Saturday, March 8, 2008

Q:- Define ratio ? Give its importance ? What are main ratio ?

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

  1. Take the formula of ratio

  2. collect two items from financial statement .

  3. calculation of ratio

  4. comparison of two ratios according to level of time or two different business

  5. 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


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


a.q.r. = cash +bank+marketable securities+short term investment

rule of thumb =1:2 favourable

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