Questions
8 questions per paper
Difficulty
Medium
Importance
Key for Class 12 Boards
Overview
Accounting Ratios are mathematical relationships between two figures derived from financial statements, acting as essential diagnostic tools for assessing business health. For board exams, mastering these is crucial as they bridge the gap between theoretical accounting and practical financial analysis. Aspirants must grasp the logic behind the numerator and denominator to derive insights into liquidity, solvency, efficiency, and profitability.
Liquidity Ratios
Liquidity ratios measure the short-term ability of a company to meet its current obligations. Examiners focus heavily on these to test a student's understanding of what constitutes a 'current' asset or liability.
- Current Ratio = Current Assets / Current Liabilities
- Quick Ratio = Quick Assets / Current Liabilities
- Ideal Current Ratio is 2:1
- Ideal Quick Ratio is 1:1
- Quick Assets = Current Assets - Inventories - Prepaid Expenses
Solvency Ratios
These ratios evaluate the long-term sustainability and the capital structure of an organization. They demonstrate the balance between owner's funds and borrowed funds, which is a frequent area for analytical questions.
- Debt-Equity Ratio = Long-term Debt / Shareholders' Funds
- Proprietary Ratio = Shareholders' Funds / Total Assets
- Total Assets to Debt Ratio = Total Assets / Long-term Debt
- Interest Coverage Ratio = EBIT / Interest on Long-term Debt
- Ideal Debt-Equity Ratio is 2:1
Activity/Efficiency Ratios
Activity ratios determine how effectively a company utilizes its assets and resources to generate revenue. These are often presented as turnover ratios, requiring precise calculation of average figures.
- Inventory Turnover Ratio = Cost of Revenue from Operations / Average Inventory
- Trade Receivables Turnover Ratio = Net Credit Sales / Average Trade Receivables
- Trade Payables Turnover Ratio = Net Credit Purchases / Average Trade Payables
- Working Capital Turnover Ratio = Revenue from Operations / Working Capital
Profitability Ratios
Profitability ratios indicate the efficiency of the business in generating earnings relative to sales, assets, or equity. These are the most common focus areas for multi-step numerical problems in board examinations.
- Gross Profit Ratio = (Gross Profit / Revenue from Operations) * 100
- Net Profit Ratio = (Net Profit after Tax / Revenue from Operations) * 100
- Return on Investment (ROI) = (EBIT / Capital Employed) * 100
- Earnings Per Share (EPS) = Net Profit After Tax / No. of Equity Shares
Formula Sheet
Current Ratio = Current Assets / Current Liabilities
Quick Ratio = (Current Assets - Inventory - Prepaid Expenses) / Current Liabilities
Debt-Equity Ratio = Long-term Debt / Shareholders' Funds
Inventory Turnover Ratio = COGS / Average Inventory
Gross Profit Ratio = (Gross Profit / Net Sales) * 100
Operating Ratio = (COGS + Operating Expenses) / Net Sales * 100
Return on Investment = (EBIT / Capital Employed) * 100
Exam Tip
Always write the formula first before substituting values to ensure you receive partial marks even if the final calculation has an arithmetic error.
Common Mistakes
- Including prepaid expenses in Quick Assets when calculating the Quick Ratio.
- Using total sales instead of net credit sales for Trade Receivables Turnover Ratio calculations.
- Confusing 'Capital Employed' with 'Shareholders' Funds' when calculating ROI.
More Revision Notes
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