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Accounting Ratios

Acidity Ratios

A firm calculates ratios using the financial data and carries out Ratio Analysis to interpret the results meaningfully. The company takes funding, financing and investing decisions on this basis. Functional Classification of ratios is on the basis of the purpose of the ratio. As per this classification, we classify ratios into Liquidity Ratios, Solvency Ratios, Turnover Ratios, and Profitability Ratios.

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Acidity Ratios

The turnover or Acidity Ratios measure the efficiency of operations of a firm on the basis of effective utilization of resources. Thus, these are also called Efficiency or Performance Ratios. These ratios assess the efficiency with which the business manages and uses its assets. Hence, we also call these Asset management ratios. It also measures the frequency of sales with respect to capital assets, working capital or average inventory.

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Various Acidity Ratios are:

A. Asset Turnover Ratios

1. Total Asset Turnover Ratio

It indicates the efficiency with which a business utilizes its total assets. Thus,

Total Asset Turnover Ratio = Sales or Cost of goods sold/Total Assets

2. Fixed Asset Turnover Ratio:

It indicates the efficiency with which a business utilizes its fixed assets. A higher ratio shows the efficient utilization of fixed assets to generate sales. Thus,

Fixed Asset Turnover Ratio = Sales or Cost of goods sold/Fixed Assets

3. Capital Turnover Ratio or Net Assets Turnover Ratio:

It measures the entity’s ability to generate sales or cost of goods sold per rupee of long-term investment. A higher ratio indicates better utilization of long-term funds of owners and the lenders. Thus,

Capital Turnover Ratio = Sales or Cost of Goods sold/Net Assets

Net Assets or Capital employed  = Net Fixed Assets + Net Current Assets

Net Current Assets = Current Assets – Current Liabilities.

4. Current Assets Turnover Ratio:

It assesses the efficiency with which the entity uses its current assets. Therefore,

Current Assets Turnover Ratio =  Sales or Cost of Goods sold/Current Assets

 

Turnover Ratios

B. Working Capital Turnover Ratio:

It measures the efficiency with which a firm is using its working capital. Thus,

Working Capital Turnover Ratio = Sales or Cost of Goods sold/Working Capital

However, we usually segregate the Working Capital Turnover into various ratios, namely:

1. Inventory Turnover Ratio:

It studies the relationship between the cost of goods sold during the year and average inventory held during the year by a firm. In other words, it indicates the efficiency with which it manages its stock. Thus, it is also called Stock Turnover Ratio. It is also an indicator of how fast the stock is sold or used. A high ratio is good as it indicates more liquidity and vice versa. Therefore,

(i) Inventory Turnover Ratio = Sales or Cost of Goods sold/Average Inventory

Where Average Inventory = Opening Stock + Closing Stock/2

(ii) Raw-material Turnover Ratio = Raw-material consumed/Average Raw-material Stock

2. Debtors or Receivables Turnover Ratio:

It indicates the efficiency with which a firm manages its debtors or accounts receivables. When a firm sells goods on credit it creates debtors. It realizes the number of such sales in cash on a later date. Thus, this affects its liquidity. This ratio reflects the collection and credit policies of an entity. Hence,


Debtors or Receivables Turnover Ratio = Credit Sales/Average Debtors

Where, Average Debtors = Opening Debtors + Closing Debtors/2

Debtors or Receivables Velocity: It calculates the average collection period directly.

Debtors or Receivables Velocity = Average Debtors/Average Daily credit sales

Or

= 12 months or 52 weeks or 360 days/Debtors Turnover Ratio

Where, Average daily credit sales = Credit Sales/360 days

3. Creditors or Payables Turnover Ratio: It indicates the efficiency with which a firm manages its creditors or accounts payable. A lower ratio is preferable. Thus,

Creditors or Payables Turnover Ratio = Annual net Credit Purchases/Average Creditors

Where Average Creditors = (Opening Creditors + Closing Creditors)/2

Creditors or Payables Velocity: It calculates the average payment period directly.

Creditors or Payables Velocity = Average Creditors/Average Daily credit sales

Or

= 12 months or 52 weeks or 360 days/Creditors Turnover Ratio

Where Average daily credit purchases =Credit Purchases/360 days

Solved Example For You

From the following information calculate Total Asset Turnover Ratio, Fixed Asset Turnover Ratio, Capital Turnover Ratio, Current Assets Turnover Ratio, and Working Capital Turnover Ratio.

Particulars Amount Particulars Amount
Equity share capital 1500000 Building 1200000
Preference share capital 900000 Machinery 1300000
General Reserve 200000 Office furniture 250000
Profit 500000 Motor Van 500000
12% Debentures 300000 Inventory 420000
10% Bank loan 300000 Debtors 260000
Creditors 420000 Cash and bank 175000
Outstanding salary 25000 Sales 5200000

 

Ans.

  1. Total Asset Turnover Ratio = Sales or Cost of goods sold/Total Assets

= \(\frac{5200000}{4105000}\)

= 1.27 times

  1. Fixed Asset Turnover Ratio = Sales or Cost of goods sold/Fixed Assets

= \(\frac{5200000}{3250000}\)

= 1.6 times

  1. Capital Turnover Ratio = Sales or Cost of Goods sold/Net Assets

= \(\frac{5200000}{3660000}\)

= 1.42 times

  1. Current Assets Turnover Ratio = Sales or Cost of Goods sold/Current Assets

= \(\frac{5200000}{855000}\)

= 6.08 times

  1. Working Capital Turnover Ratio = Sales or Cost of Goods sold/Working Capital

= \(\frac{5200000}{410000}\)

= 12.68 times

Working Notes:
  1. Total Assets = Building + Machinery + Office furniture + Motor van + Inventory + Debtors + Cash and bank

=1200000 + 1300000 + 250000 + 500000 + 420000 + 260000 + 175000 = 410500

2. Fixed Assets = Building + Machinery + Office furniture + Motor van

= 1200000 + 1300000 + 250000 + 500000 = 3250000

3. Net Assets or Capital employed = Equity Share Capital + Preference Share Capital + General reserve + Profit + 12% Debentures + 10% Bank Loan

= 1500000 + 900000 + 200000 + 500000 + 300000 + 300000 = 3660000

4. Current Assets = Inventory + Debtors + Cash and bank

= 420000 + 260000 + 175000 = 855000

5. Working Capital = Current Assets – Current Liabilities

= 855000 – 445000 = 410000

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