Ans. Ratio's definition
Ratio is just relationship between two numbers. Ratio is always in percentage form.
"A ratio is an expression of quantitative relationship between two numbers .
Definition of ratio analysis
"ratio analysis is important tool of financial analysis. With the help of ratio , we can easily analyze the profitability , solvency and financial position of any business .
Procedure of calculating ratio
- Take the formula of ratio
- collect two items from financial statement .
- calculation of ratio
- comparison of two ratios according to level of time or two different business
- interpretation of ratio
Main kinds or type of ratio
- liquidity ratio /test of liquidity
test of short term solvency
A (I) current ratio or working capital ratio :-
this ratio is relation ship between current asset and current liabilities . It tells us what is financial position to pay current liabilities .
Current ratio = current assets divided by current liabilities
current asset is cash + bank+marketable securities +sundry debtors +bill receivable +stock +prepaid exp.
current liabilities = sundry creditors +outstanding expenses +bank overdraft +bill payable
rule of thumb or standard rule of bankers=2:1
interpretation
if actual ratio is more than standard ratio . it is called favourable . other wise unfavourable.
B) liquidity ratio or quick ratio
liquidity ratio or quick ratio is relationship between liquid asset and current liabilities
quick ratio = liquid asset divided by current assets
liquid assets = cash +bank + marketable securities + b/r +debtors
current liabilities = same as above
rule of thumb =1:1 favourable
c) absolute quick ratio /cash ratio this ratio shows the relationship between absolute liquid asset and current liabilities
absolute quick ratio = absolute liquid assets divided current liabilities
or
a.q.r. = cash +bank+marketable securities+short term investment
rule of thumb =1:2 favourable
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