Answer No (1)

INTRODUCTION
a) Liquidity Ratio:-
A company’s liquidity is its ability to meet its short-term financial obligations. This is
done by comparing a company's most liquid assets, those that can be easily converted
to cash, with its short-term liabilities.

Liquidity is not only a measure of how much cash a business has. It is also a measure
of how easy it will be for the company to raise enough cash or convert assets into cash .

b) Solvency Ratio:-
Solvency ratios measure the ability of a company to pay its long-term debt and the
interest on that debt. It is important since the investors would like to know about the
solvency of the firm to meet their interest payments and to ensure that their investments are
safe.

Solvency ratios, as a part of financial ratio analysis, which help the business owner
determine the chances of the firm's long-term survival. Better solvency ratios indicate a
more creditworthy and financially sound company in the long-term.

CONCEPTS & APPLICATION

Investor will look at the current ratio, quick ratios, as key measurements of
a company’s short term liquidity.

a) Current Ratio:-
The first step in liquidity analysis is to calculate the company's current ratio. The current
ratio shows how many times over the firm can pay its current debt obligations based on
its assets. "Current" usually means a short time period of less than twelve months.

This ratio measures the financial strength of the company. Generally 2:1 is treated as
the ideal ratio, but it depends on industry to industry .
Formula  
Current Ratio=Current Assets/ Current Liability
Where,
A. Current Assets = Stock, Debtor, Cash and bank, receivables, loan and advances,
and other current assets.
B. Current Liability = Creditor, Short-term loan, bank overdraft, outstanding expenses,
and other current liability.
Example
Star Ltd. which in deal in variety of home appliances. Finance Dept. of company is
applying for loans to set up new factory. Star Ltd. bank asks for his balance sheet so
they can analysis his current debt levels. According to Star Ltd. balance sheet he
reported Rs1,00,000 of current liabilities and only Rs.25,000 of current assets.

Current ratio would be calculated like this:

Formula:-

Current Ratio=Current Assets/ Current Liability

25,000
Current Ratio=
1,00,000

=0.25

As you can see, Star Ltd. only has enough current assets to pay off 25 percent of his
current liabilities. This shows that Star Ltd. is highly leveraged and highly risky. Banks
would prefer a current ratio of at least 1 or 2, so that all the current liabilities would be
covered by the current assets. Since current ratio is so low, it is unlikely that he will get
approved for his loan.

b) Quick Ratio:-
The quick ratio or acid test ratio is a liquidity ratio that measures the ability of a
company to pay its current liabilities when they come due with only quick assets. Quick
assets are current assets that can be converted to cash within 90 days or in the short-
term. Cash, cash equivalents, short-term investments or marketable securities, and
current accounts receivable are considered quick asset. Generally 1:1 is treated as an
ideal ratio

Formula:-
Quick Ratio = Current Assets-Inventory-Prepaid Expenses/Current
Liabilities

Example
Let’s assume Benjon’s Clothing Store is applying for a loan to remodel the storefront.
The bank asks the owner for a detailed balance sheet, so it can compute the quick ratio.
Balance sheet included the following accounts:

 Inventory: Rs 5,000
 Prepaid taxes: Rs 500
 Total Current Assets: Rs 21,500
 Current Liabilities: Rs 15,000

Quick ratio would be calculated like this:

Formula:-

Quick Ratio = Current Assets-Inventory-Prepaid Expenses/Current

Liabilities
21,500−5,000−500
Quick Ratio= 15,000

=1.07

As you can see quick ratio is 1.07. This means that Benjon’s clothing store can pay off
current liabilities with quick assets and still have some quick assets left over .

Investor will look at the debt-equity ratio and proprietary ratio, as key
measurements of a company’s long term solvency.

a) Debt to Equity Ratio:-

The debt to equity ratio measures the relationship between long-term debt of a firm and its
total equity. It is a measure of the degree to which a company is financing its operations
through debt versus wholly owned funds. More specifically, it reflects the ability of
shareholder equity to cover all outstanding debts in the event of a business downturn.
The maximum a company should maintain is the ratio of 2:1, i.e. twice the amount of debt
to equity.

Formula:- Debt to Equity Ratio = Long-Term Debt/Shareholders Funds

Long Term Debt = Debentures + Long Term Loans

Shareholders Funds = Equity Share Capital + Preference Share Capital +

Reserves – Fictitious Assets

Example

Assume a company has Rs 1,00,000 of bank lines of credit and Rs 5,00,000 mortgage
on its property. The shareholders of the company have invested Rs12,00,000

Debt-Equity ratio would be calculated like this:

Formula:-

Debt to Equity Ratio = Long-Term Debt/Shareholders Funds

1,00,000+ 5,00,000
= 12,00,000

= 0.5 times or 50%

A debt-equity ratio of .5 means that there are half as many liabilities than
there is equity. In other words, the assets of the company are funded 2-to-1
by investors to creditors.

b) Proprietary Ratio:-
It expresses the relationship between the proprietor’s funds, i.e. the funds of all the
shareholders and total assets. The proprietary ratio highlights two important financial
concepts of a solvent and sustainable business. The first component shows how much
of the total company assets are owned outright by the investors.

The second component inversely shows how leveraged the company is with debt. The
equity ratio measures how much of a firm’s assets were financed by investors .

Formula:-

Proprietary Ratio = Shareholders’ Funds/Total Assetsx100

Example:-

Suppose, a firm has total assets worth Rs 40,00,000 and proprietary funds worth Rs
30,00,000.

Proprietary ratio of the firm would be calculated like this:

Formula:-

Proprietary Ratio = Shareholders’ Funds/Total Assetsx100

30,00,000
= 40,00,000

=0.75 times or 75%

This implies that 25% of the firm’s funds are financed by outside creditors.

CONCLUSION
What Does the Liquidity Ratio Tell Investor?
In general, the greater the level of coverage of liquid assets to short-term liabilities the
better. A company with a low coverage rate should raise a red flag for investors as it
may be a sign that the company will have difficulty meeting its short-term financial
obligations, and consequently in running its day-to-day operations.

During hard times for the business or the economy, a company with insufficient liquidity
might be forced to make tough choices to meet their obligations. These could include
liquidating productive assets, selling inventory or even a business unit. These moves
could prove detrimental to both the company’s short-term viability and their long-term
financial health.

What Does the Solvency Ratio Tell Investor?

 The solvency ratio is a comprehensive measure of solvency, as it measures a firm's
actual cash flow rather than net income by adding back depreciation and other non-
cash expenses to assess the company’s capacity to stay afloat. It measures this cash
flow capacity in relation to all liabilities, rather than only short-term debt. This way, the
solvency ratio assesses a company's long-term health by evaluating its repayment
ability for its long-term debt and the interest on that debt.

As a general rule of thumb, a solvency ratio higher than 20% is considered to be

financially sound; however, solvency ratios vary from industry to industry. A company’s
solvency ratio should, therefore, be compared with its competitors in the same industry
rather than viewed in isolation.

Answer No (2)

INTRODUCTION
Non Operating Income (Other Income):- Non-operating income is
any profit or loss generated by activities outside of the core operating activities of a
business. Non-operating income is more likely to be a one-time event, such as a
loss/gain on asset impairment. However, some types of income, such as dividend
income, are of a recurring nature, and yet are still considered to be part of non-
operating. When a company experiences a sudden spike or decline in its income,
this is likely to have been caused by non-operating income, since core earnings tend
to be relatively stable over time. Non-operating income is itemized at the bottom of
the income statement, after the operating profit line item.

The following are all components of other income:-

 Dividend Income
 Interest Income
 Net gain/losses on sale of assets.
 Commission
 Gains and Losses On Foreign Exchange Transactions

CONCEPTS & APPLICATION

Components of Other Income:-
a)Gain on sale of assets:-
This is a non-operating or "other" item resulting from the sale of an asset (other than
inventory) for more than the amount shown in the company's accounting records. The
gain is the difference between the proceeds from the sale and the carrying amount
shown on the company's books.

b)Interest Income:-
Interest Income is the amount which is allocated as interest received by the company
investments. It actually is the revenue earned from the lending money. It is the term
which is used by the companies on their income statement to report the interest earned
on the cash held in the savings account, certificates of deposits or other investments.If
the core income does not come from interest then it is non-operating interest income
and comes under other income.

C)Gains and Losses On Foreign

Exchange Transactions:-
Exchange differences which arise on reporting the enterprise’s monetary items at the
rates different from the ones at which they’re recorded initially must be recognized as
the income or as an expense under head other income in Statement of Profit and Loss
Accounts.

d) Commission Income:-
Commission Income earned by companies by making sales or closing deals for third
parties is treated as non operating income and is shown under head other income in
Statement of Profit and Loss Accounts .Companies can earn Commission income by
acting as real estate brokers, stock brokers, insurance agencies, travel agencies, and
the like.

e) Dividend Income:-

Dividend income earned by companies by investing in shares of other domestic as well

as foreign companies is treated as non operating income and is shown under head
other income in Statement of Profit and Loss Accounts.
Difference Between Revenue From Operations and
Other Income
Revenue from operations refers to operating income resulting from a company’s core
business, as well as other activities that are a logical extension of the core business.
This would include things such as revenue from sales of goods and srevices, costs of
goods needed to produce products for sale, and items that are a regular part of the
business and usually have a recurring nature.

Whereas ,Other Income includes revenue and costs that are outside the normal course
of a company’s core business. Say, for example, a manufacturing company made a
one-time sale of property and realized a capital gain. This would produce non operating
income, Similarly Dividend Income received by way of investment in other companies
will be regarded as other income ,while an annual contribution to retiring employees
would be a recurring operating income item, even if the amount varied year-to-year.

CONCLUSION
Other Income gives an estimate of the proportion of income due to non operating
activities. It allows bifurcating the secondary income and expenses from the mainstream
income from the company’s core operations. It allows the stakeholders to compare the
pure operating performance of the company and also draw a comparison across the
peers.

From the entity’s point of view, reporting of other shows that the entity has nothing to
hide. It establishes a transparent image of the entity and all the stakeholders including
employees and investors, feel more comfortable in taking the risk along with the entity’s
growth plans.

It also help the stakeholder in assessing more realistic figures instead of forgetting them
and making plans based on fictitious numbers.

Answer No (3)

INTRODUCTION
3(a) Cost of Goods Available for Sale:- The cost of goods available
for sale is the cost of the inventory that you have on hand. You haven’t sold this
inventory to your customers yet. You simply have it in your stock and you could
potentially sell it to them. It is different from the cost of goods sold which looks at what
you have already sold to your customers.

When calculating the cost of goods available for sale, the process that you undertake is
pretty simple you take the inventory you had at the beginning of the accounting cycle
and add to it the purchases you made in the course of the year or accounting cycle.
That is what you have available for sale by the end of the accounting cycle.

APPLICATION
The cost of goods available for sale equation is calculated by adding the
net purchases for the year to the opening inventory .

Information Given:-

Opening stock as on 1 April ,2019 750 chips @Rs 1550 per chip.

Purchases:-1) April 10,2019 1000 chips @1750 per chip.

2)April 20, 2019 1650 chips @1875 per chip.

Formula:-

Cost of Goods Available for Sale = Opening Inventory + Purchases

=750×1550 +(1000×1750+1650×1875)

Cost of Goods Available for Sale =6,006,250

CONCLUSION
This calculation measures the amount of inventory that a dealer in computer chips has
on hand at any point during the year. Managers can use this equation to see the
amount of inventory that is in stock and able to be sold to customers.

Although management often uses this formula, it doesn’t typically reflect the true
amount of inventory that customers can purchase. Over time inventory become
obsolete, damaged, or even stolen. This equation doesn’t take these factors into
account. The only way to truly know the actual amount of inventory available is to do an
inventory count, but a properly maintained inventory system can keep track of damaged
and obsolete goods fairly accurately with reserve accounts .

INTRODUCTION
3(b) Gross Profit:-
Gross profit is the profit a business makes after covering the expenses required to make
their products or provide their services.

Gross profit is presented on a multiple-step income statement prior to deducting sellling,

general and administrative expenses and prior to nonoperating revenues, nonoperating
expenses, gains and losses.

APPLICATION
Gross Profit is calculated by subtracting the net sales for the year from
cost of goods sold.
Information Given:-

Opening stock as on 1 April ,2019 750 chips @Rs 1550 per chip.

Purchases:-1) April 10,2019 1000 chips @Rs1750 per chip.

2) April 20, 2019 1650 chips @Rs1875 per chip.

Sales:- 1) April 15,2019 900 chips @Rs3000 per chip.

2) April 16, 2019 1950 chips @Rs3250 per chip.

Formula:-

Gross Profit = Sales – Cost of Goods Sold (COGS)

COGS=Opening Stock+Purchase-Closing Stock.

=750×1550 +(1000×1750+1650×1875)

=6,006,250.

Since no closing stock is given , therefore Cost of Goods Available and

Cost of Goods Sold are same.

Gross Profit = Sales – Cost of Goods Sold (COGS)

=(900 ×3000+ 1950×3250)- 6006250

Gross Profit = 3,031,250.

CONCLUSION
Gross Profit is one of the many available basic accounting tools for small business. You
can use this figure to check how efficiently you produce revenue. The greater your
revenue and the lower your production costs are, the higher your gross profit is.

You can make positive changes to your business based on your gross profit. If you
notice production costs are close to or above your revenue, make adjustments. You
could decrease COGS by finding less expensive ways to produce goods or perform
services. Or, you could increase revenue by expanding your marketing efforts.