Accounts Tips for Preparation of Financial Position

Ratios Analysis of Financial Accounts

Liquidity Ratios

Profitability Ratios

Working Capital Ratios

Capital Structure Ratios

Overall Profitability Ratio

Ratio Analysis

A) Cash Position Ratio : –

1) Absolute Cash Ratio = Cash Reservoir

                                          Current Liabilities

Standard : 1:.25

2) Cash Position to Total asset Ratio = Cash Reservoir          * 100

     (Measure liquid layer of assets)       Total Assets

3) Interval measure                                                   =   Cash Reservoir

     (ability of cash reservoir to meet cash expenses)    Average daily cash expenses

                                                                 ( Answer in days)

Notes : –

• Cash Reservoir = Cash in hand + Bank + Marketable Non trade investment at market value.
• Current liabilities = Creditors + Bills Payable + Outstanding Expenses + Provision for tax (Net of advance tax) + Proposed dividend + Other provisions.
• Total assets = Total in asset side – Miscellaneous expenses – Preliminary expenses + Any increase in value of marketable non trading Investments.
• Average cash expenses =Total expenses in debit side of P & L a/c – Non cash item such as depreciation, goodwill, preliminary expenses written off, loss on sale of investments, fixed assets written off + advance tax (Ignore provision for tax) . The net amount is divided by 365 to arrive average expenses.

Remarks : – In Comparison

• When absolute cash ratio is lower then current liability is higher
• When cash position to Total Asset ratio is lower then the total asset is relatively higher.
• When cash interval is lower the company maintain low cash position. It is not good to maintain too low cash position or too high cash position.

B) Liquidity Ratio : –

1) Current ratio = Current asset

                             Current Liability

Standard : 2:1

A higher current ratio is always more favorable than a lower current ratio because it shows the company can more easily make current debt payments.

If a company has to sell of fixed assets to pay for its current liabilities, this usually means the company isn’t making enough from operations to support activities. In other words, the company is losing money. Sometimes this is the result of poor collections of accounts receivable.

The current ratio also sheds light on the overall debt burden of the company. If a company is weighted down with a current debt, its cash flow will suffer.

2) Quick ratio or Acid Test ratio = Quick Asset

                                                                   Quick liability

Standard : 1:1

Higher quick ratios are more favorable for companies because it shows there are more quick assets than current liabilities. A company with a quick ratio of 1 indicates that quick assets equal current assets. This also shows that the company could pay off its current liabilities without selling any long-term assets. An acid ratio of 2 shows that the company has twice as many quick assets than current liabilities.

Obviously, as the ratio increases so does the liquidity of the company. More assets will be easily converted into cash if need be. This is a good sign for investors, but an even better sign to creditors because creditors want to know they will be paid back on time.

Notes : –

• Quick Asset = Current Asset – Stock
• Quick Liability = Current liability – Cash credit, Bank borrowings, OD and other Short term Borrowings.
• Secured loan is a current liability and also come under cash credit
• Sundry debtors considered doubtful should not be taken as quick asset.
• Creditors for capital WIP is to be excluded from current liability.
• Current asset can include only marketable securities.
• Loans to employees in asset side are long term in nature and are not part of current assets.
• Provision for gratuity is not a current liability.
• Gratuity fund investment is not a part of marketable securities.
• Trade investments are not part of marketable securities.

Remarks : –

• Higher the current ratios better the liquidity position.

C) Capital structure ratios : –

1) Debt equity ratio        =Debt

                                           Total Equity

         Standard :        1:2                                

Debt = Current Liabilities  + Short Term Loan +Long Term Loan

Total Equity = Total Liabilities =  Current Liabilities  + Short Term Loan +Long Term Loan + Capital + Earning profit + reserve etc. 

2) Proprietary ratio = Proprietary fund

                                      Total Assets

Standard : 3:4

3) Total Liability to Net worth ratio = Total Liabilities

   Net worth

4) Capital gearing ratio = Preference share capital + Debt

                                         Equity – Preference share capital

Standard : 1:2

Notes : –

• Share holders fund (or) Equity (or) Proprietary fund (or) Owners fund (or) Net worth = Equity share + Preference share + Reserves and surplus – P & L a/c – Preliminary Expenses.
• Debt (or) Long term liability (or) Long term loan fund = Secured loan (excluding cash credit) + unsecured loan + Debentures.
• Total asset = Total assets as per Balance sheet – Preliminary expenses.
• Total liability = Long term liability + Current liability (or) short term liability
• Long term fund = Total asset – Current liability = Share holders fund + long term loan fund.

Remarks : –

• In debt equity ratio higher the debt fund used in capital structure, greater is the risk.
• In debt equity ratio, operates favorable when if rate of interest is lower than the return on capital employed.
• In total liability to Net worth Ratio = Lower the ratio, better is solvency position of business, Higher the ratio lower is its solvency position.
• If debt equity ratio is comparatively higher then the financial strength is better.

D) Profitability Ratio : –

1) Gross Profit Ratio = Gross Profit       * 100

                                          Sales

Standard : 15% to 20%

2) Net Profit Ratio = Net Profit  (NPAT)         * 100

                             Sales

Standard : 5% to 10%

Net profit (NP) ratio is a useful tool to measure the overall profitability of the business. A high ratio indicates the efficient management of the affairs of business.

There is no norm to interpret this ratio. To see whether the business is constantly improving its profitability or not, the analyst should compare the ratio with the previous years’ ratio, the industry’s average and the budgeted net profit ratio.

The use of net profit ratio in conjunction with the assets turnover ratio helps in ascertaining how profitably the assets have been used during the period.

3) Operating Profit ratio = Operating profit         *   100

                                                Sales

4) Return to shareholders = Net profit after interest and tax

                                                  Share holders fund

5)  Return on Net Worth = Return on Net worth      * 100

                                                Net worth

6) Return on capital employed (or) Return on investment = Return (EBIT)

                                                                    Capital Employed

Standard : 10% to 15%

7) Expenses Ratios :-

     a) Direct expenses Ratios : –

          i) Raw material consumed        * 100

                       Sales

         ii) Wages      * 100

              Sales

        iii) Production Expenses     *   100

                     Sales

    b) Indirect expenses Ratios : –

         i) Administrative Expenses      * 100

                      Sales

        ii) Selling Expenses     *   100

                  Sales

       iii) Distribution Expenses      *   100

                    Sales

        iv) Finance Charge      * 100

                    Sales

Notes : –

• In the above the term “term” is used for business engaged in sale of goods, for other enterprises the word “revenue” can be used.
• Gross profit = Sales – Cost of goods sold
• Operating profit = Sales – Cost of sales

                                 = Profit after operating expenses but before Interest and tax.

Operating profit= Net sales – (Cost of goods sold + Administrative and office expenses + Selling and distribution exp.)

• Operating Expenses = Administration Expenses + Selling and distribution expenses, Interest on short term loans etc.
• Return = Earning before Interest and Tax

                  = Operating profit

                  = Net profit + Non operating expenses – Non operating Income

• Capital employed = Share holders fund + Long term borrowings

                                   = Fixed assets + Working capital

• If opening and closing balance is given then average capital employed can be substituted in case of capital employed which is

Opening capital employed + Closing capital employed

                                                                 2

E) Debt service coverage ratios

E) Debt service coverage ratios = Profit available for debt servicing

                                                           Loan Installments + Interest

Notes : –

• Profit available for debt servicing = Net profit after tax provision + Depreciation + Other non cash charges + Interest on debt.

Remarks : –

• Higher the debt servicing ratio is an indicator of better credit rating of the company.
• It is an indicator of the ability of a business enterprise to pay off current installments and interest out of profits.

F) Turnover Ratios: –

i) Assets turnover =       Sales

                                  Total assets

2) Fixed assets turnover =      Sales            [Number of times fixed assets has

                                            Fixed assets              turned into sales]

3) Working capital turnover =      Sales             

                                                  Working capital

4) Inventory turnover = Cost of goods sold

     (for finished goods)   Average inventory

Standard : 5 Time or 8 Time for trading company

Standard :  2 to 3 for Textile  and RMG Actual

Average Inventory – Average of stock levels maintained by a business in an accounting period, it can be calculated as;

• (Opening Stock + Closing Stock)/2
• Stock to include = Raw material + Work in Progress + Finished Goods

High Ratio – If the stock turnover ratio is high it shows more sales are being made with each unit of investment in inventories. Though high is favourable, a very high ratio may indicate a shortage of working capital and lack of sufficient inventories.

Low Ratio – A low inventory turnover ratio may indicate unnecessary accumulation of stock, inefficient use of investment, over-investment in inventories, etc. This is a concern for the company as inventory could become obsolete and may result in future losses.

5) Debtors turnover (or) Average collection period = Average accounts receivable   *   360(in days)

Net Sale

Standard : 60Days to 90 Days

6) Creditors turnover (or) Average payment period :Average accounts Payable   *   360 (in days)

  Credit Purchases

7) Inventory Turnover (for WIP) = Cost of production

                                                         Average Inventory (for WIP)

8) Inventory Turnover (for Raw material) = Raw material consumed

                                                                       Average inventory (for raw material)

10) Inventory Holding Period =                  365                  .

                                                      Inventory turnover ratio

11) Capital Turnover ratio = Cost of sales

                                              Capital employed

Note : –

• Working capital = Current asset – Current liability

                                 = 0.25 * Proprietary ratio

• Accounts Receivable = Debtors + Bills receivable
• Accounts payable = Creditors + Bills Payable

Remarks : –

• If assets turnover ratio is more than 1, then profitability based on capital employed is profitability based on sales.
• Higher inventory turnover is an indicator of efficient inventory movement. It is an indicator of inventory management policies.
• Low inventory holding period lower working capital locking, but too low is not safe.
• Higher the debtors turnover, lower the credit period offered to customers. It is an indicator of credit management policies.
• Higher the creditors turnover, lower the credit period offered by suppliers.

G) Other Ratios: –

1) Operating profit ratio = Net profit ratio + Non operating loss / Sales ratio

2) Gross profit ratio = Operating profit ratio + Indirect expenses ratio

3) Cost of goods sold / Sales ratio = 100% – Gross profit ratio

4) Earnings per share = Net profit after interest and tax

                                         Number of equity shares

5) Price earning ratio = Market price per equity share

                                            Earning per share

6) Pay out ratio = Dividend per equity share         *   100

                             Earning per equity shares

7) Dividend yield ratio = Dividend per share        *   100

                                         Market price per share

8) Fixed charges coverage ratio = Net profit before interest and tax

                                                Interest charges

9) Time Interest Earned ratio(TIER) = Earning before interest and tax

                                      Interest charges

10) Fixed dividend coverage ratio =         Net profit                      .

                                                 Annual Preference dividend

11) Over all profitability ratio = Operating profit           * 100

                                           Capital employed

12) Productivity of assets employed =         Net profit       .

                                                              Total tangible asset

13) Retained earning ratio = Retained earnings   * 100

                                       Total earnings

H) General Remarks: –

• Fall in quick ratio when compared with last year or other company is due to huge stock pilling up.
• If current ratio and liquidity ratio increases then the liquidity position of the company has been increased.
• If debt equity ratio increases over a period of time or is greater when comparing two ratios, then the dependence of the company in borrowed funds has increased.
• Direct expenses ratio increases in comparison then the profitability decreases.
• If there is wages / Sales ratio increases, then this is to verified
  • Wage rate
  • Output / Labour rate
• Increment in wage rate may be due to increased rate or fall in labour efficiency.
• Again there are many reasons for fall in labour productivity namely abnormal idle time due to machine failure, power cut etc.
• Reduction in Raw material consumed / sales ratio may be due to reduction in wastage or fall in material price.
• Increase in production expenses ratio may also be due to price raise.
• Stock turnover ratio denotes how many days we are holding stock.
• In stock turnover ratio greater the number of days, the movement of goods will be on the lower side.
• Financial ratios are Current ratio, Quick ratio, Debt equity ratio, Proprietary ratio, Fixed asset ratio.
• Short term solvency ratios are current ratio, Liquidity ratio
• Long term solvency or testing solvency of the company ratios are Debt equity ratio, fixed asset ratio, fixed charges coverage ratio (or) Interest coverage ratio.
• To compute financial position of the business ratios to be calculated are – current ratio, Debt equity ratio, Proprietary ratio, fixed asset ratio.
• Fictitious asset are Preliminary expenses, Discount on issue of shares and debentures, Profit and loss account debit balance.

Current Portion of Long-Term Debt

Long-term debt is debt with a maturity of longer than one year. This can be anywhere from two years, to five years, ten years, or even thirty years. The current portion of long-term debt is the amount of principal and interest of the total debt that is due to be paid within one year’s time.

This is not to be confused with current debt, which is debt with a maturity of less than one year. Some firms will consolidate the two amounts into a generic current debt line item on the balance sheet

Definition of Current Portion of Long-Term Debt

The current portion of long-term debt is the amount of principal that will be due within one year of the date of the balance sheet. This amount is reported on the balance sheet as one of the company’s current liabilities.

IAS 1 requires an entity to present current liabilities and non-current liabilities as separate classifications in its statement of financial position.

Calculating the Current Portion

An analyst should attempt to find information to build out a company’s debt schedule. This schedule outlines the major pieces of debt a company is obliged under, and lays it out based on maturity, periodic payments, and outstanding balance. Using the debt schedule, an analyst can measure the current portion of long term debt that a company owes.

Example Borrower Inc. takes on a five-year loan of $5,000,000. The loan terms specify equal payments over the five years. The current portion of this long term debt is $1,000,000 (excluding interest ication

Golden Business :

Prevailing Rates of  Gross Profit

RETAIL

RECIEPT

MANUFACTURE

WHOLESALE

Sample :

[65C. Rate of allowances in respect of expenditure on distribution of free samples.—

1. For the purpose of section 30(f) (iv) of the Ordinance, the rates in excess of which no deduction shall be admissible for expenditure in respect of distribution of free samples shall be the following :
   1. (a)In case of a pharmaceutical industry-
   1. (i)for a turnover upto take 5 crore, at the rate of 2%
   1. (ii)for a turnover in excess of taka 5 crorebut upto 10 crore, at the rate of 1%
   1. (iii)for a turnover in excess of taka 10 crore, at the rate of 0.50%;
   1. (b)in case of a food, cosmetics and toilletries industry-
   1. (i)for a turnover upto taka 5 crore, at the rate of 1%
   1. (ii) for a turnover in excess of taka 5 crorebut upto 10 crore, at the tate of 0.25%
   1. (iii) for a turnover in excess of taka 10 crore, at the rate of 0.25%
   1. (c)in case of any other industries-
   1. (i)for a turnover upto taka 5 crore, at the rate of 0.5%
   1. (ii)for a turnover in excess of taka 5 crorebut upto 10 crore, at the rate of 0.25%
   1. (iii)for a turnover in excess of taka 10 crore, at the rate of 0.1%.

Entertainment:

65. Amount or rate for allowance on entertainment expense.–

1. For the purpose of section 30 (f) (i) of the Ordinance, the amounts or rates excess of which no deduction shall be admissible for expenditure in respect entertainment are specified as below : —
   1. (a) On the first taka 10 lakhs of income, profits and gains of the business or pro­fession (computed before making any allowance in respect of expenditure on entertainment) …………………… at the rate of 4 %;
   1. (b) On the balance of income, profits and gains of the business or profession (computed in the mariner aforesaid). …… at the rate of 2%.

Entertainment :

I. T. Manual, Part II

1[65. Amount or rate for allowance of entertainment expense.-

For the purpose of section 30 (f) (i) of the Ordinance, the

amounts or rates in excess of which no deduction shall be

admissible for expenditure in respect of entertainment are

specified below:¾(a)

On the first take 10 lakh of income, profits and gains of

the business or profession (computed before making any allowance in respect of expenditure on entertainment)

………………………… at the rate of 4%;

(b)On the balance of income, profits and gains of the

business or profession (computed in the manner

aforesaid) …….. at the rate of 2%.]

2[65A. Allowance in respect of expenditu

Sample :

172

I. T. Manual, Part II

1[65C. Rate of allowances in respect of expenditure on distribution

of free samples.¾For the purpose of section 30(f) (iv) of the

Ordinance, the rates in excess of which no deduction shall be

admissible for expenditure in respect of distribution of free

samples are specified below:¾(a)for a turnover upto taka 5 crore …. at the rate of

2[1.5%](b)for a turnover in excess of taka 5 crore

but upto 10 crore…………………… at the rate of 2[ 0.75%](c) for any amount or a turnover in execss of taka 10 crore …………………… at the rate of

2[0.375%];3[Provided tha

t in the case of a pharmaceutical industry, the rates in respect of distribution of free samples are specified below:(a)For a turn-

over upto taka five crore ….. at the rate of 2%(b)For a turn-over in excess oftaka five crore out upto ten crore…

………………………… at the rate of 1%

(c) For a turn-over in excessof taka

ten crore ………………………………… at the rate of 0.50%];