financial analysis
DESCRIPTION
Financial analysis details - For CA IPCC students for FM subjectsTRANSCRIPT
3. FINANCIAL ANALYSIS & PLANNING
Learning Objective
Inter-Firm and Intra-Firm analysis
Brief note on use of Ratios in Cash Flow Statements
Financial Forecasting Technique
Tools of Financial Forecasting
Implementation
Functional management
Types of Financial Statement analysis
\
Whatever you can do, or drem you can do, begin it. Boldness has genius, power, and magic in it Begin it now
Goethe
Topper’s Institute Financial Analysis 3.2
Q.1 Who are the entities interested in Financial Statements Analysis?
Financial Statement Analysis is a meaningful interpretation of financial statements, in order to meet the information
requirements of the parties who use such financial information.
The users of financial information include:
(a) Management- for day to day decision making and also for performance evaluation.
(b) Proprietor / Shareholders -for analysing performance, profitability and financial position. Prospective
investors need to know track record of performance.
(c) Lenders -Banks and Financial Institutions -for determining financial position of the company, debt service
coverage etc.
(d) Suppliers -to determine the credit worthiness of the company in order to grant credit.
(e) Customers -to know the general business viability before entering into long-term contracts and
arrangements.
(f) Government -to ensure prompt collection of direct and indirect tax revenues, to evaluate performance and
contribution to social objectives.
(g) Research Scholars -for study, research and analysis purposes.
Q.2 What are the types of financial statement analysis?
Financial Statement Analysis may be of the following types:
(1) Internal and External Analysis :
Internal Analysis External Analysis
It is done within the Company, i.e. by the Corporate
Finance Department.
It is done by outside parties e.g. bankers, investors, suppliers
etc.
It is more extensive and detailed. It looks into all
aspects of functioning and performance.
It is restricted according to the requirements of the user. For
example, a trade creditor may be interested in the general
profitability and financial standing. A lender may be
interested in debt-service coverage etc.
(2) Horizontal and Vertical Analysis:
Horizontal Analysis Vertical Analysis
It involves comparison of financial statements of one
year with other years.
It involves analysis of relationship between various items
in the financial statements of one year.
Items are compared on a one-to-one basis, e.g. sales
increase, comparative net profit for two years etc.
Relationship between items i.e. ratios or percentages are
considered under this analysis.
(3) Inter-Firm and Intra-Firm analysis:
Inter-Firm Analysis Intra-Firm Analysis
It involves comparison of financial statements of one
firm with other firms.
It involves comparison of financial statements of one
firm for different time periods or different divisions of
the firm for the same year.
Q.3 Ratios are not everything in financial analysis. Outline the limitations of Financial Ratio Analysis.
Ratios are useful tools for financial analysis. However the following limitations do exist.
(a) Window Dressing: Ratios depict the picture of performance at a particular point of time. Sometimes, a business
can make year-end adjustments in order to result in favourable ratios (e.g. current ratio, operating profit ratio,
debt-equity ratio etc.)
Topper’s Institute Financial Analysis 3.3
(b) Impact of Inflation: Financial Statements are affected by inflation. Ratios may not depict the correct picture. For
example, fixed assets are accounted at historical cost while profits are measured in current rupee terms. In
inflationary situations, the Return on Assets or Return on Capital Employed may be very high due to less
investment amount of fixed assets. Ratios may not indicate the true position in such situations.
(c) Product Line diversification: Detailed ratios for different divisions, products and market segments etc. may not be
available to the users in order to make an informed judgement. For example, loss in one product may be set off
by substantial profits in another product line. But, the overall net profit ratio may be favourable.
(d) Impact of Seasonal Factors: When the operations do not follow a uniform pattern during the financial period,
ratios may not indicate the collect situation. For example, if the peak supply season of a business is between
February to June, it will hold substantial stocks on the balance sheet date. This will lead to a very favourable
current ratio on that date. But the position for the rest of the year may be entirely different.
(e) Differences in Accounting Policies: Different firms follow different accounting policies) e.g. rate and methods of
depreciation. Straight-jacket comparison of ratios may lead to misleading, results.
(f) Lack of Standards: Even though some norms can be set for ratios there is no uniformity as to what an "ideal" ratio
is. Generally it is said that Current Ratio should be 2:1. But if a firm supplies mainly to Government
Departments where debt collection period is high, the Current Ratio of 4:1 or 5:1, may also be considered
normal.
(g) High or Low: A number by itself cannot be 'high" or "low". Hence, a ratio by itself cannot become "good" or
"bad". The line of difference between "good ratio" and "bad ratio" is very thin.
(h) Interdependence: Financial Ratios cannot be considered in isolation. Decision taken on the basis of one ratio may
be incorrect when a set of ratios are analysed.
Q.4 Write a brief note on use of Ratios in Cash Flow Statements.
Cash Flow Statement can be prepared by reference to the Direct and Indirect Methods, as prescribed by the
Accounting Standard - 3 issued by the ICAI.
The ratios used in cash flow Statement Analysis are:
(a) Cash Generating Efficiency Ratios: It is the ability of the firm to generate cash from its current or continuing
operations. This may be measured by any of the following ratios:
Net Cash Flow from Operating Activities
(i) Cash flow yield = –––––––––––––––––––––––––––––––––
Net Cash Flow from Operating Activities
(ii) Cash flow Sales = –––––––––––––––––––––––––––––––––
Net Sales
Net Cash Flow from Operating Activities
(iii) Cash flow yield = –––––––––––––––––––––––––––––––––
Average Total Assets
(b) Free Cash Flow Ratios : Free cash flow represents the amount of cash that remains after deducting current
commitments and outflows. It is equal to the cash flow that remains after meeting current operating expenses,
interest, instalments (if any), income-tax, dividends and net capital expenditure. A positive free cash flow will
indicate that surplus funds are available for investment or repayment of debt. A negative free cash flow will
require sale of investments or raising of finance through loans or equity. The ratios based on free cash Flow are:
Price per share
(i) Price to Free Cash Flow = –––––––––––––––––––––––
Free cash Flow per Share
Operating Cash Flow
(ii) Operating Cash Flow to Profit = ––––––––––––––––––
Operating profit
Internal funding
(iii) Self financing investment ratio = –––––––––––––
Net Investment
Topper’s Institute Financial Analysis 3.4
Q.5. What is Financial Forecasting? Describe in brief, its utility and how it is affected.
Forecasting is the first stage in the financial planning process. This refers to the formal process of predicting future
events technique of determining in advance the requirements and utilisation of funds for a future period. It
While forecasting refers to finding the most profitable course of events or at best a range of probabilities, planning is
deciding what one will do about it. Planning deals with the futurity of present decisions in terms of (a) setting goals
and developing strategies to achieve them and (b) translating strategies into detailed operational programmes and
assuring that plans are carried out. The former one can be called as strategic planning, the other is termed as
programming.
Financial forecasting aims at pre-determining the demand for funds and the avenues wherein the funds are to be
utilised. Thus, a systematic projection of financial data is made in the form of projected financial statements with the
help of fund flow statements, ratio analysis etc. These projections are based on past record of the organisation with a
view to predict the future financial performance. Forecasting generates information which is utilised by the
management of an enterprise, for making proper decisions and for judging the financial efficiency of the funds and
projecting a scale of standards to be followed in the future course. Another objective of financial forecasting is to use
it as control device. Standards of financial performance of an enterprise could bc laid down through financial
forecasting for evaluating the results and assuring its growth. Optimum utilisation of funds can be achieved through
forecasting. A pre-testing of financial feasibility of implementation of production prospects or programmes can also
be made by rupees forecasting.
Through use of computers, financial forecasting has scaled new heights. Financial forecasting has utility for a
business organisation because
(i) It generates useful information for decision making.
(ii) It provides significant information for successful financial planning.
(iii) It facilitates the organisation to plan its growth and its financial needs.
(iv) It functions as a control device by providing a standard of financial performance for the future.
(v) It enables the organisation to make optimum utilisation of available funds/resources.
(vi) It makes the organisation to adopt appropriate financial policies.
(vii) It updates the financial plans periodically and make them relevant according to changing circumstances.
Financial forecasting uses the following tools: (a) Day's sales method (b) Percentage of sales method (c) Simple
regression method (d) Multiple regression method.
Financial forecasting helps an organisation in the preparation of statements like proforma income statement,
proforma balance sheet, funds flow statement, cash budget etc. as tools for long and medium term financial planning.
Q.6. Write a short note on Financial Forecasting Technique.
Financial forecasting is the starting point in a planning process. It facilitates pre-testing of the financial feasibility of
various programmes, acts as a control device, helps in funds, and improves utilisation of surplus cash.
A few forecasting techniques are briefly discussed as under:
(i) Percentage of Sales Method
It is the simplest approach to forecasting financial requirements of a firm. This method expresses the firm's financial
needs ill terms of the percentage of annual sales invested in each individual item of Balance Sheet. Under this
method, the forecaster computes past relationship between assets and liabilities on one hand and sales on the other on
the assumption that the same relationship will continue, he app lies new sales forecast figure to get an estimate the
financial requirements. This method is more suitable for short-term forecasting.
(ii) Simple Regression Method
An alternative method used to forecast financial requirements is the simple regression scatter diagram method. With
the sales forecast as the starting point and based on the past relationship between sales and Balance sheet items, it is possible to construct a line-of best it or the regression line. It is possible to link sales with one item of asset at a time.
This method is more suitable for long-term forecasting.
(iii) Multiple Regression Method
Topper’s Institute Financial Analysis 3.5
A more sophisticated approach to financial forecasting calls for the use of multiple regression analysis. Unlike simple
regression method, here sales are assumed to be a function of several variables. It is, therefore, a superior method.
Q.7 Write a short note on the Tools of Financial Forecasting:
(1) Days' sales method is a traditional method under which an attempt is made to calculate the number of. days sales
and tie it up with the balance sheet items. As different components of the balance sheet are forecasted in terms of
days's sale, this method measures the resources that are to be financed.
(2) Percentage of sales method is another tool of financial forecasting in which the balance sheet items are expressed
as percentages of sales. This will clearly (to some extent) show the financial needs caused by increase in sales.
(3) Simple regression method: On the basis of past relationship between sales and different items, a line of the best
fit is drawn. This method requires linking sales with one item at "a time. Thus data about different items can be
projected with changes in sales level for study and evaluation.
(4) Multiple regression method: In the case of simple regression method sales are considered as a function of one
variable. Multiple regression line is drawn considering the sales as a function of several variables.
A financial analyst may adopt any of the above techniques depending upon the availability of data and purpose of
forecasting.
Q.8 Mention a few symptoms which might indicate that industrial sickness lies ahead.
As far as the case of industrial sickness in India is concerned, the Tiwari Committee had identified certain symptoms
which would be quite helpful in the detection of sickness at the incipient stage. Such symptoms of sickness are
continuous irregularity in cash credit accounts, low capacity utilisation, profit fluctuations, downward trends in sales
and stagnation or fall in profits followed by contraction in the share of the market, high rate of rejection of goods
manufactured, reduction in credit summations failure to pay statutory liabilities, larger and longer outstanding in the
bill accounts, longer period of credit allowed on sale documents negotiated through the bank and frequent returns by
customers of the same, constant utilisation of cash facilities to the maximum and failure to pay timely instalment of
principal and interest on term loans and instalment credits non-submission of periodical financial data/stock
statements, etc. in time, financing capital expenditure out of funds provided for working capital purpose, rapid
turnover of key personnel, existence of a large number of law suits against the company rapid expansion and too
much diversification within a short time, sudden/frequent changes in management – whether professional or
otherwise and/ or dominated by on man/few individuals, diversion of funds for purposes other than running the unit,
any major change in the shareholdings.
Q.9 Briefly indicate the cause of industrial sickness in India.
Causes of Industrial sickness: The causes of industrial sickness in India may be broadly classified as follows:
A. Internal causes: Under this category, the following causes arc generally responsible' the industrial sickness in India.
(1) Planning
(a) Technical feasibility: Viz. Inadequate technical know- how, locational disadvantage, outdated production
process.
(b) Economic viability: High cost of inputs, break-even point too high, uneconomic of project, under-estimation of
the financial requirements, unduly large investment in fi assets, over-estimation of demand, poor labour
relations, lack of trained/skilled labour technically competent personnel.
(c) Marketing management: Dependence on a single customer or a limited number customers/single or a limited
number of products, poor sales realisation, defective pricing policy, booking of large orders at fixed prices in
an inflationary market, weak market feed back and market research. Lack of knowledge of marketing
techniques, unscrupulous sales/purchase practices.
(d) Financial management: Poor resources management and financial planning, faulty costing, liberal dividend
policy, general financial indiscipline and application of funds unauthorised purposes, deficiency of funds,
over-trading, unfavourable gearing or keeping adverse debt Equity-ratio, inadequate working capital, absence
of cost consciousness, lack of effective collection machinery.
Topper’s Institute Financial Analysis 3.6
(e) Administrative management: Over centralisation, lack of professionalism, lack of feed-back to management.
(2) Implementation: Cost over-runs resulting from delays in getting licences/sanctions, inadequate mobilisation of
finance.
(3) Functional management:
(a) Production management: Inappropriate product-mix, poor quality control, high of production, poor inventory
management, inadequate maintenance and replacement, of timely and adequate modernisation, etc., high
wastage, poor capacity utilisation.
(b) Labour-management relations: Excessively high wage structure, inefficient had of labour problems, excessive
manpower, poor labour productivity,
(c) Lack of proper manage information system and controls, lack of timely diversification, excessive expenditure
Research & Development, divided loyalties (where the same management has interest in than one unit, cases
are known where promoters of limited companies who also have own private interests first tend to look after
the interest of the latter, often at the cost former), dissension within the management, incompetent and
dishonest management. ,
B. External causes and other factors:
The following factors may be mentioned in this respect
(a) Government controls and policies, etc.: Government price controls, fiscal abrupt changes in Government
policies affecting costs/prices/imports/exports/licensing.
(b) Procedural delays on the part of financial/licensing/other controlling or regulation authorities like Banks,
Financial Institution, Government departments, Lice Authorities, MRTP authorities, etc.
(c) Market constraints : Market saturation, Revolutionary technological advances rendering the products
absolute, and Recession – fall in domestic/export demand.
Extraneous factors: Natural calamities, Political situation (domestic as well as international) and strikes and
multiplicity of labour unions etc.
Profitability Ratios Income statement
Sales
Material Consumed
Opening stock
Add. : Purchase
Less : Closing Stock
Wages
Carriage
Other direct exps.
Cost of sales
Gross profit
Admin. exps.
Selling exps.
Operating profit
non - operating Income
Non operating exps.
Net profit
Capital employed: Return
Equity share cap. Operating Profit Reserves & surplus Add: Non operating Income
Less: Fictitious assets: - Less: Non operating Exps.
Preliminary exps.
P/L A/C (Dr.) Profit before interest and tax (PBIT)
Equity Shareholder’s fund less: interest on long term fund
Add: Preference Share Capital Profit before tax (PBT)
Shareholder's fund Less: Provision for tax
Add: Debentures Profit after tax (PAT)
Topper’s Institute Financial Analysis 3.7
Long Term Loan Less: Preference Dividend
Gross Cap. employed Less: Non trading investment
Net capital employed (investment) Earnings available to Eq. Sh. holder
RATIO ANALYSIS
A. PROFITABILITY RATIOS BASED ON SALES
Ratio FORMULA NUMERATOR DENOMINATOR USEFULNESS 1. Gross Profit Ratio Gross Profit
Sales
Gross Profit as per Trading
Account
Sales net of returns Indicator of Basic
Profitability
2. Operating Profit ratio Operating
Profit
Sales
Sales Less : Cost of Sales
Sales net of returns Indicator of
Operating
Performance of
business.
3. Net Profit Ratio Net Profit
Sales
Net Profit Sales net of returns Indicator of
overall
profitability
B. PROFITABILITY RATIOS- OWNER'S VIEW POINT
1. Return on
Investment (ROI)
or Return on
Capital Employed
(ROCE)
Total
Earnings
Total
Capital
Employed
PBIAT Assets Route:
Net Fixed Assets (including
intangible assets like patents, but
not fictitious assets like
miscellaneous expenditure not
w/off)
+ Net working Capital
Liability Route:
Equity Share Capital
+ Preference Share Capital
+ Reserves & Surplus
+ Debentures and Long Term
Loans
Less: Accumulated Losses
Less: Non-Trade Investments
Overall profitability of the
business for the capital
employed; Indicates the
return on the total capital
Employed Comparison of
ROCE with rate of interest
of debt leads to financial
leverage. If ROCE >
interest Rate, use of debt
funds is Justified.
2. Return on Equity
[ROE]
Earnings
after Taxes
Net Worth
Profit After
Taxes
Net Fixed Assets
+ Net Working Capital invested
Less: External Liabilities (long
term
Profitability of Equity
Funds in the business.
3. Earnings Per
Share [EPS]
[PAT-Pref.
Divid.]
Number of
Equity
Shares
Profit After
Taxes Less
Preference
dividend
Number of Equity Shares
outstanding
Return or income per
share, whether or not
distributed as dividends.
4. Dividend per
Share [DPS]
Dividends
Number of
Equity
Share
Profits
distributed to
Equity
Shareholders
Equity Share Capital
Face Value per share
Amount of Profits
distributed per share
5. Return on Assets
[ROA]
Net Profit
after taxes Average
Total
Assets
Net Profit
after taxes
Average Total Assets i.e. ½ of
opening and closing Balance
Net Income per rupee of
average fixed assets.
C. TURNOVER / ACTIVITY / PERFORMANCE RATIOS
Topper’s Institute Financial Analysis 3.8
1 Capital
Turnover Ratio
Sales
Capital Employed
Sales net of
returns
Assets Route : Net
fixed asset
+ Net working
capital
Liability Route:
Equity Share Capital
+ Preference Share
Capital
+ Reserves &
Surplus
+ Debentures and
Long Term Loans
Less: Accumulated
Losses
Less: Non- Trade
Investments
Ability to generate sales per rupee of long-
term investment.
The higher the turnover ratio, the better it
is.
2. Fixed Assets
Turnover Ratio
Turnover
Fixed Assets
Sales net of
returns
Net Fixed Assets Ability to generate sales per rupee of
Fixed Asset.
3. Working
Capital
Turnover Ratio
Turnover
Net Working
Capital
Sales net of
returns
Current Assets Less
Current Liabilities
Ability to generate sales per rupee of
Working Capital.
4. Finished
goods or Stock
Turnover Ratio
Cost of Goods
sold
Average stock
For
Manufacturers
:
Opening
Stock
+ Cost of
Production
Less: Closing
Stock
For Trader:
Opening
Stock
+ Purchases
Less: Closing
Stock
(Opening stock +
Closing Stock)
2
or
(Max. stock + Min.
Stock)
2
Indicate how fast inventory is used/ sold.
A high turnover ratio generally indicates
fast moving material while low ratio may
mean dead or excessive stock.
5. Raw Material
Turnover ratio
Cost of Material
Consumed
Average stock of
RM
Opening stock
of RM
+ Purchases
Less: Closing
stock
(Opening stock +
Closing Stock)
2
Indicates how fast raw materials are used
in production.
6. Debtors
Turnover ratio
Credit Sales
Average A/c
Receivable
Credit Sales
net of returns
A/c Receivables =
Debtors + B/R
Average A/c
Receivable =
(Opening Bal. +
Closing Bal. )
2
Indicates speed of collection of credit
sales.
7. Creditor
Turnover ratio
Credit Purchases
Average A/c
Payable
Credit
Purchases net
of returns, if
any
A/c Payable =
Creditors + B/P
Average A/c
Payable =
(Opening Bal. +
Closing Bal. )
2
Indicates velocity of debt payment.
Note : The turnover ratios can also be computed in terms of days as 365 / Turnover Ratio. For example, Number of
days average stock is held = 365 / Stock Turnover Ratio
D. LIQUIDITY RATIOS - Short Term Solvency
Topper’s Institute Financial Analysis 3.9
Ratio Formula Numerator Denominator Significance I Indicator
1. Current
Ratio
Current Assets
Current Liabilities
Inventories
+ Debtors
+ Cash & Bank
+ Receivables /
Accruals
+ Short terms Loans
+ Marketable
Investments
Sundry Creditors (for
goods)
+ Outstanding Expenses
(for services)
+ Short Term Loans &
Advances (Cr.)
+ Bank over draft / Cash
Credit
+ Provision for taxation
+ Purpose or Unclaimed
Dividend
Ability to repay
short-term
commitments
promptly. (Short-
term Solvency)
Ideal Ratio is 2:1.
High Ratio
indicates existence
of idle current
Assets.
2. Quick
Ratio or Acid
Quick Assets
Quick Liabilities
Current Assets
Less: Inventories
Less: Prepaid Expenses
Current Liabilities
Less: Bank Overdraft
Less: Cash Credit
Ability to meet
immediate test ratio
liabilities. Ideal
Ratio is 1: 33: 1
3. Absolute
Cash Ratio
(Cash + Marketable
Securities)
Current Liabilities
Cash in Hand
+ Balance at Bank
(Dr.) + Marketable
Securities & short term
investments
Sundry Creditors (for
goods)
+ Outstanding Expenses
(for services)
+ Short Term Loans
&Advances (Cr.)
+ Bank Overdraft / Cash
Credit + Provision for
taxation
+ Proposed or Unclaimed
Dividend
Availability of cash
to meet short term
commitments.
4. Interval
Measure
Quick Assets
Cash Expenses Per Day
Current Assets
Less: Inventories
Less: Prepaid Expenses
Annual Cash Expenses
365
Cash Expenses = Total
Expenses less Depreciation
and write offs.
Ability to meet
regular cash
expenses.
E. CAPITAL STRUCTURE RATIOS - Indicator of Financing Techniques & long - term
solvency
1. Equity to
Total
Funds Ratio
Shareholde
r's Funds
Total
Funds
Equity Share
Capital
+ Preference
Share Capital
+ Reserves &
Surplus
Less:
Accumulated
Losses
Total Liabilities
(including Current
Liabilities & Provisions)
Indicates Long Term Solvency; mode of
financing; extent of own funds used in
operations.
2. Debt Equity
Ratio
Debt
Equity
Long Term
Borrowed
Funds, i.e.
Debentures,
Long Term
Loans from
institutions
Equity Share Capital
+ Preference Share
Capital
+ Reserves & Surplus
Indicates the relationship between Equity
debt & equity; Ideal ratio is 2: 1.
3. Capital
Gearing Ratio
Fixed
Charge
Bearing
Capital
Equity
Shareholde
r's Funds
Preference
Share Capital
+ Debentures
+ Long Term
Loans
Equity Share Capital
+ Reserves & Surplus
Less: Accumulated
Losses
Shows proportion of fixed charge
(dividend or interest) bearing capital to
equity funds; the extent of advantage or
leverage enjoyed by Equity shareholders.
Topper’s Institute Financial Analysis 3.10
4. Fixed
Assets to
Long Term
Fund Ratio
Fixed
Assets
Long Term
Fund
Net Fixed
Assets i.e.
Gross Block
Less:
Depreciation
Long Term Funds =
Shareholder's funds (as in
BI) + Debt funds (as in
B2)
Shows proportion of fixed assets (long-
term assets) financed by long term funds.
Indicates the financing approach followed
by the firm i.e. conservative, matching or
aggressive;
Ideal Ratio is less than one.
5. Proprietary
Ratio
Proprietary
Funds
Total
Assets
Equity Share
Capital
+ Preference
Share Capital
+ Reserves &
Surplus
Less:
Accumu1ated
losses
Net Fixed Assets
+ Total Current Assets
Less: Accumulated
Losses
Shows extent of owner's funds utilised in
financing assets.
Note: Proprietary Funds can be computed through two ways from the Balance Sheet:
Liability Route : [Equity Share Capital + Preference Share Capital + Reserves & Surplus] Less: Accumulated
losses
Assets Route: (Net Fixed Assets + Net Working Capital] Less: Long Term Liabilities.
F. COVERAGE RATIOS - Ability to Serve Fixed Liabilities
1. Debt
Service
Coverage
Ratio
Earnings for
Debt Service
(Interest +
Instalment)
Net Profit after
taxation
Add : Taxation
Add: Interest on
Debt Funds
Add: Non-cash
operating
Expenses (e.g.
depreciation and
amortization's)
Add: Non-operating
adjustment
(e.g. loss on sale of
fixed assets )
Interest on
Debt
Add:
Instalment of
Debt
(Principal
repaid)
Indicates extent of current earnings
available for meeting commitments and
outflow towards interest instalment. Ideal
ratio must be between 2 to 3 times
2. Interest
Coverage
Ratio
Earnings before
Interest & Tax
Interest
Earnings before
Interest and Taxes
=Sales Less Variable
and Fixed Costs
(excluding interest)
(or) EAT + Taxation
+ Interest
Interest on
Debt Fund
Indicates ability to meet Interest obligations
of the current year Should generally be
greater than 1.
3. Preference
Dividend
coverage
Ratio
Earnings after
Tax
Preference
Dividend
Earnings after Tax =
EAT
Dividend on
Preference
Share Capital
Indicates ability to pay dividend on
preference share capital.
Theory
Q.1. Indicate the important accounting ratios that would be used by each of the following : -
(i) A long term creditor interested in determining whether his claim is adequately secured.
(ii) A bank who has been approached by a company for short term loan / overdraft.
A shareholder who is examining his portfolio and who is to decide whether he should hold or sell his
shares in a company.
Topper’s Institute Financial Analysis 3.11
PRACTICAL PROBLEMS
Calculation of Ratios
Problem 1.
Following figures have been extracted from the final accounts of Sumant Ltd.:
Rs.
Sundry Creditors as on 31.3.1996 30,000 Bills Payable as on 31.3.1996 20,000
Purchases for the year ended 31.3.1996 3,00.000 Purchase Return for the above period 10,000
Sundry Creditors as on 31.3.1995 26,000 Bills Payable as on 31.3.1995 4,000
Taking year for 360 days, calculate: (i) Creditors Turnover Ratio (ii) Average Payment Period.
Solution
25.7000,40
000,90,2
/:
PBandCreditorsAverage
purchaseCreditRatioTurnoverCreditors
dayspurchasescreditdialyAverage
PBandCreditorsAveragePaymentAverage 50
000,90,2
360000,40/:
Working Notes:
1. Average creditors and B/P:
Opening Balance of creditors and B/P + Closing Balance of creditors and B/P
2
30,000 + 50,000
2 = Rs. 40,000.
2. Purchases less returns (net purchases) will be taken.
3. In the absence of information total purchases have been treated as credit purchases.
Problem.2.
The balance sheets of Pilcom Ltd. For the last 3 years read as below; (Rs. In lakh)
1994 1995 1996
Sources
Share Capital 2,000 2,000 3,000
(shares of Rs. 10 each)
Share Premium 1,500 1,500 500
Reserves 1,500 1,700 1,800
(after 10%dividend)
Long Term Loan 1,000 800 800
6,000 6,000 6,100
Represented by
Fixed Assets 2,000 2,500 3,000
Less : Depreciation 700 950 1,250
1,300 1,550 1,750
Capital Work-in-progress 800 900 700
Investments 200 200 200
2,300 2,650 2,650
Net Current Assets : Current Assets :
Debtors 1,700 1,800 1,850
Stocks 1,800 1,900 2,400
Cash & Bank 500 500 500
Topper’s Institute Financial Analysis 3.12
Others 400 600 1,400
4,400 4,800 6,150
Current Liabilities 700 1,450 2,700
3,700 3,350 3,450
Total Assets 6,000 6,000 6,100
Sales 3,900 4,000 5,000
Sales excludes excise duty and sales tax at 20%. Calculate for the years 1995 & 1996:
(i) Fixed Assets Turnover Ratio.
(ii) Stock Turnover Ratio
(iii) Debtors Turnover ratio in terms of number of days sales
(iv) Earnings per share.
Briefly comment on the performance of the company.
Solution 1995 1996
(i) 2.80 times 3.03 times
(ii) 2.16 times 2.33 times
(iii) 133 days 111 days
(iv) Rs. 2.00 Rs. 1.33
Problem 3.
The following extracts of financial information relate Curious Ltd. (Rs. In lakhs)
Balance Sheet as at 31st
December 1995 1994
Share Capital 10 10
Reserves and Surplus 30 10
Loans funds 60 70
100 90
Fixed Assets (Net) (A) 30 30
Current Assets
Stock 30 20
Debtors 30 30
Cash and Bank Balances 10 20
Other Current Assets 30 10
100 80
Less : Current Liabilities 30 20
Net Current Assets (B) 70 60
Total Assets 100 90
Sales (Rs. Lakhs) 270 300
(i) Calculate for two years, Debt-equity Ratio, quick Ratio, and Working Capital Turnover Ratio and
(ii) Find the sales volume that would have been generated in 1995 if the company has maintained
its Working Capital Turnover Ratio.
Solution
Debt Equity Ratio [1.5 times 3.5 times]; Quick Ratio [1.33 : 1], 2.5 : 1 ; Working Capital Turnover Ratio [3.86
Times, 5 times.]
Problem4.
The Balance Sheet of Y Ltd. Stood as follows:
Topper’s Institute Financial Analysis 3.13
Liabilities 31.3.95 31.3.94 Assets 31.3.95 31.3.94
Capital
Reserves
Loans
Creditors and
Other Current
Liabilities
250
116
100
129
250
100
120
25
Fixed Assets
Less: Depre.
Investment
Stock
Debtors
Cash/Bank
Other Current Assets
Misc. Expenditure
400
140
260
40
120
70
20
25
60
300
100
200
30
100
50
20
25
70
595 495 595 495
You are given the following information for the year 1994—95.
Sales 600 PBIT 150
Interest 24 Provision for tax 60
Proposed Dividend 50
From the above particulars calculate for the years 1994—95;
(a) Return on Capital Employed Ratio. (d) Stock Turnover Ratio
(b) Return on Net Worth Ratio. (e) Current Ratio
(c) Proprietory Ratio [CA Final]
[Ans. Return on capital employed 22.33%; Stock turnover ratio—5.45 times ; Return on net worth 22.53%; Current
ratio = 1.82 times; Proprietory ratio – 0.57.]
Problem 5.
Mr. T. Munim is made an offer by the promoters of Siva Enterprises Ltd. to invest in the project of the company by
purchasing a substantial portion of the share capital. He is promised good returns by way of dividends and capital
appreciation.
Mr. Munim desires that you compute the following ratios for the financial analysis. Workings should form part of
your answer.
1. Return on Investment Ratio; 2. Net Profit Ratio;
3. Stock Turnover Ratio; 4. Current Ratio;
5. Debt Equity Ratio;
The figure given to him are as under : (Rs. ‗000s)
Sales 16,000 Raw Materials Consumed 7,800
Consumables 800 Direct Labour 750
Other Direct Expenses 480 Administrative Expenses 1,200
Selling Expenses 260 Interest 1,440
Fixed Assets 14,000 Income – Tax 50%
Depreciation 700 Share Capital 5,000
Reserves & Surplus 1,500 Secured Term Loans 12,000
Unsecured Term Loans 1,500 Trade Creditors 3,350
Investments 400 Inventories 6,000
Receivables 3,700 Cash at hand & bank 100
Provisions 650 Other Current Liabilities 200
[CA Inter]
[Ans. (1) 13.625 % (2) 8.03 % (3) 1.64 times (4) 2.33 : 1 (5) 2.08 times.]
Topper’s Institute Financial Analysis 3.14
Problem 6. The following are the summarised Profit and Loss A/c of Hind Products Limited for the year ending 31s1 March
1994 and the Balance Sheet as on that date.
PROFIT AND LOSS ACCOUNT
Rs. Rs.
To Opening Stock 99,500 By Sales(Credit) 8,50,000
To Purchases 5,45,250 By Closing Stock 1,49,000
To Incidental Expenses 14,250
To Gross Profit 3,40,000
9,99,000 9,99,000
To Operating Expenses 1,95,000 By Gross Profit 3,40,000
To Non-Operating Expenses 4,000 By Non-Operating Income 9,000
To Net Profit 1,50,000
. 3,49,000 3,49,000
BALANCE SHEET
Liabilities Rs. Assets Rs.
Share Capital - Land and Building 1,50,000
2,000 Equity Share of Rs. 10 Plant and Machinery 80,000
each 2,00,000 Stock in Trade 1,49,000
Reserves 90,000 Sundry Debtors 41,000
Other Current Liabilities 90,000 Cash and Bank Balance 30,000
Profit and Loss A/c 60,000 Bills Receivable 30,000
Bills Payable 40,000
4,80.000 4,80.000
From the above statements you are required to calculate the following ratios:
(i) Gross Profit Ratio,
(ii) Net Profit Ratio,
(iii) Operating Profit Ratio,
(iv) Operating Ratio,
(v) Return on Capital Employed,
(vi) Net Profit to Fixed Assets Ratio,
(vii) Stock Turnover Ratio,
(viii) Receivable Turnover Ratio,
(ix) Creditors Turnover Ratio,
(x) Sales to Working Capital,
(xi) Sales to Fixed Assets,
(xii) Sales to Capital Employed,
(xiii) Return on Total Resources,
(xiv) Turnover of Total Assets.
Additional Information
Average Receivables Rs. 85,000
Average Payables Rs. 80,000
Topper’s Institute Financial Analysis 3.15
Solution
(i) Gross Profit Ratio 100Sales
ofitPrGross
= %,,
,,40100
000508
000403
(ii) Net Profit Ratio 100Sales
ofitPrGross %.
,,
,,6517100
000508
000501
(iii) Operating Profit Ratio 100Pr
Sales
ofitOperating %06.17100
000,50,8
000,45,1
(iv) Operating Ratio Sales
ensesexpOperatinggoodsofCost 100
%.,,
,,,,9482100
000508
000951000105
(v) Return on capital Employed 100Pr
EmployeedCapital
ofitoperting %43.41100
000,50,3
000,45,1
(vi) Net Profit to F A 100AssetsFixed
ofitPrNet %.
,,
,,2265100
000302
000501
(vii) Stock turnover Ratio InventoryAverage
soldgoodsofCost
2
gStocksinCloStockOpening
ofitPrGrossSales
times.,,
,,
,,,
,,,,14
250241
000105
2
000491500099
000403000508
(viii) Receivables Turnover Ratio ceivableReAverage
SalesCreditNet times
,
,,10
00085
000508
(ix) Creditors Turnover Ratio payableAccountAverage
PurchaseCredit times.
,
,,86
00080
200455
(x) Sales to Working Capital CapitalWorking
Sales 1087
000201
000508:.
,,
,,
(xi) Sales to Fixed Assets AssetsFixed
Sales 173
000302
000508:.
,,
,,
Topper’s Institute Financial Analysis 3.16
(xii) Sales to Capital Employed EmployedCapital
Sales 1432
000503
000508:.
,,
,,
(xiii) Return on total Resources 100AssetsTotal
ofitPrNet %.
,,
,,2531100
000804
000501
(xiv) Turnover on total Assets AssetsTotal
SalesNet 1771
000804
000508:.
,,
,,
Problem 7.
The following Balance Sheet of Rim Zim Ltd. as on 31st March, 1994 calculate (i) Current
Ratio, (ii) Quick Ratio (iii) Absolute Liquidity Ratio, (iv) Ratio of Inventory to Working Capital, (v) Ratio of Current
Assets to Fixed Assets (vi) Debt to Equity Ratio, (vii) Proprietary Ratio, (viii) Capital Gearing Ratio and (ix) Fixed
Assets Ratio.
BALANCE SHEET
Liabilities Rs. Assets Rs.
Equity Share capital 10,00,000 Goodwill (At cost) 5,00,000
6% Preference Share Capital 5,00,000 Plant and Machinery 6,00,000
General Reserve 1,00,000 Land and Building 7,00,000
Profit and loss A/c 4,00,000 Furniture and fixtures 1,00,000
Provision for Tax 1,76,000 Stock-in-trade 6,00,000
Bills payable 1,24,000 Bills Receivable 30,000
Bank Overdraft 20,000 Debtors 1,50,000
Creditors 80,000 Bank 2,00,000
12%debentures 5,00,000 Marketable Securities 20,000
29,00,000 29,00,000
Solution
(i) Current Ratio 152000004
0000010:.
,,.Rs
,,.Rs
sLiabilitieCurrent
AssetsCurrent
(ii) Quick Ratio 1051000803
000004:.
,,.Rs
,,.Rs
sLiabilitieLiquid
AssetsLiquid
(iii) Absolute Liquidity ratio 1550000004
000202:.
,,
,,
sLiabilitieCurrent
SecuritiesMarketableankBatCash
(iii) Inventory to Working Capital 11000006
000006:
,,
,,
CapitalWorking
Inventory
(iv) Current Assets to Fixed Assets 1:526.019:10000,00,19.
000,00,10.or
Rs
Rs
AssetsFixed
AssetsCurrent
(vi) Debt to Equity Ratio 12500000020
000005:.
,,
,,
fundss'rShareholde
DebtstermLong
or
Topper’s Institute Financial Analysis 3.17
(vii) Proprietary Ratio 169029200000029
0000020:.or:
,,
,,
AssetsTotal
fundss'rShareholde
(viii) Capital Gearing Ratio Surplus&servesReCapitalShareEquity
SecuritiesBearingerestintFixed
5110000015
0000010.:
,,
,,
(ix) Fixed Assets Ratio 1:76.0000,00,25.
000,00,19.
Rs
Rs
EmployedCapital
AssetsFixed
Problem 8.
From the following Balance sheet and the sub-joined information of a Company, you are required to calculate.
1. Current ratio
2. Quick ratio
3. Inventory turnover
4. Average collection period presuming 360 days in a year.
5. Owned funds to liabilities ratio.
Balance Sheet
Liabilities Rs. Assets Rs.
Share capital 2,00,000 Goodwill 1,20,000
Reserves and surplus 58,000 Plant and machinery 1,50,000
Debentures 1,00,000 Stock 80,000
Creditors 40,000 Debtors 45,000
Bills payable 20,000 Cash 17,000
Other current liabilities 2,000 Misc. Current assets 8,000
4,20,000 4,20,000
Sales (credit) for the year Rs. 4,00,000
Gross profit Rs. 1,60,000 [CS Dec. 98]
Solution Current Assets Rs. 1,50,000
(i) Current Ratio = –––––––––––––––– = –––––––––––– = 2.41 : 1
Current Liabilities Rs. 62,000
Current Assets = Stock + Debtors + Cash + Misc. current Assets
= Rs. (80,000 + 45,000 + 17,000 + 8,000) = Rs. 1,50,000
Current Liabilities = Creditors + Bills payable + other current Liabilities
= Rs. (40,000 + 20,000 + 2,000) = Rs. 62,000
(ii) Quick Ratio = sLiabilitieCurrent
Stock Closing - AssetsCurrent
1:129.1000,62
000,80000,50,1
Topper’s Institute Financial Analysis 3.18
Cost of goods sold Rs. 2,40,000
(iii) Inventory turnover = –––––––––––––––– = –––––––––––– = 3
Average Inventory Rs. 80,000
Cost of goods sold = Sales – Gross profit
= Rs. 4,00,000 – Rs. 1,60,000 = Rs. 2,40,000
Average Inventory = Rs. 80,000
Note: Opening inventory has not been given
(iv) Average collection period
Days in a year 360
= ––––––––––––– = –––––– = 40 days
Debtors turnover 9
Net credit sales Rs. 4,0,000 4,00,000
Debtors turnover = ––––––––––––––– = –––––––––– = –––––––– = 8.88 = 9 (approx)
Sundry debtors + B/R 45,000 + 0 45,000
2. Owned funds to Liabilities Ratio
Owned funds Rs. 2,58,000
= ––––––––––––– = –––––––––––– = 1.6 : 1
Liabilities Rs. 1,62,000
Own funds = Share capital + Reserve & Surplus
= Rs. 2,00,000 + Rs. 5,800
= Rs. 2,58,000
Liabilities = Debentures + Creditor + B/P + Other Current Liabilities
= Rs. (1,00,000 + 40,000 + 20,000 + 2,000) = Rs. 1.62,000
Problem 9.
The AB Company ‘s financial statements contain the following information:
31st March, 98 31
st March, 99
Cash 2,00,000 1,60,000
Sundry debtors 3,20,000 4,00,000
Temporary investments 2,00,000 3,20,000
Stock 18,40,000 21,60,000
Prepaid expenses 28,000 12,000
Total current assets 25,88,000 30,52,000
Total assets 56,00,000 64,00,000
Current liabilities 6,40,000 8,00,000
10% Debentures 16,00,000 16,00,000
Equity share capital 20,00,000 20,00,000
Retained earnings 4,68,000 8,12,000
Statements of Profit for the year ended 31st March, 1999
Rs.
Sales 40,00,000
Less: Cost of goods sold 28,00,000
Less: interest 1,60,000 29,00,000
Net profit for 1999 10,40,000
Less: Taxes @ 50% 5,20,000
5,20,000
Dividend declared on equity shares Rs. 2,20,000.
From the above figures, appraise the financial position of the Company from the points of view of (I) liquidity; (ii)
solvency; (iii) profitability and (iv) activity. [June-96]
Topper’s Institute Financial Analysis 3.19
Solution
I. Liquidity Ratios Current Assets
a. Current Ratio = ––––––––––––––
Current Liabilities
Rs. 25,88,000 Rs. 30,52,000
1998 = –––––––––––––––– = 4.04 1999 = –––––––––––– = 3.82
Rs. 6,40,000 Rs. 8,00,000
Quick Assets
b. Acid Test Ratio = ––––––––––––––
Current Liabilities
Rs. 7,20,000 Rs. 8,80,000
1998 = –––––––––––––– = 1.12 1999 = –––––––––––– = 1.1
Rs. 6,40,000 Rs. 8,00,000
II. Solvency Ratios Long-term Debts
a. Debt Equity Ratio = –––––––––––––––––
Shareholder‘s Funds
Rs. 16,00,000 Rs. 16,00,000
1998 = –––––––––––––– = 0.65 (approx) 1999 = –––––––––––– = 0.57(approx)
Rs. 24,68,000 Rs. 28,12,000
Profit before interest + Taxes
b. Interest Coverage Ratio = ––––––––––––––––––––––
Interest charges
Rs. 12,00,000
1999 = ––––––––––––– = 7.5 times
Rs. 1,60,000
III Profitability Ratios Net Profit
a. Net Profit Ratio = ––––––––––––– 100
Sales
Rs. 5,20,000
1999 = –––––––––––––– 100 = 13 %
Rs. 40,00,000
Net Profit before interest + taxes
b. Returns on capital employed = –––––––––––––––––––––––––––––– 100
Average capital employed
Rs. 12,00,000
1999 = –––––––––––– 100 = 28.3 %
Rs. 42,40,000
IV Activity Ratios Cost of goods sold Rs. 28,00,000
a. Stock turnover ratio = ––––––––––––––––– = –––––––––– = 1.4 times
Average Stock Rs. 20,00,000
Sales Rs. 40,00,000
b. Total assets turnover ratio = ––––––––––––– = –––––––––––– = 0.625 times
Total Assets Rs. 64,00,000
Topper’s Institute Financial Analysis 3.20
Comments: Company ‗s position is sound from the point of view of (i) Liquidity (ii) Solvency (iii) Profitability.
However its activity ratios do not seem to be adequate.
Problem 10.
Particulars 1st Case 2nd Case 3rd Case
Return 75,000 80,000 60,000
Sales 3,00,000 3,00,000 3,00,000
Capital Employed 2,00,000 2,25,000 1,75,000
Compute capital turnover Ratio, Net operating Profit ratio and applying Dupont analysis stat the relationship
between the two.
Solution
Case I Case II Case III
1. Capital Turnover Ratio
Turnover
Capital
31.5 Times
2
1.33 Times
1.71 Times
2. Net operating Profit Ratio
100Return
sales
75100 25%
300
= 26.67%
20%
3. ROI (1 × 2) 37.5% 35.47% 34.2%
Problem 11.
The profit margin of a company is 10% and the capital turnover is 3 times. What is the return on investment (ROI) of
the company? Applying Du Pont analysis, state by what percentage will the company's return on investment increase
or decrease if
(i) the profit margin increases by 2% (ii) the profit margin decreases by 2%;
(iii) the capital turnover increases by 1: and (iv) the capital turnover decreases by I?
[Ans.: ROI - 36%, 24%, 40%, 20%] [Increase/Decrease in ROI +6%, -6%, +10%, -10%]
Problem 12.
Compute the return on capital employed from the following data relating to company A and B applying Du Pont
analysis:-
A Company B Company
Net Sales for the year Rs.5,00,000 Not known
Capital Employed Not known Rs.1,00,000
Operating Profit on Sales 5% 6%
Turnover on Capital Employed 5 Times Not known
Gross Profit margin 30% Rs.90,000(15%)
[Ans: ROI: A- 25%; B-36%
Problem 13.
Calculate Absolute Cash Ratio from following information.
Yr.1 Yr.2
Rs. Rs.
Bank Balance 50,000 70,000
Cash 15,000 5,000
Investments (Total) 1,50,000 1,20,000
Current Liabilities 4,00,000 5,00,000
Trade Investments 20,000 30,000
Market value of quoted Total investments 1,35,000 96,000
Topper’s Institute Financial Analysis 3.21
Solution
Only Non-Trade Investments at its market value will be taken.
Yr.1 Yr.2
Total Investments 1,50,000 1,20,000
Less: Trade Investments 20,000 30,000
Non- Trade Investments 1,30,000 90,000
000201
0009000096
000501
000301000351ValueMarket
,,
,,
,,
,,,,
= Rs. 1,17,000 = Rs. 72,000
Comment: Absolute cash ratio has declined from .46 to .29. This indicates that availability of cash to pay firm‘s current
liabilities has sharply declined.
Problem 14.
Relevant figures derived from the Balance sheet of A Ltd. as on 31.3.1996 are as under: Total Assets (including
preliminary Expenses of Rs. 10 lacs) = Rs. 190 Lacs
Cash in hand. = Rs. 5 Lacs
Bank Balance. = Rs. 12 Lacs
Total Investments. = Rs. 6 Lacs.
Details of Investments: Trade -Rs. 4 Lacs, Non- Trade Rs. 2 Lacs, Quoted Rs. 3 Lacs out of which Non- Trade is Rs.
1.50 Lacs. Market quotations are Rs. 4.50 Lacs of which Rs. 1.75 Lacs are ) for Non- Trade Investments. Other
investments are not readily marketable. Calculate Cash Position to Total Assets Ratio. Industry average of the ratio is
.18.
Solution
Cash position to Total Assets Ratio = Cash Reservoir
Total Assets
Cash Reserve:
Rs. (in Lacs) Cash in hand 5.00
Bank Balance 12.00
Non- Trade Investments in marketable securities. 1.75
18.75
Total Assets:
Assets as given. 190.00
Less: Preliminary Expenses. 10.00
180.00
Add: Increase in value of marketable non-trade investments. 0.25
180.25
Cash position to Total assets Ratio = 18.75 / 180.25 =.10
Comment: Industry average of the ratio is .18, where as ratio of the firm is only .10. This shows firm is maintaining
low cash balance. This may adversely affect firm's capacity to pay its current liabilities and meet day to day
expenses.
Absolute Cash Ratio =Cash + Non - Trade marketable securities
Current Liabilities
Topper’s Institute Financial Analysis 3.22
Problem 15.
The following data is available from the records of X Ltd. and Y Ltd. in the same industry the year ended 31st
March, 2000: (Rs. '000)
X Ltd. Y Ltd.
Assets
Plant and machinery 6,780 9,600
Stock 4,920 3,800
Debtors 1,320 2,520
Cash 840 1,280
13,860 17,200
Liabilities
Equity share capital 4,400 7,000
Retained earnings 3,860 2,000
10% debentures 2,000 4,000
Sundry Creditors 3,600 4,200
13,860 17,200
Sales 22,400 32,800
Cost of goods sold 16,000 25,800
Other operating expenses 3,200 3,440
Interest expenses 200 400
Income tax 1,500 1,580
Dividend . 400 720
You are required to calculate the relevant ratios and answer the following questions:
(i) Which of the companies is able to meet its current debts in a better way?
(ii) Which of the companies collects its receivables faster, assuming all sales are on credit basis?
(iii) Which of the companies is making more profitable use of the shareholders' money?
(iv) If you have to purchase the debentures of one of the companies, which company would be preferred by you?
(v) Which of the companies retains a larger proportion of its income in the business?
[Ans.: X Ltd.]
Problem 16.
Following is Profit and Loss account of A. B. C. Ltd. for the year ended 31st March. 1996,
Rs. Rs.
To Opening stock 4,00,000 By Sales 24,00,000
To Purchases 16,00,000 By Closing stock. 8,00,000
To Gross Profit 12.00.000
32.00.000 32,00,000
To salaries, allowance and bonus 3,20,000 By Gross Profit 12,00,000
To Stationery 32,000
To Telegrams, Postage Telephones 8,000
To Advertisements 8,000
To Commission 4,000
To Depreciation 16,000
To Preliminary expenses written off 4,000
To Loss on sale of fixed assets 8,000
To Provision for taxation 4,00,000
To Net Profit 4,00,000
12,00,000 12,00,000
Advance tax paid Rs. 3,40,000, Cash Reservoir Rs. 1,40,000. Find out average daily cash expenses and calculate
cash interval.
Topper’s Institute Financial Analysis 3.23
Solution
Average daily cash expenses: Rs.
Expenses as per Profit and Loss Account excluding non-cash items:
Purchases 16,00,000
Salaries, allowances, bonus 3,20,000
Stationery 32,000
Telegrams, postage, telephones 8,000
Advertisements 8,000
Commission 4,000
19,72,000
Add Advance tax. 3,40,000
23,12,000
-Average daily expenses = 23,12,000 / 365 = Rs. 6.334
Cash Interval = Cash Reservoir
Average daily cash expenses = 1,40,000/ 6,334 = 22 days.
Problem 17.
A business furnishes you with the following details:
(i) Opening Stock Rs. 50,000
(ii) Closing Stock Rs. 70,000
(iii) Sales:
Credit Rs. 2,10,000
Cash Rs. 1,50,000
(iv) Gross profit Rs. 60,000
(v) Year end debtors Rs. 20,000
Less: Provision Rs. 2,000
For bad debts 18,000
(iv) Year end bills receivable Rs. 15,000
A year may be taken to be of 360 days. You are asked to:
(i) Work out stock turnover and debtors turnover ratios.
(ii) Calculate the operating cycle and state its significance. [CA Nov'99]
Analysis of Ratio
Problem 18.
You have the following information on the performance of Prosper Co., as also industry averages:
(i) determine the indicated ratios for the Prosper Co. ; and
(ii) indicate the company's strengths and weaknesses as shown by your analysis.
Balance Sheet as on 31st December, 1998
Liabilities Rs. Assets Rs. Equity share capital 24,00,000 Net fixed assets 12,10,000
10% debentures 4,60,000 Cash 4,40,000
Sundry creditors 3,30,000 Sundry debtors 5,50,000
Bills payable 4,40,000 Stock 16,50,000
Other current liabilities 2,20,000
38,50,000 38,50,000
Topper’s Institute Financial Analysis 3.24
Statement of Profit for the year ending 31st December, 1998
Rs. Sales 55,00,000
Less: Cost of goods sold:
––Materials 20,90,000
––Wages 13,20,000
––Factory overheads 6,49,000 40,59,000
Gross Profit 14,41,000
Less: Selling & distribution cost 5,50,000
Administration and general
expenses 6,14,000 11,64,000
Earning before Interest and taxes 2,77,000
Less: Interest charges 46,000
Earnings before taxes 2,31,000
Less: Taxes (50%) 1,15,500
Net Profit 1,15,500
Ratios considered: Industry
Current assets/current liabilities 2.4
Sales/debtors 8.0
Sales/stocks 9.8
Sales/total assets 2.0
Net profit/sales 3.3%.
Net profit/total assets 6.6%
Net profit/net worth 10. 7%
Total debts/total assets 63.5%
[CS June-91]
Solution
Company strength:
(a) Current ratio is better than that of industry.
(b) Sales / Debtors ratio indicates that the debts collection period of the company is better than that of industry.
Company's weakness:
(a) As for the industry's standard the stock should have been Rs. 5,61,224 (55,00,000/9.8). But the company's
stock was Rs. 16,50,000 i. e. three times more. Thus it is seen that the greatest weakness of the company is
the high level of inventories.
(b) The high level of inventory leads 10 a decline in the Sales / Total assets Ratio.
(c) The cost of high level of inventory affects the profitability in an adverse manner.
(d) Due to low profitability the ratio at 5,6 &7 are also lower than those of the industry.
(e) The Net Profit / Net Worth is low because1he company is using less amount of debts i.e. 37.7 % as
compared to the industry's figure of 63.5%.
Remedial Action
The stock should be maintained at Rs. 5,50,000 i. e. stock should be reduced by Rs. 11,00,000. If it is reduced the
ratios at 3 & 4 will be as follows:
Sales Rs. 55,00,000
–––––––– = –––––––––––––– = 10.0
Stock Rs. 5,50,000
Sales Rs. 55,00,000
–––––––––– = ––––––––––– = 2.0
Total Assets Rs. 27,50,000
Topper’s Institute Financial Analysis 3.25
Due to reduction in stock level the profitability of the company will improve. Further debentures can be obtained.
This will improve the ratio of Net Profits / Net Worth. To sum up reduction of stock and increase of debt will be
highly beneficial to the company.
Problem 19.
Given below are cash position ratios of MRD Ltd. and the Industry Average. Industry Average is arrived at by taking
average position of 25 companies of the similar trade :
Absolute Cash ratio Cash Position to total Cash interval
Assets ratios
MRD. Ltd. 0.36 12.50% 25 days
Industry Average 0.30 15% 33 days
How do you feel about the cash position of MRD Ltd.?
[Ans. (i) Absolute cash ratio is better than industry average.
(ii) Cash position to total assets ratio of MRD Ltd. is lower than that of industry.
(iii) Overall assessment: it can be concluded that MRD Ltd. is maintaining low cash position.]
Problem 20.
On the basis of the following figures derived from the accounts of a company; prepare a report on the level of
efficiency of financial and operational management of the company:
Years Capital Net Profit ROI Current
Turnover on Sales (%) Ratio
Ratio (%)
1 1.0 8 8 6.0
2 2.0 10 20 4.0
3 3.0 11.5 34.5 2.0
4 5.0 13 65 0.5
[June 86]
Solution To,
The Managing Director
Sub.:- Level of efficiency of financial and operational management
Sir,
After analysing the figures derived from the accounts of our company I have come on the point that the level of
efficiency on financial and operational management of the company are as follows.
1st year
In the first year there is poor utilisation of the available capital as the capital turnover ratio is very low. While the
current ratio is too high which also indicates that company did not utilised its funds. Considering these two ratios, it
can be concluded that there is a case of over capitalisation. The percentage of net profit on sales and ROI are also not
upto mark.
2nd
year
In the second year though there is improvement in all the ratios so there is very much scope for reduction in current
ratio and improvement in the capital turnover ratio.
3rd
year
In the third year the capital turnover ratio has gone upto 3:0 and current ratio has come down to 2:0 which indicates a
good situation in this year. ROI is also excellent at 34.5 %.
4th
year
In the fourth year as the capital turnover ratio, percentage of net profit on sales and ROI are very high. i.e. 5.0, 13,
65. As current ratio has come down to 0.5 this shows that there was no sufficient working capital to meet the
Topper’s Institute Financial Analysis 3.26
financial liabilities of the company, which is not a good situation. So efforts should be made to improve the current
ratio to 2.
Final conclusion
It is advised to maintain these ratios in the fourth year and improve the current ratio to 2 by ploughing back profits
for meeting the working capital requirement.
Yours faithfully
Date Sd/-
Management Accountant
Problem 21.
A Ltd. and B Ltd. are two Companies belonging to the same industry. In 1988—89 each of them has maintained the
inventory almost at the same level at which its inventory stood at the beginning of the year. The industry has
developed the following accounting ratios for inter firm comparison.
Current Ratio 1.8‘ Liquid Ratio 1.1 (liquid liability is taken after excluding overdraft); Gross Profit Ratio to sales .25
(after considering only material cost) Return on own capital 40; Debtors velocity 80 days Creditors Velocity 75 days
and stock Velocity 4.
From the following details of A Ltd. and B Ltd. relating to 1988—89, comment upon the financial management and
operational efficiency of the two companies in terms of the norms for the industry as stated above.
A Ltd. B Ltd
Sales Rs. 250 lakhs Rs. 200 lakhs
Bank overdraft Rs. 25 lakhs Rs. 10 lakhs
Debtors velocity 3 months 2 months
Gross profit % on sales (considering only material cost) 20% 30%
Stock Rs. 35 lakhs Rs. 40 lakhs
Expenses Rs. 30 lakhs Rs. 25 lakhs
Own capital velocity (with respect to sales) 8 2
Trade creditors Rs. 65 lakhs Rs. 28 lakhs
Expenses creditors Rs. 3 lakhs Rs. 2 lakhs
Liquid assets (other than Book Debts) Rs. 4 lakhs Rs. 8 lakhs
Note : For calculation of velocity in days 365 days in a year have been considered in all the cases.
[CA May 1989]
Solution A Ltd. Profit & Loss Account
To Cost of Sales (80%) of sales 200.00 By Sales 250.00
(Material consumed)
To Gross Profit (20%) of sales 50.00
250.00 250.00
To Expenses (12%) of sales 30.00 By Gross Profit 50.00
To Profit before Interest and Tax
(8% ) of sales 20.00
50.00 50.00
Balance Sheet as on
(Rs. in Lakhs)
Liabilities Amount Assets Amount
Own Capital
Bank Overdraft
Trade Creditors
Expense Creditors
31.25
25.00
65.00
3.00
Fixed Assets
(balancing figure)
Stock
Liquid Assets
Debtors
22.75
35.00
4.00
62.50
124.25 124.25
Topper’s Institute Financial Analysis 3.27
B Ltd.
Profit & Loss Account
To Material consumed 140.00 By Sales 200.00
To Gross Profit (30%) of sales 60.00
200.00 200.00
To Expenses (12.5%) of sales 25.00 By Gross Profit 60.00
To Profit before Tax
(17.50% ) of sales 35.00
60.00 60.00
Balance Sheet as on (Rs. in Lakhs)
Liabilities Amount Assets Amount
Capital own
Bank Overdraft
Creditors
Expense for Creditors
100.00
10.00
28.00
2.00
Fixed Assets
(balancing figure)
Stock
Liquid Assets
Debtors
58.67
40.00
8.00
33.33
140.00 140.00
Notes:
(i) It has been assumed that expenses include interest cost.
(ii) In the absence of information about tax, it has been assumed that return on capital computed is before tax.
Statement showing relevant ratios of industry Averages, A Ltd. and B Ltd. and comments thereon
Ratio Industry
Average
A Ltd. B Ltd.
Current Ratio: Current Assets/Current Liabilities
1.8 101.50
1.0993
81.33
2.0340
Liquid Ratio: Quick Assets / Quick Liabilities
(CL-Bank overdraft)
1.1 66.50
.9968.00
41.33
1.3830
Gross Profit Ratio: Gross Profit/Sales × 100
Return on Own Capital
Profit / own capital × 100
25%
40%
50100 20%
250
20100 64%
31.25
60100 30%
200
%35100100
35
Debtors’ velocity (in days): 365/credit sales × closing debtors
80 days 365
62.50 91 days250
365
33.33 61 days200
Creditors’ Velocity (in days): 365/credit purchase × closing creditors
75 days 365
65 119 days200
365
28 73 days140
Stock Velocity (time): Cost of Goods sold/Closing stock or
Average stock
4
2005.71
35
1403.5
40
Current ratio indicates short term financial position of a firm. A Ltd‘s current ratio (1.09) is much below the industry
average of 1.8 indicating weak short term financial position, whereas B Ltd. s‘ current ratio of 2.03 above the
industry average points towards its sound short-term financial position. It may be noted that the generally accepted
current ratio is 2 : 1
Liquid ratio of 0.98 (taking current liability without bank overdraft) of A Ltd, is also below industry average of 1.1,
indicating that the company does not possess adequate liquidity to pay current liabilities at a given point of time even
after excluding overdraft. The liquidity ratio of B Ltd (1.38) is better than industry average of 1.1, showing much
better short term solvency position than that of A Ltd. and also in comparison to industry as a whole.
Topper’s Institute Financial Analysis 3.28
A Ltd. is earning 5% less gross profit than industry average whereas B Ltd. is earning 5% more than industry
average. It shows that operational efficiency, particularly management of purchase of B Ltd. is higher than that of A
Ltd. and also better than industry average.
A Ltd. ‗s debtors‘ velocity is lower than industry average. However, debtors‘ velocity of B its is slightly better than
that of A Ltd. and in comparison to industry average.
A Ltd. shows much higher return on own investments i.e. 64% in spite of lower net profit ratio. It has been possible
mainly because of higher fixed assets turnover ratio, apart from higher stock Velocity. B Ltd. ‗s return on investment
is lower than industry average. It may be explained by lower fixed assets turnover and lower stock velocity.
A Ltd. is taking 119 days to pay its creditors against the industry average of 75 days. It may partly responsible for
paying higher purchase price resulting in lower GP ratio. B Ltd. is taking 73 days to pay its creditors four days less
than industry average. It may be said that it is making timely payment to its creditors enjoying better credit
worthiness.
Higher stock velocity of A Ltd. (5.71) as compared to industry average of 4, shows comparatively less investment in
stock. B Ltd.‘s stock velocity of 3.5 is below industry average indicating relatively more investment in stock.
In conclusion, it may be said that B Ltd. has better financial management and operational efficiency in comparison to
A Ltd. It is also surprising why it has heavy investment in fixed assets
Problem 22.
The Balance Sheets of A Ltd. and B Ltd. as on 31st March 1994 are as follows:
Liabilities A Ltd. B Ltd.
Share Capital 40,00,000 40,00,000
Reserves & Surplus 32,30,000 25,00,000
Secured Loans 25,25,000 32,50,000
Current Liabilities & Provisions :
Sundry Creditors 15,00,000 14,00,000
Outstanding Expenses 2,00,000 3,00,000
Provision for Taxation 3,00,000 3,00,000
Proposed Dividend 6,00,000
Unclaimed Dividend 15,000 —
1,23,70,000 1,17,50,000 Assets
Fixed Assets Less Depreciation 80,00,000 50,00,000
Investments 15,00,000 —
Inventory at cost 23,00,000 45,00,000
Sundry Debtors — 17,00,000
Cash and Bank 5,70,000 5,50,000
1,23,70,000 1,17,50,000
Additional information available:
(i) 75% of the Inventory in A Ltd. readily saleable at cost plus 20%
(ii) 50% of Sundry Debtors of B Ltd. are due from C Ltd. which is not in a position to repay the amount B Ltd.
agreed to accept 15% debentures of C Ltd.
(iii) B Ltd. had also proposed 15% dividend but that was not shown in the accounts.
(iv) At the year end, B Ltd. sold investments amounting to Rs. 1,20,000 and repaid Sundry Creditors.
On the basis of the given Balance Sheet and the additional information, you are required to evaluate liquidity of the
companies. All working should form part of the answer.
Solution Particulars A B
CA. Stock (23,00,000 × 75%) + 20%
Debtor (17,00,000 × 50%)
Cash & Bank
20,70,000
-
5,70,000
-
8,50,000
5,50,000
Topper’s Institute Financial Analysis 3.29
Liquid Assets
Stock(23,00,000 × 25%) 26,40,000
5,75,000 14,00,000
45,00,000
Total CA 32,15,000 59,00,000
CL
Proposed Dividend
Creditor
Out Exp.
Provision for tax
Unclaimed Dividend
6,00,000
15,00,000
2,00,000
3,00,000
15,000
6,00,000
15,20,000
3,00,000
3,00,000
-
26,15,000 27,20,000
Evaluation of Liquidity
A B
1. CL
CARatioCurrent
32,15,0001.23
26,15,000
59,00,0002.17
27,20,000
2. CL
LARatioLiquid 009.1
000,15,26
000,40,26 51.
000,20,27
000,00,14
Problem 23.
Mr. Smarty intends to supply goods on credit to Surya Ltd. and, Chandra Ltd. The relevant financial data relating to
the companies for the year ended 31st December; 1998 are as follows:
Surya Ltd. Chandra Ltd.
Terms of payment 3 months 3 months
(Started) (Rs.) (Rs.)
Stock 8,00,000 1,00,000
Debtors 1,70,000 1,40,000
Cash 30,000 60,000
Trade creditors 3,00,000 1,60,000
Bank overdraft 40,000 30,000
Creditors for expenses 60,000 10,000
Total purchases 9,30,000 6,60,000
Cash purchases 30,000 20,000
Advise with reasons, as to which of the companies he should prefer to deal with. [CS Dec.-87]
Solution
First of all Let us find out current ratio, liquid ratio, creditors velocity and average credit period as follows.
Surya Ltd. Chandra Ltd.
Rs. Rs.
Debtors 1,70,000 1,40,000
Cash 30,000 60,000
Liquid Assets 2,00,000 2,00,000
Stock 8,00,000 1,00,000
Current Assets 10,00,000 3,00,000
Trade creditors 3,00,000 1,60,000
Bank overdraft 40,000 30,000
Creditors for expenses 60,000 10,000
Current liabilities 4,00,000 2,00,000
(i) Current ratio: Surya Ltd. Chandra Ltd.
Rs. Rs.
Current Assets 10,00,000 3,00,000
Current Liabilities 4,00,000
2,00,000
= 2.5 = 1.5
(ii) Liquid Ratio (Including Bank overdraft)
Topper’s Institute Financial Analysis 3.30
Liquid Assets Rs. 2,00,000 Rs. 2,00,000
= –––––––––––––– = ––––––––––– = ––––––––––––
Current Liabilities Rs. 4,00,000 Rs. 2,00,000
= 0.50 = 1.00
(iii) Creditor's Turnover Ratio
Credit purchases Rs. 9,00,000 Rs. 6,40,000
= –––––––––––––– = –––––––––––– = ––––––––––––
Trade creditors Rs. 3,00,000 Rs. 1,60,000
= 3 times = 4 times.
(iv) Average Credit Period:
Days in a year 365 365
–––––––––––––––––––– –––– ––––
Creditor's Turnover Ratio 3 4
= 122 days = 91 days
After calculating all above ratio we see that liquid ratio, creditors velocity and average credit period are better in case
of chandra Ltd.
Terms of payment: 3 months chandra Ltd. is following this as the average credit period in this case is 91 days.
Though Current Ratio is better, Surya Ltd. is not reliable in regard to liquidity, creditors velocity and Average credit
period which is of 4 months instead of 3 months. That means Surya Ltd. is discharging liabilities in an average period
of 4 months.
So my advise is to deal with chandra Ltd. due to above reasons.
Problem 24.
Assuming the current ratio is 2, state and explain in each of the following cases whether the current ratio will
improve or decline or will have no change:
(i) Payment of a current liability;
(ii) purchase of fixed assets;
(iii) cash collected from customers;
(iv) bills receivable dishonoured; and
(v) issue of new shares. [CS Dec. 90]
Solution
Current Ratio = 1:2sLiabilitieCurrent
AssetsCurrent
Let us assume current assets are Rs. 21akhs and current liabilities are Rs. 1 lakh.
(i) Payment of a current liability: Current ratio will improve:- When current ratio is 2 : 1, payment of current liabilities will
reduce in the same amount in the numerator and denominator. Hence current ratio will improve. Exp. Payment of
current liability = Rs. 10,000
then current asset = Rs.1 ,90,000
current liability = Rs. 90,000
Current Ratio = 1:2000,90.
000,90,1.
Rs
Rs
(ii) Purchase of fixed assets
(a) On Cash for Rs. 10,000
Current liabilities = Rs. 1,00,000
Then Current Asset = Rs. 1,90,000
Topper’s Institute Financial Analysis 3.31
Current Ratio = 9.1000,06,1.
000,90,1.
Rs
Rs
Current ratio will decline.
(b) On Credit for Rs. 10,000
Current liabilities = Rs. 1,10,000
Then Current Asset = Rs. 2,00,000
Current Ratio = 82.1000,10,1.
000,00,2.
Rs
Rs
Current ratio will decline
Note: In both the cases i.e. purchase of fixed asset on cash or on credit current ratio will decline.
(iii) Cash collected from customers: Current ratio will not change.
Reason: Cash will increase and debtors will decrease. Hence no change in current assets.
(iv) Bills receivable dishonoured: Current ratio will not change. Reason: Bills receivable will come down and debtors will
increase. Hence no change in current assets.
(v) Issue of new shares: Current ratio will improve.
Example: Issue of new shares for Rs. 20,000 cash. Cash will increase by Rs. 20,000 and consequentially increase in
current assets.
Current ratio = 2.2000,00,1.
000,20,2.
Rs
Rs
Problem 25.
Following figures are available from the accounts of a large industrial unit. Compute relevant ratios to assess the
efficiency of working capital management for 1999-2000 and 2000-01.
(Rs. crores)
Particulars 1998-99 1999-2000 2000-2001
Inventories 50.0 52.5 65.0
Debtors 67.0 57.0 77.0
Other current assets 5.0 15.0 20.0
Cash and bank balances 30.0 10.0 15.0
Total 152.0 134.5 177.0
Current liabilities 52.0 54.5 72.0
Net working capital 100.0 80.0 105.0
Sales 300.0 300.0 340.0
Total assets 220.0 200.0 240.0
(CWA Dec., 1994)
Solution Working Notes:
(Rs. crores)
1. Average Inventory (Op. Stock + Closing Stock)/2
1999-2000 (50 + 52.5)/2 51.25
2000-2001 (52.5 + 65)/2 58.75
2. Average Debtors (Op. Balance + Closing Balance)/2
1999-2000 (67 + 57)/2 62
2000-2001 (57 + 77)/2 67
3. Average Working Capital (Op. Balance + Closing Balance)/2
1999-2000 (100 + 80)/2 90
Topper’s Institute Financial Analysis 3.32
2000-2001 (80 + 105)/2 92.5
4. Average Current Assets (Op. Balance + Closing Balance)/2
1999-2000 (152 + 134.5)/2 143.25
2000-2001 (134.5 + 177)/2 155.75
Computation of Ratios for assessment of Working Capital (Rs. crores)
Particulars 1999-2000 2000-2001
1. Current Ratio (Current assets/Current liabilities) (134.5/54.5) (177 /72)
= 2.47 = 2.46
2. Liquid Ratio (Current Assets -Inventory/Current Liabilities) (134.5- 52.5)/54.5 (177- 65)/72
= 1.50 = 1.56
3. Current Assets to Total Assets (Current assets/Total assets) (134.5/200) (177/240)
= 0.67 = 0.74
4. Inventory turnover ratio (Sales/Average inventory) (300/51.25) (340/58.75)
= 5.85 = 5.79
5. Debtors Turnover Ratio (Sales/Average debtors) (300/62) (340/67)
6. Current Assets Turnover Ratio (Sales/ Average current assets) (300/143.25) (340/155.75)
= 2.09 = 2.18
7. Working Capital Turnover Ratio (Sales/ Average net working capital) (300/90) (340/92.5)
= 3.33 = 3.68
B. Financial Statement
Problem 26.
Assume that a firm has owners' equity of Rs. 1,00,000. The ratios for the firm are:
Current debt to total debt .40
Total debt to owners' equity .60
Fixed assets to owners' equity .60
Total assets turnover 2 times
Inventory turnover 8 times
Complete the following balance sheet, given the above information.
Liabilities Rs. Assets Rs. Current debt ………. Cash ……….
Long-term debt ………. Inventory ……….
Total debt ………. Total current assets ……….
Owners' equity ………. Fixed assets ……….
Total Capital ………. Total assets ……….
Solution
Equities Rs. Assets Rs Current debt 24,000 Cash 60,000
Long-term debt 36,000 Inventory 40,000
Total debt 60,000 Total current assets 1,00,000 Owners' equity 1,00,000 Fixed assets 60,000
Total Capital 1,60,000 Total assets 1,60,000
Total Debt = 1,00,000 X 0.6 = 60,000
Current Debt = 60,000 X 0.4 = 40,000
Topper’s Institute Financial Analysis 3.33
Fixed Assets = 1,00,000 X 0.6 = 60,000
Problem 27.
Complete the following annual financial statements on the basis of ratios given below :-
Profit and loss account for the year ended 30th
June, 1990
Dr. Rs. Cr. Rs. To cost of goods sold 6,00,000 By Sales 20,00,000
― Operating Expenses ---
― Earning before interest
and Tax ---
-----
To Debenture Interest 10,000 By Earnings before
― Income – tax --- Interest & tax
― Net Profit ---
--- -----
Balance Sheet as at 30th
June, 1990
Rs. Rs.
Net Worth : Fixed Assets ----
Share Capital ----- Current Assets:
Reserve & Cash -----
Surplus ----- Stock -----
10% Debentures ----- Debtors 35,000
Sundry Creditors 60,000 _______
Net Profit to sales 5% Current Ratio 1.5 times
Return on net worth 20% Inventory turnover (based on cost of goods sold) 15 times
Share capital to reserves 4:1 Rate of Income- tax 50
Solution P/L Account
To Cost of good sold
To Operating Exp
EBIT
6,00,000
11,90,000
2,10,000
By Sales
20,00,000
20,00,000 20,00,000
To Debt Int.
To Income Tax
To N.P
10,000
1,00,000
1,00,000
EBIT 2,10,000
2,10,000 2,10,000
Balance Sheet
S. Capital
Reserve
N. W.
10% Deb
Creditors
4,00,000
1,00,000
5,00,000
1,00,000
60,000
Fixed Assets
CA
Cash
Stock
Deb
5,70,000
15,000
40,000
35,000
90,000
6,60,000 6,60,000
Problem 28.
Working capital of a company is Rs. 1,35,000 and currant ratio is 2.5 Liquid ratio is 1.5 and proprietary ratio is 75%.
Bank overdraft is Rs. 30,000. There are no long term loans and fictitious assets. Reserves and surplus amount to Rs.
90,000 and the gearing ratio (equity Capital/Preference Capital) is 2.
From the above draw the statement of proprietary fund.
Topper’s Institute Financial Analysis 3.34
Solution
Computation of Net Block and Proprietary Fund:
Proprietary Ratio = Proprietary Fund / Total Assets
= Proprietary Fund / Net Block + Current Assets = 0.75
i.e. Proprietary Fund = 0.75 Net Block + .75 2,25,000
= .75 Net Block + 1,68,750
Since there in no long term loan,
Hence, Proprietary funds = Net Block + Working Capital
= Net Block + 1,35,000
= 0.75 Net Block + 1,68,750
or, 0.25 Net Block = Rs. 33,750
Net Block = Rs. 1,35,000
Proprietary Funds Statement
Particulars Rs. Rs.
Sources: Equity Capital 1,20,000
Preference Capital 60,000
Reserve and Surplus 90,000
2,70,000
Applications: Net Block 1,35,000
Current Assets:
Stock 1,35,000
Other Current Assets 90,000 2,25,000
3,60,000
Less: Current Liabilities
Bank Overdraft 30,000
Other Current Liabilities 60,000 90,000
2,70,000
Problem 29.
Important ratios of a firm for the year ended 1999 are given below:
Stock velocity (stock holding period) 4 months Debt collection period 2 months
Creditors payments period 73 days Gross profit Rs. 2,00,000
Gross profit margin 20% Cash and Bank balance 5% of Sales
Credit purchase 25%
The firm expects in increase of 50% in sales in the ensuing year
Estimate the working capital requirement of the firm for the ensuing year.
Ans. W.C. 6,65,000
Problem 30.
Using the following data, complete the Balance Sheet of X Ltd. as at 31.3.2000.
Gross profit 25% of Sales Gross profit Rs. 1,20,000
Shareholders equity Rs. 20,000 Credit Sales to total sales 80%.
Total turnover to total assets 4 times Cost of sales to inventory 10 times
Topper’s Institute Financial Analysis 3.35
Average collection period 5 days Long-term debt ?
Current ratio 1.5 Sundry creditors Rs. 60,000
assume 365 days in a year
Balance Sheet of X Ltd. as at 31.3.2000
Liabilities Rs. Assets Rs.
Sundry Creditors Cash
Long-term Debt Sundry Debtors
Share Capital Inventory
––––––––– Fixed Assets –––––––––
Problem 31.
From the following prepare a balance sheet:
Current ratio is 1.75 Liquid ratio is 1.25
Stock turnover ratio (closing stock) is 9 times Gross profit ratio is 25%
Debtors collection period is 1.5 months Reserves to capital is 0.2
Turnover fixed Assets is 1.2 Capital gearing ratio is 0.6
Fixed Assets to net worth is 1.25 Sales for the year is Rs. 12,00,000
Solution Balance Sheet
Liabilities Rs. Assets Rs.
Share capital 6,66,670 Fixed Assets 10,00,000
Reserves & Surplus 1,33,330 Investment 1,30,000
Current Assets :
Long-term Loans 4,80,000 Stock 1,00,000
Current Liabilities 2,00,000 Debtors 1,50,000
Cash 1,00,000 3,50,000
14,80,000 14,80,000
Working Notes:
1. Gross profit ratio = Sales
Profit Gross
Gross Profit
25% or ¼ = 12,00,000
Profit Gross
Gross profit = Rs. 3,00,000
Sales – Gross profit = Cost of goods sold
Rs. 12,00,000 –Rs. 3,00,000 = Rs. 9,00,000
2. Stock turnover ratio = stock Closing
sold goods ofCost
9 = stock Closing
9,00,000 Rs.
9 Closing stock = Rs. 9,00,000
Closing stock = Rs. 1,00,000
Topper’s Institute Financial Analysis 3.36
3. Liquid ratio sLiabilitieCurrent
Stock - AssetsCurrent
1.25 sLiabilitieCurrent
1,00,000 Rs. - AssetsCurrent
Current Assets- Rs. 1,00,000 = 1.25 Current Liabilities
4. Current ratio sLiabilitieCurrent
AssetsCurrent
1.75 = sLiabilitieCurrent
AssetsCurrent
Current Assets = 1.75 Current Liabilities
1.25 Current Liabilities = Current Liabilities – Rs. 1,00,000
0.50 Current Liabilities = 1.75 Current Liabilities – Rs. 1,00,000
0.50 Current Liabilities = Rs. 1,00,000
Current Liabilities = Rs. 2,00,000
1.75 Current Liabilities = Rs. 2,00,000 1.75 = Rs. 3,50,000
5. Debtors turnover ratio = 12Sales
Debtors
3 Debtors 12
–– months = ––––––––––––
2 Rs. 12,00,000
24 Debtors = Rs. 36,00,000
Debtors = Rs. 1,50,000
Current Assets = Rs. 3,50,000
Less: Stock 1,00,000
Debtors 1,50,000 2,50,000
Cash balance 1,00,000
Sales Rs. 12,00,000
6. Fixed Assets turnover ratio= ––––––––––––––– 1.2 = ––––––––––––
Fixed Assets Fixed Assets
1.2 Fixed Assets = Rs. 12,00,000
Fixed Assets = Rs. 10,00,000
Fixed Assets
Fixed Assets to net worth = –––––––––––
Net Worth
Rs. 10,00,000
1.25 = ––––––––––––
Net Worth
1.25 Net Worth = Rs. 10,00,000
Topper’s Institute Financial Analysis 3.37
Net Worth = Rs. 8,00,000
7. Net worth includes share capital and reserves and surplus
Net worth = Share capital + Reserve
Rs. 8,00,000 = y + 0.2 y (reserves to capital 0.2)
1.2 y = Rs. 8,00,000
y = Rs. 6,66,670
Share capital is Rs. 6,66,670 and reserves Rs. 1,33,330
Long-term loans
8. Capital gearing ratio = –––––––––––––––
Shareholders fund
Long-term loans
0.6 = –––––––––––––––––
Rs. 8,00,000
Long-term loans = Rs. 8,00,000 0.6 = Rs. 4,80,000.
Problem 32.
From the following information make out a statement of proprietor's funds with details:
Current ratio 2.5 Liquid ratio 1.5
Proprietary ratio (fixed assets/proprietary fund) 0.75 Working capital Rs. 60,000
Reserve and surplus Rs. 40,000 Bank overdraft Rs. 10, 000
There is no long term loan or fictitious assets.
[CS Dec.-91, Jun-94, Dec.-98]
Solution Balance Sheet as on......
Particulars Rs. Particulars Rs. Share capital 2,00,000 Fixed Assets 1,80,000
Reserves & Surplus 40,000 Stock 55,000
Bank overdraft 10,000 Other current assets 45,000
Other current liabilities 30,000
2,80,000 2,80,000
Working Notes:
(i) Proprietary ratio (fixed assets / proprietor's funds) = 0.75
Proprietary ratio (working capital/ proprietary funds) = 0.25
Let Proprietary fund = X
0.25X = Working capital = Rs.60,000
Rs. 60,000
X = ––––––––––– = Rs.2,40,000
25
Proprietary fund = Rs. 2,40,000
(ii) Fixed assets = 0.75 × Rs. 2,40,000
= Rs.1 ,80,000
(iii) Current Ratio = 2.5
Let Current Liabilities = X Current Assets Current Assets
––––––––––––––– = 2.5 –––––––––––– = 2.5
Current Liabilities X
Topper’s Institute Financial Analysis 3.38
Current Assets = 2.5 X
Current Assets -Current Liabilities = Working Capital
2.5X –X = Rs. 60,000 or 1.5 = Rs. 60,000
Rs.60,000
or X = ––––––––––– = Rs. 40,000
1.5
Current Liabilities = Rs. 40,000
Current Assets = 2.5 X = 2.5 × Rs. 40,000 = Rs. 1,00,000
(iv) Liquid Ratio = overdraft Bank - sLiabilitieCurrent
Stock - AssetsCurrent = 1.5
Rs.10,000- Rs.40,000
Stock - 0Rs.1,00,00= 1.5,
Rs.30,000
Stock - 0Rs.1,00,00= 1.5
Rs. 1,00,000 - Stock = Rs.30,000 1.5
Rs. 1,00,000 - Stock = Rs.45,000 Or Stock = Rs. 55,000
(v) Proprietors' fund = Share capital + Reserves & Surplus
Rs. 2,40,000 = Share Capital + Rs. 40,000
Share Capital = Rs. 2,00,000
Problem 33.
The following ratios and information relate to the business at Lakhotia Traders Ltd.
Credit period allowed to Debtors 2 months
Stock Turnover Ratio 8
Lag in payments to Suppliers 1 month
Gross Profit Ratio 25% on turnover
Opening stock Rs.l,05,000
Gross profit for the year ended 31.3.1999 amounted to Rs. 3,00,000.
Find out:
(a) Sales
(b) Sundry Debtors
(c) Closing Stock
(d) Sundry Creditors
Solution
Pr .3,00,000(a) .12,00,000
Pr 25%
Gross ofit RsSales Rs
Gross ofit Ratio onturnover
2(b) .12,00,000 .2,00,000
12 12
Averagecollection PeriodSundry Debtors Net credit Sales Rs Rs
Cost of goods sold= Sales- Gross profit = Rs.12,00,000 – Rs.3,00,000 =Rs.9,00,000
9,00,000(c) .1,12,500
8
Cost of Goods soldAverage Stock Rs
stock Turnover Ratio
Closing Stock = (2 × Average Stock) –Opening Stock = (2 × Rs.1,12,500) – Rs.1,05,000 =Rs.1,20,000
Topper’s Institute Financial Analysis 3.39
(d) Purchases = Cost of goods sold + Closing Stock-opening stock = Rs.9,00,000 + Rs.1,20,000 - Rs.1,05,000 =
Rs.9,15,000
Sundry Creditors :-
Net Credit Purchase × 250,76.12
1000,15,9.
12
supRsRs
plierstopaymentinLog
Problem 34.
SKS does not maintain proper books of accounts. However, he provides you with the following details :
(a) Sales and Purchase Policy. Total sales during 1987 Rs. 6,00,000. Volume of sales during 2nd
half of
1987 was 1/3 that of 1st half. Volume of credit sales was twice that of cash sales throughout the year.
(b) Credit Policy. Closing debtors represent last two months sales whereas closing creditors represent last 3
months purchases.
(c) Price Policy. Goods were sold at 10% profit on credit sales. Cash selling price was always at a profit of
5% of Sales.
(d) Inventory policy First 2 months requirement was held as opening stock whereas last months requirement
was held as closing stock.
From the above details ascertain the following:
1. Opening stock as on 1.1.1987, Closing stock as on 31.12.1987,
2. Total purchases during 1987 and Closing debtors and creditors as on 31.12.1987
Solution
Basic Calculations
(i) Cash & Credit Sales : (1: 2)
Cash Sales : 1/3th of Rs. 6,00,000 = Rs. 2,00,000
Credit Sales : 2/3rd
of Rs. 6,00,000 = Rs. 4,00,000
(ii) Sales in 1st
Half and 2nd Half
Total 1st Half 2
nd Half,
Rs. Rs. Rs.
Cash 2,00,000 3/4th 1,50,000 1/4
th 50,000
Credit 4,00,000 3/4th 3,00,000 1/4
th 1,00,000
6,00,000 4,50,000 1,50,000
(1) Opening Stock as on 1.1.1987:
Total Sales for first two months: 1/3rd
of Rs. 4,50,000 = Rs. 1,50,000
(i.e., January 1987 and February 1987):
(a) Cash Sales: 1/3 rd of Rs. 1,50,000 = Rs. 50,000
Less: Profit Margin @ 5% on Sales = Rs. 2,500
Cost of goods sold 47,500
(b) Credit Sales: 2/3 of Rs. 1,50,000 = Rs. 1,00,000
Less: Profit margin @ 10% = Rs. 10,000
Cost of goods sold 90,000
Total Opening stock at cost as on 1.1.87 1,37,500
(2) Closing Stock as on 31.12.1987:
Total Sales for last month = 1/6th of Rs. 1,50,000 = Rs. 25,000
(i.e., December, 1987)
(a) Cash Sales: 1/3rd of Rs. 25,000 = Rs. 8,333
Topper’s Institute Financial Analysis 3.40
Less: Profit Margin @ 5% on sales Rs. 417 Rs. 7,916
(b) Credit Sales: 2/3rd of Rs. 25,000 Rs. 16,667
Less: Profit Margin @ 10% on sales Rs. 1,667 Rs. 15,000
Total Closing Stock at cost 22,916
(3) Total Purchases during 1987: Rs.
Total Sales during 1987 6,00,000
Less: Profit on goods sold:
5% on. Rs. 2,00,000 = Rs. 10,000
10% on Rs. 4,00,000 = Rs. 40,000 50,000 5,50,000
Add: Closing Stock 22,916
5,72,916
Less: Opening Stock 1,37,500
Total Purchases during 1987 4,35,416
(4) Closing Debtors and Creditors as on 31.12.1987:
(a) Closing Debtors:
Total credit sales for the late two months (i.e. Nov. 1987 & Dec. 1987)
= 1/3rd of Rs. 1,00,000 Rs. 33,333
(b) Closing Creditors;
Total Purchases for the last three months (i.e. October, 1987, Nov. 1987
and Dec. 1987, 1/4 of Rs. 4,35,416 Rs. 1,08,854
Problem 35.
From the following particulars prepare the balance sheet.
Current ratio 2 Working capital Rs.4,00,000
Capital block to current assets 3:2 Fixed assets to turnover 1:3
Sales cash/credit 1:2 Debentures/share capital 1:2
Stock velocity 2 months Creditors velocity 2 months
Debtors velocity 3 months Gross profit ratio 25% (to sales)
Reserve 2½ % of turnover Net Profit 10% of turnover
[CS Dec. 92]
Solution
Working Notes :
(i) Since Current Ratio is 2,
Current Assets ÷ Current Liabilities = 2
Current Assets = 2 Current Liabilities
W.C. = Current Asset – Current Liabilities = 4,00,000
Current Asset – Current Liabilities =
2 Current Liabilities(CA= 2CL) – Current Liabilities = 4,00,000
Current Liabilities = 4,00,000
Current Assets = 2 Current Liabilities = 8,00,000
(ii) Capital Employed = 8,00,000 2
3 = 1,20,000
(iii) Since the total liabilities are Rs. 16,00,000 (i.e.Rs.12,00,000 + Rs.4,00,000), the total assets
Topper’s Institute Financial Analysis 3.41
will also be Rs.16,00,000.
Fixed Assets (Rs. 16,00,000 - Rs. 8,00,000) Rs. 8,00,000
(iv) Turnover (Rs. 8,00,000 3) Rs. 24,00,000
Credit Sales Rs. 16 00 000
Cash Sales Rs. 8,00,000
(v) Debtors velocity 3 months
Debtors are therefore (Rs.16,00,000 × 3/12) Rs. 4,00,000
(vi) Gross Profit (Rs.24,00,000 × 25/100) Rs. 6,00,000
Cost of Goods Sold Rs. 18,00,000
(vii) Stock turnover 2 months
Stock is therefore (Rs. 18,00,000 × 2/12) Rs. 3,00,000
(viii) Creditors velocity 2 months
Creditors are therefore (Rs.18,00,000 × 2/12) Rs. 3,00,000
(ix) Cash Balance (Rs.8,00,000 - Rs. 7,00,000) Rs. 1,00,000
(x) Reserves (Rs.24,00,000 2.5/100) Rs. 60,000
Profit (Rs.24,00,000 10/100) Rs. 2,40,000
(xi) Block or Fixed Capital Rs. 12,00,000
Reserve and Profit Rs. 3,00,000
Debentures and Share Capital Rs. 9,00,000
Share Capital Rs. 6,00,000
Debentures Rs. 3.00,000
Balance Sheet as on….
Liabilities Rs. Assets Rs.
Share capital 6,00,000 Fixed Assets 8,00,000
Reserves 60,000 Current Assets :
Profit & Loss Account 2,40,000 Debtors 4,00,000
Debentures 3,00,000 Stock 3,00,000
Sundry Creditors 3,00,000 Cash 1,00,000
Other Current liabilities 1,00,000
16,00,000 16,00,000
Problem 36.
From the following information, prepare a summarised balance sheet as at March 31, 1999:
Stock Turnover ratio 6 Fixed assets turnover ratio 4
Capital turnover ratio 2 Gross profit 20%
Debt collection period 2 months Creditors payment period 73 days
The gross profit was Rs. 60,000
Closing stock was Rs. 5,000 in excess of the opening stock. [CS June-93, June-98]
Solution Balance Sheet as at March 31, 1999
Liabilities Rs. Assets Rs.
Capital 1,50,000 Fixed Assets 75,000
Creditors 49,000 Closing Stock 42,500
Debtors 50,000
Cash (Bal. Fig.) 31,500
1,99,000 1,99,000
Topper’s Institute Financial Analysis 3.42
Working Notes:
1. Gross Profit Ratio = Sales
100Profit Gross 20 =
Sales
100000,60Rs. or Sales = Rs. 3,00,000
Cost of Goods Sold = Sales -Gross Profit
Rs. 3,00,000 - Rs. 60,000 = Rs. 2,40,000
2. Stock Velocity = Stock Average
sold goods ofost C =
Stock Average
2,40,000 Rs.= 6
Average Stock = (Opening Stock + Closing Stock) / 2 = Rs. 40,000
Opening Stock + Closing Stock = Rs. 40,000 × 2 = Rs. 80,000
Closing Stock = Opening Stock + 5,000
Opening Stock + Opening Stock + 5,000 = Rs. 80,000
Opening Stock = Rs. 37,500
Closing Stock = Opening Stock + 5,000 = Rs. 42,500
3. Capital Turnover Ratio = Capital
Turnover= 2 =
Capital
3,00,000 Rs. or Capital = Rs. 1,50,000
4. Fixed Assets Turnover ratio = Assets Fixed
Sales =
Assets Fixed
3,00,000 Rs = 4
Fixed Assets = Rs. 75,000
5. Debt collection period = 2 months
Debtors = Sales × 000,50.12
2000,00,3
12
2Rs
6. Creditors' payment period = 73 days
Assuming all purchases to be credit purchases, the amount of credit purchasing is determined as follows .
Cost of Goods Sold = 2,40,000
Opening Stock + Purchases - Closing Stock = 2,40,000
2,40,000 = Rs. 37,500 + Purchases - Rs. 42,500
Purchases = Rs. 2,45,000
Creditors = Credit Purchase × 73/365 = Rs. 2,45,000 × 73/365 = Rs. 49,000
Problem 37.
From the following particulars you are required to prepare the balance sheet of a Zinc Company :
Fixed Assets (after writing off 30%) Rs. 10,50,000
Fixed Assets Turnover Ratio (on Cost of Goods Sold) 2
Finished goods Turnover Ratio (on Cost of Goods Sold) 6
G.P. rate on sales 25%
Net profit (before interest) to sales 8%
Fixed charges cover (debenture interest 7%) 8
Debt collection period 1.5 months
Material consumed to sales 30%
Stock of raw materials (in terms of months consumption) 3
Current ratio 2.4
Quick ratio 1.0
Reserve to capital ratio 0.21
Topper’s Institute Financial Analysis 3.43
Solution Balance Sheet of Zinc Company as on ……
Liabilities Rs. Rs. Assets Rs. Rs.
Capital (J) 10,00,000 Fixed Assets 10,50,000
Reserves (J) 2,10,000 12,10,000 Current Assets : (I)
Debentures (E) 4,00,000 Debtors (F) 3,50,000
Current Liabilities (I) 4,00,000 Stocks –
Finished goods* 3,50,000
Raw material (H) 2,10,000
Cash (Bal. fig. of
current Assets ) 50,000 9,60,000
20,10,000 20,10,000
Working notes:
A. Cost of sales/Fixed Assets = 2
Fixed Assets = 10.5 lakhs
Cost of sales = Rs. 21,00,000
B. Cost of sales/Finished goods = 6
6goods Finished
000,00,21
6 Finished goods = Rs. 21,00,000
* Finished goods = Rs. 3,50,000
C. Gross Profit on sales = 25%
Cost of sales + Profit = Sales
Rs. 21,00,00 + .25X = X
Rs. 21,00,000
Sales = ––––––––––––– = Rs. 28,00,000
0.75
Gross profit = 7,00,000
D. Net Profit before interest = Rs. 28,00,000 8%
= Rs. 2,24,000
Net profit before interest
––––––––––––––––– = 8
Interest
Interest charges = Rs. 28,000
E. 7% interest charges = Rs. 28,000
Rs. 28,000
Debentures = ––––––––––– = Rs. 4,00,000
7%
F. Debt collection period = 1.5 times
000,50,3.12
5.1000,00,28 RsDebtors
G. Material consumed to sales is 30%..
Material consumed = Rs. 28,00,000 30%
= Rs. 8,40,000
H. Stock of raw material = Rs. 8,40,000 3 / 12
= Rs. 2,10,000
I. sLiabilitieCurrent
AssestCurrent = 2.4 times
sLiabilitieCurrent
Assets Liquid= 1 times
Value of Stock = 2.4 – 1.0 = 1.4
Finished goods + Raw material
= Rs. 3,50,000 + Rs. 2,10,000 = 1.4
Current assets = Rs. 9,60,000
Current Liabilities = Rs. 4,00,000
J. Reserves to capital = 0.21
If capital is 1.00 then Reserve = .21
If net worth is Rs. 12,10,000
then Capital = Rs. 10,00,000
Reserve = Rs. 2,10,000
Problem 38.
From the following information relating to Wise Limited you are required to prepare its summarised Balance Sheet .
Current ratio 2.5 Acid test ratio 1.5
Gross profit/sales ratio 0.2 Net working capital/Net worth ratio 0.3
Sales / Net Fixed Assets ratio 2.0 Sales/Net worth ratio 1.5
Sales/ Debtors ratio 6.0 Reserves/Capital ratio 1.0
Stock velocity 2 months. Paid up share capital Rs. 10 lakhs
Net worth /long term loan 20.0 [CA Final]
Solution Wise Ltd.
Balance Sheet as on……
Liabilities Rs. Assets Rs.
Paid-up Share Capital 10 Fixed Assets 15
Reserves 10 Stock 4
Long-term Loans- 1 Debtors 5
Current Liabilities 4 Other Current – Assets 1
Total 25 Total 25
Topper’s Institute Financial Analysis 3.44
Problem 39.
From the following information and Ratios prepare the profit and Loss Account for the year ended 31st March. 1994;
and the Balance Sheet as on that date of M/s Stan & Co. an export company.
Current Assets to Stock 3 : 2 Current Ratio 3.00
Acid Test Ratio 1.00 Financial Leverage 2.20
Earnings per Share (each of Rs. 10 ) 10.00 Book Value per Share (Rs.) 40.00
Stock Turnover Ratio 5.00 Fixed Assets Turnover Ratio 1.20
External Liabilities to Net Worth 2.75 Net Working Capital Rs. 10.00 lakhs
Net Profit to Sales 10% Variable Cost 60%
Long—term Loan Interest 12% Taxation NIL
Ave. Collect. Period (assume 360 days in the year) 30 days [CA Inter Nov. 94]
Solution M/s. Stan & Co. Profit and Loss Account for the year ended 31
st March, 94
Rs. Sales 50,00,000 Less: Variable costs 30,00,000
20,00,000
Less: Fixed costs (excluding interest) 9,00,000
Earnings before interest and taxes 11,00,000
Less: Interest 6,00,000
Earnings before tax 5,00,000
Less: Tax Nil
Profit after tax 5,00,000
Balance Sheet as at 31st March, 1994
Rs. Rs.
Sources
Shareholder's Funds 20,00,000
Long term Liabilities 50,00,000
70,00,000
Applications
Fixed Assets 41,66,667
Current Assets:
Stock 10,00,000
Debtors 4,16,667
Others 83,333
15,00,000
Less: Current Liabilities 5,00,000
Net Current Assets 10,00,000
Investments (balancing figure) 18,33,333
70,00,000
Problem 40.
From the following information, prepare the projected trading and profit and Loss Account for the next financial
year ending December 31, 1985 and the projected Balance Sheet as on that date: — [CA Final]
Ratio of Gross Profit 25%
Stock Turnover Ratio 5 times
Creditors Velocity 3 months
Proprietary Ratio(Fixed Assets to Capital Employed) 80%
General Reserve and profit and Loss to Equity Capital 25%
Net Profit to Equity Capital 10%
Topper’s Institute Financial Analysis 3.45
Average Debt Collection Period 2 months
Current Ratio 2
Capital Gearing Ratio (Pref. Shares and debentures to Equity) 30%
Preference Share Capital to Debentures 2
Cost of Sales consists of 40% for materials and balance for Wages and Overheads.
Gross Profit Rs. 6,00,000
Problem 41.
The balance sheet of Major Ltd. as on 31st March, 1998 is as follows:
Liabilities Rs. Assets Rs.
Share Capital: Fixed assets:
2,000 eq. sh. of Rs. 100 each fully paid 2,00,000 Cost 5,00,000
7½% preference shares 1,00,000 Less: Depreciation 1,60,000 3,40,000
General reserve 60,000 Current assets:
12% debenture 60,000 Stock 60,000
Current liabilities: Debtors 80,000
Sundry Creditors 80,000 Bank 20,000
5,00,000 5,00,000
The company wishes to forecast balance sheet as on 31st March, 1999. The following additional particulars are
available:
(i) Fixed assets costing Rs. 1,00,000 have been installed on 1st April, 1998 but the payment will be made on
31st March, 1999.
(ii) The fixed assets turnover ratio on the basis of gross value of fixed assets would be 1.5.
(iii) The stock turnover ratio would be 14.4 (calculated on the basis of average stock).
(iv) The break up of cost and profit would be as under:
Material 40%
Labour 25%
Manufacturing expenses 10%
Office and selling expenses 10%
Depreciation 5%
Profit 10%
100%
The profit is subject to interest and taxation at 50%
(v) Debtors would be 1/9 of sales
(vi) Creditors would be 1/5 of material consumed.
(vii) In March, 1999, a dividend @ 10% on equity capital would be paid.
(viii) 12% debentures for Rs. 25, 000 have been issued on 1st April, 1998.
Prepare the forecast balance sheet as on 31st March, 1999 and show the following resultant ratios:
(a) Current ratio; (b) Fixed assets/net worth ratio; and (b) Debt equity ratio. [CS June-90]
Solution
Working Notes:
(1) Fixed assets at cost = Rs. 5,00,000 + Rs. 1,00,000 = Rs. 6,00,000
(2) Fixed assets turnover ratio = assets Fixed
Sales= 1.5 (by Question)
Topper’s Institute Financial Analysis 3.46
Sales = Rs. 6,00,000 1.5 = Rs. 9,00,000
(3) Average stock =ratioover Stock turn
sold goods ofCost =
14.40
7,20,000 = Rs. 50,000
(4) Materials = 40% of sales = 3,60,000
Labour 25% = 2,25,000
Mfg exp. 10% = 90,000
Depreciation 5% = 45,000
Cost of goods sold = 7,20,000
office and selling exp. 10% = 90,000
Cost of sales or total cost = 8,10,000
Profit = 10% of sales = 90,000
Sales = 9,00,000
Profit & Loss Account
Rs. Rs.
To interests on Debentures
(Rs. 7,200 + Rs. 3,000) 10,200 By EBIT 90,000
To Provision for taxation (Earning before
(50% of Rs. 90,000 - Rs. 10,200) 39,900 Interest & tax)
To Net Profit 39,900 ______
90,000 90,000
To Preference Dividend
(7.5% of Rs. 1,00,000) 7,500 By Net profit 39,900
To Equity Dividend
(10% on Rs. 2,00,000) 20,000
To Balance c/d to B/s 12,400
39,900 39,900
(5) Debtors = 9
0Rs.9,00,00 Rs. 1,00,000
(6) Creditors = Rs. 3,60,000/5 = Rs. 72,000
Further data:-
Closing stock on 31-3-99 = (Rs. 50,000 × 2) – Rs. 60,000 = Rs. 40,000
Net profit after tax = Rs. 39,900 + Depreciation = Rs. 39,900 + Rs. 45,000
Fund from Operations = Rs. 84,900
Bank A/c
Rs. Rs.
To Balance b/d 20,000 By Debtors increase 20,000
To Stock Decrease 20,000 By Creditors decrease 8,000
To Debentures 25,000 By Purchase of fixed assets 1,00,000
To Funds from operations 84,900 By Preference dividend 7,500
To Provision to Income for taxation 39,900 By Equity dividend 20,000
(Increase in liability due to _______ By Balance c/d 34,300
nonpayment) 1,89,800 1,89,800
Topper’s Institute Financial Analysis 3.47
Forecast Balance sheet as on 31.3.1999
Liabilities Rs. Assets Rs.
Share capital: Fixed Assets: 2,000 Equity shares of Actual cost 6,00,000
Rs. 100 each fully paid 2,00,000 Less: Depreciation
7 ½ % preference share 1,00,000 (1,60,000 + 45,000) 2,05,000 3,95,000
General reserve 60,000 Current Assets:
P & L A/C 12,400 Stock 40,000
Net Worth 3,72,400 Debtors 1,00,000
12% Debentures 85,000 Cash at Bank 34,300
Current liabilities:
Sundry creditors 72,000
Provision for taxation 39,900
5,69,300 5,69,300
Calculation of Ratios:
(a) Calculation of Current Assets and Current Liabilities
Current Assets = Stock + Debtors + Bank
= Rs. 40,000 + Rs. 1,00,000 + Rs. 34,300 = Rs.1,74,300
Current Liabilities = Sundry Creditors + provision for tax
= Rs. 72,000 + Rs. 39,900 = Rs.1,11,900
Current Ratio = 1:56.1900,11,1.
300,74,1.
sLiabilitieCurrent
AssetsCurrent
Rs
Rs
(b) Fixed Assets / Net Worth Ratio = 1:06.1400,72,3.
000,95,3.
Rs
Rs
(c) Debt Equity Ratio = 1:19.0400,57,4.
000,85.
000,85.400,72,3.
000,85.
Debt Equity
Debt
Rs
Rs
RsRs
Rs
Problem 42.
Following is the abridged balance sheet of the Everest Co. Ltd. As at 31st March, 1996:
Rs. Rs.
Paid up share Capital 5,00,000 Free hold Property 4,00,000
Profit & Loss Account 85,000 Plant & Machinery 2,50,000
Current Liabilities 2,00,000 Depreciation 75,000 1,75,000
Stocks 1,05,000
Debtors 1,00,000
Bank 5,000
7,85,000 7,85,000
From the following information you are required to prepare profit and loss account and balance sheet as at 31st
March, 1997:
(a) The composition of the total of the Liabilities side of the company‘s balance sheet as 31st March, 1997 (the paid
up share capital remaining the same as at 31st March, 1996) was :
Share capital 50 per cent Profit and loss A/c 15 per cent
7 per cent debentures 10 per cent Creditors 25 per cent
The Debentures were issued on 1st April, 1996, interest being paid on 30
th September 1996 and 31
st March, 1997.
Topper’s Institute Financial Analysis 3.48
(b) During the year ended on 31st March 1997. Addition plant and machinery had been bought and a further Rs.
25,000 depreciation written off. Freehold property remained unchanged. The total fixed assets then constituted
60 per cent of total fixed and current assets.
(c) The current ratio was 1.6 : 1. The quick assets ratio was 1: 1
(d) The debtors (four—fifths of the quick assets) to sales ratio revealed a credit period of two months.
(e) Gross profit was at the rate of 15 per cent of selling price and return on Net worth as at 31st March, 1997 was
10 per cent. Ignore taxation.
Solution Balance Sheet as at 31st March, 1996
Liabilities Rs. Assets Rs.
Share Capital: 5,00,000 Fixed Assets :
Reserves & Surplus Freehold Property 4,00,000
Profit & Loss A/c 1,50,000 Plant and Machinery 3,00,000
Less: Depreciation 1,00,000 2,00,000
7% Debentures 1,00,000 6,00,000
Current Assets:
Stock 1,50,000
Creditors 2,50,000 Debtors 2,00,000
________ Bank 50,000 4,00,000
10,00,000 10,00,000
Dr. Profit and Loss Account for the year ended March 31, 1996 Cr.
Particulars Rs. Particulars Rs.
To Opening stock 1,05,000 By Sales 12,00,000
To Purchases (Balance figure) 10,65,000 By Closing Stock 1,50,000
To Gross Profit 1,80,000 ________
13,50,000 13,50,000
To Expenses (Balance figure) 83,000 by Gross Profit b/d 1,80,000
To Debenture Interest 7,000
To Depreciation 25,000
To Net Profit 65,000 ________
1,80,000 1,80,000
(i) Total of Liabilities Side = Rs. 5,00,000/ .50 = Rs. 10,00,000.
(ii) Profit & Loss A/c (Cr. Balance ) = 15% of Rs. 10,00,000 = Rs. 1,50,000.
(iii) 7% Debentures = 10% of Rs. 10,00,000 = Rs. 1,00,000.
(iv) Creditors = 25% of Rs. 10,00,000 = Rs. 2,50,000.
(v) Net fixed Assets = 60% of Rs. 10,00,000 = Rs. 6,00,000.
(vi) Net Plant & Machinery = Rs. 6,00,000 – Rs. 4,00,000 = Rs. 2,00,000.
(vii) Gross Plant & Machinery = Rs. 2,00,000 + (Rs. 75,000 + Rs. 25,000) = Rs. 3,00,000.
(viii) Current Assets = Rs. 2,50,000 1.6 = Rs. 4,00,000.
(ix) Liquid Assets = RS. 2,50,000 1 = Rs. 2,50,000
(x) Stock = Rs. 4,00,000- Rs. 2,50,000 = Rs. 1,50,00.
(xi) Debtors = Rs. 2,50,000 4 5 = Rs. 2,00,000.
(xii) Sales = Rs. 2,00,000 12/2 = Rs. 12,00,000.
(xiii) Gross Profit = 15 % of Rs. 12,00,000 = Rs. 1,80,000
(xiv) Net Worth = Rs. 5,0,000 + Rs. 1,50,000 = Rs. 6,50,000.
(xv) Net Profit = 10% of Rs. 6,50,000 = Rs. 65,000.
Topper’s Institute Financial Analysis 3.49
THEORETICAL QUESTIONS
Q.1 Discuss any three ratios computed for investment analysis.
[Nov-2004] 3 Marks
Answer
The three ratios computed for investment analysis are as follows:
(i) Equity to Total Funds Ratio = Shareholder's Funds
Total Funds
(ii) Debt Equity Ratio = Debt
Equity
(iii) Capital Gearing Ratio = Fixed Charge Bearing Capital
Equity Shareholder's Funds
(iv) Fixed Assets to Long Term Fund Ratio = Fixed Assets
Long Term Fund
(v) Proprietary Ratio = Proprietary Funds
Total Assets.
Note:
Proprietary Funds for B-5 can be computed through two ways from the Balance Sheet:
Liability Route : [Equity Share Capital + Preference Share Capital + Reserves & Surplus] Less: Accumulated
losses
Assets Route: (Net Fixed Assets + Net Working Capital] Less: Long Term Liabilities.
Q.2 Discuss the financial ratios for evaluating company performance on operating efficiency and liquidity position
aspects. [Nov-2006] 4 Marks
Answer
The financial ratios for evaluating company performance on operating efficiency and liquidity position aspects are
discussed as follows:
Evaluation of Operating Efficiency: Ratios throw light on the degree of efficiency in the management andutilisation of assets
and resources. These are indicated by activity or performance or turnover ratios e.g. Stock Turnover Ratio, Debtors
Turnover Ratio, Fixed Assets Turnover Ratio. These indicate the ability of the firm togenerate revenue (sales) per
rupee of investment in its assets.
Following are example the example of Operating Efficiency ratio/Activity based Ratios:
(i) Capital Turnover Ratio = Sales
Capital Employed
(ii) Fixed Assets Turnover Ratio = Turnover
Fixed Assets.
(iii) Working Capital Turnover Ratio = Turnover
Net Working Capital
(iv) Finished goods or Stock Turnover Ratio = Cost of Goods sold
Average stock
(v) Raw Material Turnover ratio = Cost of Material Consumed
Average stock of RM
Topper’s Institute Financial Analysis 3.50
(vi) Debtors Turnover ratio = Credit Sales
Average A/c Receivable
(vii) Creditor Turnover ratio = Credit Purchases
Average A/c Payable
Note:
The turnover ratios can also be computed in terms of days as 365 / Turnover Ratio. For example, Number of days
average stock is held = 365 / Stock Turnover Ratio.
Evaluation of Profitability: Profitability ratios i.e. Gross Profit Ratio, Operating Profit Ratio, Net Profit Ratio are basic
indicators of the profitability of the firm. In addition, various profitability indicators like Return on Capital Employed
(ROCE), Earnings per share (EPS), Return on Assets (ROA) etc. are used to assess the financial performance.
Following are example the example of Profitability based Ratios:
(i) Gross Profit Ratio = Gross Profit
Sales
(ii) Operating Profit ratio = Operating Profit
Sales
(iii) Net Profit Ratio = Net Profit
Sales
Q.3 Explain the need of debt service coverage ratio. [May-2007] 2 Marks
Or
Q. How is Debt service coverage ration calculated? What is its significance? [May-2009] 2 Marks
Answer
Debt service coverage ratio is the vital indicator to the lender to assess the extent of ability of the borrower to service
the loan in regard to timely payment of interest and repayment of principal amount. It shows whether the business is
earning sufficient profits to pay not only the interest charges, but also the installment due of the principal amount.
Debt service coverage ratio of 2:1 is considered ideal by the financial institutions. This ratio will enable the lender to
take correct view of the borrower‘s repayment capacity.
The ratio is calculated as follows:
Debt service coverage ratio = Earning available for debt service*
Interest on loan+Instalment of the principal
*Where earning available for Debt service = Profit after tax + Depreciation+ Interest on Loan
Q.4 Diagrammatically present the DU PONT CHART to calculate return on equity. [May-2007] 3 Marks
Answer
The financial ratios in themselves are not useful to assess the performance of a company in a given year. To interpret
the financial health of a company it is crucial to analyse and compare the ratios for a given year vis-a-vis the previous
financial years and the industry ratios. The DU-Pant company of USA pioneered a system of financial analysis which
has received widespread recognition and acceptance. The usefulness of DU-Pant chart lies in the fact that it presents
the overall picture of the performance of a firm and enables the management to identify the factors which have a
bearing on its profitability, Return on investment (ROI) represents the earning power of the company. ROI depends on
two ratios: (a) Net Profit Ratio and (b) Capital Turnover Ratio. A change in any of these ratios will change the firm's
earning power. These two ratios are affected by many factors. A change in any of these factors will change these ratios
also. The analysis has been presented by DU- Pont Company of U.S.A. through a chart popularly known as DU-Pont
Chart. The chart has been presented below:
Topper’s Institute Financial Analysis 3.51
DU PONT CONTROL CHART
+
X
+
The chart shows that return on capital employed is affected by a number of factors. Any change in these factors will
affect the return on capital employed. For example, if the cast of gods said increases, without any responding
increase in the selling price of the goods, the net profit would decrease and consequently ROI would also decrease.
Similarly, if there is, increase in working capital, the total capital employed would increase and, before, in the
absence of any increase in the net profit, ROI would decrease.
The chart helps the management in concentrating attention an different farces affecting profit. An increase in fit can
be achieved either by ",are effective use of capital which will result in a higher turnover ratio or better les efforts
which will result in a higher net profit ratio.
Q.5 How return on capital employed is calculated? What is its significance? [Nov-2008] 2 Marks
Answer
Return on capital employed = Total Earnings
Total Capital Employed
Total Earning:
Profits after taxes xxx
Add: Taxation xxx
Add: Interest xxx
Add: Non-trading expenses xxx
Less: Non-operating incomes like rents, interest and dividends (xxx)
Total Earning xxx
Total Capital Employed:
Assets Route:
Net Fixed Assets (including intangible assets like patents,
but not fictitious assets like miscellaneous expenditure not w/off) xxx
+ Net working Capital xxx
Total Capital Employed ___
Liability Route:
Equity Share Capital xxx
+ Preference Share Capital xxx
+ Reserves & Surplus xxx
Return
on
Equity
(ROE)
Net Profit
Ratio
Net Profit
Sales
Sale Cost of
Goods sold
Adm., Selling
and Distribution
Expenses
Expenses
Capital
Turnover
Sales
Capital
Employed
Working
Capital
Current
Assets
Current
Liabilities Fixed Assets
Topper’s Institute Financial Analysis 3.52
+ Debentures and Long Term Loans xxx
Less: Accumulated Losses (xxx)
Less: Non-Trade Investments (xxx)
Total Capital Employed
It’s significance in financial Analysis: Overall profitability of the business for the capital employed; indicates the return on the total capital Employed
Comparison of ROCE with rate of interest of debt leads to financial leverage. If ROCE > interest Rate, use of debt
funds is Justified.
Q.6 What is Quick ratio? What does it signify? [Nov-2008] 2 Marks
Answer
Quick Ratio or Acid = Quick Assets
Quick Liabilities
Quick Assets = Current Assets Less : Inventories Less: Prepaid Expenses
Quick Liabilities = Current Liabilities Less: Bank Overdraft Less: Cash Credit
Significance of Quick Ratio on Financial Analysis: Ability to meet immediate test ratio liabilities. Ideal Ratio is 1: 33:
1
Q.7 What do you mean by Stock turnover Ratio and Gearing ratio? [Nov-2008] 3 Marks
Answer
Stock turnover Ratio: It establishes the relationship between the cost of goods sold during the year and average inventory
held during the year.
It calculated as follows:
Stock turnover Ratio = Sales/Turnover
Average inventory
In above formula:
Average Inventory = Opening Stock+Closing Stock
2
This ratio indicates that how fat inventory is sold.
A high ratio is good from the view point of liquidity and a low ratio would indicate that inventory that inventory is
not sold and remains in godown for a long time.
Note: Turnover is generally taken as cost of goods sold.
Gearing ratio: It is also called as ―Capital Gearing Ratio‖. It shows the proportion of fixed interest (dividend) bearing
capital to funds belonging to equity shareholders funds.
It calculated as follows:
Capital Gearing Ratio = Preference capital+Debentures+Longterm loans
Eqity share Capital + Reserves and surplus - losses
This ratio helps to judge the long term solvency position of a firm.
Q.8 Discuss the composition of Return on Equity (ROI) using the DuPont model. [May-2009] 3 Marks
Answer
Composition of Return on Equity using the DuPont Model
There are three components in the computation of return on equity using the traditional DuPont the net profit margin,
asset turnover, and the equity multiplier. By examining each input individually, the sources of a company‘s return on
equity can be discovered and compared to its competitors.
Topper’s Institute Financial Analysis 3.53
(i) Net Profit Margin: The net profit margin is simply the after-tax profit a company generates for each rupee of
revenue.
Net profit margin = Net income + Revenue
Net profit margin is a safety cushion; the lower the margin, lesser the room for error.
(ii) Asset Turnover: The asset turnover ratio is a measures of how effectively a company converts its assets into
sales. It is calculated as follows:
Asset Turnover = Revenue + Assets
The asset turnover ratio tends to be inversely related to the net profit margin; i.e., the higher the net profit
margin, the lower the asset turnover.
(iii) Equity Multiplier: It is possible for a company with terrible sales and margins to take on excessive debt and
artificially increase its return on equity. The equity multiplier, a measure of financial leverage, allows the
investor to see what portion of the return on equity is the result of debt. The equity multiplier is calculated as
follows:
Equity Multiplier = Assets + Shareholder‘s Equity
Computation of Return on Equity To calculate the return on equity using the DuPont model, simply multiply the three components (net profit margin,
asset turnover, and equity multiplier.) Return on Equity = Net profit margin × Asset turnover × Equity multiplier.
Q.9 Explain briefly the limitations of Financial ratios.
[May 2009] 2 Marks
Answer
Limitations of Financial Ratios
The limitations of financial ratios are listed below:
(a) Diversified product lines: Many businesses operate a large number of divisions in quite different industries.
In such cases, ratios calculated on the basis of Aggregate data cannot be used for inter-firm comparisons.
(b) Financial data are badly distorted by inflection: Historical cost values may be Substantially different from
true values. Such distortions of financial data are also carried in the financial ratios.
(c) Seasonal factors may also influence financial data.
(d) To give a good shape to the popularly used financial ratios (like current ratio, debt-equity ratios, etc.): The
business may make some year-end adjustments. Such window dressing can change the character of financial
ratios which would be different had there been no such change.
(e) Differences in accounting policies and accounting period: It can make the accounting data of two firms non-
comparable as also the accounting ratios.
(f) There is no standard set of ratios against which a firm‘s ratios can be compared:
(g) Sometimes a firm‘s ratios are compared with the industry average. But if a firm desires to be above the
average, then industry average becomes a low standard. On the other hand, for a below average firm, industry
averages become too high a standard to achieve.
(h) It is very difficult to generalize whether a particular ratio is good or bad: For example, a low current ratio may
be said ‗bad‘ from the point of view of low. Liquidity, but a high current ratio may not be ‗good‘ as this may
result from inefficient working capital management.
(i) Financial ratios are inter-related, not independent: Viewed in isolation one ratio may highlight efficiency. But when considered as a set of ratios they may speak differently. Such interdependence among the ratios can be
taken of thoughts multivariate analysis.
(Note: Students to write any four limitations)
Topper’s Institute Financial Analysis 3.54
PRACTICAL PROBLEMS
Q.10 From the following information, prepare a summarised Balance Sheet as at 31st March, 2002:
Working Capital Rs. 2,40,000
Bank overdraft Rs. 40,000
Fixed Assets to Proprietory ratio 0.75
Reserves and Surplus Rs. 1,60,000
Current ratio 2.5
Liquid ratio 1.5
[Nov. 2002] 6 Marks
Solution Working Notes:
1. Current assets and Current liabilities computation:
(say)k 1
sliabilitieCurrent
5.2
assetsCurrent or
1
5.2
sliabilitieCurrent
assetsCurrent
Or, Current assets = 2.5 k and Current liabilities = k
Or, working capital = (Current assets- Current liabilities)
Or, Rs. 2,40,000 = k (2.5 - 1) = 1.5 k
Or, k = Rs. 1,60,000
Current liabilities = Rs. 1,60,000
Current assets = Rs. l,60,000 2.5 = Rs. 4,00,000
1. Computation of stock
Liquid ratio = sliabilitieCurrent
assets Liquied
Or, 1.5 =0Rs.1,60,00
Stock-assetsCurrent
Or, 1.5 Rs. 1,60,000 = Rs. 4,00,000 – Stock
Or, Stock = Rs. 1,60,000
2. Computation of Proprietary fund; Fixed assets; Capital and Sundry Creditor Fixed assets
Proprietary ratio = –––––––––––––– = 0.75
Proprietary fund
Fixed assets = 0.75 Proprietary fund
and Net working capital = 0.25 Proprietary fund
Or, Rs.2,40,000 / 0.25 = Proprietary fund
Or Proprietary fund = Rs.9,60,000
and Fixed assets = 0.75 proprietary fund
= 0.75 Rs.9,60,000
= Rs. 7,20,000
Capital = Proprietary fund - Reserves & surplus
= Rs. 9,60,000 - Rs. 1,60,000
= Rs.8,00,000
Sundry creditors = (Current liabilities - Bank overdraft)
= (Rs. 1,60,000 - Rs,40,000)
= Rs. 1,20,000
Topper’s Institute Financial Analysis 3.55
Construction of Balance sheet
Amount Rs. Amount Rs.
Capital 8,00,000 Fixed assets 7,20,000
Reserves & Surplus 1,60,000 Stock 1,00,000
Bank overdraft 40,000 Current assets 2,40,000
Sundry creditors 1,20,000
11,20,000 11,20,000
Q.11 The Financial statements of Excel AMP Graphics Limited are as under:
Balance Sheet
As at 31 December, 2001 (Rs. in crores)
2001 2000
Sources of Funds: Shareholders‘ Funds
Shares Capital 1,121 931
Reserves & Surplus 8,950 10,071 7,999
8,930
Loan Funds: Secured Loans – 259
Finance lease obligations 74 –
Unsecured loans 171 245 115
10,316 9,304
Applications of Funds: Fixed Assets
Gross Block 6,667 5,747
Less: Depreciation (3,150) 2,561
Net Block 3,517 3,186
Capital Work-in-progress 27 3,544 28
3,214
Investments 288 222
Current Assets, Loans & Advances :
Inventories 2,709 2,540
Sundry debtors 9,468 9,428
Cash & Bank Balances 3,206 662
Loans & Advances 2,043 1,712
17,426 14,342
Less: Current liabilities & Provisions
Current liabilities 10,109 7,902
Provisions 513 572
10,622 8,474
Net Current Assets 6,804 5,868
Net Deferred Tax Liability (320) –
10,316 9,304
Profit and Loss Account
For the year ended 31st December, 2001 (Rs. in crores)
2001 2000
Income:
Sales & Services 23,436 17,849
Other Income 320 306
A 23,756 18,155
Expenditure:
Cost of Materials 15,179 10,996
Personnel Expenses 2,543 2,293
Other Expenses 3,546 2,815
Depreciation 419 383
Less: Transfer from revaluation reserve 7 412 6 377
Interest 164 88
Topper’s Institute Financial Analysis 3.56
B 21,844 16,569
Profit before Tax (A-B) 1,912 1,586
Provision for Tax: Current Tax 450 371
Deferred Tax (6) –
Profit after Tax 1,468 1,215
Required:
(a) Compute and analyse the return on capital employed (ROCE) in a Du-Pont control chart framework
(b) Compute and analyse the average inventory holding period and average collection period.
(c) Compute and analyse the return on equity (ROE) by bringing out clearly the impact of financial
leverage. [Nov. 2003] (8+4+4=16 Marks)
Solution
(a) Working note: Computation of Cost of goods sold (COGS), Operating profit before depreciation, interest & tax (OPBDIT),
Operating profit before interest and tax (OPBIT), Profit before interest and tax (PBIT), Profit before tax (PBT) and
Profit after tax (PAT)
(Rs. in crores)
Year 2001 2000
Cost of goods sold (COGS) 21,268 16104
(Material consumed + Personnel expenses + Other expenses)
Operating profit before depreciation, interest and tax (OPBDIT) 2,168 1,745
(Income from sales & service - COGS)
Operating profit before interest and tax (OPBIT) 1,756 1,368
(OP§DIT - depreciation)
Profit before interest and tax (PBIT) 2,076 1,674
(OPBIT + Other incomes)
Profit before tax (PBT) 1,912 1,586
(PBIT - Interest)
Profit after tax (P AT) 1,465 1,215
(PBT - Tax)
Return on capital employed (ROCE): (Before interest & tax)
Operating profits before interest and tax Sales
= ×Sales Capital employed
OPBIT
=Capital employed
Capital employed = (Balance sheet total- Capital WIP - Investments - Loans & advances)
Year
2001 2000
ROCE 22.07% 18.63%
(Refer to working note)
100
436,23.
756,1.
Rs
Rs
Operating profit margin 7.49% 7.66%
(Refer to working note)
100
436,23.
756,1.
Rs
Rs
100
849,17.
368,1.
Rs
Rs
Material consumed/ Sales 64.77% 61.61%
Personnel expenses/ S ales 10.85% 12.85%
Other expenses/ Sales 15.13% 15.77%
Topper’s Institute Financial Analysis 3.57
Depreciation/ Sales 1.76% 2.11%
(b) Computation and analysis of average inventory holding period and average collection period:
(Rs.' in crores)
Year 2001 2000
1. Inventory turnover ratio:
(Material consumed/ Closing inventory)
5.6
(Rs.15,179/Rs.2,709)
4.33
(Rs.10,996/Rs.2,540)
2. Average inventory turnover period:
(360 days / Inventory turnover ratio) 64 days 83 days
3. Receivables turnover ratio:
(Net credit sales / Closing Sundry debtors)
2.48
(Rs.23,436/Rs.9,468)
1.89
(Rs.17,849/Rs.9,428)
4. Average collection period:
(360 days / Receivables turnover ratio) 145 days 190 days
(c) ROE = PAT
Equity Fund
2001 2000 1,468 Cr. 1,215Cr.
10,071 Cr. 8,930 Cr
= 14.58 % 13.61%
ROE = ROA + E
D{ (ROA - i * ( 1 - Tc )}
ROA (Post tax) 14.34% 12.11 %
{(ROCE * (1 - .35)}
Tax I PBT 23.22% 2.37%
Loan funds / Total funds 23.39% 4.02%
Shareholders Funds I Total funds 97.63% 95.98%
ROE is marginally better than ROA, as debt ratio employed by the company is minimal.
Q.12 With the help of the following information complete the Balance Sheet of MNOP Ltd.:
Equity share capital Rs. 1,00,000
The relevant ratios of the company are as follows:
Current debt to total debt .40
Total debt to owner's equity .60
Fixed assets to owner's equity .60
Total assets turnover 2 Times
Inventory turnover 8 Times
[May 2005] 7 Marks
Solution In the Books of MNOP LTD
Balance Sheet
Particulars Rs. Assets Rs.
Equity share capital 1,00,000 Fixed assets 60,000
Current debt 24,000 Inventory 40,000
Long term debt 36,000 Cash 60,000
1,60,000 1,60,000
Topper’s Institute Financial Analysis 3.58
Working Notes:
1. Total debt = 0.60 × Owners equity = 0.60 × Rs 1,00,000 = Rs 60,000
2. Current debt to total debt = 0.40, hence current debt = 0.40 × 60,000
= Rs. 24,000
3. Fixed assets = 0.60 × Owners equity = 0.60 × Rs. 1,00,000 – Rs.60,000
4. Total equity = Total debt + Owners equity = Rs.60,000 + 1,00,000
= Rs.1,60,000
5. Total assets consisting of fixed assets and current assets must be equal to
Rs.1,60,000 hence, current assets should be Rs 1,00,000.
6. Total assets turnover = 2 Times: Inventory turnover = 8 Times
Inventory 2 1
Total Assets 8 4
Inventory 1
.1,60,000 4Rs
Or, 4 × Inventory = 1 × Rs.1,60,000
= Rs.1,60,000
Or, Inventory =Rs.1,60,000
4
= Rs.40,000
Balance on Assets side
Cash = Rs.1,60,000 – Rs. 60,000 – Rs. 40,000
= Rs.60,000
Q.13 Using the following data, complete the Balance Sheet given below:
Gross Profits Rs. 54,000
Shareholders‘ Funds Rs. 6,00,000
Gross Profit margin 20%
Credit sales to Total sales 80%
Total Assets turnover 0.3 times
Inventory turnover 4 times
Average collection period (a 360 days year) 20 days
Current ratio 1.8
Long-term Debt of Equity 40%
Balance Sheet
Creditors …….. Cash ……..
Long-term debt …….. Debtors ……..
Shareholders' funds …….. Inventory ……..
Fixed assets
[Nov. 2005] 12 Marks
Solution Balance Sheet
Liabilities Amount (Rs.) Assets Amount (Rs.)
Creditors 60,000 Cash 42,000
Long term debts 2,40,000 Debtors 12,000
Share holders fund 6,00,000 Inventory 54,000
Fixed Assets 7,92,000
9,00,000 4,00,000
Working Notes:
1. Gross Profit :
GP margin = 20%
GP = Rs.54,000
Sales = Rs.2,70,000
Topper’s Institute Financial Analysis 3.59
2. Credit Sales :
Cr. Sales = 80% of total sales
= 2,70,000 × 80%
= Rs.2,16,000.
3. Total Assets :
Total Assets Turnover = Sales 0.3 times
Total Assets
Total Assets = 2,70,000
Rs.9,00,0000.3
4. Inventory Turnover :
Inventory Turnover = Cash
100 0.3 timesInventory
4 = 2,70,000-54,000
Inventory
Inventory = Rs.54,000
5. Debtors :
Debtors = Credit Sales
20 days360 days
= Rs.2,16,000
20 360
= Rs.12,000.
6. Creditors:
Long Term Debt
equity
= 40%
Long term debt = 40% of equity
= 6,00,000 × 40%
= Rs.2,40,000.
Creditors + Long term debt + Shareholders funds = Rs.9,00,000
Creditors + Rs.2,40,000 + Rs. 6,00,000 = Rs. 9,00,000
Creditors = Rs. 60,000.
7. Current Ratio – Cash :
Current Ratio = Current Assets
Current Liabilities
1.8 = Debtors+Inventory + cash
Creditors
1.8 = 12,000 + 54,000 + Cash
60,000
1,08,000 = 66,000 + Cash
Topper’s Institute Financial Analysis 3.60
Cash = Rs.42,000
8. Fixed Assets: It is the balancing figure on assets side.
Q.14 JKL Limited has the following Balance Sheets as on March 31, 2006 and March 31, 2005:
Balance Sheet (Rs. in Lakh)
March 31, 2006 March 31, 2005
Sources of Funds: Shareholders‘ Funds 2,377 1,472
Loan Funds 3,570 3,083
5,947 4,555
Applications of Funds: Fixed Assets 3,466 2,900
Cash and bank 489 470
Debtors 1,495 1,168
Stock 2,867 2,407
Other Current Assets 1,567 1,404
Less: Current Liabilities (3,937) (3,794)
5,947 4,555
The Income Statement of the JKL Ltd. for the year ended is as follows:
(Rs. in Lakh)
March 31, 2006 March 31, 2005
Sales 22,165 13,882
Less: Cost of Goods sold 20,860 12,544
Gross Profit 1,305 1,338
Less: Selling, General and Administrative exps. 1,135 752
Earnings before Interest and Tax (EBIT) 170 586
Interest Expense 113 105
Profits before Tax 57 481
Tax 23 192
Profits after Tax (PAT) 34 289
10 Marks
Required:
(i) Calculate for the year 2005-06
(a) Inventory turnover ratio
(b) Financial Leverage
(c) Return on Investment (ROI)
(d) Return on Equity (ROE)
(e) Average Collection period.
(ii) Give a brief comment on the Financial position of JKL Limited. [May 2006] 2 Marks
Solution (i) Computation of Ratios
Particulars March 31, 2006 March 31, 2005
(a) Inventory Turnover Ratio
Cost of goods sold
Closing stock
20,8607.28
2,867
12,5445.21
2,407
(b) Financial Leverage=EBIT
EBT
1702.98
57
5681.22
481
(c) Return on Investment (ROI) 170100 2.86%
5,947 586
100 12.86%4,555
Topper’s Institute Financial Analysis 3.61
EBIT100
Capital employed
(d) Return on Equity PAT
100Net worth
34100 1.43%
2,377 289
100 19.63%1,472
(e) Average Collection Period
Debtors365
Credit sales
1,495365 24.6
22,165
1,168365 30.7
13,882
(ii) Brief Comment on the Financial Position of JKL Ltd.:
The inventory turnover ratio is increased from 5.21 times to 7.28 times. This indicates the reduction in
investment of stock and increase in sale turnover with reduced stocks.
The financial leverage of the company is increased from 1.22 times to 2.98 times, which indicates the
lower the cushion for paying interest on borrowings. The increase in ratio warns the increase in risk as to
over gearing, which constitutes a strain on profits.
There is a steep fall in ROI from 12.86% to 2.86%, this may be due to increase in finances from fresh
issue of share and loan funds for expansion, modernization or new investment proposals, and increase in
sales has not resulted in increase of company‘s profitability.
The return on equity has also fallen from 19.63% to 1.43%. The current year PAT may not be sufficient
for declaration of dividends to shareholders.
The increase in sale and reduction in investment in debtor‘s balances has resulted in reduction of average
collection period from 30.7 days to 24.6 days.
Q.15 From the informations given below calculate the amount of Fixed assets and Proprietor's fund.
Ratio of fixed assets to proprietors fund = 0.75
Net working capital = Rs. 6,00,000. [Nov. 2009] 2 Marks
Solution Calculation of Fixed Assets and Proprietor’s Fund Since Ratio of Fixed Assets to proprietor‘s Fund = 0.7
Therefore, Fixed Assets = 0.75Proprietor‘s Fund
Net Working Capital = 0.25 Proprietor‘s Fund
6, 00,000 =0.25 Proprietor‘s Fund
Therefore, Proprietor‘s Fund = 000,00,2425.0
000,00,6.
Rs
Proprietor’s Fund = Rs. 24, 00,000 Since, Fixed Assets = 0.75 Proprietor‘s Fund
Therefore, Fixed Assets = 0.75 × 24, 00,000
= Rs.18, 00,000
Fixed Assets = Rs. 18, 00,000
Q.16 The following figures and ratios are related to a company:
(i) Sales for the year (all credit) Rs. 30,00,000
(ii) Gross Profit ratio 25 percent
(i) Fixed assets turnover (basis on cost of goods sold) 1.5
(ii) Stock turnover (basis on cost of goods sold) 6
Topper’s Institute Financial Analysis 3.62
(v) Liquid ratio 1 : 1
(vi) Current ratio 1.5 : 1
(vii) Debtors collection period 2 months
(viii) Reserve and surplus to Share capital 0.6 : 1
(ix) Capital gearing ratio 0.5
(x) Fixed assets to net worth 1.20 : 1
You are required to prepare:
(a) Balance Sheet of the company on the basis of above details.
(b) The statement showing Working capital requirement, if the company wants to make a provision for
contingencies @ 10 percent of net working capital including such provision.
[May- 2010] 4 Marks
Solution
(a) Projected Balance Sheet
(1) Sales
ofitGrossRatioofitGross
PrPr
000,00,3025.0
GP
000,50,7GP
Cost of Goods Sold = 30,00,000 75% = 22,50,000
(2) Fixed Assets Turnover Ratio = AssetsFixedAssetsFixed
SoldGoodsofCost 000,50,225.1
Fixed Assets = 15,00,000
(3)
WorthNetNetWorthNetWorth
AssetsFixedWorthNettoAssetsFixed
000,00,1520.1
(3) Let us assume that preference Share capital is zero.
DebtDebt
preferenceEquity
preferenceDebtRatioGearningCapital
0000,50,12
05.0
= 6,25,000
(5) Reserves & Surplus = 12,50,000 × 0.6/1.6 = 4,68,750
Share Capital = 12,50,000 × 1/1.6 = 7,81,250
(6) Stock Turnover =
TurnoverStock 000,75,3000,50,22
6 StockStockStock
SoldGoodsofCost
(7) Debtors 000,00,512
20000,00,30
12
PeriodCollectionSales
(8) Looking at the liquid ratio and Current ratio we can say that stock to current liability ratio is 0.5
000,50,7000,75,3
5.0 LiabilityCurrentLiabilityCurrent
AssetsCurrentAssetsCurrent
LiabitliesCurrent
etCurrentAssRatioCurrent
0000,50,750.1 = 11,25,0000
Cash in Hand = 11,25,000 – 3,75,000 -5,00,000 = 2,50,000
Topper’s Institute Financial Analysis 3.63
Balance Sheet
Liabilities Rs. Assets Rs.
Share Capital 7,81,250 Fixed Assets 15,00,000
Reserve & Surplus 4,68,750 Stock 3,75,000
Debt 6,25,000 Debtors 5,00,000
Current Liabilities 7,50,000 Cash 2,50,000
26,25,000 26,25,000
(b) Calculation of working capital: Working Capital = Current Assets – Current Liabilities
= 11,25,000 – 7,50,000
= 3,75,000
If the above amount of Rs. 3,75,000 is 90% then full amount is = 3,75,000/0.9=Rs. Rs. 4,16,667.
Q.17 MNP Limited has made plans for the next year 2010-11. It is estimated that the company will employ total assets
of Rs.25,00,000; 30% of assets being financed by debt at an interest cost of 9% p.a. the direct costs for the
year are estimated at Rs.15,00,000 and all other operating expenses are estimated at Rs.2,40,000. The sales
revenue are Required to calculate:
(i) Net profit margin
(ii) Return on Assets
(iii) Assets turnover
(iv) Return on equity
[Nov. 2010] 4 Marks
Solution
(i) Net Profit Margin = × 100
= × 100 = 11.80%
(ii) Return on Assets = × 100
= × 100
= 13.32%
(iii) Assets turnover =
Income ` Sales Revenue
Less: Direct Cost
Contribution
Less: Other operating expenses
EBDIT
Less: Interest on 9% Debt
[ 2500000 × 30% × 9%]
EBDT
Less: Depreciation
EBT
Less: Taxes @ 40%
EAT
22,50,000
15,00,000
7,50,000
2,40,000
5,10,000
67,500
4,42,500
Nil
4,42,500
1,77,000
2,65,500
Topper’s Institute Financial Analysis 3.64
= = 0.90 times
(iv) Return on Equity = × 100
= × 100
= 15.17%
Q.18 Explain the following ratios: (i) Operating ratio
(ii) Price earnings ratio [May - 2011] 4 Marks
Solution (i) Operating Ratio: This ratio measures the relationship between operating cost & Net Sales.
Where:-
Operating Cost = Cost of goods sold & other operating exps
and
Net Sales = Gross Sales less Sales returns
Operating Ratio = 100SalesNet
CostOperating
The main objective of computing this ratio is to determine the operational efficiency with which production purchase
and selling operations are carried on.
(ii) Price Earnings Ratio:-
This ratio measures the relationship between the market price per share & earning per share.
The objective of computing this ratio is to find out expectations of the shareholders about the earning of the firm.
P.E. Ratio = ShareperEarning
sharepericeMarketPr
Note:- MPPS may be any share price or closing share price.
Q.19 The financial statements of a company contain the following information for the year ending 31st March, 2011.
Particulars Rs.
Cash
Sundry Debtors
Short-term Investment
Stock
Prepaid Expenses
Total Current Assets
Current Liabilities
10% Debentures
Equity Share Capital
Retained Earnings
1,60,000
4,00,000
3,20,000
21,60,000
10,000
30,50,000
10,00,000
16,00,000
20,00,000
8,00,000
Statement of profit for the4 year ended 31st March, 2011
Sales (20% cash sales)
Less: Cost of goods sold
Profit before Interest & Tax
Less: Interest Profit Before Tax
Less: Tax @ 30%
Profit After Tax
40,00,000
28,00,000
12,00,000
1,60,000 10,40,000
3,12,000
7,28,000
Topper’s Institute Financial Analysis 3.65
You are required to calculate:
(i) Quick Ratio
(ii) Debt-equity Ratio
(iii) Return on Capital employed, and
(iv) Average collection period (Assuming 360 days in a year)
[Nov. - 2011] 8 Marks
Solution
1. sLiabilitieCurrent
Pr RatioQuick
ExpsepaidStockAssetsCurrent
times88.010,00,000
000,60,21000,50,30
2. Earning)RatinedEsc.Equity(i.e
%)10...( D
eiDebtRatioEquityebt
1:57.0)000,00,8000,00,20(
000,00,16
3. ]000,00,16)000,00,8000,00,20[(
000,00,12
DebtEquity
EBITROCE
= 27.27%
4. 000,00,4
000,00,40%80
Debtors Average /D
ofSalesCreditRatioOTebt
= 8 Times
day 458
360 = period Collection Average So
Q.20 Explain the important ratios that would be used in each of the following situations.
(i) A bank is approached by a company for a loan of ` 50 lakh for working capital purposes.
(ii) A long term creditors interested in determining whether his claim is adequately secured.
(iii) A shareholder who is examining his portfolio and who is to decide whether he should hold or sell
his holding in the company.
(iv) A finance manager interested to know effectiveness with which a firm uses its available resources.
[May - 2012] 4 Marks
Solution
(i) Current Ratio, Quick Ratio, Stock Turnover Ratio
(ii) Proprietary ratio, Debt – equity ratio
(iii) Earning per share, P/E ratio, Return on equity
(iv) Capital Turnover ratio, Return on capital employed.
Q.21 The following accounting information and financial rations of M Limited relate to the year ended 31st March, 2012:
Inventory Turnover Ratio 6 Times Creditors Turnover Ratio 10 Times Debtors Turnover Ratio 8 Times Current Ratio 2.4
Topper’s Institute Financial Analysis 3.66
Gross Profit Ratio 25% Total sales ` 3,00,000, each sales 25% of credit sales; cash purchase ` 2,30,000; working capital ` 2,80,000; closing inventory is Rs. 80,000 more than opening inventory.
You are required to calculate: (i) Average Inventory (ii) Purchases (iii) Average Debtors (iv) Average Creditors (v) Average Payment Period (vi) Average Collection Period (vii) Current Assets (viii) Current Liabilities
[Nov - 2012] 8 Marks
Ans.(i) Average Inventory:-
Inventory Turnover Ratio = InventorsAvg
cons.= 6 times
6 Avg. inventory = Cons = Sales – Gross profit
Avg. inventory = 6
%25000,00,30 = 3,75,000/-
(ii) Purchases:-
Purchase = Cons + Closing Stock – Opening stock = (30,00,000 – 25%) + 80,000 = 23,30,000/- (iii) Average Debtors:-
Debtors Turnover Ratio = DebtorsAverage
SalesCredit= 8 times
Average Debtors = times8
%25000,00,24 = 3,00,000/-
Credit Sales = Credit Sales + Cash Sales = 30,00,000
Credit Sale + 25% of Credit Sales = 30,00,000
Credit Sales = 000,00,24%125
000,00,30
(iv) Average Creditors:-
Creditors Turnover Ratio = timesCreditorsAverage
PurchaseCredit10
Average Creditors = 10
PurchaseCashPurchaseTotal
= 10
000,30,2000,30,23 = 2,10,000/-
Topper’s Institute Financial Analysis 3.67
(v) Average Payment period = RatioTurnoverCreditors
Days365
= .)(3710
365AppxDays
Days
(vi) Average Collection Period = RatioTurnoverDebtors
Days365
= .)(468
365AppxDays
Days
(vii) Current Assets:-
Current Assets - Current Liabilities = Working Capital
= 2,80,000……………………(i)
4.2sLiabilitieCurrent
AssetsCurrent
Current Assets = 2.4 Current Liabilities……………………(ii) Current Assets – Current Liabilities = 2,80,000 2.4 Current Liabilities – Current Liabilities = 2,80,000
Current Liabilities = 000,00,240.1
000,80,2
Current Assets = 2.4 × 2,00,000
= 4, 80,0000/-
(viii) Current Liabilities = 2,00,000/-