets - Total Liabilities (or Debt + Current Liabilities)
Equity = Rs. 30,00,000 - Rs. 18,50,000 = Rs. 11,50,000

Now, calculate the Debt-equity ratio:
\[ Debt \text{-} equity \: ratio = \frac{Debt \: (Non \text{-} current \: liabilities)}{Equity \: (Shareholder's \: funds)} \] \[ Debt \text{-} equity \: ratio = \frac{14,00,000}{11,50,000} \] \[ Debt \text{-} equity \: ratio = 1.22:1 \]In simple words: This ratio assesses how much of a company's financing comes from long-term debt versus shareholder investments. A 1.22:1 ratio suggests that for every rupee of equity, the company has 1.22 rupees of long-term debt.

🎯 Exam Tip: When total assets are given, Equity can be derived by subtracting total external liabilities (both current and non-current) from total assets. Ensure accurate classification of long-term debt and equity components to get the correct debt-equity ratio.

 

Question 11.
From the following information of 'N' Company Limited, calculate debt-equity ratio:

Particulars	(Rs.)	Particulars	(Rs.)
Creditors	1,60,000	Non-current assets	12,00,000
Bills payables	1,40,000	Current assets	10,00,000
Outstanding expenses	1,00,000	Total liabilities	10,00,000

Answer:
First, we need to calculate Debt (Non-current liabilities) and Equity (Shareholder's funds).
Debt (Non-current liabilities):
Total liabilities (given) = Rs. 10,00,000
Current liabilities = Creditors + Bills payables + Outstanding expenses
Current liabilities = Rs. 1,60,000 + Rs. 1,40,000 + Rs. 1,00,000 = Rs. 4,00,000
Non-current liabilities (Debt) = Total liabilities - Current liabilities
Non-current liabilities (Debt) = Rs. 10,00,000 - Rs. 4,00,000 = Rs. 6,00,000
Equity (Shareholder's funds):
Total Assets = Non-current assets + Current assets
Total Assets = Rs. 12,00,000 + Rs. 10,00,000 = Rs. 22,00,000
Equity = Total Assets - Total Debt
Equity = Total Assets - (Non-current liabilities + Current liabilities)
Equity = Rs. 22,00,000 - Rs. 10,00,000 = Rs. 12,00,000

Now, calculate the Debt-equity ratio:
\[ Debt \text{-} equity \: ratio = \frac{Debt \: (Non \text{-} current \: liabilities)}{Equity \: (Shareholder's \: funds)} \] \[ Debt \text{-} equity \: ratio = \frac{6,00,000}{12,00,000} \] \[ Debt \text{-} equity \: ratio = 0.5:1 \]In simple words: This ratio indicates the proportion of long-term debt used to finance assets compared to the equity contributed by owners. A ratio of 0.5:1 suggests the company relies more on equity than long-term debt.

🎯 Exam Tip: When 'Total Liabilities' are given, carefully separate them into current and non-current components. 'Non-current liabilities' will represent the debt for the ratio, and 'Equity' can be determined by subtracting total liabilities from total assets.

 

Question 12.
From the following information of 'R' Company Limited, calculate total assets-debt ratio :

Particulars	(Rs.)	Particulars	(Rs.)
Preference Share Capital	10,00,000	Non-current liabilities	4,00,000
Equity Share Capital	6,00,000	Current liabilities	4,00,000
Reserve and surplus	2,00,000

Answer:
In this case, the total asset value is not explicitly provided. However, the details of the capital and liabilities side are given. Therefore, the total of the capital-liabilities side will be considered as the total assets.
Total assets:
Equity share capital: Rs. 6,00,000
Preference share capital: Rs. 10,00,000
Reserves and surplus: Rs. 2,00,000
Non-current liabilities: Rs. 4,00,000
Current liabilities: Rs. 4,00,000
Total Assets = Rs. 6,00,000 + Rs. 10,00,000 + Rs. 2,00,000 + Rs. 4,00,000 + Rs. 4,00,000 = Rs. 26,00,000
The formula for Total assets-debt ratio is:
\[ Total \: assets \text{-} debt \: ratio = \frac{Total \: assets}{Debt \: (Long \: term \: liabilities \: / \: Non \text{-} current \: liabilities)} \] Here, Debt refers to Non-current liabilities which is Rs. 4,00,000.
\[ Total \: assets \text{-} debt \: ratio = \frac{26,00,000}{4,00,000} \] \[ Total \: assets \text{-} debt \: ratio = 6.5:1 \]In simple words: The total assets-debt ratio indicates how many times a company's total assets can cover its long-term debt. A ratio of 6.5:1 suggests a strong position, meaning the company has significant assets relative to its long-term obligations.

🎯 Exam Tip: When total assets are not directly given, remember that the sum of all liabilities (current and non-current) and owner's equity equals total assets. Ensure that only long-term debt is used in the denominator for the total assets-debt ratio, not total liabilities.

 

Question 13.
From the following information of 'T' Company Limited, calculate proprietary ratio :

Particulars	(Rs.)	Particulars	(Rs.)
Equity share capital	12,00,000	Current liabilities	4,00,000
Preference share capital	8,00,000	Non-current assets	12,00,000
Reserve and surplus	4,00,000	Current assets	24,00,000
Non-current liabilities	8,00,000

Answer:
First, we calculate Owner's funds (Shareholder's funds) and Total assets.
Owner's funds (Shareholder's funds):
Equity share capital: Rs. 12,00,000
Preference share capital: Rs. 8,00,000
Reserve and surplus: Rs. 4,00,000
Total Owner's funds = Rs. 12,00,000 + Rs. 8,00,000 + Rs. 4,00,000 = Rs. 24,00,000
Total assets:
Non-current assets: Rs. 12,00,000
Current assets: Rs. 24,00,000
Total assets = Rs. 12,00,000 + Rs. 24,00,000 = Rs. 36,00,000

Now, calculate the Proprietary ratio:
\[ Proprietary \: ratio = \frac{Owner's \: funds}{Total \: assets} \] \[ Proprietary \: ratio = \frac{24,00,000}{36,00,000} \] \[ Proprietary \: ratio = 0.66:1 \]In simple words: The proprietary ratio measures the proportion of total assets funded by shareholders' equity. A ratio of 0.66:1 implies that 66% of the company's assets are financed by the owners' funds, indicating financial stability.

🎯 Exam Tip: When computing the proprietary ratio, ensure that 'Owner's funds' include all forms of equity capital, reserves, and surplus, and 'Total assets' encompass both current and non-current assets. This ratio indicates the extent of owners' stake in the business's assets.

 

Question 14.
From the following information of 'K' Company Limited, calculate interest coverage ratio :

Particulars	(Rs.)	Particulars	(Rs.)
Profit after tax	7,50,000	Taxes paid	2,50,000
10% Debentures	20,00,000	12% Loan	10,00,000

Answer:
First, we calculate the total interest on long-term liabilities and Profit before interest and tax.
Interest on long-term liabilities:
10% Debentures (10% of Rs. 20,00,000) = Rs. 2,00,000
12% Loan (12% of Rs. 10,00,000) = Rs. 1,20,000
Total interest on long-term liabilities = Rs. 2,00,000 + Rs. 1,20,000 = Rs. 3,20,000
Profit before interest and tax:
Profit after tax: Rs. 7,50,000
Taxes paid: Rs. 2,50,000
Profit before tax = Profit after tax + Taxes paid = Rs. 7,50,000 + Rs. 2,50,000 = Rs. 10,00,000
Profit before interest and tax = Profit before tax + Total interest
Profit before interest and tax = Rs. 10,00,000 + Rs. 3,20,000 = Rs. 13,20,000

Now, calculate the Interest coverage ratio:
\[ Interest \: coverage \: ratio = \frac{Profit \: before \: interest \: and \: tax}{Interest \: on \: long \text{-} term \: liabilities} \] \[ Interest \: coverage \: ratio = \frac{13,20,000}{3,20,000} \] \[ Interest \: coverage \: ratio = 4.125 \: times \]In simple words: The interest coverage ratio indicates a company's ability to meet its interest obligations from its operating earnings. A ratio of 4.125 times suggests the company's earnings before interest and tax are more than four times its interest expenses, indicating good financial solvency.

🎯 Exam Tip: To calculate the interest coverage ratio, always use profit *before* interest and tax in the numerator, as this represents the earnings available to cover interest payments. The denominator should only include the interest on long-term liabilities.

 

Question 15.
Calculate stock turnover ratio from the following information of 'L' Company Limited :

Particulars	(Rs.)	Particulars	(Rs.)
Sales	30,00,000	Opening stock	3,50,000
Closing stock	2,50,000	Purchases	12,00,000
Gross profit rate	30%

Answer:
First, calculate Cost of goods sold and Average Stock.
Cost of goods sold = Sales - Gross Profit
Gross Profit = 30% of Sales = 30% of Rs. 30,00,000 = Rs. 9,00,000
Cost of goods sold = Rs. 30,00,000 - Rs. 9,00,000 = Rs. 21,00,000
Average Stock = \(\frac{Opening \: stock \: + \: Closing \: stock}{2}\)
Average Stock = \(\frac{3,50,000 \: + \: 2,50,000}{2}\)
Average Stock = \(\frac{6,00,000}{2} = 3,00,000\)

Now, calculate the Stock Turnover Ratio:
\[ Stock \: Turnover = \frac{Cost \: of \: goods \: sold}{Average \: stock} \] \[ Stock \: Turnover = \frac{21,00,000}{3,00,000} \] \[ Stock \: Turnover = 7 \: times \]In simple words: The stock turnover ratio measures how many times a company has sold and replaced its inventory during a period. A ratio of 7 times indicates efficient inventory management, meaning the stock is converted into sales frequently.

🎯 Exam Tip: The stock turnover ratio highlights inventory efficiency. Always use the Cost of Goods Sold in the numerator and Average Stock (calculated from opening and closing stock) in the denominator. A higher ratio generally signifies better inventory management, but it varies by industry.

 

Question 16.
Calculate stock turnover ratio from the following information of 'Y' Company Limited :

Particulars	(Rs.)	Particulars	(Rs.)
Opening stock	2,00,000	Closing stock	1,50,000
Sales	40,00,000	Purchases	22,00,000
Purchase expenses	1,00,000	Wages	2,50,000

Answer:
First, calculate Cost of goods sold and Average stock.
Average stock = \(\frac{Opening \: stock \: + \: Closing \: stock}{2}\)
Average stock = \(\frac{2,00,000 \: + \: 1,50,000}{2}\)
Average stock = \(\frac{3,50,000}{2} = 1,75,000\)
Cost of goods sold = Opening stock + Purchase + Purchase expenses + Wages - Closing stock
Cost of goods sold = Rs. 2,00,000 + Rs. 22,00,000 + Rs. 1,00,000 + Rs. 2,50,000 - Rs. 1,50,000 = Rs. 26,00,000

Now, calculate the Stock Turnover Ratio:
\[ Stock \: turnover \: ratio = \frac{Cost \: of \: goods \: sold}{Average \: stock} \] \[ Stock \: turnover \: ratio = \frac{26,00,000}{1,75,000} \] \[ Stock \: turnover \: ratio = 14.86 \: times \]In simple words: This ratio measures how quickly a company sells its inventory. A result of 14.86 times indicates that the company replenishes and sells its entire average stock almost 15 times within the accounting period.

🎯 Exam Tip: When calculating Cost of Goods Sold (COGS), ensure all direct costs like opening stock, purchases, purchase expenses, and wages are added, and closing stock is subtracted. Accuracy in COGS and average stock is crucial for a reliable stock turnover ratio.

 

Question 17.
Calculate working capital turnover ratio (based In sales and cost of goods sold), from the following information of 'Z' Company Limited:

Particulars	(Rs.)	Particulars	(Rs.)
Cost of goods sold	32,00,000	Gross profit	8,00,000
Non-current assets	10,00,000	Current assets	5,00,000
Non-current liabilities	6,00,000	Current liabilities	3,00,000

Answer:
First, calculate Working capital and Sales.
Working capital = Current assets - Current liabilities
Working capital = Rs. 5,00,000 - Rs. 3,00,000 = Rs. 2,00,000
Sales = Cost of goods sold + Gross profit
Sales = Rs. 32,00,000 + Rs. 8,00,000 = Rs. 40,00,000

Working capital turnover (based on sales):
\[ Working \: capital \: turnover = \frac{Sales}{Working \: capital} \] \[ Working \: capital \: turnover = \frac{40,00,000}{2,00,000} \] \[ Working \: capital \: turnover = 20 \: times \]
Working capital turnover (based on cost of goods sold):
Cost of goods sold = Rs. 32,00,000
\[ Working \: capital \: turnover = \frac{Cost \: of \: goods \: sold}{Working \: capital} \] \[ Working \: capital \: turnover = \frac{32,00,000}{2,00,000} \] \[ Working \: capital \: turnover = 16 \: times \]In simple words: The working capital turnover ratio assesses how efficiently a company uses its working capital to generate sales or cover the cost of goods sold. A higher ratio indicates more effective utilization of current assets and liabilities.

🎯 Exam Tip: Remember to calculate 'Working Capital' as Current Assets minus Current Liabilities. The ratio can be computed using either Sales or Cost of Goods Sold in the numerator, depending on the specific objective, so be mindful of what the question asks.

 

Question 18.
From the following information of 'B' Company Limited, calculate debtors turnover and collection period in days. What will be answer if collection period is calculated in terms of weeks and months? (Assume 360 days of the year)

Particulars	(Rs.)	Particulars	(Rs.)
Total Sales	4,50,000	Credit Sales	3,65,000
Opening debtors	70,000	Closing debtors	50,000
Opening bills receivables	20,000	Closing bills receivables	6,000
Opening creditors	45,000	Closing creditors	48,000

Answer:
First, calculate Average trade receivables.
Average trade receivables = \(\frac{(Opening \: debtors \: + \: Opening \: bills \: receivables) \: + \: (Closing \: debtors \: + \: Closing \: bills \: receivables)}{2}\)
Average trade receivables = \(\frac{(70,000 \: + \: 20,000) \: + \: (50,000 \: + \: 6,000)}{2}\)
Average trade receivables = \(\frac{90,000 \: + \: 56,000}{2} = \frac{1,46,000}{2} = 73,000\)

Debtors turnover = \(\frac{Credit \: sales}{Average \: trade \: receivables}\)
Debtors turnover = \(\frac{3,65,000}{73,000} = 5 \: times\)

Collection period :
In days = \(\frac{360}{Debtors \: turnover} = \frac{360}{5} = 72 \: days\)
In months = \(\frac{12}{Debtors \: turnover} = \frac{12}{5} = 2.4 \: months\)
In weeks = \(\frac{52}{Debtors \: turnover} = \frac{52}{5} = 10.4 \: weeks\)
In simple words: The debtors turnover ratio indicates how efficiently a company collects its credit sales. The collection period then translates this efficiency into the average number of days, weeks, or months it takes to collect money from customers.

🎯 Exam Tip: When calculating debtors turnover, always use credit sales in the numerator, not total sales. The average trade receivables should include both debtors and bills receivables (opening and closing). Be precise with the number of days/weeks/months used for the collection period calculation.

 

Question 19.
From the following information of 'C' Company Ltd., calculate creditors turnover and payment period in days. What will be answer if payment period Is calculated in terms of weeks and months? (Assume 360 days of the year)

Particulars	(Rs.)	Particulars	(Rs.)
Opening balance:
Creditors	45,000	Credit sales	6,00,000
Bills payables	15,000	Cash sales	4,00,000
Bills receivables	30,000	Total sales	10,00,000
Debtors	30,000	Total purchase	6,00,000
Closing balances :		Cash purchase	2,40,000
Creditors	40,000
Bills payables	20,000
Bills receivables	40,000
Debtors	20,000

Answer:
First, calculate Average trade payables and Credit Purchase.
Average trade payables = \(\frac{(Opening \: creditors \: + \: Opening \: bills \: payables) \: + \: (Closing \: creditors \: + \: Closing \: bills \: payables)}{2}\)
Average trade payables = \(\frac{(45,000 \: + \: 15,000) \: + \: (40,000 \: + \: 20,000)}{2}\)
Average trade payables = \(\frac{60,000 \: + \: 60,000}{2} = \frac{1,20,000}{2} = 60,000\)
Credit Purchase = Total purchase - Cash purchase
Credit Purchase = Rs. 6,00,000 - Rs. 2,40,000 = Rs. 3,60,000

Creditors Turnover = \(\frac{Credit \: Purchase}{Average \: trade \: payables}\)
Creditors Turnover = \(\frac{3,60,000}{60,000} = 6 \: times\)

Payment Period :
In days = \(\frac{360}{Creditors \: Turnover} = \frac{360}{6} = 60 \: days\)
In months = \(\frac{12}{Creditors \: Turnover} = \frac{12}{6} = 2 \: months\)
In weeks = \(\frac{52}{Creditors \: Turnover} = \frac{52}{6} = 8.67 \: weeks\)
In simple words: The creditors turnover ratio shows how quickly a company pays its suppliers, while the payment period indicates the average number of days, weeks, or months it takes to settle accounts payable. These ratios are vital for assessing a company's short-term financial management.

🎯 Exam Tip: When calculating creditors turnover, use only credit purchases in the numerator. Average trade payables should include both creditors and bills payables (opening and closing). Ensure consistency in the number of days, weeks, or months used for the payment period calculation.