AMD (Unit 2) PDF - Balance Sheet Ratios

## 10.1 Compute Balance Sheet Ratios ### 10.1.1 Preparing Vertical Balance Sheet **Illustration 25: (From Horizontal BS - Comprehensive)** Following is the Balance Sheet of Roland Ltd. **Balance Sheet as on 31st March, 2017** | Liabilities | ₹ | Assets | ₹ | |---|---|---|---| | Equity Share Capi...

## 10.1 Compute Balance Sheet Ratios ### 10.1.1 Preparing Vertical Balance Sheet **Illustration 25: (From Horizontal BS - Comprehensive)** Following is the Balance Sheet of Roland Ltd. **Balance Sheet as on 31st March, 2017** | Liabilities | ₹ | Assets | ₹ | |---|---|---|---| | Equity Share Capital | 1,00,000 | Cash in Hand | 2,000 | | 8% Preference Share Capital | 1,00,000 | Cash at Bank | 10,000 | | 7% Debentures | 40,000 | Bills Receivable | 30,000 | | 8% Public Deposits | 20,000 | Debtors | 70,000 | | Bank Overdraft | 40,000 | Stock | 40,000 | | Creditors | 60,000 | Advances | 20,000 | | Unpaid Dividend | 10,000 | Furniture | 30,000 | | Outstanding Expenses | 7,000 | Machinery | 1,00,000 | | Reserves | 1,50,000 | Land & Building | 2,20,000 | | Provision for Tax | 20,000 | Goodwill | 30,000 | ## & Loss Account ## Vertical Balance Sheet as on 31st March, 2017 ### Sources of Funds - **Owner's Funds** - Equity Share Capital - Equity Share Capital: ₹1,00,000 - Less: Calls-in-arrears: ₹(5,000) - Reserve: ₹95,000 - Reserves and Surplus - Profit & Loss A/c: ₹1,50,000 - Less: Preliminary Expenses: ₹20,000 - Reserves & Surplus: ₹1,70,000 - Equityholders' Funds: ₹1,60,000 - 6% Preference Capital: ₹2,55,000 - Proprietors' Funds: ₹1,00,000 - **Borrowed Funds** - Secured Loans - 7% Debentures: ₹40,000 - Unsecured Loans - 8% Public Deposit: ₹20,000 ### Capital Employed ### Application of Funds - **Fixed Assets** - Goodwill: ₹30,000 - Land and Building: ₹2,20,000 - Machinery: ₹1,00,000 - Furniture: ₹30,000 - **Working Capital** - **Current Assets** - Cash-in-hand: ₹2,000 - Cash at Bank: ₹10,000 - Bills Receivable: ₹30,000 - Debtors: ₹70,000 - Advances: ₹20,000 - Stock: ₹40,000 - **Current Liabilities** - Creditors: ₹60,000 - Unpaid Dividend: ₹10,000 - Outstanding Expenses: ₹7,000 - Provision for Tax: ₹20,000 - Bank Overdraft: ₹40,000 ### Capital Employed - Working Capital: ₹35,000 ### Calculation of Ratios - Current Ratio: $CA/CL = 1,72,000/1,37,000 = 1.26:1$ - Quick Ratio: $QA/QL = 1,32,000/97,000 = 1.36:1$ - Proprietory Ratio: $PF/TA \times 100 = 3,55,000/5,52,000 \times 100 = 64.31%$ - Capital Gearing Ratio: $(PC + BF)/EF \times 100 = 1,60,000/2,55,000 \times 100 = 0.63:1$ - Stock Working Capital Ratio: $Stock/Working Capital \times 100 = 40,000/35,000 \times 100 = 114.29%$ ## **Comments** a) **Liquidity/Solvency**: Current Ratio of 1.26 : 1 is less than the standard ratio of 2:1. However, the composition of the working capital indicated by the Stock of Working Capital is satisfactory (SWC of 114% shows that there are no slow moving or obsolete stocks). Liquid Ratio of 1.36: 1 is more than the standard ratio of 1:1. This shows a favourable position to meet any day-to-day liabilities. Proprietory Ratio of 0.64 : 1 is close to the standard ratio. It shows a good capitalisation structure. It also indicates optimum capitalisation. It shows a proper balance between the own funds and the debt funds. It means that there is neither over-capitalisation (as the own funds are more then the borrowed funds). b) **Capitalisation**: Standard Proprietory ratio also indicates optimum capitalisation. It shows a proper balance between the own funds and the debt funds. It means that there is neither over-capitalisation (as the own funds are more than the borrowed funds). Capital gearing ratio of 0.63:1 is less than 1 (0.63). The shareholders depend on the Capital Gearing Ratio (CGR). Since the CGR is less than 1 the equity shareholders depend on the returns to equity shareholders through debt. The use of debt (known as trading on equity) will be low. The shareholders will earn even less if there is a recession. ## Balance Sheets | Particulars | 31-3-2016 (Amount: ₹ ) | 31-3-2017 (Amount: ₹) | |---|---|---| | Liabilities | | | | Share Capital | 4,50,000 | 6,60,000 | | Retained Earnings | 2,31,000 | 2,00,000 | | Provision for Income Tax | | 84,000 | | Debentures | 2,20,000 | 1,80,000 | | Accounts Payable | 58,000 | 64,000 | | Other Current Liabilities | 21,000 | 33,000 | | Total | 10,64,000 | 11,37,000 | | Assets | | | | Building and Equipments | 4,50,000 | 5,00,000 | | Land | 80,000 | 80,000 | | Patents | | 65,000 | | Accounts Receivables | 54,000 | 46,000 | | Inventories | 3,00,000 | 3,12,000 | | Prepaid Expenses | 6,000 | 4,000 | | Cash | 1,19,000 | 1,30,000 | | Total | 10,64,000 | 11,37,000 | ## Ratio Analysis and Interpretation ### Sources of Funds - Equity Share Capital: ₹4,50,000 ₹6,60,000 - Reserves & Surplus: ₹2,31,000 ₹2,00,000 - Borrowed Funds: - Debentures: ₹2,20,000 ₹1,80,000 - Proprietors' Funds (PF): ₹6,81,000 ₹8,60,000 ### Use of Funds - Capital Employed (PF+BF): ₹9,01,000 ₹10,40,000 ### Fixed Assets - Building: ₹4,50,000 ₹5,00,000 - Land: ₹80,000 ₹80,000 - Patents: ₹55,000 ₹65,000 ### Quick Assets - Debtors: ₹5,85,000 ₹6,45,000 - Cash: ₹54,000 ₹46,000 - Closing Stock: ₹1,19,000 ₹1,30,000 - Pre-paid Expenses: ₹1,73,000 ₹1,76,000 - Current Assets: ₹3,00,000 ₹3,12,000 ### Quick Liabilities - Creditors: ₹58,000 ₹64,000 - Prov. For Tax: ₹21,000 ₹33,000 - Other Liabilities: ₹84,000 ### Quick/Current Liabilities - Working Capital: ₹3,16,000 ₹3,95,000 - Capital Employed (FA+WC): ₹9,01,000 ₹10,40,000 ### Calculation of Ratios - **2016** - Debt-Equity Ratio: $BF/PF = 2,20,000/6,81,000 = 0.32$ - Quick/Liquid Ratio: $QA/QL = 1,73,000/1,63,000 = 1.06$ - Stock Working Capital: $CST/WC \times 100 = 3,00,000/3,16,000 \times 100 = 95%$ - Proprietors' Ratio: $PF/TA \times 100 = 6,81,000/10,64,000 \times 100 = 64%$ - **2017** - Debt-Equity Ratio: $BF/PF = 1,80,000/8,60,000 = 0.21$ - Quick/Liquid Ratio: $QA/QL = 1,79,000/97,000 = 1.81$ - Stock Working Capital: $CST/WC \times 100 = 3,12,000/3,95,000 \times 100 = 79%$ - Proprietors' Ratio: $PF/TA \times 100 = 8,60,000/11,37,000 \times 100 = 76%$ ### Comparison 1. Deb-equity ratio has decreased from 0.32 to 0.21 due to repayment of debentures and increase in share capital. 2. Quick Ratio has increased from 1.06 to 1.81 due to reduction in liabilities (mainly tax provision.) 3. Stock-Working Capital Ratio has decreased from 95% to 79% due to increase in working capital from ₹3,16,000 to ₹3,95,000. 4. Proprietor's ratio has increased from 64% to 76% due to increase in share capital. ## 10.2.2 No Vertical Format ### Illustration 32 Following is the Profit and Loss Account of Moon Enterprises for the year ended 31-03-2017. | Particulars | ₹ | Particulars | ₹ | |---|---|---|---| | To Opening stock | 4,00,000 | By Sales | | | To Purchases | 9,80,000 | - Credit | 18,00,000 | | To Wages | 2,90,000 | - Cash | 7,00,000 | | To Factory expenses | 1,90,000 | By Closing stock | | | To Office salaries | 1,20,000 | | | | To General Administrative Expenses | 1,30,000 | By Sale of scrap | 6,00,000 | | To Selling expenses | 1,12,500 | | | | To Depreciation on Machinery | 2,50,000 | By Dividend Received | 10,000 | | To Provision for Tax | 1,40,500 | | | | To Trf. to General Reserve | 2,00,000 | | | | To Net Profit | 2,98,000 | | | |   | | | | |   | 31,11,000 | | 31,11,000 | ### You are required to compute the following ratios: - Gross Profit Ratio - Stock-Turnover Ratio - Administrative Expenses Ratio - Net Profit Before Tax Ratio **Solution:** - Gross Profit Ratio: $(Gross Profit/Sales) \times 100=(10,00,000/25,00,000) \times 100=40%$ - Stock Turnover Ratio: $(Cost of Goods Sold (COGS))/(Opening Stock + Closing Stock)/2 = 15,00,000/5,00,000 = 3 times ## Accounting For Menagerial Decisions - Administrative Expenses ratio: $(Administrative Expenses/Sales) \times 100=2,50,000/25,00,000 \times 100= 10%$ - Net Profit Before Tax (NPBT) Ratio: $(NPBT/Sales)\times 100 = 6,38,500/25,00,000 \times 100 = 25.54%$ ## Trading, Profit and Loss Account for the year ended 31st March, 2017 | Particulars | ₹ | Particulars | ₹ | |---|---|---| | To Opening Stock | 27,150 | By Sales | | | To Purchases | 1,63,575 | By Closing Stock | 42,000 | | To Carriage Inward | 4,275 | By Interest Received on Investment | 2,700 | | To Office Expenses | 45,000 | | | | To Sales Expenses | 13,500 | | | | To Loss on Sale of Fixed Assets | 1,200 | | | | To Net Profit c/d | 2,99,700 | | | |   | 2,99,700 | | 2,99,700 | ### Calculate the following ratios: - Gross Profit - Stock Turnover Ratio - Administrative Expenses Ratio - Operating Ratio - Office Expenses Ratio - Net Profit Before Tax Ratio **Solution:** - Gross Profit Ratio: $(Gross Profit/Sales) \times 100 = (1,02,000/2,55,000) \times 100 = 40%$ - Stock Turnover Ratio: $(Cost of Goods Sold (COGS))/(Opening Stock + Closing Stock)/2 = 1,53,000/34,575 = 4.43 times$ - Administrative Expenses Ratio: $(Administrative Expenses/Sales) \times 100 = 45,000/2,55,000 \times 100 = 17.65%$ - Operating Ratio: $(Operating Expenses/Sales) \times 100 = 2,11,500/2,55,000 \times 100= 82.94%$ - Net Profit Before Tax (NPBT) Ratio: $(NPBT/Sales) \times 100 = 45,000/2,55,000 \times 100 = 17.65%$ ### Working Notes - Cost of Goods Sold (COGS): Opening Stock + Purchases + Carriage Inward - Closing Stock = 27,150 + 1,63,575 + 4,275 - 42,000 = 1,53,000 - Gross Profit (GP): Sales - COGS = 2,55,000 - 1,53,000 = ₹ 1,02,000 - Operating Expenses: COGS + Office Expenses + Sales Expenses = 1,53,000 + 45,000 + 13,500 = ₹2,11,500 ### Objective Questions #### Multiple Choice Questions ##### Conceptual 1. Current Ratio - (a) Balance Sheet Ratio - (b) Revenue Statement Ratio - (c) Composite Ratio - (d) None of the above 2. Balance Sheet Ratios may indicate - (a) relationship between the profits and the investments of the concern. - (b) relationship between the assets and the liabilities of the concern. - (c) relationship between the profitability and the sales of the concern - (d) relationship between the profits and the assets of the concern. 3. Gross Profit Ratio - (a) Balance Sheet Ratio - (b) Revenue Statement Ratio - (c) Composite Ratio - (d) None of the above #### True/False Questions - **True** Liquid ratio indicates the company's ability to meet its long term liabilities. - **False** Quick Assets = Current Assets - (Stock - Prepaid Expenses) - **False** Bank Overdraft = Current Liabilities - Quick Liabilities - **False** Bank Overdraft = Current Assets - Stock - **True** High Proprietary Ratio indicates low risk for the creditors. - **False** High Stock Turnover Ratio indicates high cost of goods sold. - **True** All other things remaining the same, issue of new shares will improve the current ratio. - **False** The difference between the current and quick ratio is that inventory is reduced from current liabilities when computing liquid ratio. - **False** Liquidity means the firm's ability to pay its debts in the long run. - **False** A lower Inventory Turnover Ratio indicates higher efficiency in inventory management. - **True** While computing Debt Equity Ratio, Pref. Share Capital is to be ignored. - **True** While computing Proprietory Ratio, Pref. Share Capital is taken as part of the Proprietors' Funds.