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frequent stock outs and thus the firm may incur high stock out costs.

the other hand, a too lowratio may be the result of excessive inventory levels,
slow moving or obsolete inventory and thus, thefirm may incur high carrying
costs. Thus, a firm should have neither very high ratio nor low ratio.(Stock out
means customer going out of shop due to unavailability of stock.)
Debtors Turnover Ratio (in times)
Debtors Ratio
Debt Velocity Ratio (in days) =
week/52365/360/12Sales CreditB/RDebtors(Avg)

Objective:The objective is to determine the efficiency with which the trade debtors are

High Debtors T/O ratio =shorter debtors ratio = quick recovery of money.Low
debtors T/O ratio = higher debtor ratio = delay in recovery of money.It shows
the efficiency of collection policy of the firm. It is always a goods idea to
collect quickly,money from debtors as uncertainty of collection increases with
credit policy being liberal. However afirm should under take cost benefit
study of liberal credit policy, if benefit is more than cost than itshould
increase credit period.


In profit due to

In sales

In bad debt

In collection expenses

In Interest cost on money blocked with debtor

Tutorial Notes:
(i)The Provision for doubtful debts is not deducted from the total amount of
trade debtorssince here, the purpose is to calculate the number of days for
which sales are tied up indebtors and not to ascertain the realizable value of
debtors.(ii)If the figure of Average Debtors cannot be ascertained due to the
absence of the figure of opening Debtors, the figure of closing Debtors may
be applied by giving a suitable note tothat effect.(iii)If the figure of Net Credit
Sales is not ascertainable, the figure of total sales given may beused
assuming that all sales are credit sales.
Objective: The objective is to determine the efficiency with which the creditors are

High creditor T/O ratio = low creditor ratio = quick payment to creditor Low
creditor T/O ratio = high creditor ratio = delayed payment to creditor It shows
the market standing of the firm. A new firm may have less creditors ratio, as
their marketstanding will be less. An established firm will have greater market
standing hence it is in position to pay their creditor later. However a firm

should study advantage of paying early and availing of cashdiscount.

Total Assets Turnover Ratio (in times)
Assets TotalSales Net

How efficiently assets are employed in business.

This ratio suggests how a rupee of asset contributes to earn sales more the
ratio more efficiently assetsare used in gainful operation.

Simplifies financial statements:
Ratio Analysis simplifies the comprehension of financial statements. Ratios
tell the wholestory of changes in the financial condition of the business. It
gives reader full idea about overallsituations of the firm without going deep in
to the financial statement.2.
Facilitates inter firm comparison:
Ratio Analysis provides data for inter firm comparison. Ratios highlight the
factors associatedwith successful and unsuccessful firms. They also reveal
strong firms and weak firms, over valued and undervalued firms.3.
Makes intra firm comparison possible:
Ratio Analysis also makes possible comparison of the performance of the
different divisions of the firm. The ratios are helpful in deciding about their

efficiency or otherwise in the past andlikely performance in the future.4.

Helps in planning:
Ratio analysis helps in planning and forecasting. Over a period of time a firm
or industrydevelops certain norms that may indicate future success or failure.
If relationship changes infirms data over different time periods, the ratios
may provide clues on trends and future problems.
6. Helps in decision making :
Some times ratio may indicate better guideline for decision making.
: good trend of profitability and dividend payout ratio helps investor to buy
shares.Lower debt service coverage ratio & int coverage ratio prevent bank
from financing tocompany.

:1.Comparative study required:
Ratios are useful in judging the efficiency of the business only when they are
compared withthe past results of the business or with the results of a similar
business. However, such acomparison only provides a glimpse of the past
performance, and forecasts for future may not be correct since several other
factors like market conditions, management policies, competition,local factors
etc., may affect the future operations.
2.Ratios alone are not adequate:
Ratios are only indicators; they cannot be taken as final judgment regarding
good or badfinancial position of the business. Other things have also to be
seen. For example, a highcurrent ratio does not necessarily mean that the
concern has a good liquid position in casecurrent assets mostly comprise of
outdated stocks.
3.Window dressing:
The term window dressing means manipulation of accounts in a way so as to
conceal vital factsand present the financial statements in a way to show a
better position than what it actually is,On account of such a situation,
presence of a particular ratio may not be a definite indicator of good or bad
management. For example, a high stock turnover ratio is generally

considered to be an indication of operational efficiency of the business. But

this might have been achieved byunwarranted price reductions of closing
stock or failure to maintain proper stock of goods.
4.Problems of price level changes:
Financial analysis based on accounting ratios will give misleading results if
the effects of changes in price level are not taken into account. For example,
two companies set up indifferent years, having plant and machinery of
different ages, cannot be compared, on the basisof traditional accounting
statements. This is because the depreciation charged on plant andmachinery
in case of old company would be at a much lower figure as compared to
thecompany which has been se up recently.
5.No fixed standards:
No fixed standards can be laid down for ideal ratios. For example, current
ratio is generallyconsidered to be ideal if current assets are twice the current
liabilities. However, in case of those concerns which have adequate
arrangements with their banks for providing funds when
they require, it may be perfectly ideal if current assets are equal to slightly
more than currentliabilities.It is therefore necessary to avoid many rules of
thumb. Financial analysis is an individualmatter and value for a ratio which is
perfectly acceptable for one company or one industry maynot be at all
acceptable in case of another.
6.6.Inaccurate base:
The accounting ratios can never be more correct than the information from
which they arecomputed. If the accounting data is not accurate, the
accounting ratios based on these figureswould give misleading results.
7.Investigation necessary:
It must be remembered that accounting ratios are only a preliminary step in
investigation. Theysuggest areas were investigation or inquiry is necessary. It
can never be used as conclusion.
8.Rigidity harmful:
If in the use of ratios, the manager remains rigid and sticks to them, it will
lead to dangeroussituation. For example, if the manager believes the current
ratio should not fall below 2: 1, thenmany profitable opportunities will have to
be foregone

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