class 12 accountancy ratio analysis or accounting ratio important Notes

Accounting Ratio.... Short & Easy Notes for Board Exam

#1. What is ratio analysis? What are its main importance?

=> Ratio analysis means examination and interpretation of numerical relationship between two numbers. It  is used as yardstick for evaluating the financial position of the group.

Following are its importance;

i. It makes the figure simple and understandable.

ii. It provide basis for preparing budget and determine future line of action.

iii. It analyse the performance of the firm.

iv. It indicates efficiency and profitability of the business.

v. It helps the assessing solvency position of the business.

vi. It helps in measuring short term and long term financial position.

vii. It helps to know overall strength of the industries.

#2. Write the objectives of accounting ratio.

=> Following are its main objectives

i. To measure the profitability of the concern.

ii. To determine the operating efficiency of the business.

iii. To know the solvency position of the business.

iv. To help in forecasting and budgeting.

v. To help in making financial plan.

vi. To help the management in decision making.

vii. To indicate the overall efficiency of the business.

viii. To simplify and summaries the accounting information.

#3. What do you mean by current ratio?

=> It is the ratio of current assets to current liabilities. It is also called as working capital ratio. It shows the short-term financial position of the concern. The ideal current ratio indicate 2:1

  Current ratio = current assets/current liabilities

#4. What do you mean by quick ratio?

=> It shows the relationship between quick Assets and current liabilities. An asset is said to be quick, if it can be converted into cash within a short period without loss of the value. It is also called liquidity ratio.

   Quick ratio = quick or liquid assets/current liabilities.

Whereas, quick assets = current assets - (stock + prepaid expense)

Ideal quick ratio will be 1:1

#5.  What do you mean by Debt equity ratio?

=> It is computed to find out the long term financial position of the concern. It shows the relationship between long term debts and shareholder's fund.

Debt equity ratio = long term debt/shareholder's fund
Whereas,
long term debts = debenture+loan+public deposit+other long term loan.
Shareholder's fund = non current assets+current assets-current liabilities-current liabilities.

or

Shareholder's fund = equity share capital + reserve + profit - fictitious assets.

The ideal debt equity ratio will be 1:1 or 2:1

#6. What do you mean by stock turnover ratio?

=> it shows the relationship between stock of goods sold and average stock. This ratio indicates the efficiency of the firm.

   Stock turnover ratio = cost of goods sold/average stock

#7. What do you mean by debtor turnover ratio?

=> it shows the relationship between credit sale and average debtors. It indicates the efficiency which debts are collected?

   Debtor turnover ratio = credit sale/average debtor.

#8. What do you mean by gross profit ratio?

=> It shows the relationship between gross profit and net sale. Increase in gross profit ratio reduce the cost. Higher gross profit ratio is always in the interest of the business.

   Gross profit ratio = gross profit/net sale*100

#9. What do you mean by operating ratio?

=> Operating ratio shows the relationship between operating cost and sale.

     Operating ratio = cost of goods sold +operating expense/net sale*hundred

or, Operating ratio = operating cost/net Sale/100

Whereas,  operating cost = cost of goods sold + operating expense.

  

#10. Write the limitation of accounting ratio.

=> i. If financial statement are incorrect, calculation of ratio will be false.

     ii. Firm don't use uniform accounting policy to calculate accounting ratio.

     iii. Now a days, window dressing are adopted by the firm to calculate ratio.

     iv. Interpret the same ratio in different way. Price level change affect accounting ratio.

POINTS;

1. Accounting ratio: The ratio based on financial statement are called financial ratio or accounting ratio.

2. Ratio analysis or accounting ratio can be expressed in three ways;

    i. Pure ratio or in fraction: the relation between two figure can be presented in pure ratio.

     i.e, 2:1, 3:4, 5:8, etc

    ii. Percentage ratio: The relationship between two figures age presented in percentage.

     i.e, 27%, 37%,25%, etc

    iii. Rate ratio or quotient or times: according to this method, one figure is expressed in       terms of other relative figure. This ratio is commonly used in respect of activity ratio.

     i.e, 2 times, 3 times, 1 times, etc

3. Profitability ratio: profitability refer  to the ability of a business to earn profit. It shows the efficiency of the business. These ratio measures the profit earning capacity of the company. General profitability ratio is calculated in percentage. Profitability ratio is calculated on the basis of these;

i. Profitability ratio is based on sales.

ii. Profitability ratio is based on investment or capital employed.

iii. Profitability ratio is based on earning on share.

4. There are two types of liquidity ratio.

5. There are four types of solvency ratio.

6. There are 7 types of activity or performance or efficiency or turnover ratio.

7. There are 8 types of profitability or income ratio.

8. Activity ratio are those ratio which indicates the activity and operational efficiency of the business concern. It measure the efficiency or effectiveness with which manage and utilize their resources. These ratio is also called performance or turnover ratio, because it indicates the speed with which assets are converted into sale. It always Express in number of times. 

9. Liquidity ratio measures the firm's ability to meet current obligations. These ratio are called short term solvency ratio.

10. Solvency ratio indicates the firm's ability to meet long term liability at maturity. It is also known as leverage ratio.

   

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