This page is for Class 12 Accountancy students who want the official NCERT Chapter 5, “Accounting Ratios” — the complete accounting ratios class 12 chapter from the Accountancy Part II textbook (Company Accounts and Analysis of Financial Statements).
It runs from printed page 193 to page 240 and explains the meaning, objectives, advantages and limitations of ratio analysis, the types of ratios, and the four ratio families — liquidity, solvency, activity and profitability — each developed through worked illustrations. The official Accounting Ratios Class 12 PDF sits right below.
Download the Accounting Ratios Class 12 PDF
The Accounting Ratios Class 12 PDF below is the official NCERT file for this chapter — the same edition the board references — so you can read the chapter, its worked illustrations and its exercises exactly as printed. It is the NCERT Reprint 2026-27 edition, hosted on the official NCERT website.
| What the chapter holds | Count | Where it is used |
|---|---|---|
| Printed pages | 47 | |
| Sections in the chapter | 28 | |
| Tables | 55 | |
| Worked examples | 26 | solved step by step in our NCERT Solutions |
| Official NCERT PDF | Download the chapter PDF | the chapter exactly as NCERT publishes it |
Chapter at a Glance
The table on this page lists how much the chapter holds — its sections, worked illustrations, tables and equations — drawn from the chapter itself. The description below focuses on the order in which the chapter builds its ideas.
The chapter opens with the meaning of accounting ratios and the objectives of ratio analysis, then works through the advantages and limitations of ratios before classifying them into types.
Four teaching blocks follow, one per ratio family, and the chapter closes with a list of terms introduced, a Summary, three Test Your Understanding quizzes, two Do it Yourself sets, and short-answer, long-answer and numerical question sets with answers printed at the end.
What This Chapter Covers
Chapter 4 of this book introduced financial statement analysis as a whole — comparative statements, common-size statements and trend analysis through graphs and charts. This chapter takes the next step: it turns individual accounting numbers into ratios that measure solvency, efficiency and profitability. Use the table below as a map and jump straight to the block you need.
| Chapter block | Printed pages | What it teaches | Ratios inside the block |
|---|---|---|---|
| Meaning, objectives, advantages and limitations | pp. 193-198 | What ratios are, why they are used, what they cannot do | None — sets up the tool |
| Types of ratios | pp. 197-198 | Traditional vs functional classification | Liquidity, solvency, activity, profitability |
| Liquidity ratios | pp. 199-203 | Short-term paying ability | Current ratio, quick (liquid) ratio |
| Solvency ratios | pp. 203-212 | Long-term debt safety | Debt-equity, debt to capital employed, proprietary, total assets to debt, interest coverage |
| Activity (turnover) ratios | pp. 212-222 | Speed of operations | Inventory turnover, trade receivables turnover, average collection period, trade payables turnover, average payment period, net assets / fixed assets / working capital turnover |
| Profitability ratios | pp. 222-231 | Profit against revenue or the funds used to earn it | Gross profit, operating, operating profit, net profit, ROI/ROCE, RONW, EPS, book value, dividend payout, P/E |
| Closing material | pp. 232-240 | Terms, summary, quizzes, exercises | None — revision aids |
Liquidity Ratios: Current Ratio and Quick Ratio
Liquidity ratios ask the simplest question in business: can the firm pay what it owes in the near term? Both ratios compare current assets against current liabilities, and both are short-term in nature.
Current ratio
The current ratio is the proportion of current assets to current liabilities (NCERT, p. 200):
\[ \text{Current Ratio} = \frac{\text{Current Assets}}{\text{Current Liabilities}} \]
Current assets include current investments, inventories, trade receivables (debtors and bills receivable), cash and cash equivalents, short-term loans and advances, and other current assets such as prepaid expenses, advance tax and accrued income. Current liabilities include short-term borrowings, trade payables (creditors and bills payable), other current liabilities and short-term provisions.
The excess of current assets over current liabilities is the safety margin against uncertainty in collecting current assets and in the flow of funds. NCERT notes that a very high ratio reflects heavy investment in current assets — under-utilisation of resources — while a low ratio endangers the firm’s ability to pay short-term debt on time.
Normally it is safe within the range of 2:1 (NCERT, p. 201).
Quick (liquid) ratio
The quick ratio, also called the acid-test ratio, is quick assets divided by current liabilities (NCERT, p. 201):
\[ \text{Quick Ratio} = \frac{\text{Quick Assets}}{\text{Current Liabilities}} \]
Quick assets = current assets − inventories − prepaid expenses − advance tax. Inventory and prepaid items are excluded because they are not quickly convertible into cash, which is why this ratio is a stricter, supplementary check on liquidity. NCERT advises a ratio of about 1:1 as safe — too low is risky, too high means funds parked in less profitable short-term investments.
Worked example (new numbers): From a balance sheet: inventories Rs.
80,000, trade receivables Rs.
70,000, cash and cash equivalents Rs.
30,000, prepaid insurance Rs.
6,000, current liabilities Rs.
1,00,000.
Step 1: Identify current assets = 80,000 + 70,000 + 30,000 + 6,000 = Rs.
1,86,000. All four items are current assets; the prepaid insurance is a prepaid expense.
\[ \text{Current Ratio} = \frac{1,86,000}{1,00,000} = 1.86 : 1 \]
Step 2: Compute quick assets by removing inventories and the prepaid expense: 1,86,000 − 80,000 − 6,000 = Rs.
1,00,000. There is no advance tax in this data.
\[ \text{Quick Ratio} = \frac{1,00,000}{1,00,000} = 1 : 1 \]
Final answer: Current ratio 1.86 : 1 (below the 2 : 1 benchmark), quick ratio 1 : 1 (meets the acid-test norm). The firm’s immediately liquid assets exactly cover its current liabilities even though the full current ratio is low — the gap is inventory and the prepaid amount.
Solvency Ratios: Debt Equity and Long Term Safety
Long-term lenders care about two things: the interest paid periodically and the principal repaid at the end. Solvency ratios therefore measure how much of the business is funded by debt, and how comfortably profits cover interest.
The five solvency ratios
The chapter presents five ratios in order. The first is the debt-equity ratio (NCERT, p. 205):
\[ \text{Debt-Equity Ratio} = \frac{\text{Long-term Debts}}{\text{Shareholders’ Funds}} \]
- Long-term debts = long-term borrowings + other long-term liabilities + long-term provisions. Current liabilities are never part of debt.
- Shareholders’ funds = share capital + reserves and surplus + money received against share warrants + share application money pending allotment. Alternatively, shareholders’ funds = non-current assets + working capital − non-current liabilities, where working capital = current assets − current liabilities.
NCERT considers a debt-equity ratio of about 2 : 1 safe, though it varies by industry. Less debt means more security for outsiders; from the owners’ side, greater debt (trading on equity) can raise returns when the earnings rate on capital employed exceeds the interest rate.
The next two ratios use capital employed — long-term debt plus shareholders’ funds, which equals net assets (total assets − current liabilities) (NCERT, p. 209):
- Debt to Capital Employed Ratio = long-term debt ÷ capital employed.
- Proprietary Ratio = shareholders’ funds ÷ capital employed (or total assets).
- Total Assets to Debt Ratio = total assets ÷ long-term debts — a higher figure means assets are mainly financed by owners and loans are well covered.
- Interest Coverage Ratio = net profit before interest and tax ÷ interest on long-term debts (NCERT, p. 212). A higher ratio means safer interest payments.
The book highlights a checkable relationship: debt to capital employed ratio + proprietary ratio = 1. Because every rupee of capital employed comes from either debt or owners, the two proportions must add up to one (NCERT, p. 209).
Worked example (new numbers): Share capital Rs.
16,00,000; reserves and surplus Rs.
5,00,000; money received against share warrants Rs.
3,00,000; long-term borrowings Rs.
6,00,000; other long-term liabilities Rs.
1,00,000; long-term provisions Rs.
1,00,000; current liabilities Rs.
4,00,000; non-current assets Rs.
28,00,000; current assets Rs.
8,00,000.
Step 1: Shareholders’ funds = 16,00,000 + 5,00,000 + 3,00,000 = Rs.
24,00,000.
Step 2: Long-term debts = 6,00,000 + 1,00,000 + 1,00,000 = Rs.
8,00,000. The current liabilities of Rs.
4,00,000 stay out of debt.
Step 3: Working capital = 8,00,000 − 4,00,000 = Rs.
4,00,000. Check the alternative equity: 28,00,000 + 4,00,000 − 8,00,000 = Rs.
24,00,000 — both routes agree.
\[ \text{Debt-Equity Ratio} = \frac{8,00,000}{24,00,000} = 0.33 : 1 \]
Step 4: Capital employed = 24,00,000 + 8,00,000 = Rs.
32,00,000 (also = 36,00,000 − 4,00,000).
\[ \text{Debt to Capital Employed} = \frac{8,00,000}{32,00,000} = 0.25 : 1, \quad \text{Proprietary Ratio} = \frac{24,00,000}{32,00,000} = 0.75 : 1 \]
Step 5: Verify the relationship: 0.25 + 0.75 = 1.
So 25% of capital employed comes from debt and 75% from owners’ funds.
Final answer: Debt-equity 0.33 : 1 (low debt, high security for lenders), debt to capital employed 0.25 : 1, proprietary ratio 0.75 : 1, and the two proportions sum to one.
When profit figures are given after tax, first backtrack to profit before interest and tax using the tax rate: net profit before tax = net profit after tax × 100 ÷ (100 − tax rate); then add back interest on long-term debt (the method NCERT uses in its interest coverage illustration).
Activity Ratios: Inventory, Receivables and Payables Turnover
Activity (turnover) ratios measure speed: how quickly inventory turns into revenue, how quickly debtors pay, and how quickly creditors are paid. Higher turnover generally means better use of assets, improved efficiency and better profitability.
Inventory turnover
The inventory turnover ratio (NCERT, p. 215):
\[ \text{Inventory Turnover Ratio} = \frac{\text{Cost of Revenue from Operations}}{\text{Average Inventory}} \]
Cost of revenue from operations = revenue from operations − gross profit. Average inventory is the arithmetic mean of opening and closing inventory. When only closing inventory is given, it is treated as average inventory — NCERT states this assumption in its own solved illustration.
Low turnover may mean bad buying or obsolete inventory; very high turnover needs careful reading, since it can come from buying in small lots or selling quickly at a low margin.
Trade receivables and trade payables turnover
The trade receivables turnover ratio uses credit revenue only (NCERT, p. 217):
\[ \text{Trade Receivables Turnover} = \frac{\text{Net Credit Revenue from Operations}}{\text{Average Trade Receivables}} \]
Take debtors before provision for doubtful debts. When opening figures are unavailable, the book uses year-end trade receivables as they are, without dividing by two. The average collection period = 365 ÷ trade receivables turnover. Similarly, trade payables turnover = net credit purchases ÷ average trade payables, and the average payment period = 365 ÷ trade payables turnover (NCERT, p. 219).
A low payables turnover means suppliers allow long credit, or the firm is delaying payment — which can hurt its reputation.
Worked example (new numbers): Revenue from operations Rs.
5,00,000; gross profit ratio 20%; opening inventory Rs.
70,000, closing inventory Rs.
90,000; opening trade receivables Rs.
75,000, closing trade receivables Rs.
1,25,000; opening creditors Rs.
90,000, closing creditors Rs.
1,10,000; credit revenue is 90% of total revenue; all purchases are on credit.
Step 1: Gross profit = 20% of 5,00,000 = Rs.
1,00,000, so cost of revenue = 5,00,000 − 1,00,000 = Rs.
4,00,000. Average inventory = (70,000 + 90,000) ÷ 2 = Rs.
80,000.
\[ \text{Inventory Turnover} = \frac{4,00,000}{80,000} = 5 \text{ times} \]
Step 2: Average trade receivables = (75,000 + 1,25,000) ÷ 2 = Rs.
1,00,000. Credit revenue = 90% of 5,00,000 = Rs.
4,50,000.
\[ \text{Trade Receivables Turnover} = \frac{4,50,000}{1,00,000} = 4.5 \text{ times}, \quad \text{Collection Period} = \frac{365}{4.5} \approx 81 \text{ days} \]
Step 3: Purchases = cost of revenue + closing inventory − opening inventory = 4,00,000 + 90,000 − 70,000 = Rs.
4,20,000. Average trade payables = (90,000 + 1,10,000) ÷ 2 = Rs.
1,00,000.
\[ \text{Trade Payables Turnover} = \frac{4,20,000}{1,00,000} = 4.2 \text{ times}, \quad \text{Payment Period} = \frac{365}{4.2} \approx 87 \text{ days} \]
Final answer: Inventory turns over 5 times; receivables are collected in about 81 days while suppliers are paid in about 87 days — the firm collects from customers slightly before it must pay creditors, a reasonably comfortable cash cycle.
The chapter also derives three broader efficiency ratios from these: net assets (capital employed) turnover = revenue ÷ capital employed, fixed assets turnover = net revenue ÷ net fixed assets, and working capital turnover = net revenue ÷ working capital. Higher values indicate efficient utilisation of the funds employed.
Profitability Ratios: From Gross Profit to Price Earning
Profitability ratios compare profit against revenue or against the funds used to earn it. The single most common error is using the wrong profit figure, because each ratio is built on a different profit concept.
The chapter presents ten ratios. Their working distinction matters more than their arithmetic:
- Gross profit ignores operating expenses — it is simply revenue minus cost of revenue (NCERT, p. 223).
- Operating profit excludes non-operating items — no interest paid, no loss on sale of assets, no dividend received (NCERT, pp. 224-225).
- Net profit is all-inclusive — profit after tax and after both operating and non-operating expenses and incomes (NCERT, p. 226).
- ROCE uses profit before interest and tax; RONW uses profit after tax (NCERT, pp. 226-227).
| Ratio | Formula | Profit concept used |
|---|---|---|
| Gross Profit Ratio | \( \dfrac{\text{Gross Profit}}{\text{Net Revenue}} \times 100 \) | Gross profit |
| Operating Ratio | \( \dfrac{\text{Cost of Revenue} + \text{Operating Expenses}}{\text{Net Revenue}} \times 100 \) | Operating cost |
| Operating Profit Ratio | \( 100 – \text{Operating Ratio} \) | Operating profit |
| Net Profit Ratio | \( \dfrac{\text{Net Profit}}{\text{Revenue}} \times 100 \) | Profit after tax (generally) |
| Return on Investment (ROCE) | \( \dfrac{\text{PBIT}}{\text{Capital Employed}} \times 100 \) | Profit before interest and tax |
| Return on Shareholders’ Funds (RONW) | \( \dfrac{\text{PAT}}{\text{Shareholders’ Funds}} \times 100 \) | Profit after tax |
| Earnings per Share | \( \dfrac{\text{Profit available for equity}}{\text{Number of equity shares}} \) | PAT − preference dividend (p. 227) |
| Book Value per Share | \( \dfrac{\text{Equity shareholders’ funds}}{\text{Number of equity shares}} \) | Shareholders’ funds − preference capital (p. 227) |
| Dividend Payout Ratio | \( \dfrac{\text{Dividend per share}}{\text{Earnings per share}} \) | Distribution of earnings (p. 227) |
| Price/Earning Ratio | \( \dfrac{\text{Market price per share}}{\text{EPS}} \) | EPS (p. 228) |
Worked example (new numbers): Revenue from operations Rs.
8,00,000; cost of revenue Rs.
5,60,000; selling expenses Rs.
1,20,000; administrative expenses Rs.
80,000; profit after tax Rs.
1,40,000; 10% preference share capital Rs.
2,00,000; equity share capital Rs.
5,00,000 in Rs.
10 shares; market price per share Rs.
36.
Step 1: Gross profit = 8,00,000 − 5,60,000 = Rs.
2,40,000.
\[ \text{Gross Profit Ratio} = \frac{2,40,000}{8,00,000} \times 100 = 30\% \]
Step 2: Operating cost = 5,60,000 + 1,20,000 + 80,000 = Rs.
7,60,000.
\[ \text{Operating Ratio} = \frac{7,60,000}{8,00,000} \times 100 = 95\%, \quad \text{Operating Profit Ratio} = 100 – 95 = 5\% \]
Step 3: Preference dividend = 10% of 2,00,000 = Rs.
20,000. Profit available for equity = 1,40,000 − 20,000 = Rs.
1,20,000. Number of equity shares = 5,00,000 ÷ 10 = 50,000.
\[ \text{EPS} = \frac{1,20,000}{50,000} = \text{Rs. } 2.40, \quad \text{P/E Ratio} = \frac{36}{2.40} = 15 \]
Final answer: Gross profit ratio 30%, operating ratio 95%, operating profit ratio 5%, EPS Rs. 2.40, P/E ratio 15. A 95% operating ratio means only 5% of revenue is left as operating profit before interest, tax and non-operating items.
How a Transaction Changes a Ratio
NCERT asks not just “calculate the ratio” but also “will this transaction improve, reduce or not change the ratio” — questions that test understanding, not arithmetic. The book’s method: assume convenient base figures, apply the transaction to both sides, recompute and compare. The table below gathers the conclusions from the chapter’s solved illustrations.
| Transaction | Ratio affected | Effect | Why (using the chapter’s base figures) |
|---|---|---|---|
| Payment of a current liability | Current ratio | Improves | Both sides fall, but the fall in liabilities is proportionately larger: 2 : 1 becomes 2.67 : 1 |
| Purchase of goods on credit | Current ratio | Reduces | Both sides rise; the ratio falls to 1.7 : 1 |
| Sale of a fixed asset at a loss | Current ratio | Improves | Cash (a current asset) rises by the sale proceeds; current liabilities unchanged |
| Sale of merchandise at a profit | Current ratio | Improves | Cash rises by the full sale price while inventory falls only by cost — net current assets rise |
| Payment of unclaimed dividend | Current ratio | Improves | Current assets and current liabilities fall by the same amount; the ratio rises |
| Further issue of equity shares | Debt-equity ratio | Reduces | Internal funds rise, external funds unchanged: 0.5 : 1 becomes 0.45 : 1 |
| Cash received from debtors | Debt-equity ratio | No change | Only the composition of current assets changes; debt and equity are untouched |
| Cash sale of goods | Debt-equity ratio | No change | Neither debt nor equity is affected |
| Redemption of debentures | Debt-equity ratio | Reduces | Long-term debt falls to Rs. 4,00,000 from Rs. 5,00,000: 0.5 : 1 becomes 0.4 : 1 |
| Purchase of goods on credit | Debt-equity ratio | No change | Affects current items only — not debt or equity |
The chapter’s caution applies to every row: the change depends on the original ratio. A transaction that improves a 2 : 1 current ratio could reduce a 1.5 : 1 ratio’s distance to the norm differently — always recompute from assumed figures instead of memorising outcomes.
How the Chapter Teaches: Balance Sheet Tables and Illustrations
This chapter contains no diagrams. There are no charts or graphs to interpret; instead, the chapter teaches through balance sheet tables, working tables, and a repeated question–solution–significance loop.
Every solved illustration follows the same pattern: the question gives figures, the solution shows the substitution, and the significance paragraph explains what the number means and what a healthy range looks like.
The balance sheet tables follow the standard format used throughout the book. On the Equity and Liabilities side you will always find three groups: Shareholders’ funds (share capital, reserves and surplus, money received against share warrants), Non-current liabilities (long-term borrowings, other long-term liabilities, long-term provisions) and Current liabilities (short-term borrowings, trade payables, other current liabilities, short-term provisions).
On the Assets side: Non-current assets (fixed assets, non-current investments, long-term loans and advances) and Current assets (current investments, inventories, trade receivables, cash and cash equivalents, short-term loans and advances). The ABC Co. Ltd.
balance sheet used for the debt-equity illustration shows this full layout, and the second company balance sheet adds a Notes to Accounts section that splits share capital into equity and preference components.
Because the significance paragraph after each solution is where NCERT explains the meaning of the number, it is also the raw material for short-answer questions. Use the three Test Your Understanding quizzes and the two Do it Yourself sets as self-checks — their answers are printed at the end of the chapter.
Key Terms and Definitions at a Glance
Ratio questions are won or lost on knowing what each figure in the formula contains. Check the meaning before you substitute numbers.
| Term | Meaning (NCERT basis) |
|---|---|
| Ratio | A mathematical relationship between two numbers, expressed as a fraction, proportion, percentage or number of times (p. 195) |
| Accounting ratio | A ratio calculated from two related accounting numbers taken from the financial statements (p. 195) |
| Liquidity | The ability of the business to pay amounts due to stakeholders as and when they fall due; short-term in nature (p. 199) |
| Solvency | The ability to meet contractual obligations, especially long-term ones towards external stakeholders (p. 199) |
| Current assets | Current investments, inventories, trade receivables, cash and cash equivalents, short-term loans and advances, prepaid expenses, advance tax and accrued income (p. 200) |
| Current liabilities | Short-term borrowings, trade payables, other current liabilities and short-term provisions (p. 200) |
| Quick assets | Current assets minus inventories, prepaid expenses and advance tax — assets quickly convertible into cash (p. 201) |
| Working capital | Current assets − current liabilities (p. 205) |
| Shareholders’ funds | Share capital + reserves and surplus + money received against share warrants + share application money pending allotment (p. 205) |
| Capital employed | Shareholders’ funds + long-term debt; equivalently net assets = total assets − current liabilities (p. 209) |
| Cost of revenue from operations | Revenue from operations − gross profit (p. 215) |
| Operating expenses | Office, administrative, selling and distribution expenses, depreciation and employee benefit expenses (p. 224) |
| Trade receivables | Debtors and bills receivable, taken before provision for doubtful debts (p. 217) |
| Trade payables | Creditors and bills payable (p. 219) |
| Average inventory | The arithmetic mean of opening and closing inventory (p. 215) |
| Earnings per share | Profit available for equity shareholders ÷ number of equity shares (p. 227) |
| Book value per share | Equity shareholders’ funds ÷ number of equity shares (p. 227) |
| Price-earning ratio | Market price of a share ÷ earnings per share (p. 228) |
Common Mistakes in Ratio Questions
These are the errors the chapter’s own notes and solved illustrations are written to prevent. Name the mistake before you make it.
| Mistake | Correct rule | How to check your answer |
|---|---|---|
| Including inventories, prepaid expenses or advance tax in quick assets | Quick assets = current assets − inventories − prepaid expenses − advance tax | Subtract all three items, not just inventory, before dividing by current liabilities |
| Treating a higher current ratio as always better | Very high current ratio means idle, under-utilised resources; very low means default risk | State whether the ratio is inside the normal 2 : 1 range and what either extreme implies |
| Counting current liabilities inside “debt” for debt-equity | Debt means only long-term borrowings + other long-term liabilities + long-term provisions | Check each liability’s term — current liabilities belong in working capital, not in debt |
| Confusing total assets with net assets (capital employed) | Capital employed = total assets − current liabilities; proprietary and debt-to-capital ratios use capital employed | Verify whether the denominator you used excludes current liabilities |
| Using total revenue instead of credit revenue for trade receivables turnover | Numerator = net credit revenue from operations, not total revenue | Subtract cash revenue from total revenue before substituting |
| Dividing year-end receivables by two without data | When opening figures are unavailable, use year-end figures as they are and say so | Look at the question — if only one figure is given, do not average it |
| Treating closing inventory as average inventory silently | This is allowed only when no opening figure exists; the assumption must be stated | Note the assumption in your working, as NCERT does |
| Forgetting to subtract the preference dividend before EPS | Profit available for equity = profit after tax − preference dividend | If preference shares exist, deduct their dividend from PAT before dividing |
| Forgetting to add back interest and tax for PBIT | PBIT = PAT × 100 ÷ (100 − tax rate) + interest, or PAT + tax + interest | For interest coverage and ROCE, confirm the numerator is profit before interest and tax |
| Mixing operating and non-operating items in the operating ratio | Exclude loss on sale of assets, interest paid, dividend received, loss by fire, speculation gains | List every expense you included and classify it operating or non-operating first |
| Treating 2 : 1 and 1 : 1 as universal laws | They are normal benchmarks; NCERT says the 2 : 1 debt-equity norm varies by industry | Use the norms as interpretation, not as a pass/fail test |
Using This Chapter for Exam Preparation
This is a calculation-heavy chapter, but the calculation is the easy part — the marks go to identifying the correct components and interpreting the result. The chapter’s own materials show exactly what to practise.
The closing numerical question set covers every ratio family, and answers are printed at the end. The table maps each question to the ratio it tests.
| Question | Ratio(s) tested |
|---|---|
| 1 | Current ratio |
| 2 | Current ratio and liquid ratio |
| 3 | Current ratio (missing figures: assets and liabilities) |
| 4 | Current ratio and quick ratio (missing figures) |
| 5 | Current assets, liquid assets and inventory from ratios |
| 6 | Current ratio, given inventory and liquid assets |
| 7 | Debt-equity ratio |
| 8 | Current ratio, derived from liquid assets and quick ratio |
| 9 | Inventory turnover ratio |
| 10 | Current, liquid, operating and gross profit ratios |
| 11 | Gross profit, inventory turnover, current, liquid, net profit and working capital ratios |
| 12 | Working capital turnover, debt-equity and proprietary ratios |
| 13, 14 | Inventory turnover ratio |
| 15 | Gross profit, reconstructed from inventory turnover |
| 16 | Inventory turnover and trade receivables turnover |
| 17 | Debt-equity, working capital turnover and trade receivables turnover |
| 18 | Liquid ratio, inventory turnover and return on investment |
| 19 | Debt-equity, total assets to debt and proprietary ratios |
| 20 | Operating ratio |
| 21 | Gross profit, current, acid-test, inventory turnover and fixed assets turnover ratios |
| 22 | Gross profit, inventory turnover and trade receivables turnover |
Two question types recur and are worth drilling. The first is reconstructing missing figures from ratio formulas — the chapter’s own solved examples rebuild opening and closing inventory from the inventory turnover ratio, and current assets from the quick ratio. The method works like this:
- Convert revenue to cost: gross profit = gross profit ratio × revenue from operations; cost of revenue from operations = revenue from operations − gross profit.
- Extract average inventory: average inventory = cost of revenue from operations ÷ inventory turnover ratio.
- Split average inventory into opening and closing: if closing is Rs. x more than opening, then opening + (opening + x) = 2 × average; solve for opening.
- Use the quick ratio to find liquid assets: liquid assets = quick ratio × current liabilities.
- Add closing inventory: current assets = liquid assets + closing inventory.
For example, if inventory turnover is 5 times, revenue is Rs. 5,00,000, the gross profit ratio is 20%, closing inventory is Rs. 15,000 more than opening, current liabilities are Rs. 60,000 and the quick ratio is 0.75 : 1: cost = 4,00,000, average inventory = 80,000, opening = 72,500, closing = 87,500, liquid assets = 45,000, so current assets = 45,000 + 87,500 = Rs. 1,32,500.
The second type is judging the effect of a transaction on a ratio — covered in the decision table above. Finally, remember that textbook contents and the examinable syllabus are not always identical — check the current official CBSE syllabus.
Every Ratio in the Chapter: One Table for Quick Recall
The chapter’s own Summary groups the ratios into the four families; this table condenses them all into one place. It is the section to print the night before the exam.
| Family | Ratio | Formula | What it measures | Safe level / significance |
|---|---|---|---|---|
| Liquidity | Current ratio | \( \dfrac{\text{Current Assets}}{\text{Current Liabilities}} \) | Short-term paying ability | Safe within 2 : 1; both extremes are bad |
| Liquidity | Quick (acid-test) ratio | \( \dfrac{\text{Quick Assets}}{\text{Current Liabilities}} \) | Immediate liquidity without inventory and prepaids | Normally safe at 1 : 1 |
| Solvency | Debt-equity ratio | \( \dfrac{\text{Long-term Debts}}{\text{Shareholders’ Funds}} \) | Degree of indebtedness | About 2 : 1; varies by industry |
| Solvency | Debt to capital employed | \( \dfrac{\text{Long-term Debts}}{\text{Capital Employed}} \) | Debt share of total long-term funds | Low ratio gives lenders security |
| Solvency | Proprietary ratio | \( \dfrac{\text{Shareholders’ Funds}}{\text{Capital Employed}} \) | Owners’ stake in the assets | Higher proportion = more creditor security; adds to debt-to-capital to make 1 |
| Solvency | Total assets to debt ratio | \( \dfrac{\text{Total Assets}}{\text{Long-term Debts}} \) | Coverage of long-term debt by assets | Higher = loans adequately covered |
| Solvency | Interest coverage ratio | \( \dfrac{\text{PBIT}}{\text{Interest on long-term debts}} \) | How many times profit covers interest | Higher = safer interest payments |
| Activity | Inventory turnover | \( \dfrac{\text{Cost of Revenue from Operations}}{\text{Average Inventory}} \) | Speed of inventory conversion | High is good but read carefully — small lots or low margins can inflate it |
| Activity | Trade receivables turnover | \( \dfrac{\text{Net Credit Revenue}}{\text{Average Trade Receivables}} \) | Speed of collection from debtors | Higher = speedy collection |
| Activity | Average collection period | \( \dfrac{365}{\text{Trade Receivables Turnover}} \) | Days taken to collect from customers | Compare with the credit terms offered |
| Activity | Trade payables turnover | \( \dfrac{\text{Net Credit Purchases}}{\text{Average Trade Payables}} \) | Pattern of paying suppliers | Low = long credit or delayed payment, which can hurt reputation |
| Activity | Average payment period | \( \dfrac{365}{\text{Trade Payables Turnover}} \) | Days taken to pay suppliers | Reveals the bill-paying pattern |
| Activity | Net assets (capital employed) turnover | \( \dfrac{\text{Revenue from Operations}}{\text{Capital Employed}} \) | Efficiency of total long-term funds | Higher = efficient utilisation |
| Activity | Fixed assets turnover | \( \dfrac{\text{Net Revenue}}{\text{Net Fixed Assets}} \) | Efficiency of fixed assets | Higher = better use of fixed assets |
| Activity | Working capital turnover | \( \dfrac{\text{Net Revenue}}{\text{Working Capital}} \) | Efficiency of working capital | Higher = better liquidity and profitability |
| Profitability | Gross profit ratio | \( \dfrac{\text{Gross Profit}}{\text{Net Revenue}} \times 100 \) | Gross margin on products sold | Higher is always a good sign |
| Profitability | Operating ratio | \( \dfrac{\text{Operating Cost}}{\text{Net Revenue}} \times 100 \) | Cost of operations against revenue | Lower operating ratio is a very healthy sign |
| Profitability | Operating profit ratio | \( 100 – \text{Operating Ratio} \) | Operating margin | Corollary of operating ratio |
| Profitability | Net profit ratio | \( \dfrac{\text{Net Profit}}{\text{Revenue}} \times 100 \) | Overall efficiency, all expenses included | Main variable in computing return on investment |
| Profitability | ROI / ROCE | \( \dfrac{\text{PBIT}}{\text{Capital Employed}} \times 100 \) | Return on all long-term funds | Good for inter-firm comparison; compare with the interest rate paid |
| Profitability | RONW (return on shareholders’ funds) | \( \dfrac{\text{PAT}}{\text{Shareholders’ Funds}} \times 100 \) | Return to owners on their funds | Should be higher than ROI |
| Profitability | Earnings per share | \( \dfrac{\text{PAT} – \text{Preference dividend}}{\text{Number of equity shares}} \) | Profit earned per equity share | Key for equity holders and share price |
| Profitability | Book value per share | \( \dfrac{\text{Equity shareholders’ funds}}{\text{Number of equity shares}} \) | Asset backing per equity share | Gives the value of a holding |
| Profitability | Dividend payout ratio | \( \dfrac{\text{Dividend per share}}{\text{EPS}} \) | Proportion of earnings distributed | Reflects dividend policy and growth in owners’ equity |
| Profitability | Price/earning ratio | \( \dfrac{\text{Market price per share}}{\text{EPS}} \) | Market expectation of future earnings | Varies from industry to industry and company to company |
Related Resources
These links move you between this chapter, the full book and the revision notes for the subject.
- Class 12 Accountancy Part II book page — the complete book, all chapters.
- Class 12 NCERT books — every subject in one place.
- Previous chapter: Chapter 4, Analysis of Financial Statements — comparative statements, common-size statements and trend analysis.
- Next chapter: Cash Flow Statement — Chapter 6 of this book.
- Revision help: Class 12 Accountancy notes, Class 12 notes, and the main CBSE notes index.
Sources and Data Verification
All page references on this page describe the NCERT Class 12 Accountancy Part II textbook (Company Accounts and Analysis of Financial Statements), Chapter 5 “Accounting Ratios”, Reprint 2026-27, printed pages 193-240.
- Scope: this page covers only Chapter 5 of that book — not the other chapters of Accountancy Part II.
- Maintenance: the page is maintained for the current academic session using the NCERT edition available on ncert.nic.in.
- Authority: NCERT settles textbooks, editions and PDFs; CBSE settles curriculum, syllabus and examinations.
Frequently Asked Questions
What is the formula of current ratio and quick ratio?
Current ratio = current assets ÷ current liabilities. Quick ratio = quick assets ÷ current liabilities, where quick assets = current assets − inventories − prepaid expenses − advance tax (NCERT, pp. 200-201).
How do you calculate debt equity ratio from a balance sheet?
Divide long-term debts by shareholders’ funds. From a balance sheet, take long-term borrowings + other long-term liabilities + long-term provisions as debt; take share capital + reserves and surplus + money received against share warrants + share application money pending allotment as equity. Never include current liabilities in debt (NCERT, p. 205).
What is the difference between current ratio and liquid ratio?
The current ratio includes all current assets, while the liquid (quick) ratio excludes inventories, prepaid expenses and advance tax because they are not quickly convertible into cash. The liquid ratio is the stricter supplementary check — which is why it is called the acid-test ratio (NCERT, pp. 200-201).
How to calculate inventory turnover ratio when the gross profit ratio is given?
First compute gross profit = gross profit ratio × revenue from operations. Then cost of revenue from operations = revenue − gross profit. Finally, inventory turnover = cost of revenue from operations ÷ average inventory (the method of NCERT’s solved illustration on p. 215).
Why is the quick ratio also called the acid test ratio?
Because it is the decisive test of immediate liquidity. It removes the least liquid current assets — inventory, prepaid expenses and advance tax — and asks whether the firm can cover its current liabilities with assets that are already near-cash. If the firm fails this test, it fails the “acid test” of short-term solvency (NCERT, p. 201).
How does paying creditors or issuing shares change the current ratio?
Paying a current liability improves the current ratio, because both current assets and current liabilities fall but the liabilities fall proportionately more. Issuing shares brings in cash, a current asset, without creating a current liability, so the current ratio also improves — and the debt-equity ratio falls because internal funds rise.
As NCERT emphasises, the exact effect always depends on the original ratio.
Reference: NCERT Class 12 Accountancy textbook, chapter 5, official edition on ncert.nic.in.
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