Page 57 - MA12

4.2 Management Accounting (Section B)—ISC XII

11. Profitability Ratios
These ratios show the profitability of the enterprise. These include: Gross Profit Ratio; Net Profit
Ratio; Operating Ratio; Operating Profit Ratio, Earning Per Share (EPS), Price Earning (P/E)
Ratio and Return on Investment (ROI).

SUMMARY OF THE CHAPTER

• Accounting Ratio is a mathematical expression of the relationship between two items or group of items
shown in the financial statements. In simple words, when ratios are calculated on the basis of accounting
information these are called accounting ratios.
• Ratio Analysis is the process of computing, determining and presenting the relationship of items and
group of items in the financial statements. It is an important tool or technique of financial analysis.

• Ratio may be expressed as (i) Pure ratio; (ii) Percentage; (iii) Number of Times; or (iv) Fraction.
• Objectives of Ratio Analysis
(i) To simplify the accounting information.
(ii) To analyse the Financial Statements.
(iii) To judge the operating efficiency of business.
(iv) To help in forecasting, planning and control.
(v) To help in comparative analysis.
(vi) To find out strengths and weaknesses of the business.
• Limitations of Ratio Analysis
(i) Ratios may be misleading if they are based on incorrect accounting information.
(ii) Variance in accounting practices.
(iii) Ignores price level changes.
(iv) Only quantitative analysis and not qualitative analysis.
(v) Based on historical data. Hence, it is historical analysis.
(vi) Only symptom and not cure.
(vii) No single standard ratio.
(viii) In the absence of absolute data, ratios may be misleading.
(ix) Not free from bias.
(x) Window dressing.

• Classification of Accounting Ratios
Liquidity Ratios Solvency Ratios Activity Ratios Profitability Ratios
1. Current Ratio 1. Debt to Equity Ratio 1. Trade Receivables 1. Gross Profit Ratio
2. Quick/Liquid Ratio 2. Proprietary Ratio Turnover Ratio 2. Net Profit Ratio
3. Debt to Total Assets 2. Trade Payables 3. Operating Ratio
Ratio Turnover Ratio 4. Operating Profit
4. Interest Coverage 3. Working Capital Ratio
Ratio Turnover Ratio 5. Earning Per Share (EPS)
4. Inventory 6. Price Earning (P/E) Ratio
Turnover Ratio 7. Return on Investment (ROI)