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Ratio Analysis

In Practice a number of techniques are used for the analysis of financial statements, such as, common-size financial statements, percentage increases or decreases f various items, trend analysis and so on. But the most popular and widely used technique is the ratio analysis which highlights the relationship between different figures in the same financial statement, that is, balance sheet or income statement or relationship of gigues in both the financial statements. Ratio is numerical relationship between one item and another. Ratios are expressed in various forms stated below:

(a)    Pure ratio: It is the simple division of one item by another, e.g., Ratio of Current Assets to Current liabilities and is shown as : Current Assets/Current Liabilities = 4,000 /2, 000, i.e., Current assets to Current liabilities ratio is 2 to 1.

(b)    Rate: The ratio between tow numerical facts, e.g., stocks turnover is 6 times a year or current assets are tow times that current liabilities.

(c)    Percentage: It is a special type of rate which expresses the relation in hundredth, e.g., the return on equity capital is 15% or gross margin on sales is 40 per cent of net sales.

In short, a particular ratio may be expressed as a common fraction, decimally or in percentage form. Thus, if the total revenues of an accounting period amount to 1,00,000 rupees and the total of operating expenses, non-operating expenses and taxes, are 80,000 rupees, the ratio of expenses to revenues may be expressed as given below:

80,000 / 1,00,000 = 8 : 10

(i) The expenses are 8/10 of the revenues, (ii) the expenses are 80 per cent of total revenues, (iii) the ratio of expenses to revenues is 8 : 10 or 4 : 5, (iv) there are expenses fo 8 for earning revenuer of 10

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