CBSE Class 12 — Notes, Chapters & Practice Quizzes

Chapter 5: Accounting Ratios

Summary

An accounting ratio is a mathematical relationship between two accounting figures drawn from the financial statements, expressed as a fraction, proportion, percentage or number of times. Ratio analysis is a major tool of financial statement analysis used to assess the solvency, liquidity, efficiency and profitability of an enterprise and to make intra-firm and inter-firm comparisons. Ratios are commonly classified into liquidity ratios, solvency ratios, activity or turnover ratios and profitability ratios. Liquidity ratios test short-term financial position: the current ratio relates current assets to current liabilities (\(\text{Current Ratio}=\dfrac{\text{Current Assets}}{\text{Current Liabilities}}\)) and the quick ratio relates quick assets to current liabilities (\(\text{Quick Ratio}=\dfrac{\text{Quick Assets}}{\text{Current Liabilities}}\)). Solvency ratios test long-term financial position, the chief example being the debt-equity ratio (\(\text{Debt-Equity Ratio}=\dfrac{\text{Long-term Debts}}{\text{Shareholders Funds}}\)). Activity ratios measure how efficiently resources are used, such as the inventory turnover ratio (\(\text{Inventory Turnover Ratio}=\dfrac{\text{Cost of Revenue from Operations}}{\text{Average Inventory}}\)) and the trade-receivables turnover ratio. Profitability ratios measure earning capacity, including the gross profit ratio, operating ratio, net profit ratio and return on investment. The chapter explains the meaning, objectives and limitations of ratio analysis and shows how each ratio is computed and interpreted.

Key terms

Important questions

Explore interactively