Take a breath. If you have just opened your Accountancy book, seen a page full of formulas with names like Total Assets to Debt Ratio and Interest Coverage Ratio, and felt your stomach drop — that is completely normal, and it is also completely temporary. By the time you reach the end of this page you will not be memorising twenty unrelated formulas. You will be holding one simple idea in your head, and every formula will hang off it like a coat on a peg.
Here is that one idea. A ratio is a health check-up reading. When a doctor takes your blood pressure, she does not read out every drop of blood in your body. She gives you one number — 120 over 80 — and from that single number she can say a great deal about how you are doing. An accounting ratio does exactly the same job for a business. The Balance Sheet and the Statement of Profit and Loss are enormous. Nobody can read them page by page and instantly say whether the company is healthy. So we take two figures that belong together, divide one by the other, and get one small number that summarises a lot.
That is the whole chapter. Two figures, one division, one honest sentence about what the answer means. Everything else is practice.
This chapter belongs to Part B, Unit 3 of the CBSE Class 12 Accountancy syllabus (subject code 055) for the 2026-27 session, and it carries a serious weight in the Analysis of Financial Statements unit. Ratio Analysis is listed under this unit in the CBSE 2026-27 curriculum document, so every minute you spend here is a minute the Board is likely to pay you back for — do still check it against your school’s current syllabus copy, since boards occasionally trim a unit mid-cycle. Cash Flow Statement is a separate chapter of its own — we will point to it where the two touch, but we will not wander into it here.
Go slowly. Read each sub-topic, then close the page and try to write the formula from memory before you look again. If a section does not click, read it a second time before moving on. There is no prize for finishing fast.
What You’ll Learn
- What An Accounting Ratio Is
- Objectives And Advantages Of Ratio Analysis
- Limitations Of Ratio Analysis
- How Ratios Are Expressed: Pure Ratio, Percentage, Times, Days
- The Four Families Of Ratios
- Current Ratio
- Quick Or Liquid Ratio
- Effect Of Transactions On Current And Quick Ratio
- Debt To Equity Ratio
- Total Assets To Debt Ratio
- Proprietary Ratio
- Interest Coverage Ratio
- Debt To Capital Employed Ratio
- Inventory Turnover Ratio
- Trade Receivables Turnover Ratio And Average Collection Period
- Trade Payables Turnover Ratio And Average Payment Period
- Working Capital Turnover Ratio
- Gross Profit Ratio
- Operating Ratio And Operating Profit Ratio
- Net Profit Ratio
- Return On Investment (Return On Capital Employed)
- Capital Employed: The Three Ways To Find It
- Working Backwards From A Given Ratio
- Master Formula Sheet
- Common Mistakes Students Make
- How Marks Are Awarded In The Board Exam
- Practice Worksheet
Your Game Plan
- Read the first five sub-topics in one sitting. They contain almost no arithmetic — they build the vocabulary you will use for the rest of the chapter.
- Learn the four families and their colours. Once you can name the family, you can usually guess the formula.
- Take one family per day. Do not try to swallow all twenty ratios in one evening.
- For each ratio: write the formula, work the easy example, then close the page and redo the hard example on blank paper.
- Spend a whole session on working backwards. The Board loves it and most students skip it.
- Finish with the Practice Worksheet. Write full solutions before you open any answer.
Study Notes
What An Accounting Ratio Is
An accounting ratio is the relationship between two accounting figures, expressed as a single number. That is the entire definition. You take one figure from the financial statements, you take a second figure that is meaningfully connected to it, and you divide.
The word that matters most in that definition is meaningfully. You could divide the Managing Director’s salary by the number of chairs in the office, and you would get a number — but it would tell you nothing. A ratio is only useful when the two figures genuinely belong together. Current Assets and Current Liabilities belong together because current assets are what the company will use to pay current liabilities. Gross Profit and Revenue from Operations belong together because gross profit is earned out of that revenue. Ask yourself, every single time: does the top figure have anything to do with the bottom figure?
Notice that computing and interpreting are two separate skills. A calculator can compute. Only you can interpret. In the Board exam, marks are usually split between the two: some for the correct working, some for the correct conclusion. Students who only learn to divide leave marks on the table.
Let us make the doctor analogy concrete. Suppose a company’s Current Assets are ₹4,00,000 and its Current Liabilities are ₹2,00,000. Divide, and you get 2. We write it as 2:1 and read it as: for every one rupee the company must pay in the short term, it holds two rupees of short-term resources. That single sentence is worth more than the number. Anyone can say “2”. You want to be the student who can say what the 2 means.
One more thing before we move on. Ratios are almost never judged alone. A Current Ratio of 2:1 is meaningless in isolation — it becomes meaningful when you compare it with last year’s figure, with a competitor’s figure, or with the accepted norm for that industry. Comparison is the whole point. A single blood pressure reading tells a doctor something; a year of readings tells her far more.
Objectives And Advantages Of Ratio Analysis
Why does anyone bother? Because raw financial statements are hard to compare. Suppose Company A earns a profit of ₹10,00,000 and Company B earns ₹2,00,000. Which is the better performer? You cannot say, because you do not know how big each company is. But if you learn that A earned that profit on Revenue from Operations of ₹5,00,00,000 while B earned its profit on ₹10,00,000 of revenue, the picture flips instantly: A is earning 2% on revenue, B is earning 20%. Ratios strip away the effect of size and let you compare fairly.
The objectives of ratio analysis can be listed cleanly:
- To simplify. A hundred-page annual report is compressed into a handful of readable numbers.
- To judge short-term solvency (liquidity). Can the business pay the bills that fall due in the next few months?
- To judge long-term solvency. Can the business service and eventually repay its long-term borrowings?
- To measure operating efficiency. How quickly is the business converting inventory into sales and sales into cash?
- To measure profitability. How much of each rupee of revenue is actually being kept as profit, and how well is the capital invested being used?
- To enable comparison. Year against year, firm against firm, firm against industry standard.
- To help forecasting and planning. Trends in ratios feed directly into budgets and targets.
The advantages follow naturally from the objectives, but the Board sometimes asks for them separately, so learn them as a distinct list:
- Useful in analysis of financial statements. Bankers, investors and creditors use ratios to read statements quickly.
- Simplifies complex figures. “Gross Profit Ratio 30%” is easier to hold in the mind than a page of trading figures.
- Helps in locating weak spots. If Inventory Turnover has fallen from 8 times to 4 times, management knows exactly where to look.
- Helps in comparative study. Intra-firm comparison (this year versus last year) and inter-firm comparison (us versus them) both become possible.
- Helps in cost control and budgeting. Operating Ratio movements point straight at rising expenses.
- Useful to a wide range of users. Management, shareholders, lenders, employees, suppliers and government all read ratios.
Limitations Of Ratio Analysis
A good student knows the limits of the tool she is using. Ratio analysis is powerful, but it is not magic, and the Board asks about its limitations often enough that you should know them properly rather than vaguely.
- Ratios are only as good as the figures behind them. If the financial statements are window-dressed or the accounting is sloppy, the ratios will be confidently wrong. Garbage in, garbage out.
- They ignore price level changes. A machine bought in 2010 sits in the books at its 2010 cost. Comparing today’s revenue against yesterday’s asset values quietly distorts the answer.
- Different firms use different accounting policies. One firm charges depreciation on the straight line method, another on the written down value method. One values inventory at FIFO, another at weighted average. Their ratios are not strictly comparable.
- They ignore qualitative factors. The quality of management, staff morale, brand reputation, the state of the industry — none of these appear in any ratio, yet all of them decide whether a company survives.
- A single ratio in isolation is misleading. A very high Current Ratio might look wonderful, but it may simply mean the company is sitting on unsold inventory and uncollected debts.
- There is no single ideal standard. The “ideal” Current Ratio of 2:1 is a convention, not a law. A supermarket chain with rapid cash sales can be perfectly healthy at 1.2:1.
- Window dressing. A firm can deliberately settle creditors just before the year-end to make its Current Ratio look better on the Balance Sheet date.
- Ratios are historical. They describe what has already happened. They do not guarantee what will happen next.
How Ratios Are Expressed: Pure Ratio, Percentage, Times, Days
This is a small sub-topic that quietly costs students a lot of marks. Every ratio has a correct form of expression, and writing the right number in the wrong form is treated as an incomplete answer. There are four forms.
1. Pure ratio (written as a proportion, x:1). Used when both figures are of the same nature — assets against liabilities, debt against equity. You divide, and then write the answer against 1. Current Ratio, Quick Ratio, Debt to Equity Ratio, Total Assets to Debt Ratio and Debt to Capital Employed Ratio are all pure ratios. If Current Assets are ₹4,00,000 and Current Liabilities ₹2,00,000, the answer is 2:1, not “2” and not “200%”.
2. Percentage. Used when one figure is a part of the other, and you want to know what portion it forms. All the profitability ratios — Gross Profit Ratio, Operating Ratio, Operating Profit Ratio, Net Profit Ratio, Return on Investment — are expressed as percentages, and so is the Proprietary Ratio when the question asks for it that way.
3. Times. Used when the answer measures how many times something turned over or was covered during the year. Inventory Turnover, Trade Receivables Turnover, Trade Payables Turnover, Working Capital Turnover and Interest Coverage are all expressed in times. Write “6 times”, not “6:1”.
4. Days (or months). A turnover ratio can be flipped into a period. Average Collection Period and Average Payment Period are expressed in days (or sometimes months). We convert by dividing 365 days by the turnover ratio.
Average Payment Period = 365 ÷ Trade Payables Turnover Ratio (in days)
If the question asks in months, use 12 instead of 365.
For each of the following, state the correct form of expression and give the answer.
(a) Current Assets ₹6,00,000; Current Liabilities ₹2,50,000.
Working: 6,00,000 ÷ 2,50,000 = 2.4. This is a pure ratio, so the answer is 2.4:1.
(b) Gross Profit ₹6,00,000; Revenue from Operations ₹20,00,000.
Working: (6,00,000 ÷ 20,00,000) × 100 = 30. Profitability, so express as a percentage: 30%.
(c) Cost of Revenue from Operations ₹12,00,000; Average Inventory ₹2,00,000.
Working: 12,00,000 ÷ 2,00,000 = 6. A turnover, so: 6 times.
(d) Trade Receivables Turnover Ratio is 5 times. Find the Average Collection Period.
Working: 365 ÷ 5 = 73. A period, so: 73 days.
Why it works: the form of expression is decided by what the two figures are. Same-nature figures give a proportion; a part-of-a-whole gives a percentage; a flow divided by a balance gives times; and times flipped into a calendar gives days.
A note on rounding. Throughout this chapter we round to two decimal places and we say so in the answer. If your figure comes out as 2.176, write 2.18:1. If it comes out exactly, as most well-set questions do, write the exact figure. Never round in the middle of a calculation — carry the full figure and round only at the very end.
The Four Families Of Ratios
Here is the single most useful page in the chapter. Every ratio in your syllabus belongs to exactly one of four families, and each family answers exactly one question. Learn the four questions and you will never again stare at a formula wondering what it is for.
Now the four questions, one per family.
Liquidity ratios (sky blue) ask: can the business pay its bills over the next few months? They compare short-term resources with short-term obligations. Two ratios live here — Current Ratio and Quick Ratio. Both take Current Liabilities as the denominator; they differ only in how strictly they define the resources on top.
Solvency ratios (coral) ask: can the business survive its long-term borrowings? They look at the structure of the money the business runs on — how much is borrowed, how much belongs to the owners, and whether profits comfortably cover the interest bill. Five ratios live here: Debt to Equity, Total Assets to Debt, Proprietary, Interest Coverage and Debt to Capital Employed.
Activity or turnover ratios (teal) ask: how hard are the assets working? They divide a flow figure from the Statement of Profit and Loss (revenue, cost, purchases) by a balance figure from the Balance Sheet (inventory, receivables, payables, working capital). The answer is always in times. Four ratios live here.
Profitability ratios (sunshine yellow) ask: how much of it is actually profit? Four of them measure profit against Revenue from Operations; the fifth, Return on Investment, measures profit against the capital that produced it. Five ratios live here.
One structural insight that will save you a lot of trouble later: liquidity ratios use Current Liabilities on the bottom; solvency ratios use long-term figures; activity ratios put a Statement of Profit and Loss figure on top and a Balance Sheet average on the bottom; profitability ratios put a profit figure on top and either Revenue from Operations or Capital Employed on the bottom. If you can remember what goes on the bottom, you are most of the way to the formula.
Don’t move on until this tree feels comfortable. Everything from here is detail.
Current Ratio
We start with the friendliest ratio in the syllabus. The Current Ratio asks one blunt question: if every short-term bill fell due tomorrow, how many rupees of short-term resources does the company have for each rupee it owes?
Expressed as a pure ratio, x:1. Conventionally regarded as satisfactory at about 2:1.
What counts as a Current Asset? Anything expected to be converted into cash, sold or consumed within twelve months of the reporting date (or within the operating cycle, if that is longer). In the Schedule III format that means: Current Investments, Inventories, Trade Receivables, Cash and Cash Equivalents, Short-term Loans and Advances, and Other Current Assets such as Prepaid Expenses and Accrued Income.
What counts as a Current Liability? Anything payable within twelve months: Short-term Borrowings (including bank overdraft), Trade Payables, Other Current Liabilities such as outstanding expenses, unclaimed dividend and current maturities of long-term debt, and Short-term Provisions such as provision for tax and proposed dividend.
Let us set up one small company and use it for the next three sub-topics, so you do not have to keep learning new numbers. Here is Nayantara Traders Ltd. as at 31st March, 2027.
| Equity and Liabilities | ₹ | Assets | ₹ |
|---|---|---|---|
| Share Capital | 6,00,000 | Fixed Assets (Tangible, net) | 9,50,000 |
| Reserves and Surplus | 2,00,000 | Non-current Investments | 1,00,000 |
| 10% Debentures | 4,00,000 | Inventory | 90,000 |
| Long-term Provisions | 50,000 | Trade Receivables | 1,70,000 |
| Trade Payables | 1,30,000 | Cash and Cash Equivalents | 90,000 |
| Other Current Liabilities | 30,000 | Current Investments | 40,000 |
| Short-term Provisions | 40,000 | Prepaid Expenses | 10,000 |
| Total | 14,50,000 | Total | 14,50,000 |
Check the totals yourself before you go on. Both sides come to ₹14,50,000. A Balance Sheet that does not balance is a Balance Sheet you have copied wrongly, and every ratio you build on it will be wrong too.
Compute the Current Ratio of Nayantara Traders Ltd.
Step 1 — pick out the Current Assets.
Inventory ₹90,000 + Trade Receivables ₹1,70,000 + Cash and Cash Equivalents ₹90,000 + Current Investments ₹40,000 + Prepaid Expenses ₹10,000 = ₹4,00,000.
Fixed Assets and Non-current Investments are deliberately sitting there to tempt you. They are not current. Leave them out.
Step 2 — pick out the Current Liabilities.
Trade Payables ₹1,30,000 + Other Current Liabilities ₹30,000 + Short-term Provisions ₹40,000 = ₹2,00,000.
The 10% Debentures and Long-term Provisions are non-current. Leave them out.
Step 3 — substitute.
Current Ratio = 4,00,000 ÷ 2,00,000 = 2
Current Ratio = 2:1
Why it works: the company holds two rupees of resources that will turn into cash within a year for every one rupee it must pay within a year. It has a comfortable cushion. At exactly 2:1 it sits on the conventional norm — neither straining nor sitting idle on excess funds.
The Current Ratio of a company is 3:1 and its Working Capital is ₹4,80,000. Calculate the Current Assets and Current Liabilities.
Step 1 — write what you know as algebra.
Let Current Liabilities = x. Then Current Assets = 3x (because the ratio is 3:1).
Step 2 — use the definition of Working Capital.
Working Capital = Current Assets − Current Liabilities
4,80,000 = 3x − x = 2x
Step 3 — solve and substitute back.
x = 4,80,000 ÷ 2 = ₹2,40,000 ⇒ Current Liabilities = ₹2,40,000
Current Assets = 3 × 2,40,000 = ₹7,20,000
Check: 7,20,000 − 2,40,000 = 4,80,000 ✓ and 7,20,000 ÷ 2,40,000 = 3 ✓
Why it works: a ratio of 3:1 does not tell you the actual amounts, only the proportion. Working Capital supplies the missing scale. The difference between the two sides of the ratio (3 − 1 = 2 parts) equals the Working Capital, so one part is ₹2,40,000.
Two companies have identical Current Liabilities of ₹2,00,000. Company P has Current Assets of ₹4,00,000, of which Inventory is ₹90,000. Company Q has Current Assets of ₹6,00,000, of which Inventory is ₹4,50,000. Compute both Current Ratios and comment.
Company P: 4,00,000 ÷ 2,00,000 = 2:1
Company Q: 6,00,000 ÷ 2,00,000 = 3:1
Comment. On the Current Ratio alone Q looks stronger. But look at what Q’s current assets are made of: ₹4,50,000 out of ₹6,00,000 is unsold inventory. Only ₹1,50,000 is in a genuinely quick form. P has ₹3,10,000 outside inventory. If both companies were asked to pay ₹2,00,000 next week, P would manage far more easily than Q, despite the lower ratio.
Why it works: the Current Ratio treats every current asset as equally liquid, which is not true. Inventory has to be sold before it becomes cash, and it may not sell. This is precisely the weakness that the Quick Ratio was invented to fix — which is where we go next.
Quick Or Liquid Ratio
The Quick Ratio is the Current Ratio with the slow items taken out. It is also called the Liquid Ratio or the Acid-Test Ratio — three names, one formula. It answers a harsher question: if the company could not sell a single item of stock, could it still pay its short-term bills?
where Quick Assets = Current Assets − Inventory − Prepaid Expenses
Expressed as a pure ratio, x:1. Conventionally regarded as satisfactory at about 1:1.
Why remove exactly those two? Inventory is removed because it is the slowest current asset — it must first be sold, and often sold on credit, before it becomes cash. Prepaid Expenses are removed because they can never become cash at all; you have already paid for a service you will receive later, and no one will refund it to settle your creditors. Everything else — Trade Receivables, Cash and Cash Equivalents, Current Investments, Short-term Loans and Advances, Accrued Income — stays in.
Using the same Balance Sheet as Example 2, compute the Quick Ratio.
Route 1 — add up the quick assets directly.
Trade Receivables ₹1,70,000 + Cash and Cash Equivalents ₹90,000 + Current Investments ₹40,000 = ₹3,00,000
Route 2 — start from Current Assets and subtract.
Current Assets ₹4,00,000 − Inventory ₹90,000 − Prepaid Expenses ₹10,000 = ₹3,00,000 ✓ same figure.
Substitute.
Quick Ratio = 3,00,000 ÷ 2,00,000 = 1.5
Quick Ratio = 1.5:1
Why it works: even with every rupee of inventory written off as unsellable, the company still holds ₹1.50 of near-cash for every ₹1 of short-term debt. It is comfortably above the 1:1 norm. Always do Route 2 as a check on Route 1 — if the two disagree, you have misclassified something.
A company’s Current Ratio is 2.5:1 and its Quick Ratio is 1.5:1. Its Current Liabilities are ₹3,20,000. There are no Prepaid Expenses. Calculate the Current Assets, the Quick Assets and the Inventory.
Step 1 — Current Assets.
Current Assets = 2.5 × Current Liabilities = 2.5 × 3,20,000 = ₹8,00,000
Step 2 — Quick Assets.
Quick Assets = 1.5 × Current Liabilities = 1.5 × 3,20,000 = ₹4,80,000
Step 3 — Inventory is the gap between them.
Inventory = Current Assets − Quick Assets = 8,00,000 − 4,80,000 = ₹3,20,000
Check: 8,00,000 ÷ 3,20,000 = 2.5 ✓ and 4,80,000 ÷ 3,20,000 = 1.5 ✓
Why it works: both ratios share the same denominator. So the difference between them, 2.5 − 1.5 = 1, multiplied by Current Liabilities, is exactly the item that was removed — the Inventory. There is a shortcut hiding in that sentence: Inventory = (Current Ratio − Quick Ratio) × Current Liabilities, valid whenever there are no prepaid expenses. It is worth knowing, but show the full steps in the exam.
Effect Of Transactions On Current And Quick Ratio
This is the question type that separates students who understand ratios from students who have memorised them. The examiner gives you a starting ratio, then a list of transactions, and asks whether each one makes the ratio go up, go down, or leave it unchanged — often with the new ratio as well.
There is a reliable three-step method. Do not try to reason it out in your head; the intuition lies to you surprisingly often.
Step 2. Adjust each figure for the transaction.
Step 3. Divide again and compare with the opening ratio.
There is one shortcut worth trusting: if the ratio is more than 1:1, an equal decrease in both Current Assets and Current Liabilities increases the ratio, and an equal increase in both decreases it. If the ratio is less than 1:1, both effects reverse. If the ratio is exactly 1:1, an equal change to both leaves it unchanged.
Let us stay with Nayantara Traders Ltd.: Current Assets ₹4,00,000, Current Liabilities ₹2,00,000, Quick Assets ₹3,00,000. Opening Current Ratio 2:1, opening Quick Ratio 1.5:1. Each transaction below is considered independently from that same opening position — this is what “independent” means in an exam question, and it is easy to forget halfway down the list.
| Transaction | New CA / CL | Current Ratio | Quick Ratio | Effect |
|---|---|---|---|---|
| Opening position | 4,00,000 / 2,00,000 | 2:1 | 1.5:1 | — |
| Paid Trade Payables ₹50,000 in cash | 3,50,000 / 1,50,000 | 2.33:1 | 1.67:1 | Both increase ↑ |
| Purchased goods on credit ₹60,000 | 4,60,000 / 2,60,000 | 1.77:1 | 1.15:1 | Both decrease ↓ |
| Sold goods costing ₹40,000 for ₹50,000 cash | 4,10,000 / 2,00,000 | 2.05:1 | 1.75:1 | Both increase ↑ |
| Cash received from Trade Receivables ₹70,000 | 4,00,000 / 2,00,000 | 2:1 | 1.5:1 | No change |
| Purchased machinery for cash ₹80,000 | 3,20,000 / 2,00,000 | 1.6:1 | 1.1:1 | Both decrease ↓ |
| Issued 9% Debentures for cash ₹1,00,000 | 5,00,000 / 2,00,000 | 2.5:1 | 2:1 | Both increase ↑ |
| Bills Receivable ₹30,000 endorsed to a creditor | 3,70,000 / 1,70,000 | 2.18:1 | 1.59:1 | Both increase ↑ |
Read down the table and notice the pattern. Four of the seven transactions changed both figures by the same amount; because the opening ratio was above 1:1, an equal fall raised the ratio and an equal rise lowered it. Two transactions touched only Current Assets. One transaction — collecting cash from Trade Receivables — simply swapped one current asset for another and therefore changed nothing at all.
The Current Ratio of Meghna Ltd. is 2.5:1 and its Current Liabilities are ₹1,60,000. The company pays a creditor ₹40,000. State the effect on the Current Ratio and compute the new ratio.
Step 1 — put the opening position into rupees.
Current Liabilities = ₹1,60,000 (given)
Current Assets = 2.5 × 1,60,000 = ₹4,00,000
Step 2 — adjust for the transaction. Paying a creditor in cash reduces Cash (a current asset) and reduces Trade Payables (a current liability) by the same ₹40,000.
New Current Assets = 4,00,000 − 40,000 = ₹3,60,000
New Current Liabilities = 1,60,000 − 40,000 = ₹1,20,000
Step 3 — divide again.
New Current Ratio = 3,60,000 ÷ 1,20,000 = 3
New Current Ratio = 3:1. The ratio has increased.
Why it works: this is the result that feels wrong until you see the arithmetic. Paying off a debt seems like it should weaken you. But when the ratio already exceeds 1:1, the denominator is the smaller number, so taking ₹40,000 off it hurts it proportionately more than taking ₹40,000 off the larger numerator. The ratio therefore rises. This is exactly the trick behind window dressing — a company can flatter its Current Ratio simply by settling creditors just before the year-end.
Nayantara Traders Ltd. (Current Assets ₹4,00,000; Current Liabilities ₹2,00,000; Quick Assets ₹3,00,000) sells goods costing ₹60,000 on credit for ₹60,000. State the effect on (a) Current Ratio and (b) Quick Ratio.
(a) Current Ratio. Inventory falls by ₹60,000; Trade Receivables rise by ₹60,000. Total Current Assets are unchanged at ₹4,00,000. Current Liabilities are untouched at ₹2,00,000.
New Current Ratio = 4,00,000 ÷ 2,00,000 = 2:1 — no change.
(b) Quick Ratio. Here the story is different. Inventory is not a quick asset but Trade Receivables are. So Quick Assets rise by the full ₹60,000.
New Quick Assets = 3,00,000 + 60,000 = ₹3,60,000
New Quick Ratio = 3,60,000 ÷ 2,00,000 = 1.8
New Quick Ratio = 1.8:1 — an increase.
Why it works: the same transaction can leave one ratio flat and lift the other, because the two ratios define the numerator differently. Whenever a transaction moves something across the inventory boundary, expect the two answers to differ. Sold at no profit, the Current Ratio cannot move; the Quick Ratio must.
Debt To Equity Ratio
We now cross into the coral family: solvency. These ratios stop worrying about next month’s bills and start worrying about the shape of the company’s funding. The Debt to Equity Ratio is the headline number of the family.
where Debt = Long-term Debt = Non-current Liabilities (Long-term Borrowings + Long-term Provisions)
and Equity = Shareholders’ Funds = Share Capital + Reserves and Surplus
Expressed as a pure ratio, x:1. Conventionally regarded as satisfactory at about 2:1 or lower.
Two definitions deserve a slow read. Debt in this ratio means long-term debt only — Current Liabilities are excluded, because the ratio is about the long-term funding structure. Equity means Shareholders’ Funds, which is Share Capital (equity plus preference) plus Reserves and Surplus. If Reserves and Surplus shows a negative balance, that debit balance is deducted.
There is a second, equally valid way to reach Shareholders’ Funds when the question gives you asset-side information instead:
Use whichever route the question makes possible. Both give the same figure, because the Balance Sheet balances.
From the following, compute the Debt to Equity Ratio: Share Capital ₹5,00,000; Reserves and Surplus ₹1,00,000; 12% Debentures ₹4,00,000; Long-term Provisions ₹50,000; Trade Payables ₹1,20,000; Short-term Provisions ₹30,000.
Step 1 — Debt. Only the non-current liabilities count.
Debt = 12% Debentures ₹4,00,000 + Long-term Provisions ₹50,000 = ₹4,50,000
Trade Payables and Short-term Provisions are current — they are excluded.
Step 2 — Equity.
Shareholders’ Funds = Share Capital ₹5,00,000 + Reserves and Surplus ₹1,00,000 = ₹6,00,000
Step 3 — substitute.
Debt to Equity Ratio = 4,50,000 ÷ 6,00,000 = 0.75
Debt to Equity Ratio = 0.75:1
Why it works: for every ₹1 the owners have put in, outsiders have lent ₹0.75 on a long-term basis. That is a conservatively financed company. Lenders like it because their money is well cushioned by the owners’ money.
A company has Total Assets of ₹12,00,000, Current Liabilities of ₹2,00,000 and Shareholders’ Funds of ₹6,00,000. Compute its Debt to Equity Ratio.
Step 1 — find Debt by difference. Everything on the Equity and Liabilities side must add up to Total Assets.
Debt = Total Assets − Shareholders’ Funds − Current Liabilities
Debt = 12,00,000 − 6,00,000 − 2,00,000 = ₹4,00,000
Step 2 — substitute.
Debt to Equity Ratio = 4,00,000 ÷ 6,00,000 = 0.6666…
Debt to Equity Ratio = 0.67:1 (rounded to two decimal places)
Why it works: the Balance Sheet equation does the heavy lifting. Whenever three of the four blocks — Total Assets, Shareholders’ Funds, Non-current Liabilities, Current Liabilities — are known, the fourth follows by subtraction. Get comfortable with this; the Board uses it constantly.
A company’s Debt is ₹4,50,000 and its Equity is ₹6,00,000, giving a Debt to Equity Ratio of 0.75:1. State the effect of each of the following independent transactions and give the new ratio.
(a) Issue of equity shares for cash ₹1,50,000. Debt unchanged, Equity rises.
4,50,000 ÷ 7,50,000 = 0.6:1 — decreases ↓
(b) Redemption of debentures ₹1,50,000. Debt falls, Equity unchanged.
3,00,000 ÷ 6,00,000 = 0.5:1 — decreases ↓
(c) Issue of 10% Debentures ₹1,50,000. Debt rises, Equity unchanged.
6,00,000 ÷ 6,00,000 = 1:1 — increases ↑
(d) Purchase of machinery on long-term credit ₹2,00,000. This creates a non-current liability.
6,50,000 ÷ 6,00,000 = 1.08:1 — increases ↑
(e) Cash paid to Trade Payables ₹40,000. Trade Payables are a current liability — not part of Debt at all. Neither figure moves.
4,50,000 ÷ 6,00,000 = 0.75:1 — no change
(f) Profit of ₹90,000 transferred to Reserves. Equity rises.
4,50,000 ÷ 6,90,000 = 0.65:1 — decreases ↓
Why it works: only two questions matter each time — does this touch long-term debt, and does it touch shareholders’ funds? Anything that touches neither (item e) leaves the ratio exactly where it was. Students lose marks here by assuming that every cash transaction must move every ratio.
Total Assets To Debt Ratio
If the Debt to Equity Ratio asks “how much of the funding is borrowed?”, the Total Assets to Debt Ratio asks the lender’s favourite question: how much asset backing is there behind every rupee I have lent?
where Total Assets = Non-current Assets + Current Assets (the whole assets side)
and Debt = Long-term Debt = Non-current Liabilities
Expressed as a pure ratio, x:1. A higher ratio means better security for lenders.
Note the direction carefully, because it is the opposite of Debt to Equity. Here, higher is safer. A ratio of 4:1 means every rupee of long-term debt is backed by four rupees of assets. A ratio of 1.2:1 would make a lender nervous.
Total Assets ₹12,00,000; Shareholders’ Funds ₹6,00,000; Current Liabilities ₹2,00,000. Compute the Total Assets to Debt Ratio.
Step 1 — find Debt.
Debt = 12,00,000 − 6,00,000 − 2,00,000 = ₹4,00,000
Step 2 — substitute.
Total Assets to Debt Ratio = 12,00,000 ÷ 4,00,000 = 3
Total Assets to Debt Ratio = 3:1
Why it works: these are the same figures as Example 10, so you can see the two solvency ratios side by side. Debt to Equity was 0.67:1 and Total Assets to Debt is 3:1. They are two views of one funding structure: modest borrowing, generous asset cover.
Non-current Assets ₹9,00,000; Current Assets ₹5,00,000; Long-term Borrowings ₹3,00,000; Long-term Provisions ₹50,000; Current Liabilities ₹2,50,000. Compute the Total Assets to Debt Ratio.
Step 1 — Total Assets.
Total Assets = 9,00,000 + 5,00,000 = ₹14,00,000
Step 2 — Debt.
Debt = Long-term Borrowings ₹3,00,000 + Long-term Provisions ₹50,000 = ₹3,50,000
Current Liabilities of ₹2,50,000 are not part of Debt. They are there to see whether you know that.
Step 3 — substitute.
Total Assets to Debt Ratio = 14,00,000 ÷ 3,50,000 = 4
Total Assets to Debt Ratio = 4:1
Why it works: every rupee lent long term is covered four times over by assets. If the company were wound up and its assets fetched even a quarter of their book value, the long-term lenders would still be repaid in full.
Proprietary Ratio
The Proprietary Ratio — sometimes called the Equity Ratio — asks: what share of everything the company owns is genuinely financed by its owners?
May be expressed either as a pure ratio (x:1) or as a percentage — do whichever the question asks. A higher ratio means a financially stronger, less geared company.
Because the answer is a fraction of the whole, it must always lie between 0 and 1. If you ever get a Proprietary Ratio of 2.5, you have put the figures upside down. That single sanity check will save you a mark or two over a career of exams.
Shareholders’ Funds ₹6,00,000; Total Assets ₹12,00,000. Compute the Proprietary Ratio.
Substitute.
Proprietary Ratio = 6,00,000 ÷ 12,00,000 = 0.5
Proprietary Ratio = 0.5:1, or 50%
Why it works: exactly half the assets are financed by the owners; the other half by outsiders, long term and short term together. Read alongside Examples 10 and 12, this completes the picture of the same company from a third angle.
Equity Share Capital ₹7,00,000; Preference Share Capital ₹2,00,000; Reserves and Surplus ₹1,00,000; Non-current Assets ₹11,00,000; Current Assets ₹5,00,000. Compute the Proprietary Ratio.
Step 1 — Shareholders’ Funds. Both classes of share capital belong to the shareholders.
7,00,000 + 2,00,000 + 1,00,000 = ₹10,00,000
Step 2 — Total Assets.
11,00,000 + 5,00,000 = ₹16,00,000
Step 3 — substitute.
Proprietary Ratio = 10,00,000 ÷ 16,00,000 = 0.625
Proprietary Ratio = 0.63:1 (rounded), or 62.5%
Why it works: nearly two-thirds of the asset base is owner-funded. Note the small courtesy of quoting 62.5% rather than 63% — when you express as a percentage the figure is exact, so there is no need to round at all. Round only when the decimal genuinely does not terminate.
Interest Coverage Ratio
Every other solvency ratio looks at the Balance Sheet. This one looks at the Statement of Profit and Loss and asks the most practical question of all: is the company earning enough to pay the interest on what it has borrowed?
Expressed in times. A higher figure means the interest burden is comfortably covered.
The whole difficulty of this ratio is getting the numerator right. Questions almost never hand you “Profit before Interest and Tax”. They give you Net Profit after tax and a tax rate, and expect you to walk back up.
Profit before Interest and Tax = Profit before Tax + Interest on Long-term Debt
Do the two steps in that order. Never add interest first and then gross up — interest is not taxed at the company’s rate in this calculation; it is deducted before arriving at Profit before Tax.
A company’s Net Profit after Tax is ₹3,50,000. The rate of income tax is 30%. It has 10% Debentures of ₹10,00,000. Compute the Interest Coverage Ratio.
Step 1 — gross up to Profit before Tax.
If 30% went in tax, then ₹3,50,000 is the remaining 70%.
Profit before Tax = 3,50,000 ÷ (1 − 0.30) = 3,50,000 ÷ 0.70 = ₹5,00,000
Step 2 — compute the interest.
Interest = 10% of ₹10,00,000 = ₹1,00,000
Step 3 — add interest back.
Profit before Interest and Tax = 5,00,000 + 1,00,000 = ₹6,00,000
Step 4 — substitute.
Interest Coverage Ratio = 6,00,000 ÷ 1,00,000 = 6
Interest Coverage Ratio = 6 times
Why it works: the company earns six rupees of operating profit for every one rupee of interest it must pay. Its profits could fall by more than 80% before it started struggling to service the debentures. Check your Step 1 by reversing it: 30% tax on ₹5,00,000 is ₹1,50,000, and 5,00,000 − 1,50,000 = ₹3,50,000 ✓
Net Profit after Tax ₹4,20,000; rate of tax 40%; 10% Debentures ₹8,00,000. Compute the Interest Coverage Ratio.
Step 1. Profit before Tax = 4,20,000 ÷ (1 − 0.40) = 4,20,000 ÷ 0.60 = ₹7,00,000
Step 2. Interest = 10% of ₹8,00,000 = ₹80,000
Step 3. Profit before Interest and Tax = 7,00,000 + 80,000 = ₹7,80,000
Step 4. Interest Coverage Ratio = 7,80,000 ÷ 80,000 = 9.75
Interest Coverage Ratio = 9.75 times
Why it works: notice that the ratio is expressed in times and can perfectly well carry decimals — 9.75 times is a complete, correct answer. Do not round it to “10 times”. Check Step 1 again: 40% of ₹7,00,000 = ₹2,80,000, and 7,00,000 − 2,80,000 = ₹4,20,000 ✓
Debt To Capital Employed Ratio
This is the last member of the coral family, and it is a close cousin of Debt to Equity. Instead of comparing debt with the owners’ money alone, it compares debt with the whole long-term pot — owners’ money plus borrowed money together.
where Capital Employed = Shareholders’ Funds + Non-current Liabilities
Expressed as a pure ratio or a percentage. A lower figure means less dependence on borrowed funds.
Debt ₹4,00,000; Shareholders’ Funds ₹6,00,000. Compute the Debt to Capital Employed Ratio.
Step 1 — Capital Employed.
Capital Employed = 6,00,000 + 4,00,000 = ₹10,00,000
Step 2 — substitute.
Debt to Capital Employed = 4,00,000 ÷ 10,00,000 = 0.4
Debt to Capital Employed Ratio = 0.4:1, or 40%
The link worth noticing. The same company’s Debt to Equity Ratio is 4,00,000 ÷ 6,00,000 = 0.67:1. The two ratios describe one fact in two ways: 40% of the long-term funding is borrowed, 60% belongs to the owners, and 40 divided by 60 is 0.67.
Why it works: Debt to Capital Employed always lies between 0 and 1 because Debt is a part of Capital Employed. Debt to Equity has no upper limit, because Debt can exceed Equity. That is the simplest way to remember which is which.
Inventory Turnover Ratio
Welcome to the teal family. Activity ratios — also called turnover or efficiency ratios — all share one shape: a flow figure taken from the Statement of Profit and Loss on top, and an average balance taken from the Balance Sheet underneath. The answer always comes out in times, and it always means the same thing: how many times during the year did this asset complete a full round trip?
Before the formula, look at the picture. Every activity ratio is measuring one stage of the same loop.
Read the loop once more, slowly. Cash goes out to buy goods. Goods sit as inventory. Inventory is sold. Sales made on credit become Trade Receivables. Receivables are collected and turn back into cash, ready to start again. The faster a business goes round this loop, the more times a year it earns a profit on the same rupee of capital. That is the entire point of the activity family.
Inventory Turnover measures the leg from inventory to sale.
where Average Inventory = (Opening Inventory + Closing Inventory) ÷ 2
Expressed in times. A higher figure generally means faster-moving stock.
Note the numerator with care: it is Cost of Revenue from Operations, not Revenue from Operations. Inventory is carried at cost, so the flow figure above it must also be at cost. Mixing a selling-price numerator with a cost denominator is the single most common error in this ratio.
Route 2: Cost of Revenue from Operations = Revenue from Operations − Gross Profit
Route 3: If the Gross Profit Ratio is given, Cost of Revenue from Operations = Revenue from Operations × (1 − Gross Profit Ratio)
Direct expenses include carriage inwards, wages, freight and any other cost of bringing goods to a saleable condition.
Cost of Revenue from Operations ₹12,00,000; Opening Inventory ₹1,80,000; Closing Inventory ₹2,20,000. Compute the Inventory Turnover Ratio.
Step 1 — Average Inventory.
(1,80,000 + 2,20,000) ÷ 2 = 4,00,000 ÷ 2 = ₹2,00,000
Step 2 — substitute.
Inventory Turnover Ratio = 12,00,000 ÷ 2,00,000 = 6
Inventory Turnover Ratio = 6 times
Why it works: the company sold and replaced its entire stock six times during the year, or roughly once every two months. Read alongside the loop diagram, this is the speed of the leg from INVENTORY to SALE.
Revenue from Operations ₹15,00,000; Gross Profit Ratio 20%; Opening Inventory ₹1,50,000; Closing Inventory ₹2,50,000. Compute the Inventory Turnover Ratio.
Step 1 — Gross Profit.
20% of ₹15,00,000 = ₹3,00,000
Step 2 — Cost of Revenue from Operations.
15,00,000 − 3,00,000 = ₹12,00,000
Step 3 — Average Inventory.
(1,50,000 + 2,50,000) ÷ 2 = ₹2,00,000
Step 4 — substitute.
Inventory Turnover Ratio = 12,00,000 ÷ 2,00,000 = 6
Inventory Turnover Ratio = 6 times
Why it works: the Gross Profit Ratio is the bridge between selling price and cost. Twenty per cent of the selling price is profit, so eighty per cent is cost — and 80% of ₹15,00,000 is ₹12,00,000, which confirms Step 2 in one line.
The Inventory Turnover Ratio of a company is 5 times and its Cost of Revenue from Operations is ₹20,00,000. The Closing Inventory is ₹80,000 more than the Opening Inventory. Find the Opening and Closing Inventory.
Step 1 — Average Inventory from the ratio.
Average Inventory = Cost of Revenue from Operations ÷ Inventory Turnover Ratio
= 20,00,000 ÷ 5 = ₹4,00,000
Step 2 — turn the average back into a total.
Opening + Closing = 2 × 4,00,000 = ₹8,00,000
Step 3 — use the relationship between them.
Let Opening Inventory = x. Then Closing Inventory = x + 80,000.
x + (x + 80,000) = 8,00,000
2x = 7,20,000
x = ₹3,60,000 ⇒ Opening Inventory = ₹3,60,000
Closing Inventory = 3,60,000 + 80,000 = ₹4,40,000
Check: (3,60,000 + 4,40,000) ÷ 2 = ₹4,00,000 ✓ and 20,00,000 ÷ 4,00,000 = 5 ✓
Why it works: a turnover ratio can always be rearranged. Flow ÷ Average = Ratio, therefore Average = Flow ÷ Ratio. Once you have the average, doubling it gives the sum of the two inventories, and any second piece of information about them lets you split that sum.
Trade Receivables Turnover Ratio And Average Collection Period
This ratio measures the last leg of the operating cycle — the journey from a credit sale back to cash in the bank. It tells you how efficiently the company collects from its customers.
where Average Trade Receivables = (Opening Trade Receivables + Closing Trade Receivables) ÷ 2
and Trade Receivables = Debtors + Bills Receivable
Expressed in times. A higher figure means faster collection.
or 12 ÷ Trade Receivables Turnover Ratio (in months)
A shorter period is better — it means money comes home faster.
Three details decide whether you get this right.
One: the numerator is credit revenue only. Cash sales never create a receivable, so they must be excluded. If the question gives Revenue from Operations without splitting it, and gives you no way to split it, then and only then use the whole figure — and write a note saying you have assumed all sales are credit sales.
Two: “net” means after returns. Deduct Sales Return (Return Inward) from credit sales before you divide.
Three: use gross Trade Receivables. Provision for Doubtful Debts is not deducted when computing this ratio. The provision is an estimate of what may not be collected; the ratio is measuring how much was actually outstanding.
Total Revenue from Operations ₹14,00,000, of which cash sales are ₹4,00,000. Opening Trade Receivables ₹1,80,000; Closing Trade Receivables ₹2,20,000. Compute the Trade Receivables Turnover Ratio and the Average Collection Period.
Step 1 — Net Credit Revenue from Operations.
14,00,000 − 4,00,000 = ₹10,00,000
Step 2 — Average Trade Receivables.
(1,80,000 + 2,20,000) ÷ 2 = ₹2,00,000
Step 3 — the turnover.
Trade Receivables Turnover Ratio = 10,00,000 ÷ 2,00,000 = 5
Trade Receivables Turnover Ratio = 5 times
Step 4 — the collection period.
365 ÷ 5 = 73
Average Collection Period = 73 days
Why it works: the company converts its receivables into cash five times a year, so on average a customer takes about seventy-three days to pay. If the company’s stated credit terms are “60 days net”, then customers are running about a fortnight late and the credit control department has a job to do.
The Trade Receivables Turnover Ratio is 6 times and Net Credit Revenue from Operations is ₹24,00,000. Closing Trade Receivables exceed Opening Trade Receivables by ₹1,00,000. Find both figures.
Step 1 — Average Trade Receivables.
24,00,000 ÷ 6 = ₹4,00,000
Step 2 — the sum of the two.
Opening + Closing = 2 × 4,00,000 = ₹8,00,000
Step 3 — split the sum.
Let Opening = x, so Closing = x + 1,00,000.
2x + 1,00,000 = 8,00,000 ⇒ 2x = 7,00,000 ⇒ x = ₹3,50,000
Opening Trade Receivables = ₹3,50,000; Closing Trade Receivables = ₹4,50,000
Check: (3,50,000 + 4,50,000) ÷ 2 = ₹4,00,000 ✓ and 24,00,000 ÷ 4,00,000 = 6 ✓
Why it works: identical logic to Example 21. Once you notice that every turnover ratio works backwards the same way, three or four apparently different Board questions collapse into one method.
Trade Payables Turnover Ratio And Average Payment Period
The mirror image of the last ratio. Instead of asking how fast customers pay us, it asks how fast we pay our suppliers.
where Average Trade Payables = (Opening Trade Payables + Closing Trade Payables) ÷ 2
and Trade Payables = Creditors + Bills Payable
Expressed in times.
or 12 ÷ Trade Payables Turnover Ratio (in months)
Interpretation here needs a light touch, and examiners reward students who show it. A low turnover (long payment period) is not automatically bad — it may simply mean the company has negotiated generous credit terms, which is free finance. But if it is long because the company cannot pay, that is a liquidity warning. Say both sides when you comment.
Net Credit Purchases ₹9,00,000. Opening balances: Creditors ₹1,10,000, Bills Payable ₹30,000. Closing balances: Creditors ₹1,80,000, Bills Payable ₹40,000. Compute the Trade Payables Turnover Ratio and the Average Payment Period.
Step 1 — Opening Trade Payables.
1,10,000 + 30,000 = ₹1,40,000
Step 2 — Closing Trade Payables.
1,80,000 + 40,000 = ₹2,20,000
Step 3 — Average Trade Payables.
(1,40,000 + 2,20,000) ÷ 2 = ₹1,80,000
Step 4 — the turnover.
9,00,000 ÷ 1,80,000 = 5
Trade Payables Turnover Ratio = 5 times
Step 5 — the payment period.
365 ÷ 5 = 73
Average Payment Period = 73 days
Why it works: the company settles its suppliers about every seventy-three days. Compare it with Example 22, where customers also took seventy-three days: money is coming in at exactly the speed it is going out, so trade credit is neither financing the business nor draining it.
Total Purchases ₹12,00,000, of which cash purchases are ₹2,00,000. The Trade Payables Turnover Ratio is 4 times and Opening Trade Payables are ₹2,00,000. Find the Closing Trade Payables and the Average Payment Period.
Step 1 — Net Credit Purchases.
12,00,000 − 2,00,000 = ₹10,00,000
Step 2 — Average Trade Payables from the ratio.
10,00,000 ÷ 4 = ₹2,50,000
Step 3 — unwind the average.
Opening + Closing = 2 × 2,50,000 = ₹5,00,000
Closing = 5,00,000 − 2,00,000 = ₹3,00,000
Step 4 — the payment period.
365 ÷ 4 = 91.25
Average Payment Period = 91.25 days, that is about 91 days
Check: (2,00,000 + 3,00,000) ÷ 2 = ₹2,50,000 ✓ and 10,00,000 ÷ 2,50,000 = 4 ✓
Why it works: the two-decimal convention applies here too. Write 91.25 days and then, if you wish, add “approximately 91 days”. Do not silently round to 91 without showing the exact figure — the examiner wants to see that your division was right.
Working Capital Turnover Ratio
The last of the teal family. This one steps back from individual assets and asks how much revenue the company squeezed out of its working capital as a whole.
where Working Capital = Current Assets − Current Liabilities
Expressed in times. Note that the numerator here is Revenue from Operations, not Cost.
Why revenue and not cost this time? Because working capital is not an item that is sold; it is the pool of short-term funds that supports the whole selling operation. The measure of that support is the total revenue generated. Some questions ask for the ratio on Cost of Revenue from Operations instead — if they do, follow the question, but the standard formula uses Revenue from Operations.
Revenue from Operations ₹24,00,000; Current Assets ₹6,00,000; Current Liabilities ₹2,00,000. Compute the Working Capital Turnover Ratio.
Step 1 — Working Capital.
6,00,000 − 2,00,000 = ₹4,00,000
Step 2 — substitute.
24,00,000 ÷ 4,00,000 = 6
Working Capital Turnover Ratio = 6 times
Why it works: every rupee tied up in working capital generated six rupees of revenue during the year. A rising figure usually signals better efficiency — unless it is rising because working capital has shrunk dangerously low, which is why you should always read this ratio next to the Current Ratio.
A company’s Working Capital Turnover Ratio is 8 times, its Revenue from Operations is ₹32,00,000 and its Current Ratio is 3:1. Compute the Current Assets and the Current Liabilities.
Step 1 — Working Capital from the turnover.
Working Capital = 32,00,000 ÷ 8 = ₹4,00,000
Step 2 — bring in the Current Ratio.
Let Current Liabilities = x, so Current Assets = 3x.
3x − x = 4,00,000 ⇒ 2x = 4,00,000 ⇒ x = ₹2,00,000
Step 3 — write both answers.
Current Liabilities = ₹2,00,000; Current Assets = 3 × 2,00,000 = ₹6,00,000
Check: 6,00,000 − 2,00,000 = ₹4,00,000 ✓ and 32,00,000 ÷ 4,00,000 = 8 ✓
Why it works: two ratios, two unknowns, one small pair of equations. This question type — chaining an activity ratio into a liquidity ratio — is a Board favourite because it tests whether you actually understand the definitions rather than just recalling formulas.
Gross Profit Ratio
Into the sunshine family. Profitability ratios ask the question every owner cares about: of every hundred rupees of revenue, how many are actually kept? The Gross Profit Ratio answers it at the very first level — before a single office expense has been paid.
where Gross Profit = Revenue from Operations − Cost of Revenue from Operations
Expressed as a percentage.
Revenue from Operations ₹20,00,000; Cost of Revenue from Operations ₹14,00,000. Compute the Gross Profit Ratio.
Step 1 — Gross Profit.
20,00,000 − 14,00,000 = ₹6,00,000
Step 2 — substitute.
Gross Profit Ratio = (6,00,000 ÷ 20,00,000) × 100 = 30
Gross Profit Ratio = 30%
Why it works: thirty paise out of every rupee of revenue survives the direct cost of the goods. That thirty paise must then cover every other expense of the business, and whatever is left is net profit.
The Gross Profit Ratio of a company is 25% and its Cost of Revenue from Operations is ₹9,00,000. Compute the Revenue from Operations and the Gross Profit.
Step 1 — think in percentages of revenue.
Let Revenue from Operations = 100. Gross Profit = 25. Therefore Cost of Revenue from Operations = 100 − 25 = 75.
Step 2 — set up the proportion.
If 75 parts = ₹9,00,000, then 100 parts = 9,00,000 × (100 ÷ 75)
Step 3 — compute.
Revenue from Operations = 9,00,000 × 100 ÷ 75 = ₹12,00,000
Gross Profit = 12,00,000 − 9,00,000 = ₹3,00,000
Check: (3,00,000 ÷ 12,00,000) × 100 = 25% ✓
Why it works: the Gross Profit Ratio is always calculated on revenue, so revenue is 100 and cost is (100 − ratio). The general formula is Revenue from Operations = Cost of Revenue from Operations ÷ (1 − Gross Profit Ratio), here 9,00,000 ÷ 0.75 = ₹12,00,000. This is exactly the reverse question the Board sets year after year.
Revenue from Operations ₹15,00,000; Opening Inventory ₹2,00,000; Net Purchases ₹10,00,000; Direct Wages ₹50,000; Carriage Inwards ₹25,000; Closing Inventory ₹1,50,000. Compute the Gross Profit Ratio.
Step 1 — Cost of Revenue from Operations.
Opening Inventory ₹2,00,000
+ Net Purchases ₹10,00,000
+ Direct Wages ₹50,000
+ Carriage Inwards ₹25,000
− Closing Inventory ₹1,50,000
= ₹11,25,000
Step 2 — Gross Profit.
15,00,000 − 11,25,000 = ₹3,75,000
Step 3 — substitute.
Gross Profit Ratio = (3,75,000 ÷ 15,00,000) × 100 = 25
Gross Profit Ratio = 25%
Why it works: direct wages and carriage inwards are costs of getting goods ready to sell, so they belong in cost. Carriage outwards, by contrast, is a selling expense and would not appear here at all. Sorting expenses into direct and indirect is half the battle in profitability questions.
Operating Ratio And Operating Profit Ratio
These two are a matched pair. Together they always add up to 100%, which gives you a free check on every answer you write.
Expressed as a percentage. A lower Operating Ratio is better — it means less of each rupee of revenue is being eaten by running costs.
where Operating Profit = Revenue from Operations − (Cost of Revenue from Operations + Operating Expenses)
or, equivalently, Operating Profit = Net Profit before Tax + Non-operating Expenses − Non-operating Income
And always: Operating Ratio + Operating Profit Ratio = 100%
What counts as an operating expense? Anything incurred in the normal, regular running of the business: Employee Benefit Expenses, office and administrative expenses, selling and distribution expenses, carriage outwards, depreciation on operating assets.
What does not? Interest on borrowings, loss on sale of a fixed asset or investment, and any expense written off such as goodwill or preliminary expenses. On the income side, interest received, dividend received, rent received, and profit on the sale of a fixed asset are all non-operating income. Income tax is not an operating expense either — it comes after everything.
Revenue from Operations ₹20,00,000; Cost of Revenue from Operations ₹14,00,000; Employee Benefit Expenses ₹1,60,000; Other Operating Expenses ₹40,000. Compute the Operating Ratio and the Operating Profit Ratio.
Step 1 — total operating cost.
14,00,000 + 1,60,000 + 40,000 = ₹16,00,000
Step 2 — Operating Ratio.
(16,00,000 ÷ 20,00,000) × 100 = 80
Operating Ratio = 80%
Step 3 — Operating Profit and its ratio.
Operating Profit = 20,00,000 − 16,00,000 = ₹4,00,000
(4,00,000 ÷ 20,00,000) × 100 = 20
Operating Profit Ratio = 20%
Check: 80% + 20% = 100% ✓
Why it works: eighty paise of every rupee of revenue goes on running the business; twenty paise is operating profit. Because the two ratios are complements, computing one gives you the other for free — but write out both workings, because the examiner is marking the method as well as the answer.
Revenue from Operations ₹25,00,000; Cost of Revenue from Operations ₹16,00,000; Office and Administrative Expenses ₹2,00,000; Selling and Distribution Expenses ₹1,50,000; Loss on Sale of Machinery ₹50,000; Interest on Debentures ₹1,00,000; Dividend Received ₹30,000. Compute the Operating Ratio and the Operating Profit Ratio.
Step 1 — sort the items.
Operating: Cost of Revenue from Operations, Office and Administrative Expenses, Selling and Distribution Expenses.
Non-operating: Loss on Sale of Machinery, Interest on Debentures (expenses); Dividend Received (income).
Step 2 — total operating cost.
16,00,000 + 2,00,000 + 1,50,000 = ₹19,50,000
Step 3 — Operating Ratio.
(19,50,000 ÷ 25,00,000) × 100 = 78
Operating Ratio = 78%
Step 4 — Operating Profit Ratio.
Operating Profit = 25,00,000 − 19,50,000 = ₹5,50,000
(5,50,000 ÷ 25,00,000) × 100 = 22
Operating Profit Ratio = 22% and 78% + 22% = 100% ✓
Step 5 — the second route, as a proof.
Net Profit before Tax = 25,00,000 − 19,50,000 − 50,000 − 1,00,000 + 30,000 = ₹4,30,000
Operating Profit = Net Profit before Tax + Non-operating Expenses − Non-operating Income
= 4,30,000 + 50,000 + 1,00,000 − 30,000 = ₹5,50,000 ✓ identical to Step 4.
Why it works: the two routes must agree, because they are the same subtraction done in a different order. If yours do not agree, you have misclassified an item — go back to Step 1 and sort again. Always run this check when non-operating items are present; it takes twenty seconds and it catches almost every error.
Net Profit Ratio
The bottom line, literally. Everything has been paid — cost of goods, running expenses, interest, tax — and this is what survives.
Expressed as a percentage. If the question says “Net Profit before Tax”, use that figure and label your answer accordingly.
Revenue from Operations ₹25,00,000; Net Profit after Tax ₹2,50,000. Compute the Net Profit Ratio.
Substitute.
(2,50,000 ÷ 25,00,000) × 100 = 10
Net Profit Ratio = 10%
Why it works: ten paise of every rupee of revenue reached the shareholders. Simple — but note how far it has fallen from a Gross Profit Ratio that might have been 30%. The gap between the two is where all the expenses live.
Take the company in Example 32 and assume income tax is charged at 30%. Compute the Net Profit Ratio.
Step 1 — Net Profit before Tax (already computed in Example 32).
₹4,30,000
Step 2 — tax.
30% of 4,30,000 = ₹1,29,000
Step 3 — Net Profit after Tax.
4,30,000 − 1,29,000 = ₹3,01,000
Step 4 — substitute.
(3,01,000 ÷ 25,00,000) × 100 = 12.04
Net Profit Ratio = 12.04% (rounded to two decimal places)
Why it works: follow the same company down the whole Statement of Profit and Loss and the three profitability ratios line up in a story — Operating Profit Ratio 22%, then interest and the loss on machinery pull it down, dividend income pushes it back up a little, tax takes nearly a third, and 12.04% survives. When a question asks you to “comment”, that story is your answer.
Return On Investment (Return On Capital Employed)
This is the grandest ratio in the chapter, and the one a serious investor cares about most. Every other profitability ratio compares profit with revenue. This one compares profit with the money that was put in to earn it.
Also called Return on Capital Employed (ROCE). Expressed as a percentage.
Why before interest and tax? Because Capital Employed includes both the owners’ money and the lenders’ money. The profit figure on top must therefore be the profit available to both groups — that is, before any of it has been handed to the lenders as interest, and before the government has taken its share as tax. Match the numerator to the denominator; that single habit will keep you right in every ratio you ever meet.
Shareholders’ Funds ₹10,00,000; 12% Long-term Loan ₹5,00,000; Net Profit after Tax ₹1,47,000; rate of tax 30%. Compute the Return on Investment.
Step 1 — Capital Employed.
10,00,000 + 5,00,000 = ₹15,00,000
Step 2 — Profit before Tax.
1,47,000 ÷ (1 − 0.30) = 1,47,000 ÷ 0.70 = ₹2,10,000
Step 3 — interest on long-term debt.
12% of ₹5,00,000 = ₹60,000
Step 4 — Profit before Interest and Tax.
2,10,000 + 60,000 = ₹2,70,000
Step 5 — substitute.
Return on Investment = (2,70,000 ÷ 15,00,000) × 100 = 18
Return on Investment = 18%
Why it works: the business earned eighteen rupees for every hundred rupees of long-term capital tied up in it. Since the loan costs only 12%, the company is earning more on borrowed money than it pays for it — the surplus belongs to the shareholders. That is trading on equity, and it is exactly why some borrowing can be a good thing.
Return to the Balance Sheet in Example 2. During the year Nayantara Traders Ltd. earned a Net Profit after Tax of ₹1,75,000. The rate of tax was 30%. Compute the Return on Investment.
Step 1 — Capital Employed.
Shareholders’ Funds (₹6,00,000 + ₹2,00,000) = ₹8,00,000
Non-current Liabilities (10% Debentures ₹4,00,000 + Long-term Provisions ₹50,000) = ₹4,50,000
Capital Employed = 8,00,000 + 4,50,000 = ₹12,50,000
Step 2 — Profit before Tax.
1,75,000 ÷ 0.70 = ₹2,50,000
Step 3 — interest.
10% of ₹4,00,000 = ₹40,000 (Long-term Provisions carry no interest)
Step 4 — Profit before Interest and Tax.
2,50,000 + 40,000 = ₹2,90,000
Step 5 — substitute.
Return on Investment = (2,90,000 ÷ 12,50,000) × 100 = 23.2
Return on Investment = 23.2%
Bonus — the Interest Coverage Ratio falls out for free.
2,90,000 ÷ 40,000 = 7.25 times
Why it works: one Profit before Interest and Tax figure feeds two different ratios. Whenever a question asks for both Return on Investment and Interest Coverage, compute Profit before Interest and Tax once, box it, and use it twice.
Capital Employed: The Three Ways To Find It
Capital Employed sits underneath Return on Investment and Debt to Capital Employed, and it is where most marks are quietly lost. The good news is that there are exactly three routes to it, and all three must give the identical figure. If yours do not agree, you have made an error — and you have caught it before the examiner did.
Route 2 (assets side): Capital Employed = Non-current Assets + Working Capital
Route 3 (short cut): Capital Employed = Total Assets − Current Liabilities
Use whichever the data allows, and use a second one as a check.
Compute the Capital Employed of Nayantara Traders Ltd. (Example 2) by all three routes and show that they agree.
Route 1 — liabilities side.
Shareholders’ Funds = Share Capital ₹6,00,000 + Reserves and Surplus ₹2,00,000 = ₹8,00,000
Non-current Liabilities = 10% Debentures ₹4,00,000 + Long-term Provisions ₹50,000 = ₹4,50,000
Capital Employed = 8,00,000 + 4,50,000 = ₹12,50,000
Route 2 — assets side.
Non-current Assets = Fixed Assets ₹9,50,000 + Non-current Investments ₹1,00,000 = ₹10,50,000
Current Assets = ₹4,00,000; Current Liabilities = ₹2,00,000
Working Capital = 4,00,000 − 2,00,000 = ₹2,00,000
Capital Employed = 10,50,000 + 2,00,000 = ₹12,50,000
Route 3 — the short cut.
Total Assets ₹14,50,000 − Current Liabilities ₹2,00,000 = ₹12,50,000
All three agree at ₹12,50,000. ✓
Why it works: the Balance Sheet balances, so Total Assets equal Shareholders’ Funds plus Non-current Liabilities plus Current Liabilities. Take Current Liabilities off both sides and you are left with exactly the identity above. The three routes are not three different ideas — they are one identity read from three directions.
Working Backwards From A Given Ratio
Most students practise only in one direction: figures in, ratio out. The Board very often runs the film backwards — ratio in, figures out. It is the same arithmetic, but if you have never rehearsed it, it feels like a completely different subject in the exam hall. Let us rehearse it properly.
2. Put a letter against each unknown quantity.
3. Turn every sentence in the question into an equation.
4. Solve, then substitute your answers back into the original ratio to check.
Step 4 is not optional. It costs fifteen seconds and it catches nearly every mistake.
The Gross Profit Ratio of a company is 20% and its Cost of Revenue from Operations is ₹16,00,000. Compute the Revenue from Operations and the Gross Profit.
Step 1 — write the relationship in parts.
Revenue from Operations = 100 parts; Gross Profit = 20 parts; Cost of Revenue from Operations = 80 parts.
Step 2 — scale from the known part.
80 parts = ₹16,00,000, so 1 part = ₹20,000.
Step 3 — read off the answers.
Revenue from Operations = 100 × 20,000 = ₹20,00,000
Gross Profit = 20 × 20,000 = ₹4,00,000
Check: 20,00,000 − 16,00,000 = 4,00,000 ✓ and (4,00,000 ÷ 20,00,000) × 100 = 20% ✓
Why it works: the algebraic form is Revenue from Operations = Cost of Revenue from Operations ÷ (1 − Gross Profit Ratio) = 16,00,000 ÷ 0.80 = ₹20,00,000. The “parts” method and the algebra are the same thing; use whichever you find easier to write out under exam pressure.
A company’s Current Ratio is 2.5:1 and its Quick Ratio is 1.5:1. Its Inventory is ₹3,00,000 and there are no prepaid expenses. Compute the Current Assets, the Current Liabilities and the Quick Assets.
Step 1 — let Current Liabilities = x.
Then Current Assets = 2.5x and Quick Assets = 1.5x.
Step 2 — the gap between them is the Inventory.
Current Assets − Quick Assets = Inventory
2.5x − 1.5x = 3,00,000
1x = 3,00,000 ⇒ Current Liabilities = ₹3,00,000
Step 3 — substitute back.
Current Assets = 2.5 × 3,00,000 = ₹7,50,000
Quick Assets = 1.5 × 3,00,000 = ₹4,50,000
Check: 7,50,000 ÷ 3,00,000 = 2.5 ✓; 4,50,000 ÷ 3,00,000 = 1.5 ✓; 7,50,000 − 4,50,000 = 3,00,000 ✓
Why it works: both ratios sit on the same denominator, so subtracting one from the other cancels the denominator and isolates the item that was removed. This is the reverse of Example 6, and between them the two examples cover almost every version of this question the Board has ever set.
A company’s Proprietary Ratio is 0.6:1 and its Total Assets are ₹25,00,000. Its Current Liabilities are ₹4,00,000. Compute (a) Shareholders’ Funds, (b) Debt, (c) the Debt to Equity Ratio and (d) the Total Assets to Debt Ratio.
(a) Shareholders’ Funds.
Proprietary Ratio = Shareholders’ Funds ÷ Total Assets
0.6 = Shareholders’ Funds ÷ 25,00,000
Shareholders’ Funds = 0.6 × 25,00,000 = ₹15,00,000
(b) Debt.
Debt = Total Assets − Shareholders’ Funds − Current Liabilities
= 25,00,000 − 15,00,000 − 4,00,000 = ₹6,00,000
(c) Debt to Equity Ratio.
6,00,000 ÷ 15,00,000 = 0.4
Debt to Equity Ratio = 0.4:1
(d) Total Assets to Debt Ratio.
25,00,000 ÷ 6,00,000 = 4.1666…
Total Assets to Debt Ratio = 4.17:1 (rounded to two decimal places)
Why it works: one ratio plus one absolute figure was enough to unlock the entire funding structure. This is why the Balance Sheet identity deserves a place in your memory right beside the formulas. Notice too that part (d) is the first genuinely non-terminating answer in this chapter — we round to two decimals and say so, exactly as promised at the start.
Master Formula Sheet
Everything in one table. The row colours match the four families in the tree diagram: sky for liquidity, coral for solvency, teal for activity, sunshine for profitability. Photograph this table, print it, stick it above your desk.
| Ratio | Formula | What It Tells You | Form & Typical Norm |
|---|---|---|---|
| Current Ratio | Current Assets ÷ Current Liabilities | Short-term ability to pay bills | Pure ratio; about 2:1 |
| Quick (Liquid) Ratio | (Current Assets − Inventory − Prepaid Expenses) ÷ Current Liabilities | Ability to pay without selling stock | Pure ratio; about 1:1 |
| Debt to Equity Ratio | Debt (Non-current Liabilities) ÷ Shareholders’ Funds | How geared the funding is | Pure ratio; up to about 2:1 |
| Total Assets to Debt Ratio | Total Assets ÷ Debt | Asset cover behind each rupee lent | Pure ratio; higher is safer |
| Proprietary Ratio | Shareholders’ Funds ÷ Total Assets | Owners’ share of the asset base | Ratio or %; higher is stronger |
| Interest Coverage Ratio | Profit before Interest and Tax ÷ Interest on Long-term Debt | Comfort in paying interest | Times; higher is safer |
| Debt to Capital Employed | Debt ÷ Capital Employed | Borrowed share of long-term funds | Ratio or %; lower is safer |
| Inventory Turnover Ratio | Cost of Revenue from Operations ÷ Average Inventory | Speed of stock movement | Times; higher is better |
| Trade Receivables Turnover | Net Credit Revenue from Operations ÷ Average Trade Receivables | Speed of collection from customers | Times; higher is better |
| Average Collection Period | 365 ÷ Trade Receivables Turnover Ratio | Days customers take to pay | Days; shorter is better |
| Trade Payables Turnover | Net Credit Purchases ÷ Average Trade Payables | Speed of paying suppliers | Times; read with care |
| Average Payment Period | 365 ÷ Trade Payables Turnover Ratio | Days taken to pay suppliers | Days; read with care |
| Working Capital Turnover | Revenue from Operations ÷ Working Capital | Revenue earned per rupee of working capital | Times; higher is usually better |
| Gross Profit Ratio | (Gross Profit ÷ Revenue from Operations) × 100 | Margin before indirect expenses | Percentage |
| Operating Ratio | [(Cost of Revenue from Operations + Operating Expenses) ÷ Revenue from Operations] × 100 | Share of revenue eaten by running costs | Percentage; lower is better |
| Operating Profit Ratio | (Operating Profit ÷ Revenue from Operations) × 100 | Profit from core operations | Percentage; 100% − Operating Ratio |
| Net Profit Ratio | (Net Profit after Tax ÷ Revenue from Operations) × 100 | Final margin for shareholders | Percentage |
| Return on Investment (ROCE) | (Profit before Interest, Tax and Dividend ÷ Capital Employed) × 100 | Overall return on long-term capital | Percentage; higher is better |
The three supporting definitions that the table depends on, and that you must be able to write without hesitating: Capital Employed = Shareholders’ Funds + Non-current Liabilities = Total Assets − Current Liabilities. Working Capital = Current Assets − Current Liabilities. Cost of Revenue from Operations = Revenue from Operations − Gross Profit.
Common Mistakes Students Make
Almost every mark lost in this chapter falls into one of the following ten holes. Read them the night before the exam.
- Using Revenue from Operations instead of Cost of Revenue from Operations in the Inventory Turnover Ratio. Inventory is at cost, so the numerator must be at cost.
- Including Current Liabilities in “Debt”. In Debt to Equity, Total Assets to Debt and Debt to Capital Employed, Debt means long-term debt only.
- Forgetting to remove Prepaid Expenses from Quick Assets. Inventory and Prepaid Expenses both come out.
- Treating a bank overdraft as a deduction from cash. It is a Short-term Borrowing and sits in Current Liabilities.
- Using Net Profit after Tax in Return on Investment or Interest Coverage. Both need Profit before Interest and Tax.
- Multiplying instead of dividing when grossing up for tax. Profit before Tax = Net Profit after Tax ÷ (1 − tax rate).
- Using total sales when only credit sales belong in the numerator of the Trade Receivables Turnover Ratio — and the same slip with purchases in the Trade Payables Turnover Ratio.
- Deducting Provision for Doubtful Debts from Trade Receivables, or leaving out Bills Receivable and Bills Payable.
- Writing the answer in the wrong form — “6:1” for a turnover, or “200%” for a Current Ratio.
- Carrying one transaction’s effect into the next when the question says the transactions are independent.
How Marks Are Awarded In The Board Exam
Ratio Analysis sits inside Unit 3 of Part B, which carries 12 marks in the Class 12 Accountancy paper for 2026-27. It usually appears as a mixture of one-mark objective questions, a three or four-mark computation, and sometimes a longer question combining several ratios from a single Balance Sheet. Here is what examiners actually look for.
One-mark questions. Typically a definition, a classification (“Which category does the Proprietary Ratio belong to?”), or a one-line effect question (“State whether the Current Ratio will improve, decline or not change if a bill payable is discharged”). Answer in one clean sentence. Do not write a paragraph — there is no extra credit and you will lose time.
Three and four-mark computations. The marks are split roughly like this: one mark for the correct formula, one for the correct substitution of figures, one for the correct arithmetic and unit, and where asked, one for the interpretation. Because the formula carries its own mark, always write it out even if you can do the sum in your head. A student who writes only “= 2:1” and is right gets fewer marks than a student who shows all three lines and makes a small arithmetic slip.
Working notes. Anything you derive along the way — Average Inventory, Cost of Revenue from Operations, Capital Employed, Profit before Interest and Tax — should be shown in a clearly labelled working note. Examiners award part marks from working notes when the final answer is wrong.
Format of the answer. Pure ratio as x:1. Percentage with the % sign. Turnover with the word “times”. Period with the word “days” or “months”. Rupee amounts with the ₹ symbol. These are small courtesies and they are marked.
A note on scope. Ratio Analysis is one part of Unit 3 of Part B. The Cash Flow Statement is a separate chapter with its own weight, so keep the two apart in your revision — the ratios in this chapter never require a cash flow working. And “Accounting for Not-for-Profit Organisations” is no longer part of the syllabus, so do not let an old question bank pull you into it.
Practice Worksheet
Ten original questions. Work every one on paper first — formula, substitution, answer with unit — and only then open the solution. If you get one wrong, do not just read the correct answer; find the exact line where you diverged, and redo the whole question from the top. Round to two decimal places where the figures do not come out exactly.
Q1. From the following, compute the Current Ratio and the Quick Ratio: Inventory ₹2,40,000; Trade Receivables ₹3,00,000; Cash and Cash Equivalents ₹1,20,000; Current Investments ₹60,000; Prepaid Expenses ₹30,000; Trade Payables ₹2,00,000; Short-term Provisions ₹60,000; Other Current Liabilities ₹40,000.
Step 1 — Current Assets.
2,40,000 + 3,00,000 + 1,20,000 + 60,000 + 30,000 = ₹7,50,000
Step 2 — Current Liabilities.
2,00,000 + 60,000 + 40,000 = ₹3,00,000
Step 3 — Current Ratio.
7,50,000 ÷ 3,00,000 = 2.5 ⇒ Current Ratio = 2.5:1
Step 4 — Quick Assets.
7,50,000 − Inventory 2,40,000 − Prepaid Expenses 30,000 = ₹4,80,000
Cross-check by adding directly: 3,00,000 + 1,20,000 + 60,000 = ₹4,80,000 ✓
Step 5 — Quick Ratio.
4,80,000 ÷ 3,00,000 = 1.6 ⇒ Quick Ratio = 1.6:1
Both are comfortably above the conventional norms of 2:1 and 1:1.
Q2. A company’s Current Assets are ₹6,00,000 and its Current Liabilities are ₹2,00,000. State the effect of each of the following independent transactions on the Current Ratio, and give the new ratio: (i) Cash paid to Trade Payables ₹50,000; (ii) Goods purchased on credit ₹1,00,000; (iii) Non-current investment of book value ₹50,000 sold for ₹60,000 cash; (iv) Cash received from Trade Receivables ₹80,000; (v) Bills Payable of ₹40,000 discharged.
Opening position: 6,00,000 ÷ 2,00,000 = 3:1. Every part below starts again from here.
(i) Cash paid to Trade Payables ₹50,000. Both sides fall by ₹50,000.
5,50,000 ÷ 1,50,000 = 3.6666… ⇒ 3.67:1 — increases
(ii) Goods purchased on credit ₹1,00,000. Inventory rises, Trade Payables rise.
7,00,000 ÷ 3,00,000 = 2.3333… ⇒ 2.33:1 — decreases
(iii) Non-current investment (book value ₹50,000) sold for ₹60,000 cash. A non-current asset becomes cash, so Current Assets rise by the full ₹60,000 received. Current Liabilities are untouched.
6,60,000 ÷ 2,00,000 = 3.3 ⇒ 3.3:1 — increases
(iv) Cash received from Trade Receivables ₹80,000. One current asset simply becomes another.
6,00,000 ÷ 2,00,000 = 3 ⇒ 3:1 — no change
(v) Bills Payable of ₹40,000 discharged. Both sides fall by ₹40,000.
5,60,000 ÷ 1,60,000 = 3.5 ⇒ 3.5:1 — increases
Q3. From the following Balance Sheet extract, compute (a) Debt to Equity Ratio, (b) Total Assets to Debt Ratio, (c) Proprietary Ratio and (d) Debt to Capital Employed Ratio: Share Capital ₹10,00,000; Reserves and Surplus ₹4,00,000; Long-term Borrowings ₹6,00,000; Long-term Provisions ₹1,00,000; Current Liabilities ₹4,00,000; Non-current Assets ₹18,00,000; Current Assets ₹7,00,000.
Working note — the three building blocks.
Shareholders’ Funds = 10,00,000 + 4,00,000 = ₹14,00,000
Debt (Non-current Liabilities) = 6,00,000 + 1,00,000 = ₹7,00,000
Total Assets = 18,00,000 + 7,00,000 = ₹25,00,000
Balance check: 14,00,000 + 7,00,000 + 4,00,000 = ₹25,00,000 ✓
(a) Debt to Equity Ratio = 7,00,000 ÷ 14,00,000 = 0.5 ⇒ 0.5:1
(b) Total Assets to Debt Ratio = 25,00,000 ÷ 7,00,000 = 3.5714… ⇒ 3.57:1
(c) Proprietary Ratio = 14,00,000 ÷ 25,00,000 = 0.56 ⇒ 0.56:1, or 56%
(d) Debt to Capital Employed Ratio.
Capital Employed = 14,00,000 + 7,00,000 = ₹21,00,000
Cross-check: Total Assets − Current Liabilities = 25,00,000 − 4,00,000 = ₹21,00,000 ✓
7,00,000 ÷ 21,00,000 = 0.3333… ⇒ 0.33:1, or 33.33%
Q4. A company’s Net Profit after Tax is ₹5,40,000, the rate of tax is 40% and it has 9% Debentures of ₹10,00,000. Compute the Interest Coverage Ratio.
Step 1 — Profit before Tax.
5,40,000 ÷ (1 − 0.40) = 5,40,000 ÷ 0.60 = ₹9,00,000
Check: 40% of 9,00,000 = ₹3,60,000; 9,00,000 − 3,60,000 = ₹5,40,000 ✓
Step 2 — Interest.
9% of ₹10,00,000 = ₹90,000
Step 3 — Profit before Interest and Tax.
9,00,000 + 90,000 = ₹9,90,000
Step 4 — substitute.
9,90,000 ÷ 90,000 = 11 ⇒ Interest Coverage Ratio = 11 times
Interest is covered eleven times over — a very comfortable position for the debenture holders.
Q5. (a) Revenue from Operations ₹30,00,000; Gross Profit Ratio 30%; Opening Inventory ₹3,00,000; Closing Inventory ₹4,00,000. Compute the Inventory Turnover Ratio. (b) In a different company the Gross Profit Ratio is 25% and the Gross Profit is ₹4,00,000. Compute the Revenue from Operations and the Cost of Revenue from Operations.
(a) Step 1 — Gross Profit.
30% of ₹30,00,000 = ₹9,00,000
Step 2 — Cost of Revenue from Operations.
30,00,000 − 9,00,000 = ₹21,00,000
Step 3 — Average Inventory.
(3,00,000 + 4,00,000) ÷ 2 = ₹3,50,000
Step 4 — substitute.
21,00,000 ÷ 3,50,000 = 6 ⇒ Inventory Turnover Ratio = 6 times
(b) Step 1 — Revenue from Operations. Gross Profit is 25% of Revenue from Operations.
Revenue from Operations = 4,00,000 ÷ 0.25 = ₹16,00,000
Step 2 — Cost of Revenue from Operations.
16,00,000 − 4,00,000 = ₹12,00,000
Check: (4,00,000 ÷ 16,00,000) × 100 = 25% ✓
Q6. Total Revenue from Operations is ₹36,00,000. Cash sales are one-third of credit sales. Opening Trade Receivables ₹5,00,000; Closing Trade Receivables ₹5,80,000. Compute the Trade Receivables Turnover Ratio and the Average Collection Period.
Step 1 — split the revenue.
Let credit sales = 3 parts. Then cash sales = 1 part, and total = 4 parts.
4 parts = ₹36,00,000, so 1 part = ₹9,00,000.
Credit Revenue from Operations = 3 × 9,00,000 = ₹27,00,000; cash sales = ₹9,00,000.
Check: 9,00,000 is one-third of 27,00,000 ✓ and 27,00,000 + 9,00,000 = ₹36,00,000 ✓
Step 2 — Average Trade Receivables.
(5,00,000 + 5,80,000) ÷ 2 = 10,80,000 ÷ 2 = ₹5,40,000
Step 3 — the turnover.
27,00,000 ÷ 5,40,000 = 5 ⇒ Trade Receivables Turnover Ratio = 5 times
Step 4 — the collection period.
365 ÷ 5 = 73 ⇒ Average Collection Period = 73 days
Q7. Total Purchases ₹20,00,000, of which cash purchases are ₹4,00,000. Opening balances: Creditors ₹2,40,000, Bills Payable ₹60,000. Closing balances: Creditors ₹4,20,000, Bills Payable ₹80,000. Compute the Trade Payables Turnover Ratio and the Average Payment Period.
Step 1 — Net Credit Purchases.
20,00,000 − 4,00,000 = ₹16,00,000
Step 2 — Opening and Closing Trade Payables.
Opening = 2,40,000 + 60,000 = ₹3,00,000
Closing = 4,20,000 + 80,000 = ₹5,00,000
Step 3 — Average Trade Payables.
(3,00,000 + 5,00,000) ÷ 2 = ₹4,00,000
Step 4 — the turnover.
16,00,000 ÷ 4,00,000 = 4 ⇒ Trade Payables Turnover Ratio = 4 times
Step 5 — the payment period.
365 ÷ 4 = 91.25 ⇒ Average Payment Period = 91.25 days (about 91 days)
Q8. Revenue from Operations ₹40,00,000; Cost of Revenue from Operations ₹26,00,000; Employee Benefit Expenses ₹4,00,000; Other Operating Expenses ₹2,00,000; Interest on Debentures ₹1,20,000; Gain on Sale of Fixed Asset ₹80,000; rate of tax 30%. Compute the Operating Ratio, the Operating Profit Ratio and the Net Profit Ratio.
Working note — sort the items. Operating: Cost of Revenue from Operations, Employee Benefit Expenses, Other Operating Expenses. Non-operating: Interest on Debentures (expense), Gain on Sale of Fixed Asset (income).
Step 1 — total operating cost.
26,00,000 + 4,00,000 + 2,00,000 = ₹32,00,000
Step 2 — Operating Ratio.
(32,00,000 ÷ 40,00,000) × 100 = 80 ⇒ Operating Ratio = 80%
Step 3 — Operating Profit Ratio.
Operating Profit = 40,00,000 − 32,00,000 = ₹8,00,000
(8,00,000 ÷ 40,00,000) × 100 = 20 ⇒ Operating Profit Ratio = 20%
Check: 80% + 20% = 100% ✓
Step 4 — Net Profit before Tax.
8,00,000 − 1,20,000 + 80,000 = ₹7,60,000
Step 5 — tax and Net Profit after Tax.
Tax = 30% of 7,60,000 = ₹2,28,000
Net Profit after Tax = 7,60,000 − 2,28,000 = ₹5,32,000
Step 6 — Net Profit Ratio.
(5,32,000 ÷ 40,00,000) × 100 = 13.3 ⇒ Net Profit Ratio = 13.3%
Q9. From the following, compute the Capital Employed by all three routes and then the Return on Investment: Share Capital ₹12,00,000; Reserves and Surplus ₹3,00,000; 10% Debentures ₹5,00,000; Current Liabilities ₹4,00,000; Fixed Assets (net) ₹16,00,000; Non-current Investments ₹2,00,000; Current Assets ₹6,00,000. Net Profit after Tax for the year was ₹2,10,000 and the rate of tax is 30%.
Balance check first.
Equity and Liabilities: 12,00,000 + 3,00,000 + 5,00,000 + 4,00,000 = ₹24,00,000
Assets: 16,00,000 + 2,00,000 + 6,00,000 = ₹24,00,000 ✓
Route 1 — liabilities side.
Shareholders’ Funds = 12,00,000 + 3,00,000 = ₹15,00,000
Non-current Liabilities = ₹5,00,000
Capital Employed = 15,00,000 + 5,00,000 = ₹20,00,000
Route 2 — assets side.
Non-current Assets = 16,00,000 + 2,00,000 = ₹18,00,000
Working Capital = 6,00,000 − 4,00,000 = ₹2,00,000
Capital Employed = 18,00,000 + 2,00,000 = ₹20,00,000
Route 3 — short cut.
24,00,000 − 4,00,000 = ₹20,00,000 — all three agree ✓
Step 4 — Profit before Interest and Tax.
Profit before Tax = 2,10,000 ÷ 0.70 = ₹3,00,000
Interest = 10% of ₹5,00,000 = ₹50,000
Profit before Interest and Tax = 3,00,000 + 50,000 = ₹3,50,000
Step 5 — Return on Investment.
(3,50,000 ÷ 20,00,000) × 100 = 17.5 ⇒ Return on Investment = 17.5%
The company earns 17.5% on its long-term capital while paying only 10% on the debentures — the surplus benefits the shareholders.
Q10. A company’s Current Ratio is 3:1, its Quick Ratio is 1.2:1 and its Working Capital is ₹4,00,000. Its Revenue from Operations for the year was ₹20,00,000. There are no prepaid expenses. Compute the Current Assets, the Current Liabilities, the Inventory and the Working Capital Turnover Ratio.
Step 1 — Current Liabilities from Working Capital.
Let Current Liabilities = x, so Current Assets = 3x.
3x − x = 4,00,000 ⇒ 2x = 4,00,000 ⇒ x = ₹2,00,000
Step 2 — Current Assets.
3 × 2,00,000 = ₹6,00,000
Step 3 — Quick Assets.
1.2 × 2,00,000 = ₹2,40,000
Step 4 — Inventory.
6,00,000 − 2,40,000 = ₹3,60,000
Step 5 — Working Capital Turnover Ratio.
20,00,000 ÷ 4,00,000 = 5 ⇒ Working Capital Turnover Ratio = 5 times
Checks: 6,00,000 ÷ 2,00,000 = 3 ✓; 2,40,000 ÷ 2,00,000 = 1.2 ✓; 6,00,000 − 2,00,000 = ₹4,00,000 ✓
Notice the story the numbers tell: the Current Ratio of 3:1 looks strong, but ₹3,60,000 of the ₹6,00,000 is inventory, so the Quick Ratio is only 1.2:1. Always read the two together.
One Question Better Than Yesterday
You have just met about twenty formulas. Nobody — not your teacher, not a chartered accountant, not the person who set your paper — learned them all in one evening. They learned them the way you will: one ratio at a time, worked properly, until the formula stopped needing to be recalled and simply arrived.
So here is the only study plan you need for this chapter. Tomorrow, do one question. Not ten. One. Write the formula, write the substitution, write the answer with its unit, and check it. If it is wrong, find the exact line where you went off and redo it from the top. Then close the book.
Do that every day and you will have done around two hundred and forty questions before the Board exam. That is more ratio practice than almost anyone in your class will have, and you will have got there without a single late night. Small, honest, daily improvement — the Japanese call it kaizen — beats heroic panic every single time.
One question better than yesterday. That is all. See you tomorrow.