Types of Ratios Video Lecture | Accountancy Class 12 - Commerce

types of ratios
types of ratios there is a two way
classification of ratios one traditional
classification two functional
classification the traditional
classification has been on the basis of
financial statements to which the
determinants of ratios belong whereas
the alternative classification of
functional classification is based on
the purpose for which a ratio is
computed and is the most commonly used
classification under the traditional
classification the ratios are classified
as income statement ratios balance sheet
ratios composite ratios
income statement ratios a ratio of two
variables from the income statement is
known as income statement ratio for
example ratio of gross profits to sales
known as gross profit ratio is
calculated using both figures from the
income statement balance sheet ratios in
case both variables are from balance
sheet it is classified as balance sheet
ratios for example ratio of current
assets to current liabilities known as
current ratio is calculated using both
figures from balance sheet composite
ratios if a ratio is computed with one
variable from income statement and
another variable from balance sheet it
is called composite ratio for example
ratio of credit sales to debtors and
Bill's receivable known as data turnover
ratio is calculated using one figure
from income statement or credit sales
and another figure from balance sheet or
debtors and bills receivable
under the functional classification the
ratios are classified as liquidity
ratios solvency ratios activity or
turnover ratios profitability ratios
liquidity ratio the ability of the
business to pay the amount due to
stakeholders as and when it is to is
known as liquidity and the ratio is
calculated to measure it are known as
liquidity ratios they are essentially
short-term in nature the two ratios
included in this category are current
ratio and liquid or quick ratio current
ratio current ratio is the proportion of
current assets to current liabilities it
is expressed as shown current assets
include cash in hand bank balance
debtors bills receivable stock prepaid
expenses accrued income and short-term
investments or marketable securities
current liabilities include creditors
Bills payable outstanding expenses
provision for taxation net of advance
tax bank overdraft short-term loans
income received in advance
etc
let us understand the same with an
example as show liquid or quick ratio
quick ratio is the ratio of quick or
liquid asset to current liabilities it
is expressed as shown the quick assets
are defined as those assets which are
quickly convertible into cash while
calculating quick assets we exclude the
closing stock and prepaid expenses from
the current assets because of exclusion
of non liquid current asset it is
considered better than current ratio as
a measure of liquidity position of the
business it is calculated to serve as a
supplementary check on liquidity
position of the business and is
therefore also known as asset test ratio
let us see the calculations for the same
solvency ratios solvency of business is
determined by its ability to meet its
contractual obligations toward
stakeholders particularly towards
external stakeholders and the ratios
calculated to measure solvency position
are known as solvency ratios they
essentially long term in nature the
following ratios are normally computed
for evaluating solvency of the business
one debt equity ratio to debt ratio 3
proprietary ratio for total assets to
debt ratio 5 interest coverage ratio
debt equity ratio debt equity ratio
measures the relationship between
long-term debt and equity if debt
component of the total long-term funds
employed is small Outsiders feel more
secure from security point of view
capital structure with less debt and
more equity is considered favorable as
it reduces the chances of bankruptcy
normally it is considered to be safe if
debt equity ratio is 2 is to 1
it is computed as shown let us
understand the same with the help of an
example
debt ratio
the debt ratio refers to the ratio of
long-term debt to the total of external
and internal funds or capital employed
or net assets it is computed as shown
capital employed is equal to the
long-term debt plus shareholders fund
alternatively it may be taken as net
assets which are equal to the total non
fictitious assets minus current
liabilities let us understand the same
with the help of an example
proprietary ratio proprietary ratio
expresses relationship of proprietors or
shareholders funds to net assets and is
calculated as shown let us understand
the same with the help of an example
total assets to debt ratio this ratio
measures the extent of the coverage of
long-term debt by assets it is
calculated as shown the higher ratio
indicates that asset have been mainly
financed by owners funds and the
long-term debt is adequately covered by
assets it is better to take the net
assets or capital employed instead of
total assets for computing this ratio
also it will be observed that in that
case the ratio will be the reciprocal of
the debt ratio let us understand the
same with the help of an example
interest coverage ratio it is a ratio
which deals with a servicing of interest
on loan it is a measure of security of
interest payable on long-term debt it
expresses the relationship between
profits available for payment of
interest and the amount of interest
payable it is calculated as shown let us
understand the same with the help of an
example
activity or turnover ratios the turnover
ratios basically exhibits the activity
levels characterized by the capacity of
the business to make more sales or
turnover the activity ratios express the
number of times as its employed or for
that matter any constituent of assets is
turned into sales during an accounting
period higher turnover ratio means
better utilization of assets and
signifies improved efficiency and
profitability and as such unknown as
efficiency ratios the important activity
ratios calculated under this category
are stop turnover debtors are receivable
turnover creditors or payable turn over
investment or net assets turnover fixed
assets turnover working capital turnover
stopped Innova ratio
it determines the number of times
stopped is turned in sales during the
accounting period under consideration it
expresses the relationship between the
cost of goods sold and stock of goods
the formula for its calculation is as
shown let us understand the same with
the help of an example
debtors are receivables turnover ratio
it expresses the relationship between
credit sales and debtors it is
calculated as follows it needs to be
noted that debtors should be taken
before making any provision for doubtful
dance let us understand the same with a
help of an example
creditors turnover ratio creditors
turnover ratio indicates the pattern of
payment of accounts payable as accounts
payable arise on account of credit
purchases it expresses relationship
between credit purchases and accounts
payable it is calculated as shown let us
understand the same with the help of an
example
investment or net assets turnover ratio
it reflects relationship between
employed in the business higher turnover
means better liquidity and profitability
it is calculated as shown capital
turnover with studies turnover of
capital employed on net assets is
analyzed further by following two
turnover ratios let us understand the
same with the help of an example
one more example for calculation of
working capital turnover ratio
profitability ratios the profitability
of financial performance is mainly
summarized in income statement
profitability ratios are calculated to
analyze the earning capacity of the
business which is the outcome of
utilization of resources employed in the
business there is a close relationship
between the profit and the efficiency
with which the resources employed in the
business are utilized the various ratios
which are commonly used to analyze the
profitability of the business are one
gross profit ratio to operating ratio 3
operating profit ratio for net profit
ratio 5 return on investment or ROI or
return on capital employed or ROC e6
return on net worth or ro nw7 earnings
per share 8 book value per share 9
dividend payout ratio 10 price earning
ratio
gross profit ratio gross profit ratio as
a percentage of sales is computed to
have an idea about cross margin it is
computed as shown let us understand the
scene with the help of an example
operating ratio it is computed to
analyze cost of operation in relation to
sales it is calculated as shown
operating expenses include office
expenses administrative expenses selling
expenses and distribution expenses cost
of operation is determined by excluding
non operating incomes and expenses such
as loss on sale of assets interest paid
dividend received loss by fire
speculation gain and so on let us
understand the same with the help of an
example
operating profit ratio it is calculated
to reveal operating margin it may be
computed directly or as a residual of
operating ratio let us understand the
same with the help of an example
net profit ratio net profit ratio is
based on all-inclusive concept of profit
it relates sales to net profit after
operational as well as non operational
expenses and incomes generally net
profit refers to profit after tax or ba
t it is calculated as shown
let us understand the same with the help
of an example
return on capital employed or investment
ROC e or ROI it explains the overall
utilization of funds by a business
enterprise capital employed means the
long term funds employed in the business
and includes shareholders find
debentures and long term loans
alternatively capital employed may be
taken as the total of non factious
assets current liabilities profit refers
to the profit before interest and tax or
P bi T for computation of this ratio
thus it is computed as shown
let us understand the same with the help
of an example
earnings per share the ratio is defined
as given in this context earnings refer
to profit available for equity
shareholders which is worked out as
profit after tax dividend on preference
shares this ratio is very important from
equity shareholders point of view and so
also for the share price in the stock
market this also helps comparison with
other firms to ascertain its
reasonableness and capacity to pay
dividends book value per share
this ratio is calculated as shown equity
share holder funds refer to shareholders
funds preference share capital this
ratio is again very important from
equity shareholders point of view as it
gives an idea about the value of the
holding and effects market price of the
shares dividend payout ratio
this refers to the proportion of earning
that are distributed against the
shareholders it is calculated as shown
this reflects company's dividend policy
and growth in owner's equity
price-earning ratio the ratio is defined
as shown for example if the EPS of
company X is ten rupees and the market
price is hundred rupees the
price-earning ratio will be ten in
brackets one hundred divided by ten it
reflects investors expectation about the
growth in the firm's earnings and
reasonableness of the market price of
its shares p/e ratios vary from industry
to industry and company to company in
the same industry depending upon
investors perception of their future
let's explain the above-mentioned ratios
with the help of an example
to summarize the flowchart here shows
the various types of ratios categorized
under the traditional and functional
classification