## Ratio Analysis — Introduction & Key Concepts

### Why ratio analysis?

Financial analysis, planning and decision-making rest on financial statements — mainly the Balance Sheet and the Profit & Loss Account.
The P&L A/c shows operating activities over a period of time; the Balance Sheet shows the financial position at a point in time.
These statements alone do not disclose all relevant information. To assess an enterprise's financial strengths and weaknesses, the data must be analysed.
Ratio Analysis is one of the main analytical tools. A ratio is a mathematical expression of the relationship between two accounting figures.

### Key formats to memorise

A. Trading Account

```

Sales / Revenue XXX

(-) COGS (XXX)

Gross Profit XXX

```

> COGS = Opening Stock + Purchases − Closing Stock + Direct Expenses

B. Profit & Loss Account

```

Gross Profit XXX

Less: Operating Expenses (Salary/Rent/AOH/POH/SOH)(XXX)

Less: Non-Operating Expenses (e.g. Interest) (XXX)

Add: Non-Operating Income (e.g. Rent/Interest Recd)XXX

Net Profit before Tax XXX

Less: Tax (XXX)

Profit after Tax (PAT) XXX

Less: Preference Dividend (XXX)

Earnings for Equity Shareholders XXX

Less: Equity Dividend (XXX)

Retained Earnings XXX

```

C. Balance Sheet — Liabilities side (build-up)

```

Equity Share Capital XXX

Reserves & Surplus XXX

Less: Accumulated Losses (XXX)

Less: Miscellaneous Expenses (XXX)

(a) Equity Shareholders' Funds XXX

(b) Preference Share Capital XXX

(d) Debentures / Bonds / Long-Term Loans XXX

(e) Current Liabilities XXX

Total Liabilities XXX

```

> Total Debt = (d) + (e)  |  Total Capital Employed = (c) + (d)

Balance Sheet — Assets side

```

Net Fixed Assets (Tangible + Intangible) XXX

Add: Investments XXX

(a) Fixed / Non-Current Assets XXX

(b) Current Assets XXX

Total Assets (a + b) XXX

```

> Net Fixed Assets = Fixed Assets − Accumulated Depreciation

### Types of Ratios

1. Liquidity / Short-term Solvency Ratios

2. Leverage / Long-term Solvency Ratios — split into Capital Structure ratios and Coverage ratios

3. Activity / Efficiency / Turnover Ratios — related to sales

4. Profitability Ratios — related to overall Return on Investment (Assets / Capital Employed / Equity), owner's point of view, and the market

Worked example

### Example 1

Computing COGS for the Trading A/c: If Opening Stock = ₹20,000, Purchases = ₹1,00,000, Direct Expenses = ₹5,000, Closing Stock = ₹15,000, then COGS = 20,000 + 1,00,000 + 5,000 − 15,000 = ₹1,10,000.

### Example 2

Capital Employed vs Total Debt: Given Net Worth (c) = ₹6,00,000, Long-term Loans (d) = ₹2,00,000, Current Liabilities (e) = ₹1,00,000 → Total Capital Employed = (c)+(d) = ₹8,00,000; Total Debt = (d)+(e) = ₹3,00,000.

⚠️ Common exam mistakes

Forgetting to subtract closing stock (and add direct expenses) when computing COGS.
Including Current Liabilities in Capital Employed — Total Capital Employed = Net Worth + Long-term Debt only; Current Liabilities sit inside Total Debt.
Reporting Fixed Assets gross instead of Net of accumulated depreciation.

Reference:

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Introduction & Key Terms (Trading A/c, P&L A/c, Balance Sheet)

Worked example

⚠️ Common exam mistakes