Tuesday, March 11, 2008

Efficiency ratio or activity ratio or current asset movement ratio / turnover ratio

Efficiency here means power of business man to sold goods quicky ,receive money from debtor quickly , and payment to his creditors as quickly as possible , so efficiency ratio tells us rate of stock turnover , debtor and creditor turnover ratio .

(I) stock turnover ratio

stock turnover ratio is relation ship between stock and sale

stock turnover ratio = cost of goods sold / average inventory at cost


stock turnover ratio = opening stock + purchase +direct expenses divided by opening stock +closing stock/2


stock turnover ratio = sale - gross profit / opening stock +closing stock/2


higher ratio tells us good efficiency of business . If there isn't given above information stock or inventory turnover ratio = net sale / inventory

Debtor turnover ratio

debtor turnover ratio is just relationship between credit sale and average receivables

debtor turnover ratio = credit sale / average receivable

3. Analysis of long term solvency position or test of solvency :-

test of long term solvency is test of fixed assets and outside fixed liabilities. If businessman has capicity to pay the interest of long term loan and repay them on maturity . It is called that business is strong or sound in long term . following ratios help in decision of long term solvency problem .

  1. debt quity ratio

this ratio is just relationship between long term outside debt and company shareholder fund .


debt quity ratio = outside debt / shareholder fund

outside debt = debenture +long term debt +mortgage loan +bank loan +current liabilities

shareholder fund = equity share capital +pref. share capital +reserve and surplus +share premium +loss (accumulated)-discount on issue


no standard rule but perportion of high shareholder fund is favourable 2

2. debt service or interest coverage ratio

debt service ratio or interest coverage ratio is just relationship of net profit (before tax and interest ) and fixed interest charges . If net profit is more than fixed income it shows our sound long term financial position .

interest coverage ratio = net profit ( before tax and interest )/fixed interest charges

suppose 100000 rupees are loan which is given @ 12% p.a.

I.C.R. = net profit / interest = 60000/12000 = 5 times

3. Fixed asset Ratio :-

Fixed Asset ratio is just relation ship between long term funds and fixed asset

fixed asset ratio = long term fund /fixed assets


f.a.r. = quity share capital +loan / fixed assets

if long term fund is more than fixed assets . it shows our long term soundness .

4. Debt to total fund or solvency ratio

debt total fund ratio = total liabilities / total assets

debt to total fund ratio is relationship between total liabilities and total assets .

5. reserve to capital ratio

reserve to capital ratio is just relationship between reserve and capital . it is calculated when we divided reserve by capital . if answer multiply will 100 . we can receive reserve % on capital .

reserve to capital ratio = reserve and fund divided by capital


higher % of reserve shows higher rate of soundness .

6 capital gearing ratio

capital gearing ratio tells us what type of gear you should maintain in business . in starting of business , company should maintain low gear , when company earn high rate of profit , company can increase his growth speed through high gear . it is a time when company can work on high gear . Capital gearing rate is just relationship between equity and fixed cost bearing securities .

capital gearing ratio = equity share capital + reserve fund + other profits / pref. share capital +debenture + long term loan

3. return on investment (r.o.i.) = net profit before interest and tax divided by capital employed and multiply with 100

4. earning per share

= net profit after tax and pref. dividend/ no. of quity shares

for seeing next note , keep in touch with comments

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