Amity Business School: MBA Class of 2012, Semester I

Amity Business School

MBA Class of 2012, Semester I
ACCOUNTING FOR MANAGEMENT
Module III
BHAVNA RANJAN
1
II. Profitability Ratios Amity Business School
2
a) Profitability Ratios Related to Sales
(I) Gross Profit Ratio: Gross Profit * 100

Net Sales
Sales – Cost of Goods Sold *100
Net Sales
Interpretation
(II) Net Profit Ratio: Net Profit * 100
Net Sales
Interpretation
P & L A/c
Contd..
(III) Operating Ratio: Operating Costs * 100

Net Sales
where operating costs = Cost of goods sold + Operating
expenses
Operating Expenses are : Administrative and office
expenses + Selling and distribution expenses
Interpretation
IV) Expenses ratio: Expenses *100
Net sales
P & L A/c
b) Profitability Ratios related to Investment
i) Return on Total Assets
Return on Total Assets =Net Profit after tax * 100

Total Assets
Interpretation
ii) Return on Capital Employed
Return on Capital Employed= Profit before interest, tax*100

Capital Employed
Where Capital employed = Equity Share Capital +

Preference Share Capital + Reserves and Surplus + long
Loans + debentures – fictitious Assets like preliminary
expenses
Interpretation
iii) Return on Investment
Return on Investment= Profit after tax*100

Shareholder’s fund
Shareholder’s funds = Equity Share Capital + Preference

Share Capital + Reserves and Surplus –fictitious Assets like
preliminary expenses
Interpretation
iv) Return on Equity
Return on Equity = Net Profit after tax and Preference Div *100
Equity capital
Return on Equity Shareholder’s funds=Net Profit after tax&Preference

Div *100
Equity Shareholder’s funds
Shareholder’s funds = Equity share capital+ Reserves and Surplus-

Accumulated Losses
Interpretation
v) Earnings per share
Earnings per share =Net profit after tax&Preference Dividend

Number of Equity Shares
Interpretation
III. Turnover ratios
Turnover Ratios / Activity Ratios / Efficiency Ratios measure

the efficiency with which a firm manages its resources.
• Inventory Turnover ratio

• Debtors Turnover ratio
• Creditors turnover ratio
• Working capital turnover ratio
• Fixed assets turnover ratio
The ratio is expressed in times
i) Inventory Turnover Ratio
Inventory Turnover Ratio = Cost of goods sold

Average inventory
Inventory Conversion Period = 365

Inventory Turnover Ratio
(expressed in days)
ii) Debtors Turnover Ratio
Debtor Turnover Ratio = Net Credit Sales

Average Debtors (Debtors + B/R)
This ratio measures how rapidly receivables are collected.
A high ratio indicative of shorter time-lag between credit
sales and cash collection. A low ratio shows that debts are
not being collected rapidly.
Average Collection Period/ Debtor days= 365
DTR
iii) Creditors Turnover Ratio:
Creditor turnover Ratio = Net Credit Purchases

Average Creditors (creditors+B/P)
A low turnover ratio reflects liberal credit terms granted
by suppliers, while a high ratio shows that accounts are to
be settled rapidly.
Average payment period / Creditor Days = 365

Creditor Turnover Ratio
IV) LEVERAGE RATIO
Financial leverage refers to the use of debt finance.

Leverage ratios help in assessing the risk arising from the
use of debt capital.
two types of ratios:
a) Structural ratios – based on proportions of debt and
equity in financial statements
b) Coverage ratios – show the relationship between debt
service commitments and sources of meeting these
burdens
i) Debt Equity Ratio
Debt Equity ratio = Debt

Equity shareholder’s funds
Debt : All external long term liabilities

Equity shareholder’s funds: Share Capital + Reserves and
Surplus- Accumulated Losses
ii) Debt to Total Assets
Debt to Total Assets Ratio= Debt

Total assets
iii) Capital Gearing Ratio
Fixed Interest bearing funds

Equity shareholder’s funds
Fixed Interest bearing funds : debentures + long term loans +

preference share capital
Equity shareholder’s funds : equity share capital + reserves

and surplus – accumulated losses
iv) Proprietary ratio
Shareholder’s Net Worth

Total Assets
Shareholder’s Net worth = equity share capital + preference

share capital +Reserves and Surplus – Intangible assets –
fictitious assets
Total Assets = Net Fixed assets +Current assets – fictitious

assets
v) Interest Coverage Ratio
Interest Coverage ratio = Net profit (before interest and tax)

Interest
vi) Debt Service Coverage Ratio
DSCR = PAT + Depreciation + other non cash expenses

+Interest on term loan
Interest on Term loan + Term loan Installments
VALUATION RATIOS
Price-Earning Ratio = Market Price of the share

Earnings Per Share
Dividend payout ratio = Dividend per share * 100

Earning per share
Numericals
Profit & Loss A/c of a Ltd Co for the year ending 31st March, 2009
Dr Cr
To Opening Stock 9,950 By Sales 85,000
To Purchases 54,525 By Closing Stock 14,900
To carriage Inward 1,425
To Gross Profit c/d 34,000
99,900 99,900
To Office expenses 15,000
To Selling & Distribution Exp. 3,000 By Gross Profit b/d 34,000
To Financial Expenses 1,500 By Profit on sale of shares 600
To Loss on sale of asset 400 By interest on investments 300
To Net Profit 15,000
34,900 34,900
Ratio
Balance Sheet as on March 31, 2009
Liabilities Assets
Share Capital 20,000 Land and Buildings 15,000
Reserves and Surplus 9,000 Plant 8,000
Profit and Loss Account 6,000 Stock 14,000
Bank overdraft 3,000 Debtors 7,000
Sundry Creditors 8,000 Bills Receivables 1,000
Outstanding expenses 2,000 Cash and Bank Balance 3,000
48,000 48,000

Ratio
24

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Amity Business School

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a) Profitability Ratios Related to Sales

(I) Gross Profit Ratio: Gross Profit * 100

(III) Operating Ratio: Operating Costs * 100

b) Profitability Ratios related to Investment

i) Return on Total Assets

Return on Total Assets =Net Profit after tax * 100

ii) Return on Capital Employed

Return on Capital Employed= Profit before interest, tax*100

Where Capital employed = Equity Share Capital +

iii) Return on Investment

Return on Investment= Profit after tax*100

Shareholder’s funds = Equity Share Capital + Preference

iv) Return on Equity

Return on Equity Shareholder’s funds=Net Profit after tax&Preference

Shareholder’s funds = Equity share capital+ Reserves and Surplus-

v) Earnings per share

Earnings per share =Net profit after tax&Preference Dividend

III. Turnover ratios

Turnover Ratios / Activity Ratios / Efficiency Ratios measure

• Inventory Turnover ratio

i) Inventory Turnover Ratio

Inventory Turnover Ratio = Cost of goods sold

Inventory Conversion Period = 365

ii) Debtors Turnover Ratio

Debtor Turnover Ratio = Net Credit Sales

iii) Creditors Turnover Ratio:

Creditor turnover Ratio = Net Credit Purchases

Average payment period / Creditor Days = 365

IV) LEVERAGE RATIO

Financial leverage refers to the use of debt finance.

i) Debt Equity Ratio

Debt Equity ratio = Debt

Debt : All external long term liabilities

ii) Debt to Total Assets

Debt to Total Assets Ratio= Debt

iii) Capital Gearing Ratio

Fixed Interest bearing funds

Fixed Interest bearing funds : debentures + long term loans +

Equity shareholder’s funds : equity share capital + reserves

iv) Proprietary ratio

Shareholder’s Net Worth

Shareholder’s Net worth = equity share capital + preference

Total Assets = Net Fixed assets +Current assets – fictitious

v) Interest Coverage Ratio

Interest Coverage ratio = Net profit (before interest and tax)

vi) Debt Service Coverage Ratio

DSCR = PAT + Depreciation + other non cash expenses

Price-Earning Ratio = Market Price of the share

Dividend payout ratio = Dividend per share * 100

Balance Sheet as on March 31, 2009

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