RATIO ANALYSIS

Course Name: Working Capital Management

Course Code: FIN-4201

 Theoretical Questions

1. Explain different types of Liquidity Ratios.

Ans:
Various Liquidity Ratios are:
A. Current Ratio: The Current Ratio is one of the best-known measures of short-term solvency. It is
the most common measure of short-term liquidity.
B. Quick Ratio or Acid test Ratio: The Quick Ratio is sometimes called the "acid-test" ratio and is
one of the best measures of liquidity. The Quick Ratio is a much more conservative measure of
short-term liquidity than the Current Ratio. Quick Assets consist of only cash and near cash assets.
Inventories are deducted from current assets on the belief that these are not ‘near cash assets’ and
because in times of financial difficulty inventory may be saleable only at liquidation value.
C. Cash Ratio or Absolute Liquidity Ratio: This ratio considers only the absolute liquidity available
with the firm. The Absolute Liquidity Ratio only tests short-term liquidity in terms of cash and
marketable securities/ current investments.
D. Net Working Capital Ratio: Net working capital is more a measure of cash flow than a ratio. The
result of this calculation must be a positive number.

2. How Ratio analysis helps in period of financial decision making?

Ans:
A popular technique of analyzing the performance of a business concern is that of financial ratio
analysis. As a tool of financial management, they are of crucial significance. Financial Ratios helps in
decision making by Evaluating Performance
(a) Liquidity Position: With the help of ratio analysis one can draw conclusions regarding the liquidity
position of a firm. The liquidity position of a firm would be satisfactory if it is able to meet its
obligations when they become due. This ability is reflected in the liquidity ratios of a firm. The
liquidity ratios are particularly useful in credit analysis by banks and other suppliers of short-term
loans.
(b) Long-term Solvency: Ratio analysis is equally useful for assessing the long- term financial
viability of a firm. This aspect of the financial position of a borrower is of concern to the long-term
creditors, security analysts and the present and potential owners of a business.
The long-term solvency is measured by the leverage/capital structure and profitability ratios which
focus on earning power and operating efficiency.
The leverage ratios, for instance, will indicate whether a firm has a reasonable proportion of various
sources of finance or whether heavily loaded with debt in which case its solvency is exposed to serious
strain. Similarly, the various profitability ratios would reveal whether the firm is able to offer an
adequate return to its owners consistent with the risk involved.
(c) Operating Efficiency: Ratio analysis throws light on the degree of efficiency in the management
and utilization of its assets. The various activity ratios measure this kind of operational efficiency. In
fact, the solvency of a firm is, in the ultimate analysis, dependent upon the sales revenues generated
by the use of its assets – total as well as its components.
(d) Overall Profitability: Unlike the outside parties which are interested in one aspect of the financial
position of a firm, the management is constantly concerned about the overall profitability of the
enterprise. That is, they are concerned about the ability of the firm to meet its short-term as well as
long- term obligations to its creditors, to ensure a reasonable return to its owners and secure optimum
utilisation of the assets of the firm. This is possible if an integrated view is taken, and all the ratios are
considered together.
(e) Inter-firm Comparison: Ratio analysis not only throws light on the financial position of a firm
but also serves as a steppingstone to remedial measures. This is made possible due to inter-firm
comparison/comparison with industry averages. An inter-firm comparison would demonstrate the
relative position vis-a-vis its competitors. If the results are at variance either with the industry average
or with those of the competitors, the firm can seek to identify the probable reasons and, in the light,
take remedial measures.

3. What are the limitations of Financial Ratios?

Ans:
The limitations of financial ratios are listed below:
(i) Diversified product lines: Many businesses operate in a large number of divisions in quite
different industries. In such cases ratios calculated because of aggregate data cannot be used for inter-
firm comparisons.
(ii) Financial data are badly distorted by inflation: Historical cost values may be substantially
different from true values. Such distortions of financial data are also carried in the financial ratios.
(iii) Seasonal factors: It may also influence financial data.
Example: A company deals in cotton garments. It keeps a high inventory during October - January
every year. For the rest of the year its inventory level becomes just 1/4th of the seasonal inventory
level.
So, liquidity ratios and inventory ratios will produce biased picture. The year end picture may not be
the average picture of the business. Sometimes it is suggested to take monthly average inventory data
instead of year end data to eliminate seasonal factors. But for external users it is difficult to get monthly
inventory figures. (Even in some cases monthly inventory figures may not be available).
(iv) 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.
(v) Differences in accounting policies and accounting period: It can make the accounting data of
two firms non-comparable as also the accounting ratios.
(vi) No standard set of ratios against which a firm’s ratios can be compared: 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.
(vii) Difficulty to generalise 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.
(viii) 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 care of through multivariate analysis.

4. Define Horizontal and Vertical Analysis.

Ans:
There are two types of Financial Analysis: - Horizontal and vertical.
Horizontal Analysis: When financial statements of one year are analysed and interpreted after
comparing with another year or years, it is known as horizontal analysis. It can be based on the ratios
derived from the financial information over the same time span.
Vertical Analysis: When a financial statement of a single year is analyzed then it is called vertical
analysis. This analysis is useful in inter firm comparison. Every item of Profit and loss account is
expressed as a percentage of gross sales, while every item on a balance sheet is expressed as a
percentage of total assets held by the firm.

5. What is financial leverage? What ratios measure the firm’s degree of indebtedness? What
ratios assess the firm’s ability to service debts?

Ans:
Financial leverage refers to the use of debt or borrowed funds to increase the potential return on
investment for a business or investor. It involves using borrowed money to finance the operations or
expansion of a company with the expectation that the return on the investment will be greater than the
cost of borrowing. Financial leverage can amplify both profits and losses.
There are several ratios that measure a firm's degree of indebtedness and assess its ability to service
debts:
1. Debt-to-Equity Ratio (D/E Ratio): This ratio measures the proportion of a company's
financing that comes from debt compared to equity. It is calculated by dividing total debt by
total equity. A high D/E ratio indicates a higher degree of indebtedness, which can be risky if
the company struggles to meet its debt obligations.
Formula: D/E Ratio = Total Debt / Total Equity
2. Debt Ratio: The debt ratio is similar to the D/E ratio but focuses solely on the proportion of a
company's assets that are financed by debt. It is calculated by dividing total debt by total assets.
A higher debt ratio means a larger portion of the company's assets is funded by debt.
Formula: Debt Ratio = Total Debt / Total Assets
3. Debt-to-Capital Ratio: This ratio assesses the proportion of a company's capital structure that
consists of debt. It is calculated by dividing total debt by the sum of total debt and total equity.
A higher debt-to-capital ratio implies a higher level of financial leverage.
Formula: Debt-to-Capital Ratio = Total Debt / (Total Debt + Total Equity)
4. Interest Coverage Ratio (ICR): The ICR measures a company's ability to cover its interest
expenses with its earnings before interest and taxes (EBIT). A higher ICR indicates a stronger
ability to service debt because it means the company generates sufficient earnings to cover
interest payments.
Formula: ICR = EBIT / Interest Expenses
5. Debt Service Coverage Ratio (DSCR): DSCR is often used in the context of project finance
and assesses a company's ability to meet its debt obligations, including interest and principal
payments. It is calculated by dividing a company's operating income (or EBITDA) by its total
debt service (interest + principal payments).
Formula: DSCR = EBITDA / Total Debt Service
These ratios are essential tools for investors, creditors, and financial analysts to evaluate a company's
financial health, risk profile, and its ability to manage its debt obligations. A high degree of
indebtedness can lead to increased financial risk, while strong debt service ratios indicate a company's
capacity to handle its debt burden effectively.

6. Regarding financial ratio analysis, how do the viewpoints held by the firm’s present and
prospective shareholders, creditors, and management differ?

Ans:
Financial ratio analysis is a critical tool used by various stakeholders, including the firm's present and
prospective shareholders, creditors, and management. Each group has different perspectives and
interests when it comes to analyzing financial ratios:
1. Firm's Present Shareholders:
• Investment Performance: Present shareholders are primarily concerned with
assessing the company's financial health and profitability to determine the return on
their investment. They use financial ratios to gauge the company's ability to generate
profits and provide a return on equity or dividends.
• Stability and Dividends: Shareholders may focus on ratios related to stability and
dividend payments, such as the dividend yield and payout ratio. These ratios provide
insights into the company's ability to sustain and grow dividend payments over time.
• Market Value: Present shareholders may also consider ratios related to market value,
such as the price-to-earnings (P/E) ratio, to assess the company's stock price relative to
its earnings. This helps them evaluate whether the stock is overvalued or undervalued.
2. Firm's Prospective Shareholders (Potential Investors):
• Growth Prospects: Prospective shareholders are interested in the company's growth
potential and future prospects. They analyze ratios like the price-to-earnings growth
(PEG) ratio and return on equity (ROE) to evaluate the company's growth and
profitability potential.
• Risk Assessment: Prospective shareholders assess the company's risk profile by
looking at ratios related to liquidity, leverage, and financial stability. These ratios help
them gauge the level of risk associated with investing in the company.
• Valuation: They also consider valuation ratios like the P/E ratio to determine whether
the company's stock is trading at an attractive price relative to its earnings.
3. Creditors (Lenders and Bondholders):
• Credit Risk Assessment: Creditors are primarily concerned with the company's ability
to meet its debt obligations. They focus on ratios that assess the company's liquidity,
solvency, and debt servicing capacity, such as the current ratio, debt-to-equity ratio,
and interest coverage ratio.
• Asset Coverage: Creditors may also analyze asset-based ratios like the asset turnover
ratio to assess the company's ability to generate sufficient cash flows and collateral to
cover its debts.
• Stability: Creditors are interested in the company's financial stability and any potential
signs of financial distress that may impact its ability to repay debt.
4. Management:
• Operational Efficiency: Management uses financial ratios to evaluate the efficiency
of the company's operations. They may focus on ratios like the inventory turnover ratio
and accounts receivable turnover ratio to optimize working capital management.
 • Profitability and Growth: Management assesses profitability ratios to monitor the
company's financial performance and growth. They aim to improve profitability and
ensure the company's long-term sustainability.
• Resource Allocation: Ratios help management allocate resources effectively, whether
it's deciding on capital investments, managing costs, or optimizing the capital structure.
In summary, while all stakeholders use financial ratios to assess a company's performance, they do so
with different objectives and perspectives. Shareholders are interested in returns and dividends,
prospective shareholders focus on growth and risk, creditors emphasize debt repayment capacity, and
management uses ratios for operational and strategic decision-making. Understanding these differing
viewpoints is crucial for effectively using financial ratios to meet the needs of each stakeholder group.

7. What types of deviations from the norm should the analyst pay primary attention to when
performing cross-sectional ratio analysis?

Ans:
When performing cross-sectional ratio analysis, which involves comparing financial ratios of a
company to those of its peers or industry benchmarks, analysts should pay primary attention to
deviations from the norm that could indicate potential strengths or weaknesses in the company's
financial performance. Here are some types of deviations to focus on:
1. Significant Outliers: Look for ratios that are significantly higher or lower than the industry
average or peer group. These outliers can indicate areas where the company excels or where it
may be underperforming relative to its peers.
2. Trends Over Time: Analyze how the company's ratios have changed over time. A significant
deviation from historical performance may signal a shift in the company's financial health.
3. Relative Performance: Compare the company's ratios to those of its closest competitors or
industry benchmarks. Deviations from the norm in key areas like profitability, liquidity, or
leverage can reveal competitive advantages or weaknesses.
4. Consistency with Industry Norms: Evaluate whether the company's ratios align with industry
norms and standards. A significant deviation from industry standards may warrant further
investigation.
5. Key Drivers: Understand the key drivers behind deviations. For instance, if a company has a
higher profit margin than its peers, is it due to superior cost management or higher pricing
power? Conversely, if it has a lower liquidity ratio, is it due to inefficient working capital
management or industry-specific factors?
6. Industry-Specific Factors: Consider industry-specific factors that may influence ratios. Some
industries have unique characteristics that can affect financial ratios, such as seasonality,
regulatory changes, or technological disruptions.
 7. Comparability: Ensure that the companies being compared are reasonably comparable.
Sometimes, differences in business models, geographic regions, or customer bases can lead to
natural deviations in ratios.
8. Materiality: Focus on deviations that are material and significant. Minor deviations may not
be as relevant or indicative of a problem.
9. Qualitative Factors: Incorporate qualitative information, such as news, management
commentary, and market dynamics, to provide context for deviations in ratios. These factors
can help explain unusual financial performance.
10. Peer Group Selection: Ensure that the peer group used for comparison is relevant and up-to-
date. Changes in the competitive landscape may require adjustments to the peer group.
11. External Factors: Consider external economic factors, such as changes in interest rates,
inflation, or consumer sentiment that could impact the company's ratios.
12. Benchmark Ratios: Use industry benchmarks and standards as a reference point to assess
deviations. Industry associations, research reports, and financial databases can provide
valuable benchmark data.
In summary, cross-sectional ratio analysis should not only identify deviations from the norm but also
strive to understand the reasons behind those deviations. This analysis can provide valuable insights
into a company's competitive position and financial health, helping stakeholders make informed
decisions.

8. Why it is preferable to compare ratios calculated using financial statements that are dated at
the same point in time during the year?

Ans: Comparing ratios calculated using financial statements that are dated at the same point in time
during the year is preferable for several reasons:
1. Seasonal Variations: Many businesses experience seasonal fluctuations in their operations
and financial performance. Comparing ratios based on financial statements from the same time
of year helps mitigate the impact of these seasonal variations. For instance, a retailer's
profitability ratios may look very different when comparing year-end financials (after the
holiday season) to mid-year financials.
2. Accurate Benchmarking: To effectively benchmark a company against its peers or industry
standards, it's important to ensure that the financial data being compared reflects a similar
operating environment. Ratios based on financial statements from different quarters or months
may not provide an accurate basis for comparison.
3. Timely Relevance: Financial data can become outdated quickly, especially in fast-paced
industries. Comparing ratios from the same point in time ensures that the information being
used for analysis is relevant and up to date, making it more useful for decision-making.
 4. Consistency: Consistency is essential when conducting financial analysis. Using financial
statements from the same point in time ensures that the analysis is conducted on a level playing
field, reducing the potential for biases or inaccuracies in the assessment.
5. Accounting Changes and Events: Companies may make accounting changes or experience
significant events during the year that can impact their financial statements. Comparing ratios
from different periods could lead to misinterpretations if these events are not taken into
account.
6. Quarterly Reporting: Many publicly traded companies provide quarterly financial statements
in addition to annual reports. Using financial data from the same quarter allows for a more
granular analysis and monitoring of a company's performance over time.
7. Investor Expectations: Investors and analysts often have expectations based on a company's
historical performance during specific quarters or periods. Comparing ratios from the same
point in time helps align analysis with these expectations.
8. Cyclical Businesses: Some businesses operate in cyclical industries where performance can
vary significantly throughout the year. Comparing ratios from the same period helps capture
the impact of economic cycles on financial performance.
9. Management's Focus: Management may have specific goals or strategies for certain quarters
or periods. Analyzing ratios from the same point in time allows for a more accurate assessment
of whether management's initiatives are achieving their intended results.
In conclusion, comparing ratios based on financial statements dated at the same point in time during
the year enhances the accuracy, relevance, and reliability of financial analysis. It helps ensure that
seasonal variations, accounting changes, and other factors do not distort the analysis, making it a more
effective tool for decision-making and benchmarking.
 Problems

Problem: 1

Equity & Liabilities Tk. Assets Tk.

Equity Share Capital 500000 Land & Building 100000
Preference share capital 200000 Machinery 400000
General Reserve 100000 Furniture 50000
Secured Loan 300000 Inventory 300000
Short Term Bank Loans 100000 Receivables 300000
Cash/Bank Balance 50000
Total 1200000 Total 1200000

Calculate Following Ratios from the above balance sheet:

1. Current Ratio
2. Quick Ratio
3. Cash Ratio
4. Debt Equity Ratio
5. Proprietary Ratio

Ans:
𝐂𝐮𝐫𝐫𝐞𝐧𝐭 𝐀𝐬𝐬𝐞𝐭𝐬
1. Current ratio =
𝐂𝐮𝐫𝐫𝐞𝐧𝐭 𝐋𝐢𝐚𝐛𝐢𝐥𝐢𝐭𝐢𝐞𝐬
Current Assets = Inventory + Receivables + Cash
= 300000 + 300000 + 50000
= 650000
Current liabilities = Short term bank loans
= 100000
650000
Current Ratio =
100000
= 6.5

𝐐𝐮𝐢𝐜𝐤 𝐀𝐬𝐬𝐞𝐭𝐬
2. Quick Ratio =
𝐂𝐮𝐫𝐫𝐞𝐧𝐭 𝐋𝐢𝐚𝐛𝐢𝐥𝐢𝐭𝐢𝐞𝐬
Quick Assets = Current Assets − Inventories
 = 650000 − 300000
= 350000
Current Liabilities = 100000
350000
Quick Ratio =
100000
= 3.5

𝐂𝐚𝐬𝐡
3. Cash Ratio =
𝐂𝐮𝐫𝐫𝐞𝐧𝐭 𝐋𝐢𝐚𝐛𝐢𝐥𝐢𝐭𝐢𝐞𝐬
Cash = 50000
Current Liabilities = 100000
50000
Cash Ratio =
100000
= 0.5

𝑻𝒐𝒕𝒂𝒍 𝑫𝒆𝒃𝒕
4. Debt Equity Ratio =
𝑺𝒉𝒂𝒓𝒆𝒉𝒐𝒍𝒅𝒆𝒓′ 𝒔 𝑬𝒒𝒖𝒊𝒕𝒚
Total debt = Secured Loan + Short term bank loan
= 300000 + 100000
Shareholder’s Equity = Equity share + Preference share + Reserves
= 500000 + 200000 + 100000
= 800000
400000
Debt Equity Ratio =
800000
= 0.50

𝑷𝒓𝒐𝒑𝒓𝒊𝒆𝒕𝒂𝒓𝒚 𝑭𝒖𝒏𝒅
5. Proprietary Ratio =
𝑻𝒐𝒕𝒂𝒍 𝑨𝒔𝒔𝒆𝒕𝒔
Proprietary Fund = Equity share + Preference Share + Reserves

= 500000 + 200000 + 100000

= 800000
Total Assets = Fixed Assets + Current Assets
= 550000 + 650000
= 1200000
 800000
Proprietary Ratio =
1200000
= 0.67

Problem 2

The details of ABC Company are as under:

Particular Tk. Particular2 Tk.

Equity share capital 2000000 Fixed Assets 5500000
10% Preference share capital 2000000 Stock 175000
Reserves 1100000 Debtors 350000
10% Debentures 1000000 Bills receivable 50000
Creditors 100000 Cash 225000
Bank‐overdraft 150000 Inventory 100000
Bills payable 45000
Outstanding expenses 5000

Total 6400000 6400000

Income Statement
Sales (40% cash sales) 15,00,000
Less: Cost of sales 7,50,000
Gross Profit: 7,50,000
Less: Office Exp. (including int. on debentures) 1,25,000
Selling Exp. 1,25,000 2,50,000
Profit before Taxes: 5,00,000
Less: Taxes 2,50,000
Net Profit: 2,50,000

Besides the details mentioned above, the opening stock was of Tk. 3,25,000. Taking 360 days of the
year, calculate the following ratios; also discuss the position of the company:
(1) Gross profit ratio, (2) Stock turnover ratio, (3) Operating Profit ratio, (4) Liquidity ratio, (5)
Average Collection Period, (6) Average Payment Period, (7) Proprietary ratio
Ans.

𝐆𝐫𝐨𝐬𝐬 𝐏𝐫𝐨𝐟𝐢𝐭
1. Gross Profit Margin = × 𝟏𝟎𝟎
𝐒𝐚𝐥𝐞𝐬

Gross profit = 750000

Sales = 15,00,000
750000
Gross Profit Margin = × 100
1500000

= 50%

𝐂𝐨𝐬𝐭 𝐨𝐟 𝐠𝐨𝐨𝐝𝐬 𝐬𝐨𝐥𝐝

2. Stock Turnover Ratio =
𝐀𝐛𝐠. 𝐬𝐭𝐨𝐜𝐤

Cost of goods sold= 750000

Opening stock+ Closing stock
Avg. stock =
2
325000+175000
=
2

= 250000
750000
Stock Turnover Ratio =
250000

= 3 times

𝐎𝐩𝐞𝐫𝐚𝐭𝐢𝐧𝐠 𝐏𝐫𝐨𝐟𝐢𝐭
3. Operating Profit Ratio =
𝐍𝐞𝐭 𝐬𝐚𝐥𝐞𝐬

Operating profit = Sales − (Operating expenses + COGS)

= 15,00,000 – (25000 + 125000 + 750000)
= 600000 Here,
Net sales = 1500000 Office expense including interest expense is Tk.125000
600000 Interest expense on debenture (10% of 1000000) Tk.
Operating ratio =
1500000 100000
= 0.4 Office Exp. = (125000 – 100000)
= 25000
 𝑳𝒊𝒒𝒖𝒊𝒅 𝑨𝒔𝒔𝒆𝒕𝒔
4. Liquidity Ratio =
𝑪𝒖𝒓𝒓𝒆𝒏𝒕 𝑳𝒊𝒂𝒃𝒊𝒍𝒊𝒕𝒊𝒆𝒔

(Liquid) Quick Assets = Current Assets ‐ Stock

= (Stock + debtors + Bills receivable + Cash+Inventory) – Stock
− Inventories
= (1,75,000 + 3,50,000 + 50,000 + 2,25,000 + 100000) −
175000 − 100000
= 625000
Current Liabilities = Creditors + bank overdraft + Bills payable + Outstanding expenses
= 1,00,000 + 1,50,000 + 45,000 + 5,000
= 300000
625000
Liquid Ratio =
300000

= 2.083

𝑫𝒆𝒃𝒕𝒐𝒓𝒔+𝑩𝒊𝒍𝒍𝒔 𝒓𝒆𝒄𝒆𝒊𝒗𝒂𝒃𝒍𝒆
5. Average Collection Period = × 𝟑𝟔𝟎 𝒅𝒂𝒚𝒔
𝑪𝒓𝒆𝒅𝒊𝒕 𝒔𝒂𝒍𝒆𝒔

Sales = 60% of 1500000

= 900000
350000+50000
Average Collection Period = × 360 days
900000

= 160 days

𝐂𝐫𝐞𝐝𝐢𝐭𝐨𝐫𝐬+𝐁𝐢𝐥𝐥𝐬 𝐩𝐚𝐲𝐚𝐛𝐥𝐞
6. Average Payment Period = × 𝟑𝟔𝟎 𝐝𝐚𝐲𝐬
𝐂𝐫𝐞𝐝𝐢𝐭 𝐏𝐮𝐫𝐜𝐡𝐚𝐬𝐞

Credit Purchase = Cost of goods sold

= 750000
100000 +45000
Average Collection Period = × 360 days
750000

= 69 days

𝐒𝐡𝐚𝐫𝐞𝐡𝐨𝐥𝐝𝐞𝐫 ′ 𝐬 𝐅𝐮𝐧𝐝𝐬
7. Proprietary Ratio =
𝐓𝐨𝐭𝐚𝐥 𝐀𝐬𝐬𝐞𝐭𝐬
Shareholder’s Funds = Eq. Sh. Cap. + Reserves & Surplus + Preference Sh.
Cap.
= 20,00,000 + 20,00,000 + 11,00,000
= 5100000
Total Assets = 6400000
5100000
Proprietary ratio =
6400000

= 0.797

Problem 3

Balance Sheet
Assets & Liabilities 2018 2019
Fixed Assets (Net Block) - 30,000 - 40,000
Receivables 50,000 82,000
Cash at Bank 10,000 7,000
Stock 60,000 94,000
Total Current Assets (CA) 1,20,000 1,83,000
Payables 50,000 76,000
Total Current Liabilities
50,000 76,000
(CL)
Working Capital (CA - CL) 70,000 1,07,000
Total Asset 1,00,000 1,47,000
Represented by:
Share Capital 75000 75,000
Reserve and Surplus 25,000 42,000
Debentures - 30,000

1,00,000 1,47,000

Income Statement

Particulars 2018 2019

Cash Sales 30,000 32,000
Credit Sales 2,70,000 3,00,000 3,42,000 3,74,000
Less: Cost of goods sold 2,36,000 2,98,000
Gross profit 64,000 76,000
 Less: Operating Expenses

Warehousing 13,000 14,000

Transport 6,000 10,000
Administrative 19,000 19,000
Selling 11,000 14,000
49,000 57,000
Net Profit 15,000 19,000

You are required to CALCULATE the following ratios for the years 2018 and 2019.
1. Gross Profit Ratio
2. Operating Expenses to Sales Ratio.
3. Operating Profit Ratio
4. Capital Turnover Ratio
5. Stock Turnover Ratio
6. Net Profit to Net Worth Ratio (ROE), and
7. Receivables Collection Period.

Ans:

Computation of Ratios
Ratio 2018 2019

1. Gross profit ratio (Gross (64,000×100) (76,000×100)

=21.3% =20.3%
profit/sales) / 3,00,000 / 3,74,000
2. Operating expense to sales
(57,000×100)
ratio (Operating expense/Total (49,000×100) =16.3% =15.2%
/ 3,74,000
sales) / 3,00,000
3. Operating profit ratio (15,000×100) (19,000×100)
=5% =5.08%
(Operating profit / Total sales) / 3,00,000 / 3,74,000
4. Capital turnover ratio (Sales / 3,00,000 / 3,74,000/
3 2.54
capital employed) 1,00,000 1,47,000
5.Stock turnover ratio (COGS / 2,36,000 / 2,98,000 /
=3.93 =3.87
Average stock) 60,000 77,000
6. Net Profit to Net worth (Net (15,000×100) (19,000×100)
=15% =12.93%
profit / Net worth) / 1,00,000 / 1,47,000

7.Receivables collection period 50,000 / 82,000 / =87.5

(Average receivables / =67.6 days
739.73 936.99 days
Average daily credit sales)
2,70,000 / 365 =739.73 =936.99
 3,42,000 /
Working note: Average sales /
365
365
Problem 4
X Company has made plans for the next year. It is estimated that the company will employ total assets
of 800000; 50 percent of the assets being financed by borrowed capital at an interest cost of 8 percent
per year. The direct costs for the year are estimated at 480000 and all other operating expenses are
estimated at 80,000. The goods will be sold to customers at 150 percent of the direct costs. The tax
rate is assumed to be 50 percent. Required to Calculate:
(a) Net profit margin, (b) Return on assets., (c) Asset Turnover, (d) Return on owner’s equity.

Ans:

Particulars
Sales (150% of 4,80,000) 7,20,000
Direct costs 4,80,000
Gross profit 2,40,000
Operating expenses 80,000
Interest changes (8% of 4,00,000) 32,000 1,12,000
Profit before taxes 1,28,000
Taxes (@ 50%) 64,000
Net profit after taxes 64,000

𝐏𝐫𝐨𝐟𝐢𝐭 𝐚𝐟𝐭𝐞𝐫 𝐭𝐚𝐱𝐞𝐬

1. Net profit margin =
𝐒𝐚𝐥𝐞𝐬
64000
=
720000

= 0.89

𝐍𝐞𝐭 𝐏𝐫𝐨𝐟𝐢𝐭 𝐀𝐟𝐭𝐞𝐫 𝐓𝐚𝐱𝐞𝐬

2. Return on assets =
𝐀𝐬𝐬𝐞𝐭𝐬
64000
=
800000

= 0.08

𝐒𝐚𝐥𝐞𝐬
3. Asset turnover ratio =
𝐀𝐬𝐬𝐞𝐭𝐬
720000
=
800000
 = 0.9 times

𝑵𝒆𝒕 𝒑𝒓𝒐𝒇𝒊𝒕 𝒂𝒇𝒕𝒆𝒓 𝒕𝒂𝒙𝒆𝒔

4. Return on owner’s equity =
𝑶𝒘𝒏𝒆𝒓′ 𝒔𝒆𝒒𝒖𝒊𝒕𝒚
64000
=
50% of 800000
64000
=
400000

= 0.16

Problem 5

The Balance sheet as of 2002 & 2003

Liabilities 2002 2003 Assets 2002 2003

Equity share capital 1,00,000 1,25,000 Land and 50,000 75,000
General Reserve 12,500 15,000 Buildings Plant
57,500 55,000
Machinery
Profit & Loss A/c 10,000 7,500 10,000 12,500
Creditors Stock
5,000 6,250 7,500 10,000
Bills payable O/s. Debtors
3,750 7,500
Cash & Bank 5,000 7,500
Expenses Provident 1,250 3,750
Bills Receivable 2,500 5,000
Fund 7,500 5,000
Preliminary Exp. 7,500 5,000
1,40,000 1,70,000
1,40,000 1,70,000

Profit & Loss

Particulars 2002 2003 Particulars 2002 2003
To Op. Stock 5,000 10,000 By Sales 62,500 1,12,500
To Purchase To 37,500 47,500 10,000 12,500
By ClosingStock
Office Exp. 7,500 10,000
By Profit on Sale of 2,500 ‐‐‐‐
To Selling exp. 5,000 12,500 Furniture
To Fin. Exp. 2,500 15,000
To Net Profit 17,500 30,000

75,000 1,25,000 75,000 1,25,000

Find out (1) Current Ratio, (2) Stock Turnover Ratio, (3) Gross Profit Ratio, (4) Liquid Ratio, (5)
Average Collection Period (working days 300), (6) Return on Equity Capital employed, (7)
Ownership Ratio.

Ans:

Current Assets
1. Current Ratio =
Current liabilities
Current Assets = Stock + debtors + Bills receivable + Cash &
Bank Balance

Current Liabilities = Creditors + Bills payable + O/s Exp. + PF

2002:
= 10,000 +7,500 + 5,000 + 2,500
5,000 + 3,750 + 1,250 + 7,500
= 25,000
17,500
= 1.43 :1

2003‐04:
= 12,500 + 10,000 + 7,500 + 5,000
6,250 + 7,500 + 3,750 + 5,000
= 35,000
22,500
= 1.56 : 1

Cost of goods sold

2. Stock Turnover Ratio =
Avg. Stock
Avg. stock = Opening Stock + Closing Stock
2
2002‐03:
5000 + 10000
2
= 7,500
 2003‐04:
10000 + 12500
2
= 11,250
Gross Profit = Sales + Closing Stock ‐ (Opening
Stock + Purchase)
COGS = Sales ‐ GP
2002: = 62,500 + 10,000 ‐ (5,000 + 37,500)
= 30,000
COGS = 62,500 ‐ 30,000
= 32,500
2003: = 1,12,500 + 12,500 ‐ (10,000 + 47,500)
= 67,500
COGS = 1,12,500 ‐ 67,500
= 45,000
2002‐03:
= 32,500
7,500
= 4.33 times
2003‐04:
= 45,000
11,250
= 4 times

Gross profit
3. Gross Profit Margin = X 100
Sales
GP = Sales ‐ COGS
2002‐03:
2002: = 62,500 + 10,000 ‐
(5,000 +37,500)
= 30,000
2003‐04: = 1,12,500 + 12,500 ‐
(10,000 + 47,500)
= 67,500
2002‐03:
= 30,000 X 100
62,500

= 48%
 2003‐04:
= 67,500 X 100
1,12,500

= 60%

Liquid Assets
4. Liquid Ratio = Liquid liabilities

(Liquid) Quick Assets = Current Assets ‐ Stock

(Liquid) Quick Liabilities = Current Liabilities –

BOD
2002‐03:
= 25,000 ‐10,000
17,500
= 15,000
17,500

= 0.86 :1

2003‐04:
= 35,000 ‐ 12,500
22,500

5. Debtors Ratio =
Debtors + Bills receivable X 300 days
(Avg. debt collection period) Credit sales

2002‐03:
= 7,500 + 2,500 X 300 days
62,500
= 10,000
X 300 days
62,500
 = 48 days

2003‐04:
= 10,000 + 5,000 X 300 days
1,12,500
= 15,000
X 300 days
1,12,500
= 40 days

6. Rate of return on Equity Shareholders Fund:

2002
= PAT – Pref. Div.
Here, ESHF X 100

Surplus = Profit & loss account ESHF = Eq. Sh. Cap. + Reserves + Surplus –
Fictitious Assets
ESHF = 1,00,000 + 12,500 + 10,000 ‐ 7,500
= 1,15,000
= 17,500 X 100
1,15,000
= 15.22 %

2003:

ESHF: 1,25,000 + 15,000 + 7,500 ‐ 5,000

= 1,42,500
= 30,000
X 100
1,42,500

= 21.05%
 Shareholders’ Funds
7. Ownership Ratio =
Total Assets

SHF = Eq. Sh. Cap. + Reserves + Surplus – Fictitious Assets

Total Assets = Total Assets – Fictitious Assets

2002 = SHF = 1,00,000 + 12,500 + 10,000 ‐ 7,500

= 1,15,000
TA = 1,40,000 ‐ 7,500
= 1,32,500
= 1,15,000
1,32,500
= 0.87 : 1
OR
= 87%
2003 = SHF = 1,25,000 + 15,000 + 7,500 ‐ 5,000
= 1,42,500
TA = 1,70,000 ‐ 5,000
1,65,000
= 1,42,500
1,65,000
= 0.86 : 1
OR
= 86%
Problem 6

Particular 2017 2018 2019

Cash 30,000 20,000 5,000
Accounts receivable 2,00,000 2,60,000 2,90,000
Inventory 4,00,000 4,80,000 6,00,000
Net fixed assets 8,00,000 8,00,000 8,00,000
14,30,000 15,60,000 16,95,000

Accounts payable 2,30,000 3,00,000 3,80,000

Accruals 2,00,000 2,10,000 2,25,000
Bank loan, short-term 1,00,000 1,00,000 1,40,000
Long-term debt 3,00,000 3,00,000 3,00,000
Common stock 1,00,000 1,00,000 1,00,000
Retained earnings 5,00,000 5,50,000 5,50,000
14,30,000 15,60,000 16,95,000

Sales 40,00,000 43,00,000 38,00,000

Cost of goods sold 32,00,000 36,00,000 33,00,000
Net profit 3,00,000 2,00,000 1,00,000

Analyze the company’s financial condition and performance over the last 3 years. Are there any
problems?

Ans:

Ratios 2017 2018 2019

Current ratio 1.19 1.25 1.2
Acid-test ratio 0.43 0.46 0.4
Average collection period 18 22 27
Inventory turnover 8.2 6.1
Total debt to net worth 1.38 1.4 1.61
Long-term debt to total capitalization 0.33 0.32 0.32
Gross profit margin 0.200 0.163 0.132
Net profit margin 0.075 0.047 0.026
Asset turnover 2.80 2.76 2.24
Return on assets 0.21 0.13 0.06
Analysis: The company’s profitability has declined steadily over the period. As only 50,000 is
added to retained earnings, the company must be paying substantial dividends. Receivables are
growing slower, although the average collection period is still very reasonable relative to the terms
given. Inventory turnover is slowing as well, indicating a relative buildup in inventories. The
increase in receivables and inventories, coupled with the fact that net worth has increased very
little, has resulted in the total debt-to-worth ratio increasing to what would have to be regarded on
an absolute basis as a high level.
The current and acid-test ratios have fluctuated, but the current ratio is not particularly inspiring.
The lack of deterioration in these ratios is clouded by the relative build-up in both receivables and
inventories, evidence of deterioration in the liquidity of these two assets. Both the gross profit and
net profit margins have declined substantially. The relationship between the two suggests that the
company has reduced relative expenses in 2016. The build-up in inventories and receivables has
resulted in a decline in the asset turnover ratio, and this, coupled with the decline in profitability,
has resulted in a sharp decrease in the return on assets ratio.

Problem 7

The following information is available for Navana Ltd. along with various ratios relevant to the
particulars industry it belongs to. APPRAISE your comments on the strengths and weakness of
Navana Ltd., comparing its ratios with the given industry norms.

Navana Ltd.
BALANCE SHEET AS AT 31.3.2019

Liabilities & Equities Amount Assets Amount

Equity Share Capital 4800000 Fixed Assets 24,20,000
10% Debentures 9200000 Cash 8,80,000
Sundry
Sundry Creditors 660000 debtors 11,00,000
Bills Payable 880000 Stock 33,00,000
Other current
Liabilities 440000 -
Total 7700000 Total 77,00,000
 STATEMENT OF PROFITABILITY
FOR THE YEAR ENDING 31.3.2019

Amount Amount
Particulars (Tk) (Tk)
Sales 1,10,00,000
Less: Cost of goods sold: - -
Material 41,80,000 -
Wages 26,40,000 -
Factory Overhead 12,98,000 81,18,000
Gross Profit - 28,82,000
Less: Selling and Distribution Cost 11,00,000 -
Administrative Cost 12,28,000 23,28,000
Earnings before Interest and Taxes - 5,54,000
Less: Interest Charges - 92,000
Earning before Tax - 4,62,000
Less: Taxes & 50% - 2,31,000
Net Profit (PAT) 2,31,000

Industry Average

Ratios Norm
Current Assets/Current
Liabilities 2.5
Sales/ debtors 8
Sales/ Stock 9
Sales/ Total Assets 2
Net Profit/ Sales 0.035
Net profit /Total Assets 0.07
Net Profit/ Net Worth 0.105
Total Debt/Total Assets 0.6
Ans:

Industry
No. Ratios Navana
Average
Current Assets / Current 5280000 /
1 = 2.67 2.5
Liabilities 1980000
11000000 /
2 Sales / Debtors = 10.0 8
1100000
11000000 /
3 Sales / Stock =3.33 9
3300000
11000000 /
4 Sales/ Total Assets = 1.43 2
7700000
231000 /
5 Net Profit / Sales = 2.10% 3.5%
11000000
231000 /
6 Net Profit / Total Assets = 3.00% 7%
7700000
231000 /
7 Net Profit / Net Worth = 4.81% 10.5%
4800000
2900000 /
8 Total Debt / Total Assets =37.66% 60%
7700000

Comments:
1. The position of Navana Ltd. is better than the industry norm with respect to Current Ratios
and the Sales to Debtors Ratio.
2. However, the position of sales to stock and sales to total assets is poor compared to industry
norm.
3. The firm also has its net profit ratios, net profit to total assets and net profit to total worth
ratios much lower than the industry norm.
4. The total debt to total assets ratio suggests that the firm is geared at a lower level and debt
is used to Asset.
Problem 8
Balance Sheet

Property, Plant & Equpment $ 1907 M

Intangiable Assets $6M
Capital Work-in-Progress $ 450 M
Total non-current Assets $ 2364 M

Current Assets:
Inventories $ 890 M
Trade & Other Receivables $ 163 M
Cash & Cash Equivalents $ 247 M
Total Current Assets $ 1300 M
Total Assets $ 3664 M

Income Statement

Revenue $ 11291 M
Cost of sales $ 7523 M
Administrative Expenses $ 292 M
Selling expenses $ 1322 M
Interest Expense $ 118 M
Income Tax Expenses $ 580 M

Additional Information:
Outstanding Shares $200 M, Share Capital $ 1999 M, Retained Earnings $3413 M, Market price per
share $50, Dividend Per Share $5

Compute:

❖ Gross Profit Margin ❖ Price to Earnings Ratio

❖ Operating Profit Margin ❖ Dividend yield
❖ Net Profit Margin ❖ Earnings Yield
❖ Return On Asset (ROA)
❖ Return On Equity (ROE)
❖ Earnings Per Share (EPS)
Ans:

Gross Profit (Sales – COGS)

Gross Profit Margin = Sales

$11291M − $7523M
=
$11291M

= 0.33

Operating Profits
Operating Profit Margin =
Sales

$2154 M
=
$11291M

= 0.19

Net Profit Available For

Common Shareholders
Earnings Per Share = ⬚
Number of Shares Outstanding

$1456 M
=
$200 M

= $7.28
 Earnings (Profit)
Net Profit Margin =
Sales
$1456 M
=
$11291M

= 0.13

Net Profit Available For

Shareholders
Return on Asset = ⬚
Total Assets

$1456 M
=
$3664 M

= 0.397 or 39.7%

Net Profit Available For

Shareholders
Return On Equity = ⬚
Total Equity
$1456 M
=
$5413M

= 0.269 or 26.9%
 Market Price Per Share
P/E Ratio =
Earnings Per Share (EPS)

$50
=
$7.28

= 6.87

Dividend Per Share

Dividend Yield = × 𝟏𝟎𝟎
Market Price Per Share

$5
= × 100
$50

= 10%

EPS
Earnings Yield = × 𝟏𝟎𝟎
Market Price Per Share

$7.28
= × 100
$50

= 14.56%
Problem-09

Company ABC has a Cost of Goods Sold (COGS) of $500,000 during the fiscal year. At the
beginning of the year, the company had an inventory worth $100,000, and at the end of the year,
the inventory was valued at $80,000. Net Credit Sales of $1,000,000 during the year. At the
beginning of the year, the accounts receivable (debtors) balance was $50,000, and at the end of the
year, it was $30,000.
Requirement
I. Inventory turnover ratio
II. Accounts Receivable Turnover Ratio

Ans:
Average Inventory= (Beginning Inventory + Ending Inventory)/2
= ($100,000+$80,000) /2
=$90,000

Inventory Turnover Ratio

=Cost of Goods Sold / Average Inventory
=$500,000/$90,000
≈5.56
Average Accounts Receivables
= (Beginning Accounts Receivable+ Ending Accounts Receivable)/2
= ($50,000+$30,000)/2
= $40,000

Accounts Receivable Turnover Ratio

=Net Credit Sales / Average Accounts Receivable
=$1,000,000/ $40,000
=25

Problem-10

Net Credit Purchases: $600,000

Beginning Accounts Payable: $40,000
Ending Accounts Payable: $30,000
Accounts Payable: $120,000
Total Credit Purchases during the Year: $600,000
Requirement:
I. Payables turnover ratio
II. Average Payment Period

Ans:
Average Accounts Payable
=(Beginning Accounts Payable + Ending Accounts Payable)/2
=$40,000+$30,000
=$35,000
Payables Turnover Ratio
=Net Credit Purchases / Average Accounts Payable
=$600,000 / 35,000
≈17.14
Average Daily Credit Purchases
= Total Credit Purchases/ Number of Days in the Year
=$600,000 / 365
≈$1,644.44 per day
Average Payment Period
=Accounts Payable / Average Daily Credit Purchases
=$120,000 /$1,644.44
≈73 days

Problem-11
Company ABC has the following financial information for the year 2022:
Net Sales: $1,500,000
Beginning Total Assets: $1,000,000
Ending Total Assets: $1,200,000

Requirement:
i. Total Asset Turnover
Ans:

Total Asset Turnover= Net Sales / Average Total Assets

Average Total Assets= ($1000000+$1200000)/2
=$1100000
Total Asset Turnover
=$1500000 / $1100000
=1.36
A Total Asset Turnover Ratio of 1.36 means that for every dollar of assets the company owns, it
generated $1.36 in sales revenue during the year.