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Question
Long Answer Question
What are important profitability ratios? How are these worked out?
Solution
rofitability ratios are calculated on the basis of profit earned by a business. This ratio gives a percentage measure to assess the financial viability, profitability and operational efficiency of the business. The various important Profitability Ratios are as follows:
1. Gross Profit Ratio
2. Operating Ratio
3. Operating Profit Ratio
4. Net Profit Ratio
5. Return on Investment or Capital Employed
6. Earnings per Share Ratio
7. Dividend Payout Ratio
8. Price Earnings Ratio
1. Gross Profit Ratio- It shows the relationship between Gross Profit and Net Sales. It depicts the trading efficiency of a business. A higher Gross Profit Ratio implies a better position of a business, whereas a low Gross Profit Ratio implies an inefficient unfavourable sales policy.
`"Gross Profit Ratio"= "Gross Profit"/"Net sales"xx" 100`
`" Gross profit"= " Net Sales" - "Cost of Goods Sold"`
`" Cost of Goods Sold" ="Sales" - "Gross profit"`
3. Operating Profit Ratio- It shows the relationship between the Operating Profit and Net Sales. It helps in assessing the operational efficiency and the performance of the business.
`" Operating Profit Ratio"= "Operating Profit"/"Sales"xx"100`
`"Operating Profit Ratio" = 100 - "Operating Ratio"`
`"Operating Profit" " Sales" - "Opeartion Cost"`
4. Net Profit Ratio- It shows the relationship between net profit and sales. Higher ratio is better for firm. It depicts the overall efficiency of a business and acts as an important tool to the investors for analysing and measuring the viability and performance of the business.
`" Net Profit Ratio" = "Net Profit"/ "Net Sales"xx"100`
`"or. Net Profit Ratio" = "Profit Before Tax"/" Net Sales"xx"100`
`"or. Net Profit Ratio" = "Profit After Tax"/" Net Sales"xx"100`
`"Net Sales" =" Total Sales" - "Sales Return"`
5. Return on Investment or Capital Employed- It shows the relationship between the profit earned and the capital employed to earn that profit. It is calculated as:
`"Return on Investment or Capital Employed" = "Profit Before Interest and Tax"/" Capital Employed"xx"100`
`"Capital Employed" ="Fixed Assets" + "Current Assets - Current Liablities"`
`"or. Capital Employed" = " Share capital" +"Reserve and Surplus" +"Long Term Funds" - "Fictitious assets"`
This ratio depicts the efficiency with which the business has utilised the capital invested by the investors. It is an important yardstick to assess the profit earning capacity of the business.
6. Earning per Shares- It shows the relationship between the amount of profit available to distribute as dividend among the equity shareholders and number of equity shares.
`"Earning per share" = " Profit available for equity shareholders"/"Number of equity shares"`
`"Profit available for equity shareholders" = "Net Profit after Tax" - "Preference share Dividend"`
7. Dividend Payout Ratio- It shows the relationship between the dividend per share and earnings per share. This ratio depicts the amount of earnings that is distributed in the form of dividend among the shareholders. A high Dividend Payout Ratio implies a better position and goodwill of the business for the shareholders.
`"Dividend Payout Ratio"= "Dividend per share"/"Earning per share"`
`"Dividend per share" = "Dividend paid"/"No. of shares"`
8. Price Earning Ratio- It shows the relationship between the market price of a share and the earnings per share. This ratio is the most common tool that is used in the stock markets. This ratio depicts the degree of reliance and trust that the shareholders have on the business. This ratio reflects the expectation of the shareholders regarding the rise in the future prices of the company’s shares. A higher Price Earning Ratio definitely enables a company to enjoy favourable position in the market.
`"Profit Earning Ratio" = "Market Price of a share"/"Earnings per share"`
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RELATED QUESTIONS
Short Answer Question
The liquidity of a business firm is measured by its ability to satisfy its long-term obligations as they become due. What are the ratios used for this purpose?
Following is the Balance Sheet of Raj Oil Mills Limited as at March 31, 2017. Calculate Current Ratio.
| Particulars | (Rs) |
| I. Equity and Liabilities: | |
|
1. Shareholders’ funds |
|
|
a) Share capital |
7,90,000 |
|
b) Reserves and surplus |
35,000 |
|
2. Current Liabilities |
|
|
a) Trade Payables |
72,000 |
| Total | 8,97,000 |
| II. Assets | |
|
1. Non-current Assets |
|
|
a) Fixed assets |
|
|
Tangible assets |
7,53,000 |
|
2. Current Assets |
|
|
a) Inventories |
55,800 |
|
b) Trade Receivables |
28,800 |
|
c) Cash and cash equivalents |
59,400 |
| Total | 8,97,000 |
Calculate Inventory Turnover Ratio if:
Inventory in the beginning is Rs. 76,250, Inventory at the end is 98,500, Gross Revenue from Operations is Rs. 5,20,000, Sales Return is Rs. 20,000, Purchases is Rs. 3,22,250.
A company had Current Assets of ₹4,50,000 and Current Liabilities of ₹2,00,000. Afterwards it purchased goods for ₹30,000 on credit. Calculate Current Ratio after the purchase.
Current Liablilites of a company were ₹1,75,000 and its Current Ratio was 2:1. It paid ₹30,000 to a Creditor. Calculate Current Ratio after payment.
State giving reason, whether the Current Ratio will improve or decline or will have no effect in each of the following transactions if Current Ratio is 2:1:
(a) Cash paid to Trade Payables.
(b) Bills Payable discharged.
(c) Bills Receivable endorsed to a creditor.
(d) Payment of final Dividend already declared.
(e) Purchase of Stock-in-Trade on credit.
(f) Bills Receivable endorsed to a Creditor dishonoured.
(g) Purchases of Stock-in-Trade for cash.
(h) Sale of Fixed Assets (Book Value of ₹50,000) for ₹45,000.
(i) Sale of FIxed Assets (Book Value of ₹50,000) for ₹60,000.
Total Assets ₹22,00,000; Fixed Assets ₹10,00,000; Capital Employed ₹20,00,000. There were no Long-term Investments.
Calculate Current Ratio.
Following figures have been extracted from Shivalika Mills Ltd.
Inventory at the end of the year ₹ 1,00,000.
Inventory Turnover Ratio 8 times.
Selling price 25% above cost.
Calculate Return on Investment (ROI) from the following details: Net Profit after Tax ₹ 6,50,000; Rate of Income Tax 50%; 10% Debentures of ₹ 100 each ₹ 10,00,000; Fixed Assets at cost ₹ 22,50,000; Accumulated Depreciation on Fixed Assets up to date ₹ 2,50,000; Current Assets ₹ 12,00,000; Current Liabilities ₹ 4,00,000.
y Ltd.'s profit after interest and tax was ₹ 1,00,000. Its Current Assets were ₹ 4,00,000; Current Liabilities ₹ 2,00,000 ; Fixed Assets ₹ 6,00,000 and 10% Long-term Debt ₹ 4,00,000. The rate of tax was 20%. Calculate 'Return on Investment' of Y Ltd.
From the following Balance Sheet of Global Ltd., you are required to calculate Return on Investment for the year 2018-19:
BALANCE SHEET OF GLOBAL LTD.
as at 31st March, 2019
|
Particulars |
Note No. |
Amount ₹ |
| I. EQUITY AND LIABILITIES
1. Shareholder's Funds |
||
|
(a) Share Capital–Equity Shares of ₹ 10 each Fully paid |
|
5,00,000 |
|
(b) Reserves and Surplus |
|
4,20,000 |
|
2. Non-Current Liabilities |
||
|
15% Long-term Borrowings |
|
16,00,000 |
|
3. Current Liabilities |
|
8,00,000 |
|
Total |
|
33,20,000 |
| II. ASSETS | ||
|
1. Non-Current Assets |
||
|
(a) Fixed Assets |
|
16,00,000 |
|
(b) Non-Current Investments: |
|
|
|
(i) 10% Investments |
|
2,00,000 |
|
(ii) 10% Non-trade Investments |
|
1,20,000 |
|
2. Current Assets |
14,00,000 | |
|
Total |
|
33,20,000 |
Additional Information: Net Profit before Tax for the year 2018-19 is rs 9,72,000.
Opening Inventory ₹80,000; Purchases ₹4,30,900; Direct Expenses ₹4,000; Closing Inventory ₹1,60,000; Administrative Expenses ₹21,100; Selling and Distribution Expenses ₹40,000; Revenue from Operations, i.e., Net Sales ₹10,00,000. Calculate Inventory Turnover Ratio; Gross Profit Ratio; and Opening Ratio.
From the information given below, calculate any three of the following ratio:
(ii) Working Capital Turnover Ratio:
(iii) Debt to Equity Ratio; and
(iv) Proprietary Ratio.
| ₹ | ₹ | |||
| Revenue from Operations (Net Sales) | 5,00,000 | Current Liabilities | 1,40,000 | |
| Cost of Revenue from Operations (Cost of Goods Sold) | 3,00,000 | Paid-up Share Capital | 2,50,000 | |
| Current Assets | 2,00,000 | 13% Debentures | 1,00,000 |
Liquid ratio is also known as ____________.
An annual Report is issued by a company to its ______?
Calculate 'Liquid Ratio' from the following information:
Current Liabilities Rs. 50,000, Current Assets Rs. 80,000, Stock Rs.25,000, Prepaid Expenses Rs.5,000
Consider the following data and answer the question that follows:
| Particulars | ₹ |
| Revenue From Operations | 12,00,000 |
| Cost of Revenue from Operations | 9,00,000 |
| Operating Expenses | 15,000 |
| Inventory | 20,000 |
| Other Current Assets | 2,00,000 |
| Current Liabilities | 75,000 |
| aid up Share Capital | 4,00,000 |
| Statement of Profit and Loss (Dr.) | 47,500 |
| Total Debt | 2,50,000 |
What is the working capital turnover ratio?
Which ratios measure the firm's ability to meet its short-term obligations in time?
Pick the odd one out.
How much amount will be added while computing Net Profit before Tax?
| 01.04.2020 | 31.03.2021 | |
| Provision for Tax | ₹ 54,000 | ₹ 72,900 |
Tax paid during the year ended 31st March 2021 is ₹ 64,800.
