
Q1 What do you mean by Ratio Analysis? Ans: Ratio analysis is a quantitative procedure of obtaining a look into a firm’s functional efficiency, liquidity, revenues, and profitability by analysing its financial records and statements. Ratio analysis is a very important factor that will help in doing an analysis of the fundamentals of equity.
Q2 What are various types of ratios? Ans: The various kinds of financial ratios available may be broadly grouped into the following six silos, based on the sets of data they provide:
1)Liquidity Ratios.
2)Solvency Ratios.
3)Profitability Ratios.
4)Efficiency Ratios.
5)Coverage Ratios.
6)Market Prospect Ratios.Q3 What relationships will be established to study? (a) Inventory Turnover (b) Debtor Turnover (c) Payables Turnover (d) Working Capital Turnover Ans: (a) Inventory Turnover Ratio: This ratio is a relationship between the cost of goods sold during a particular period of time and the cost of average inventory during a particular period. It is expressed in number of times. Stock turnover ratio/inventory turnover ratio indicates the number of time the stock has been turned over during the period and evaluates the efficiency with which a firm is able to manage its inventory. This ratio indicates whether investment in stock is within proper limit or not. The ratio is calculated by dividing the cost of goods sold by the amount of average stock at cost. The formula for calculating inventory turnover ratio is as follows
(b)Debtor Turnover Ratio :Debtor turnover ratio or accounts receivable turnover ratio indicates the velocity of debt collection of a firm. In simple words it indicates the number of times average debtors (receivable) are turned over during a year. The formula for calculating Debtors turnover ratio is as follows
(c)Creditors/Payables Turnover Ratio :It compares creditors with the total credit purchases. It signifies the credit period enjoyed by the firm in paying creditors. Accounts payable include both sundry creditors and bills payable. Same as debtor’s turnover ratio, creditor’s turnover ratio can be calculated in two forms, creditors’ turnover ratio and average payment period. The following formula is used to calculate the creditors Turnover Ratio
(d)Working Capital Turnover Ratio Working capital turnover ratio indicates the velocity of the utilization of net working capital. This ratio represents the number of times the working capital is turned over in a year and is calculated as follows
Q4 The liquidity of a business firm is measured by its ability to satisfy itslong term obligations as they become due. What are the ratios used forthis purpose? Ans: Yes it is true that the liquidity of a business firm is measured by its ability to pay its long term obligations as they become due. Here the long term obligation means payments of principal amount on the due date and payments of interests on the regular basis. For measuring the long term solvency of any business we calculate the following ratios.
Debt Equity Ratio: Debt equity ratio indicates the relationship between the
external equities or outsiders funds and the internal equities or shareholders
funds. It is also known as external internal equity ratio. It is determined to ascertain soundness of the long term financial policies of the company. Following formula is used to calculate debt to equity ratio.Debt Equity Ratio = External Equities.
Shareholders fundsProprietory Ratio/Total Assets to Debt Ratio: Total assets to Debt Ratio or
Proprietory Ratio are a variant of the debt equity ratio. It is also known as equity
ratio or net worth to total assets ratio. This ratio relates the shareholder’s funds
to total assets. Proprietory / Equity ratio indicates the longterm or future
solvency position of the business. Formula ofProprietory or Equity Ratio = Shareholders funds
Total AssetsProprietory/Equity Ratio Interest Coverage Ratio: This ratio deals only with
servicing of return on loan as interest. This ratio depicts the relationship between
amount of profit utilise for paying interest and amount of interest payable. A high
Interest Coverage Ratio implies that the company can easily meet all its interest
obligations out of its profit.Interest Coverage Ratio = Net Profit before interest and tax
Interest on Long Term loansQ5 The average age of inventory is viewed as the average length of time inventory is held by the firm or as the average number of days’ sales in inventory. Why? Ans: Inventory Turnover Ratio: This ratio is a relationship between the cost of goods sold during a particular period of time and the cost of average inventory during a particular period. It is expressed in number of times. Stock turnover ratio/inventory turnover ratio indicates the number of time the stock has been turned over during the period and evaluates the efficiency with which a firm isable to manage its inventory. The formula for calculating inventory turnover ratio is as follows:
Inventory Turnover Ratio = Cost of goods sold
Average Inventory at CostCost of goods sold = Opening Stock + Purchase + Direct Expenses  Closing Stock
Alternatively cost of goods sold = Net Sales  Gross Profit
Average Inventory = Opening Stock + Closing Stock
2From the above formula, it is clear that this ratio reveals the average length of
time for which the inventory is held by the firm.