A) CURRENT RATIO

Current ratio may be defined as the relationship between current assets and current
liabilities. This ratio is also known as working capital ratio. It is a measure of general liquidity
and is most widely used to make the analysis for short term financial position or liquidity of a
firm. It is calculated by dividing the total of the current assets by total of the current liabilities.
Current Ratio Total current assets ! Total current liabilities
B) ACID TEST OR QUICK RATIO
"iquid ratio is also termed as "iquidity Ratio# $cid Test Ratio or %uick Ratio. The
term &quick assets' refers to current assets which can be
converted into cash immediately. It comprises all current assets e(pect stock
and prepaid e(penses. $n $cid Test Ratio of )*) is considered satisfactory as a firm can easily
meet all its current liabilities. It is the ratio of liquid assets to current liabilities. The true liquidity
refers to the ability of a firm to pay its short term obligations as and when they become due.
%uick Ratio %uick $ssets ! Current "iabilities
C) ABSOLUTE LIQUID RATIO
$bsolute liquidity is represented by cash and near cash items. It is a ratio of absolute
liquid assets to current liabilities. In the computation of this ratio only the absolute liquid assets
are compared with the liquid liabilities. The absolute liquid assets are cash# bank and marketable
securities. It is to be observed that receivables +debtors!accounts receivables and bills
receivables, are eliminated from the list of liquid assets in order to obtain absolute for liquid
assets since there may be some doubt in their liquidity.
$bsolute "iquid Ratio $bsolute "iquid $ssets ! Current "iabilities
This ratio gains much significance only when it is used in con-unction with the current
and liquid ratios. $ standard of ../*) absolute liquidity ratio
is considered an acceptable norm. That is# from the point of view of absolute liquidity# fifty cents
worth of absolute liquid assets are considered sufficient for one dollar worth of absolute liquid
liabilities. 0owever# this ratio is not in much use.
I. LEVERAGE RATIOS
These ratios are also called efficiency ratios. These ratios measure the owner's
stake in the business vis121vis that of outsiders. The long term solvency of the business can be
e(amined by using leverage ratios. "everage ratios may be calculated from the balance sheet
items to determine the proportion of debt in total financing. 3any variations of these ratios e(ist4
but all these ratios indicate the same thing1 the e(tent to which the
firm has relied on debt in financing assets. "everage ratios are also computed from the profit and
loss items by determining the e(tent to which operating profits are sufficient to cover the fi(ed
charges. The following are the important leverage ratios.
A. DEBT-EQUITY RATIO
The relationship between borrowed funds and owner's capital is a popular
measure of the long term financial solvency of a firm. This relationship is shown by the debt1
equity ratio. The term &debt' refers to the total outside liabilities. It includes all current liabilities
and other outside liabilities like loan# debentures etc the term &equity' refers to net worth or
shareholders fund. $n acceptable norm for this ratio is considered to 5*). $ high ratio shows
that the claims of creditors are greater than those of owners. $ low debt1equity ratio implies a
greater claim of owners than creditors.
6ebt 7quity Ratio 8utsiders 9unds ! :hareholders 9unds
B. PROPRIETORY RATIO OR EQUITY RATIO
This is a variant of the debt1to1equity 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. Total assets
include all assets including goodwill +e(cluding fictitious assets,. The acceptable norm of the
ratio is )*;. It is calculated by dividing shareholder's funds by the total assets. <roprietary !
7quity ratio indicates the long1term or future solvency position of the business.
<roprietary or 7quity Ratio :hareholders 9unds ! Total $ssets
C. FIXED ASSETS TO PROPRIETORS FUND RATIO
9i(ed assets to proprietor's fund ratio establish the relationship between fi(ed
assets and shareholder's funds. The purpose of this ratio is to indicate the percentage of the
owner's funds invested in fi(ed assets. If the ratio is greater than one# it means that creditors
have been used to acquire a part of the fi(ed assets.
9i(ed $seets to <roprietors 9und 9i(ed $ssets ! :hareholders 9und
II. ACTIVITY RATIOS
9unds of creditors and owners are invested in various assets to generate sales and profits.
The better the management of assets# the larger the amount of sales. $ctivity ratios are employed
to evaluate the efficiency with which the firm manages and utili=es its assets. These ratios are
also called turnover ratios because they indicate the speed with which assets are being converted
or turned over into sales. $ctivity ratios# thus# involve a relationship between sales and assets. $
proper balance between sales and assets generally reflects that assets are managed well. :everal
activity ratios can be calculated to -udge the effectiveness of asset utili=ation.
A. INVENTORY TURNOVER RATIO OR STOCK TURNOVER RATIO (ITR)
7very firm has to maintain a certain level of inventory of finished goods so as to
be able to meet the requirements of the business. >ut the level of inventory should neither be too
high nor too low. $ too high inventory means higher carrying costs and higher risk of stocks
becoming obsolete whereas too low inventory may mean the loss of business opportunities. It is
very essential to keep sufficient stock in business. :tock turnover ratio and inventory turnover
ratio are the same. This ratio is a relationship between the costs of goods sold during a particular
period of time and the cost of average inventory during a particular period. It is e(pressed in
number of times. :tock inventory 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.
Inventory Turnover Ratio Cost of ?oods :old ! $verage Inventory at Cost
B. FIXED ASSETS TURNOVER RATIO
9i(ed assets turnover ratio is also known as sales to fi(ed assets ratio. This measures the
efficiency and profit earning capacity of the concern. 0igher the ratio# greater is the intensive
utili=ation of fi(ed assets. "ower ratio means under1utili=ation of fi(ed assets. The ratio is
calculated by using following formula*
9i(ed $ssets Turnover Ratio @et :ales ! @et 9i(ed $ssets

C. WORKING CAPITAL TURNOVER RATIO
Aorking capital turnover ratio indicates the velocity of the utili=ation of net
working capital. This ratio indicates the number of times the working capital is turned over in
the course of a year. This ratio measures the efficiency with which the working capital is
being used by a firm.
D. DEBTORS TURNOVER RATIO $
concern may sell goods on cash as well as on credit. Credit is one of the important elements of
sales promotion. The volume of sales can be increased by following a liberal credit policy. The
effect of a liberal credit policy may result in tying up substantial funds of a firm in the form of
trade debtors +or receivables,. Trade debtors are e(pected to be converted into cash within a short
period of time and are included in current assets. 0ence# the liquidity position of concern to pay
its short term obligations in time depends upon the quality of its trade debtors. 6ebtor's 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.
Cost of ?oods :old
Aorking Capital Turnover Ratio 11111111111111111111111111111111111
@et Aorking Capital
6ebtors Turnover Ratio @et Credit :ales ! $verage Trade 6ebtors

E. AVERAGE COLLECTION PERIOD RATIO
The 6ebtors ! Receivable Turnover Ratio when calculated in terms of days is known as
$verage Collection <eriod or 6ebtors Collection <eriod Ratio. The average collection period
ratio represents the average number of days for which a firm has to wait before its debtors are
converted into cash.
$verage Collection <eriod Ratio +Trade 6ebtors B @o. of Aorking 6ays, ! @et
Credit :ales

F. CREDITORS TURNOVER RATIO (OR) ACCOUNTS PAYABLE TURNOVER
RATIO
$ccounts payable are the short term credits that the company has to pay within a set
period of time# usually within less than one year# but more often than not this period is a few
months. This ratio determines the financial stability of the company with a good accuracy.
Creditors Turnover Ratio Credit <urchase ! $verage Trade Creditors
G. AVERAGE PAYMENT PERIOD RATIO
The creditors ! payable turnover ratio when calculated in terms of days is known as
$verage <ayment <eriod or creditors payment period ratio. The average payment period ratio
represents the average number of days for which a firm has to wait before its creditors are
converted into cash.
$verage 6ebt <ayment <eriod +in month, +Trade Creditors B )5, ! @et Credit
<urchase
III. PROFITABILITY RATIOS
$ company should earn profits to survive and grow over a long period of time. <rofits are
essential# but it would be wrong to assume that every action initiated by management of a
company should be aimed at ma(imi=ing profits# irrespective of concerns for customers#
employees# suppliers or social consequences. It is unfortunate that the word &profit' is looked
upon as a term of abuse since some firms always want to ma(imi=e profits at the cost of
employees# customers and society. 7(cept such infrequent cases# it is a fact that sufficient profits
must be earned to sustain the operations of the business to be able to obtain funds from investors
for e(pansion and growth and to contribute towards the social overheads for the welfare of the
society. <rofit is the difference between revenues and e(penses over a period of time +usually
one year,. <rofit is the ultimate &output' of a company# and it will have no future if it fails to
make sufficient profits. Therefore# the financial manager should continuously evaluate the
efficiency of the company in term of profits. The profitability ratios are calculated to measure the
operating efficiency of the company. >esides management of the company# creditors and owners
are also interested in the profitability of the firm. Creditors want to get interest and repayment of
principal regularly. 8wners want to get a required rate of return on their investment. This is
possible only when the company earns enough profits. The following are the important
profitability ratios.
A. GROSS PROFIT RATIO (GP RATIO)
?ross profit ratio is the ratio of gross profit to net sales e(pressed as a
percentage. It e(presses the relationship between gross profit and sales. The gross profit should
be adequate to cover fi(ed e(penses# dividends and building up of reserves. $n important
factor which will affect the ratio of gross profit to sales is that of the practice of increasing or
reducing the sale price of goods sold by mark1ups and mark1downs .
?ross <rofit Ratio +?ross <rofit ! @et :ales, B )..
B. NET PROFIT RATIO
@et profit ratio is used to measure the overall profitability and hence it is
very useful to proprietors. This ratio e(plains per rupee profit generating capacity of sales.
This ratio is very useful to the proprietors and prospective investors because it reveals the
overall profitability of the concern. It is e(pressed as percentage. This is the ratio of net profit
after ta(es to net sales and is calculated below*
@et <rofit Ratio @et <rofit ! @et :ales B )..
C. OPERATING RATIO
8perating ratio is the ratio of cost of goods sold plus operating e(penses to net
sales. It is generally e(pressed in percentage. 8perating ratio measures the cost of operations per
dollar of sales. This is closely related to the ratio of operating profit to net sales.
8perating Ratio 8perating Cost ! @et :ales B )..
8perating Cost cost of goods sold C operating e(penses
D. RETURN ON TOTAL ASSET RATIO
<rofitability can be measured in terms of relationship between net profit and total
assets. This ratio is also known as return on gross capital employed. It measures the profitability
can be known by applying this ratio. The term @et profit stands for @et profit before interest
and ta( and dividend.
Return on Total $sset Ratio @et <rofit ! Total $ssets B )..
E. RETURN ON NET CAPITAL EMPLOYED
This ratio is also known as return on investment +R8I,. The primary ob-ective of
making investment in any business is to obtain satisfactory return on capital invested. It indicates
the return on capital employed in the business and it can be used to show the efficiency of the
business as a whole. The term net capital employed refers to long term funds supplied by the
creditors and owners of the firm.
Return on @et 7mployed @et <rofit >efore Interest and Ta( ! @et Capital
7mployed B )..
F. RETURN ON SHAREHOLDERS INVESTMENT OR NET WORTH RATIO
It is the ratio of net profit to shareholder's investment. It is the relationship
between net profit +after interest and ta(, and shareholder's ! proprietor's fund. This ratio
establishes the profitability from the shareholder's point of view. The ratio is generally
calculated in percentage.
Return on :hareholders Investment @et <rofit +after interest and ta(,!
:hareholders 9und B )..