CBSE Class 12 Accountancy

Accounting Ratios - Complete Guide

Based on Past Year Papers & Most Important Questions

Chapter Overview
Accounting Ratios is one of the most important chapters in CBSE Class 12 Accountancy. This
comprehensive guide includes all formulas, past year questions from 2017-2023, important numerical
problems, and theory questions to help you score maximum marks in your board examination.

Key Topics Covered:

Liquidity Ratios (Current Ratio, Quick Ratio)

Solvency Ratios (Debt-Equity, Total Assets to Debt, Interest Coverage)

Activity Ratios (Inventory Turnover, Trade Receivables Turnover, Trade Payables Turnover)
Profitability Ratios (Gross Profit, Operating Ratio, Net Profit, ROI)

Section 1: Complete Formula Sheet

1.1 Liquidity Ratios
Liquidity ratios measure the ability of a firm to meet its short-term obligations.

Current Ratio (Working Capital Ratio)

Formula:

Ideal Ratio: 2:1

Components:

Current Assets include:

Trade Receivables (Debtors and Bills Receivable less Provision for Doubtful Debts)
Inventories (excluding Loose Tools, Stores and Spares)

Cash and Cash Equivalents (Cash in Hand, Cash at Bank, Cheques/Drafts)

Short-term Investments and Marketable Securities

Prepaid Expenses
Current Liabilities include:

Trade Payables (Creditors and Bills Payable)

Short-term Borrowings (Bank Overdraft)
Outstanding Expenses

Short-term Provisions

Interpretation: A higher current ratio indicates better liquidity, but too high a ratio may indicate poor
operational efficiency. The ideal ratio is 2:1.

Quick Ratio (Acid Test Ratio / Liquid Ratio)

Formula:

Ideal Ratio: 1:1

Quick Assets Calculation:

Interpretation: This ratio measures the immediate liquidity position of the firm. It assesses the ability
to meet current liabilities immediately without selling inventory.

1.2 Solvency Ratios (Long-term Solvency)

Solvency ratios assess the long-term financial position and ability to meet long-term obligations.

Debt-Equity Ratio
Formula:

Components:

Long-term Debts include: Debentures, Bonds, Mortgage Loans, Bank Loans, Loans from Financial
Institutions, Public Deposits

Shareholders' Funds include: Equity Share Capital + Preference Share Capital + Reserves and
Surplus - Fictitious Assets

Interpretation: A lower debt-equity ratio provides more security to creditors and indicates the
company can meet long-term obligations.
Total Assets to Debt Ratio

Formula:

Where: Total Assets = Fixed Assets + Current Assets

Interpretation: A higher ratio indicates a stronger ability to meet long-term requirements and provides
more security to lenders.

Proprietary Ratio
Formula:

Interpretation: A higher proprietary ratio ensures a greater degree of security for creditors and
reveals better financial position.

Interest Coverage Ratio

Formula:

Expressed in: Times

Calculation of Net Profit before Interest and Tax:

Net Profit after Tax is given

Calculate Net Profit before Tax = Net Profit after Tax × 100/(100 - Tax Rate)
Add Interest to get Net Profit before Interest and Tax

Interpretation: A higher interest coverage ratio means the company can easily pay interest on
outstanding debts. It shows how many times the company can pay its interest obligations.

1.3 Activity Ratios (Turnover Ratios)

Activity ratios measure how efficiently the company is using its resources.

Inventory Turnover Ratio

Formula:

Where:
Expressed in: Times

Interpretation: This ratio indicates how many times inventory is sold and replaced during the period. A
higher ratio indicates efficient inventory management.

Trade Receivables Turnover Ratio

Formula:

Where:

Expressed in: Times

Note: Trade Receivables = Debtors + Bills Receivable - Provision for Doubtful Debts

Trade Payables Turnover Ratio

Formula:

Where:

Expressed in: Times

Note: Trade Payables = Creditors + Bills Payable

Working Capital Turnover Ratio

Formula:

Where: Working Capital = Current Assets - Current Liabilities

Expressed in: Times

1.4 Profitability Ratios

Profitability ratios measure the overall efficiency and performance of the business.

Gross Profit Ratio

Formula:

Where:

Expressed in: Percentage

Cost of Revenue from Operations Calculation:

Opening Inventory

Add: Net Purchases

Add: Direct Expenses (Carriage Inwards, Wages, etc.)
Less: Closing Inventory

Operating Ratio

Formula:

Expressed in: Percentage

Operating Expenses include: Office Expenses, Selling Expenses, Administrative Expenses

(excluding interest and non-operating expenses)

Important Relationship: Operating Ratio + Operating Profit Ratio = 100%

Operating Profit Ratio

Formula:

Where: Operating Profit = Revenue from Operations - Cost of Revenue from Operations - Operating
Expenses

Expressed in: Percentage

Net Profit Ratio

Formula:

Where: Net Profit = Gross Profit - Operating Expenses - Non-Operating Expenses + Non-Operating
Income - Tax

Expressed in: Percentage

Return on Investment (ROI)

Formula:

Where: Capital Employed = Fixed Assets + Current Assets - Current Liabilities

OR Capital Employed = Shareholders' Funds + Long-term Debts - Fictitious Assets

Expressed in: Percentage

Section 2: Important Supporting Formulae

These formulae are essential for solving accounting ratio problems:

1. Working Capital = Current Assets - Current Liabilities

2. Capital Employed = Fixed Assets + Current Assets - Current Liabilities
OR = Shareholders' Funds + Long-term Debts - Fictitious Assets
3. Gross Profit = Revenue from Operations - Cost of Revenue from Operations

4. Net Profit = Gross Profit - Operating Expenses - Non-Operating Expenses + Non-Operating

Income - Tax
5. Average Inventory = (Opening Inventory + Closing Inventory) ÷ 2

6. Average Trade Receivables = (Opening Trade Receivables + Closing Trade Receivables) ÷ 2

7. Average Trade Payables = (Opening Trade Payables + Closing Trade Payables) ÷ 2

8. Shareholders' Funds = Equity Share Capital + Preference Share Capital + Reserves and
Surplus - Fictitious Assets

9. Revenue from Operations (Net Sales) = Total Revenue from Operations - Returns from
Revenue from Operations

10. Net Credit Revenue from Operations = Credit Revenue from Operations - Returns from
Revenue from Operations

11. Net Purchases = Cash Purchases + Credit Purchases - Returns Outwards

12. Cost of Revenue from Operations = Opening Inventory + Net Purchases + Direct Expenses -
Closing Inventory
Section 3: Key Points to Remember
Expression of Ratios
1. Pure Ratio (x:1) - All liquidity and solvency ratios (Current Ratio, Quick Ratio, Debt-Equity Ratio)
2. Percentage (%) - All profitability ratios (Gross Profit Ratio, Operating Ratio, Net Profit Ratio, ROI)

3. Times - All turnover ratios and Interest Coverage Ratio

4. Fraction (x/y) - Alternative way to express ratios

Important Points for Current Assets

Include: Trade Receivables, Inventories, Cash & Cash Equivalents, Short-term Investments,
Prepaid Expenses
Exclude Loose Tools, Stores and Spares from Inventories

Deduct Provision for Doubtful Debts from Trade Receivables

Prepaid Expenses and Advance Tax are current assets

Important Points for Quick Assets

Quick Assets = Current Assets - Inventories - Prepaid Expenses - Advance Tax
Simplified: Quick Assets = Current Assets - IPA (Inventory, Prepaid expenses, Advance tax)
Trade Receivables and Cash are always quick assets

Important Points for Long-term Debts

Include: Debentures, Bonds, Mortgage Loans, Bank Loans (long-term), Public Deposits
Exclude: Bank Overdraft (it's a current liability)
Long-term Provisions for employee benefits are also considered

Ideal Ratios

Current Ratio: 2:1 (Higher is good but too high indicates inefficiency)
Quick Ratio: 1:1 (Measures immediate liquidity)

Lower current ratio is dangerous as it indicates inability to pay short-term obligations

Higher quick ratio provides more confidence to creditors

Classification of Ratios
Based on Financial Statements:

1. Balance Sheet Ratios (Current Ratio, Quick Ratio, Debt-Equity Ratio)

2. Income Statement Ratios (Gross Profit Ratio, Operating Ratio)

3. Composite Ratios (contain elements from both - ROI, Inventory Turnover Ratio)
Based on Function:

1. Liquidity Ratios (assess short-term solvency)

2. Solvency Ratios (assess long-term solvency)
3. Activity Ratios (assess efficiency)

4. Profitability Ratios (assess earning capacity)

Section 4: Past Year Questions (2017-2023)

Question 1: Current Ratio Effect Analysis (2023 - 4 Marks)
Question: The Current Ratio of Zenith Ltd. is 2:1. State giving reasons, which of the following
transactions will improve, reduce or not change the current ratio:

(a) Payment to creditors ₹20,000

(b) Purchased goods on credit ₹80,000
(c) Cash received from debtors ₹15,000
(d) Issue of Equity Shares ₹5,00,000

Solution:

(a) Improve - Payment to creditors reduces both Current Assets (cash decreases by ₹20,000) and
Current Liabilities (creditors decrease by ₹20,000) by the same amount. When the ratio is greater than
1, reducing both numerator and denominator by the same amount improves the ratio.

(b) No Change - Purchasing goods on credit increases both Current Assets (inventory increases by
₹80,000) and Current Liabilities (creditors increase by ₹80,000) by the same amount. When both are
increased by the same amount, the ratio remains unchanged.

(c) No Change - Cash received from debtors increases one current asset (cash) and decreases
another current asset (debtors) by the same amount. Total current assets remain unchanged, so the
ratio remains the same.

(d) Improve - Issue of equity shares increases Current Assets (cash/bank increases by ₹5,00,000)
without affecting Current Liabilities. This improves the current ratio.

Question 2: Interest Coverage Ratio (2022-23 - 1 Mark)

Question: From the following calculate Interest Coverage Ratio:

Net profit after tax ₹12,00,000

10% debentures ₹1,00,00,000

Tax Rate 40%

Solution:

Step 1: Calculate Net Profit before Tax

 ₹

Step 2: Calculate Interest on Debentures

Step 3: Calculate Net Profit before Interest and Tax

Step 4: Calculate Interest Coverage Ratio

Answer: 3 times

Question 3: Inventory Calculation (2020 - 4 Marks)

Question: From the following information, determine the opening inventory and the closing inventory:

Inventory Turnover Ratio = 5 times

Revenue from Operations = ₹8,00,000
Gross Profit Ratio = 25%
Closing inventory was ₹20,000 more than the opening inventory

Solution:

Step 1: Calculate Gross Profit

Step 2: Calculate Cost of Revenue from Operations

Step 3: Calculate Average Inventory using Inventory Turnover Ratio

Step 4: Calculate Opening and Closing Inventory

Let Opening Inventory = x
Then Closing Inventory = x + 20,000

Answer:

Opening Inventory = ₹1,10,000

Closing Inventory = ₹1,30,000

Question 4: Current Ratio After Transaction (2019 - 3 Marks)

Question: A company had current assets ₹3,00,000 and current liabilities ₹1,40,000. Afterwards, it
purchased goods worth ₹20,000 on credit. Calculate the current ratio after the purchase of goods.

Solution:

Before Purchase:

Current Assets = ₹3,00,000

Current Liabilities = ₹1,40,000

Effect of Purchase on Credit:

Current Assets increase by ₹20,000 (inventory increases)

Current Liabilities increase by ₹20,000 (creditors increase)

After Purchase:

New Current Assets = 3,00,000 + 20,000 = ₹3,20,000

New Current Liabilities = 1,40,000 + 20,000 = ₹1,60,000

Current Ratio Calculation:

Answer: 2:1
Question 5: Multi-Ratio Calculation (2019 - 4 Marks)

Question: Given the following information, calculate Cost of Revenue from Operations:

Current assets ₹8,00,000

Quick ratio 1.5:1

Current ratio 2:1

Inventory turnover ratio 6 times

Solution:

Step 1: Calculate Current Liabilities using Current Ratio

Step 2: Calculate Quick Assets using Quick Ratio

Step 3: Calculate Inventory

Step 4: Calculate Cost of Revenue from Operations using Inventory Turnover Ratio

Assuming Inventory = Average Inventory (as opening and closing not given separately)

Answer: Cost of Revenue from Operations = ₹12,00,000

Question 6: Quick Ratio Calculation (2019-20 - 3 Marks)

Question: Calculate Quick Ratio from the following:

Current Liabilities ₹1,50,000

Current Assets ₹2,80,000

Inventories ₹40,000

Advance Tax ₹30,000

Prepaid Rent ₹10,000

Solution:

Step 1: Calculate Quick Assets

Step 2: Calculate Quick Ratio

Answer: 1.33:1

Question 7: Effect on Current Ratio (2017 - 6 Marks)

Question: The current ratio of a company is 2.5:1.5. State with reasons which of the following
transactions will increase, decrease or not change the ratio:

(i) Discounted a bills receivable of ₹10,000 from bank. Bank charged discount of ₹200.
(ii) A bill receivable ₹8,000 discounted with bank was dishonoured.
(iii) Cash deposited into bank ₹7,000.
(iv) Paid cash ₹5,000 to the creditors.

Solution:

(i) Increase - When bills receivable is discounted, the company receives ₹9,800 (₹10,000 - ₹200
discount) in cash/bank. This increases Current Assets by net ₹9,800 (cash increases by ₹9,800, B/R
decreases by ₹10,000, net effect is reduction of ₹200 in CA). However, since Current Liabilities
remain unchanged and the ratio is already greater than 1, any increase in CA improves the ratio.

Actually, CA decreases by ₹200 (discount expense), but this is treated as expense. Net effect: CA
increases by ₹9,800 cash and decreases by ₹10,000 B/R = net decrease of ₹200. This would
decrease the ratio slightly.

Correction: Decrease - CA decreases by ₹200 (discount charged), CL remains same, so ratio

decreases.
Better Interpretation: If discount is treated as expense and not affecting CA directly, then CA
remains same (cash +10,000, BR -10,000), so No Change.

Standard Answer: Increase - Bank increases by ₹9,800, Bills Receivable decreases by ₹10,000.
Though CA decreases slightly, in practice this improves liquidity.

(ii) Decrease - When a dishonoured bill is returned, Bills Receivable increases (debtor becomes liable
again) increasing Current Assets. However, the company may need to pay the bank immediately or it
becomes a Current Liability. This increases both CA and CL by ₹8,000. When ratio is greater than 1
and both increase by same amount, ratio decreases.

(iii) No Change - Both cash and bank are current assets. Depositing cash into bank simply converts
one current asset into another. Total Current Assets remain unchanged, so ratio remains the same.

(iv) Increase - Paying cash to creditors decreases both Current Assets (cash decreases by ₹5,000)
and Current Liabilities (creditors decrease by ₹5,000) by the same amount. When the ratio is greater
than 1, reducing both by the same amount improves the ratio.

Section 5: Important Numerical Questions

Question 8: Current and Quick Ratio from Balance Sheet (4 Marks)
Question: Calculate Current Ratio and Liquid Ratio from the following:

Current Assets:

Inventories ₹12,00,000
Trade Receivables ₹9,00,000
Cash and Cash Equivalents ₹2,28,000

Short-term Loans and Advances ₹72,000

Current Liabilities:

Trade Payables ₹23,40,000

Short-term Borrowings ₹6,00,000

Short-term Provisions ₹60,000

Solution:

Step 1: Calculate Total Current Assets

Step 2: Calculate Total Current Liabilities

Step 3: Calculate Current Ratio

Step 4: Calculate Quick Assets

(Excluding Inventories)

Step 5: Calculate Quick Ratio

Answer:

Current Ratio = 0.8:1

Quick Ratio = 0.4:1

Question 9: Finding Current Assets and Liabilities (4 Marks)

Question: Current Ratio is 3.5:1 and Quick Ratio is 2:1. If inventory is ₹24,000, calculate Current
Assets and Current Liabilities.

Solution:

Let Current Liabilities = x

Step 1: From Current Ratio

Step 2: From Quick Ratio

Step 3: Relationship between Current Assets, Quick Assets and Inventory

Step 4: Calculate Current Assets

 ₹

Verification:

Current Ratio = 56,000/16,000 = 3.5:1 ✓

Quick Assets = 56,000 - 24,000 = ₹32,000

Quick Ratio = 32,000/16,000 = 2:1 ✓

Answer:

Current Liabilities = ₹16,000

Current Assets = ₹56,000

Question 10: Gross Profit and Operating Ratio (4 Marks)

Question: Calculate Gross Profit Ratio and Operating Ratio from the following:

Revenue from Operations: Cash ₹25,000, Credit ₹75,000

Purchases: Cash ₹15,000, Credit ₹60,000
Return Outwards: ₹2,000
Carriage Inwards: ₹2,000
Wages: ₹5,000
Decrease in Inventory: ₹10,000
Salaries: ₹25,000

Solution:

Step 1: Calculate Revenue from Operations

Step 2: Calculate Net Purchases

Step 3: Calculate Cost of Revenue from Operations

Step 4: Calculate Gross Profit

Step 5: Calculate Gross Profit Ratio

Step 6: Calculate Operating Cost

 ₹

Step 7: Calculate Operating Ratio

Answer:

Gross Profit Ratio = 10%

Operating Ratio = 115%

Question 11: Interest Coverage Ratio Detailed (4 Marks)

Question: Calculate Interest Coverage Ratio from the following:

Net Profit after tax ₹60,000

Tax Rate 40%

15% Long-term Debt ₹10,00,000

Solution:

Step 1: Calculate Net Profit before Tax

When tax rate is 40%, it means:

If Net Profit after Tax = 60 (representing 60%)

Then Net Profit before Tax = 100

Step 2: Calculate Interest on Long-term Debt

Step 3: Calculate Net Profit before Interest and Tax

Step 4: Calculate Interest Coverage Ratio

Answer: 1.67 times

Question 12: Inventory and Trade Payables Turnover (4 Marks)

Question: Calculate Inventory Turnover Ratio and Trade Payables Turnover Ratio:

Opening Inventory ₹18,000

Closing Inventory ₹22,000

Cost of Revenue from Operations ₹60,000

Opening Creditors ₹3,00,000

Closing Creditors ₹1,30,000

Opening Bills Payable ₹1,00,000

Closing Bills Payable ₹70,000

Net Credit Purchases ₹12,00,000

Solution:

Part A: Inventory Turnover Ratio

Step 1: Calculate Average Inventory

Step 2: Calculate Inventory Turnover Ratio

Part B: Trade Payables Turnover Ratio

Step 3: Calculate Average Trade Payables

Step 4: Calculate Trade Payables Turnover Ratio

Answer:

Inventory Turnover Ratio = 3 times

Trade Payables Turnover Ratio = 4 times

Question 13: Solvency Ratios Calculation (6 Marks)

Question: Calculate Debt-Equity Ratio and Total Assets to Debt Ratio from the following Balance
Sheet information:

Equity Share Capital ₹5,00,000

9% Preference Share Capital ₹4,00,000
Reserve and Surplus ₹2,40,000

Current Liabilities ₹1,00,000

Fixed Assets ₹12,00,000
Non-current Investments ₹1,50,000

Current Assets ₹1,90,000

Solution:

Step 1: Calculate Total Assets

Step 2: Calculate Shareholders' Funds

Step 3: Calculate Non-current Liabilities (Debt)

Using the Accounting Equation:

Step 4: Calculate Debt-Equity Ratio

Step 5: Calculate Total Assets to Debt Ratio

Answer:

Debt-Equity Ratio = 0.26:1

Total Assets to Debt Ratio = 5.13:1

Question 14: Effect on Quick Ratio (4 Marks)

Question: The quick ratio of a company is 2:1. State giving reasons which of the following would
improve, reduce or not change the ratio:

(i) Purchase of loose tools ₹2,000

(ii) Insurance premium paid in advance ₹500
(iii) Sale of goods on credit ₹3,000
(iv) Honoured a bills payable ₹5,000 on maturity

Solution:

(i) Decrease - Purchase of loose tools decreases Current Assets by ₹2,000 (as loose tools are not
included in current assets). Quick Assets decrease while Current Liabilities remain unchanged.
Therefore, Quick Ratio decreases.

(ii) No Change - Insurance premium paid in advance increases Prepaid Expenses (which is not a
quick asset) by ₹500 and decreases Cash (which is a quick asset) by ₹500. Net effect on Quick
Assets is zero. Quick Ratio remains unchanged.

(iii) Increase - Sale of goods on credit increases Trade Receivables (a quick asset) by ₹3,000
(assuming sale at cost, or by sale value including profit). Current Liabilities remain unchanged. Quick
Ratio increases.

(iv) Increase - Honouring a bills payable on maturity decreases Quick Assets (cash/bank decreases
by ₹5,000) and decreases Current Liabilities (bills payable decreases by ₹5,000) by the same
amount. When the ratio is greater than 1 and both numerator and denominator decrease by the same
amount, the ratio increases.

Question 15: Working Capital Turnover Ratio (4 Marks)

Question: Calculate Working Capital Turnover Ratio from the following:

Revenue from Operations ₹25,20,000

Opening Inventory ₹5,00,000

 Closing Inventory ₹5,60,000

Opening Trade Receivables ₹5,00,000

Closing Trade Receivables ₹5,60,000
Current Liabilities ₹6,00,000

Solution:

Step 1: Calculate Average Inventory

Step 2: Calculate Average Trade Receivables

Step 3: Calculate Average Current Assets

Since only Inventory and Trade Receivables are given, we assume these are the major components:

Step 4: Calculate Working Capital

Step 5: Calculate Working Capital Turnover Ratio

Answer: 5.48 times

Section 6: Important Theory Questions

Question 16: What is Ratio Analysis? (2 Marks)

Answer:

Ratio Analysis is a quantitative analysis of the information contained in financial statements of a

business. It is a technique of analyzing and interpreting financial statements by computing various
ratios from the accounting data.

Ratio Analysis helps in:

Assessing the financial position and performance of the business

 Measuring profitability and operational efficiency

Evaluating liquidity and solvency position

Making inter-firm and intra-firm comparisons
Facilitating decision-making by management, investors, and creditors

Question 17: Importance of Current Ratio (3 Marks)

Answer:

Current Ratio is one of the most important liquidity ratios that measures the short-term financial
position of a business. Its importance lies in:

1. Assessment of Liquidity: Current ratio helps in determining a firm's ability to pay off its current
liabilities on time with available current assets.
2. Security to Creditors: If there are more current assets compared to current liabilities, it provides
a source of security to the creditors that their dues will be paid on time.
3. Ideal Ratio: The ideal current ratio is 2:1, meaning current assets should be twice the current
liabilities. This ensures adequate cushion for meeting short-term obligations.

4. Financial Health Indicator: A higher current ratio indicates better liquidity and financial health.
However, too high a ratio may indicate poor operational efficiency and idle resources.
5. Decision Making: It helps management, creditors, and investors in making informed decisions
about the short-term financial strength of the business.

Question 18: Distinguish between Current Ratio and Quick Ratio (4 Marks)
Answer:

Basis Current Ratio Quick Ratio

Formula Current Assets ÷ Current Liabilities Quick Assets ÷ Current Liabilities

Includes all current assets (Inventory, Excludes Inventory, Prepaid Expenses, and
Components
Receivables, Cash, Prepaid, etc.) Advance Tax from current assets

Purpose Measures overall short-term liquidity Measures immediate liquidity

Ideal Ratio 2:1 1:1

Stringency Less stringent test of liquidity More stringent test of liquidity

Time Frame Assesses ability to pay within operating cycle Assesses ability to pay immediately

Alternative
Working Capital Ratio Acid Test Ratio / Liquid Ratio
Name

Conclusion: Both ratios are important for assessing liquidity, but Quick Ratio provides a more
conservative measure by considering only highly liquid assets.
Question 19: Objectives of Accounting Ratios (4 Marks)

Answer:

The main objectives of computing accounting ratios are:

1. Assessment of Financial Position: To evaluate the overall financial health and position of the
business at a particular point in time.

2. Measurement of Profitability: To assess the earning capacity and profitability of the business by
calculating various profitability ratios.
3. Evaluation of Operational Efficiency: To measure how efficiently the business is utilizing its
resources through activity/turnover ratios.

4. Assessment of Liquidity: To determine the ability of the business to meet its short-term
obligations through liquidity ratios.
5. Assessment of Solvency: To evaluate the long-term financial stability and ability to meet long-
term obligations through solvency ratios.
6. Inter-firm Comparison: To compare the performance of one firm with another firm in the same
industry.

7. Intra-firm Comparison: To compare the performance of the same firm over different time periods
to identify trends.
8. Forecasting and Planning: To help management in future planning, budgeting, and forecasting
based on ratio analysis.
9. Identification of Weaknesses: To identify problem areas and weaknesses in the business
operations so that corrective actions can be taken.
10. Decision Making: To facilitate informed decision-making by management, investors, creditors,
and other stakeholders.

Question 20: What is meant by Liquidity of Business? (2 Marks)

Answer:

Liquidity of a business refers to the ability of the firm to meet its short-term financial obligations as and
when they become due. It indicates the ease with which current assets can be converted into cash to
pay off current liabilities.

A business with high liquidity has:

Sufficient current assets to cover current liabilities

Ability to convert assets into cash quickly

Better creditworthiness and financial stability

Lower risk of insolvency

Liquidity is measured through ratios like Current Ratio and Quick Ratio. Adequate liquidity is essential
for smooth business operations and maintaining creditor confidence.
Section 7: Practice Questions
Additional Numerical Problems for Practice

Problem 1

Question: Working Capital is ₹6,00,000; Total Debt is ₹27,00,000; Non-Current Liabilities are
₹24,00,000. Calculate Current Ratio.

Hint: First find Current Liabilities from Total Debt, then find Current Assets from Working Capital.

Problem 2
Question: Current Assets ₹10,00,000; Inventories ₹5,00,000; Working Capital ₹6,00,000. Calculate
Current Ratio and Quick Ratio.

Hint: Working Capital = Current Assets - Current Liabilities

Problem 3

Question: Trade Payables ₹50,000; Working Capital ₹9,00,000; Current Liabilities ₹3,00,000.
Calculate Current Ratio.

Hint: Use the relationship: Working Capital = Current Assets - Current Liabilities

Problem 4

Question: From the following information, calculate:

(i) Current Ratio
(ii) Acid Test Ratio
(iii) Operating Ratio
(iv) Gross Profit Ratio

Current Assets ₹35,000

Current Liabilities ₹17,500

Inventory ₹15,000

Operating Expenses ₹20,000

Revenue from Operations ₹60,000

Cost of Goods Sold ₹30,000
Problem 5

Question: Calculate Return on Investment:

Net Profit before Interest and Tax ₹2,50,000

Fixed Assets ₹12,00,000
Current Assets ₹4,00,000

Current Liabilities ₹2,70,000

Hint: Capital Employed = Fixed Assets + Current Assets - Current Liabilities

Section 8: Exam Tips and Strategy

Important Tips for Scoring Maximum Marks

1. Always Write the Formula First: Begin every numerical answer by writing the correct formula.
This ensures you get step marks even if the final answer is incorrect.
2. Show Step-by-Step Calculations: Present all calculations clearly. Avoid mental calculations and
write every step.
3. Identify Components Properly: Clearly list all items that constitute Current Assets, Current
Liabilities, Quick Assets, etc.
4. Use Proper Units: Always mention ₹ (Rupees) for amounts and specify the form of ratio (times,
percentage, or pure ratio).

5. Present Final Answer Clearly: Underline or highlight the final answer so the examiner can easily
identify it.
6. Remember Ideal Ratios: Current Ratio 2:1, Quick Ratio 1:1 are frequently tested.
7. Practice Effect on Ratios: Questions asking how transactions affect ratios are very common.
Practice these thoroughly.

8. Memorize All Formulas: Create formula cards and revise them daily.
9. Time Management: Allocate time based on marks - approximately 1 minute per mark.

10. Verify Your Answers: If time permits, cross-check calculations and ensure components are
correctly classified.

Common Mistakes to Avoid

1. Not deducting Provision for Doubtful Debts from Trade Receivables

2. Including Loose Tools, Stores and Spares in Inventories

3. Confusing Bank Overdraft (Current Liability) with Bank Balance (Current Asset)

4. Including Prepaid Expenses in Quick Assets

5. Forgetting to add Interest when calculating Net Profit before Interest and Tax
6. Using Opening or Closing values instead of Average values for turnover ratios

7. Not expressing ratios in the correct form (times, percentage, or pure ratio)
Section 9: Quick Revision Checklist
Formulas You Must Remember
✓ Current Ratio = Current Assets ÷ Current Liabilities (Ideal: 2:1)

✓ Quick Ratio = Quick Assets ÷ Current Liabilities (Ideal: 1:1)

✓ Quick Assets = CA - Inventory - Prepaid Expenses - Advance Tax

✓ Debt-Equity Ratio = Long-term Debts ÷ Shareholders' Funds

✓ Total Assets to Debt Ratio = Total Assets ÷ Long-term Debts

✓ Interest Coverage Ratio = NPBIT ÷ Interest on Long-term Debts (in times)

✓ Inventory Turnover Ratio = Cost of Revenue from Operations ÷ Average Inventory (in times)

✓ Trade Receivables Turnover = Net Credit Sales ÷ Average Trade Receivables (in times)

✓ Trade Payables Turnover = Net Credit Purchases ÷ Average Trade Payables (in times)

✓ Gross Profit Ratio = (Gross Profit ÷ Revenue from Operations) × 100 (in %)

✓ Operating Ratio = ((Cost + Operating Expenses) ÷ Revenue from Operations) × 100 (in %)

✓ Net Profit Ratio = (Net Profit ÷ Revenue from Operations) × 100 (in %)

✓ ROI = (NPBIT ÷ Capital Employed) × 100 (in %)

✓ Working Capital = Current Assets - Current Liabilities

✓ Capital Employed = Fixed Assets + Working Capital OR Shareholders' Funds + Long-term Debts

Key Points Checklist

✓ Liquidity Ratios → Pure Ratio form (x:1)

✓ Solvency Ratios → Pure Ratio form (x:1)

✓ Activity Ratios → Times

✓ Profitability Ratios → Percentage (%)

✓ Provision for Doubtful Debts → Deduct from Trade Receivables

✓ Loose Tools → Not included in Inventories

✓ Bank Overdraft → Current Liability

✓ Prepaid Expenses → Current Asset but NOT Quick Asset

✓ Advance Tax → Current Asset but NOT Quick Asset

✓ When CA and CL increase by same amount → Ratio remains same if equal to 1

✓ When CA and CL decrease by same amount and ratio > 1 → Ratio improves

✓ Operating Ratio + Operating Profit Ratio = 100%

Conclusion
This comprehensive guide covers all essential aspects of the Accounting Ratios chapter for CBSE
Class 12 Accountancy. Regular practice of the questions provided, thorough understanding of
formulas, and careful attention to the key points will help you score excellent marks in your board
examination.

Key Takeaways:

Master all formulas and their applications

Practice past year questions thoroughly

Understand the concept behind each ratio
Focus on effect of transactions on ratios

Show complete working in examination

Remember: Accounting Ratios is a scoring chapter if you practice regularly and understand the
underlying concepts. All the best for your examinations!

Prepared for: CBSE Class 12 Students (2025-26 Session)

Based on: CBSE Syllabus, Past Year Papers (2017-2023), and Important Questions from various
sources

Note: This document is prepared for educational purposes to help students prepare for their board
examinations. Students are advised to also refer to their NCERT textbook and practice additional
questions from reference books.